| GULFMARK OFFSHORE INC ITEM 1A Risk Factors We rely on the oil and natural gas industry, and volatile oil and natural gas prices impact demand for our services |
| Demand for our services depends on activity in offshore oil and natural gas exploration, development and production |
| The level of exploration, development and production activity is affected by factors such as: • prevailing oil and natural gas prices; • expectations about future prices; • the cost of exploring for, producing and delivering oil and natural gas; 11 _________________________________________________________________ [63]Table of Contents • the sale and expiration dates of available offshore leases; • demand for petroleum products; • current availability of oil and natural gas resources; • the rate of discovery of new oil and natural gas reserves in offshore areas; • local and international political and economic conditions; • technological advances; and • ability of oil and natural gas companies to generate or otherwise obtain funds for capital |
| During recent years, the level of offshore exploration, development and production activity has been volatile |
| Currently, there is a period of high prices for oil and natural gas, and oil and natural gas companies have increased their exploration and development activities |
| This activity increase began in the second half of 2004 and continued into 2005 and early 2006 after reduced levels of activity were experienced in 2002-2004 despite high prices for oil and natural gas during that period |
| A decline in the worldwide demand for oil and natural gas or prolonged low oil or natural gas prices in the future below historical oil and gas prices, however, would likely result in reduced exploration and development of offshore areas and a decline in the demand for our offshore marine services |
| Any such decrease in activity is likely to reduce our day rates and our utilization rates and, therefore, could have a material adverse effect on our financial condition and results of operations |
| An increase in the supply of offshore support vessels would likely have a negative effect on charter rates for our vessels, which could reduce our earnings |
| Charter rates for marine support vessels depend in part on the supply of the vessels |
| Excess vessel capacity in the industry may result from: • constructing new vessels; • moving vessels from one offshore market area to another; or • converting vessels formerly dedicated to services other than offshore marine services |
| In the last ten years, construction of vessels of the type operated by us for use in the North Sea and elsewhere has significantly increased |
| The addition of new capacity to the worldwide offshore marine fleet is likely to increase competition in those markets where we presently operate which, in turn, could reduce day rates, utilization rates and operating margins which would adversely affect our financial condition and results of operations |
| Government regulation and environmental risks reduce our business opportunities and increase our costs |
| We must comply with extensive government regulation in the form of international conventions, federal and state laws and regulations in jurisdictions where our vessels operate and are registered |
| These conventions, laws and regulations govern: • oil spills and other matters of environmental protection; • worker health, safety and training; • construction and operation of vessels; and • vessel and port security |
| We believe that we are in compliance with the laws and regulations to which we are subject |
| We are not a party to any material pending regulatory litigation or other proceeding and we are unaware of any threatened litigation or proceeding, which, if adversely determined, would have a material adverse effect on our financial condition or results of operations |
| However, the risks of incurring substantial compliance costs, liabilities and penalties for noncompliance are inherent in offshore marine services operations |
| Compliance with environmental, health, safety and vessel and port security laws increases our costs of doing business |
| Additionally, environmental, health, safety and vessel and port security laws change frequently |
| Therefore, we are unable to predict the future costs or other future impact of environmental, health, safety and vessel and port security laws on our operations |
| There can be no assurance that we can avoid significant costs, liabilities and penalties imposed on us as a result of government regulation in the future |
| We are subject to hazards customary for the operation of vessels that could adversely affect our financial performance if we are not adequately insured or indemnified |
| Our operations are subject to various operating hazards and risks, including: • catastrophic marine disaster; 12 _________________________________________________________________ [64]Table of Contents • adverse sea and weather conditions; • mechanical failure; • navigation errors; • collision; • oil and hazardous substance spills, containment and clean up; • labor shortages and strikes; • damage to and loss of drilling rigs and production facilities; and • war, sabotage and terrorism risks |
| These risks present a threat to the safety of personnel and to our vessels, cargo, equipment under tow and other property, as well as the environment |
| We could be required to suspend our operations or request that others suspend their operations as a result of these hazards |
| In such event, we would experience loss of revenue and possibly property damage, and additionally, third parties may have significant claims against us for damages due to personal injury, death, their property damage, pollution and loss of business |
| We maintain insurance coverage against substantially all of the casualty and liability risks listed above, subject to deductibles and certain exclusions |
| We have renewed our primary insurance program for the insurance year 2006-2007, and have negotiated terms for renewal in 2007-2008 for our primary coverage |
| Additionally, there is no assurance that our insurance coverage will be available beyond the renewal periods, adequate to cover future claims that may arise |
| Substantially all our revenues are derived from our international operations and those operations are subject to government regulation and operating risks |
| We derive substantially all of our revenues from foreign sources |
| We therefore face risks inherent in conducting business internationally, such as: • foreign currency exchange fluctuations or imposition of currency exchange controls; • legal and government regulatory requirements; • difficulties and costs of staffing and managing international operations; • language and cultural differences, • potential vessel seizure or nationalization of assets; • import-export quotas or other trade barriers; • difficulties in collecting accounts receivable and longer collection periods; • political and economic instability; • imposition of currency exchange controls; and • potentially adverse tax consequences |
| In the past, these conditions or events have not materially affected our operations |
| However, we cannot predict whether any such conditions or events might develop in the future |
| Also, our subsidiary structure and our operations are in part based on certain assumptions about various foreign and domestic tax laws, currency exchange requirements and capital repatriation laws |
| While we believe our assumptions are correct, there can be no assurance that taxing or other authorities will reach the same conclusion |
| If our assumptions are incorrect, or if the relevant countries change or modify such laws or the current interpretation of such laws, we may suffer adverse tax and financial consequences, including the reduction of cash flow available to meet required debt service and other obligations |
| Any of these factors could materially adversely affect our international operations and, consequently, our business, operating results and financial condition |
| 13 _________________________________________________________________ [65]Table of Contents Our international operations are vulnerable to currency exchange rate fluctuations and exchange rate risks |
| We are exposed to foreign currency exchange rate fluctuations and exchange rate risks as a result of our foreign operations |
| To minimize the financial impact of these risks, we attempt to match the currency of our debt and operating costs with the currency of the revenue streams |
| We occasionally enter into forward foreign exchange contracts to hedge specific exposures, but we do not speculate in foreign currencies |
| Because we conduct a large portion of our operations in foreign currencies, any increase in the value of the US dollar in relation to the value of applicable foreign currencies could potentially adversely affect our operating revenues when translated into US dollars |
| Vessel construction and repair projects are subject to risks, including delays and cost overruns, that could have an adverse impact on our results of operations |
| Our vessel construction and repair projects are subject to the risks of delay and cost overruns inherent in any large construction project, including: • shortages of equipment; • unforeseen engineering problems; • work stoppages; • weather interference; • unanticipated cost increases; and • shortages of materials or skilled labor |
| Significant cost overruns or delays in connection with our repair projects would adversely affect our financial condition and results of operations |
| Significant delays could also result in penalties under, or the termination of, most of the long-term contracts under which we plan to operate our vessels |
| Our current operations and future growth may require significant additional capital, and our substantial indebtedness could impair our ability to fund our capital requirements |
| Expenditures required for the repair, certification and maintenance of a vessel typically increase with vessel age |
| These expenditures may increase to a level at which they are not economically justifiable |
| We cannot assure you that we will have sufficient resources to maintain our fleet either by extending the economic life of existing vessels through major refurbishment or by acquiring new or used vessels |
| Our industry is highly competitive, which depresses vessel prices and utilization and adversely affects our financial performance |
| We operate in a competitive industry |
| The principal competitive factors in the marine support and transportation services industry include: • price, service and reputation of vessel operations and crews; • national flag preference; • operating conditions; • suitability of vessel types; • vessel availability; • technical capabilities of equipment and personnel; • safety and efficiency; • complexity of maintaining logistical support; and • cost of moving equipment from one market to another |
| Many of our competitors have substantially greater resources than we have |
| Competitive bidding and downward pressures on profits and pricing margins could adversely affect our business, financial condition and results of operations |
| The operations of our fleet may be subject to seasonal factors |
| Operations in the North Sea are generally at their highest levels during the months from April to August and at their lowest levels during November to February |
| Vessels operating offshore Southeast Asia are generally at their lowest utilization rates during the monsoon season, which moves across the Asian continent between September and early March |
| The actual monsoon season for a 14 _________________________________________________________________ [66]Table of Contents specific Southeast Asian location is about two months |
| In addition, operations in any market may be affected by unusually long or short construction seasons due to, among other things, abnormal weather conditions, as well as market demand associated with increased drilling and development activities |
| We are subject to war, sabotage and terrorism risk |
| War, sabotage, and terrorist attacks or any similar risk may affect our operations in unpredictable ways, including changes in the insurance markets, disruptions of fuel supplies and markets, particularly oil, and the possibility that infrastructure facilities, including pipelines, production facilities, refineries, electric generation, transmission and distribution facilities, could be direct targets of, or indirect casualties of, an act of terror |
| Terrorist attacks have made it difficult to obtain insurance coverage, the costs for which has increased and could continue to increase |
| We will evaluate the need to maintain this coverage as it applies to our fleet in the future |
| Instability in the financial markets as a result of war, sabotage or terrorism could also affect our ability to raise capital and could also adversely affect the oil, gas and power industries and restrict their future growth |
| We depend on key personnel |
| We depend to a significant extent upon the efforts and abilities of our executive officers and other key management personnel |
| There is no assurance that these individuals will continue in such capacity for any particular period of time |
| The loss of the services of one or more of our executive officers or key management personnel could adversely affect our operations |
| We have previously identified material weaknesses under the Sarbanes-Oxley Act relating to the effectiveness of our internal controls over financial reporting and we may identify additional material weaknesses in the future |
| As a result of Section 404 of the Sarbanes-Oxley Act, or Sarbanes-Oxley, and the rules issued thereunder by the SEC and the Public Company Accounting Oversight Board, or PCAOB, we are required to include a report on our internal controls over financial reporting with our annual report on Form 10-K beginning with the Form 10-K for the year ended December 31, 2004 |
| Our report must include an assessment by management on the effectiveness of our internal controls as well as a report from our independent registered public accounting firm attesting to management’s assessment |
| Further, our report is required to include a disclosure of any “material weakness” in our internal controls over financial reporting we have identified |
| Management’s report on the effectiveness of our internal controls is contained in Part II, Item 9A(b), and the report from our independent registered public accounting firm attesting to management’s assessment is contained in Part II, Item 9A(e) |
| We assessed the effectiveness of our internal control over financial reporting at December 31, 2005 and 2004, and in making this assessment, used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework in accordance with the standards of the PCAOB As previously reported, three material weaknesses were identified as of December 31, 2004 |
| A material weakness was identified related to the financial statement close process, including insufficient controls over properly analyzing and reconciling inter-company accounts, maintaining appropriate support and analyses of certain non-routine accruals, properly analyzing certain deferred cost accounts, and properly assessing the accounting and reporting implications related to new contractual agreements |
| We identified a second material weakness related to the accounting for the effects of foreign currencies, including insufficient controls over the analysis of the foreign currency translation and transaction impact on inter-company amounts, as well as amounts owed to third parties denominated in non-functional currencies |
| A third material weakness was identified related to accounting for income taxes associated with new international operations, including insufficient controls over the proper identification and application of the relevant Brazilian tax rules to the calculation of the tax provision of our new Brazilian operations |
| Our lack of adequate accounting and tax resources, in terms of size, technical expertise and institutional knowledge (due to unusually high levels of personnel turnover in the finance and accounting organization) to address certain of the financial and tax reporting aspects of our multi-national operations, was the underlying cause of these material weaknesses |
| In response to the material weaknesses identified in 2004, we implemented a remediation program, including the establishment of additional controls that are intended to strengthen our financial reporting and to specifically address the identified material weaknesses as follows: • Financial statement close process |
| As previously reported, we have enhanced our corporate accounting function by creating and filling several new positions, including those of Accounting Manager and Assistant Controller-Financial Reporting, to provide greater review and analysis of financial results at both the corporate and subsidiary levels |
| The Internal Audit Director has coordinated the ongoing monitoring of Sarbanes-Oxley compliance and has performed financial and operational audits |
| The Information Technology Director will implement a global information 15 _________________________________________________________________ [67]Table of Contents technology strategy for us, and has played a major role in the evaluation of our information system as we look to improve the automation of both foreign currency and inter-company transactions |
| Overall, newly hired staff has and should continue to bring experience, stability and the skills related to the review and analysis of complex activity in large multi-national companies |
| Beginning in the first quarter of 2005, an outside consultant evaluated and assisted us in establishing improved controls over the process associated with inter-company transactions |
| The consultant also assisted in the training of the new and existing personnel in the execution of the controls and processes established |
| As of the end of 2005, this material weakness has been remediated |
| • Translation and transaction effects of foreign currency exchange |
| The outside consultant also assisted us in implementing procedures to continue to analyze the foreign currency impact on our inter-company and third party transactions |
| In addition, the consultant trained our staff to identify, segregate, analyze and measure the foreign currency impact on future transactions |
| Where these processes cannot be automated, we have established processes to ensure proper review of the required calculations in the interim, until it is determined whether or not a new information system can automate the calculations |
| These steps will enable the appropriate measurement of the foreign currency translation and transaction impact on our consolidated financial statements as identified in the material weakness |
| As of the end of 2005, this material weakness has been remediated |
| • Taxes related to new Brazilian operations |
| During 2005, there has been tremendous effort made to improve the internal control processes related to taxes and ensure an appropriate level of research, analysis and review of complex international tax issues associated with our existing and future tax jurisdictions by proactively training staff, reviewing tax consequences of transactions, improving documentation, and continuing to engage third-party tax service providers for more complex areas of our income tax accounting |
| We also hired a Corporate Tax Director who began working at GulfMark mid January 2006 |
| The Corporate Tax Director has extensive international tax experience with the majority of that experience in oil and gas services industry, including the marine transportation business segment |
| This position is responsible for the analysis and monitoring of taxes in all of our existing tax jurisdictions and related tax accounting guidance and review |
| We believe that these actions and resulting improvement in controls will strengthen our disclosure controls and procedures, as well as our internal control over financial reporting, and have remediated the material weaknesses that we identified in our internal control over financial reporting at December 31, 2004 |
| We estimate that the remedial steps outlined above cost us approximately dlra0dtta7 million in 2005, excluding reallocation of internal resources |
| For information on our disclosure controls, and internal controls over financial reporting, at December 31, 2005, see Item 9A “Controls and Procedures |
| ” Although we have taken the foregoing steps to correct the identified internal control deficiencies, these measures may not ensure that we will implement and maintain adequate controls over our financial reporting in the future |
| Any failure to implement required new or improved controls, or difficulties encountered in their implementations, could cause us to fail to meet our future reporting obligations |
| In addition, we may in the future identify further material weaknesses or significant deficiencies in our internal controls over financial reporting |