PARKER DRILLING CO /DE/ - Annual Report: 2009 (Form 10-K)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

 

 

COMMISSION FILE NUMBER 1-7573

PARKER DRILLING COMPANY

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:
(281) 406-2000

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

The aggregate market value of our common stock held by non-affiliates on June 30, 2009 was $488.1 million. At January 29, 2010, there were 116,243,899 shares of common stock issued and outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of our definitive proxy statement for the Annual Meeting of Shareholders to be held on May 7, 2010 are incorporated by reference in Part III.

 

 

TABLE OF CONTENTS

 

 

 

General

 

Unless otherwise indicated, the terms “Company,” “we,” “us” and “our” refer to Parker Drilling Company together with its subsidiaries and “Parker Drilling” refers solely to the parent, Parker Drilling Company. Parker Drilling Company was incorporated in the state of Oklahoma in 1954 after having been established in 1934. In March 1976, the state of incorporation of the Company was changed to Delaware through the merger of the Oklahoma corporation into its wholly-owned subsidiary Parker Drilling Company, a Delaware corporation. Our principal executive offices are located at 5 Greenway Plaza, Suite 100, Houston, Texas 77046.

 

We are a leading worldwide provider of contract drilling and drilling-related services. Since beginning operations in 1934, we have operated in 53 foreign countries and the United States, making us among the most geographically experienced drilling contractors in the world. We have extensive experience and expertise in drilling geologically difficult wells and in managing the logistical and technological challenges of operating in remote, harsh and ecologically sensitive areas. We believe our quality, health, safety and environmental policies and procedures are among the leaders in our industry.

 

Our 2009 revenues are derived from five segments:

 

 

Our Rig Fleet

 

The diversity of our rig fleet, both in terms of geographic location and asset class, enables us to provide a broad range of services to oil and gas operators worldwide. As of December 31, 2009, our company-owned fleet of rigs consisted of:

 

 

In 2008, we began the construction of two new build rigs designed to operate efficiently in the Alaskan environment. These rigs are expected to be delivered to Alaska in mid-2010 to begin drilling on long-term contracts for our customer, BP. We believe there is a growing need for rigs of this type in the Alaskan market.

 

Our Rental Tools Business

 

Our subsidiary, Quail Tools, L.P., (Quail Tools) provides premium rental tools for land and offshore oil and gas drilling and workover activities. Quail Tools offers a full line of drill pipe, drill collars, tubing, high- and low-pressure blowout preventers, choke manifolds, junk and cement mills and casing scrapers. Approximately 20 percent of Quail Tools’ revenues are derived from equipment utilized in offshore and coastal water operations

of the GOM. Quail Tools’ base of operations is in New Iberia, Louisiana. Other facilities are located in Texas, Wyoming, North Dakota and Pennsylvania. Quail Tools’ principal customers are major and independent oil and gas exploration and production companies operating in the major U.S. energy producing markets on land and in the GOM. Quail Tools has been increasing tool rentals to customers operating internationally in countries including Angola, Brazil, Canada, Chad, Congo, Egypt, Equatorial Guinea, Libya, Mexico, Sakhalin Island, Russia and the United Arab Emirates.

 

Our Project Management and Engineering Services Business

 

We provide non-capital intensive services such as Front End Engineering and Design (“FEED”), Engineering, Procurement, Construction and Installation (“EPCI”), Operations and Maintenance (“O&M”) and other project management services (such as labor, maintenance, logistics, etc.) for operators who own their own drilling rigs and who choose to engage our technical expertise to perform contracted drilling operations. We are currently involved in one Pre-FEED study project and detailed engineering and procurement phase of the Arkutun Dagi project for Exxon Neftegas Limited (“ENL”) and have O&M and project management activities in Alaska, Kuwait and Sakhalin Island, Russia.

 

Our Construction Contract Business

 

In 2008, we were awarded the EPCI phase of the BP-owned Liberty extended reach drilling rig project. The rig is scheduled to commence drilling mid-year 2010. We believe the Liberty rig will be one of the most technologically advanced drilling rigs in the world, capable of drilling ultra-extended reach wells nearly two miles deep and as far as eight miles out from the drilling pad.

 

Our Market Areas

 

International Markets (including Alaska).  The majority of the international drilling markets in which we operate have one or more of the following characteristics:

 

 

Typically, our international contracts have multi-year terms.

 

U.S. Gulf of Mexico and Inland Waterways.  The drilling industry in the GOM is characterized by highly cyclical activity where utilization and dayrates are typically driven by current oil and natural gas prices. Within this area, we operate barge rigs primarily in shallow water in and along the inland waterways and coasts of Louisiana and Texas. Historically, two-thirds of our barge rigs, including our three ultra-deep drilling barge rigs, are usually contracted by oil and gas companies to drill natural gas prospects, and one-third to drill oil prospects. However, in today’s market, we have experienced a shift where two-thirds of activity is related to drilling for oil and one-third to drilling for natural gas. These contracts are typically well-to-well, with durations averaging 30 to 150 days. In a strong market, driven by high commodity prices, terms can extend up to twelve months and longer.

 

U.S. Land Market.  The market for rental tools is primarily U.S. land drilling, a highly cyclical market driven by oil and natural gas prices and availability of financing. The customer base is very fragmented and includes large major oil companies and many independents of various sizes. Since tools are rented on a daily basis and are often used for only a portion of a well drilling program, they are requested by the customer at the time they are needed, requiring rental tool companies to keep a broad inventory of tools and to have them available for delivery within a time acceptable to the rig operator. In addition, unconventional lateral or horizontal drilling, often used in drilling shale formations, generally employs more rental tools than does conventional vertical drilling, which is an attractive

market for our rental tools segment. As a result, our rental tool market areas are those within a short delivery range of our inventory locations and are focused in the regions of the primary shale plays.

 

Our Strategy

 

Our strategy is to achieve and maintain market leadership as a leading worldwide provider of drilling and drilling-related services and products, rental tools, project management and engineering services to the energy industry; to grow our business through selective investments in new assets and lines of businesses; to differentiate the Parker Drilling brand by leveraging our core competencies, or “four pillars” as described below to provide best value solutions; and to exercise financial discipline and maintain a strong balance sheet. Key elements of our strategy include:

 

Achieving and Maintaining Market Leadership.  We believe we achieve and sustain the preference for our barge and land rigs throughout the energy business cycle by building, upgrading and maintaining a fleet of rigs that we expect to be preferred based on quality and dependability and through strategic placement in areas we believe evidence long-term development opportunities. By original design or through upgrades, we offer rigs capable of efficient, safe and economic performance for customers operating in select locations throughout the world, including those in difficult, hazardous or environmentally sensitive areas.

 

Growing Through Selective Investment.  We believe we can improve our competitive position and financial performance through investments in new assets or lines of business that complement and expand our capabilities. We are focused on expanding and broadening our non-capital intensive project management and engineering services activities by leveraging our experience and recent successes in this area; growing our rental tools operation by locating new service facilities in markets with growing demand from existing customers; adding new equipment to our drilling rig fleet that enhances our position of preference by operators; and entering new markets that align with the products and services we offer.

 

Differentiating the Parker Brand.  We differentiate ourselves from other providers of similar services by focusing on our core competencies, or “four pillars”: safety, training, technology and performance. We seek to provide our customers increased performance, innovation in our services, and safe and efficient operations through these four pillars as follows:

 

Safety:  Our industry-leading safety performance is a crucial factor in our status as a preferred drilling contractor. We have a portfolio of tools and proactive measures we apply to reinforce and continually improve our safety performance.

 

Training:  The challenges of our business are magnified when considering the technological requirements of our work. We have invested significant resources to provide a full curriculum of standardized training in multiple languages to overcome barriers to working safely and operating efficiently.

 

Technology:  We have a 75-year legacy of developing new technologies for drilling in frontier environments. Our rigs have set numerous records worldwide, including drilling some of the longest-reaching wells. Developing new technology to create greater efficiencies in the drilling process lies at the heart of our competitive edge. We continually look for and evaluate new technologies that have the potential to, among other things, improve drilling efficiency, reduce environmental impacts, and enhance safety.

 

Performance:  A primary aim is to provide services that benefit both the operator and our company. We strive to achieve this by planning, executing and measuring our performance against our goals and our customers’ expectations. We have aligned performance metrics to our business practices tailored to our operations and regularly share them with our customers.

 

Maintaining Financial Discipline.  We strive to maintain strong financial controls and disciplines in every aspect of our business to ensure that our internal assessment of projects and plans adhere to solid financial principles and to assure reasonable debt to equity ratios. Our operating philosophy emphasizes continuous improvement of processes, equipment standardization and global quality, safety, and supply chain

management, and vigilance in monitoring and controlling costs. Capital expenditures are aligned with core objectives. Our planned maintenance programs, including preventive maintenance to facilitate dependable operating efficiency and minimize down time, helps to establish us as a “contractor of choice.” These principles are intended to lead to stronger-than-peer financial performance in terms of capital utilization and generation of value to our shareholders while allowing operational effectiveness.

 

2009 Strategic Actions.

 

In 2009 the following actions, among others, were the direct result of implementing our strategy:

 

 

Our Competitive Strengths

 

Our competitive strengths have historically contributed to our operating performance and we believe the following strengths enhance our outlook for the future:

 

Geographically Diverse Operations and Assets.  We currently operate or manage rigs in Algeria, Colombia, Indonesia, Kazakhstan, Kuwait, Mexico, New Zealand, Russia, and the United States. Since our founding in 1934, we have operated in 53 foreign countries and the United States, making us among the most geographically diverse and experienced drilling contractors in the world. Our international drilling revenues constituted approximately 50 percent of our total revenues for the year ended December 31, 2009.

 

Outstanding Safety, Planned Maintenance, Inventory Control and Training Programs.  We have an outstanding safety record. In 2009, we achieved the lowest Total Recordable Incident Rate (“TRIR”) in our history. Our safety record, as evidenced by our low TRIR, has made us a leader in occupational injury prevention. Our TRIR has been below the industry average for each of the last ten years, with rates less than half the industry average since 2004. In recognition of our achievements we were named one of America’s Safest Companies by Occupational Hazards magazine in 2007. We believe that this safety record, along with integrated quality, safety maintenance and supply chain management programs, has contributed to our success

in obtaining drilling contracts, as well as contracts to manage and provide labor resources to drilling rigs owned by third parties. Our training centers in Louisiana and Alaska provide safety and technical training curriculums in four different languages and provide regulatory compliance training throughout the world.

 

Technological Leadership.  We have demonstrated technological leadership within the drilling industry. We have previously established records for drilling depths including breaking the then extended-reach drilling record in 2008 at Sakhalin Island, Russia. This well reached over seven miles under the sea floor with the Yastreb, a rig designed, built and operated by us. We continue to perform contracts that require technological leadership such as the FEED contract to design a rig for BP to develop the Liberty Field six miles offshore the Alaskan North Slope, Alaska, which we were awarded in 2006. In July 2008, we were awarded the EPCI contract to construct and commission this rig, and in August 2009 we were awarded the O&M contract for the first phase of drilling at Liberty Field.

 

Strong and Experienced Senior Management Team.  Our management team has extensive experience in the contract drilling industry. Our executive chairman, Robert L. Parker Jr., joined Parker Drilling in 1973 and served as our president from 1977 through June 2007, chief executive officer from 1991 until October 2009, and has been a director since 1973. Under the leadership of Mr. Parker Jr. we have continued our reputation as a leading worldwide provider of contract drilling services. David C. Mannon, our new chief executive officer and a member of the board of directors effective October 2009, joined our senior management team in late 2004 as senior vice president and chief operating officer and was appointed president in July 2007. Prior to joining our company, Mr. Mannon served in various managerial positions, culminating with his appointment as president and chief executive officer for Triton Engineering Services Company, a subsidiary of Noble Drilling. He brings a broad range of nearly 30 years of experience to our drilling operations which enhances our ability to achieve our goals. Our chief financial officer, W. Kirk Brassfield, joined Parker Drilling in 1998 and has served in several executive positions including vice president, controller and principal accounting officer. He brings 30 years of experience to the management team, including 19 years in the energy industry. Denis Graham, vice president-engineering, brings more than 30 years of experience in drilling industry engineering design, maintenance and regulatory compliance and has established an excellent reputation for Parker Drilling through management of large engineering projects for major oil companies. Mike Drennon, our vice president-operations, brings over 30 years of experience in the oil and gas industry. Mr. Drennon joined Parker Drilling in 2005 from BP and Amoco where he had worked since 1977.

 

Project Management

 

We are active in managing and providing labor resources for drilling rigs owned by third parties. In Russia, we designed, constructed and sold a rig to ENL and currently manage drilling operations under a multi-year O&M contract. This rig has drilled one of the world’s longest extended reach wells from Sakhalin Island, reaching out over seven miles under the sea floor for a total measured depth of 38,322 feet. We also operate a second rig to drill from the Orlan platform under an O&M contract for ENL offshore Sakhalin Island, Russia.

 

During 2006 we began working on a technical service FEED study for BP to provide a conceptual design for a land-based drilling rig targeting the Liberty Field six miles offshore the Alaskan North Slope. Parker Drilling, through an affiliate, commenced construction of this rig for BP pursuant to an EPCI contract in 2008. We are working closely with BP on the final establishment of the rig on the North Slope of Alaska. Parker Drilling Arctic Operating, Inc. in August 2009, was awarded the O&M contract for the rig from BP, which will include the drilling of ultra extended-reach wells, nearly two miles deep and as far as eight miles from the pad.

 

We also provided labor services on third party-owned drilling rigs in Kuwait and China during 2009 and 2008.

 

Customers

 

Our customer base consists of major, independent and national oil and gas companies and integrated service providers. In 2009 our two largest customers, BP and ExxonMobil (including subsidiaries and joint ventures of each), accounted for approximately 26 percent and 15 percent of our total revenues, respectively. Our ten most significant customers collectively accounted for approximately 75 percent of our total revenues in 2009.

Competition

 

The contract drilling industry is a highly competitive business characterized by high capital requirements and challenges in securing and retaining qualified field personnel.

 

In international land markets, we compete with a number of international drilling contractors as well as smaller local contractors. Most contracts are awarded on a competitive bidding basis and operators often consider technical expertise and quality of equipment in addition to price. Although U.S. based local drilling contractors typically have lower labor and mobilization costs, we are generally able to distinguish ourselves from these companies based on our technical expertise, safety performance, quality of our equipment, planned maintenance, experience and safety record. In international markets, our experience in operating in challenging environments has been a significant factor in securing contracts. We believe that the market for drilling contracts will continue to be highly competitive for the foreseeable future.

 

In the GOM barge drilling markets, we are awarded most contracts through a competitive bidding process. We have achieved some success in differentiating ourselves from competitors through our upgraded fleet, planned maintenance programs and general strategy to warm-stack rigs, a standby mode of operational readiness where the Company’s support costs are reduced, while the equipment is maintained in a near market ready condition for quick return to operations, which has led to a more efficient and safer operation. During the 2009 downturn in business, we believe, from reliable market information, that the total marketable barge rig fleet was reduced significantly.

 

Our management believes that Quail Tools is one of the leading rental tools companies in the offshore GOM and other major U.S. energy producing markets. Quail Tools competes against other rental tool companies based on price and quality of service.

 

An increasing trend indicates that a number of our customers have been seeking to establish exploration or development drilling programs based on partnering relationships or alliances with a limited number of preferred drilling contractors. Such relationships or alliances can result in longer-term work and higher efficiencies that increase profitability for drilling contractors and result in a lower overall well cost for oil and gas operators. We are currently a preferred contractor for operators in certain U.S. and international locations which our management believes is a result of our reputation for providing efficient, safe, environmentally conscious and innovative drilling services, in addition to the quality of equipment, personnel, service and experience.

 

Contracts

 

Most drilling contracts are awarded based on competitive bidding. The rates specified in drilling contracts are generally on a dayrate basis, and vary depending upon the type of rig employed, equipment and services supplied, geographic location, term of the contract, competitive conditions and other variables. Our contracts generally provide for an operating dayrate during drilling operations, with lower rates for periods of equipment breakdown, adverse weather or other conditions, and no payment when certain conditions continue beyond a contractually established duration. When a rig mobilizes to or demobilizes from an operating area, the contract typically provides for a different dayrate or specified fixed payments during the mobilization or demobilization. The terms of most of our contracts are based on either a specified period of time or the time required to drill a specified number of wells. The contract term in some instances may be extended by the customer exercising options for the drilling of additional wells or for an additional time period, or by exercising a right of first refusal. Most of our contracts allow termination by the customer prior to the end of the term without penalty under certain circumstances, such as the loss of or major damage to the drilling unit or other events that cause the suspension of drilling operations beyond a specified period of time. Many of our contracts require the customer to pay an early termination fee if the customer terminates a contract before the end of the term without cause, but in the remainder of the contracts the customer has the discretion to terminate the contract without cause prior to the end of the term without penalty.

 

Rental tools contracts are typically on a dayrate basis with rates based on type of equipment, investment and competition. Rental rates generally apply from the time the equipment leaves our facility until it is returned. Rental contracts generally require the customer to pay for lost or damaged equipment.

Seasonality

 

Our rigs in the GOM are subject to severe weather during certain periods of the year, particularly during hurricane season from June through November, which could halt operations for prolonged periods or limit contract opportunities during that period. Otherwise, our business activities are not typically affected by unanticipated seasonal fluctuations.

 

Insurance and Indemnification

 

In our drilling contracts, we generally seek to obtain indemnification from our customers for some of the risks related to our drilling services. To the extent that we are unable to transfer such risks to customers by contract or indemnification agreements, we generally seek protection through insurance. To address the hazards inherent in our business, we maintain insurance coverage that includes physical damage coverage, third party general liability coverage, employer’s liability, environmental and pollution coverage and other coverage. We believe that our insurance coverage is customary for the industry and adequate for our business. However, there are risks against which insurance will not adequately protect us or insurance may not be available to cover any or all of the potential liability arising from all of the consequences and hazards we may encounter in our drilling operations. See Item 1A, “Risk Factors” for additional information.

 

Employees

 

The following table sets forth the composition of our employee base:

 

 

 

 

Environmental Considerations

 

Our operations are subject to numerous federal, state, local and foreign laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. Numerous foreign and domestic governmental agencies, such as the U.S. Environmental Protection Agency (“EPA”), issue regulations to implement and enforce such laws, which often require difficult and costly compliance measures that carry substantial administrative, civil and criminal penalties or may result in injunctive relief for failure to comply. These laws and regulations may require the acquisition of a permit before drilling commences; restrict the types, quantities and concentrations of various substances that can be released into the environment in connection with drilling and production activities; limit or prohibit construction or drilling activities on certain lands lying within wilderness, wetlands, ecologically sensitive and other protected areas; require remedial action to prevent pollution from former operations; and impose substantial liabilities for pollution resulting from our operations. Changes in environmental laws and regulations occur frequently, and any changes that result in more stringent and costly compliance could adversely affect our operations and financial position, as well as those of similarly situated entities operating in the same markets. While our management believes that we comply with current applicable environmental laws and regulations, there is no assurance that compliance can be maintained in the future.

As an owner or operator of both onshore and offshore facilities, including mobile offshore drilling rigs in or near waters of the United States, we may be liable for the costs of removal and damages arising out of a pollution incident to the extent set forth in the Federal Water Pollution Control Act, as amended by the Oil Pollution Act of 1990 (“OPA”), the Clean Water Act (“CWA”), the Clean Air Act (“CAA”), the Outer Continental Shelf Lands Act (“OCSLA”), the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), the Resource Conservation and Recovery Act (“RCRA”), Emergency Planning and Community Right to Know Act (“EPCRA”), Hazardous Materials Transportation Act (“HMTA”) and comparable state laws, each as may be amended from time to time. In addition, we may also be subject to applicable state law and other civil claims arising out of any such incident.

 

The OPA and regulations promulgated pursuant thereto impose a variety of regulations on “responsible parties” related to the prevention of oil spills and liability for damages resulting from such spills. A “responsible party” includes the owner or operator of a vessel, pipeline or onshore facility, or the lessee or permittee of the area in which an offshore facility is located. The OPA assigns liability of oil removal costs and a variety of public and private damages to each responsible party.

 

The OPA liability for a mobile offshore drilling rig is determined by whether the unit is functioning as a vessel or is in place and functioning as an offshore facility. If operating as a vessel, liability limits of $600 per gross ton or $0.5 million, whichever is greater, apply. If functioning as an offshore facility, the mobile offshore drilling rig is considered a “tank vessel” for spills of oil on or above the water surface, with liability limits of $1,200 per gross ton or $10.0 million, whichever is greater. To the extent damages and removal costs exceed this amount, the mobile offshore drilling rig will be treated as an offshore facility and the offshore lessee will be responsible up to higher liability limits for all removal costs plus $75.0 million. The party must reimburse all removal costs actually incurred by a governmental entity for actual or threatened oil discharges associated with any Outer Continental Shelf facilities, without regard to the limits described above. A party also cannot take advantage of liability limits if the spill was caused by gross negligence or willful misconduct or resulted from violation of a federal safety, construction or operating regulation. If the party fails to report a spill or to cooperate fully in the cleanup, liability limits likewise do not apply.

 

Few defenses exist to the liability imposed by the OPA. The OPA also imposes ongoing requirements on a responsible party, including proof of financial responsibility for offshore facilities and vessels in excess of 300 gross tons (to cover at least some costs in a potential spill) and preparation of an oil spill contingency plan for offshore facilities and vessels. The OPA requires owners and operators of offshore facilities that have a worst case oil spill potential of more than 1,000 barrels to demonstrate financial responsibility in amounts ranging from $10.0 million in specified state waters to $35.0 million in federal Outer Continental Shelf waters, with higher amounts, up to $150.0 million, in certain limited circumstances where the U.S. Minerals Management Service believes such a level is justified by the risks posed by the quantity or quality of oil that is handled by the facility. For “tank vessels,” as our offshore drilling rigs are typically classified, the OPA requires owners and operators to demonstrate financial responsibility in the amount of their largest vessel’s liability limit, as those limits are described in the preceding paragraph. A failure to comply with ongoing requirements or inadequate cooperation in a spill may even subject a responsible party to civil or criminal enforcement actions.

 

In addition, the OCSLA authorizes regulations relating to safety and environmental protection applicable to lessees and permittees operating on the Outer Continental Shelf. Specific design and operational standards may apply to Outer Continental Shelf vessels, rigs, platforms, vehicles and structures. Violations of environmentally related lease conditions or regulations issued pursuant to the OCSLA can result in substantial civil and criminal penalties as well as potential court injunctions curtailing operations and the cancellation of leases. Such enforcement liabilities can result from either governmental or citizen prosecution.

 

All of our operating U.S. drilling rigs have zero-discharge capabilities as required by law, e.g. CWA. In addition, in recognition of environmental concerns regarding dredging of inland waters and permitting requirements, we conduct negligible dredging operations, with approximately two-thirds of our offshore drilling contracts involving directional drilling, which minimizes the need for dredging. However, the existence of such laws and regulations (e.g., Section 404 of the CWA, Section 10 of the Rivers and Harbors Act, etc.) has had and will continue to have a restrictive effect on us and our customers.

Our operations are also governed by laws and regulations related to workplace safety and worker health, primarily the Occupational Safety and Health Act and regulations promulgated thereunder. In addition, various other governmental and quasi-governmental agencies require us to obtain certain miscellaneous permits, licenses and certificates with respect to our operations. The kind of permits, licenses and certificates required in our operations depend upon a number of factors. We believe that we have all such miscellaneous permits, licenses and certificates that are material to the conduct of our existing business.

 

CERCLA (also known as “Superfund”) and comparable state laws impose liability without regard to fault or the legality of the original conduct, on certain classes of persons who are considered to be responsible for the release of a “hazardous substance” into the environment. While CERCLA exempts crude oil from the definition of hazardous substances for purposes of the statute, our operations may involve the use or handling of other materials that may be classified as hazardous substances. CERCLA assigns strict liability to each responsible party for all response and remediation costs, as well as natural resource damages. Few defenses exist to the liability imposed by CERCLA.

 

RCRA generally does not regulate most wastes generated by the exploration and production of oil and gas. RCRA specifically excludes from the definition of hazardous waste “drilling fluids, produced waters, and other wastes associated with the exploration, development or production of crude oil, natural gas or geothermal energy.” However, these wastes may be regulated by EPA or state agencies as solid waste. Moreover, ordinary industrial wastes, such as paint wastes, waste solvents, laboratory wastes, and waste oils, may be regulated as hazardous waste. Although the costs of managing solid and hazardous wastes may be significant, we do not expect to experience more burdensome costs than similarly situated companies involved in drilling operations in the Gulf Coast market.

 

Recent scientific studies have suggested that emissions of certain gases, commonly referred to as “greenhouse gases” (“GHGs”) and including carbon dioxide and methane, may be contributing to the warming of the atmosphere resulting in climate change. In response to such studies, the issue of climate change and the effect of GHG emissions, in particular emissions from fossil fuels, is attracting increasing attention worldwide. Legislative and regulatory measures to address concerns that emissions of GHGs are contributing to climate change are in various phases of discussions or implementation at the international, national, regional and state levels.

 

In 2005, the Kyoto Protocol to the 1992 United Nations Framework Convention on Climate Change, which establishes a binding set of emission targets for GHGs, became binding on all those countries that had ratified it. International discussions are currently underway to develop a treaty to replace the Kyoto Protocol after its expiration in 2012. The United States Congress is also actively considering legislation to reduce emissions of GHGs. In addition, at least 17 states have already taken legal measures to reduce emissions of GHGs, primarily through the planned development of GHG emission inventories and/or regional GHG cap and trade programs. On October 30, 2009, EPA published a final rule requiring the reporting of GHG emissions from specified large sources in the United States beginning in 2011 for emissions occurring in 2010. In addition, on December 15, 2009, EPA published a Final Rule finding that current and projected concentrations of six key GHGs in the atmosphere threaten public health and welfare of current and future generations. EPA also found that the combined emissions of these GHGs from new motor vehicles and new motor vehicle engines contribute to the GHG pollution that threatens public health and welfare. This Final Rule, also known as EPA’s Endangerment Finding, does not impose any requirements on industry or other entities directly; however, the effectiveness of the rule on January 14, 2010 allows the EPA to finalize motor vehicle GHG standards, the effect of which could reduce demand for motor fuels refined from crude oil. Finally, according to EPA, the final motor vehicle GHG standards will trigger construction and operating permit requirements for stationary sources. As a result, EPA has proposed to tailor these programs such that only stationary sources, including refineries, that emit over 25,000 tons of GHGs per year will be subject to air permitting requirements. In addition, on September 22, 2009, EPA issued a “Mandatory Reporting of Greenhouse Gases” final rule (“Reporting Rule”). The Reporting Rule establishes a new comprehensive scheme requiring operators of stationary sources emitting more than established annual thresholds of carbon dioxide-equivalent GHGs to inventory and report their GHG emissions annually on a facility-by-facility basis. Further, proposed legislation has been introduced in Congress that would establish an economy-wide cap on emissions of GHGs in the United States and would require most sources of GHG emissions to obtain GHG emission “allowances” corresponding to their annual emissions of GHGs. New legislation or regulatory programs that restrict emissions of

GHGs in areas where we conduct business could adversely affect our operations and the demand for hydrocarbon products generally. Moreover, incentives to conserve or use alternative energy sources could reduce demand for fossil fuels, resulting in a decrease in demand for our drilling and drilling related services. The impact of such future programs cannot be predicted, but we do not expect material adverse affects to our operations at this time.

 

Climate change also poses potential physical risks, including an increase in sea level and changes in weather conditions, such as an increase in changes in precipitation and extreme weather events. To the extent that such unfavorable weather conditions are exacerbated by global climate change or otherwise, our operations may be adversely affected to a greater degree than we have previously experienced, including increased delays and costs. However, the uncertain nature of changes in extreme weather events (such as increased frequency, duration, and severity) and the long period of time over which any changes would take place make estimating any future financial risk to our operations caused by these physical risks of climate change extremely challenging.

 

The drilling industry is dependent on the demand for services from the oil and gas exploration and development industry, and accordingly, is affected by changes in laws and policies relating to the energy business. Our business is affected generally by political developments and by federal, state, local and foreign regulations that may relate directly to the oil and gas industry. The adoption of laws and regulations, both U.S. and foreign, that curtail exploration and development drilling for oil and gas for economic, environmental and other policy reasons may adversely affect our operations by limiting available drilling opportunities.

 

FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS AND GEOGRAPHIC AREAS

 

We operate in five segments: International Drilling, U.S. Drilling, Rental Tools, Project Management and Engineering Services, and Construction Contracts. Information about our reportable segments and operations by geographic areas for the years ended December 31, 2009, 2008 and 2007 is set forth in Note 12 in the notes to the consolidated financial statements included in Item 8 of this report.

 

EXECUTIVE OFFICERS

 

Officers are elected each year by the board of directors following the annual meeting for a term of one year and until the election and qualification of their successors. The current executive officers of the Company and their ages, positions with the Company and business experience are presented below:

 

 

 

Other Parker Drilling Company Officers

 

 

Available Information

 

We make available free of charge on our website at www.parkerdrilling.com our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission (“SEC”). We also provide paper or electronic copies of our reports free of charge upon request. Additionally, these reports are available on an Internet website maintained by the SEC at http://www.sec.gov.

 

 

The contract drilling, project management and engineering services, and rental tools businesses involve a high degree of risk. You should consider carefully the risks and uncertainties described below and the other information included in this Form 10-K, including the financial statements and related notes, before deciding to invest in our securities. While these are the risks and uncertainties we believe are most important for you to consider, you should know that they are not the only risks or uncertainties facing us or which may adversely affect our business. If any of the following risks or uncertainties actually occur, our business, financial condition or results of operations could be adversely affected.

 

Risks Related to Our Business

 

Continued instability in the global economy may result in an extended decrease in demand for our drilling rigs and rental tools business, which could have a material adverse effect on our drilling, project management and engineering services and rental tool business.

 

Over the past 18 months, corporate credit availability and capital market access has been volatile and uncertain, leading to periods of liquidity shortages for industrial businesses worldwide. Although recent economic trends appear to have stabilized and public debt markets were active in the second half of 2009, bank credit

availability continues to remain tight. Increased instability in the financial and insurance markets could make it more difficult for us to access capital and to obtain insurance coverages that we consider adequate or are required by our contracts. Meanwhile, a slowdown in economic activity would likely reduce worldwide demand for energy and result in an extended period of lower crude oil and natural gas prices. Our business depends to a significant extent on the level of international onshore drilling activity and GOM inland and offshore drilling activity for oil and natural gas. Oil and gas prices have remained at lower levels during the past twelve months in this tough global economic environment and any prolonged reduction in crude oil and natural gas prices will depress the levels of exploration, development and production activity which could cause our revenues and margins to decline, decrease daily rates and utilization of our rigs and limit our future growth prospects. Any significant decrease in daily rates or utilization of our rigs could materially reduce our revenues and profitability. In addition, current and potential customers who depend on financing for their drilling projects may be forced to curtail or delay projects and may also experience an inability to pay suppliers and service providers, including us. The continued weak global economic environment also could impact our vendors’ and suppliers’ ability to meet obligations to provide materials and services in general. Continued volatility in oil and natural gas prices and overall global economic conditions could have a material adverse effect on our business and financial results.

 

Rig upgrade, refurbishment and construction projects are subject to risks and uncertainties, including delays and cost overruns, which could have an adverse impact on our results of operations and cash flows.

 

We often have to make upgrade and refurbishment expenditures for our rig fleet to comply with our quality management and planned maintenance system or contractual requirements or when repairs are required or to comply with environmental regulations. Rig upgrade, refurbishment and construction projects are subject to the risks of delay or cost overruns inherent in any large construction project, including the following:

 

 

Significant cost overruns or delays could adversely affect our financial condition and results of operations. Delays in the delivery of rigs being constructed or undergoing upgrade, refurbishment or repair may, in many cases, result in delay in contract commencement, resulting in a loss of revenue to us, and may also cause our customer to

renegotiate the drilling contract for the rig or terminate or shorten the term of the contract under applicable late delivery clauses, if any. If one of these contracts is terminated, we may not be able to secure a replacement contract on as favorable terms, if at all. Additionally, capital expenditures for rig upgrade, refurbishment or construction projects could exceed our planned capital expenditures, impairing our ability to service our debt obligations.

 

Failure to retain skilled and experienced personnel could affect our operations.

 

We require highly skilled and experienced personnel to provide our customers with the highest quality technical services and support for our drilling operations. We compete with other oilfield services businesses and other employers to attract and retain qualified personnel with the technical skills and experience we require. Competition for the skilled and other labor required for our operations intensifies as the number of rigs activated or added to worldwide fleets or under construction increases, creating upward pressure on wages. In periods of high utilization, we have found it more difficult to find and retain qualified individuals. A shortage in the available labor pool of skilled workers or other general inflationary pressures or changes in applicable laws and regulations could make it more difficult for us to attract and retain personnel and could require us to enhance our wage and benefits packages. In addition, labor costs may increase. Increases in our operating costs could adversely affect our business and financial results. Moreover, the shortages of qualified personnel or the inability to obtain and retain qualified personnel could negatively affect the quality, safety and timeliness of our operations.

 

Our ability to service our debt obligations is primarily dependent upon our future financial performance.

 

As of December 31, 2009, we had:

 

 

Our ability to meet our debt service obligations depends on our ability to generate positive cash flows from operations. We have in the past, and may in the future, incur negative cash flows from one or more segments of our operating activities. Our future cash flows from operating activities will be influenced by the demand for our drilling services, the utilization of our rigs, the dayrates that we receive for our rigs, general economic conditions and financial, business and other factors affecting our operations, many of which are beyond our control.

 

If we are unable to service our debt obligations, we may have to take one or more of the following actions:

 

 

Additional indebtedness or equity financing may not be available to us in the future for the refinancing or repayment of existing indebtedness, or if available, such additional indebtedness or equity financing may not be available on a timely basis, or on terms acceptable to us and within the limitations contained in the documentation contained in our existing debt instruments. In addition, in the event we decide to sell assets, we can provide no assurance as to the timing of any asset sales or the proceeds that could be realized by us from any such asset sale. Our ability to generate sufficient cash flow from operating activities to pay the principal of and interest on our indebtedness is subject to certain market conditions and other factors which are beyond our control.

 

Increases in the level of our debt and the covenants contained in the instruments governing our debt could have important consequences to you. For example, they could:

 

 

 

Our current operations and future growth may require significant additional capital, and the amount of our indebtedness could impair our ability to fund our capital requirements.

 

Our business requires substantial capital. Currently, we anticipate that our capital expenditures in 2010 will be approximately $150 to $175 million, consisting of approximately $70 to $80 million for maintenance projects and rental tool investments. We may require additional capital in the event of significant departures from our current business plan or unanticipated expenses. Sources of funding for our future capital requirements may include any or all of the following:

 

 

Additional financing may not be available on a timely basis or on terms acceptable to us and within the limitations contained in the indentures governing the 9.625% Senior Notes and the 2.125% Convertible Senior Notes and the documentation governing our senior secured credit facility. Failure to obtain appropriate financing, should the need for it develop, could impair our ability to fund our capital expenditure requirements and meet our debt service requirements and could have an adverse effect on our business.

 

Volatile oil and natural gas prices impact demand for our drilling and related services. A decrease in demand for crude oil and natural gas or other factors may reduce demand for our services and substantially reduce our profitability or result in our incurring losses.

 

The success of our operations is materially dependent upon the exploration and development activities of the major, independent and national oil and gas companies that comprise our customer base. Oil and natural gas prices and market expectations regarding potential changes in these prices can be extremely volatile, and therefore, the level of exploration and production activities can be extremely volatile. Increases or decreases in oil and natural gas prices and expectations of future prices could have an impact on our customers’ long-term exploration and development activities, which in turn could materially affect our business and financial performance. Higher commodity prices do not necessarily result in increased drilling activity because our customers’ expectations of future commodity prices typically drive demand for our drilling services.

 

Commodity prices and demand for our drilling and related services also depends upon other factors, many of which are beyond our control, including:

 

 

 

Certain of our contracts are subject to cancellation by our customers without penalty with little or no notice.

 

Certain of our contracts are subject to cancellation by our customers without penalty and with relatively little or no notice. When drilling market conditions are depressed, customers may leverage their termination rights in an effort to renegotiate contract terms.

 

Our customers may also seek to terminate drilling contracts if we experience operational problems. If our equipment fails to function properly and cannot be repaired promptly, we will not be able to engage in drilling operations, and customers may have the right to terminate the drilling contracts. The cancellation or renegotiation of a number of our drilling contracts could materially reduce our revenue and profitability.

 

We rely on a small number of customers, and the loss of a significant customer could adversely affect us.

 

A substantial percentage of our revenues are generated from a relatively small number of customers, and the loss of a major customer would adversely affect us. In 2009, our two largest customers, BP and ExxonMobil (including subsidiaries and joint ventures) accounted for approximately 26 percent and 15 percent of our total revenues, respectively. Our ten most significant customers collectively accounted for approximately 75 percent of our total revenues in 2009. Our results of operations could be adversely affected if any of our major customers terminate their contracts with us, fail to renew our existing contracts or refuse to award new contracts to us.

 

Contract drilling and the rental tools business are highly competitive and cyclical, with intense price competition.

 

The contract drilling and rental tools markets are highly competitive and although no single competitor is dominant, many of our competitors in both the contract drilling and rental tools business may possess greater financial resources than we do. Some of our competitors also are incorporated in tax-haven countries outside the United States, which provides them with significant tax advantages that are not available to us as a U.S. company and which may materially impair our ability to compete with them for many projects.

 

Contract drilling companies compete primarily on a regional basis, and competition may vary significantly from region to region at any particular time. Many drilling and workover rigs can be moved from one region to another in response to changes in levels of activity, provided market conditions warrant, which may result in an oversupply of rigs in an area. Many competitors have constructed numerous rigs during the previous period of high energy prices and, consequently, the number of rigs available in the markets we operate has exceeded the demand for rigs for extended periods of time, resulting in intense price competition. Most drilling and workover contracts

are awarded on the basis of competitive bids, which also results in price competition. Historically, the drilling service industry has been highly cyclical, with periods of high demand, limited rig supply and high dayrates often followed by periods of low demand, excess rig supply and low dayrates. Periods of low demand and excess rig supply intensify the competition in the industry and often result in rigs being idle for long periods of time. During periods of decreased demand we typically experience significant reductions in dayrates and utilization. If we experience reductions in dayrates or if we cannot keep our rigs utilized, our financial performance will be adversely impacted. Prolonged periods of low utilization and dayrates could result in the recognition of impairment charges on certain of our rigs if future cash flow estimates, based upon information available to management at the time, indicate that the carrying value of these rigs may not be recoverable.

 

Our operations could be adversely affected by terrorism, war, civil disturbances, political instability and similar events.

 

We currently have operations in 11 countries, including Netherlands, Singapore and the United States. Our operations are subject to interruption, suspension and possible expropriation due to terrorism, war, civil disturbances, political and capital instability and similar events, and we have previously suffered loss of revenue and damage to equipment due to political violence. We may not be able to obtain insurance policies covering risks associated with these types of events, especially political violence coverage, and such policies may only be available with premiums that are not commercially justifiable.

 

Our international operations are also subject to governmental regulation and other risks.

 

We derive a significant portion of our revenues from our international operations. In 2009, we derived approximately 50 percent of our revenues from operations in countries outside the United States. Our international operations are subject to the following risks, among others:

 

 

Our international operations are subject to the laws and regulations of a number of foreign countries whose political, regulatory and judicial systems and regimes may differ significantly from those in the United States. Our ability to compete in international contract drilling markets may be adversely affected by foreign governmental regulations and/or policies that favor the awarding of contracts to contractors in which nationals of those foreign countries have substantial ownership interests or by regulations requiring foreign contractors to employ citizens of, or purchase supplies from, a particular jurisdiction. Furthermore, our foreign subsidiaries may face governmentally imposed restrictions or fees from time to time on the transfer of funds to us.

A significant portion of the workers we employ in our international operations are members of labor unions or otherwise subject to collective bargaining. We may not be able to hire and retain a sufficient number of skilled and experienced workers for wages and other benefits that we believe are commercially reasonable.

 

We may experience currency exchange losses where revenues are received or expenses are paid in nonconvertible currencies or where we do not take protective measures against exposure to a foreign currency. We may also incur losses as a result of an inability to collect revenues because of a shortage of convertible currency available to the country of operation, controls over currency exchange or controls over the repatriation of income or capital. Given the international scope of our operations, we are exposed to risks of currency fluctuation and restrictions on currency repatriation. We attempt to limit the risks of currency fluctuation and restrictions on currency repatriation where possible by obtaining contracts payable in U.S. dollars or freely convertible foreign currency. In addition, some parties with which we do business could require that all or a portion of our revenues be paid in local currencies. Foreign currency fluctuations therefore could have a material adverse effect upon our results of operations and financial condition.

 

Our international operations are also subject to disruption due to risks associated with worldwide health concerns. In particular, although we have no evidence to believe this will occur, it is possible that concerns due to the transmission of illness (viral, bacterial or parasitic) could result in cancellations or delays in international flights and/or the quarantine of drilling crews in foreign locations, which could materially impair our international operations and consequently have an adverse effect on our business and financial results for the operations that are affected.

 

Inconsistent application of foreign tax and other laws may adversely affect our operations.

 

Tax and other laws and regulations in some foreign countries are not always interpreted consistently among local, regional and national authorities, which often results in good faith disputes between us and governing authorities. The ultimate outcome of these disputes is never certain, and it is possible that the outcomes could have an adverse effect on our financial performance.

 

We are subject to hazards customary for drilling operations, which could adversely affect our financial performance if we are not adequately indemnified or insured.

 

Substantially all of our operations are subject to hazards that are customary for oil and natural gas drilling operations, including blowouts, reservoir damage, loss of well control, cratering, oil and natural gas well fires and explosions, natural disasters, pollution and mechanical failure. Our offshore operations also are subject to hazards inherent in marine operations, such as capsizing, sinking, grounding, collision and damage from severe weather conditions. Any of these risks could result in damage to or destruction of drilling equipment, personal injury and property damage, suspension of operations or environmental damage. We have had accidents in the past demonstrating some of these hazards. To the extent that we are unable to insure against these risks or to obtain indemnification agreements to adequately protect us against liability from all of the consequences of the hazards and risks described above, then the occurrence of an event not fully insured or for which we are not indemnified against, or the failure of a customer or insurer to meet its indemnification or insurance obligations, could result in substantial losses. In addition, insurance may not continue to be available to cover any or all of these risks. For example, pollution, reservoir damage and environmental risks generally are not dully insurable. Even if such insurance is available, insurance premiums or other costs may rise significantly in the future, so as to make the cost of such insurance prohibitive.

 

Certain areas in and near the GOM are subject to hurricanes and other extreme weather conditions. When operating in the GOM, our drilling rigs and rental tools may be located in areas that could cause them to be susceptible to damage or total loss by these storms. In addition, damage caused by high winds and turbulent seas to our rigs, our shore bases and our corporate infrastructure could potentially cause us to curtail operations for significant periods of time until the damages can be repaired.

 

The oil and natural gas industry has sustained several catastrophic losses in recent years, including damage from hurricanes in the GOM. As a result, insurance underwriters have increased insurance premiums and restricted certain insurance coverage such as for losses arising from a named windstorm.

Although not a hazard specific to our drilling operations, we could incur significant liability in the event of loss or damage to proprietary data of operators or third parties during our transmission of this valuable data.

 

Government regulations and environmental risks, which reduce our business opportunities and increase our operating costs, might worsen in the future.

 

Government regulations control and often limit access to potential markets and impose extensive requirements concerning employee safety, environmental protection, pollution control and remediation of environmental contamination. Environmental regulations, in particular, prohibit access to some markets and make others less economical, increase equipment and personnel costs and often impose liability without regard to negligence or fault. In addition, governmental regulations, such as those related to climate change, may discourage our customers’ activities, reducing demand for our products and services. We may be liable for damages resulting from pollution of offshore waters and, under United States regulations, must establish financial responsibility in order to drill offshore. See Part I, Business, “Environmental Considerations.”

 

We are regularly involved in litigation, some of which may be material.

 

We are regularly involved in litigation, claims and disputes incidental to our business, which at times involve claims for significant monetary amounts, some of which would not be covered by insurance. We undertake all reasonable steps to defend ourselves in such lawsuits. Nevertheless, we cannot predict the ultimate outcome of such lawsuits and any resolution which is adverse to us could have a material adverse effect on our financial condition. See Note 13, “Commitments and Contingencies,” in Item 8 of this Form 10-K for a discussion of the material legal proceedings affecting us.

 

We are currently conducting an investigation into possible violations of the Foreign Corrupt Practices Act (“FCPA”) and other laws concerning our international operations. The Securities and Exchange Commission and the Department of Justice are conducting parallel investigations into possible FCPA violations. If we are found to have violated the FCPA or other legal requirements, we may be subject to criminal and civil penalties and other remedial measures, which could materially harm our business, results of operations, financial condition and liquidity.

 

As previously disclosed, the Company received requests from the United States Department of Justice (“DOJ”) in July 2007 and the United States Securities and Exchange Commission (“SEC”) in January 2008 relating to the Company’s utilization of the services of a customs agent. The DOJ and the SEC are conducting parallel investigations into possible violations of U.S. law by the Company, including the FCPA. In particular, the DOJ and the SEC are investigating the Company’s use of customs agents in certain countries in which the Company currently operates or formerly operated, including Kazakhstan and Nigeria. The Company is fully cooperating with the DOJ and SEC investigations and is conducting an internal investigation into potential customs and other issues in Kazakhstan and Nigeria. The internal investigation has identified issues relating to potential non-compliance with applicable laws and regulations, including the FCPA, with respect to operations in Kazakhstan and Nigeria. At this point, we are unable to predict the duration, scope or result of the DOJ or the SEC investigation or whether either agency will commence any legal action.

 

Further, in connection with our internal investigation, we also have learned that an individual who may be considered a foreign official under the FCPA owns in trust a substantial stake in a foreign subcontractor with whom the Company does business through a joint venture relationship in Kazakhstan. We are currently engaged in efforts to evaluate and implement alternatives to restructure or end the relationship with the subcontractor. At this point, we are unable to predict the outcome of our restructuring efforts or whether termination will result, either of which could negatively impact some of our operations in Kazakhstan and potentially have a material adverse impact on our business, results of operations, financial condition and liquidity.

 

The DOJ and the SEC have a broad range of civil and criminal sanctions under the FCPA and other laws and regulations, which they may seek to impose against corporations and individuals in appropriate circumstances including, but not limited to, injunctive relief, disgorgement, fines, penalties and modifications to business practices and compliance programs. These authorities have entered into agreements with, and obtained a range of sanctions

against, several public corporations and individuals arising from allegations of improper payments and deficiencies in books and records and internal controls, whereby civil and criminal penalties were imposed. Recent civil and criminal settlements have included multi-million dollar fines, deferred prosecution agreements, guilty pleas, and other sanctions, including the requirement that the relevant corporation retain a monitor to oversee its compliance with the FCPA. In addition, corporations may have to end or modify existing business relationships. Any of these remedial measures, if applicable to us, could have a material adverse impact on our business, results of operations, financial condition and liquidity.

 

We are subject to laws and regulations concerning our international operations, including export restrictions, U.S. economic sanctions and other activities that we conduct abroad. We have conducted an internal review concerning our compliance with these legal requirements and have voluntarily disclosed the results of our review to the U.S. government. If we are not in compliance with applicable legal requirements, we may be subject to civil or criminal penalties and other remedial measures, which could materially harm our business, results of operations, financial condition and liquidity.

 

We are subject to laws and regulations restricting our international operations, including activities involving restricted countries, organizations, entities and persons that have been identified as unlawful actors or that are subject to U.S. economic sanctions. Pursuant to an internal review, we have identified certain shipments of equipment and supplies that were routed through Iran as well as other activities, including drilling activities, which may have violated applicable U.S. laws and regulations. We have reviewed these shipments, transactions and drilling activities to determine whether the timing, nature and extent of such activities or other conduct may have given rise to violations of these laws and regulations, and we have voluntarily disclosed the results of our review to the U.S. government. At this point, we are unable to predict whether the government will initiate an investigation or any proceedings against the Company or the ultimate outcome that may result from our voluntary disclosure. If U.S. enforcement authorities determine that we were not in compliance with export restrictions, U.S. economic sanctions or other laws and regulations that apply to our international operations, we may be subject to civil or criminal penalties and other remedial measures, which could have an adverse impact on our business, results of operations, financial condition and liquidity.

 

Risks Related to Our Common Stock

 

The market price of our common stock has fluctuated significantly.

 

The market price of our common stock may continue to fluctuate in response to various factors and events, most of which are beyond our control, including the following:

 

 

A hostile takeover of our company would be difficult.

 

Some of the provisions of our Restated Certificate of Incorporation and of the Delaware General Corporation Law may make it difficult for a hostile suitor to acquire control of our company and to replace our incumbent

management. For example, our Restated Certificate of Incorporation provides for a staggered Board of Directors and permits the Board of Directors, without stockholder approval, to issue additional shares of common stock or a new series of preferred stock.

 

Risks Related to our Debt Securities

 

We may not be able to repurchase our 9.625% Senior Notes upon a change of control.

 

Upon the occurrence of specific change of control events affecting us, the holders of our 9.625% Senior Notes will have the right to require us to repurchase our notes at 101 percent of their principal amount, plus accrued and unpaid interest. Our ability to repurchase our notes upon such a change of control event would be limited by our access to funds at the time of the repurchase and the terms of our other debt agreements. Upon a change of control event, we may be required immediately to repay the outstanding principal, any accrued interest on and any other amounts owed by us under our senior secured credit facilities, our notes and other outstanding indebtedness. The source of funds for these repayments would be our available cash or cash generated from other sources. However, we may not have sufficient funds available upon a change of control to make any required repurchases of this outstanding indebtedness.

 

In addition, the change of control provisions in the indenture governing our 9.625% Senior Notes may not protect the holders of our notes from certain important corporate events, such as a leveraged recapitalization (which would increase the level of our indebtedness), reorganization, restructuring, merger or other similar transaction, unless such transaction constitutes a “Change of Control” under the indenture. Such a transaction may not involve a change in voting power or beneficial ownership or, even if it does, may not involve a change that constitutes a “Change of Control” as defined in the indenture that would trigger our obligation to repurchase the notes. Therefore, if an event occurs that does not constitute a “Change of Control” as defined in the indenture, we will not be required to make an offer to repurchase the notes and the holders may be required to continue to hold their notes despite the event.

 

We may not have sufficient cash to repurchase the 2.125% Convertible Senior Notes at the option of the holder upon a fundamental change or to pay the cash payable upon a conversion.

 

Upon the occurrence of a fundamental change as defined in the indenture governing our 2.125% Convertible Senior Notes, subject to certain conditions, we will be required to make an offer to repurchase for cash all outstanding notes at 100 percent of their principal amount plus accrued and unpaid interest, including additional amounts, if any, up to but not including the date of repurchase. In addition, unless we elect to satisfy our conversion obligation entirely in shares of our common stock, upon a conversion, we will be required to make a cash payment of up to $1,000 for each $1,000 in principal amount of notes converted. However, we may not have enough available cash or be able to obtain financing at the time we are required to make repurchases of tendered notes or settlement of converted notes. Any credit facility in place at the time of a repurchase or conversion of the notes may also define as a default thereunder the events requiring repurchase or cash payment upon conversion of the notes or otherwise limit our ability to use borrowings to pay for a repurchase or conversion of the notes and may prohibit us from making any cash payments on the repurchase or conversion of the notes if a default or event of default has occurred under that facility without the consent of the lenders under that credit facility. Our failure to repurchase tendered notes at a time when the repurchase is required by the indenture or to pay any cash payable on a conversion of the notes would constitute a default under the indenture. A default under the indenture or the fundamental change itself could lead to a default under the other existing and future agreements governing our indebtedness. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase the notes or make cash payments upon conversion thereof.

The indenture for our 9.625% Senior Notes and our senior secured credit agreement impose significant operating and financial restrictions, which may prevent us from capitalizing on business opportunities and taking some actions.

 

The indenture governing our 9.625% Senior Notes and the agreement governing our senior secured credit facility impose significant operating and financial restrictions on us. These restrictions limit our ability to:

 

 

These limitations are subject to a number of important qualifications and exceptions. Our senior secured credit agreement also requires us to maintain ratios for consolidated leverage, consolidated interest coverage and consolidated senior secured leverage. These covenants may adversely affect our ability to finance our future operations and capital needs and to pursue available business opportunities. A breach of any of these covenants could result in a default in respect of the related indebtedness. If a default were to occur, the holders of our 9.625% Senior Notes and the lenders under our senior secured credit facility could elect to declare the indebtedness, together with accrued interest, immediately due and payable. If the repayment of the indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness.

 

DISCLOSURE NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Form 10-K contains statements that are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. All statements contained in this Form 10-K, other than statements of historical facts, are forward-looking statements for purposes of these provisions, including any statements regarding:

 

 

 

In some cases, you can identify these statements by forward-looking words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “outlook,” “may,” “should,” “will” and “would” or similar words. Forward-looking statements are based on certain assumptions and analyses made by our management in light of their experience and perception of historical trends, current conditions, expected future developments and other factors they believe are relevant. Although our management believes that their assumptions are reasonable based on information currently available, those assumptions are subject to significant risks and uncertainties, many of which are outside of our control. The following factors, as well as any other cautionary language included in this Form 10-K, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements:

 

 

 

Each forward-looking statement speaks only as of the date of this Form 10-K, and we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Before you decide to invest in our securities, you should be aware that the occurrence of the events described in these risk factors and elsewhere in this Form 10-K could have a material adverse effect on our business, results of operations, financial condition and cash flows.

 

 

None.

 

 

We lease corporate headquarters office space in Houston, Texas. Additionally, we own and lease office space and operating facilities in various locations, primarily to the extent necessary for administrative and operational support functions.

 

Land Rigs — International

 

The following table shows, as of December 31, 2009, the locations and drilling depth ratings of our 28 land rigs available for service. 18 of these rigs were under contract and ten more available for service as of December 31, 2009.

 

Barge Rigs

 

The following table sets forth information regarding our two international deep drilling barges as of December 31, 2009. One rig was under contract and one was available for service as of December 31, 2009.

 

 

The following table sets forth information regarding our 13 deep and intermediate depth drilling barge rigs located in the GOM as of December 31, 2009. Five of these barge rigs were under contract and eight were available for service as of December 31, 2009.

 

The following table presents our utilization rates and rigs available for service for the years ended December 31, 2009 and 2008.

 

 

 

 

 

For information on Legal Proceedings, see Note 13, Commitments and Contingencies, in the notes to the consolidated financial statements included in Item 8 of this annual report on Form 10-K, which information is incorporated herein by reference.

 

 

 

Parker Drilling Company’s common stock is listed for trading on the New York Stock Exchange under the symbol “PKD.” At the close of business on December 31, 2009, there were 1,872 holders of record of Parker Drilling common stock. The following table sets forth the high and low closing sales prices per share of Parker Drilling’s common stock, as reported on the New York Stock Exchange composite tape, for the periods indicated:

 

 

Most of our stockholders maintain their shares as beneficial owners in “street name” accounts and are not, individually, stockholders of record. As of January 29, 2010, our common stock was held by 1,862 holders of record and an estimated 24,729 beneficial owners as of February 9, 2010.

 

Restrictions contained in Parker Drilling’s existing credit agreement and the indenture for the 9.625% Senior Notes restrict the payment of dividends. We have no present intention to pay dividends on our common stock in the foreseeable future.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

When restricted stock awarded by Parker Drilling becomes taxable compensation to personnel, shares may be withheld to satisfy the associated withholding tax liabilities. Information on our purchases of equity securities by means of such share withholdings is provided below:

 

 

These were the only repurchases of equity securities made by us during the three months ended December 31, 2009. We do not have a stock repurchase program.

 

The following table presents selected historical consolidated financial data derived from the audited financial statements of Parker Drilling Company for each of the five years in the period ended December 31, 2009. The following financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes appearing elsewhere in this Form 10-K.

 

 

 

 

 

OVERVIEW AND OUTLOOK

 

Summary

 

We delivered sound financial results in 2009 despite significant market instability and uncertainty. Our business balance and geographic diversity enabled us to mitigate the impact of the volatile conditions and difficult market forces that we faced. Guided by our long-term strategy, we continued to invest for future growth during this industry down-cycle and to position ourselves for stronger performance in the years ahead. In 2009 we captured a lead position in the U.S. barge drilling market, expanded the geographic presence of our rental tools operations and moved forward on our projects to begin drilling operations in Alaska. We entered 2010 in sound financial condition with sufficient resources to provide for the needs of our current operations and to fund our growth initiatives.

 

Overview

 

Parker Drilling’s revenues for the 2009 fourth quarter declined to $175.8 million, or by 17 percent, from 2008 fourth quarter revenues of $212.4 million. The Company’s 2009 fourth quarter gross margin declined to $43.0 million, or by 46 percent, from 2008 fourth quarter gross margin of $79.6 million, while gross margin as a percentage of revenues decreased to 24 percent in the 2009 fourth quarter from 38 percent in the 2008 fourth quarter.

 

International Drilling revenues declined 16 percent, to $72.7 million for the 2009 fourth quarter from $86.2 million for the 2008 fourth quarter, and gross margin declined 21 percent, to $21.9 million for the 2009 fourth quarter from $27.7 million in the 2008 fourth quarter. As a result, the segment’s gross margin as a percent of revenues declined to 30 percent from 32 percent. The revenue decline reflects a lower average fleet utilization, modestly higher average dayrates and the impact of Rig 257, our Caspian Sea barge rig, being in the shipyard for a scheduled overhaul and upgrade during the latter part of the 2009 fourth quarter. These effects were matched by lower operating costs throughout the segment. Average fleet utilization for the 2009 fourth quarter was 64 percent, compared with 87 percent for the 2008 fourth quarter. For the 2009 fourth quarter, the ten-rig Americas regional fleet operated at 80 percent utilization, the twelve-rig CIS/AME regional fleet operated at 68 percent utilization and the eight-rig Asia Pacific regional fleet operated at 46 percent utilization. Rig 259 was retired at the end of 2009, reducing the Company’s international fleet to 29 rigs and the CIS/AME regional fleet to eleven rigs.

 

U.S. Drilling revenues declined by 57 percent to $14.5 million for the 2009 fourth quarter from $33.6 million for the 2008 fourth quarter, while gross margin declined 91 percent, to $1.3 million from $14.6 million. The decline in revenues and gross margin are due to a sharp drop in rig activity and reduced average dayrates. The operation produced a better-than-breakeven gross margin despite the significant downturn in industry demand. Average fleet utilization for the fourth quarter of 2009 was 52 percent, compared with 61 percent for the fourth quarter of 2008. The Company’s barge fleet dayrates averaged $19,300 for the fourth quarter of 2009, compared with $39,400 for the

fourth quarter of 2008. At December 31, 2009, our GOM barge rig fleet was reduced to 13 rigs with the retirements of workover barge rigs 6B and 16B.

 

Revenues for Rental Tools declined by 45 percent, to $25.1 million for the 2009 fourth quarter from $45.7 million for the 2008 fourth quarter, and the segment’s gross margin declined 52 percent to $13.8 million from $28.7 million. These reductions were primarily due to the decline in U.S. land and GOM shelf drilling activity and the impact of price discounting. This was partially offset by increased demand for workover equipment, growing coverage in the U.S. shale drilling areas and additional offshore deep drilling and international placements.

 

Project Management and Engineering Services revenues declined 27 percent, to $27.6 million for the 2009 fourth quarter from $37.9 million for the 2008 fourth quarter, and gross margin declined 33 percent to $5.4 million from $8.2 million. The prior year’s fourth quarter included revenues associated with the relocation and upgrade of the Yastreb rig for ENL on Sakhalin Island and operational revenues for ENL’s Orlan platform which has since moved to a warm-stack rate with reduced crew levels.

 

Construction Contract revenue increased to $35.8 million from $8.9 million while gross margin increased $0.1 million to $0.6 million from $0.5 million, representing progress made on the BP Liberty EPCI project.

 

Capital expenditures for the three month and twelve month periods ended December 31, 2009 totaled $33.2 million and $160.1 respectively. Major spending projects in 2009 including $62.2 million for the construction of Parker Drilling’s two new build arctic land rigs for Alaska and $36.8 million for tubular goods and other rental equipment.

 

Outlook

 

The steep market declines of late 2008 and early 2009 in certain of our markets have moderated and there are signs in some areas that improvements are underway. The utilization rate for the GOM barge drilling fleet has improved, though dayrates remain low. The domestic land rig count has recovered significantly, particularly in the shale plays where rental tool usage is more prevalent, leading to growing demand for rental tools and a lessening of price discounts. The number of international rig tenders has grown, yet commitments are slow to develop and pressure on dayrates remain. Our project engineering and project management opportunities are growing, indicating an expanded field for our unique capabilities and offering the prospect of significant future growth from this business segment

 

Though we are encouraged by the recent direction of activity in some of our markets, we remain cautious about the immediacy of a broad upturn and the near term impact on our financial performance. We believe we are well positioned to deliver profitable growth as the markets improve. Accordingly, we will continue to focus on cost management within our operations, improvements in delivering efficient performance to our customers and maintaining a safe environment for our employees.

 

We expect our international drilling business will continue to feel the effects of the 2009 downturn in E&P spending in our primary markets, including continued pressure on dayrates and gaps in the work schedule of certain rigs coming off contract during 2010. In addition, Rig 257, our Caspian Sea barge rig, will be on a reduced dayrate during its overhaul and upgrade period, which will continue into the second quarter.

 

Our U.S. Drilling business has experienced improved market conditions of late. Further improvement driven by higher natural gas prices or an increase in deep gas programs, may provide some upward momentum to the revenues and earnings of this business.

 

The rental tools business should benefit from its expanded international and offshore placements and rising demand in U.S. drilling, particularly the increases in the shale plays. A further reduction in price discounting could enhance results.

 

Based on our current project activity, we expect the higher revenues and earnings in 2010 for our project management business. The addition of the O&M for the BP-owned Liberty project is expected to account for much of this change. We are currently bidding on several projects that, should we be successful, could add to our backlog and revenue later this year.

The revenues and earnings for the Construction Contract segment will phase out as the BP-Liberty project transitions from EPCI to O&M, which is expected to occur in the second quarter of 2010. This project is expected to generate some revenue but relatively little earnings during that time.

 

Capital expenditures, funded primarily through operating cash flows and use of revolving credit facilities, for 2010 are projected to be approximately $150 to $175 million comprised of approximately $70 to $80 million for maintenance projects, including rental tool investments. Major project spending includes approximately $70 million to complete construction and delivery of the two Parker Drilling-owned drill rigs for Alaska and approximately $15 million for the overhaul and upgrade of Rig 257, our Arctic Class barge drilling rig operating in the Caspian Sea.

 

RESULTS OF OPERATIONS

 

Year Ended December 31, 2009 Compared with Year Ended December 31, 2008

 

We recorded net income of $9.3 million for the year ended December 31, 2009, as compared to net income of $22.7 million for the year ended December 31, 2008. Operating gross margin was $83.5 million for the year ended December 31, 2009, which consists of decreases in U.S. drilling and rental tools of $129.8 million offset by increases in international drilling operations, project management and engineering services and construction contract of $18.9 million and a $3.0 million decrease in depreciation expense as compared to the year ended December 31, 2008.

 

The following is an analysis of our operating results for the comparable periods:

 

 

 

 

 

International Drilling Segment

 

International drilling segment revenues decreased $31.8 million to $293.3 million for the year ended December 31, 2009 as compared with December 31, 2008. Revenues in the CIS/AME region decreased by $10.3 million primarily attributable to a reduction in operating days for rigs operating on land in Kazakhstan and minimal drilling operations in Turkmenistan. These reductions in revenue were partially offset by increases in drilling revenue from operations in the Karachaganak area of Kazakhstan, Caspian Sea barge rig and Algeria, which increased by $4.5 million, $5.3 million and $1.9 million, respectively.

 

In our Americas region, revenues decreased $4.9 million due to lower revenues of $8.5 million in Mexico, due to contract completion on Rig 53B and lower average dayrates, offset by increased revenues of $3.6 million in Colombia, a result of higher utilization.

 

In our Asia Pacific region, revenues decreased $19.8 million due mainly to lower utilization in Papua New Guinea, Indonesia and New Zealand, whose revenues decreased by $14.9 million, $3.5 million and $1.4 million, respectively.

 

The international drilling segment operating gross margin, excluding depreciation and amortization, increased $8.2 million to $101.9 million during the year ended December 31, 2009 compared to the year ended December 31, 2008, due primarily to increases in operating gross margin, excluding depreciation and amortization in the CIS/AME region and Colombia of $15.0 million and $1.2 million, respectively. The increases were partially offset by a decrease in Mexico of $8.0 million. The increase in the CIS/AME region is attributable to an overall increase in average dayrates and a decrease in operating expenses for reduced labor costs and fewer rigs in operation. The increase in Colombia is attributable to increased operating days. In Algeria, revenues increased due to decreased downtime and operating expenses were lower due to a reduction in labor related costs. The decrease in Mexico is attributable to reduced operating days as a result of the completion of the contract for Rig 53B.

U.S. Drilling Segment

 

Revenues from the U.S. drilling segment decreased $124.0 million to $49.6 million for the year ended December 31, 2009 as compared to the year ended December 31, 2008. The revenue reduction was primarily attributable to the decline in industry-wide barge drilling. As a result, we experienced a $28.7 million decrease for our barge drilling operations as average dayrates fell approximately $15,000 per day, further decreased by $93.1 million as a result of utilization decreasing from 77 percent to 35 percent in 2009 and $2.2 million in other decreases for reimbursable revenues.

 

As a result of the above mentioned factors, gross margins, excluding depreciation and amortization, decreased $87.6 million to $1.6 million for the year ended December 31, 2009 as compared to the same period of 2008.

 

Rental Tools Segment

 

Revenues from the rental tools segment decreased $56.5 million to $115.1 million during the year ended December 31, 2009 as compared to 2008. The decrease was due to greater discounting and lower utilization that was partially offset by decreased operating costs related to lower labor costs.

 

The rental tools segment gross margins, excluding depreciation and amortization, decreased $42.2 million to $62.3 million for 2009 as compared with 2008.

 

Project Management and Engineering Services Segment

 

Revenues for this segment decreased $0.7 million during 2009 as compared with 2008. This slight decrease was attributable to lower revenues of $10.9 million in Orlan, where we were on a warm-stack, or reduced stand-by rate most of the year, $6.4 million in Kuwait due to lower reimbursable revenues, and the completion of the contract in China in 2009. These decreases were offset by higher revenues for our operations on the Yastreb rig in Sakhalin Island ($5.1 million) and Engineering Services ($18.1 million) primarily related to our Arkutun Dagi project. For Sakhalin operations, $0.2 million was due to higher dayrates and $4.9 million due to reimbursable expenses on which we earn a fixed fee during the rig move, upgrade and customer modification phase of the contract. Project management and engineering services do not incur depreciation and amortization, and as such, gross margin for this segment increased $4.9 million in 2009 as compared to 2008 primarily due to the Arkutun Dagi project.

 

Construction Contract Segment

 

Revenues from the construction contract segment increased $136.0 million for the year ended December 31, 2009 compared with the year ended December 31, 2008.

 

Revenues from the construction of the extended-reach drilling rig for use in the Alaskan Beaufort Sea were $185.4 million for 2009 compared with $49.4 million in 2008. This project is a cost plus fixed fee contract. Gross margin for the 2009 EPCI project is based on the percentage of completion of the contract in which costs-to-date compared to projected total costs are used to determine the percentage of completion utilizing the cost to cost method. Gross margin recognized during 2009 was $8.1 million compared with $2.6 million in 2008.

 

Other Financial Data

 

Gains on asset dispositions were $5.9 million in 2009, an increase of $3.2 million as a result of various asset sales in 2009 as compared with $2.7 million in 2008. The gain on asset dispositions in 2009 is primarily attributable to a $4.0 million settlement with a tugboat company in regards to a barge rig that was overturned in 2005 while being transported to shore. Interest expense for 2009 was $29.5 million, an increase of $0.2 million as compared with 2008. Interest income for 2009 decreased $0.4 million as compared with 2008. General and administration expense for 2009 increased $10.8 million as compared with 2008. The increased general and administrative costs are primarily related to higher legal and professional fees associated with the ongoing DOJ and SEC investigations and our work product related to various matters further discussed in Note 13 in the notes to the consolidated financial statements. These fees included improvements to our overall compliance process, code of conduct and other matters arising as a result of our internal investigation and responses to the SEC and DOJ inquiries. In addition, we incurred severance and personnel-related costs of approximately $1.6 million in 2009.

Income tax expense was $0.6 million for the year ended December 31, 2009, as compared to income tax expense of $6.9 million for the year ended December 31, 2008. Income tax expense for 2009 includes a benefit of an additional $5.4 million to the amount of $12.2 million claimed in 2008 for the recovery of prior years foreign taxes as a credit in the U.S. versus a deduction, the establishment of a valuation allowance of $0.5 million related to excess current year foreign tax credits and a charge of $1.8 million accounted for under FIN 48 related to a characterization of certain intercompany notes for foreign tax credit calculation. Income tax expense for 2008 includes a benefit of $13.4 million of FIN 48 interest and foreign currency exchange rate fluctuations related to our settlement of interest related to our Kazakhstan tax case (see Note 13 in the notes to the consolidated financial statements), the establishment of a valuation allowance of $4.1 million related to a Papua New Guinea deferred tax asset, the reversal of a $5.7 million valuation allowance relating to 2007 foreign tax credits, a charge of $4.5 million accounted for under FIN 48 related to certain intercompany transactions between our U.S. companies and foreign affiliates, a charge of $12.6 million related to non-deductible goodwill and a benefit of $12.2 million for the recovering of prior years’ foreign taxes as a credit in the U.S. versus a deduction. Based on the level of projected future taxable income over the periods for which the deferred tax asset is deductible in Papua New Guinea, management believes that it is more likely than not that our subsidiary will not realize the benefit of this deduction in Papua New Guinea.

 

Year Ended December 31, 2008 Compared with Year Ended December 31, 2007

 

We recorded net income of $22.7 million for the year ended December 31, 2008 which included a goodwill write-off of $100.3 million, as compared to net income of $102.8 million for the year ended December 31, 2007. Operating gross margin was $191.5 million for the year ended December 31, 2008 which consists of increases in international drilling operations, rental tools, project management and engineering services and construction contract of $63.6 million offset by a decrease of $41.7 million in U.S. drilling and a $31.2 million increase in depreciation expense as compared to the year ended December 31, 2007.

 

In 2008, we began separate presentation of our project management and engineering services segment. We have begun to separately monitor this non-capital intensive segment as a focus of our long-term strategic growth plan. Prior to 2008, these results were included in the U.S. and International drilling segments, and as such, 2007 segment information has been recast to conform to the new presentation. We also created a new segment in 2008 to separately reflect results of our extended-reach rig construction contract.

The following is an analysis of our operating results for the comparable periods:

 

 

 

 

 

 

International Drilling Segment

 

International drilling revenues increased $111.5 million to $325.1 million for the year ended December 31, 2008 as compared to the same period in 2007.

 

Revenues in Mexico, Algeria and Turkmenistan increased by $69.0 million, $11.1 million and $3.6 million, respectively, as there were minimal drilling operations in these countries during 2007. The increase in Mexico was partially attributable to dayrate increases for our barge rig operating in Mexico. Revenues in the CIS region increased by $63.7 million primarily due to a $19.5 million increase in the Karachaganak area of Kazakhstan as a result of the addition of Rigs 249 and 258 to existing operations of Rigs 107 and 216, an increase in the dayrate for our barge rig operating in the Caspian Sea and the above mentioned Turkmenistan revenues. These increases were partially offset by an increase of $22.2 million in revenues in Colombia as compared with 2007, due to lower utilization of our two rigs in Colombia in 2008.

 

In our Asia Pacific region, revenues decreased $8.2 million in 2008 due mainly to completion of our contract within Bangladesh for Rig 225 in March 2007 ($3.5 million) and 50 percent lower utilization in Papua New Guinea ($15.6 million). These increases were partially offset by a $4.8 million increase in New Zealand due to increased dayrates and operating days and a $6.2 million increase in our Indonesia operations.

 

International operating gross margin, excluding depreciation and amortization, increased $34.5 million to $93.7 million during 2008 compared with the year ended 2007, due primarily to favorable increases in our operations in Mexico ($25.5 million) and the CIS region ($21.4 million), offset by decreases in Colombia ($14.3 million) and our Asia Pacific region ($2.2 million). The increase in Mexico is attributable to five rigs operating the entire period in 2008 and two rigs commencing operations in February in 2008 as we were in the start up phase for these operations in the third quarter of 2007. In the CIS region, the primary driver was the increased dayrates for our barge rig operating in the Caspian Sea, increased utilization in the Karachaganak area of Kazakhstan and operation of Rig 230 in Turkmenistan were the main drivers of the increase. In Colombia, the completion of our contracts in late 2007 and late February 2008 were the cause of the decrease, although Rig 268 began a one year contract in mid-May 2008. Our Asia Pacific region decline of $2.2 million was a result of Rig 225 in Bangladesh not operating in 2008 as compared to 2007 and Papua New Guinea incurring lower utilization when compared to the same period of 2007, with these declines being partially offset by increases in our New Zealand and Indonesia operations.

U.S. Drilling Segment

 

Revenues for the U.S drilling segment decreased $51.6 million to $173.6 million for the year ended December 31, 2008 as compared to the year ended December 31, 2007. The decreased revenues were primarily due to a $40.3 million decrease for our barge drilling operations as average dayrates for our deep drilling barges fell approximately $4,500 per day. During 2007 we had two land rigs drilling in the U.S. that historically operated in our international land segment. These rigs contributed $11.3 million in U.S. revenues in 2007 as compared to no U.S. revenues in the same period for 2008, as the two rigs were relocated to our Mexico operations during 2007.

 

As a result of the above mentioned factors, gross margins, excluding depreciation and amortization, decreased $41.7 million to $89.2 million for the year ended December 31, 2008 as compared to the same period of 2007.

 

Rental Tools Segment

 

Rental tools revenues increased $33.5 million to $171.6 million during the year ended December 31, 2008 as compared to 2007. The increase was due primarily to an increase in rental revenues of $13.6 million at our Texarkana, Texas facility, $2.8 million at our New Iberia, Louisiana facility, $20.2 million from our newest location in Williston, North Dakota and $1.3 million from our Victoria, Texas location, partially offset by declines of $0.9 million from our Evanston, Wyoming facility, $1.7 million at our Odessa, Texas location and $1.8 million at our international operations. Revenues increased as a result of our expansion efforts in Texarkana, Texas and Williston, North Dakota.

 

The rental tools segment gross margins, excluding depreciation and amortization, increased $20.9 million to $104.5 million in 2008 as compared with 2007. The 2007 and 2008 expansion of Quail tools was completed as equipment had been delivered and Quail tools new facility in Texarkana, Texas opened in April 2007. The facility provides increased coverage of the Barnett, Fayetteville, Woodford and Haynesville shale areas in East Texas, Southwest Arkansas, Southeast Oklahoma and Northwest Louisiana.

 

Project Management and Engineering Services Segment

 

Revenues for this segment increased $32.4 million during 2008 as compared to 2007. This increase was the result of higher revenues for our operations in Sakhalin Island ($20.9 million) and Kuwait ($13.1 million). For Sakhalin operations, $9.1 million of the increase was due to higher dayrates and $11.8 million was due to reimbursable expenses on which we earn a fixed fee. For our Kuwait contract, $11.0 million of the increase was due to reimbursables and $2.1 million was due to additional services provided. These increases were partially offset by a decrease of $1.9 million in our Papua New Guinea project management contracts that ceased operations during 2007. Project management and engineering services gross margin for this segment increased $5.7 million in 2008 as compared with 2007. Labor rate increases effective in November 2008, which were retroactive to June 2008, positively impacted gross margin.

 

Construction Contract Segment

 

Revenues from the construction of the extended-reach drilling rig for use in the Alaskan Beaufort Sea were $49.4 million for 2008. This project is a cost plus fixed fee contract. Gross margin for the EPCI project was $2.6 million based on the percentage of completion of the contract in which costs-to-date compared to projected total costs are used to determine the percent complete (cost to cost method).

 

Other Financial Data

 

Gain on asset dispositions was $2.7 million in 2008, a decrease of $13.7 million from 2007 as a result of minor asset sales in 2008 as compared to gains of $16.4 million during the same period in 2007 as we sold two workover barge rigs in January 2007 for a recognized gain of $15.1 million. Interest expense for 2008 was $29.3 million, an increase of $2.1 million as compared to 2007. Interest income for 2008 decreased $5.1 million due to lower cash balances available for investments as compared to 2007. General and administration expense increased $10.0 million in 2008 as compared with 2007, due primarily to higher legal and professional fees associated with the ongoing

DOJ and SEC investigations into the customs agent discussed in Note 13 in the notes to the consolidated financial statements. These fees included upgrades to our compliance process and code of conduct.

 

In 2004, we entered into two variable-to-fixed interest rate swap agreements. The swap agreements did not qualify for hedge accounting and accordingly, we reported the mark-to-market change in the fair value of the interest rate derivatives in earnings. During 2008, we had no swaps outstanding and therefore reported no charge or benefit related to swaps, as compared to the year ended December 31, 2007 where we recognized a $0.7 million decrease in the fair value of the derivative positions. For additional information see Note 6 in the notes to the consolidated financial statements.

 

Income tax expense was $6.9 million for the year ended December 31, 2008, as compared to income tax expense of $36.9 million for the year ended December 31, 2007. Income tax expense for 2008 includes a benefit of $13.4 million of FIN 48 interest and foreign currency exchange rate fluctuations related to our settlement of interest related to our Kazakhstan tax case (see Note 13 in the notes to the consolidated financial statements), the establishment of a valuation allowance of $4.1 million related to a Papua New Guinea deferred tax asset, the reversal of a $5.7 million valuation allowance relating to 2007 foreign tax credits, a charge of $4.5 million accounted for under FIN 48 related to certain intercompany transactions between our U.S. companies and foreign affiliates, a charge of $12.6 million related to non-deductible goodwill and a benefit of $12.2 million for the recovering of prior years’ foreign taxes as a credit in the U.S. versus a deduction. Based on the level of projected future taxable income over the periods for which the deferred tax asset is deductible in Papua New Guinea, management believes that it is more likely than not that our subsidiary will not realize the benefit of this deduction in Papua New Guinea.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity

 

As of December 31, 2009, we had cash and cash equivalents of $108.8 million, a decrease of $63.5 million from December 31, 2008. The following table provides a summary for the last three years:

 

 

Operating Activities

 

Cash flows from operating activities were $110.9 million in 2009, compared to $220.3 million in 2008. The net cash impact of earnings, after adjusting for the write-off of Goodwill in 2008, was a reduction of $113.8 million in 2009. Working capital requirements decreased by $34.0 million in 2009, principally driven by a smaller increase in accounts receivable, a decrease in other current assets, an increase in accounts payable and accrued liabilities and higher accrued income taxes.

 

Cash flows from operating activities were $220.3 million for 2008 compared to $74.3 million for 2007. The increase in cash provided from operating activities is due to decreased working capital requirements and the net effect of a decrease to net income. Lower working capital requirements of $118.8 million were principally driven by a smaller increase in accounts receivable, lower accrued taxes and higher accrued liabilities compared to changes in 2007. Depreciation in 2008 increased to $117.0 million compared to $85.8 million in 2007 due to additional rigs being placed into service and major upgrades to existing rigs. All of our remaining goodwill, $100.3 million, was impaired in 2008 compared to no impairment in 2007.

 

Investing Activities

 

Cash flows used in investing activities were $150.7 million for 2009. Our primary use of cash was $160.1 million for capital expenditures. Major capital expenditures for the period included $62.2 million for

the construction of two new Alaska rigs and $36.8 million for tubular and other rental tools for Quail Tools. Sources of cash included $9.3 million of proceeds from asset sales, and $4.0 million relating to the settlement of a claim involving Barge Rig 57.

 

Cash flows used in investing activities were $196.6 million for 2008. Our primary use of cash was $197.1 million for capital expenditures and a $5.0 million investment in our Saudi joint venture, which was sold in April 2008. Major capital expenditures for the period included $58.3 million on the construction of two new Alaska rigs, $41.5 million for tubulars and other rental tools for Quail Tools and $31.2 million on construction of new international land rigs. Sources of cash included $5.5 million of proceeds from assets sales and insurance proceeds.

 

Our estimated expenditures for 2010 will primarily be directed to our two new Alaska rigs as well as normal levels of maintenance capital. Any discretionary spending will be evaluated based upon adequate return requirements and available liquidity. We believe that from our operating cash flows and borrowings under our revolving credit facilities, as required, we have sufficient cash and available liquidity to sustain operations and fund our capital expenditures for 2010, though there can be no assurance that we will continue to generate cash flows at current levels or be able to obtain additional financing if necessary. See “Item 1A. Risk Factors” for a discussion of additional risks related to our business.

 

Financing Activities

 

Cash flows used in financing activities were $23.6 million for 2009. Our primary uses of cash included a net pay down on our credit facilities of $22.0 million and excess tax benefits from stock options exercised of $1.8 million.

 

Cash flows from financing activities were $88.5 million for 2008. Our primary sources of cash included a net drawdown on our credit facilities of $88.0 million and proceeds of $2.0 million from stock options exercised, offset by a payment of $1.8 million for debt issuance costs relating to our 2008 Credit Facility.

 

2008 Credit Facility

 

On May 15, 2008 we entered into a new Credit Agreement (as amended “the 2008 Credit Facility”) with a five year senior secured $80.0 million revolving credit facility (“Revolving Credit Facility) and a senior secured term loan facility (“Term Loan Facility”) of up to $50.0 million. Our obligations under the 2008 Credit Facility are guaranteed by substantially all of our domestic subsidiaries, except for domestic subsidiaries owned by foreign subsidiaries and certain immaterial subsidiaries, each of which has executed a guaranty. The obligations under the 2008 Credit Facility are secured by a pledge of the stock of all of the subsidiary guarantors, certain immaterial domestic subsidiaries and first-tier foreign subsidiaries, all receivables of the Company and the subsidiary guarantors, a naval mortgage on certain eligible barge drilling rigs owned by a subsidiary guarantor and the inventory and equipment of the Quail Tools, L.P., a subsidiary guarantor, and other tangible and intangible assets of the Company and its subsidiaries. The 2008 Credit Facility contains customary affirmative and negative covenants regarding ratios for consolidated leverage, consolidated interest coverage and consolidated senior secured leverage. As of December 31, 2009 our Consolidated Leverage Ratio was 2.67 to 1 compared to the maximum permitted 4.00 to 1; our Consolidated Interest Coverage Ratio was 5.57 to 1 compared to the minimum permitted 2.50 to 1 and our Consolidated Senior Secured Leverage Ratio was 0.52 to 1 compared to the maximum permitted 1.50 to 1. We do not currently anticipate triggering any of these covenants during 2010.

 

The 2008 Credit Facility is available for general corporate purposes and to fund reimbursement obligations under letters of credit the banks issue on our behalf pursuant to this facility. Revolving loans are available under the 2008 Credit Facility subject to a borrowing base calculation based on a percentage of eligible accounts receivable, certain specified barge drilling rigs and eligible rental equipment of the Company and its subsidiary guarantors. As of December 31, 2009, there were $12.7 million in letters of credit outstanding, $44.0 million outstanding on the Term Loan Facility and $42.0 million outstanding on the Revolving Credit Facility. The Term Loan began amortizing on September 30, 2009 at equal installments of $3.0 million per quarter. As of December 31, 2009, the amount drawn represents 68 percent of the capacity of the Revolving Credit Facility. On January 30, 2009, Lehman Commercial Paper, Inc., one of the lenders under the 2008 Credit Facility, assigned its obligations to Trustmark

National Bank. We expect to use the drawn amounts over the next twelve months to fund construction of two new rigs for work in Alaska. Although the economic downturn may affect certain customers’ ability to pay, the Company anticipates it has sufficient liquidity to meet its expected capital expenditures and manage any delays in collection of receivables.

 

2.125% Convertible Senior Notes

 

As discussed in Note 1 to our consolidated financial statements, our consolidated financial statements as of and for the years ended December 31, 2008 and 2007 have been adjusted to account for the retrospective application related to newly adopted accounting guidance in regards to Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion. The debt discount is accretive to interest expense over the life of the debt. The $15.8 million reclassified to Additional Paid-In Capital supported adjustments to interest expense, deferred income taxes and long-term debt as discussed further in the notes to consolidated financial statements.

 

On July 5, 2007, we issued $125.0 million aggregate principal amount of 2.125% Convertible Senior Notes (the “Notes”) due July 15, 2012. The Notes were issued at par and interest is payable semiannually on July 15th and January 15th.

 

The significant terms of the convertible notes are as follows:

 

 

As of December 31, 2009, none of the conditions allowing holders of the Senior Notes to convert had been met.

 

Concurrently with the issuance of the Notes, the Company purchased a convertible note hedge (the “note hedge”) and sold warrants in private transactions with counterparties that were different than the ultimate holders of the Notes. The note hedge included purchasing free-standing call options and selling free-standing warrants, both exercisable in the Company’s common shares. The note hedge allows us to receive shares of our common stock from the counterparties to the transaction equal to the amount of common stock related to the excess conversion value that we would issue and/or pay to the holders of the Notes upon conversion.

 

The terms of the call options mirror the Notes’ major terms whereby the call option strike price is the same as the initial conversion price as are the number of shares callable, $13.85 per share and 9,027,713 shares respectively. This feature prevents dilution of the Company’s outstanding shares. The warrants allow the Company to sell 9,027,713 common shares at a strike price of $18.29 per share. The conversion price of the Notes remains at $13.85 per share, and the existence of the call options and warrants serve to guard against dilution at share prices less than

$18.29 per share, since we would be able to satisfy our obligations and deliver shares upon conversion of the Notes with shares that are obtained by exercising the call options.

 

We paid a premium of approximately $31.48 million for the call options, and we received proceeds for a premium of approximately $20.25 million for the sale of the warrants. This reduced the net cost of the note hedge to $11.23 million. The expiration date of the note hedge is the earlier of the last day on which the Notes remain outstanding and the maturity date of the Notes.

 

The Notes are classified as a liability in our consolidated financial statements. Because we have the choice of settling the call options and the warrants in cash or shares of our common stock and these contracts meet all of the applicable criteria for equity classification, the cost of the call options and proceeds from the sale of the warrants are classified in stockholders’ equity in the Consolidated Balance Sheets. In addition, because both of these contracts are classified in stockholders’ equity and are solely indexed to our own common stock, they are not accounted for as derivatives.

 

Debt issuance costs totaled approximately $3.6 million and are being amortized over the five year term of the Notes using the effective interest method. Proceeds from the transaction of $110.2 million were used to redeem our outstanding senior floating rate notes (the “Senior Floating Rate Notes”), to pay the net cost of hedge and warrant transactions, and for general corporate purposes.

 

On September 27, 2007, we redeemed $100.0 million face value of our Senior Floating Rate Notes at the redemption price of 101.0 percent. A portion of the proceeds from the sale of our Convertible Senior Notes was used to fund the redemption.

 

2007 Credit Facility

 

On September 20, 2007, we replaced our existing $40.0 million Credit Agreement with a new $60.0 million Amended and Restated Credit Agreement (“2007 Credit Facility”) which would have expired in September 2012. The 2007 Credit Facility, which was replaced by the 2008 facility, was secured by rental tools equipment, accounts receivable and the stock of substantially all of our domestic subsidiaries, other than domestic subsidiaries owned by a foreign subsidiary, and contains customary affirmative and negative covenants such as minimum ratios for consolidated leverage, consolidated interest coverage and consolidated senior secured leverage.

 

Other Liquidity

 

Our principal amount of long-term debt, including current portion, was $423.8 million as of December 31, 2009, which consists of:

 

 

As of December 31, 2009, we had approximately $134.1 million of liquidity, which consisted of $108.8 million of cash and cash equivalents on hand and $25.3 million of availability under the 2008 Credit Facility. We do not have any unconsolidated special-purpose entities, off-balance sheet financing arrangements nor guarantees of third-party financial obligations. We have no energy, commodity, foreign currency or interest rate derivative contracts at December 31, 2009.

The following table summarizes our future contractual cash obligations as of December 31, 2009:

 

 

 

 

We used derivative instruments to manage risks associated with interest rate fluctuations in connection with our $100.0 million Senior Floating Rate Notes which were fully redeemed on September 27, 2007. These derivative instruments, which consisted of variable-to-fixed interest rate swaps, did not meet the criteria for applying hedge accounting and were therefore not designated as hedges. Accordingly, the change in the fair value of the interest rate swaps was recognized in earnings.

 

On July 17, 2007, we terminated one swap scheduled to expire on September 2, 2008, and received $0.7 million. On September 4, 2007, our one remaining swap expired.

 

OTHER MATTERS

 

Business Risks

 

Internationally, we specialize in drilling geologically challenging wells in locations that are difficult to access and can involve harsh environmental conditions. Our international services are primarily utilized by major and national oil companies and integrated service providers in the exploration and development of reserves of oil and gas. In the United States, we primarily drill in the transition zones of the GOM for major and independent oil and gas companies. Business activity is primarily dependent on the exploration and development activities of the companies that make up our customer base. See Item 1A, Risk Factors, for a discussion of risks related to our business.

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally

accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, including those related to bad debts, materials and supplies obsolescence, property and equipment, goodwill, income taxes, workers’ compensation and health insurance and contingent liabilities for which settlement is deemed to be probable. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. While we believe that such estimates are reasonable, actual results could differ from these estimates.

 

We believe the following are our most critical accounting policies as they are complex and require significant judgments, assumptions and/or estimates in the preparation of our consolidated financial statements. Other significant accounting policies are summarized in Note 1 in the notes to the consolidated financial statements.

 

Impairment of Property, Plant and Equipment.  We periodically evaluate our property, plant and equipment to ensure that the net realizable value exceeds our net carrying value. We review our property, plant and equipment for impairment annually and when events or changes in circumstances indicate that the carrying value of such assets may be impaired. For example, evaluations are performed when we experience sustained significant declines in utilization and dayrates and we do not contemplate recovery in the near future, or when we reclassify property and equipment to assets held for sale or as discontinued operations as prescribed by accounting guidance related to accounting for the impairment or disposal of long-lived assets. We consider a number of factors, including estimated undiscounted future cash flows, appraisals less estimated selling costs and current market value analysis in determining net realizable value. Assets are written down to fair value if the fair value is below net carrying value and when step one undiscounted cash flow analysis failed.

 

Asset impairment evaluations are, by nature, highly subjective. They involve expectations about future cash flows generated by our assets and reflect management’s assumptions and judgments regarding future industry conditions and their effect on future utilization levels, dayrates and costs. The use of different estimates and assumptions could result in materially different carrying values of our assets. As a result of certain impairment indicators, primarily the depressed market in the GOM, we tested our long-lived assets for impairment as of December 31, 2009 and determined that three of our rigs; two rigs in our U.S. Drilling segment and one in our International Drilling segment, required reductions of $0.4 million and $1.4 million, respectively in their net book value to salvage value based upon the our evaluation of future marketability, future cash infusions to maintain the equipment and evaluation of current market conditions affecting overall utilization of equipment in the regions in which we currently participate.

 

Insurance Reserves.  Our operations are subject to many hazards inherent to the drilling industry, including blowouts, explosions, fires, loss of well control, loss of hole, damaged or lost drilling equipment and damage or loss from inclement weather or natural disasters. Any of these hazards could result in personal injury or death, damage to or destruction of equipment and facilities, suspension of operations, environmental damage and damage to the property of others. Generally, drilling contracts provide for the division of responsibilities between a drilling company and its customer, and we seek to obtain indemnification from our customers by contract for certain of these risks. To the extent that we are unable to transfer such risks to customers by contract or indemnification agreements, we seek protection through insurance. However, these insurance or indemnification agreements may not adequately protect us against liability from all of the consequences of the hazards described above. Moreover, our insurance coverage generally provides that we assume a portion of the risk in the form of an insurance coverage deductible.

 

Based on the risks discussed above, we estimate our liability in excess of insurance coverage and record reserves for these amounts in our consolidated financial statements. Reserves related to insurance are based on the facts and circumstances specific to the insurance claims and our past experience with similar claims. The actual outcome of insured claims could differ significantly from the amounts estimated. We accrue actuarially determined amounts in our consolidated balance sheet to cover self-insurance retentions for workers’ compensation, employers’ liability, general liability, automobile liability and health benefits claims. These accruals use historical data

based upon actual claim settlements and reported claims to project future losses. These estimates and accruals have historically been reasonable in light of the actual amount of claims paid.

 

As the determination of our liability for insurance claims could be material and is subject to significant management judgment and in certain instances is based on actuarially estimated and calculated amounts, management believes that accounting estimates related to insurance reserves are critical.

 

Accounting for Income Taxes.  We are a U.S. company and we operate through our various foreign branches and subsidiaries in numerous countries throughout the world. Consequently, our tax provision is based upon the tax laws and rates in effect in the countries in which our operations are conducted and income is earned. The income tax rates imposed and methods of computing taxable income in these jurisdictions vary. Therefore, as a part of the process of preparing the consolidated financial statements, we are required to estimate the income taxes in each of the jurisdictions in which we operate. This process involves estimating the actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as depreciation, amortization and certain accrued liabilities for tax and accounting purposes. Our effective tax rate for financial statement purposes will continue to fluctuate from year to year as our operations are conducted in different taxing jurisdictions. Current income tax expense represents either liabilities expected to be reflected on our income tax returns for the current year, nonresident withholding taxes or changes in prior year tax estimates which may result from tax audit adjustments. Our deferred tax expense or benefit represents the change in the balance of deferred tax assets or liabilities reported on the consolidated balance sheet. Valuation allowances are established to reduce deferred tax assets when it is more likely than not that some portion or all of the deferred tax assets will not be realized. In order to determine the amount of deferred tax assets or liabilities, as well as the valuation allowances, we must make estimates and assumptions regarding future taxable income, where rigs will be deployed and other matters. Changes in these estimates and assumptions, as well as changes in tax laws, could require us to adjust the deferred tax assets and liabilities or valuation allowances, including as discussed below.

 

Our ability to realize the benefit of our deferred tax assets requires that we achieve certain future earnings levels prior to the expiration of our net operating loss (“NOL”) carryforwards. In the event that our earnings performance projections do not indicate that we will be able to benefit from our NOL carryforwards, valuation allowances are established. We periodically evaluate our ability to utilize our NOL carryforwards and, in accordance with accounting guidance related to accounting for income taxes, will record any resulting adjustments that may be required to deferred income tax expense.

 

We provide for U.S. deferred taxes on the unremitted earnings of our foreign subsidiaries as the earnings are not permanently reinvested.

 

On January 1, 2007, we adopted amendments to accounting standards related to uncertainty in income taxes. This accounting guidance requires that management make estimates and assumptions affecting amounts recorded as liabilities and related disclosures due to the uncertainty as to final resolution of certain tax matters. Because the recognition of liabilities under this interpretation may require periodic adjustments and may not necessarily imply any change in management’s assessment of the ultimate outcome of these items, the amount recorded may not accurately anticipate actual outcome.

 

Revenue Recognition.  We recognize revenues and expenses on dayrate contracts as drilling progresses. For meterage contracts, which are rare, we recognize the revenues and expenses upon completion of the well. Revenues from rental activities are recognized ratably over the rental term which is generally less than six months. Mobilization fees received and related mobilization costs incurred are deferred and amortized over the term of the contract period. Construction contract revenues and costs are recognized on a percentage of completion basis utilizing the cost-to-cost method.

 

Recent Accounting Pronouncements

 

Consolidation — Effective January 1, 2009, we adopted the accounting standards update related to noncontrolling interest that established accounting and reporting requirements for noncontrolling interest in a subsidiary and the deconsolidation of a subsidiary. The update required that noncontrolling interest be reported as equity on the consolidated balance sheet and required that net income attributable to controlling interest and to

noncontrolling interest be shown separately on the face of the statement of operations. The update also changes accounting for losses attributable to noncontrolling interests. Our adoption did not have a material effect on our consolidated balance sheet, statements of operations or cash flows.

 

Fair Value Measurements and Disclosures — Effective January 1, 2008, we adopted the accounting standards update related to fair value measurement of financial instruments that defined fair value, thereby offering a single source of guidance for the application of fair value measurement, established a framework for measuring fair value that contains a three-level hierarchy for the inputs to valuation techniques, and required enhanced disclosures about fair value measurements. Our adoption did not have a material effect on our consolidated balance sheet, statements of operations or cash flows.

 

Effective January 1, 2009, we adopted the remaining provisions of the accounting standards update for fair value measurement of nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. Our adoption did not have a material effect on our consolidated balance sheet, statements of operations or cash flows.

 

Effective April 1, 2009, we adopted the accounting standards update related to measuring fair value when the volume and level of activity for the assets or liability have significantly decreased and identifying transactions that are not orderly, which provided additional guidance for estimating fair value when there is no active market or where the activity represents distressed sales on an interim and annual reporting basis. Our adoption did not have a material effect on our consolidated balance sheet, statements of operations or cash flows.

 

Subsequent Events — Effective for events occurring subsequent to June 30, 2009, we adopted the accounting standards update regarding subsequent events, which established the period after the balance sheet date during which management should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. Our adoption did not have a material impact on the disclosures contained within our notes to consolidated financial statements.

 

 

Foreign Exchange Risk

 

Our international operations expose us to foreign exchange risk. There are a variety of techniques to minimize the exposure to foreign exchange risk, including customer contract payment terms and the possible use of foreign exchange derivative instruments. Our primary foreign exchange risk management strategy involves structuring customer contracts to provide for payment in both U.S. dollars, which is our functional currency, and local currency. The payment portion denominated in local currency is based on anticipated local currency requirements over the contract term. Due to various factors, including customer acceptance, local banking laws, other statutory requirements, local currency convertibility and the impact of inflation on local costs, actual foreign exchange needs may vary from those anticipated in the customer contracts, resulting in partial exposure to foreign exchange risk. Fluctuations in foreign currencies typically have not had a material impact on our overall results. In situations where payments of local currency do not equal local currency requirements, foreign exchange derivative instruments, specifically foreign exchange forward contracts, or spot purchases, may be used to mitigate foreign currency risk. A foreign exchange forward contract obligates us to exchange predetermined amounts of specified foreign currencies at specified exchange rates on specified dates or to make an equivalent U.S. dollar payment equal to the value of such exchange. We do not enter into derivative transactions for speculative purposes. At December 31, 2009, we had no open foreign exchange derivative contracts.

 

Interest Rate Risk

 

We are exposed to changes in interest rates through our fixed rate long-term debt. Typically, the fair market value of fixed rate long-term debt will increase as prevailing interest rates decrease and will decrease as prevailing interest rates increase. The fair value of our long-term debt is estimated based on quoted market prices where applicable, or based on the present value of expected cash flows relating to the debt discounted at rates currently

available to us for long-term borrowings with similar terms and maturities. The estimated fair value of our $225.0 million principal amount of 9.625% Senior Notes due 2013, based on quoted market prices, was $231.2 million at December 31, 2009. The estimated fair value of our $125.0 million principal amount of 2.125% Convertible Senior Notes due 2012 was $113.1 million on December 31, 2009. A hypothetical 100 basis point increase in interest rates relative to market interest rates at December 31, 2009 would decrease the fair market value of our long-term debt at December 31, 2009 by approximately $22.3 million for the 9.625% Senior Notes and $33.8 million for the 2.125% Convertible Senior Notes.

 

In 2004, we entered into two variable-to-fixed interest rate swap agreements. The swap agreements did not qualify for hedge accounting and accordingly, we reported the mark-to-market change in the fair value of the interest rate derivatives in earnings. For the year ended December 31, 2007, we recognized a $0.7 million decrease in the fair value of the derivative positions. On July 17, 2007, we terminated one swap scheduled to expire in September 2008 and received $0.7 million. The second swap was not renewed and expired on September 4, 2007.

 

The Board of Directors and Stockholders

Parker Drilling Company:

 

We have audited the accompanying consolidated balance sheets of Parker Drilling Company and subsidiaries (the Company) as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2009. In connection with our audits of the consolidated financial statements, we also have audited the financial statement Schedule II — Valuation and Qualifying Accounts for each of the years in the three-year period ended December 31, 2009. We also have audited the Company’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting in Item 9A. Controls and Procedures. Our responsibility is to express an opinion on these consolidated financial statements, the financial statement schedule and the Company’s internal control over financial reporting based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Parker Drilling Company and subsidiaries as of December 31, 2009 and 2008, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also in our opinion, Parker Drilling Company and

subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

As discussed in note 1 to the consolidated financial statements, the Company has changed its method of accounting for convertible debt instruments in 2008 and 2007 due to the adoption of new accounting for convertible debt instruments.

 

 

Houston, Texas

March 3, 2010

PARKER DRILLING COMPANY AND SUBSIDIARIES

 

CONSOLIDATED STATEMENT OF OPERATIONS