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):

 

 

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, 2010 was $446.3 million. At February 18, 2011, there were 116,408,639 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 5, 2011 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 an international provider of contract drilling and drilling-related services currently operating in 12 countries. We have operated in 53 foreign countries and the United States since beginning operations in 1934, 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 practices are among the leaders in our industry.

 

Our 2010 revenues were derived from the following 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, 2010, our available fleet of rigs consisted of:

 

 

In 2008, we began the construction of two newbuild land rigs designed to operate in the Alaskan environment. These rigs are expected to be delivered to Alaska in mid-2011. We anticipate drilling operations will commence in late 2011 upon final acceptance of the two rigs by our customer, BP.

 

Our International Drilling Business

 

The international drilling markets in which we operate have one or more of the following characteristics:

 

 

 

Our Rental Tools Business

 

We provide premium rental tools for land and offshore oil and gas drilling and workover activities, offering a full line of drill pipe, drill collars, tubing, high- and low-pressure blowout preventers, choke manifolds, junk and cement mills and casing scrapers. The base of operations for our rental tools business is in New Iberia, Louisiana. Other facilities where we hold an inventory of rental tools and provide service to our customers are located in Texas, Wyoming, North Dakota and Pennsylvania.

 

Our current market for rental tools is primarily U.S. land drilling, a cyclical market driven by commodity pricing and availability of project financing. The increase in unconventional lateral or horizontal drilling, often used in drilling shale formations, has added to the market demand for rental tools, keeping our current market focus in the regions of the primary shale plays.

 

Our principal customers are major and independent oil and gas exploration and production companies operating in the U.S. energy producing markets on land and in the GOM. Generally, tools are used for only a portion of a well drilling program and are requested by the customer at the time they are needed. As a result, they are usually rented on a daily or monthly basis, requiring us to keep a broad inventory of tools in stock. Approximately 15 percent of revenues from our rental tools business are derived from equipment used in offshore and coastal water operations of the GOM. In addition, from our locations within the United States, we provide tool rentals to customers operating internationally in countries including Angola, Brazil, Canada, Chad, Congo, Egypt, Equatorial Guinea, Libya, Mexico, Russia and the United Arab Emirates. During the years ended December 31, 2010, 2009 and 2008, approximately 5 percent, 9 percent and 2 percent of Rental Tools’ revenues were derived from equipment used in international applications, respectively.

 

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 (e.g., labor, maintenance, logistics, etc.) for operators who own their own drilling rigs and who choose to engage our technical expertise to perform contracted services. We have ongoing O&M and project management activities in Alaska, Kuwait and Sakhalin Island, Russia. We are also currently involved in one pre-FEED study project and are in the detailed engineering and procurement phase of the Arkutun Dagi project for Exxon Neftegas Limited (ENL).

 

Our Construction Contract Business

 

In 2008, we commenced the construction phase of the BP-owned Liberty extended reach drilling rig project. We believe the Liberty rig is one of the most technologically advanced drilling rigs in the world, designed to drill ultra-extended reach wells nearly two miles deep and eight miles out from the drilling pad. The rig is currently in place on a satellite drilling island in Alaska. In November 2010, our customer, BP, suspended construction of the rig while it reviews the rig’s engineering and design, including its safety systems. For more information, see Part II, Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Other Matters — “Liberty Project Status.”

 

In August 2009, Parker Drilling Arctic Operating, Inc. was awarded the O&M contract for the BP-owned Liberty rig, a land-based rig targeting the Liberty field. However, as noted above, in November 2010, BP suspended construction of the rig while it reviews the rig’s engineering and design, including its safety systems. The O&M contract will expire on June 1, 2011, unless extended. For more information, see Part II, Item 7 — Management’s

Discussion and Analysis of Financial Condition and Results of Operations — Other Matters — “Liberty Project Status.”

 

Our U.S. Gulf of Mexico and Inland Waterways Business

 

The drilling industry in the GOM is characterized by cyclical activity where utilization and dayrates are typically driven by current oil and natural gas prices and availability of project financing. Within this area, we operate barge rigs in the shallow waters in and along the inland waterways and coasts of Louisiana and Texas. Our rigs drill for natural gas, oil and a combination of oil and natural gas. Contract terms are typically well-to-well, with durations averaging 30 to 150 days. During periods of strong market demand, typically driven by high commodity prices, contract drilling terms can extend up to twelve months and longer.

 

During 2010, the drilling industry was impacted by the Macondo well fire and ensuing oil spill in the U.S. Gulf of Mexico. The drilling moratorium that followed had marginal impact on our barge drilling permit process, however, additional regulatory compliance enacted required us to accelerate certain upgrades already being made to the fleet in order to fully comply with the newly adopted regulatory requirements.

 

Our Strategy

 

Our strategy is to achieve and maintain market leadership in selected international markets as a provider of drilling and drilling-related services and products that include, rental tools, and 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 our brand by leveraging our core competencies, or “four pillars” as described below; to provide best value solutions; and to exercise financial discipline. 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 by building, upgrading and maintaining a fleet of rigs that we expect to be preferred by operators because of their quality and dependability, and through placing those rigs in areas we believe present long-term oil and natural gas 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:

 

 

Differentiating our 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:  We believe industry-leading safety performance is a crucial factor in our status as a preferred drilling contractor and rental tools supplier. We have a portfolio of metrics and processes we apply to reinforce and continually improve our safety and environmental 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 76-year legacy of developing new technologies for drilling in frontier environments. Our rigs continue to 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, minimize environmental impacts, and enhance safety.

 

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

 

Maintaining Financial Discipline.  We strive to maintain strong financial controls and disciplines in all aspects of our business to ensure that our internal assessment of projects and plans adhere to solid financial principles. Our operating philosophy emphasizes continuous improvement of processes, equipment standardization, global quality, safety, supply chain management, and vigilance in monitoring and controlling costs. Capital expenditures are aligned with core objectives. 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.

 

2010 Strategic Actions

 

In 2010 the following actions, among others, were the direct result of implementing the strategy discussed above:

 

 

 

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:

 

Outstanding Safety, Planned Maintenance, Inventory Control and Training Programs.  We continue to have an outstanding safety record. In 2010, our Total Recordable Incident Rate (TRIR) was 23% ahead of our targeted goal with 93% of our facilities reporting Incident Free Operations (IFO). Our safety record, as evidenced by our low TRIR, and IFO results has made us one of the leaders 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. Our safety and training programs also contain consideration of environmental safety and conservation, helping us avoid environmental incidents. 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 for drilling rigs owned by third parties. Our training centers in Louisiana, Alaska and New Zealand provide safety and technical training curricula in four different languages and provide regulatory compliance training throughout the world.

 

Geographically Targeted Operations and Assets.  We currently maintain, operate or manage rigs in Algeria, Colombia, Indonesia, Kazakhstan, Kuwait, Mexico, New Zealand, Russia, Papua New Guinea and the United States. In addition, we operate rental tool stores in seven targeted locations in the U.S. We have operated in 53 foreign countries and the United States, making us among the most geographically experienced drilling contractors in the world. Our international revenues, including drilling, project management and engineering services provided in international locations, comprised 45 percent of our total revenues for the year ended December 31, 2010.

 

Technological Leadership.  We have a demonstrated history of technological leadership within the drilling industry. Our previous contributions to the industry include the patented heli-hoist rig design, winterized rigs on wheels for arctic drilling, and an arctic-class barge rig to explore the Caspian Sea. We have established extended reach drilling depth records on several occasions, the latest achieved in December 2010 with the Yastreb rig drilling at Sakhalin Island, Russia. This well reached 40,502 feet — approximately seven and two-thirds miles — in total measured depth as it drilled under the sea floor to access the Odoptu field for ENL’s Sakhalin-1 project.

 

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 the Company 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 president and chief executive officer and member of the board of directors since 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 industry experience to his role. Our chief financial officer, W. Kirk Brassfield, joined the Company 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 20 years in the energy industry. Philip Agnew, vice president of Technical Services, joined the company in late 2010, bringing with him more than 20 years of experience in design, construction and project management expertise.

 

Project Management.  We are active in managing and providing labor resources for drilling rigs owned by third parties. In Russia, we manage two drilling operations for the ENL Sakhalin-1 project, the Yastreb land rig and the Orlan platform. We designed, constructed and provided the Yastreb land rig to ENL and continue to manage drilling operations under a multi-year O&M contract. We also operate the Orlan platform under a multi-year O&M contract for ENL.

 

We also provide management and technical services in addition to labor services on third party-owned drilling rigs in Kuwait and have provided similar services for other operators in the past.

 

Customers

 

Our customer base consists of major, independent and national oil and gas companies and integrated service providers. In 2010, our two largest customers, BP and ExxonMobil (including subsidiaries and joint ventures of each), accounted for approximately 12.4 percent and 11.6 percent of our total revenues, respectively. Our revenues associated with BP are primarily for the construction of the BP-owned Liberty rig. Our revenues from ExxonMobil

are primarily for drilling-related services. Our ten most significant customers collectively accounted for approximately 58.0 percent of our total revenues in 2010.

 

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 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 and experience. 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 (See also Item 1A — Risk Factors).

 

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 ready-stack rigs, a standby mode of operational readiness where our support costs are reduced while the equipment is maintained in a near market-ready condition for quick return to operations. This strategy can result in safer and more efficient operations.

 

We believe that our rental tools business, Quail Tools, L.P., is one of the leading rental tools companies in the U.S. oil and gas drilling markets. Quail Tools competes against other rental tool companies based on price and quality of service.

 

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 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 believe we are currently a preferred contractor for operators in both U.S. and international locations, which we believe is a result of our reputation for providing efficient, safe, environmentally conscious and innovative drilling services, in addition to quality 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, customer stoppage, 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, lost-in-hole 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. In addition, mobilization and demobilization of rigs in arctic regions can be affected by seasonal changes in weather.

 

Insurance and Indemnification

 

Our operations are subject to hazards inherent in the drilling industry, such as blowouts, reservoir damage, loss of production, loss of well control, lost or stuck drill strings, equipment defects, punch throughs, craterings, fires, explosions, pollution, and damage or loss during transportation. These hazards can cause personal injury or loss of life, severe damage to or destruction of property and equipment, pollution or environmental damage, which could lead to claims by third parties or customers, suspension of operations and contract terminations. Our fleet is also subject to hazards inherent in marine operations, either while on-site or during mobilization, such as capsizing, sinking, grounding, collision, damage from severe weather and marine life infestations.

 

Our drilling contracts provide for varying levels of indemnification between ourselves and our customers, including with respect to well control and subsurface risks. We also maintain insurance for personal injuries, damage to or loss of equipment and other insurance coverage for various business risks. Our insurance policies typically consist of 12-month policy periods.

 

Our insurance program provides coverage, to the extent not otherwise paid by the customer under the indemnification provisions of the drilling contract, for liability due to control-of-well events, liability arising from named windstorms and liability arising from third-party claims, including wrongful death and other personal injury claims by our personnel as well as claims brought on behalf of individuals who are not our employees. Generally, our program provides liability coverage up to $200 million, with a retention of $1 million or less.

 

Control-of-well events generally include an unintended flow from the well that cannot be contained by using equipment on site (e.g., a blowout preventer), by increasing the weight of drilling fluid or by diverting the fluids safely into production. Our program provides coverage for third-party liability claims relating to pollution from a control-of-well event up to $200 million per occurrence, with the first $10 million of such coverage also covering re-drilling of the well and control-of-well costs under a Contingent Operators Extra Expense policy. Our program also provides coverage for liability resulting from pollution events originating from our rigs up to $200 million per occurrence. We retain the risk for liability not indemnified by the customer below the retention and in excess of our insurance coverage. In addition, our insurance program covers only sudden and accidental pollution.

 

Our insurance program also provides coverage for physical damage to, including total loss or constructive total loss of, our rigs, including damage arising from a named windstorm in the U.S. Gulf of Mexico up to $20 million.

 

Our drilling contracts provide for varying levels of indemnification from our customers and in most cases may require us to indemnify our customers. Under our drilling contracts, liability with respect to personnel and property is customarily assigned on a “knock-for-knock” basis, which means that we and our customers assume liability for our respective personnel and property. However, in certain drilling contracts we assume liability for damage to our customer’s property and other third-party property on the rig resulting from our negligence, subject to negotiated caps per occurrence, and in other contracts we are not indemnified by our customers for damage to their property and, accordingly, could be liable for any such damage under applicable law. In addition, our customers typically indemnify us for damage to our equipment down-hole, and in some cases our subsea equipment, generally based on replacement cost minus some level of depreciation.

 

Our customers typically assume responsibility for and indemnify us from any loss or liability resulting from pollution or contamination, including clean-up and removal and third-party damages, arising from operations under the contract and originating below the surface of the land or water, including as a result of blow-outs or cratering of

the well. In some drilling contracts, however, we may have liability for damages resulting from such pollution or contamination caused by our gross negligence, or, in some cases, ordinary negligence.

 

We generally indemnify the customer for legal and financial consequences of spills of industrial waste, lubricants, solvents and other contaminants (other than drilling fluid) on the surface of the land or water originating from our rigs or equipment. We typically require our customers to retain liability for spills of drilling fluid (sometimes called “mud”) which circulates down-hole to the drill bit, lubricates the bit and washes debris back to the surface. Drilling fluid often contains a mixture of synthetics, the exact composition of which is prescribed by the customer based on the particular geology of the well being drilled.

 

The above description of our insurance program and the indemnification provisions typically found in our drilling contracts is only a summary as of the date hereof and is general in nature. Our insurance program and the terms of our drilling contracts may change in the future. In addition, the indemnification provisions of our drilling contracts may be subject to differing interpretations, and enforcement of those provisions may be limited by public policy and other considerations.

 

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 Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE) 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. barge drilling rigs have zero-discharge capabilities as required by law, such as 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, are 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. In the United States, federal legislation imposing restrictions on GHGs is under consideration. Proposed legislation has been introduced that would establish an economy-wide cap on emissions of GHGs and would require most sources of GHG emissions to obtain GHG emission “allowances” corresponding to their annual emissions. In addition, the EPA is taking steps that would result in the regulation of GHGs as pollutants under the CAA. To-date, the EPA has issued (i) a “Mandatory Reporting of Greenhouse Gases” final rule, effective December 29, 2009, which establishes a new comprehensive scheme requiring operators of stationary sources in the United States emitting more than established annual thresholds of carbon dioxide-equivalent GHGs to inventory and report their GHG emissions annually; (ii) an “Endangerment Finding” final rule, effective January 14, 2010 which states that current and projected concentrations of six key GHGs in the atmosphere, as well as emissions from new motor vehicles and new motor vehicle engines, threaten public health and welfare, which allowed the EPA to finalize motor vehicle GHG standards (the effect of which could reduce demand for motor fuels refined from crude oil); and (iii) a final rule, effective August 2, 2010, to address permitting of GHG emissions from stationary sources under the CAA’s Prevention of Significant Deterioration (PSD) and Title V programs. This final rule “tailors” the PSD and Title V programs to apply to certain stationary sources of GHG emissions in a multi-step process, with the largest sources first subject to permitting. Finally, on November 8, 2010, the EPA finalized new GHG reporting requirements for upstream petroleum and natural gas systems, which will be added to the EPA’s GHG reporting rule. Facilities containing petroleum and natural gas systems that emit 25,000 metric tons or more of CO₂ equivalent per year will now be required to report annual GHG emissions to EPA, with the first report due on March 31, 2012.

 

Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws, regulations, treaties or international agreements related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws,

regulations, treaties or international agreements reduce the worldwide demand for oil and natural gas or otherwise result in reduced economic activity generally. In addition, such laws, regulations, treaties or international agreements could result in increased compliance costs or additional operating restrictions, which may have a negative impact on our business. In addition to potential impacts on our business directly or indirectly resulting from climate-change legislation or regulations, our business also could be negatively affected by climate-change related physical changes or changes in weather patterns. An increase in severe weather patterns could result in damages to or loss of our rigs, impact our ability to conduct our operations and result in a disruption of our customers’ operations.

 

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 Contract. Information about our reportable segments and operations by geographic areas for the years ended December 31, 2010, 2009 and 2008 is set forth in Note 10 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 and construction 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, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data, 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 occurs, our business, financial condition or results of operations could be adversely affected.

 

Risks Related to 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 losses.

 

The success of our operations is significantly 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:

 

 

Our operations were impacted by the 2010 drilling rig accident in the U.S. Gulf of Mexico and its consequences and could be adversely affected in the future

 

On April 22, 2010, the Deepwater Horizon, a deepwater drilling rig owned by another contractor that was operating in the U.S. Gulf of Mexico, sank after an apparent blowout and fire (Macondo well blowout). In response to the incident, on May 30, 2010, the BOEMRE, of the U.S. Department of the Interior, at the time known as the Minerals Management Service implemented a moratorium on certain drilling activities in the U.S. Gulf of Mexico (GOM). On October 12, 2010, the BOEMRE announced that it was lifting the moratorium subject to certain specified conditions. During the pendency of the moratorium, the BOEMRE implemented various environmental, technological and safety measures intended to improve offshore safety systems and environmental protection. Among other things, each operator is required to conduct a specific review of its operations and to certify to the BOEMRE that it is in compliance with the new requirements and current regulations. Operators are also required to submit independent third-party reports on the design and operation of certain pieces of drilling equipment, including blowout preventers (BOPs) and other well control systems and to conduct tests on the functionality of various rig parts and to submit the results of those tests to the BOEMRE. Additional regulations address new standards for certain equipment involved in the construction of offshore wells, especially BOPs, and require operators to implement and enforce a safety and environmental management system including regular third-party audits of safety procedures and drilling equipment to insure that offshore rig personnel and equipment remain in compliance with the new regulations. With respect to operations that were subject to the moratorium, the reports and certifications are required to be provided to the BOEMRE prior to commencement of operations following expiration of the moratorium.

As a consequence of the Macondo well blowout, the resulting moratorium, increased regulation and longer times to obtain required permits, offshore drilling operations in the GOM have been significantly reduced. Although we had no ongoing drilling operations directly subject to the now lifted moratorium, our Rental Tools segment has customers with operations that were negatively affected. In addition, some contract drillers and operators with floating rigs located in the region have chosen to relocate the units to other international drilling areas. We cannot currently predict the rate at which new well permits will be issued or the rate at which rigs will be allowed to return to work once compliance with the new regulations has been demonstrated. The process followed by the BOEMRE to review and approve well permit applications is likely to continue to be protracted relative to past experience, resulting in significant delays in the resumption of drilling in deepwater GOM that could persist through 2011. Significant continuing delay in the issuance of drilling permits or the resumption of operations, the possibility of additional regulations and government oversight and the possibility of increased legal liability could cause additional floating rigs to depart the U.S. GOM, with fewer customers operating in the region. If this were to occur, the market for our rental tools could be further adversely affected.

 

Continued effects of the economic recession may result in lower 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.

 

Continued effects of the economic recession or a further slowdown in economic activity could lead to uncertainty in corporate credit availability and capital market access and could reduce worldwide demand for energy and result in 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. Depressed oil and gas prices will reduce the level 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 revenue 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. Likewise, continued effects of the economic recession also could impact our vendors’ and suppliers’ ability to meet obligations to provide materials and services in general. All of these factors 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 regularly make significant expenditures in connection with upgrading and refurbishing our rig fleet. These activities include planned upgrades to maintain quality standards, routine maintenance and repairs, changes made at the request of customers, and changes made to comply with environmental or other 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:

 

 

 

Any one of the above risks 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, delay commencement of a drilling contract 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 skilled labor 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. 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 debt levels and debt agreement restrictions may limit our liquidity and flexibility in obtaining additional financing and in pursuing other business opportunities.

 

As of December 31, 2010, 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, demand for our rental tools, 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 specified in our then 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 restrictions in 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 2011 will be approximately $160 to $175 million, including approximately $75 to $85 million for maintenance projects and investments in rental tool equipment. 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 9.125% 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.

Certain of our contracts are subject to cancellation or delay by our customers without penalty and 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, a customer may no longer need a rig that is currently under contract or may be able to obtain a comparable rig at a lower daily rate. Further, due to government actions, a customer may no longer be able to operate in, or it may not be economical to operate in, certain regions. As a result, 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. In our construction operations, if a rig is not timely delivered to a customer or does not pass acceptance testing, a customer may in certain circumstances have the right to terminate the contract. Even the payment of a termination fee may not fully compensate us for the loss of the contract. Early termination of a contract may result in a rig being idle for an extended period of time. The likelihood that a customer may seek to terminate a contract is increased during periods of market weakness. The cancellation or renegotiation of a number of our drilling contracts could materially reduce our revenue and profitability. In November 2010, BP suspended construction on the Liberty extended-reach drilling rig in Alaska, which is the sole project in our construction contract segment, and our construction contract has expired. In addition, our O&M contract with respect to the Liberty rig is scheduled to expire on June 1, 2011. BP has identified several areas of concern for which it has asked us to provide explanation and documentation, and we have done so. It is not possible to predict when or if BP will resume construction on the Liberty rig, or what additional actions it may request that we take with respect to the areas of concern it has raised. For more information about the status of the Liberty project, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Other Matters — “Liberty Project Status.”

 

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 could adversely affect us. In 2010, our two largest customers, BP and ExxonMobil (including subsidiaries and joint ventures) accounted for approximately 12.4 percent and 11.6 percent of our total revenues, respectively. Our revenues associated with BP are primarily for the construction of the BP-owned Liberty rig. Our revenues from ExxonMobil are primarily for drilling-related services. Our ten most significant customers collectively accounted for approximately 58.0 percent of our total revenues in 2010. Our results of operations could be adversely affected if any of our significant customers terminate their contracts with us, fail to renew our existing contracts or refuse to award new contracts to us.

 

The contract drilling and the rental tools businesses are highly competitive and cyclical, with intense price competition.

 

The contract drilling and rental tools markets are highly competitive and although we believe 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 countries that may provide them with significant tax advantages that are not available to us as a U.S. company and which may 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 some of the markets in which 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 operating, 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 international operations are also subject to governmental regulation and other risks.

 

We derive a significant portion of our revenues from our international operations. In 2010, we derived approximately 45 percent of our revenues from operations in countries outside the United States. Our international operations are subject to the following risks, among others:

 

 

We currently have operations in 12 countries. 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. Recent civil and political disturbances in Tunisia, Egypt, Libya and other North African countries may affect our operations. We currently have 2 rigs in Algeria. To the extent that Algeria experiences similar events, our operations in Algeria could be adversely affected. 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 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.

In addition, 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.

 

A 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.

 

The shipment of goods, services and technology across international borders subjects us to extensive trade laws and regulations. Our import activities are governed by the unique customs laws and regulations in each of the countries where we operate. Moreover, many countries, including the U.S., control the export and re-export of certain goods, services and technology and impose related export recordkeeping and reporting obligations. Governments may also impose economic sanctions against certain countries, persons and other entities that may restrict or prohibit transactions involving such countries, persons and entities.

 

The laws and regulations concerning import activity, export recordkeeping and reporting, export control and economic sanctions are complex and constantly changing. These laws and regulations can cause delays in shipments and unscheduled operational downtime. Moreover, any failure to comply with applicable legal and regulatory trading obligations could result in criminal and civil penalties and sanctions, such as fines, imprisonment, debarment from governmental contracts, seizure of shipments and loss of import and export privileges.

 

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 fully 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. For a description of our indemnification obligations and insurance, please read Item 1. “Business — Insurance and Indemnification.”

 

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 effects of 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 become more stringent 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 locations 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.”

 

Regulation of greenhouse gases and climate change could have a negative impact on our business.

 

Some 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 warming of the earth’s atmosphere and other climatic changes. 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 the countries that had ratified it. International discussions are underway to develop a treaty to replace the Kyoto Protocol after its expiration in 2012. In the United States, federal legislation imposing restrictions on GHGs is under consideration. In addition, the EPA is taking steps that would result in the regulation of GHGs as pollutants under the Clean Air Act (the CAA). To date, the EPA has issued (i) a “Mandatory Reporting of Greenhouse Gases” final rule, effective December 29, 2009, which establishes a new comprehensive scheme requiring operators of stationary sources in the United States emitting more than established annual thresholds of carbon dioxide-equivalent GHGs to inventory and report their GHG emissions annually; (ii) an “Endangerment Finding” final rule, effective January 14, 2010, which states that current and projected concentrations of six key GHGs in the atmosphere, as well as emissions from new motor vehicles and new motor vehicle engines, threaten public health and welfare, which allowed the EPA to finalize motor vehicle GHG standards (the effect of which could reduce demand for motor fuels refined from crude oil); and (iii) a final rule, effective August 2, 2010, to address permitting of GHG emissions from stationary sources under the CAA’s Prevention of Significant Deterioration (PSD) and Title V programs. This final rule “tailors” the PSD and Title V programs to apply to certain stationary sources of GHG emissions in a multi-step process, with the largest sources first subject to permitting. Finally, on November 8, 2010, the EPA finalized new GHG reporting requirements for upstream petroleum and natural gas systems, which will be added to the EPA’s GHG reporting rule. Facilities containing petroleum and natural gas systems that emit 25,000 metric tons or more of CO₂ equivalent per year will now be required to report annual GHG emissions to EPA, with the first report due on March 31, 2012.

 

Because our business depends on the level of activity in the oil and natural gas industry, existing or future laws, regulations, treaties or international agreements related to GHGs and climate change, including incentives to conserve energy or use alternative energy sources, could have a negative impact on our business if such laws, regulations, treaties or international agreements reduce the worldwide demand for oil and natural gas or otherwise result in reduced economic activity generally. In addition, such laws, regulations, treaties or international

agreements could result in increased compliance costs or additional operating restrictions, which may have a negative impact on our business. In addition to potential impacts on our business directly or indirectly resulting from climate-change legislation or regulations, our business also could be negatively affected by climate-change related physical changes or changes in weather patterns. An increase in severe weather patterns could result in damages to or loss of our rigs, impact our ability to conduct our operations and/or result in a disruption of our customers’ operations.

 

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 11, “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, we 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 our 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 our use of customs agents in certain countries in which we currently operate 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 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 we formerly conducted business through a joint venture relationship in Kazakhstan. The joint venture no longer does business with the foreign subcontractor.

 

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 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 us, 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.

 

Increased regulation of hydraulic fracturing could result in reductions or delays in drilling and completing new oil and natural gas wells, which could adversely impact the demand for rental tools.

 

Hydraulic fracturing is a process sometimes used in the completion of oil and gas wells whereby water, sand and chemicals are injected under pressure into subsurface formations to stimulate gas and, to a lesser extent, oil production. The EPA recently initiated a study to investigate the potential adverse impacts that fracturing may have on water quality and public health. Legislation has also been introduced in the U.S. Congress and some states that would require the disclosure of chemicals used in the fracturing process. If enacted, the legislation could cause operational delays or increased costs in exploration and production, which could adversely affect the demand for our rental tools.

 

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 9.125% Senior Notes upon a change of control.

 

Upon the occurrence of specific change of control events affecting us, the holders of our 9.125% 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 9.125% 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. Additionally, any credit facility in place at the time of a repurchase or conversion of the notes may also limit our ability to use borrowings under that credit facility 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 9.125% 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 9.125% 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 with respect to the related indebtedness. If a default were to occur, the holders of our 9.125% 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 and Barge Rigs

 

The following table shows, as of December 31, 2010, the locations and drilling depth ratings of our rigs available for service:

 

 

 

 

 

The following table presents our utilization rates and rigs available for service for the years ended December 31, 2010 and 2009:

 

 

 

 

 

For information on Legal Proceedings, see Note 11, 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.” The following table sets forth the high and low sales prices per share of our 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 February 18, 2011, our common stock was held by 1,774 holders of record and we had an estimated 20,987 beneficial owners.

 

Restrictions contained in our existing credit agreement and the indenture for the 9.125% Senior Notes restrict the payment of dividends. We have no present intention to pay dividends on our common stock in the foreseeable future.

 

Issuer Purchases of Equity Securities

 

The Company currently has no active share repurchase programs. Periodically, the Company purchases shares on the open market to meet our employer matching requirements under our Defined Contribution Plan. Additionally when restricted stock awarded by the Company 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 in the table below:

 

 

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, 2010. 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

 

Overview

 

Our results during the 2010 fourth quarter, and year, reflect our targeted geographic presence and complementary business mix that provide balance in what can be defined as a cyclical industry. Increases in revenues and earnings from our rental tools and barge drilling operations in the U.S. along with our project management business helped mitigate the effect of a slowdown in the utilization of our international rig fleet. We continue to make growth-oriented investments in our businesses, guided by our long-term strategy. In 2010, we had significant growth in our rental tools business. We continue to make strategic capital investments in this business and have expanded capabilities to service operators in several of the growing U.S. shale plays. We maintained a lead position in the U.S. barge drilling market based upon our performance, previous investment and upgrades to the barge fleet, as well as enhanced crew training. Despite the decline in E&P spending in some of our international drilling markets, we renewed and extended some existing contracts and obtained new contracts as customers turned to us to meet their drilling needs.

 

Our significant achievements of 2010 include:

 

 

Our recent performance and operating results during the 2010 fourth quarter have been driven by many of the same factors that have impacted our full year performance. Rental Tools segment revenues, segment gross margin and segment gross margin as a percent of revenues set new records. With facilities strategically located in key U.S. drilling markets and recent timely investments in rental tool inventory, our Rental Tools business continued to benefit from the continued growth in the development of shale formations and the expanded use of lateral drilling to exploit oil and natural gas resources. This led to increased demand, higher utilization and improved pricing. The increase in onshore demand was slightly offset by a decline in U.S. offshore and international revenues.

 

Our U.S. Drilling segment revenues, segment gross margin and segment gross margin as a percent of revenues increased, compared to the 2009 fourth quarter. Barge drilling in the shallow water and inland areas of the Gulf of Mexico remained active and we achieved improvements, year-to-year, in rigs working and dayrates.

 

International Drilling segment revenues, segment gross margin and segment gross margin as a percent of revenues all declined compared to the 2009 fourth quarter, primarily due to a reduction in drilling activity in the CIS/AME region and Mexico that resulted in a decline in rig utilization and lower revenues. This was offset in part by higher revenues from our Caspian Sea arctic barge rig which returned to a warm-stack rate during the fourth quarter of 2010, having been on a lower average dayrate in the prior year’s fourth quarter. Though operating costs were reduced as utilization declined, they were unable to keep pace with the decline in revenues.

Project Management and Engineering Services segment revenues increased while segment gross margin and segment gross margin as a percent of revenues declined. The increase in revenues was primarily due to higher operating rates on the Yastreb rig and Orlan platform and increased engineering services revenues. The segment’s gross margin decline is primarily attributable to lower earnings on the 2010 fourth quarter’s engineering revenues compared with those of the prior year’s comparable period. Construction Contract revenues and earnings declined compared to the prior year’s fourth quarter, representative of the work completed during each period on the customer-owned Liberty rig.

 

Outlook

 

Growing demand and improving pricing in our U.S. markets for rental tools and barge drilling were sources of revenue and gross margin increases in 2010. Our project management business provided relatively steady results while international drilling activity experienced a decline in E&P spending in many of the markets we serve.

 

Looking ahead, we believe the rental tools business should continue to benefit from continued growth in U.S. drilling activity in the oil and liquid-rich shale plays. We expect to make further investments in this business which should contribute to our growth potential. We expect our Gulf of Mexico barge drilling business will continue to improve fleet utilization and will realize higher average dayrates in 2011. Low finding costs for oil and gas and an established and manageable regulatory environment should support continued interest among operators to drill in this market. International E&P spending is predicted by many industry forecasters to increase in 2011. Should this occur, we would expect it to impact our business later in the year. The portfolio of the Project Management and Engineering Services segment is expected to continue to generate steady revenues and earnings related to the current projects we are managing, with the addition of incremental revenues and earnings during the year from the Yastreb rig-move project.

 

Capital expenditures in 2011, funded primarily through operating cash flows and use of revolving credit facilities, are projected to be approximately $160 million to $175 million, including approximately $75 to $85 million for rig fleet maintenance projects and rental tool investments. Major project spending is expected to include construction and delivery of the two newbuild, Company-owned, drill rigs for Alaska.

 

RESULTS OF OPERATIONS

 

Year Ended December 31, 2010 Compared with Year Ended December 31, 2009

 

We recorded a net loss of $14.7 million for the year ended December 31, 2010, compared with net income of $9.3 million for the year ended December 31, 2009. Operating gross margin was $73.2 million for the year ended December 31, 2010, which was comprised of increases in gross margin from our Rental Tools and U.S. Drilling segments and decreases in gross margin from our International Drilling, Project Management and Engineering Services, and Construction Contract segments.

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

 

 

Segment gross margins, excluding depreciation and amortization, are computed as revenues less direct operating expenses, excluding depreciation and amortization expense; gross margin percentages are computed as segment gross margin, excluding depreciation and amortization, as a percentage of revenues. The segment gross margin amounts, excluding depreciation and amortization, and gross margin percentages should not be used as a substitute for those amounts reported under accounting principles generally accepted in the United States (GAAP). However, we monitor our business segments based on several criteria, including segment gross margin. Management believes that this information is useful to our investors because it more accurately reflects cash generated by a segment.

Segment gross margin amounts are reconciled to our most comparable GAAP measure as follows:

 

 

 

 

International Drilling Segment

 

International Drilling segment revenues decreased $73.0 million to $220.4 million for the year ended December 31, 2010 as compared with December 31, 2009. The largest decline occurred in the CIS/AME region as a result of lower average fleet utilization for our operations throughout this region as spending on drilling programs continued to be adversely impacted by weaker financial conditions and reduced spending on state-involved E&P programs. In addition, our Caspian Sea Arctic barge, located in the CIS/AME region, was on reduced dayrates, including a zero dayrate for a period during 2010, as it underwent a planned refurbishment and upgrade project and a Parker-initiated repair program before ending the year on reduced day rates while our customer completed necessary permitting processes.

 

Revenues in our Americas region declined $15.6 million to $102.1 million primarily due to lower average fleet utilization and lower average dayrates in Mexico due to the completion of a contract in 2009 for Rig 53B and the release of two rigs in northern Mexico during 2010. Additionally, in the second quarter of 2009, we recognized a demobilization fee, which was not repeated in 2010. This was offset by increased revenues from our operations in Colombia, a result of growing activity in this market that led to higher utilization for our rigs.

 

In our Asia Pacific region, revenues decreased $7.5 million in 2010 to $26.4 million compared to 2009 due mainly to lower utilization of our rigs in New Zealand. This was partially offset by increased revenues in Indonesia and Papua New Guinea as we increased the number of rigs working and earned higher dayrates.

 

The International Drilling segment operating gross margin, excluding depreciation and amortization, decreased $59.1 million to $42.8 million during the year ended December 31, 2010 compared with the year ended December 31, 2009, with decreases in each of our three geographic regions. The largest decrease occurred in the CIS/AME region and is attributable to the overall lower revenues as well as increased expenses of the planned repair, refurbishment, and upgrade project for our Caspian Sea Arctic barge. The decrease in the Americas region is primarily due to the lower revenues and extended rig move costs and higher labor and fuel costs in Colombia. A decrease in the Asia Pacific region was due to lower overall revenues, a lower realized gross margin on the most recent contract award due to start-up costs, and the receipt in 2009 of a rig demobilization fee, not repeated in 2010.

 

U.S. Drilling Segment

 

U.S. Drilling segment revenues increased 30.1 percent, or $14.9 million, to $64.5 million for the year ended December 31, 2010 as compared to the year ended December 31, 2009. The revenue increase was attributable to a

recovering market, which has led to improved utilization for our barge drilling rig fleet. Utilization for our U.S. barge drilling rig fleet increased to 63 percent for 2010 from 35 percent for 2009 and was partially offset by a decline in average dayrates of approximately 17 percent due to a barge rig finishing a term contract at substantially higher rates to approximately $20,500 per day in 2010 from approximately $24,800 per day in 2009.

 

The U.S. Drilling segment operating gross margins, excluding depreciation and amortization, increased $9.6 million to $11.2 million for the year ended December 31, 2010 as compared to the same period of 2009 primarily as a result of the improved market and operating conditions and continued cost management.

 

Rental Tools Segment

 

Rental Tools segment revenues increased $57.5 million, or 50.0 percent to $172.6 million during the year ended December 31, 2010 as compared with 2009. The revenue increase is attributable to an increase in utilization resulting from improved market conditions, timely investments in rental tool inventory, and reduced customer discounting during the 2010 period compared with the same period during 2009. The expanded use of horizontal drilling to exploit both shale deposits and conventional oil and gas reservoirs and longer well-bores have led to greater market demand for rental tools. With its facilities strategically located in the major centers of drilling in the U.S., our Rental Tools business has benefited from servicing this growing demand. The increased revenues from domestic land markets was somewhat offset by a moderate decline in revenues to GOM offshore customers and the international offshore market in 2010 compared with 2009. The decline in revenues from GOM customers is due to the cessation and slow restart of drilling in that market following the Macondo well blowout in April 2010. The decline in international revenues for this segment was due to fewer placements of rental tools for offshore applications.

 

The rental tools segment operating gross margins, excluding depreciation and amortization, increased $50.2 million, or 80.6 percent to $112.6 million for 2010 as compared with 2009 as a result of the increase in revenues described above and reduced discounting in 2010 compared with 2009.

 

Project Management and Engineering Services Segment

 

Revenues for this segment increased $1.4 million during 2010 as compared with 2009. This increase was primarily the result of higher revenues related to our Arkutun Dagi project, increased revenues from our BP Liberty O&M contract and higher revenues in Orlan where we experienced higher dayrates offset by lower reimbursable revenues. The increases in revenue were offset by decreases in revenue for our operations on the Yastreb rig in Sakhalin Island and in Kuwait due to lower reimbursable revenues. For our Sakhalin operations, during 2009 we earned a fixed fee during the rig move, upgrade and customer modification phase of the contract, which was not repeated in 2010. Project Management and Engineering Services do not incur depreciation and amortization, and as such, gross margin for this segment decreased $2.2 million in 2010 compared with 2009 gross margin primarily due to increased operating expenses in Sakhalin.

 

Revenues from the construction contract segment decreased $94.4 million from $185.4 million for the year ended December 31, 2009 to $91.1 million for the year ended December 31, 2010. The Liberty rig project is accounted for on a percentage-of-completion basis with revenues and earnings recognized based on progress made relative to estimated total project costs. The decline in reported revenues reflects reduced work effort as the construction transitioned to rig-up labor from major construction in 2010. The construction contract segment does not incur depreciation and amortization, and as such, gross margin recognized during 2010 was $0.2 million compared with $8.1 million in 2009. The 2010 margin reduction is due to the increase in total estimated construction costs over a longer construction phase. For more information on the Liberty project, see Part II, Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Other Matters — “Liberty Project Status.”

 

Other Financial Data

 

During 2010 we recorded a provision for reduction in carrying value of certain assets of $2.0 million related to disputed customer accounts receivable. Gains on asset dispositions were $4.6 million in 2010, a decrease of $1.3 million as a result of various asset sales in 2010 as compared with $5.9 million in 2009. 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. Interest expense for 2010 was $26.8 million, a decrease of $2.6 million as compared with 2009. The decrease in interest expense is primarily the result of a $7.5 million increase in 2010 in capitalized interest on major projects offset by a $4.9 million increase in 2010 in debt-related interest expense. Interest income for 2010 decreased $0.8 million to $0.3 million as compared with 2009. General and administration expense for 2010 decreased $14.8 million to $30.7 million as compared with 2009. The decrease in general and administrative costs is primarily related to lower legal fees in 2010 associated with the ongoing DOJ and SEC investigations and our work product related to various matters further discussed in Note 11, Commitments and Contingencies in the notes to the consolidated financial statements. In addition, we experienced lower employee insurance costs and travel related administrative costs resulting from lower overall company headcount. These decreases were slightly offset by an increase in professional fees related to consulting services.

 

Income tax expense was $26.2 million for the year ended December 31, 2010, as compared to income tax expense of $0.6 million for the year ended December 31, 2009. The increase in income tax expense for 2010 is primarily related to the unfavorable ruling by the Atyrau Oblast Court to uphold the lower court decision and allow the revised Tax Notification to stand as discussed in Note 11, Kazakhstan Ministry of Finance Tax Audit, in the notes to the consolidated financial statements. The Kazakhstan tax matter increased expense by approximately $14.5 million ($6.8 million, net of anticipated tax benefits), which includes approximately $6.5 million in tax, $4.8 million in interest and $3.2 million in penalties. The Company also adjusted reserves for tax uncertainties downward by $2.0 million for uncertainties where statute of limitations had expired, partially offset by increased reserves for potential disallowed costs related to currently disputed matters and unresolved matters in certain tax jurisdictions. In addition, tax expense increased from the Company’s settlement of a foreign tax audit for one of its subsidiaries for $1.2 million, which includes approximately $0.6 million of tax, $0.1 million of interest, and $0.5 million of penalties. Income tax expense for 2009 includes a benefit of an additional $5.4 million in addition to the $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 related to a characterization of certain intercompany notes for foreign tax credit calculation in accordance with accounting for tax uncertainties.

 

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 consisted 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:

 

 

Segment gross margins, excluding depreciation and amortization, are computed as revenues less direct operating expenses, excluding depreciation and amortization expense; gross margin percentages are computed as segment gross margin, excluding depreciation and amortization, as a percentage of revenues. The segment gross margin amounts, excluding depreciation and amortization, and gross margin percentages should not be used as a substitute for those amounts reported under accounting principles generally accepted in the United States (GAAP). However, we monitor our business segments based on several criteria, including segment gross margin. Management believes that this information is useful to our investors because it more accurately reflects cash generated by a segment.

Segment gross margin amounts are reconciled to our most comparable GAAP measure as follows:

 

 

 

 

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. Revenues were further

decreased by $93.1 million as a result of rig fleet average utilization decreasing from 77 percent in 2008 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 related to the rigs under our management contract in Kuwait, and the completion of the management contract in China in 2009. These decreases were partially offset by $5.1 million of higher revenues for our operations on the Yastreb rig in Sakhalin Island and $18.1 million of higher revenues for engineering services 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 earned during the rig modification, upgrade and move 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 addition of revenues associated with 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 this 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. 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 were 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 11 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 11 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, 2010, we had cash and cash equivalents of $51.4 million, a decrease of $57.4 million from December 31, 2009. The following table provides a summary for the last three years:

 

 

Operating Activities

 

Cash flows from operating activities were $123.6 million in 2010, compared with $110.9 million in 2009. Before changes in operating assets and liabilities, cash was provided by operations primarily through a net loss of $14.7 million plus non-cash charges of $133.1 million. Net changes in operating assets and liabilities provided $5.2 million of cash in 2010, compared to $7.9 million used in 2009.

 

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.

 

Investing Activities

 

Cash flows used in investing activities were $212.7 million for 2010. Our primary use of cash was $219.2 million for capital expenditures. Major capital expenditures for the period included $112.5 million for the construction of two new Alaska rigs and $48.9 million for tubular and other rental tools for Quail Tools. Sources of cash included $6.5 million of proceeds from asset sales.

 

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.

 

Capital expenditures for 2011 are estimated to be $160 to $175 million and will primarily be directed to our Rental Tools inventory, completion of our two new Alaska rigs and 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 2011, though there

can be no assurance that we will continue to generate cash flows at sufficient 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 provided by financing activities were $31.8 million for 2010. Our primary financing activities included proceeds from the issuance of $300.0 million aggregate principal amount of 9.125% Notes, less $8.0 million of associated debt issuance costs, offset by the repayment of $225.0 million aggregate principal value of 9.625% Senior Notes including payment of $7.5 million of related debt extinguishment cost. In addition, we had a net pay down on our credit facilities of $29.0 million.

 

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.

 

9.125% Senior Notes

 

On March 22, 2010, the Company issued $300,000,000 aggregate principal amount of 9.125% Senior Notes due 2018 (9.125% Notes) pursuant to an Indenture between the Company and The Bank of New York Mellon Trust Company, N.A. (Trustee). The 9.125% Notes were issued at par with interest payable on April 1 and October 1 of each year, beginning October 1, 2010. Net proceeds from the 9.125% Notes offering were used to redeem the $225.0 million aggregate principal amount of our 9.625% Senior Notes due 2013, to repay $42.0 million of borrowings under the revolving credit facility and for general corporate purposes.

 

The 9.125% Notes are general unsecured obligations of the Company. The 9.125% Notes rank equal in right of payment with all of our existing and future senior unsecured indebtedness. The 9.125% Notes are jointly and severally guaranteed by substantially all of our direct and indirect domestic subsidiaries other than immaterial subsidiaries and subsidiaries generating revenue primarily outside the United States.

 

At any time prior to April 1, 2013, we may redeem up to 35 percent of the aggregate principal amount of 9.125% Notes at a redemption price of 109.125 percent of the principal amount, plus accrued and unpaid interest to the redemption date with the net cash proceeds of certain equity offerings by us. On and after April 1, 2014, we may redeem all or a part of the 9.125% Notes upon appropriate notice, at a redemption price of 104.563% of principal amount, and at redemption prices decreasing each year thereafter to par. If we experience certain changes in control, we must offer to repurchase the 9.125% Notes at 101 percent of the aggregate principal amount, plus accrued and unpaid interest and additional interest, if any, to the date of repurchase.

 

The Indenture restricts our ability and the ability of certain subsidiaries to: (i) sell assets; (ii) pay dividends or make other distributions on capital stock or redeem or repurchase capital stock or subordinated indebtedness; (iii) make investments; (iv) incur or guarantee additional indebtedness; (v) create or incur liens; (vi) enter into sale and leaseback transactions; (vii) incur dividend or other payment restrictions affecting subsidiaries; (viii) merge or consolidate with other entities; (ix) enter into transactions with affiliates; and (x) engage in certain business activities. Additionally, the indenture contains certain restrictive covenants designating certain events as Events of Default. These covenants are subject to a number of important exceptions and qualifications.

 

On June 21, 2010 pursuant to the Registration Rights Agreement among the Company, the guarantors named therein, the initial purchasers of the 9.125% Notes and the Trustee, entered into as of March 22, 2010 in connection with the closing of the 9.125% Notes offering, we filed an exchange offer registration statement with respect to an offer to exchange the 9.125% Notes for substantially identical notes that are registered under the Securities Act. The registration statement was deemed effective by the United States Securities and Exchange Commission (SEC) on September 1, 2010.

 

9.625% Senior Notes, due October 2013

 

As of December 31, 2009, we had outstanding $225.0 million in aggregate principal amount of 9.625% senior notes due 2013 (9.625% Notes). On March 8, 2010, we commenced a cash tender offer and consent solicitation for all of our outstanding 9.625% Notes, which expired on April 2, 2010 (Tender Offer). On March 22, 2010, we

voluntarily called for redemption all of our 9.625% Notes that were not tendered pursuant to the Tender Offer, at the redemption price of 103.208% of the principal amount of the 9.625% Notes, or $1,032.08 per $1,000 principal amount of the 9.625% Notes. On April 21, 2010, we redeemed in full the remaining $128.7 million principal amount of 9.625% Notes. This redemption resulted in the Company recording debt extinguishment costs of $7.2 million during 2010.

 

2008 Credit Agreement:

 

On May 15, 2008, we entered into a credit agreement (Credit Agreement) consisting of a senior secured $80 million revolving credit facility (Revolver) and senior secured term loan facility (Term Loan) of up to $50 million. The Credit Agreement provides that subject to certain conditions, including the approval of the Administrative Agent and the lenders’ acceptance (or additional lenders being joined as new lenders), the amount of the Term Loan Facility or Revolving Credit Facility can be increased by an additional $50 million, so long as after giving effect to such increase, the Aggregate Commitments shall not be in excess of $180 million. If the facility is increased, all other terms of the Credit Agreement remain the same, including covenants and Applicable Rates. The Credit Agreement terminates on May 14, 2013.

 

Revolver — The revolver is available for general corporate purposes and to support letters of credit. Interest on Revolver loans accrues at a Base Rate plus an Applicable Rate or LIBOR plus an Applicable Rate. The Applicable Rate varies from a rate per annum ranging from 2.75 percent to 3.25 percent for LIBOR rate loans and 1.75 percent to 2.25 percent for Base Rate loans, determined by reference to the consolidated leverage ratio (as defined in the Credit Agreement). Revolving loans are available subject to a borrowing base calculation based on a percentage of eligible accounts receivable, certain specified barge drilling rigs and rental equipment of the Company and its subsidiary guarantors. There were $25.0 million and $42.0 million in revolving loans outstanding at December 31, 2010 and December 31, 2009, respectively. Letters of credit outstanding as of December 31, 2010 and December 31, 2009 totaled $16.3 million and $12.7 million, respectively.

 

Term Loan — the Term Loan originated at $50.0 million and requires quarterly principal payments of $3.0 million. Interest on the Term Loan accrues at either a Base Rate plus 2.25 percent or LIBOR plus 3.25 percent. The outstanding balances on the Term Loan at December 31, 2010 and December 31, 2009 were $32.0 million and $44.0 million, respectively.

 

Our obligations under the Credit Agreement are guaranteed by substantially all of our domestic subsidiaries, each of which has executed guaranty agreements. The Credit Agreement contains certain customary affirmative and negative covenants. Our most restrictive of these covenants requires we maintain a consolidated leverage ratio of less than 4.00 to 1. The consolidated leverage ratio is based on the ratio of consolidated total debt to consolidated EBITDA as defined in the Credit Agreement. EBITDA, while not a GAAP measure, reflects a measurement of cash flow and is calculated as income before income taxes plus interest, income taxes, and depreciation and amortization. As of December 31, 2010 we are in compliance with all of our covenants. We do not currently anticipate triggering any of these covenants during 2011.

 

On January 15, 2010, the Credit Agreement was amended in anticipation of the issuance of 9.125% Notes described above, in order to, among other things, release certain subsidiaries from their obligations under the Credit Agreement, effective upon the repurchase or redemption of all the outstanding 9.625% Notes. These released subsidiaries are the Company’s immaterial subsidiaries and subsidiaries generating revenue primarily outside the United States. Upon the effectiveness of the amendment to the Credit Agreement, the guarantors under the Credit Agreement were the same as the guarantors of the 9.125% Notes.

 

2.125% Convertible Senior Notes

 

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, 2010, none of the conditions allowing holders of the Notes to convert had been met.

 

Concurrently with the issuance of the 2.125% Notes, we purchased a convertible note hedge (note hedge) and sold warrants in private transactions with counterparties that were different than the ultimate holders of the 2.125% Notes. The note hedge included purchasing free-standing call options and selling free-standing warrants, both exercisable in our 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 2.125% Notes upon conversion.

 

The terms of the call options mirror the 2.125% 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 our outstanding shares. The warrants allow us to sell 9,027,713 common shares at a strike price of $18.29 per share. The conversion price of the 2.125% 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 2.125% 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 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 2.125% Notes remain outstanding and the maturity date of the 2.125% Notes.

 

The 2.125% 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 Sheet. 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 related to the 2.125% Notes totaled approximately $3.6 million and are being amortized over the five year term of the 2.125% Notes using the effective interest method. Proceeds from the transaction of

$110.2 million were used to redeem our outstanding senior floating rate notes, to pay the net cost of hedge and warrant transactions, and for general corporate purposes.

 

Other Liquidity

 

Our principal amount of long-term debt, including current portion, was $472.9 million as of December 31, 2010, which consists of:

 

 

As of December 31, 2010, we had approximately $90.1 million of liquidity, which consisted of $51.4 million of cash and cash equivalents on hand and $38.7 million of availability under the 2008 Credit Facility. We do not have any unconsolidated special-purpose entities, off-balance sheet financing arrangements or guarantees of third-party financial obligations. We have no energy, commodity, foreign currency or interest rate derivative contracts at December 31, 2010.

 

The following table summarizes our future contractual cash obligations as of December 31, 2010:

 

 

 

 

OTHER MATTERS

 

Business Risks

 

See Item 1A, Risk Factors, for a discussion of risks related to our business.

 

Liberty Project Status

 

In November 2010, BP informed us that it was suspending construction on the Liberty extended reach drilling rig project to review the rig’s engineering and design, including its safety systems. We commenced construction of this rig for BP in April 2008 pursuant to an EPCI contract. In August 2009, BP also awarded us an O&M contract for the first phase of drilling on the Liberty field, which is expected to be a two-year project to drill an ultra extended-reach well, nearly two miles deep and as far as eight miles from the pad. BP has not announced a schedule for resuming construction on the rig or new target dates for drilling and production start-up.

 

The Liberty rig construction contract is a fixed fee and reimbursable contract accounted for on a percentage of completion basis. Costs on the project are reimbursed without markup, except for costs associated with changes in work scope, for which we are entitled to a markup. As of December 31, 2010, we had recognized $325.9 million in project-to-date revenues and $10.9 million in margin of the $11.7 million fixed fee portion of the contract.

 

The Liberty rig construction contract expired on February 8, 2011. Prior to expiration of the construction contract, BP indentified several areas of concern for which it asked us to provide explanations and documentation, and we have done so. Although we believe that the issues raised by BP have been adequately addressed, there can be no assurance of when or how these issues will be resolved with our client. At this point, construction on the rig is incomplete, and it cannot be completed until BP determines to resume construction.

 

The Company and BP have continued activities to preserve and maintain the rig under the “pre-operations” phase of our O&M contract. The O&M contract is scheduled to expire on May 31, 2011, and there can be no assurance that it will be extended.

 

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 we believe 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.

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 international market, we tested our long-lived assets for impairment as of December 31, 2010, noting our estimates of undiscounted future cash flows support the current carrying values of our assets. Therefore, we did not recognize any impairment of our property, plant, and equipment as of December 31, 2010.

 

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.

 

We apply the 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. 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

 

For a discussion of the new accounting pronouncements that have had or are expected to have an effect on our consolidated financial statements, see Notes to Consolidated Financial Statements — Note 16 — Recent Accounting Pronouncements.

 

 

Foreign Currency Exchange Rate Risk

 

Our international operations expose us to foreign currency exchange rate risk. There are a variety of techniques to minimize the exposure to foreign currency exchange rate risk, including customer contract payment terms and the possible use of foreign currency exchange rate risk derivative instruments. Our primary foreign currency exchange rate 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 currency exchange rate risk 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 currency exchange rate risk derivative instruments, specifically foreign currency exchange rate risk forward contracts, or spot purchases, may be used to mitigate foreign exchange rate currency risk. A foreign currency exchange rate risk 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, 2010, we had no open foreign currency exchange rate risk or interest rate 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 $300.0 million principal amount of 9.125% Senior Notes due 2018, based on quoted market prices, was $314.3 million at December 31, 2010. The estimated fair value of our $125.0 million principal amount of 2.125% Convertible Senior Notes due 2012 was $119.4 million on December 31, 2010. A hypothetical 100 basis point increase in interest rates relative to market interest rates at December 31, 2010 would decrease the fair market value of our long-term debt at December 31, 2010 by approximately $32.4 million for the 9.125% Senior Notes and $37.0 million for the 2.125% Convertible Senior Notes.

 

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, 2010 and 2009, 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, 2010. 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, 2010. We also have audited the Company’s internal control over financial reporting as of December 31, 2010, 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, 2010 and 2009, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2010, 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, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

 

Houston, Texas

February 28, 2011

 

PARKER DRILLING COMPANY AND SUBSIDIARIES

 

CONSOLIDATED STATEMENT OF OPERATIONS