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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to _______
COMMISSION FILE NUMBER 000-32855
TORCH OFFSHORE, INC.
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 74-2982117
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
401 WHITNEY AVENUE, SUITE 400
GRETNA, LOUISIANA 70056-2596
(Address of Principal Executive Offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (504) 367-7030
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 [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer as defined
in Rule 12b-2 of the Securities Exchange Act of 1934. Yes [ ] No [X]
The number of shares of the registrant's common stock outstanding as of November
22, 2004 was 12,642,950, par value $0.01 per share.
1
TORCH OFFSHORE, INC.
TABLE OF CONTENTS
Page
-----
Part I. Financial Information
Item 1. Financial Statements (Unaudited).
Condensed Consolidated Balance Sheets as of September 30, 2004 and
December 31, 2003.................................................................................. 3
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September
30, 2004 and 2003.................................................................................. 4
Condensed Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2004 and 2003.................................................................. 5
Notes to Condensed Consolidated Financial Statements................................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................................................. 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................................... 29
Item 4. Controls and Procedures.............................................................................. 29
Part II. Other Information
Item 1. Legal Proceedings.................................................................................... 30
Item 2. Unregistered Sales of Securities and Use of Proceeds................................................. 31
Item 6. Exhibits............................................................................................. 31
Signature............................................................................................ 31
Exhibit Index........................................................................................ 32
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
TORCH OFFSHORE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
2004 2003
------------- ------------
(UNAUDITED) (SEE NOTE 1)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .............................. $ 617 $ 41
Restricted cash (Note 2) ............................... 4,513 --
Accounts receivable --
Trade, less allowance for doubtful accounts ........ 15,848 20,479
Costs and estimated earnings in excess of billings on
uncompleted contracts ................................. 2,440 --
Prepaid expenses and other ............................. 5,776 3,561
-------- --------
Total current assets ............................... 29,194 24,081
PROPERTY AND EQUIPMENT, at cost,
less accumulated depreciation ......................... 167,567 143,266
DEFERRED DRYDOCKING CHARGES,
less accumulated amortization ......................... 2,856 807
SECURITY DEPOSIT (Note 7) ............................... 1,250 1,250
OTHER ASSETS ............................................ 520 502
-------- --------
Total assets ....................................... $201,387 $169,906
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable -- trade .............................. $ 17,709 $ 15,148
Accrued expenses ....................................... 10,052 4,597
Accrued payroll and related taxes ...................... 1,125 819
Financed insurance premiums ............................ 2,804 1,832
Billings in excess of costs and estimated earnings on
uncompleted contracts ................................. -- 459
Finance Facility - in default (Note 7) ................. 75,508 45,639
Current portion of long-term debt - in default (Note 7) 4,467 3,396
Long-term debt - in default (Note 7) ................... 17,493 --
Non-revolving line of credit - in default (Note 7) ..... 4,854 --
Receivable line of credit - in default (Note 7) ........ 11,203 7,227
-------- --------
Total current liabilities .......................... 145,215 79,117
LONG-TERM DEBT, less current portion (Note 7) ........... -- 20,057
COMMITMENTS AND CONTINGENCIES (Note 9)...................
STOCKHOLDERS' EQUITY .................................... 56,172 70,732
-------- --------
Total liabilities and stockholders' equity ......... $201,387 $169,906
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
TORCH OFFSHORE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2004 2003 2004 2003
---- ---- ---- ----
Revenues ................................. $ 22,572 $ 15,262 $ 53,434 $ 46,167
Cost of revenues:
Cost of sales ........................... 21,644 13,771 52,183 40,016
Depreciation and amortization ........... 2,024 1,983 6,773 5,632
General and administrative expenses ..... 1,814 1,614 4,870 4,317
Other operating expense ................. 4,100 -- 4,260 --
-------- -------- -------- --------
Total cost of revenues ........... 29,582 17,368 68,086 49,965
-------- -------- -------- --------
Operating loss ........................... (7,010) (2,106) (14,652) (3,798)
-------- -------- -------- --------
Other income:
Interest income ...................... -- -- -- 1
-------- -------- -------- --------
Total other income ............... -- -- -- 1
-------- -------- -------- --------
Loss before income taxes ................. (7,010) (2,106) (14,652) (3,797)
Income tax benefit ....................... -- 737 -- 1,329
-------- -------- -------- --------
Net loss ................................. $ (7,010) $ (1,369) $(14,652) $ (2,468)
======== ======== ======== ========
Net loss per common share:
Basic and Diluted .................... $ (0.55) $ (0.11) $ (1.16) $ (0.20)
======== ======== ======== ========
Weighted average common stock outstanding:
Basic and Diluted .................... 12,643 12,639 12,641 12,637
======== ======== ======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
TORCH OFFSHORE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
2004 2003
-------- ---------
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:
Net loss ............................................. $(14,652) $ (2,468)
Depreciation and amortization ...................... 6,773 5,632
Deferred income tax benefit ........................ -- (1,329)
Deferred drydocking costs incurred ................. (2,855) (118)
(Increase) decrease in working capital:
Accounts receivable ................................ 4,631 5,942
Costs and estimated earnings in excess of billings
on uncompleted contracts ......................... (2,899) 923
Prepaid expenses, net of financed portion .......... (1,243) (1,016)
Accounts payable - trade ........................... 2,561 5,609
Accrued payroll and related taxes .................. 306 586
Accrued expenses and other ......................... 5,630 (62)
-------- --------
Net cash provided by (used in) operating activities .. (1,748) 13,699
-------- --------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchases of property and equipment ................ (30,269) (61,298)
Changes in restricted cash ......................... (4,513) --
-------- --------
Net cash used in investing activities ................ (34,782) (61,298)
-------- --------
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Net proceeds on receivable line of credit .......... 3,976 3,169
Net proceeds on non-revolving line of credit ....... 4,854 --
Net proceeds from Finance Facility ................. 29,869 37,795
Net proceeds (payments) on long-term debt .......... (1,587) 6,712
Treasury stock purchases ........................... (6) (18)
-------- --------
Net cash provided by financing activities ............ 37,106 47,658
-------- --------
Net change in cash and cash equivalents .............. 576 59
Cash and cash equivalents at beginning of period ..... 41 327
-------- --------
Cash and cash equivalents at end of period ........... $ 617 $ 386
======== ========
Interest paid (net of amounts capitalized) ........... $ -- $ --
======== ========
Income taxes paid .................................... $ -- $ --
======== ========
SUPPLEMENTARY NON-CASH INVESTING ACTIVITIES:
Purchase of Midnight Wrangler ...................... $ -- $ (9,731)
======== ========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
TORCH OFFSHORE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND BASIS OF PRESENTATION:
The interim condensed consolidated financial statements included herein have
been prepared by Torch Offshore, Inc. (a Delaware corporation) and are
unaudited, except for the balance sheet at December 31, 2003, which has been
prepared from the Company's previously audited financial statements. The balance
sheet at December 31, 2003 has been derived from the audited financial
statements at that date. These financial statements do not include all of the
information and footnotes required by U.S. generally accepted accounting
principles (U.S. GAAP) for complete financial statements. The condensed
consolidated financial statements of Torch Offshore, Inc. include its
wholly-owned subsidiaries Torch Offshore, L.L.C., Torch Express, L.L.C., and
Vessel Ventures, L.L.C. (collectively, the "Company"). Management believes that
the unaudited interim financial statements include all adjustments (such
adjustments consisting only of a normal recurring nature) necessary for fair
presentation. Certain information and note disclosures normally included in
annual financial statements prepared in accordance with U.S. GAAP have been
condensed or omitted pursuant to rules and regulations governing interim period
reporting. The results for the three- and nine-months ended September 30, 2004
are not necessarily indicative of the results to be expected for the entire
year. The interim financial statements included herein should be read in
conjunction with the audited financial statements and notes thereto together
with Management's Discussion and Analysis of Financial Condition and Results of
Operations included in the Company's annual report on Form 10-K for the fiscal
year ended December 31, 2003.
The Company provides integrated pipeline installation, subsea construction and
support services to the offshore oil and natural gas industry, primarily in the
United States Gulf of Mexico (the "Gulf of Mexico"). The Company's focus has
been providing services primarily for oil and natural gas production in water
depths of 20 to 300 feet in the Gulf of Mexico (the "Shelf"). Over the past few
years, the Company has expanded its operations, fleet capabilities and
management expertise in order to enable it to provide services analogous to
those services it provides on the Shelf in water depths up to 10,000 feet on a
global basis.
The Company's financial statements are prepared in accordance with U.S. GAAP. As
further discussed in Note 2, the Company faces significant liquidity issues as a
result of adverse business conditions in its operating sector and the incurrence
of significant debt obligations due in 2004 associated with the conversion of
the Midnight Express, which experienced certain unbudgeted cost overruns and
unexpected delays during construction. In addition, as of December 31, 2003, the
Company was not in compliance with certain financial ratio covenants of its loan
agreements. In April 2004, the Company obtained forbearance waivers from its
lenders for such matters of noncompliance and amended these financial ratio
covenants. Through June 30, 2004, the Company maintained compliance with respect
to its debt agreements. As of September 30, 2004, the Company was not in
compliance with the amended financial ratio covenants including the minimum
consolidated current ratio of 0.70 to 1, the tangible net worth minimum of $60.0
million, the minimum debt service ratio of 1.20 to 1, and the consolidated
leverage ratio of no more than 2.00 to 1. As a consequence, the Company is in
default under its loan agreements. As a result of this default and the cross
default provisions in all of the Company's debt agreements, all of its long-term
debt has been reclassified as current in accordance with U.S. GAAP. The Company
is currently working with its lenders, including Regions Bank, Export
Development Canada (EDC), and General Electric Commercial Equipment Financing
(GE Commercial), to negotiate forbearance waivers and/or amendments to its debt
agreements. Finally, the cash flow from the Company's operations during the
nine-month period ended September 30, 2004, has not been sufficient to fund its
working capital needs.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. Management's plans in regard to these matters, which involve
inherent uncertainties and conditions
6
beyond the Company's control, are also discussed in Note 2. The accompanying
financial statements have been prepared on the basis that the Company will
continue as a going concern and do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets or
the amounts and classification of liabilities that may result from the outcome
of these uncertainties. As discussed in the Company's annual report on Form 10-K
for the year ended December 31, 2003, the Company has been significantly and
negatively affected by adverse business conditions in its industry and other
events with a direct impact on the Company's earnings. The Company has
experienced recurring losses from operations, negative operating cash flows and
a working capital deficiency. As a result, the Company's independent registered
public accounting firm advised the Company that they had reached a conclusion
that there is substantial doubt the Company's ability to continue as a going
concern and, as required by auditing standards of the Public Company Accounting
Oversight Board (United States), included in their auditors' report on the
Company's 2003 annual financial statements an explanatory paragraph to reflect
that conclusion.
2. CAPITAL RESOURCES AND LIQUIDITY:
The accompanying financial statements reflect a net loss of $14.7 million for
the first nine months of 2004 and a working capital deficit of $116.0 million as
of September 30, 2004, which includes all of the Company's debt ($113.5 million)
classified as current and in default as of September 30, 2004. In addition, the
Company generated a net loss of $9.2 million for the year ended December 31,
2003, $6.8 million of which was realized in the fourth quarter of 2003. The
Company faces significant liquidity and working capital challenges, in addition
to costs of expanding the Company's operations into the deepwater market, and
will need to cure its current debt defaults and raise additional capital to
continue to meet its debt obligations, conduct its operations as currently
contemplated and continue as a going concern.
In September 2004, the Company reached a final settlement with Cable Shipping,
Inc., the owners of the Midnight Hunter, in the amount of $4.1 million, which
was to be paid on November 19, 2004. This settlement precluded the quantum of
damages hearing which was to be held in late October 2004 in London (see Note
9). The full amount of this settlement has been recorded in the financial
statements as of September 30, 2004. As of November 22, 2004, the Company had
not paid the $4.1 million settlement amount, but is seeking to enter discussions
with Cable Shipping, Inc. with the objective of determining a feasible payment
plan for the settlement amount.
As of September 30, 2004, the Company was not in compliance with the financial
covenants (as amended in early April 2004) of the Bank Facility, the Finance
Facility and the GE Commercial term loan (See Note 1). The Company is currently
in default and is working with its lenders to negotiate forbearance waivers
and/or amendments to cure these non-compliance issues. There can be no assurance
that compliance will be attained. As depicted on the balance sheet as of
September 30, 2004, a reclassification of $17.5 million has been made of the
Company's long-term debt to a current position. This reclassification includes
the debt associated with the Midnight Eagle and Midnight Wrangler facilities
which are also in default under related cross-default provisions. Although the
Company's creditors have not issued notices of default or taken any actions as a
result of the cross-defaults (as of November 22, 2004), because the Company is
not in compliance with the terms of its debt agreements its creditors could
demand immediate payment and have the right to seize the applicable collateral.
The Company's obligations under its credit agreements are secured by
substantially all of the Company's assets. If not effectively cured, these
defaults under the Company's credit agreements will adversely impact the
Company's ability to sustain its operations in the normal course resulting in a
material impact on its financial condition and results of operations.
The Company's ability to continue in the normal course of business is dependent
upon its ability to cure its current debt defaults, raise additional capital,
refinance its existing debt, and the success of its future operations.
Management of the Company has developed a plan to address its liquidity needs.
The components of this plan involve satisfying the remainder vendor obligations
associated with the conversion of the Midnight Express, raising additional
capital and/or refinancing the existing debt to fund
7
working capital and debt obligation requirements, obtaining forbearance waivers
for non-compliance with certain debt covenants, reaching an agreement on a
payment plan of our $4.1 million settlement with Cable Shipping, Inc. cutting
administrative and operating costs, and the possible sale of certain vessels.
Management believes that these transactions must be effectively consummated to
provide sufficient funding for the Company's debt and working capital
requirements for the remainder of 2004 and beyond. Because these transactions
are not complete, they involve inherent uncertainties, including uncertainties
beyond the Company's control. There are no assurances that the Company will
successfully accomplish its current objectives described below. The Company has
retained financial advisors to assist in reviewing practical financial and
operational options. The Company is unable to predict the outcome of various
strategies under development and consideration. The Company is negotiating with
its lenders to identify mutually acceptable alternatives to restructure its debt
and/or pursue other financial arrangements that would provide relief from its
current debt defaults and provide additional funding. While management intends
to aggressively pursue such measures, there is no assurance that the Company's
objectives in this regard will be successfully achieved. In the event that the
Company is not able to negotiate amendments to, and waivers for noncompliance
with, the financial ratio covenants under its existing loan agreements and to
restructure its debt, and to the extent that the Company is unable to find other
sources of capital to address its liquidity needs, it is likely that the Company
would need to seek bankruptcy protection to continue its operations.
CONVERSION OF THE MIDNIGHT EXPRESS
In April 2004, the Company entered into an agreement with Regions Bank and EDC
for an additional $19.0 million of funding under the Finance Facility (see Note
7) to complete the conversion of the Midnight Express. In addition, the
Company's creditors agreed to extend the time frame of the construction period
of the Finance Facility from June 30, 2004 to October 31, 2004 at which point
the construction period financing was expected to convert to term status.
Regions Bank and EDC have also amended certain covenant obligations that the
Company must meet in 2004. The consolidated current ratio covenant (as defined)
is now at 0.70 to 1 for all four quarters of 2004.
The Midnight Express arrived in Scheidam, The Netherlands in mid-June 2004 and
the installation of the patented pipelay system began immediately at the
manufacturer's operation. In addition, the Company partially installed the
special-built 500-ton crane. The vessel departed for the Gulf of Mexico in late
July 2004 and arrived in the Gulf of Mexico in mid-August 2004. The final
outfitting and installation of the pipe handling system, automatic welding
system, and the gantry crane rails/racks was completed in late October 2004. The
vessel completed sea trials on November 7, 2004 and entered the active fleet as
of that date.
UTILIZATION OF THE MIDNIGHT EXPRESS
In August 2002, the Company developed a deepwater group to initiate its entrance
into the deepwater market using the Midnight Hunter and Midnight Wrangler. The
group has completed various pipelay projects and subsea construction projects in
the deepwater. This group has also been dedicated to the marketing of the
Midnight Express.
The Midnight Express began its first project in November 2004 immediately after
the completion of its sea trials. This initial project is expected to have a
duration of approximately two to three weeks. In addition, the Company has
submitted the Midnight Express to multiple customers on various types of bids
for future work. The Company is in discussions with several customers to perform
work in the last quarter of 2004 in the Gulf of Mexico and/or internationally as
well as work in 2005 and beyond. There is no assurance that such contracts will
be awarded to the Company.
ADDITIONAL CAPITAL AND RESTRUCTURING OF INDEBTEDNESS
The Company is seeking to raise capital and/or refinance its existing debt
through the private and public capital markets. The Company's ability to raise
capital will depend on factors outside of the Company's control, including the
condition of the capital markets and the Company's industry. Additionally,
pursuant to the terms of the Company's financing agreement with Regions Bank and
EDC, the Company is required to raise the lesser of $10.0 million or 20% of the
market capitalization (as defined in the
8
Finance Facility) of the Company at the time of the issuance by June 30, 2005
through an equity offering and requires that the first $10.0 million of proceeds
associated with such an offering be used to reduce amounts outstanding under the
Finance Facility.
In July 2004, the Company applied under its structured Finance Facility for the
10% of the accepted Canadian content interest rate subsidy available from
Industry Canada. In August 2004, Industry Canada paid the U.S. dollar equivalent
of approximately $5.6 million. Of this total, approximately $1.5 million was
paid directly to the Company and $1.1 million was used by the Company to pay
interest due on the Finance Facility. Approximately $0.4 million remains
available as of September 30, 2004, and is classified as restricted cash on the
balance sheet. The remaining amount of approximately $4.1 million was paid by
Industry Canada to Regions Bank and EDC to reduce or "buy down" the interest
rate on the $79.0 million Finance Facility when it converts to the three-year
term loan. This amount was recorded as a reduction of the Midnight Express
vessel construction cost and the escrowed funds are reflected as restricted cash
within the Company's September 30, 2004 balance sheet.
On July 22, 2004, the Company entered in an agreement with Regions Bank for a
$5.0 million non-revolving line of credit with an initial term of 120 days to be
used for working capital purposes. Interest on this line of credit accrues at
LIBOR plus 4.00%. The Company's obligation under this line of credit is secured
by the Midnight Rider, which also secures the Company's obligations under the
Finance Facility with Regions Bank and EDC. In order to use this vessel as
collateral in the line of credit, EDC took a subordinated secured position on
the vessel. In addition, as part of the above transaction, Regions Bank agreed
to allow the usage of approximately $1.5 million of proceeds from Industry
Canada (see discussion above) to pay the interest on the Finance Facility during
the conversion period. The proceeds were originally allocated to repay a portion
of the $19.0 million additional financing arranged in April 2004 to convert the
Midnight Express. The terms of the note called for the loan to be repaid on
November 19, 2004. The Company is seeking to repay the $5.0 million note through
a refinancing of its existing debt with the prospect of converting this $5.0
million into long-term debt. In the event the Company is successful in obtaining
refinancing of its existing debt, the Finance Facility calls for the proceeds of
the refinancing to: 1) repay this $5.0 million note, 2) repay $1.5 million of
the additional $19.0 million of financing on the Midnight Express conversion,
and 3) use 50% of the refinance proceeds received in excess of $6.5 million to
also repay a portion of the additional $19.0 million of financing on the
Midnight Express conversion.
As of November 22, 2004, the Company was in need of an additional $2.5 million
in order to satisfy certain vendor obligations incurred in connection with the
conversion of the Midnight Express. The additional funds were needed as
unexpected costs arose due to delays caused by hurricanes in the Gulf of Mexico
in September 2004. In addition to costs associated with the delays, the Company
added equipment to the vessel to give it the capability to lay pipelines in a
conventional fashion. The Company is currently in negotiations with Regions Bank
and EDC for these additional funds to secure the Company's ability to satisfy
the remaining obligations associated with the conversion of the Midnight
Express.
DISPOSAL OF VESSELS
In connection with the Company's efforts to raise capital, the Company is also
pursuing the sale of certain vessels into foreign markets either through
charters to operators in these foreign markets or the outright sale of these
vessels. The Company has had discussions with various parties; however, no
definitive agreements have been entered into. There can be no assurance that the
Company will be able to reach an agreement for the charter or sale of its
vessels, or that such an agreement will be on terms that are commercially
reasonable or acceptable to management. The Finance Facility specifies that any
proceeds from the sale of a vessel that is pledged as collateral be used to
repay the amounts due under the Finance Facility.
9
3. STOCKHOLDERS' EQUITY:
Treasury Stock - In August 2001, the Company's Board of Directors approved the
repurchase of up to $5.0 million of the Company's outstanding common stock.
Purchases were made on a discretionary basis in the open market or otherwise
over a period of time as determined by management, subject to market conditions,
applicable legal requirements and other factors. In August 2002, the Company
elected to suspend the repurchase program. Under current conditions, the Company
does not expect to repurchase shares in the near future except for certain
events related to the vesting of employee's restricted shares. As of September
30, 2004, 715,074 shares had been repurchased at a total cost of $4.3 million.
Stock Option Plan - The Company has a long-term incentive plan under which 3.0
million shares of the Company's common stock are authorized to be granted to
employees and affiliates. The awards can be in the form of options, restricted
stock, phantom stock, performance-based stock or stock appreciation rights. As
of September 30, 2004, stock options covering 434,923 shares of common stock
with a weighted average exercise price of $8.47 per share, and 38,124 shares of
restricted stock, both vesting generally over five years, were outstanding.
4. EARNINGS PER SHARE:
The Company follows Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings per Share." Basic earnings per share is calculated by dividing net
income/loss by the weighted-average number of common shares outstanding for the
applicable period, without adjustment for potential common shares outstanding in
the form of options, warrants, convertible securities or contingent stock
agreements. For calculation of diluted earnings per share, the number of common
shares outstanding are increased (if deemed dilutive) by the number of
additional common shares that would have been outstanding if the dilutive
potential common shares had been issued, determined using the treasury stock
method where appropriate.
Common stock equivalents (related to stock options and restricted stock)
excluded from the calculation of diluted earnings per share, because they were
anti-dilutive, were approximately 473,000 shares and 336,000 shares for the
third quarters of 2004 and 2003, respectively, and approximately 473,000 shares
and 361,000 shares in the first nine months of 2004 and 2003, respectively.
5. STOCK-BASED COMPENSATION:
The Company accounts for its stock-based compensation in relation to the 2001
Long-Term Incentive Plan in accordance with Accounting Principles Board Opinion
(APB) No. 25, "Accounting for Stock Issued to Employees." However, SFAS No. 123,
"Accounting for Stock-Based Compensation," and SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - An Amendment of SFAS No.
123," permits the intrinsic value-based method proscribed by APB No. 25, but
requires additional disclosures, including pro forma calculations of earnings
and net earnings per share as if the fair-value method of accounting prescribed
by SFAS No. 123 had been applied. If compensation expense had been determined
using the fair-value method in SFAS No. 123, the Company's net loss and loss per
share would have been as shown in the pro forma amounts below:
10
THREE MONTHS ENDED NINE MONTHS ENDED
(in thousands, except per share data) SEPTEMBER 30, SEPTEMBER 30,
- ---------------------------------------------------------------------------------------------------------------
2004 2003 2004 2003
-------- -------- -------- --------
Net loss, as reported ............................. $ (7,010) $ (1,369) $(14,652) $ (2,468)
Add: Stock-based compensation expense included
in net loss, net of tax ....................... 33 33 99 95
Less: Stock-based compensation expense using fair
value method, net of tax ...................... (172) (125) (537) (369)
-------- -------- -------- --------
Pro forma net loss ................................ $ (7,149) $ (1,461) $(15,090) $ (2,742)
======== ======== ======== ========
Basic and diluted loss per share .................. $ (0.55) $ (0.11) $ (1.16) $ (0.20)
Pro forma basic and diluted loss per share ........ $ (0.57) $ (0.12) $ (1.19) $ (0.22)
6. PROPERTY AND EQUIPMENT:
During the second quarter of 2004, management committed to a plan to scrap the
Midnight Runner and remove the vessel from the Company's fleet. An asset
impairment charge of $0.6 million was recorded in relation to the Midnight
Runner (included in depreciation and amortization) during the second quarter of
2004. The impairment charge was based upon the Company's estimate of the
vessel's salvage value, the impact of which reduced the Company's previous
carrying value for the vessel to approximately $50,000. During the third quarter
of 2004, the vessel was scrapped for approximately $15,000 resulting in an
additional charge of $35,000 recorded in the third quarter of 2004.
7. LONG-TERM DEBT:
In July 2002, the Company entered into a $35.0 million bank facility (the "Bank
Facility") consisting of a $25.0 million asset-based five-year revolving credit
facility and a $10.0 million accounts receivable-based working capital facility
with Regions Bank. The Company continues to have available the accounts
receivable-based working capital facility from Regions Bank. In December 2003,
the accounts receivable-based working capital facility was increased to $15.0
million. Amounts outstanding under the accounts receivable-based working capital
facility may not exceed 85% of eligible trade accounts receivable. The Company
had $11.2 million outstanding under the $15.0 million accounts receivable-based
working capital facility as of September 30, 2004. In addition, the Company
issued a $1.5 million standby letter of credit as security for the charter
payments due under the charter agreement for the Midnight Hunter against the
accounts receivable-based working capital facility. In July 2003, this letter of
credit was drawn by Cable Shipping, Inc., the owners of the Midnight Hunter. The
Company recorded the $1.5 million as a liability on its balance sheet during the
second quarter of 2003. The Company had an available borrowing capacity of up to
$11.5 million, substantially all of which was drawn, under the $15.0 million
accounts receivable-based working capital facility based upon eligible
receivables at September 30, 2004. The $15.0 million accounts receivable-based
working capital facility has a maturity date of July 2, 2005.
In April 2003, the Company finalized a credit line in the amount of $60.0
million to finance the conversion of the Midnight Express (the "Finance
Facility"). The Finance Facility originally matured on June 30, 2004. The
Finance Facility commitment is equally provided by Regions Bank and EDC ($30.0
million participation by each).
In April 2004, the Company increased the Finance Facility by $19.0 million to
$79.0 million and amended the maturity to October 31, 2004. In addition, as part
of the increase to the Finance Facility, the $25.0 million asset-based five-year
revolving credit facility was terminated and the Company paid a 1% origination
fee ($190,000) to Regions Bank and EDC for the increase in the Finance Facility
and the interest rate on the original $60.0 million financing increased to LIBOR
plus 4.00%. The amounts outstanding under the Finance Facility will convert into
two separate loans at the earlier of the facility's maturity date or completion
of the conversion of the Midnight Express. The first loan represents the
original $60.0 million borrowing and will convert to a three-year term loan
facility with a 10-year amortization payment schedule consisting of $3.0 million
semi-annual payments beginning on April 30, 2005, with a balloon payment at the
end of the three-year term. The second loan is for the additional $19.0 million
and will convert to a twenty-month term loan facility with $6.0 million
principal payments due on June 30, 2005 and December 30, 2005 and a final $7.0
million principal payment due on June 30, 2006. Interest would be payable on a
monthly basis and Regions Bank and EDC will require the Company to maintain the
same collateral and covenants as included in the Finance Facility. Regions Bank
and EDC also have the right to the first $10.0 million of any equity offering,
to the proceeds from the sale of any of the mortgaged vessels (see discussion
below) and to the interest rate buy-down received from Industry Canada during
the third quarter of 2004 (see Note 2).
The interest rate for the $60.0 million portion of the Finance Facility was
LIBOR plus a spread of 3.25%
11
to 3.50% based upon the consolidated leverage ratio of the Company before it was
increased to LIBOR plus 4.00% as part of the $19.0 million increase to the
credit line. The interest rate for the $19.0 million portion of the Finance
Facility is LIBOR plus 4.00%. The Company is providing collateral in the form of
the Midnight Express as well as a first preferred ship mortgage on the Midnight
Fox, Midnight Star, Midnight Dancer, Midnight Carrier, Midnight Brave and
Midnight Rider. The Company must comply with various covenants including
maintaining a tangible net worth of at least $60.0 million, a minimum debt
service coverage ratio of at least 1.20 to 1, a consolidated leverage ratio of
no more than 2.00 to 1 and a consolidated current ratio of 1.30 to 1. The
Company is not allowed to incur additional debt over $8.0 million without
consent from Regions Bank. As previously discussed, the Company is currently not
in compliance with certain of these debt covenants. The Company had $75.5
million outstanding under the $79.0 million Finance Facility as of September 30,
2004 and capitalized $2.8 million of 2004 interest costs in the nine months
ended September 30, 2004 in relation to the conversion of the Midnight Express
as compared to $0.9 million capitalized in the comparable nine-month period of
2003.
Upon completion of certain construction completion milestones, but no later than
October 31, 2004, the $79.0 million Finance Facility was intended to convert to
term status. As of November 22, 2004, the Finance Facility has not been
converted to term status due to the default status of the debt and the Company's
ongoing negotiations with its lenders to restructure its debt. However, since
the October 31, 2004 maturity date, the Company has drawn $1.3 million on
the Finance Facility and at November 22, 2004 the Finance Facility balance was
$78.7 million.
See Note 2 regarding the additional $5.0 million of non-revolving debt
negotiated with the Company's lenders in July 2004, payment of which was due
November 19, 2004. However, as of November 22, 2004, the Company had not repaid
the $5.0 million and is technically in default. As previously mentioned, the
Company is currently in discussions with Regions Bank and its other lenders to
restructure its debt, including this non-revolving line of credit.
In December 2002, the Company entered into a purchase agreement with Global
Marine Systems Limited (Global Marine) for the Midnight Wrangler at a cost of
approximately $10.8 million. The Company took delivery of the vessel in March
2003. The purchase of the vessel was financed by Global Marine over a five-year
period with monthly payments, including 7.00% per annum interest, of
approximately $0.2 million per month plus a $1.0 million payment at the purchase
date in March 2003 and another $1.0 million payment at the end of the five-year
period.
In March 2003, the Company finalized a $9.25 million, seven-year term loan with
General Electric Commercial Equipment Financing (GE Commercial). The loan was
structured so that the Company received $8.0 million immediately and GE
Commercial retained $1.25 million as a security deposit. The interest rate on
the term loan is the 30-day commercial paper rate plus 2.03% and includes
prepayment penalties of 2% for the first twelve months, 1% for the second twelve
months and 0% thereafter. The term loan is structured to have monthly payments
over seven years. The loan agreement contains the same financial covenants as
the Bank Facility and Finance Facility, as amended, discussed above. The
collateral for the loan is the Midnight Eagle and the security deposit described
above. The Company utilized the proceeds from the loan to fund the improvements
to the Midnight Wrangler and a portion of the Midnight Express conversion costs.
In December 2003, the Company refinanced the debt used to acquire the Midnight
Wrangler with General Electric Capital Corporation (GE Capital) by entering into
a secured term loan in the principal amount of $15.0 million. The secured term
loan is structured to have quarterly payments over seven years. The interest
rate on the term loan is 4.25% over LIBOR and the terms contained an origination
discount of 1.50%. The loan agreement contains various covenants beginning on
March 31, 2005, including a minimum EBITDA (as defined) of $18.5 million, a
minimum fixed charge ratio (as defined) of 1.05 to 1,
12
and a maximum leverage ratio (as defined) of 5.25 to 1 for the financial
quarters ended in the period from October 1, 2004 through September 30, 2005.
These maximum leverage ratios decline by 0.50 to 1 for each of the following
four years before reaching 3.25 to 1 that applies for the financial quarters
ended from October 1, 2008 and thereafter. The collateral for the loan is the
Midnight Wrangler and Midnight Gator. A final payment was made to Global Marine
in December 2003. This early termination of debt resulted in a gain to the
Company of $0.9 million that is recorded in the December 31, 2003 financial
statements.
On July 6, 2004, the Company signed a forbearance agreement with GE Capital to
defer the quarterly principal installment payment of $0.5 million due on the
Midnight Wrangler term loan. The quarterly installment payment which was
originally due on June 17, 2004 became payable on September 17, 2004. On
September 30, 2004, the Company signed another forbearance agreement with GE
Capital to defer the June 17, 2004 and September 17, 2004 quarterly principal
installment payments. Under the terms of the latest forbearance agreement, the
Company will now be required to pay GE Capital $1.6 million in cumulative
quarterly principal installment payments on December 17, 2004.
The Company's debt, all of which is currently considered in default, consists of
the following (in thousands):
SEPTEMBER 30, DECEMBER 31,
------------- ------------
2004 2003
- ------------------------------------------------------------------------
Finance Facility ....................... $ 75,508 $ 45,639
Receivable line of credit .............. 11,203 7,227
Non-revolving line of credit ........... 4,854 --
GE Commercial - Midnight Eagle term loan 7,455 8,404
GE Capital - Midnight Wrangler term loan 14,464 15,000
Other debt ............................. 41 49
-------- --------
Total debt .................... 113,525 76,319
Less current portion .......... 113,525 56,262
-------- --------
Total long-term debt .......... $ -- $ 20,057
======== ========
Earlier in 2004, the Company was not in compliance with the current ratio or the
debt service coverage ratio covenants under the Finance Facility (with respect
to the December 31, 2003 testing period). As a result, in early April 2004 the
Company obtained forbearance waivers from its lenders and effected amendments to
its loan agreements to provide certain levels of relief with respect to the
required level of minimum coverage as well as changes related to certain
components of the computation of the minimum current ratio, as defined, and the
minimum debt service coverage ratio, as defined, for the quarterly testing
periods of 2004.
See Notes 1 and 2 for discussion regarding our non-compliance with certain of
our debt covenants as of September 30, 2004.
8. INCOME TAXES:
SFAS 109, "Accounting for Income Taxes," provides for the weighing of positive
and negative evidence in determining whether it is more likely than not that a
deferred tax asset is recoverable. The Company has incurred losses in 2001 and
2003 and has losses on an aggregate basis for the three-year period ended
December 31, 2003. In addition, the Company has incurred losses in the nine
months ended September 30, 2004. Deferred income tax assets are reduced by a
valuation allowance when it is more likely than not that some portion or all of
the deferred income tax assets will not be realized. Relevant accounting
guidance suggests that a recent history of cumulative losses constitutes
significant negative evidence, and that future expectations about income are
overshadowed by such recent losses. The Company recognized no income tax benefit
in the first three quarters of 2004 for this reason.
13
9. COMMITMENTS AND CONTINGENCIES:
Contingencies - The Company has been named as a defendant in a stockholder class
action suit filed by purported stockholders regarding the Public Offering. This
lawsuit, Karl L. Kapps, et. al. v. Torch Offshore, Inc. et. al., No. 02-00582,
which seeks unspecified monetary damages, was filed on March 1, 2002 in the
United States District Court for the Eastern District of Louisiana. The lawsuit
was dismissed on December 19, 2002 for failure to state a claim upon which
relief could be granted. The plaintiffs appealed to the United States Court of
Appeals for the Fifth Circuit. On July 26, 2004 the Court of Appeals for the
Fifth Circuit dismissed the case. On August 6, 2004, the plaintiffs appealed to
the Court of Appeals for the Fifth Circuit for a re-hearing, but on August 25,
2004, the re-hearing was denied. A mandate was issued on September 2, 2004
closing the case.
In May 2002, the Company entered into an agreement with Cable Shipping, Inc. to
time charter a vessel, the G. Murray, under a three-year contract at a rate of
$18,500 per day. The time charter commenced in the third quarter of 2002 and the
vessel was renamed the Midnight Hunter. However, on January 24, 2003, the
Company terminated the time charter because of the vessel's failure to meet
certain specifications outlined in the charter agreement. In November 2003, a
London arbitrator issued a ruling against the Company's recission claim, finding
that the Company was not entitled to terminate the charter, but did rule in
favor of the Company on the warranty claim for breach of contract. An interim
award of $2.2 million was made in favor of Cable Shipping, Inc. The Company has
recorded the full amount of the interim award in its financial statements. The
Company attempted to appeal the ruling, but on April 7, 2004 the appeal was
denied. The escrowed award was released to Cable Shipping, Inc. The quantum of
damages hearing was to be held in late October 2004 where final amounts were to
be awarded to the parties, but the Company and Cable Shipping, Inc. settled the
amount in September 2004 for $4.1 million, which was to be paid by the Company
on November 19, 2004. The settlement amount has been recorded in the three
months ended September 30, 2004 as an other operating expense. As of November
22, 2004, the Company had not paid the $4.1 million settlement amount, but is
seeking to enter discussions with Cable Shipping, Inc. with the objective of
determining a feasible payment plan for the settlement amount.
In March 2003, the Company filed a lawsuit (Torch Offshore, Inc. v. Newfield
Exploration Company, No. 03-0735, filed in the United States District Court,
Eastern District of Louisiana on March 13, 2003) against Newfield Exploration
Company (Newfield) claiming damages of approximately $2.1 million related to
work completed for Newfield in the Gulf of Mexico at Grand Isle Block 103-A. The
lawsuit alleges that the Company did not receive all compensation to which it
was entitled pursuant to the contract. The Company has recorded a provision for
the full amount of this claim; however, the Company intends to continue to
pursue the claim. A trial date has been set for January 20, 2005.
In July 2003, the Company filed a lawsuit (Torch Offshore, Inc. et al v. Stolt
Offshore, Inc., Algonquin Gas Transmission Company and Duke Energy, No. 03-1915,
in the United States District Court, Eastern District of Louisiana on July 3,
2003) against Stolt Offshore, Inc. (Stolt), and its customer, seeking recovery
of approximately $7.6 million related to work completed for Stolt in Boston,
Massachusetts. The Company worked as a subcontractor to Stolt, who was engaged
by Algonquin Gas Transmission Company to complete the Boston Hubline project, an
underwater pipeline crossing the Boston Harbor. The lawsuit alleged that the
Company did not receive all compensation to which the Company was entitled
pursuant to the subcontract the Company had with Stolt. Two other subcontractors
to Stolt joined with the Company as plaintiffs in the lawsuit. Additionally, the
Company, along with two other subcontractors, filed a lawsuit in Massachusetts
(Civil Action No. 03-01585), which included a claim for breach of contract as
well as a claim to assert mechanics' liens against Algonquin's easement located
in Weymouth, Norfolk County, Massachusetts. In March 2004, the Company reached a
settlement with Stolt in the amount of $6.2 million and the full amount of the
difference between the claim and the final settlement (a loss of approximately
$1.4 million) was recorded in the Company's financial statements as of December
31, 2003. The lawsuits have been dismissed, and the lien claims have been
released.
Because of the nature of its business, the Company is, from time to time,
involved in routine litigation or subject to various other disputes or claims
related to its business operations (other miscellaneous legal matters). The
Company has engaged legal counsel to assist in defending all such legal matters,
and
14
management intends to vigorously defend all claims. The Company does not
believe, based on all available information, that the outcome of these other
miscellaneous legal matters will have a material effect on its financial
position or results of operations.
Lease Commitments - In early 2000, the Company commenced a five-year new-build
charter for the Midnight Arrow, a DP-2 deepwater subsea construction vessel. The
long-term charter was scheduled to expire in March 2005, but the Company and
Adams Offshore Ltd. (the "Lessor") reached an agreement to early terminate the
charter effective May 31, 2004. As part of the termination agreement, the Lessor
waived the early termination fee and it was agreed that the Company is to pay
the Lessor $250,000 per month until the outstanding balance of $1.8 million due
to the Lessor (all of which has been accrued) is eliminated. The charter was
accounted for as an operating lease. As of September 30, 2004, $1.5 million
remained outstanding.
In January 2004, the Company entered into a time charter for the Midnight
Hunter, a 340-foot DP-2 deepwater capable vessel. The time charter for the
Midnight Hunter is at a day rate of $14,500 per day and ends September 2, 2005,
with provisions for extension or outright purchase. The charter amount includes
the marine crew, maintenance and repairs, drydock costs and certain insurance
coverages. The vessel was previously under charter by the Company, but the
Company cancelled the charter in January 2003 because the vessel did not meet
certain specifications as outlined in the charter agreement which prevented the
Company from performing certain types of work, particularly deepwater pipelay
(see further discussion above). However, the Company has re-chartered the vessel
at a lower day rate and has altered how it utilizes the vessel. The Company is
utilizing the DP-2 vessel in a diving support capacity, which allows it to
perform deepwater tie-ins with the Company's 1,000-foot saturation system that
has been installed on the vessel.
Other Commitments - The Company has executed contracts with several critical
equipment suppliers related to the conversion of the Midnight Express. In
December 2002, the Company entered into a contract with Davie Maritime, Inc. of
Quebec, Canada to complete the conversion of the Midnight Express at a contract
value of $25.3 million ($37.1 million inclusive of assigned critical equipment
supplier contracts) that became effective in April 2003. Due to the settlement
with Davie Maritime, Inc., the shipyard contract, inclusive of assigned critical
equipment supplier contracts, had a final value of $53.2 million of which $7.8
million came from approved change orders and $8.3 million from an agreed
increase in contract price. The shipyard contract was completed with the
delivery of the Midnight Express on June 4, 2004. The remaining outstanding
contracts for the conversion of the Midnight Express aggregate $4.2 million, of
which $3.0 million had been paid as of September 30, 2004. In the event the
Company terminates these contracts, the Company is required to pay certain of
these suppliers' costs incurred to date while other suppliers are entitled to
the full value of the contract, depending upon the terms of the relevant
agreement. The Company believes its present termination cost exposure on these
contracts totals approximately $1.1 million.
As of November 22, 2004, four trade creditors had outstanding maritime liens on
various vessels in the Company's fleet, at least one of which is contested. In
addition, three trade creditors had individually brought legal action against
the Company for collection of outstanding balances due to them. The Company is
working with these trade creditors to cure the outstanding maritime liens and
litigation. All applicable liabilities have been recorded in full on the
Company's balance sheet as of September 30, 2004.
10. NEW ACCOUNTING STANDARDS:
In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS
No. 148, which provides alternative methods of transition for a voluntary change
to the fair-value based method of accounting for stock-based employee
compensation, and the new standard, which is now effective, amends certain
disclosure requirements. The Company continues to apply APB No. 25, "Accounting
for Stock Issued to Employees," and related interpretations in accounting for
its stock-based compensation;
15
therefore, the alternative methods of transition do not apply. The Company has
adopted the disclosure requirements of SFAS No. 148 (see "Stock-Based
Compensation" above).
In June 2001, the American Institute of Certified Public Accountants (AICPA)
issued an exposure draft of a proposed Statement of Position (SOP), "Accounting
for Certain Costs and Activities Related to Property, Plant, and Equipment."
This proposed SOP would change, among other things, the method by which
companies would account for normal, recurring or periodic repairs and
maintenance costs related to "in service" fixed assets. It would require that
these types of expenses be recognized when incurred rather than recognizing
expense for these costs while the asset is productive. The proposed SOP was
presented to the FASB for clearance, however in April, 2004, the FASB did not
approve the draft SOP, but rather decided to consider the relevant concepts
within the SOP in connection with the FASB's short-term convergence project on
property, plant and equipment, including depreciation currently scheduled to
take place in the 2005-2006 timeframe.
In January 2003, the FASB issued Financial Interpretation 46, "Consolidation of
Variable Interest Entities -- An Interpretation of Accounting Research Bulletin
(ARB) 51" ("FIN 46" or the "Interpretation"). FIN 46 addresses consolidation by
business enterprises of variable interest entities (VIEs). The primary objective
of the Interpretation is to provide guidance on the identification of, and
financial reporting for, entities over which control is achieved through means
other than voting rights; such entities are known as VIEs. The provisions of FIN
46 apply immediately to VIEs created after January 31, 2003. Application is
required for interests in special-purpose entities in the period ending after
December 15, 2003 and is required for all other types of VIE's in the period
ending after March 15, 2004. The Company has no VIEs and there was no material
impact on the Company's financial position or results of operations from the
adoption of FIN 46.
11. STATUS OF CERTAIN SIGNIFICANT OBLIGATIONS:
As of November 22, 2004, the Company had not paid the $4.1 million settlement
amount for the Midnight Hunter case, which was due for payment on November 19,
2004 (see Notes 2 and 9). The Company is seeking to enter discussions with Cable
Shipping, Inc. with the objective of determining a feasible payment plan for the
settlement amount.
As of November 22, 2004, the Company had not repaid the $5.0 million to Regions
Bank for the non-revolving line of credit and is technically in default (see
Notes 2 and 7). The Company is currently in discussions with Regions Bank and
its other lenders to restructure its debt, including this non-revolving line of
credit.
As of November 22, 2004, the $79.0 million Finance Facility has not been
converted to term status due to the default status of the debt and the Company's
ongoing negotiations with its lenders to restructure its debt (see Note 7).
In addition, there are approximately $60.8 million of additional short-term
obligations included within current liabilities as of September 30, 2004.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read in conjunction with our
Consolidated Financial Statements and Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in our Annual Report on
Form 10-K for the fiscal year ended December 31, 2003, and the unaudited interim
condensed consolidated financial statements and related notes contained in "Item
1. Financial Statements" above.
This Quarterly Report on Form 10-Q contains statements that are "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995 and Section 21E of the Securities Exchange Act of 1934, as amended,
concerning, among other things, our prospects, expected revenues, expenses and
profits, developments and business strategies for our operations, all of which
are subject to certain risks, uncertainties and assumptions. Our actual results
may differ materially from those expressed or implied in this Form 10-Q. Many of
these factors are beyond our ability to control or
16
predict. Accordingly, we caution investors not to place undue reliance on
forward-looking statements. There is no assurance that our expectations will be
realized. Factors that could cause or contribute to such differences include,
but are not limited to, those discussed in our Annual Report on Form 10-K for
the fiscal year ended December 31, 2003 under the captions "Forward-Looking
Statements" and "Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Risk Factors."
GENERAL
We provide subsea construction services in connection with the in-field
development of offshore oil and natural gas reservoirs. We are a leading service
provider in our market niche of installing and maintaining small diameter
flowlines and related infrastructure on the Continental Shelf of the Gulf of
Mexico. Over the last few years, we have expanded our operations, fleet
capabilities and management expertise to enable us to provide analogous services
in water depths up to 10,000 feet. In addition, we have begun to enter the
international markets of the world, including Mexico and West Africa, as we
believe these areas present opportunities for utilization of our fleet.
In the first three quarters of 2004, we reported revenues of $53.4 million,
15.7% greater than the revenues for the nine months ended September 30, 2003 of
$46.2 million. The operating loss for the first nine months of 2004 was $14.7
million, compared with an operating loss of $3.8 million in the first nine
months of 2003. During the first three quarters of 2004, based upon management's
experience, demand for subsea construction services in the Gulf of Mexico
remained relatively weak as the levels of offshore drilling activity in the
markets where we operate continue to be depressed. In addition, our operations
are cyclical and fleet-wide utilization is generally lower during the first half
of the year because of winter weather conditions in the Gulf of Mexico. These
forces have kept market prices and fleet utilization at low levels while our
operating costs have increased, and as a result, an adverse impact has been seen
on our gross margin (defined as revenues less cost of sales). Finally, adverse
weather conditions in the Gulf of Mexico during the month of September 2004,
including Hurricanes Frances and Ivan, negatively impacted our utilization for
the third quarter of 2004.
We have a working capital deficit of $116.0 million. This deficit is primarily
attributable to the classification of the outstanding indebtedness under the
Midnight Express construction finance facility, which was to mature and convert
to term status no later than October 31, 2004, as a current liability. In
addition, due to breaches of certain financial covenants as discussed below, all
of our long-term debt is classified as current and in default as of September
30, 2004. Also, we have recently reached a settlement in our Midnight Hunter
charter dispute at an amount of $4.1 million against us, which was due for
payment on November 19, 2004. These issues, among others, place a high degree of
pressure on our liquidity and could ultimately impact our operations and future
business plans. As of November 22, 2004, we had $39,000 of borrowing capacity
under our credit facilities. We must successfully restructure our debt and raise
additional debt and/or equity capital to continue to manage our liquidity needs
and meet our operating and other financial commitments.
We believe that certain factors are critical to our success, including curing
our current debt defaults; having sufficient capital resources to satisfy vendor
obligations related to the conversion of the Midnight Express in 2004; obtaining
employment contracts for the Midnight Express as soon as possible upon
completion of its sea trials; raising additional capital with a public or
private placement of equity or through the sale of certain vessels; refinancing
our existing indebtedness; reducing administrative and operating costs; managing
the utilization of our existing fleet of vessels by strategically positioning
our DP-2 vessels on jobs to promote efficiency and greater margins; and
continuing to expand our presence internationally and move into the intermediate
water depths and the deepwater markets.
In order to implement our business plan and meet our financial obligations, we
must:
17
- - Satisfy the remaining vendor obligations associated with the conversion of
the Midnight Express.
- - Reach an agreement with Cable Shipping, Inc. in relation to the $4.1
million settlement we owe to them in relation to the Midnight Hunter case.
As this settlement was due on November 19, 2004, we are delinquent on the
payment of the settlement and must work with Cable Shipping, Inc. to
formulate a payment plan strategy.
- - Attain the necessary forbearance waivers and/or amendments from our
creditors to cure our non-compliance and default issues as of September
30, 2004. In addition, we must work with our creditors to restructure our
outstanding debt with provisions that will give us the opportunity to
maintain compliance in the future.
- - Raise additional capital to fund working capital requirements, including
the payment of monthly lease amounts for the Midnight Hunter, which is
approximately $0.4 million per month for the final quarter of the year
ended December 31, 2004, and to make monthly and quarterly interest and
principal payments to General Electric Commercial Equipment Financing (GE
Commercial) as part of the Midnight Eagle term loan and General Electric
Capital Corporation (GE Capital) as part of the Midnight Wrangler term
loan (together $1.9 million for the remainder of 2004 as of September 30,
2004). The additional capital will also support other working capital
requirements, such as the drydocking of certain vessels so that they meet
U.S. Coast Guard regulations and re-enter our active fleet.
- - Enter into an agreement(s) for utilization of the Midnight Express near
the time of the completion of its final sea trials in November 2004. On
October 26, 2004, we announced that we had been awarded our first project
for the Midnight Express. This project commenced after the completion of
sea trials on November 7, 2004.
- - Pursue the sale of certain of our vessels into foreign markets either
through charters to operators in these foreign markets or the outright
sale of these vessels. We have had discussions with various parties;
however, no definitive agreements have been entered into as of November
22, 2004. In addition, the Finance Facility specifies that any proceeds
from the sale of a vessel that is pledged as collateral be used to repay
the amounts due under the Finance Facility to Regions Bank and EDC.
We have been actively attempting to implement our plan, the ultimate success of
which is beyond our control. If we are not able to successfully implement our
plan our financial condition and liquidity will be materially and adversely
affected. Because of these conditions, there is significant doubt about our
ability to continue as a going concern. For more information regarding our plan,
see Note 2 to the Financial Statements located in Item 1 of this Form 10-Q, and
for the related risks, see "Risk Factors" in "Item 7 - Management's Discussion
and Analysis of Financial Condition and Results of Operations - Risk Factors" in
our annual report on Form 10-K filing for the fiscal year ended December 31,
2003.
We remain focused on our business strategy of moving into the deepwater markets
of the world through the establishment of our fleet of DP-2 vessels. Since 1997,
we have increased the size of our total fleet of construction and service
vessels from three to ten construction and service vessels with an appraised
fleet fair market value of approximately $219.8 million. These appraised fair
market values, based on values in the ordinary course of business, were provided
by appraisers selected and contracted by our creditors to evaluate our vessels
for use as collateral for our loans and were performed between October 2003 and
October 2004. However, appraisals representing the substantial majority
(approximately 84%) of the fair market value were performed between June 2004
and October 2004. In 2002, we acquired a 520-foot vessel from Smit
International, which we renamed the Midnight Express. The Midnight Express is
being converted to a DP-2 offshore construction vessel with our patented pipelay
system. As of November 22, 2004, we were in need of an
18
additional $2.5 million to satisfy certain vendor obligations incurred in
connection with the conversion of the Midnight Express above and beyond the
original Finance Facility. The additional funds were needed as unexpected costs
arose due to delays caused by the hurricanes in the Gulf of Mexico in September
2004. In addition to the costs associated with the delays, we added equipment to
the vessel to give it the capability to lay pipe in a conventional fashion. We
are currently in negotiations with Regions Bank and EDC for these additional
funds. In December 2002, we committed to purchase a cable-lay vessel, renamed
the Midnight Wrangler, for the purpose of deepwater pipelay and subsea
construction. We took possession of this vessel in March 2003 and the vessel
entered our active fleet in August 2003 after various modifications and upgrades
were made to it. In January 2004, we entered into a new charter for the Midnight
Hunter, a deepwater capable diving support vessel. These additions to our fleet
over the past few years have positioned us to grow our business while achieving
better margins as we move into the intermediate depths and the deepwater. These
DP-2 vessels are the core of our fleet and the key to our future success.
While our fundamental business strategy and objectives continue to be focused on
further expansion into the deepwater market, we recognize that under current
conditions our ability to control our future direction is significantly and
negatively impacted by our current liquidity constraints. As a result, we have
retained financial advisors to assist in reviewing practical financial and
operational options. We are unable to predict the outcome of various strategies
under development and consideration. We are negotiating with our lenders to
identify mutually acceptable alternatives to restructure our debt and/or pursue
other financial arrangements that would provide relief from our current debt
defaults and provide additional funding. While we intend to aggressively pursue
such measures, there is no assurance that our objectives in this regard will be
successfully achieved. In the event that the Company's creditors do not continue
to forebear and we are unable to effectively address our liquidity issues, it is
likely that we would need to seek bankruptcy protection to continue our
operations.
BUSINESS ENVIRONMENT
The demand for subsea construction services has historically depended upon the
prices of oil and natural gas. However, this relationship has deteriorated over
the past 24 months as the price of oil has greatly increased without a
reciprocal increase in the activity in the Gulf of Mexico. There has been an
increase in activity in Mexico and West Africa as equipment has moved from the
Gulf of Mexico to these areas. These prices do reflect the general condition of
the industry and influence the willingness of our customers to spend capital to
develop oil and natural gas reservoirs on a global basis. We have experienced an
increase in vessel utilization and pricing in the fourth quarter of 2004 due to
the damage caused to pipelines by hurricanes in September 2004; however, the
duration of this level of activity is uncertain. We are unable to predict future
oil and natural gas prices or the level of offshore construction activity
related to the industry. In addition to the prices of oil and natural gas, we
use the following leading indicators, among others, to forecast the demand for
our services:
- - the offshore mobile and jack-up rig counts;
- - forecasts of capital expenditures by major, independent, and state oil and
natural gas companies; and
- - recent lease sale activity levels.
Even when demand for subsea construction services is strong, several factors may
affect our profitability, including the following:
- - competition;
- - availability of qualified personnel;
19
- - equipment and labor productivity;
- - cost of third party services such as catering and labor services;
- - fuel cost;
- - weather conditions;
- - contract estimating uncertainties;
- - global economic and political circumstances;
- - other risks inherent in marine construction; and
- - availability and cost of insurance.
Although greatly influenced by overall market conditions, our fleet-wide
utilization is generally lower during the first half of the year because of
winter weather conditions in the Gulf of Mexico. Accordingly, we endeavor to
schedule our drydock inspections and routine and preventative maintenance during
this period. Additionally, during the first quarter, a substantial number of our
customers finalize capital budgets and solicit bids for construction projects.
For this reason, individual quarterly/interim results are not necessarily
indicative of the expected results for any given year.
In the life of an offshore field, capital is allocated for field development
following a commercial discovery. The time that elapses between a successfully
drilled well and the development phase, in which we participate, varies
depending on the water depth of the field. On the Shelf, demand for our services
generally follows drilling activities by three to twelve months. We have noticed
that demand for pipeline installation for projects exceeding 1,000 feet of water
depth generally follows drilling activities by at least eighteen months to three
years as deepwater installations typically require much more engineering design
work than Shelf installations.
RESULTS OF OPERATIONS
COMPARISON OF THE QUARTER ENDED SEPTEMBER 30, 2004 TO THE QUARTER ENDED
SEPTEMBER 30, 2003
The following table highlights revenue days (days of vessel utilization),
revenue and gross profit for the quarters ended September 30, 2004 and September
30, 2003.
(dollars in thousands, except per
revenue day measures, unaudited) QUARTER ENDED SEPTEMBER 30,
---------------------------
2004 2003
------- -------
Revenue Days 496 484
Revenue $22,572 $15,262
Gross Profit $ 928 $ 1,491
Average per Revenue Day:
Revenue $45,508 $31,533
Gross Profit $ 1,871 $ 3,081
Revenues. Revenues were $22.6 million for the quarter ended September 30, 2004
compared to $15.3 million for the quarter ended September 30, 2003, an increase
of 47.9%. The increase in third quarter 2004 revenues was caused by the increase
in average pricing realizations (revenues divided by revenue days) and revenue
days worked when compared to those of the third quarter 2003. Average pricing
20
realizations in the third quarter of 2004 were 44.3% higher than the average
pricing realizations in the third quarter of 2003. In addition, the number of
revenue days worked increased 2.5% between periods. Our fleet worked 496 revenue
days in the third quarter of 2004 resulting in a utilization rate of 69.8%,
compared to 484 revenue days worked in the three months ended September 30,
2003, or a 62.1% utilization rate. The increase in the average pricing
realization is attributable to the international work performed by the Midnight
Brave in the quarter ended September 30, 2004. The increase in the number of
revenue days on a quarter-by-quarter basis is due to additional revenue days for
the Midnight Hunter (65 revenue days), Midnight Wrangler (52 revenue days),
Midnight Eagle (24 revenue days), Midnight Fox (23 revenue days), Midnight Brave
(17 revenue days) and Midnight Dancer (10 revenue days). The increase in revenue
days was offset by the removal of the Midnight Arrow from the fleet in the first
half of 2004 (charter terminated on May 31, 2004). This vessel contributed 92
revenue days in the third quarter of 2003. In addition, the Midnight Star did
not work during the third quarter of 2004, but had previously contributed 51
revenue days in the third quarter of 2003. Finally, the Midnight Runner, which
was scrapped in August 2004, had contributed 22 revenue days in the third
quarter of 2003, but did not work in the quarter ended September 30, 2004.
Gross Profit. Gross profit (defined as revenues less cost of sales) was $0.9
million (4.1% of revenues) for the quarter ended September 30, 2004, compared to
$1.5 million (9.8% of revenues) for the quarter ended September 30, 2003, a
decrease of 37.8%. Cost of sales consists of job related costs such as vessel
wages, insurance and repairs and maintenance. The gross profit margin in the
quarter ended September 30, 2004 declined as compared to the gross profit margin
in the quarter ended September 30, 2003 due to increases in cost of sales. The
overall increase in cost of sales in the third quarter of 2004 was primarily due
to increases in the fixed cost structure (including wages and insurance),
subcontract costs, vessel consumables, job consumables, support vessels,
equipment rental costs, and non-marine crew costs. In addition, included in cost
of sales were $0.7 million of additional costs related to the termination of the
Midnight Hunter charter for the three months ended September 30, 2003.
Depreciation and Amortization. Depreciation and amortization expense was $2.0
million for the quarter ended September 30, 2004, an increase of approximately
2.1%. compared to the quarter ended September 30, 2003. The minimal increase
consisted of depreciation expense for the Midnight Wrangler in the third quarter
of 2004 for a full three months as compared to only a partial period for the
third quarter of 2003. This was partially offset by the decrease in the
amortization of drydock costs for the Midnight Brave and Midnight Carrier in the
third quarter of 2004 as compared to the third quarter of 2003.
General and Administrative Expenses. General and administrative expenses totaled
$1.8 million (8.0% of revenues) for the quarter ended September 30, 2004
compared to $1.6 million (10.6% of revenues) for the quarter ended September 30,
2003. The third quarter 2004 general and administrative expenses were higher
than the third quarter of 2003 due to increases in legal fees, financing fees,
and personnel costs. These increase were offset partially by declines in
consulting costs.
Other Operating Expense. Other operating expense was $4.1 million for the
quarter ended September 30, 2004 compared to zero in the quarter ended September
30, 2003. The entire amount relates to the settlement of the Midnight Hunter
arbitration case.
Other Income. Other income was zero for the quarter ended September 30, 2004 and
2003. We capitalized all of our third quarter 2004 and 2003 interest costs,
totaling $1.1 million and $0.5 million, respectively, in relation to the
conversion of the Midnight Express.
Income Taxes. For the quarter ended September 30, 2004, we increased our
deferred tax asset valuation allowance by $2.5 million, recognizing no net
income tax benefit associated with our operating loss due to the uncertainty of
future taxable income. We recorded a $0.7 million benefit (a 35% effective tax
rate) during the quarter ended September 30, 2003.
21
Net Loss. Net loss for the quarter ended September 30, 2004 was $7.0 million,
compared with a net loss of $1.4 million for the quarter ended September 30,
2003.
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2004 TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2003
The following table highlights revenue days (days of vessel utilization),
revenue and gross profit for the nine-month periods ended September 30, 2004 and
September 30, 2003.
(dollars in thousands, except per
revenue day measures, unaudited) NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2004 2003
------- -------
Revenue Days 1,448 1,478
Revenue $53,434 $46,167
Gross Profit $ 1,251 $ 6,151
Average per Revenue Day:
Revenue $36,902 $31,236
Gross Profit $ 864 $ 4,162
Revenues. Revenues were $53.4 million for the nine months ended September 30,
2004 compared to $46.2 million for the nine months ended September 30, 2003, an
increase of 15.7%. The increase in revenues for the nine-month period ended
September 30, 2004 as compared to the year-ago period is the result of an
increase in average pricing realizations (revenues divided by revenue days)
offset only slightly by a decrease in the number of revenue days. Average
revenue per revenue day was $36,902 in the first nine months of 2004 as compared
to $31,236 in the first nine months of 2003, an increase of 18.1%. However, the
number of revenue days worked by our fleet decreased 2.0%. Our fleet worked
1,448 revenue days in the first nine months of 2004 resulting in a utilization
rate of 57.0%, compared to 1,478 revenue days worked in the nine months ended
September 30, 2003, or a 61.9% utilization rate. The increase in the average
pricing realization is attributable to the international work performed by the
Midnight Brave in the nine months ended September 30, 2004. The decrease in
revenue days is primarily due to the removal of the Midnight Arrow from our
fleet as of May 31, 2004. The vessel contributed only 76 revenue days in the
nine months ended September 30, 2004 as compared to 265 revenue days in the
year-ago period. The Midnight Runner, which was scrapped in August 2004,
contributed 72 revenue days in the nine-month period in 2003, but did not work
at all in 2004. Other decreases were seen with the Midnight Rider (78 revenue
days), Midnight Star (70 revenue days) and Midnight Brave (46 revenue days).
These decreases were almost entirely offset by increases in the number of
revenue days of the Midnight Wrangler, Midnight Hunter and Midnight Dancer.
Gross Profit. Gross profit (defined as revenues less cost of sales) was $1.3
million (2.3% of revenues) for the nine months ended September 30, 2004,
compared to $6.2 million (13.3% of revenues) for the nine months ended September
30, 2003. Cost of sales consists of job related costs such as vessel wages,
insurance and repairs and maintenance. The decrease in the gross profit margin
was primarily caused by a higher fixed cost structure (including wages,
insurance, and repairs and maintenance) and higher direct job costs, including
increases in job consumables, support vessels, subcontract costs, catering
costs, and equipment rental costs. In addition, there was an increase in
indirect costs as well, including communication costs. These increases were
offset somewhat by lower direct job labor when compared to the first nine months
of 2003. In addition, included in cost of sales were $2.1 million of additional
costs related to the termination of the Midnight Hunter charter in the nine
months ended September 30, 2003.
Depreciation and Amortization. Depreciation and amortization expense was $6.8
million for the nine months ended September 30, 2004, compared to $5.6 million
for the nine months ended September 30,
22
2003, an increase of 20.3%. The major portion of the increase is due to the
impairment charge of $0.6 million on the Midnight Runner during the second
quarter of 2004. In addition, the increase was a result of more depreciation of
vessels in the first nine months of 2004, as compared to the same period of 2003
offset by a decrease in amortization of drydock costs. The increases in
depreciation expense during the first nine months of 2004 came mostly from the
addition of the Midnight Wrangler to the fleet as well as from the Midnight
Gator. The amortization of drydock expense for the Midnight Brave and Midnight
Carrier decreased during the 2004 period when compared to the first nine months
of 2003.
General and Administrative Expenses. General and administrative expenses totaled
$4.9 million (9.1% of revenues) for the nine months ended September 30, 2004,
compared to $4.3 million (9.4% of revenues) for the nine months ended September
30, 2003. The general and administrative expenses were higher in the first nine
months of 2004 as compared to the nine months ended September 30, 2003, due to
increases in financing fees, personnel costs, legal fees, professional fees, and
travel costs offset by a decline in consulting costs and business promotion
expenses.
Other Operating Expense. Other operating expense was $4.3 million for the nine
months ended September 30, 2004 compared to zero in the nine months ended
September 30, 2003. The settlement of the Midnight Hunter arbitration case
accounts for $4.1 million of the total for the nine months ended September 30,
2004.
Other Income. Other income was zero for the nine months ended September 30, 2004
compared to other income of $1,000 for the nine months ended September 30, 2003.
We capitalized all of our year-to-date 2004 and 2003 interest costs, totaling
$2.8 million and $0.9 million, respectively, in relation to the conversion of
the Midnight Express.
Income Taxes. For the nine months ended September 30, 2004, we increased our
deferred tax asset valuation allowance by $5.1 million, recognizing no net
income tax benefit associated with our operating loss due to the uncertainty of
future taxable income. We recorded a $1.3 million benefit (a 35% effective tax
rate) during the nine months ended September 30, 2003.
Net Loss. Net loss for the nine months ended September 30, 2004 was $14.7
million, compared with a net loss of $2.5 million for the nine months ended
September 30, 2003.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY NEEDS AND OUR FINANCIAL PLAN
As discussed in our annual report on Form 10-K for the year ended December 31,
2003, our financial condition has been significantly and negatively impacted by
adverse conditions in the markets where we operate and our attempt to expand our
operations into the deepwater market. We have experienced recurring losses from
operations, negative operating cash flows and a working capital deficiency. As a
result, our independent registered public accounting firm advised us that they
had reached a conclusion that there is substantial doubt about our ability to
continue as a going concern and, as required by auditing standards of the Public
Company Accounting Oversight Board (United States), included in their auditors'
report on our 2003 financial statements an explanatory paragraph to reflect that
conclusion. In addition, we are currently in default of our debt obligations due
to matters of non-compliance with certain covenants under our debt agreements.
We have also recently reached a settlement in our Midnight Hunter charter
dispute at an amount of $4.1 million against us, which was due for payment on
November 19, 2004. Our ability to continue in business is dependent on our
ability to cure current defaults and restructure existing debt, raise additional
capital, and improve our operating results. We have delayed payments to vendors
and other creditors beyond stated terms, and certain of our vendors have placed
liens on our vessels.
23
As of September 30, 2004, we were not in compliance with the financial covenants
(as amended in early April 2004) of the Bank Facility, the Finance Facility and
the GE Commercial term loan, including the minimum consolidated current ratio of
0.70 to 1, the tangible net worth minimum of $60.0 million, the minimum debt
service ratio of 1.20 to 1, and the consolidated leverage ratio of no more than
2.00 to 1. We are currently in default and are working with our lenders to
negotiate forbearance waivers and/or amendments to cure these non-compliance
issues. There can be no assurance that compliance will be attained. As depicted
on the balance sheet as of September 30, 2004, a reclassification of $17.5
million has been made of our long-term debt to a current position. This
reclassification includes the debt associated with the Midnight Eagle and
Midnight Wrangler facilities which are also in default under related
cross-default provisions. Although our creditors have not issued notices of
default or taken any actions as a result of the cross-defaults (as of November
22, 2004), because we are not in compliance with the terms of our debt
agreements our creditors could demand immediate payment and have the right to
seize the applicable collateral. Our obligations under our credit agreements are
secured by substantially all of our assets. If not effectively cured, these
defaults under our credit agreements will adversely impact our ability to
sustain our operations in the normal course resulting in a material impact on
our financial condition and results of operations.
We face significant liquidity and working capital challenges, in addition to
costs of expanding our operations into the deepwater market, and will need to
raise additional capital and/or refinance our existing debt to continue to meet
our debt obligations and conduct our operations as currently conducted. In
connection with our efforts to raise capital and/or refinance our existing debt,
we have a developed a plan, the components of which include curing our current
debt defaults, the sale of certain of our vessels and raising capital, including
refinancing or debt, through the public or private capital markets. Our ability
to raise additional capital will depend upon the status of capital markets and
industry conditions. If we are not able to raise additional capital through the
public or private equity markets or the sale of vessels, then the amount of cash
generated from our operations will not be sufficient to meet our debt service
obligations and working capital requirements, which have risen significantly in
part due to our entry into the deepwater market. Please refer to Note 2 to the
Financial Statements located in Item 1 of this Form 10-Q for more details on our
plan. However, no assurances can be given that we will be able to successfully
implement our plan.
As part of our plan, in April 2004 we executed an amendment with Regions Bank
and EDC for a $19.0 million increase to our existing credit facility (the
"Finance Facility") to complete the conversion of the Midnight Express and
amended certain financial covenants. We also executed amendments in April 2004
with GE Commercial and GE Capital relating to our Midnight Eagle and Midnight
Wrangler term loans, respectively. As of November 22, 2004, the Finance Facility
has not been converted to term status due to the default status of our debt and
our ongoing negotiations with our lenders to restructure our debt.
In May 2004, we reached a settlement with Davie Maritime, Inc., the shipyard
that completed the conversion of the Midnight Express in Quebec, Canada, through
an increase in the contract price of $8.3 million. This settlement covered all
of the claims made by Davie Maritime, Inc. against us. Since the initial
contract signing, the contract price increased from $37.1 million to $53.2
million of which $7.8 million resulted from approved change orders and $8.3
million from an agreed increase in contract price. The settlement was paid from
March 1, 2004 through the delivery date (June 4, 2004) from the additional $19.0
million from the Finance Facility. Also as part of our plan, we reached a
settlement with Stolt Offshore, Inc. (Stolt) in the amount of $6.2 million for
work we completed for Stolt on the Boston Hubline project in the first half of
2003. We collected these funds in March 2004 and have used them for working
capital purposes.
On July 6, 2004, we signed a forbearance agreement with GE Capital to defer the
quarterly principal installment payment of $0.5 million due on the Midnight
Wrangler term loan. The quarterly installment payment which was originally due
on June 17, 2004 was payable on September 17, 2004. On September 30, 2004, we
signed another forbearance agreement with GE Capital to defer the June 17, 2004
and
24
September 17, 2004 quarterly principal installment payments. Under the terms of
the latest forbearance agreement, we will be required to pay GE Capital $1.6
million in cumulative quarterly principal installment payments on December 17,
2004.
In July 2004, we applied under our structured Finance Facility for the 10%
interest rate subsidy available from Industry Canada. In August 2004, Industry
Canada paid the U.S. dollar equivalent of approximately $5.6 million. Of this
total, approximately $1.5 million was paid directly to us and was to be used to
pay future interest due on the Finance Facility as discussed above.
Approximately $0.4 million remains available as of September 30, 2004. The
remaining amount of approximately $4.1 million was paid by Industry Canada to
Regions Bank and EDC to reduce or "buy down" the interest rate on the Finance
Facility when it converts to the three-year term loan.
On July 22, 2004, we entered in an agreement with Regions Bank for a $5.0
million non-revolving line of credit with an initial term of 120 days to be used
for working capital purposes. The rate on the borrowing is LIBOR plus 4.00%. The
collateral on the non-revolving line is the Midnight Rider, which is also
collateral under the Finance Facility with Regions Bank and EDC. In order to use
this vessel as collateral for this credit agreement, EDC took a subordinated
secured position on the vessel. In addition, as part of the above transaction,
Regions Bank agreed to allow the usage of approximately $1.5 million of proceeds
from Industry Canada to pay the interest on the Finance Facility during the
conversion period. The proceeds were originally allocated to repay a portion of
the $19.0 million additional financing arranged in April 2004 to convert the
Midnight Express. The terms of the note call for the loan to be repaid on
November 19, 2004. However, as of November 22, 2004, we had not repaid the $5.0
million and are technically in default. As previously mentioned, we are
currently in discussions with Regions Bank and our other lenders to restructure
our debt, including this non-revolving line of credit. We intend to repay the
$5.0 million note through a refinancing of our existing debt with the prospect
of converting this $5.0 million into long-term debt. In the event we are
successful in obtaining refinancing of our existing debt, the Finance Facility
calls for the proceeds of the refinancing to: 1) repay this $5.0 million note,
2) repay $1.5 million of the additional $19.0 million of financing on the
Midnight Express conversion, and 3) use 50% of the refinance proceeds received
in excess of $6.5 million to also repay a portion of the additional $19.0
million of financing on the Midnight Express conversion.
Our Finance Facility specifies we must raise the lesser of $10.0 million or 20%
of our market capitalization (as defined in the Finance Facility) at the time of
the issuance by June 30, 2005 and requires that the first $10.0 million of
proceeds associated with such an offering be used to reduce amounts outstanding
under the Finance Facility.
AVAILABLE CREDIT FACILITIES AND DEBT
Regions Bank Facility. In July 2002, we entered into a $35.0 million bank
facility (the "Bank Facility") with Regions Bank, consisting of a $25.0 million
asset-based five-year revolving credit facility and a $10.0 million accounts
receivable-based working capital facility. We continue to have available to us
the accounts receivable-based working capital facility from Regions Bank. In
December 2003, the accounts receivable-based working capital facility was
increased to a limit of $15.0 million. Amounts outstanding under the accounts
receivable-based working capital facility may not exceed 85% of eligible trade
accounts receivable. We had $11.2 million outstanding under the $15.0 million
accounts receivable-based working capital facility as of September 30, 2004. In
addition, we issued a $1.5 million standby letter of credit as security for the
charter payments due under the charter agreement for the Midnight Hunter against
the accounts receivable-based working capital facility. In July 2003, this
letter of credit was drawn by Cable Shipping, Inc., the owners of the Midnight
Hunter. We have recorded the $1.5 million as a liability on our balance sheet as
of December 31, 2003 as part of the receivable line of credit. We had available
borrowing capacity of up to an additional $0.3 million under the $15.0 million
accounts receivable-based working capital facility based upon eligible
receivables at September 30, 2004. The $15.0 million accounts receivable-based
working capital facility was extended and has a maturity date of
25
July 2, 2005.
Midnight Express $79.0 Million Finance Facility. In April 2003, we finalized a
credit line that in the amount of $60.0 million to finance the conversion of the
Midnight Express (the "Finance Facility"). The Finance Facility originally
matured on June 30, 2004. The Finance Facility commitment is equally provided by
Regions Bank and Export Development Canada (EDC) ($30.0 million participation by
each).
In April 2004, we increased the credit line from Regions Bank and EDC by $19.0
million to $79.0 million ($39.5 million participation by each) and amended the
maturity to October 31, 2004. In addition, as part of the increase to the
Finance Facility, the $25.0 million asset-based five-year revolving credit
facility was terminated and we paid a 1% origination fee ($190,000) to Regions
Bank and EDC for the increase in the credit line and the interest rate on the
original $60.0 million financing increased to LIBOR plus 4.00%. The amounts
outstanding under the credit line will convert into two separate loans at the
earlier of the Finance Facility's maturity date or completion of the conversion
of the Midnight Express. The first loan represents the original facility of
$60.0 million borrowing and will convert to a three-year term loan facility with
a 10-year amortization payment schedule consisting of $3.0 million semi-annual
payments beginning on April 30, 2005, with a balloon payment at the end of the
three-year term. The second loan is for the additional $19.0 million and will
convert to a twenty-month term loan facility with $6.0 million principal
payments due on June 30, 2005 and December 30, 2005 and a final $7.0 million
principal payment due on June 30, 2006. Interest would be payable on a monthly
basis and Regions Bank and EDC will require us to maintain the same collateral
and covenants as included in the Finance Facility. Regions Bank and EDC also
have the right to the first $10.0 million of any equity offering, to the
proceeds from the sale of any of the mortgaged vessels (see discussion below),
and to the interest rate buy-down received from Industry Canada during the third
quarter of 2004.
The interest rate for the $60.0 million portion of the Finance Facility was
LIBOR plus a spread of 3.25% to 3.50% based upon our consolidated leverage ratio
before it was increased to LIBOR plus 4.00% as part of the $19.0 million
increase to the credit line. The interest rate for the $19.0 million portion of
the Finance Facility is LIBOR plus 4.00%. We are providing collateral in the
form of the Midnight Express as well as a first preferred ship mortgage on the
Midnight Fox, Midnight Star, Midnight Dancer, Midnight Carrier, Midnight Brave
and Midnight Rider. We must comply with various covenants including maintaining
tangible net worth of at least $60.0 million, a minimum debt service coverage
ratio of at least 1.20 to 1, a consolidated leverage ratio of no more than 2.00
to 1 and a consolidated current ratio (defined below) of 1.30 to 1 (see below
for details of amendments). We are not allowed to incur additional debt over
$8.0 million without consent from Regions Bank. As discussed below, we are
currently not in compliance with certain of these debt covenants. We have drawn
approximately $75.5 million as of September 30, 2004 under the $79.0 million
facility.
Upon completion of certain construction completion milestones, but no later than
October 31, 2004, the $79.0 million Finance Facility was intended to convert to
term status. As of November 22, 2004, the Finance Facility has not been
converted to term status due to the default status of the debt and our ongoing
negotiations with our lenders to restructure our debt.
See discussion above regarding the $5.0 million of non-revolving debt negotiated
with our lenders in July 2004, payment of which was due on November 19, 2004.
However, as of November 22, 2004, we had not repaid the $5.0 million and are
technically in default. As previously mentioned, we are currently in discussions
with Regions Bank and our other lenders to restructure our debt, including this
non-revolving line of credit.
Earlier in 2004 we were not in compliance with the current ratio or the debt
service coverage ratio covenants under the Finance Facility (with respect to the
December 31, 2003 testing period). As a result, in early April 2004 we obtained
forbearance waivers from our lenders and effected amendments to our
26
loan agreements to provide certain levels of relief with respect to the required
level of minimum coverage as well as changes related to certain components of
the computation of the minimum current ratio, as defined, and the minimum debt
service coverage ratio, as defined, for the quarterly testing periods of 2004.
Purchase of the Midnight Wrangler. In December 2002, we entered into a purchase
agreement with Global Marine Systems Limited (Global Marine) for the purchase of
the Wave Alert, to be renamed the Midnight Wrangler, at a cost of approximately
$10.8 million. We took possession of the vessel in March 2003. The purchase of
the vessel was financed by Global Marine over a five-year period with monthly
payments, including 7% per annum interest, of approximately $0.2 million plus a
$1.0 million payment at the purchase in March 2003 and another $1.0 million
payment at the end of the five-year period.
GE Commercial Midnight Eagle Term Loan. In March 2003, we finalized a seven-year
term loan with GE Commercial. Although the principal amount of the term loan is
$9.25 million, we received $8.0 million and GE Commercial retained $1.25 million
as a security deposit. The interest rate on the term loan is the 30-day
commercial paper rate plus 2.03% and includes prepayment penalties of 2% for the
first twelve months, 1% for the second twelve months and 0% thereafter. The term
loan is structured to have monthly payments over seven years. The loan agreement
contains the same financial covenants as the Bank Facility and Finance Facility
discussed above. The collateral for the loan is the Midnight Eagle and the
security deposit described above. We used the proceeds from the loan to fund the
improvements to the Midnight Wrangler and a portion for the Midnight Express
conversion costs.
GE Capital Midnight Wrangler Term Loan. In December 2003, we refinanced the debt
used to acquire the Midnight Wrangler (as discussed above) by entering into a
secured term loan with GE Capital in the principal amount of $15.0 million. The
secured term loan is structured to have quarterly payments over seven years. The
interest rate on the term loan is 4.25% over LIBOR and the terms contained an
origination discount of 1.50%. The loan agreement contains various covenants
beginning on March 31, 2005, including a minimum EBITDA (as defined) of $18.5
million, a minimum fixed charge ratio (as defined) of 1.05 to 1, and a maximum
leverage ratio (as defined) of 5.25 to 1 for the financial quarters ended in the
period from October 1, 2004 through September 30, 2005. These maximum leverage
ratios decline by 0.50 to 1 for each of the following four years (on an annual
basis at October 1st) before reaching 3.25 to 1, which applies for the financial
quarters ended from October 1, 2008 and thereafter. The collateral for the loan
is the Midnight Wrangler and Midnight Gator. A final payment was made to Global
Marine in December 2003. This early retirement of debt resulted in a gain $0.9
million that we recorded in our income statement for the year ended December 31,
2003.
OTHER LIQUIDITY AND CAPITAL RESOURCE MATTERS
The net cash provided by or used in our operating, investing and financing
activities is summarized below:
(in thousands, unaudited) NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2004 2003
-------- --------
Cash flows provided by (used in):
Operating activities ............. $ (1,748) $ 13,699
Investing activities ............. (34,782) (61,298)
Financing activities ............. 37,106 47,658
-------- --------
Net change in cash and cash equivalents $ 576 $ 59
======== ========
Our cash flow from operating activities is affected by a number of factors,
including our net results, depreciation and amortization, drydocking
expenditures and changes in our working capital, including our accounts payable
and accrued expenses and other balances that increased by $8.2 million in the
nine months ended September 30, 2004. Our operating activities utilized net cash
of $1.7 million in the nine
27
months ended September 30, 2004 as compared to generating $13.7 million of
proceeds in the nine months ended September 30, 2003.
Cash flow used in investing activities in the nine months ended September 30,
2004 was related to the purchase of equipment, primarily related to the
conversion of the Midnight Express. Cash expenditures totaled $34.8 million for
the nine months ended September 30, 2004 compared to $61.3 million for the nine
months ended September 30, 2003. The cash expenditures in the first nine months
of 2003 do not include the $9.7 million expended for the purchase of the
Midnight Wrangler, as this amount was fully financed by the seller (see
discussion below).
Cash flow provided by financing activities was $37.1 million in the nine months
ended September 30, 2004 and related primarily to the borrowings under our
various credit agreements, principally the construction finance facility. Cash
flow provided by financing activities for the nine months ended September 30,
2003 was $47.7 million and was also related mostly to the borrowings under our
various credit agreements, primarily the construction finance facility.
We had negative working capital (current assets less current liabilities) of
$116.0 million at September 30, 2004. We are currently in default of certain
covenants of our loan agreements and therefore all of our outstanding debt has
been classified as a current liability. Of the $113.5 million of debt classified
as current, the majority relates to the $75.5 million of borrowings to finance
the Midnight Express. As this debt is associated with the conversion work on the
Midnight Express, it is classified as current as of September 30, 2004. However,
it was originally intended that once the conversion of the Midnight Express was
completed and the vessel met certain requirements as specified by the finance
agreement, the amounts borrowed to finance the conversion of the Midnight
Express would convert to term loan status. As of November 22, 2004, the Finance
Facility had not been converted to term status due to our default status and our
ongoing negotiations with our lenders to restructure our debt.
The significant changes in our financial position from December 31, 2003 to
September 30, 2004 are the increase in debt, the increase in property and
equipment, the decrease in the accounts receivable balance, and the increase in
the accounts payable and accrued expenses balances. Total debt has increased to
$113.5 million as of September 30, 2004 and consists primarily of the borrowings
to finance the conversion of the Midnight Express, the GE Capital Midnight
Wrangler term loan, the GE Commercial Midnight Eagle term loan, and the
receivable line of credit, and the $5.0 million non-revolving line of credit,
which are discussed below. Property and equipment has increased by $24.3 million
due to the capital expenditures primarily related to the conversion of the
Midnight Express and our accounts receivable balance has decreased by $4.6
million. Finally, our accounts payable balance has increased by $2.6 million and
the balance of our accrued expenses has increased by $5.5 million.
Historically, our capital requirements have been primarily for the acquisition
and improvement of our vessels and related equipment. We expect that as we
continue our entrance into the deepwater market our capital requirements will
continue to be primarily for the conversion and improvement of our vessels.
Capital expenditures totaled $34.8 million for the nine months ended September
30, 2004, compared to $71.0 million for the nine months ended September 30,
2003. Capital expenditures in 2004 and 2003 primarily relate to the conversion
of the Midnight Express. We currently estimate capital expenditures for the
remainder of 2004 to be approximately $3.6 million, primarily representing the
conversion of, and the equipment associated with, the Midnight Express. In
addition, as of November 22, 2004, we are in need of an additional $2.5 million
to complete the conversion of the Midnight Express. There are no costs for
routine capital and drydock inspections expected for our vessels to be incurred
during the remainder of 2004.
Our ability to fund our capital needs is dependent upon the successful
restructuring of our debt and/or the success of raising additional capital.
28
CASH REQUIREMENTS
The following table presents our long-term contractual obligations and the
related amounts due, in total and by period, as of September 30, 2004 (in
thousands):
Payments Due by Period
-----------------------------------------------------------------
Less Than After 5
Total 1 Year 1-3 Years 4-5 Years Years
-------- -------- ---------- ---------- ---------
Finance Facility ..................... $ 75,508 $ 75,508 $ -- $ -- $ --
Long-Term Debt ....................... 21,960 21,960 -- -- --
Receivable Line of Credit ............ 11,203 11,203 -- -- --
Non-Revolving Line of Credit ......... 4,854 4,854 -- -- --
Capital Lease Obligations ............ 156 156 -- -- --
Operating Leases ..................... 6,175 5,356 519 259 41
Unconditional Purchase Obligations.... 1,080 1,080 -- -- --
Other Obligations .................... 5,692 5,692 -- -- --
-------- -------- -------- -------- --------
Total Contractual Cash Obligations.... $126,628 $125,809 $ 519 $ 259 $ 41
======== ======== ======== ======== ========
As discussed above, we are in negotiations with our lenders concerning the
Midnight Express construction loan (Finance Facility) which we hope to convert
to two separate term loans with varying amortization payment schedules. In
addition, the majority of the long-term debt obligation consists of the Midnight
Eagle term loan with GE Commercial and the Midnight Wrangler term loan with GE
Capital, both of which are discussed above.
Included in long-term debt is a note assumed by us as part of the purchase of a
leisure fishing vessel from an investment holding company wholly-owned by Mr.
Stockstill to be used for customer entertainment purposes. The total cost of the
vessel was approximately $0.1 million, of which $41,000 was paid during 2002.
The debt assumed will be paid in monthly installments over a five-year period.
In the second quarter of 2004, we terminated the charter of our deepwater
technology vessel, the Midnight Arrow. The long-term charter was scheduled to
expire in March 2005, but we reached an agreement with Adams Offshore Ltd. (the
"Lessor") to early terminate the charter effective May 31, 2004. As part of the
termination agreement, the Lessor waived the early termination fee and we agreed
to pay the Lessor $250,000 per month beginning on July 24, 2004 until the
outstanding balance of $1.8 million due to the Lessor (all of which has been
accrued) is eliminated. As of September 30, 2004, $1.5 million remained
outstanding and is included in other long-term obligations in the table above.
As previously discussed, we have recently reached a settlement in our Midnight
Hunter charter dispute at an amount of $4.1 million against us, which was due
for payment on November 19, 2004. This amount is included in other obligations
in the table above.
We paid $1.3 million in the quarter ended September 30, 2004 for the charter of
the Midnight Hunter, a DP-2 diving support vessel. We also paid approximately
$6.1 million during the quarter ended September 30, 2004 in relation to the
purchase price and conversion of the Midnight Express bringing our total
expenditures as of September 30, 2004 to $106.9 million.
Included in the operating leases are the monthly payments for certain facilities
used in the normal course of operations. However, the majority of the operating
lease obligation relates to our charter agreement of the Midnight Hunter.
Included in unconditional purchase obligations and other long-term obligations
are the contracts with equipment suppliers related to the conversion of the
Midnight Express. We expect to finance the Midnight Express contracts with
proceeds from the $79.0 million Finance Facility discussed above. In addition,
we are in negotiations with Regions Bank and EDC for an additional $2.5 million
in financing to cover all of the costs for completion the conversion of the
vessel.
29
As of November 22, 2004, four trade creditors had outstanding maritime liens on
various vessels in our fleet, at least one of which is contested. In addition,
three trade creditors had individually brought legal action against us for
collection of outstanding balances due to them. We are working with these trade
creditors to cure the outstanding maritime liens and litigation. All applicable
liabilities have been recorded in full on our balance sheet as of September 30,
2004.
In August 2001, our Board of Directors approved the repurchase of up to $5.0
million of our outstanding common stock. Purchases were made on a discretionary
basis in the open market or otherwise over a period of time as determined by
management, subject to market conditions, applicable legal requirements and
other factors. In August 2002, we elected to suspend our repurchase program.
Under current conditions, we do not expect to repurchase shares in the near
future except for certain events related to the vesting of employee's restricted
shares. As of November 22, 2004, 715,074 shares had been repurchased at a total
cost of $4.3 million.
Consistent with the focus toward investing in new technology, including
deepwater capable assets such as the Midnight Express and the Midnight Wrangler,
five of the last six vessels added to our fleet have been DP-2 deepwater capable
(Midnight Eagle, Midnight Arrow, Midnight Express, Midnight Wrangler and
Midnight Hunter). Through September 30, 2004, we have expended approximately
$174.9 million (in combined capital expenditures, operating lease payments and
purchase payments) for these vessels, with an additional estimated $10.0 million
to be incurred in associated construction costs, operating lease payments and
drydock expenses through 2005.
We believe that our cash flow from operations and the Bank Facility will not be
sufficient to meet our existing liquidity needs for the operation of the
business in 2004. We also believe that the options offered by the Finance
Facility, the GE Commercial Midnight Eagle term loan, and the GE Capital
Midnight Wrangler term loan, in addition to our cash flow from operations, will
not be sufficient to complete our identified growth plans. Raising additional
capital during 2004 or shortly thereafter is a requirement for us to continue to
conduct our operations and meet our debt obligations. We may not be able to
raise these additional funds, or we may not be able to raise such funds on
favorable terms.
NEW ACCOUNTING STANDARDS
In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure -
an Amendment of SFAS No. 123," which provides alternative methods of transition
for a voluntary change to the fair-value based method of accounting for
stock-based employee compensation, and the new standard, which is now effective,
amends certain disclosure requirements. We continue to apply APB No. 25,
"Accounting for Stock Issued to Employees," and related interpretations in
accounting for our stock-based compensation; therefore, the alternative methods
of transition do not apply. We have adopted the disclosure requirements of SFAS
No. 148 (see Note 2 to the financial statements).
In June 2001, the American Institute of Certified Public Accountants (AICPA)
issued an exposure draft of a proposed Statement of Position (SOP), "Accounting
for Certain Costs and Activities Related to Property, Plant, and Equipment."
This proposed SOP would change, among other things, the method by which
companies would account for normal, recurring or periodic repairs and
maintenance costs related to "in service" fixed assets. It would require that
these types of expenses be recognized when incurred rather than recognizing
expense for these costs while the asset is productive. The proposed SOP was
presented to the FASB for clearance, however in April, 2004, the FASB did not
approve the draft SOP, but rather decided to consider the relevant concepts
within the SOP in connection with the FASB's short-term convergence project on
property, plant and equipment, including depreciation currently scheduled to
take place in the 2005-2006 timeframe.
30
In January 2003, the FASB issued Financial Interpretation 46, "Consolidation of
Variable Interest Entities -- An Interpretation of Accounting Research Bulletin
(ARB) 51" ("FIN 46" or the "Interpretation"). FIN 46 addresses consolidation by
business enterprises of variable interest entities (VIEs). The primary objective
of the Interpretation is to provide guidance on the identification of, and
financial reporting for, entities over which control is achieved through means
other than voting rights; such entities are known as VIEs. The provisions of FIN
46 apply immediately to VIEs created after January 31, 2003. Application is
required for interests in special-purpose entities in the period ending after
December 15, 2003 and is required for all other types of VIE's in the period
ending after March 15, 2004. We have no VIEs and there was no material impact on
our financial position or results of operations from the adoption of FIN 46.
SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES.
For a discussion of significant accounting policies and estimates, see our
Annual Report on Form 10-K for the fiscal year ended December 31, 2003.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest Rate Risk. We are subject to market risk exposure related to changes in
interest rates on our Bank Facility (when drawn upon), Midnight Eagle term loan
with GE Commercial, Midnight Wrangler term loan with GE Capital, our Finance
Facility and our $5.0 million non-revolving line with Regions Bank. Interest on
borrowings under the Bank Facility accrue at a variable rate, using LIBOR plus a
range of 1.75% to 2.25%, depending upon the level of our consolidated leverage
ratio (as defined) measured on a quarterly basis. Our Midnight Eagle term loan
with GE Commercial includes an interest rate consisting of the 30-day commercial
paper rate plus 2.03%. Our Midnight Wrangler term loan with GE Capital includes
an interest rate consisting of LIBOR plus 4.25%. Under the Finance Facility, the
interest rate during the construction financing phase is based upon our
consolidated leverage ratio at LIBOR plus 4.00%. The $60.0 million term facility
of the Finance Facility is priced at 4.00% over LIBOR and the $19.0 million term
facility of the Finance Facility is priced at LIBOR plus 4.00%. Finally, the
$5.0 million non-revolving line with Regions Bank is priced at LIBOR plus 4.00%.
ITEM 4. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures. As of the end of the period
covered by this report, our Chief Executive Officer and Chief Financial Officer,
with the participation of management, have evaluated the effectiveness of the
design and operation of our disclosure controls and procedures. Based on their
evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures have been designed and are
functioning effectively in alerting them in a timely manner to material
information relating to Torch Offshore, Inc. required to be disclosed in our
periodic Securities and Exchange Commission filings under the Securities
Exchange Act of 1934.
Changes in Internal Controls. There were no significant changes in our internal
controls or in other factors that could significantly affect these internal
controls subsequent to the date of their most recent evaluation, including any
corrective actions taken with regard to significant deficiencies and material
weaknesses.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We have been named as a defendant in a stockholder class action suit filed by
purported stockholders regarding our initial public offering. This lawsuit, Karl
L. Kapps, et. al. v. Torch Offshore, Inc. et. al., No.
31
02-00582, which seeks unspecified monetary damages, was filed on March 1, 2002
in the United States District Court for the Eastern District of Louisiana. The
lawsuit was dismissed on December 19, 2002 for failure to state a claim upon
which relief could be granted. The plaintiffs appealed to the United States
Court of Appeals for the Fifth Circuit. On July 26, 2004, the Court of Appeals
for the Fifth Circuit dismissed the case. On August 6, 2004, the plaintiffs
appealed to the Court of Appeals for the Fifth Circuit for a re-hearing, but on
August 25, 2004 the re-hearing was denied. A mandate was issued on September 2,
2004 closing the case.
We terminated our charter of the Midnight Hunter on January 24, 2003, as, among
other things, the vessel did not meet certain specifications as outlined in the
charter agreement and this prevented us from performing some types of work. In
November 2003, a London arbitrator issued a ruling against our recission claim,
finding that we were not entitled to terminate the charter, but did rule in
favor of us on the warranty claim for breach of contract. An interim award of
$2.2 million was made in favor of Cable Shipping, Inc. and such amount was
placed in escrow pending further proceedings. We have recorded the full amount
of the interim award in the financial statements. We attempted to appeal the
ruling, but on April 7, 2004 the appeal was denied. The escrowed award has been
released to Cable Shipping, Inc. The quantum of damages hearing was to be held
in late October 2004 where final amounts were to be awarded to the parties, but
we settled with Cable Shipping, Inc. in September 2004 for $4.1 million, which
is we are to pay on November 19, 2004. The settlement amount has been recorded
in the three months ended September 30, 2004 as an other operating expense.
We filed a lawsuit (Torch Offshore, Inc. v. Newfield Exploration Company, No.
03-0735, filed in the United States District Court, Eastern District of
Louisiana on March 13, 2003) against Newfield Exploration Company (Newfield)
claiming damages of approximately $2.1 million related to work completed for
Newfield in the Gulf of Mexico at Grand Isle Block 103-A. Our lawsuit alleges
that we did not receive all compensation to which we were entitled pursuant to
the contract. We have recorded a provision for the full amount of this claim;
however, we intend to continue to pursue the claim. A trial date has been set
for January 20, 2005.
In July 2003, we filed a lawsuit (Torch Offshore, Inc. et al v. Stolt Offshore,
Inc., et al, No. 03-1915, in the United States District Court, Eastern District
of Louisiana on July 3, 2003) against Stolt Offshore, Inc. (Stolt), and its
customer, seeking approximately $7.6 million related to work completed for Stolt
in Boston, Massachusetts. We worked as a subcontractor to Stolt, who was engaged
by Algonquin Gas Transmission Company to complete the Boston Hubline project, an
underwater pipeline crossing the Boston Harbor. The lawsuit alleged that we did
not receive all compensation to which we were entitled pursuant to the
subcontract we had with Stolt. Two other subcontractors to Stolt joined with us
as plaintiffs in the lawsuit. Additionally, we, along with two other
subcontractors, filed a lawsuit in Massachusetts (Civil Action No. 03-01585),
which included a claim for breach of contract as well as a claim to assert
mechanics' liens against Algonquin's easement located in Weymouth, Norfolk
County, Massachusetts. In March 2004, we reached a settlement with Stolt in the
amount of $6.2 million and we recorded the full amount of the difference between
our original claim and the final settlement (a loss of approximately $1.4
million) in our financial statements as of December 31, 2003. The lawsuits have
been dismissed, and the lien claims have been released
Additionally, due to the nature of our business, we are, from time to time,
involved in routine litigation or subject to disputes or claims related to our
business activities (other miscellaneous litigation). In our management's
opinion, none of this other miscellaneous litigation will have a material
adverse effect on our financial condition or results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
32
ITEM 6. EXHIBITS.
(a) Exhibits filed as part of this report are listed below.
Exhibit 3.1 Certificate of Incorporation (Incorporated by reference
to Exhibit 3.1 to the Company's Registration Statement
on Form S-1 (Registration No. 333-54120))
Exhibit 3.2 Bylaws (Incorporated by reference to Exhibit 3.2 to the
Company's Registration Statement on Form S-1
(Registration No. 333-54120))
Exhibit 10.1 Employment Agreement between Torch Offshore, Inc. and
Vincent Lecarme dated October 28, 2004
Exhibit 31.1 Certification by Lyle G. Stockstill Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification by Robert E. Fulton Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Certification by Lyle G. Stockstill Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 Certification by Robert E. Fulton Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Torch Offshore, Inc.
Date: November 22, 2004 By: /s/ ROBERT E. FULTON
--------------------
Robert E. Fulton
Chief Financial Officer
(Principal Accounting and Financial Officer)
33
EXHIBIT INDEX
3.1 -- Certificate of Incorporation (Incorporated by reference to
Exhibit 3.1 to the Company's Registration Statement on Form S-1
(Registration No. 333-54120))
3.2 -- Bylaws (Incorporated by reference to Exhibit 3.2 to the
Company's Registration Statement on Form S-1 (Registration No.
333-54120))
10.1 -- Employment Agreement between Torch Offshore, Inc. and Vincent
Lecarme dated October 28, 2004
31.1 -- Certification by Lyle G. Stockstill Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 -- Certification by Robert E. Fulton Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 -- Certification by Lyle G. Stockstill Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 -- Certification by Robert E. Fulton Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
34