Basis of Presentation and Significant Accounting Policies (Policies)

6 Months Ended

Jun. 30, 2023

Basis of Consolidation: The accompanying interim consolidated financial information as of June 30, 2023, and for the three and six months ended June 30, 2023 and 2022, has been prepared without audit, pursuant to the rules and regulations promulgated by the SEC, and includes our accounts and those of our majority owned subsidiaries and VIEs (as discussed below). All significant intercompany transactions and accounts have been eliminated. They reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the financial position and results of operations for the interim periods, on a basis consistent with the annual audited financial statements. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the SEC, although we believe that the disclosures made are adequate to provide for fair statement. Our Consolidated Balance Sheet at December 31, 2022 is derived from our audited consolidated financial statements for the year ended December 31, 2022. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2022, which was filed with the SEC on March 31, 2023. The results of operations for the interim periods are not necessarily indicative of the operating results for the full fiscal year or any future periods. Certain previously reported amounts have been reclassified to conform to the current period presentation.

In addition to the consolidation of our majority owned subsidiaries, we also consolidate VIEs when we are determined to be the primary beneficiary of a VIE. Determination of the primary beneficiary of a VIE is based on whether an entity has (1) the power to direct activities that most significantly impact the economic performance of the VIE and (2) the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE. Our determination of the primary beneficiary of a VIE considers all relationships between us and the VIE.

ADVantage is a joint venture company formed to operate deepwater drilling rigs in Egypt. We determined that ADVantage met the criteria of a VIE for accounting purposes because its equity at risk was insufficient to permit it to carry on its activities without additional subordinated financial support from us. We also determined that we are the primary beneficiary for accounting purposes since we are entitled to use ADVantage for deepwater drilling contract opportunities rejected by ADES, and have the (a) power to direct the operating activities associated with the deepwater drilling rigs, which are the activities that most significantly impact the entity’s economic performance, and (b) obligation to absorb losses or the right to receive a majority of the benefits that could be potentially significant to the VIE. As a result, we consolidate ADVantage in our consolidated financial statements, we eliminate intercompany transactions and we present the interests that are not owned by us as “Noncontrolling interests” in our Consolidated Balance Sheets. The carrying amount associated with ADVantage was as follows:


	June 30, 2023		December 31, 2022
(unaudited, in thousands)
Current assets	$	4,380	$	11,383
Non-current assets		736		1,590
Current liabilities		983		4,749
Non-current liabilities		2,068		4,637
Net carrying amount	$	2,065	$	3,587

As ADVantage is a majority owned subsidiary of the Company, it serves as a guarantor under the 9.50% First Lien Indenture. The 9.50% First Lien Notes are secured by a first priority lien on all of the assets of ADVantage, subject to certain exceptions. Creditors’ recourse against ADVantage for liabilities of ADVantage is limited to the assets of ADVantage.

See “Note 9. Supplemental Financial Information” of these “Notes to Unaudited Consolidated Financial Statements” for additional information regarding related party transactions associated with this joint venture.

Use of Estimates

Use of Estimates: The preparation of financial statements in accordance with U.S. GAAP requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, including those related to property and equipment, income taxes, insurance, employee benefits and contingent liabilities. Actual results could differ from these estimates.

Cash and Cash Equivalents

Cash and Cash Equivalents: Includes deposits with financial institutions and compliant financial instruments with maturities of three months or less when purchased.

Materials and Supplies

Materials and Supplies: Consists of materials, spare parts, consumables and related supplies for our drilling rigs. We record these materials and supplies at their average cost.

Property and Equipment

Property and Equipment: Consists of our drilling rigs, furniture and fixtures, computer equipment and capitalized costs for computer software. Drilling rigs are depreciated on a component basis over estimated useful lives ranging from five to 35 years on a straight-line basis as of the date placed in service. Other assets are depreciated upon placement in service over estimated useful lives ranging from three to seven years on a straight-line basis. When assets are sold, retired or otherwise disposed of, the cost and related accumulated depreciation are removed from our Consolidated Balance Sheets and the resulting gain or loss is included in “Operating costs” or “General and administrative” expenses on the Consolidated Statement of Operations, depending on the nature of the asset. For the three and six months ended June 30, 2022, we recognized a net loss of approximately $0.3 million and net gain of approximately $1.6 million, respectively, related to the sale or retirement of assets. The gain/loss related to the sale or retirement of assets for the three and six months ended June 30, 2023 was immaterial.

We evaluate the realization of property and equipment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss on our property and equipment exists when estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. Any impairment loss recognized would be computed as the excess of the asset’s carrying value over the estimated fair value. Estimates of future cash flows require us to make long-term forecasts of our future revenues and operating costs with regard to the assets subject to review. Our business, including the utilization rates and dayrates we receive for our drilling rigs, depends on the level of our customers’ expenditures for oil and gas exploration, development and production expenditures. Oil and gas prices and customers’ expectations of potential changes in these prices, the general outlook for worldwide economic growth, political and social stability in the major oil and gas producing basins of the world, availability of credit and changes in governmental laws and regulations, among many other factors, significantly affect our customers’ levels of expenditures. Sustained declines in or persistent depressed levels of oil and gas prices, worldwide rig counts and utilization, reduced access to credit markets, reduced or depressed sale prices of comparably equipped jackups and drillships and any other significant adverse economic news could require us to evaluate the realization of our drilling rigs. As of June 30, 2023, no triggering event has occurred to indicate that the carrying value of our drilling rigs may not be recoverable.

Interest costs and the amortization of debt financing costs related to the financings of our drilling rigs are capitalized as part of the cost while they are under construction and prior to the commencement of each vessel’s first contract. We did not capitalize any interest for the reported periods.

Debt Financing Costs

Debt Financing Costs: Costs incurred with financing debt are deferred and amortized over the term of the related financing facility on a straight-line basis, which approximates the effective interest method. Debt issuance costs are presented in the Consolidated Balance Sheets as a direct deduction from the carrying amount of that debt liability.

Rig and Equipment Certifications

Rig and Equipment Certifications: We are required to obtain regulatory certifications to operate our drilling rigs and certain specified equipment, and must maintain such certifications through periodic inspections and surveys. These certifications are typically valid for approximately 2.5 to 5 years. The costs associated with these certifications, including drydock costs, are deferred and amortized over the corresponding certification periods.

Revenue Recognition

Revenue Recognition: See “Note 3. Revenue from Contracts with Customers” of these “Notes to Unaudited Consolidated Financial Statements” for further information.

The activities that primarily drive the revenue earned in our drilling contracts with customers include (i) providing our drilling rig, work crews, related equipment and services necessary to operate the rig, (ii) delivering the drilling rig by mobilizing to, and demobilizing from, the drill site, and (iii) performing pre-operating activities, including rig preparation activities and/or equipment modifications required for the contract.

The integrated drilling services that we perform under each drilling contract represent a single performance obligation satisfied over time and comprised of a series of distinct time increments, or service periods. We have elected to exclude from the transaction price measurement all taxes assessed by a governmental authority.

Dayrate Drilling Revenue. Our drilling contracts generally provide for payment on a dayrate basis, with higher rates for periods when the drilling unit is operating and lower rates or zero rates for periods when drilling operations are interrupted or restricted. The dayrate billed to the customer is determined based on varying rates applicable to the specific activities performed on an hourly basis. Such dayrate consideration is allocated to the distinct hourly increment it relates to within the contract term and therefore, recognized as we perform the daily drilling services.

For rigs owned by a third party that we manage or support, the contracts generally provide for a fixed fee based on various factors, including the status of the rig or a specific duration. In addition, we may earn a marketing fee based on a percentage of the effective dayrate of a drilling contract secured on behalf of the third party and a variable management fee of the gross margin associated with managing an operating rig. We are considered the principal or agent with respect to certain contractual arrangements and therefore, we record the associated revenue at the gross or net amounts billed to the customers, respectively.

Amortizable Revenue. In connection with certain contracts, we receive lump-sum fees or similar compensation for (i) the mobilization of equipment and personnel prior to the commencement of drilling services, (ii) the demobilization of equipment and personnel upon contract completion or (iii) postponement fees in consideration for the postponement of a contract until a later date. These activities are not considered to be distinct within the context of the contract and therefore, the associated revenue is allocated to the overall single performance obligation.

Mobilization fees received prior to the commencement of drilling operations are recorded as a contract liability and amortized on a straight‑line basis over the initial contract period. Demobilization fees expected to be received upon contract completion are estimated at contract inception and recognized on a straight-line basis over the initial contract term, with an offset to an accretive contract asset. In many contracts, demobilization fees are contingent upon the occurrence or non-occurrence of a future event and the estimate for such revenue may therefore be constrained. In such cases, this may result in cumulative-effect adjustments to demobilization revenues upon changes in our estimates of future events during the contract term. Postponement fees received that are contingent upon the occurrence or non-occurrence of a future event are recognized on a straight-line basis over the contract term. Fees received for the mobilization or demobilization of equipment and personnel are included in “Contract drilling services” in our Consolidated Statement of Operations.

Capital Upgrade/Contract Preparation Revenue. In connection with certain contracts, we receive lump-sum fees or similar compensation for requested capital upgrades to our drilling rigs or for other contract preparation work. These activities are not considered to be distinct within the context of the contract and therefore, fees received are recorded as a contract liability and amortized to contract drilling revenues on a straight-line basis over the initial contract term.

Charter Lease Revenue. In relation to certain bareboat charter agreements where we lease our owned rigs to unaffiliated third parties, we receive a fixed fee based on the number of days the rig is drilling. Furthermore, under certain other bareboat charter agreements, we receive a variable fee based on a percentage of gross margin generated on a monthly basis.

Revenues Related to Reimbursable Expenses. We generally receive reimbursements from our customers for the purchase of supplies, equipment, personnel services and other services provided at their request in accordance with a drilling contract or other agreement. We may be considered a principal or an agent in such transactions and therefore, we recognize reimbursable revenues and the corresponding costs either on a gross or net basis, as applicable, as we provide the requested goods and services.

Disaggregation of Revenue

The following tables present our revenue disaggregated by revenue source for the periods indicated:


	Three Months Ended June 30, 2023								Three Months Ended June 30, 2022
	Jackups		Deepwater		Managed		Consolidated		Jackups		Deepwater		Managed		Consolidated
(unaudited, in thousands)
Dayrate revenue	$	4,975	$	35,177	$	25,526	$	65,678	$	15,963	$	24,304	$	2,840	$	43,107
Amortized revenue		123		6,103		1,338		7,564		1,439		1,038		—		2,477
Charter lease revenue		3,152		—		—		3,152		—		—		—		—
Reimbursable revenue		3,237		1,445		26,764		31,446		1,944		3,175		22,535		27,654
Total revenue	$	11,487	$	42,725	$	53,628	$	107,840	$	19,346	$	28,517	$	25,375	$	73,238


	Six Months Ended June 30, 2023								Six Months Ended June 30, 2022
	Jackups		Deepwater		Managed		Consolidated		Jackups		Deepwater		Managed		Consolidated
(unaudited, in thousands)
Dayrate revenue	$	10,098	$	54,752	$	47,251	$	112,101	$	31,294	$	50,300	$	3,943	$	85,537
Amortized revenue		236		8,280		2,662		11,178		1,659		4,404		—		6,063
Charter lease revenue		5,302		—		—		5,302		—		—		—		—
Reimbursable revenue		6,455		2,499		47,377		56,331		4,151		6,151		29,667		39,969
Total revenue	$	22,091	$	65,531	$	97,290	$	184,912	$	37,104	$	60,855	$	33,610	$	131,569

Dayrate revenue and amortized revenue for “Jackups” and “Deepwater” are included within “Contract drilling services” in our Consolidated Statement of Operations. Dayrate revenue for “Managed” is included within “Contract drilling services” and “Management fees” within our Consolidated Statement of Operations. All other revenue is included within “Reimbursables and other” in our Consolidated Statement of Operations.

Accounts Receivable, Contract Liabilities and Contract Costs

Accounts receivable are recognized when the right to consideration becomes unconditional based upon contractual billing schedules. Payment terms on customer invoices typically range from 30 to 45 days.

We recognize contract liabilities, recorded in other “Other current liabilities” and “Other long-term liabilities” within our Consolidated Balance Sheets, for prepayments received from customers and for deferred revenue received for mobilization, contract preparation and capital upgrades.

Certain direct and incremental costs incurred for contract preparation, initial mobilization and modifications of contracted rigs represent contract fulfillment costs as they relate directly to a contract, enhance resources that will be used to satisfy our performance obligations in the future and are expected to be recovered. These costs are deferred as a current or noncurrent asset depending on the length of the initial contract term and are amortized on a straight-line basis to operating costs as services are rendered over the initial term of the related drilling contract. Costs incurred for capital upgrades are capitalized and depreciated over the useful life of the asset.

Costs incurred for the demobilization of rigs at contract completion are recognized as incurred during the demobilization process. Costs incurred to mobilize a rig without a contract are expensed as incurred.

The following table provides information about contract cost assets and contract revenue liabilities from contracts with customers:


		June 30, 2023		December 31, 2022
(unaudited, in thousands)	Classification in the Consolidated Balance Sheets
Current contract cost assets	Prepaid expenses and other current assets	$	7,141	$	7,324
Current contract revenue liabilities	Other current liabilities		35,506		35,085

Significant changes in contract cost assets and contract revenue liabilities during the six months ended June 30, 2023 are as follows:


	Contract Cost Assets			Contract Revenues
(unaudited, in thousands)
Balance as of December 31, 2022	$	7,324		$	35,085
Increase due to contractual changes		9,412			64,458
Decrease due to recognition of revenue		(9,595	)		(64,037	)
Balance as of June 30, 2023 (1)	$	7,141		$	35,506

(1)

We expect to recognize contract revenues of approximately $35.5 million during the remaining six months of 2023 related to unsatisfied performance obligations existing as of June 30, 2023, which includes $26.1 million related to customer prefunding of reimbursables.

We have elected to utilize an optional exemption that permits us to exclude disclosure of the estimated transaction price related to the variable portion of unsatisfied performance obligations at the end of the reporting period, as our transaction price is based on a single performance obligation consisting of a series of distinct hourly increments, the variability of which will be resolved at the time the future services are rendered.

Income Taxes

Income Taxes: Income taxes are provided for based upon the tax laws and rates in effect in the countries in which our operations are conducted and income is earned. Deferred income tax assets and liabilities are computed for differences between the financial statement basis and tax basis of assets and liabilities that will result in future taxable or tax-deductible amounts and are based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. We do not establish deferred tax liabilities for certain of our foreign earnings that we intend to indefinitely reinvest to finance foreign activities. Valuation allowances are established when necessary to reduce deferred income tax assets to the amount expected to be realized. We recognize interest and penalties related to income taxes as a component of income tax expense.

Concentrations of Credit Risk

Concentrations of Credit Risk: Financial instruments that potentially subject us to a significant concentration of credit risk consist primarily of cash and cash equivalents, restricted cash and accounts receivable. We maintain deposits in federally insured financial institutions in excess of federally insured limits. We monitor the credit ratings and our concentration of risk with these financial institutions on a continuing basis to safeguard our cash deposits. We have a limited number of key customers, who are primarily large international oil and gas operators, national oil companies and other international oil and gas companies. Our contracts provide for monthly billings as services are performed and we monitor compliance with contract payment terms on an ongoing basis. Payment terms on customer invoices typically range from 30 to 45 days. Outstanding receivables beyond payment terms are promptly investigated and discussed with the specific customer.

Four customers accounted for approximately 30%, 22%, 15% and 15% of our consolidated trade receivables, net as of June 30, 2023, and three customers accounted for approximately 34%, 26% and 12% of our consolidated trade receivables, net as of June 30, 2022.

Credit Losses – Accounts Receivable: The allowance for credit losses is based on the Company’s assessment of the collectability of customer accounts. Current estimates of expected credit losses consider factors such as the historical experience and credit quality of our customers. The Company considers historical loss information as the most reasonable basis on which to determine expected credit losses unless current or forecasted future conditions for customers (or customer groups) indicate that risk characteristics have changed. We also considered the impact of oil price and market share volatility, as well as other applicable macroeconomic considerations, on our allowance for credit losses.

The following is a summary of the allowance for credit losses:


	June 30, 2023			December 31, 2022
(unaudited, in thousands)
Beginning balance	$	4,962		$	4,962
Additions charged to expenses		942			—
Write-offs		(2,054	)		—
Ending balance	$	3,850		$	4,962

The allowance for credit loss includes an amount that represents a customer’s decisions not to pay us for days impacted by what we believe were force majeure and other similar events for which we would still be entitled to receive payment under the applicable contracts. We disagree with the customer's decision and are currently evaluating our remedies, if any, under the applicable contracts. The write-offs in the period represent items where the Company has used reasonable collection efforts and are deemed as uncollectible receivables.

Earnings (Loss) per Share

Earnings (loss) per Share: We compute basic and diluted EPS in accordance with the two-class method. We include restricted stock units granted to employees and directors that contain non-forfeitable rights to dividends as such grants are considered participating securities. Basic earnings (loss) per share are based on the weighted average number of Ordinary Shares outstanding during the applicable period. Diluted EPS are computed based on the weighted average number of Ordinary Shares and ordinary share equivalents outstanding in the applicable period, as if all potentially dilutive securities were converted into Ordinary Shares (using the treasury stock method).

The following is a reconciliation of the number of shares used for the basic and diluted EPS computations:


	Three Months Ended June 30,				Six Months Ended June 30,
	2023		2022		2023		2022
	(unaudited, in thousands)
Weighted average Ordinary Shares outstanding for basic EPS		13,229		13,115		13,204		13,115
Restricted share equity awards		91		217		—		215
Adjusted weighted average Ordinary Shares outstanding for diluted EPS		13,320		13,332		13,204		13,330

The following sets forth the number of shares excluded from diluted EPS computations due to their antidilutive effect:


	Three Months Ended June 30,				Six Months Ended June 30,
	2023		2022		2023		2022
	(unaudited, in thousands)
Restricted share equity awards		—		—		103		—
Future potentially dilutive Ordinary Shares excluded from diluted EPS		—		—		103		—

Functional Currency

Functional Currency: We consider USD to be the functional currency for all of our operations since the majority of our revenues and expenditures are denominated in USD, which limits our exposure to currency exchange rate fluctuations. We recognize currency exchange rate gains and losses in “Other, net” in our Consolidated Statement of Operations. For the three and six months ended June 30, 2023, we recognized a net loss of approximately $0.5 million and $0.1 million, respectively, related to currency exchange rates. For the three and six months ended June 30, 2022, we recognized a net loss of approximately $1.0 million and $1.8 million, respectively, related to currency exchange rates.

Fair Value of Financial Instruments

Fair Value of Financial Instruments: The financial instruments of the Company consist primarily of cash and cash equivalents, accounts receivable and accounts payable. These items are considered Level 1 due to their short-term nature and their market interest rates and are, therefore, considered a reasonable estimate of fair value. The Company classifies short-term investments within Level 1 in the fair value hierarchy because quoted prices for identical assets in active markets are used to determine fair value. As of June 30, 2023, the fair value of the 9.50% First Lien Notes was approximately $196.6 million based on quoted market prices in a less active

market, a Level 2 measurement. See “Note 5. Debt” of these “Notes to Unaudited Consolidated Financial Statements” for additional information on the 9.50% First Lien Notes.

Share-based Compensation

Share-based Compensation: TBGs granted under the 2016 Amended MIP vest annually, ratably over four years; however, accelerated vesting is provided for in the event of a QLE. Otherwise, the settlement of any vested TBGs occurs upon the seventh anniversary of the effective date set forth in each individual award letter. PBGs granted under the 2016 Amended MIP contain vesting eligibility provisions tied to the earlier of a QLE or seven years from the Effective Date. Upon the occurrence of a vesting eligibility event, the number of PBGs that vest will be dependent on the achievement of pre-determined TEV targets specified in the grants.

Both the TBGs and PBGs are classified as equity awards. Under the provisions of ASC 718 Compensation – Stock Compensation share-based compensation expense is recognized over the requisite service period from the grant date to the fourth-year vest date for TBGs. For PBGs, expense will be recognized when it is probable that the TEV targets will be met. Once it is probable the performance condition will be met, compensation expense based on the fair value of the PBGs at the conversion date of the Convertible Notes will be recognized for the service period completed to the seventh anniversary of the Effective Date for PBGs.

Noncontrolling Interest

Noncontrolling Interest:

Noncontrolling interests represent the equity investments of the minority owner in ADVantage, a joint venture with ADES that we consolidate in our financial statements.

Recently Adopted Accounting Standards

Recently Adopted Accounting Standards:

No new accounting standards were adopted during the three-month period ended June 30, 2023.

Recently Issued Accounting Standards

Recently Issued Accounting Standards:

There have been no new accounting pronouncements not yet effective that have significance with respect to our consolidated financial statements.

VANTAGE DRILLING INTERNATIONAL 10-Q