##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549


Form 10-Q

|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|þ          |  | QUARTERLY REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|          
|           |  | For the quarterly period ended June 30,
    2004                                            
|          
|or        
|          
|o          |  | 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 001-16857

Horizon Offshore, Inc.

(Exact name of registrant as specified in its
charter)


|                                                                                                   |  |                                         
|-------------------------------------------------------------------------------------------------- |  | ----------------------------------------
|Delaware                                                                                           |  | 76-0487309                              
|(State or other jurisdiction of
    incorporation or organization)                                 |  | (I.R.S. Employer
    Identification No.)
|                                                                                                  
|2500 CityWest Boulevard, Suite 2200
    Houston, Texas(Address of principal executive
    offices) |  | 77042(Zip Code)                         

(713) 361-2600

(Registrants telephone number, including
area code)


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

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Rule 12b-2 of the
Exchange
Act).     Yes þ          No o

The number of shares of the registrants
common stock, $1.00 par value per share, outstanding as of
July 30, 2004 was 27,154,900.



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HORIZON OFFSHORE, INC. AND
SUBSIDIARIES

TABLE OF CONTENTS

|                                                        |  |                                                                                                         |    |      |    | 
|------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------- | -- | ---- | -- | 
|Description                                             |  |                                                                                                         |    | Page
|                                                        |  |                                                                                                         |    |     
|PART I. FINANCIAL
    INFORMATION                      
|Item 1.                                                 |  | Financial Statements                                                                                    |    |      | 2  | 
|                                                        |  | Consolidated Balance Sheets
    as of June 30, 2004 and December 31, 2003                               |    |      | 2  | 
|                                                        |  | Consolidated Statements of
    Operations for the Three and Six Months Ended June 30, 2004
    and 2003 |    |      | 3  | 
|                                                        |  | Consolidated Statements of
    Cash Flows for the Six Months Ended June 30, 2004 and
    2003           |    |      | 4  | 
|                                                        |  | Notes to Consolidated
    Financial Statements                                                          |    |      | 5  | 
|Item 2.                                                 |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations               |    |      | 20 | 
|Item 3.                                                 |  | Quantitative and Qualitative
    Disclosures About Market Risk                                          |    |      | 36 | 
|Item 4.                                                 |  | Controls and Procedures                                                                                 |    |      | 36 | 
|PART II. OTHER
    INFORMATION                         
|Item 2.                                                 |  | Unregistered Sales of
    Securities and Use of Proceeds                                                |    |      | 37 | 
|Item 6.                                                 |  | Exhibits and Reports on
    Form 8-K                                                                    |    |      | 37 | 
|Signatures                                              |  |                                                                                                         | 39 |     
|Cert.of Amend.to Amended Certification of Incorporation
|Certification Pursuant to Section 302                  
|Certification Pursuant to Section 302                  
|Certification Pursuant to Section 906                  
|Certification Pursuant to Section 906                  



1



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##### Table of Contents






PART I. FINANCIAL INFORMATION





|        |                     
|------- | --------------------
|Item 1. | Financial Statements

HORIZON OFFSHORE, INC. AND
SUBSIDIARIES



CONSOLIDATED BALANCE SHEETS


(Unaudited)


(In thousands, except share data)


|                                                            |                                                                                                                          |                                  |                            |              |        |         |         |         |         |         | 
|----------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------ | -------------------------------- | -------------------------- | ------------ | ------ | ------- | ------- | ------- | ------- | ------- | 
|                                                            |                                                                                                                          | June 30,                         |                            | December 31,
|                                                            |                                                                                                                          | 2004                             |                            | 2003        
|                                                            |                                                                                                                          |                                  |                            |             
|ASSETS                                                     
|CURRENT ASSETS:                                             |                                                                                                                          |                                  |                            |              |        |         |         |        
|                                                            | Cash and cash equivalents                                                                                                |                                  | $                          | 3,954        |        |         | $       | 10,115  |        
|                                                            | Accounts receivable, net                                                                                                |                                  |                            |              |        |         |         |         |        
|                                                            |                                                                                                                          | Contract receivables             |                            |              | 90,106 |         |         |         | 101,153 |        
|                                                            |                                                                                                                          | Costs in excess of billings, net |                            |              | 41,926 |         |         |         | 34,697  |        
|                                                            |                                                                                                                          | Affiliated parties               |                            |              | 3      |         |         |         | 170     |        
|                                                            |                                                                                                                          | Income tax refund receivable     |                            |              | 78     |         |         |         | 200     |        
|                                                            |                                                                                                                          | Insurance receivable             |                            |              | 23,447 |         |         |         |        |        
|                                                            | Other current assets                                                                                                     |                                  |                            | 4,071        |        |         |         | 2,616   |        
|                                                            | Assets held for sale                                                                                                     |                                  |                            | 10,068       |        |         |         |        |        
|                                                            |                                                                                                                          |                                  |                            |              |        |         |         |        
|                                                            |                                                                                                                          |                                  | Total current assets       |              |        | 173,653 |         |         |         | 148,951 | 
|PROPERTY AND EQUIPMENT, net                                 |                                                                                                                          |                                  | 205,053                    |              |        |         | 239,411 |        
|RESTRICTED CASH                                             |                                                                                                                          |                                  | 14,435                     |              |        |         |        |        
|INVENTORY                                                   |                                                                                                                          |                                  | 8,167                      |              |        |         | 8,250   |        
|OTHER ASSETS                                                |                                                                                                                          |                                  | 31,018                     |              |        |         | 12,929  |        
|                                                            |                                                                                                                          |                                  |                            |              |        |         |         |        
|                                                            |                                                                                                                          | $                                | 432,326                    |              |        | $       | 409,541 |        
|                                                            |                                                                                                                          |                                  |                            |              |        |         |         |        
|                                                           
|LIABILITIES AND STOCKHOLDERS
    EQUITY                   
|                                                           
|CURRENT LIABILITIES:                                        |                                                                                                                          |                                  |                            |              |        |         |         |        
|                                                            | Accounts payable                                                                                                         |                                  | $                          | 32,945       |        |         | $       | 31,271  |        
|                                                            | Accrued liabilities                                                                                                      |                                  |                            | 6,943        |        |         |         | 3,321   |        
|                                                            | Accrued job costs                                                                                                        |                                  |                            | 40,517       |        |         |         | 56,346  |        
|                                                            | Billings in excess of costs                                                                                              |                                  |                            | 14,172       |        |         |         | 5,834   |        
|                                                            | Current maturities of long-term debt                                                                                     |                                  |                            | 89,731       |        |         |         | 9,651   |        
|                                                            | Current portion of subordinated notes, net of
    discount                                                               |                                  |                            | 37,221       |        |         |         |        |        
|                                                            | Related party debt                                                                                                       |                                  |                            |             |        |         |         | 15,000  |        
|                                                            | Current taxes payable                                                                                                    |                                  |                            | 1,439        |        |         |         | 1,421   |        
|                                                            |                                                                                                                          |                                  |                            |              |        |         |         |        
|                                                            |                                                                                                                          |                                  | Total current liabilities  |              |        | 222,968 |         |         |         | 122,844 | 
|LONG-TERM DEBT, net of current maturities                   |                                                                                                                          |                                  | 43,733                     |              |        |         | 146,886 |        
|SUBORDINATED NOTES, net of current portion and
    discount |                                                                                                                          |                                  | 34,403                     |              |        |         |        |        
|OTHER LIABILITIES                                           |                                                                                                                          |                                  | 1,477                      |              |        |         |        |        
|                                                            |                                                                                                                          |                                  |                            |              |        |         |         |        
|                                                            |                                                                                                                          |                                  | Total liabilities          |              |        | 302,581 |         |         |         | 269,730 | 
|COMMITMENTS AND CONTINGENCIES                               |                                                                                                                          |                                  |                            |              |        |         |         |        
|STOCKHOLDERS EQUITY:                                       |                                                                                                                          |                                  |                            |              |        |         |         |        
|                                                            | Preferred stock, $1 par value,
    5,000,000 shares authorized, none issued and outstanding                              |                                  |                            |             |        |         |         |        |        
|                                                            | Common stock, $1 par value,
    100,000,000 shares authorized, 27,840,926 and
    27,290,582 shares issued, respectively |                                  |                            | 17,134       |        |         |         | 16,583  |        
|                                                            | Additional paid-in capital                                                                                               |                                  |                            | 198,154      |        |         |         | 182,687 |        
|                                                            | Accumulated deficit                                                                                                      |                                  |                            | (81,044      | )      |         |         | (54,151 | )      
|                                                            | Treasury stock, 686,026 and 809,269 shares,
    respectively                                                             |                                  |                            | (4,499       | )      |         |         | (5,308  | )      
|                                                            |                                                                                                                          |                                  |                            |              |        |         |         |        
|                                                            |                                                                                                                          |                                  | Total stockholders equity |              |        | 129,745 |         |         |         | 139,811 | 
|                                                            |                                                                                                                          |                                  |                            |              |        |         |         |        
|                                                            |                                                                                                                          | $                                | 432,326                    |              |        | $       | 409,541 |        
|                                                            |                                                                                                                          |                                  |                            |              |        |         |         |        

The accompanying notes are an integral part of
these consolidated financial statements.

2



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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES



CONSOLIDATED STATEMENTS OF
OPERATIONS


(Unaudited)


(In thousands, except share and per share
data)


|                                                                  |                                             |                                        |         |                           |       |      |         |            |       |   |         |            |       |   |         |            |       |  
|----------------------------------------------------------------- | ------------------------------------------- | -------------------------------------- | ------- | ------------------------- | ----- | ---- | ------- | ---------- | ----- | - | ------- | ---------- | ----- | - | ------- | ---------- | ----- | -
|                                                                  |                                             |                                        |         |                          
|                                                                  |                                             | Three Months Ended June 30,            |         | Six Months Ended June 30,
|                                                                  |                                             |                                        |         |                          
|                                                                  |                                             | 2004                                   |         | 2003                      |       | 2004 |         | 2003      
|                                                                  |                                             |                                        |         |                           |       |      |         |           
|CONTRACT REVENUES                                                 |                                             | $                                      | 44,932  |                           |       | $    | 57,928  |            |       | $ | 87,415  |            |       | $ | 124,989 |           
|COST OF CONTRACT REVENUES                                         |                                             |                                        | 45,963  |                           |       |      | 58,678  |            |       |   | 88,570  |            |       |   | 123,205 |           
|                                                                  |                                             |                                        |         |                           |       |      |         |            |       |   |         |            |       |   |         |           
|                                                                  | Gross profit (loss)                         |                                        |         | (1,031                    | )     |      |         | (750       | )     |   |         | (1,155     | )     |   |         | 1,784      |      
|SELLING, GENERAL AND ADMINISTRATIVE EXPENSES                      |                                             |                                        | 5,433   |                           |       |      | 6,481   |            |       |   | 11,274  |            |       |   | 11,899  |           
|IMPAIRMENT LOSS ON ASSETS HELD FOR SALE                           |                                             |                                        | 2,568   |                           |       |      |        |            |       |   | 2,568   |            |       |   |        |           
|                                                                  |                                             |                                        |         |                           |       |      |         |            |       |   |         |            |       |   |         |           
|                                                                  | Operating loss                              |                                        |         | (9,032                    | )     |      |         | (7,231     | )     |   |         | (14,997    | )     |   |         | (10,115    | )    
|OTHER:                                                            |                                             |                                        |         |                           |       |      |         |            |       |   |         |            |       |   |         |           
|                                                                  | Interest expense, net of amount capitalized |                                        |         | (6,721                    | )     |      |         | (2,106     | )     |   |         | (10,458    | )     |   |         | (3,649     | )    
|                                                                  | Interest income                             |                                        |         | 14                        |       |      |         | 10         |       |   |         | 28         |       |   |         | 21         |      
|                                                                  | Loss on debt extinguishment                 |                                        |         |                          |       |      |         | (868       | )     |   |         | (165       | )     |   |         | (868       | )    
|                                                                  | Other income (expense), net                 |                                        |         | 80                        |       |      |         | (89        | )     |   |         | 22         |       |   |         | (131       | )    
|                                                                  |                                             |                                        |         |                           |       |      |         |            |       |   |         |            |       |   |         |           
|NET LOSS BEFORE INCOME TAXES                                      |                                             |                                        | (15,659 | )                         |       |      | (10,284 | )          |       |   | (25,570 | )          |       |   | (14,742 | )         
|INCOME TAX PROVISION (BENEFIT)                                    |                                             |                                        | 536     |                           |       |      | (6,227  | )          |       |   | 1,323   |            |       |   | (7,737  | )         
|                                                                  |                                             |                                        |         |                           |       |      |         |            |       |   |         |            |       |   |         |           
|NET LOSS                                                          |                                             | $                                      | (16,195 | )                         |       | $    | (4,057  | )          |       | $ | (26,893 | )          |       | $ | (7,005  | )         
|                                                                  |                                             |                                        |         |                           |       |      |         |            |       |   |         |            |       |   |         |           
|EARNINGS (LOSS) PER SHARE  BASIC
    AND DILUTED:                |                                             |                                        |         |                           |       |      |         |            |       |   |         |            |       |   |         |           
|                                                                  |                                             | Net loss per share  basic and diluted |         | $                         | (0.60 | )    |         | $          | (0.15 | ) |         | $          | (1.00 | ) |         | $          | (0.27 | )
|                                                                  |                                             |                                        |         |                           |       |      |         |            |       |   |         |            |       |   |         |           
|WEIGHTED AVERAGE SHARES USED IN COMPUTING NET
    LOSS PER SHARE: |                                             |                                        |         |                           |       |      |         |            |       |   |         |            |       |   |         |           
|                                                                  | BASIC AND DILUTED                           |                                        |         | 27,087,771                |       |      |         | 26,417,147 |       |   |         | 26,815,196 |       |   |         | 26,402,438 |      

The accompanying notes are an integral part of
these consolidated financial statements.

3



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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES



CONSOLIDATED STATEMENTS OF CASH
FLOWS


(Unaudited)


(In thousands)


|                                                         |                                                                                                    |                                                                                     |                               |                                           |       |         |         |         |        |        |         |  
|-------------------------------------------------------- | -------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------- | ----------------------------- | ----------------------------------------- | ----- | ------- | ------- | ------- | ------ | ------ | ------- | -
|                                                         |                                                                                                    |                                                                                    
|                                                         |                                                                                                    | Six Months Ended                                                                   
|                                                         |                                                                                                    | June 30,                                                                           
|                                                         |                                                                                                    |                                                                                    
|                                                         |                                                                                                    | 2004                                                                                |                               | 2003                                     
|                                                         |                                                                                                    |                                                                                     |                               |                                          
|CASH FLOWS FROM OPERATING ACTIVITIES:                    |                                                                                                    |                                                                                     |                               |                                           |       |         |         |        
|                                                         | Net loss                                                                                           |                                                                                     | $                             | (26,893                                   | )     |         | $       | (7,005  | )     
|                                                         | Adjustments to reconcile net loss to net cash
    used in operating activities                    |                                                                                     |                               |                                           |       |         |         |         |       
|                                                         |                                                                                                    | Depreciation and amortization                                                       |                               |                                           | 8,150 |         |         |         | 9,294  |       
|                                                         |                                                                                                    | Impairment loss on assets held for sale                                             |                               |                                           | 2,568 |         |         |         |       |       
|                                                         |                                                                                                    | Deferred income tax benefit                                                         |                               |                                           |      |         |         |         | (8,871 | )     
|                                                         |                                                                                                    | Paid in-kind interest on subordinated notes                                         |                               |                                           | 3,528 |         |         |         |       |       
|                                                         |                                                                                                    | Amortization of subordinated debt discount
    recorded as interest expense         |                               |                                           | 1,609 |         |         |         |       |       
|                                                         |                                                                                                    | Amortization of deferred loan fees recorded as
    interest expense                 |                               |                                           | 1,179 |         |         |         |        |       
|                                                         |                                                                                                    | Expense recognized for issuance of treasury stock
    for 401(k) plan contributions |                               |                                           | 228   |         |         |         | 232    |       
|                                                         |                                                                                                    | Stock compensation expense                                                          |                               |                                           |      |         |         |         | 212    |       
|                                                         |                                                                                                    | Loan prepayment penalty financed through
    additional debt                        |                               |                                           |      |         |         |         | 569    |       
|                                                         |                                                                                                    | Changes in operating assets and
    liabilities                                    |                               |                                           |       |         |         |         |        |       
|                                                         |                                                                                                    |                                                                                     | Restricted cash               |                                           |       | (14,435 | )       |         |        |       |        
|                                                         |                                                                                                    |                                                                                     | Accounts receivable           |                                           |       | 11,336  |         |         |        | (4,713 | )      
|                                                         |                                                                                                    |                                                                                     | Costs in excess of billings   |                                           |       | (7,229  | )       |         |        | (3,884 | )      
|                                                         |                                                                                                    |                                                                                     | Billings in excess of costs   |                                           |       | 8,338   |         |         |        | 601    |        
|                                                         |                                                                                                    |                                                                                     | Inventory                     |                                           |       | 83      |         |         |        | (128   | )      
|                                                         |                                                                                                    |                                                                                     | Other assets                  |                                           |       | (13,207 | )       |         |        | (1,142 | )      
|                                                         |                                                                                                    |                                                                                     | Accounts payable              |                                           |       | 3,674   |         |         |        | (5,727 | )      
|                                                         |                                                                                                    |                                                                                     | Accrued and other liabilities |                                           |       | 1,375   |         |         |        | (6,570 | )      
|                                                         |                                                                                                    |                                                                                     | Accrued job costs             |                                           |       | (16,973 | )       |         |        | (6,377 | )      
|                                                         |                                                                                                    |                                                                                     | Current taxes payable         |                                           |       | 18      |         |         |        | 556    |        
|                                                         |                                                                                                    |                                                                                     |                               |                                           |       |         |         |        
|                                                         |                                                                                                    |                                                                                     |                               | Net cash used in operating activities     |       |         | (36,651 | )       |        |        | (32,953 | )
|CASH FLOWS FROM INVESTING ACTIVITIES:                    |                                                                                                    |                                                                                     |                               |                                           |       |         |         |        
|                                                         | Purchases and additions to property and equipment                                                  |                                                                                     |                               | (4,090                                    | )     |         |         | (8,412  | )     
|                                                         |                                                                                                    |                                                                                     |                               |                                           |       |         |         |        
|                                                         |                                                                                                    |                                                                                     |                               | Net cash used in investing activities     |       |         | (4,090  | )       |        |        | (8,412  | )
|CASH FLOWS FROM FINANCING ACTIVITIES:                    |                                                                                                    |                                                                                     |                               |                                           |       |         |         |        
|                                                         | Borrowings on term debt                                                                            |                                                                                     |                               |                                          |       |         |         | 16,362  |       
|                                                         | Principal payments on term debt                                                                    |                                                                                     |                               | (4,823                                    | )     |         |         | (4,169  | )     
|                                                         | Borrowings on revolving credit facilities                                                          |                                                                                     |                               | 21,750                                    |       |         |         | 66,516  |       
|                                                         | Payments on revolving credit facilities                                                            |                                                                                     |                               | (40,000                                   | )     |         |         | (39,500 | )     
|                                                         | Borrowings on related party debt                                                                   |                                                                                     |                               |                                          |       |         |         | 15,000  |       
|                                                         | Proceeds from issuance of subordinated notes                                                       |                                                                                     |                               | 43,303                                    |       |         |         |        |       
|                                                         | Proceeds from issuance of subordinated notes
    allocable to warrants                             |                                                                                     |                               | 16,593                                    |       |         |         |        |       
|                                                         | Deferred loan fees                                                                                 |                                                                                     |                               | (2,249                                    | )     |         |         | (641    | )     
|                                                         | Stock option and warrant transactions and other                                                    |                                                                                     |                               | 6                                         |       |         |         |        |       
|                                                         |                                                                                                    |                                                                                     |                               |                                           |       |         |         |        
|                                                         |                                                                                                    |                                                                                     |                               | Net cash provided by financing activities |       |         | 34,580  |         |        |        | 53,568  |  
|                                                         |                                                                                                    |                                                                                     |                               |                                           |       |         |         |        
|NET INCREASE (DECREASE) IN CASH AND CASH
    EQUIVALENTS |                                                                                                    |                                                                                     | (6,161                        | )                                         |       |         | 12,203  |        
|CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD         |                                                                                                    |                                                                                     | 10,115                        |                                           |       |         | 6,073   |        
|                                                         |                                                                                                    |                                                                                     |                               |                                           |       |         |         |        
|CASH AND CASH EQUIVALENTS AT END OF PERIOD               |                                                                                                    | $                                                                                   | 3,954                         |                                           |       | $       | 18,276  |        
|                                                         |                                                                                                    |                                                                                     |                               |                                           |       |         |         |        
|SUPPLEMENTAL DISCLOSURES:                                |                                                                                                    |                                                                                     |                               |                                           |       |         |         |        
|                                                         | Cash paid for interest                                                                             |                                                                                     | $                             | 4,372                                     |       |         | $       | 2,948   |       
|                                                         | Cash paid for income taxes                                                                         |                                                                                     | $                             | 1,305                                     |       |         | $       | 578     |       
|                                                         | Cash refund for income taxes                                                                       |                                                                                     | $                             | 122                                       |       |         | $       |        |       
|NON-CASH INVESTING AND FINANCING ACTIVITIES:             |                                                                                                    |                                                                                     |                               |                                           |       |         |         |        
|                                                         | Repayment of debt with proceeds of subordinated
    notes and additional term debt                 |                                                                                     | $                             | 15,000                                    |       |         | $       | 14,069  |       
|                                                         | Capital expenditures for property and equipment
    included in accrued liabilities                |                                                                                     | $                             | 4,185                                     |       |         | $       | 4,132   |       
|                                                         | Payment of deferred loan fees and warrant
    issuance costs with proceeds of additional term debt |                                                                                     | $                             | 8,905                                     |       |         | $       |        |       
|                                                         | Insurance receivable recorded upon involuntary
    conversion of assets from fire                  |                                                                                     | $                             | 23,447                                    |       |         | $       |        |       

The accompanying notes are an integral part of
these consolidated financial statements.

4



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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS




|   |                                                                
|-- | ---------------------------------------------------------------
|1. | Organization and Summary of Significant
    Accounting Policies

The consolidated interim financial statements
included herein have been prepared by Horizon Offshore, Inc. (a
Delaware corporation) and its subsidiaries (references to
Horizon, we or us are intended to refer to Horizon Offshore,
Inc. and its subsidiaries), and are unaudited. In the opinion of
management, the unaudited consolidated interim financial
statements include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the
financial position as of June 30, 2004, the statements of
operations for the three and six months ended June 30, 2004
and 2003, and the statements of cash flows for the six months
ended June 30, 2004 and 2003. Although management believes
the unaudited interim disclosures in these consolidated interim
financial statements are adequate to make the information
presented not misleading, certain information and footnote
disclosures normally included in annual audited financial
statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to
the rules of the Securities and Exchange Commission. The results
of operations for the six months ended June 30, 2004 are
not necessarily indicative of the results to be expected for the
entire year ending December 31, 2004. The consolidated
interim financial statements included herein should be read in
conjunction with the audited consolidated financial statements
and notes thereto included in our 2003 Annual Report on
Form 10-K.

The accompanying financial statements have been
prepared in accordance with generally accepted accounting
principles, assuming that we continue as a going concern, which
contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. Our ability to
continue as a going concern is dependent on generating
sufficient cash flows from operations for meeting our liquidity
needs, servicing our debt requirements and meeting financial
covenants. During the past two years and for the first six
months of 2004, we have experienced operating and net losses and
have had negative cash flows. Also, our inability to collect
outstanding receivables and claims from Petróleos Mexicanos
(Pemex), Williams Oil Gathering LLC (Williams) and Iroquois Gas
Transmission LP (Iroquois) continues to impact our liquidity. We
issued an aggregate of $91.0 million of
16% subordinated secured notes (the 16% Subordinated
Notes) in March 2004 and 18% subordinated secured notes
(the 18% Subordinated Notes) in May 2004 in order to meet
our current liquidity needs. We have substantial debt
obligations, including an aggregate of $57.9 million of
outstanding indebtedness under our two revolving credit
facilities with Southwest Bank of Texas N.A. (Southwest Bank),
which mature in January 2005, and our revolving credit facility
with The CIT Group/ Equipment Finance, Inc. (CIT Group), which
matures in May 2005. We must secure refinancing to replace the
Southwest Bank revolving credit facilities by January 2005 and
extend the maturity of one CIT Group revolving credit facility
by May 2005. Prior to being able to refinance our existing
revolving credit facilities, management believes that we will
need to increase our equity through the consummation of an
equity or exchange offering or other transaction in order to
refinance all or a portion of the 16% and 18% Subordinated
Notes. We are in discussions with the holders of the 16% and
18% Subordinated Notes regarding the terms and structure of
such transaction. The timing and collection of progress payments
and our ability to stay on budget and meet our cash flow
forecasts for our projects will be of critical importance for
the remainder of 2004 to allow us to meet our financial
covenants, provide cash from operations and position us to
refinance our existing indebtedness and reduce our financial
leverage. We may not be able to continue as a going concern if
we are unable to generate sufficient cash flows from operations
for meeting our liquidity needs, servicing our debt requirements
and meeting financial covenants. Managements current
forecast indicates that we will be in compliance with our
financial covenants throughout the remainder of 2004.



| |             
| | ------------
| | Organization

Horizon provides marine construction services for
the offshore oil and gas and other energy related industries
domestically in the U.S. Gulf of Mexico and internationally
in Latin America, Southeast Asia, West Africa and have recently
expanded our operations to the Mediterranean to perform work
under a new contract that we were awarded in March 2004. These
services generally consist of laying, burying or repairing

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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

marine pipelines for the transportation of oil
and gas; and installing and salvaging production platforms and
other marine structures. Work is performed primarily on a
fixed-price or day-rate basis or a combination thereof. From
time to time, work is also performed under cost-reimbursement
contracts.



| |                      
| | ---------------------
| | Significant Customers

We have domestic and international operations in
one industry segment, the marine construction services industry
for offshore oil and gas companies and energy companies.
Customers accounting for more than 10% of consolidated revenues
for the three and six months ended June 30, 2004 and 2003
are as follows:

|           |  |              |     |            |  |      |     |      |  |  |     |  |  |  |     | 
|---------- |  | ------------ | --- | ---------- |  | ---- | --- | ---- |  |  | --- |  |  |  | --- | 
|           |  |              |     |           
|           |  | Three Months |     | Six Months
|           |  | Ended        |     | Ended     
|           |  | June 30,     |     | June 30,  
|           |  |              |     |           
|Customer   |  | 2004         |     | 2003       |  | 2004 |     | 2003
|           |  |              |     |            |  |      |     |     
|Customer A |  |              | 37% |            |  |      | -%  |      |  |  | 19% |  |  |  | -%  | 
|Customer B |  |              | 23% |            |  |      | -%  |      |  |  | 18% |  |  |  | 3%  | 
|Customer C |  |              | 5%  |            |  |      | -%  |      |  |  | 16% |  |  |  | 5%  | 
|Customer D |  |              | -%  |            |  |      | 28% |      |  |  | -%  |  |  |  | 45% | 
|Customer E |  |              | -%  |            |  |      | 24% |      |  |  | -%  |  |  |  | 14% | 
|Customer F |  |              | 1%  |            |  |      | 10% |      |  |  | -%  |  |  |  | 10% | 
|Customer G |  |              | -%  |            |  |      | 16% |      |  |  | 4%  |  |  |  | 7%  | 

The amount of revenue accounted for by a customer
depends on the level of construction services required by the
customer based on the size of its capital expenditure budget and
our ability to bid for and obtain its work. Consequently,
customers that account for a significant portion of contract
revenues in one year may represent an immaterial portion of
contract revenues in subsequent years. We have domestic and
international operations in one industry segment, the marine
construction services industry for oil and gas companies and
energy companies. We currently operate in five geographic
segments. Geographic information has been provided in
Note 9 of these consolidated interim financial statements.



| |                 
| | ----------------
| | Use of Estimates

The preparation of financial statements in
conformity with accounting principles generally accepted in the
United States of America requires us to make estimates and
assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts
of revenue and expenses during the reporting period. Management
must apply significant judgments in this process. Among the
factors, but not fully inclusive of all factors, that may be
considered by management in these processes are: the range of
accounting policies permitted by accounting principles generally
accepted in the United States; managements understanding
of our business; expected rates of business and operational
change; sensitivity and volatility associated with the
assumptions used in developing estimates; and whether historical
trends are expected to be representative of future trends. Among
the most subjective judgments employed in the preparation of
these financial statements are estimates of expected costs to
complete construction projects, the collectibility of contract
receivables and claims, the fair value of salvage inventory, the
depreciable lives of and future cash flows to be provided by our
equipment, the amortization period of maintenance and repairs
for dry-docking activity, estimates for the number and magnitude
of self-insurance reserves needed for potential medical claims
and Jones Act obligations, judgments regarding the outcomes of
pending and potential litigation and certain judgments regarding
the nature of income and expenditures for tax purposes. We
review all significant estimates on a recurring basis and record
the effect of any necessary adjustments prior to publication of
our financial statements. Adjustments made with respect to the
use of estimates often relate to improved information not
previously available. Because of the inherent uncertainties in
this process, actual future results could differ from those
expected at the reporting date.

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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                    
| | -------------------
| | Revenue Recognition

Construction contract revenues are recognized on
the percentage-of-completion method, measured by the percentage
of costs incurred to date to the total estimated costs for each
construction contract. This percentage is applied to the
estimated revenue at completion to calculate revenues earned to
date. We consider the percentage-of-completion method to be the
best available measure of progress on these contracts. We follow
the guidance of American Institute of Certified Public
Accountants (AICPA) Statement of Position (SOP) 81-1,
Accounting for Performance of Construction-Type and
Certain Production-Type Contracts, for our accounting
policy relating to the use of the percentage-of-completion
method, estimated costs and claim recognition for construction
contracts. Contract revenue reflects the original contract price
adjusted for agreed upon change orders and unapproved claims. We
recognize unapproved claims only when the collection is deemed
probable and if the amount can be reasonably estimated for
purposes of calculating total profit or loss on long-term
contracts. We record revenue and the unbilled receivable for
claims to the extent of costs incurred and to the extent we
believe related collection is probable and include no profit on
claims recorded. Changes in job performance, job conditions and
estimated profitability, including those arising from final
contract settlements, may result in revisions to costs and
revenues and are recognized in the period in which the revisions
are determined. Provisions for estimated losses on uncompleted
contracts are made in the period in which such losses are
determined. The asset Costs in excess of billings
represents costs and estimated earnings recognized as revenue in
excess of amounts billed as determined on an individual contract
basis. The liability Billings in excess of costs
represents amounts billed in excess of costs and estimated
earnings recognized as revenue on an individual contract basis.

For certain service contracts, revenues are
recognized under SEC Staff Accounting Bulletin
(SAB) No. 101, Revenue Recognition in Financial
Statements, and No. 104, Revenue
Recognition, when all of the following criteria are met;
persuasive evidence of an arrangement exists; delivery has
occurred or services have been rendered; the sellers price
is fixed or determinable; and collectibility is reasonably
assured.



| |                 
| | ----------------
| | Cost Recognition

Cost of contract revenues includes all direct
material and labor costs and certain indirect costs, which are
allocated to contracts based on utilization, such as supplies,
tools, repairs and depreciation. Selling, general and
administrative costs are charged to expense as incurred.



| |                        
| | -----------------------
| | Interest Capitalization

Interest is capitalized on the average amount of
accumulated expenditures for equipment that is undergoing major
modifications and refurbishment prior to being placed into
service. Interest is capitalized using an effective rate based
on related debt until the equipment is placed into service.
There was no interest capitalized for the three and six months
ended June 30, 2004. Interest expense for the three and six
months ended June 30, 2003 was net of $13,000 and $123,000
of capitalized interest, respectively.



| |                          
| | -------------------------
| | Cash and Cash Equivalents

Cash and cash equivalents include interest
bearing demand deposits and highly liquid investments with
original maturities of three months or less.



| |                    
| | -------------------
| | Accounts Receivable

We have significant investments in billed and
unbilled receivables as of June 30, 2004. Billed
receivables represents amounts billed upon the completion of
small contracts and progress billings on large contracts in
accordance with contract terms and milestones. Unbilled
receivables on fixed-price contracts, which are

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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

included in costs in excess of billings, arise as
revenues are recognized under the percentage-of-completion
method. Unbilled amounts on cost-reimbursement contracts
represent recoverable costs and accrued profits not yet billed.
Allowances for estimated nonrecoverable costs primarily provide
for losses that may be sustained on unapproved change orders and
claims. We evaluate our contract receivables and costs in excess
of billings and thoroughly review historical collection
experience, the financial condition of our customers, billing
disputes and other factors. During the fourth quarter of 2003,
we recorded a $33.1 million reserve for unapproved claims
against Pemex. During the first six months of 2004, there was no
change in our reserve for these unapproved claims, and we have
not collected any amounts outstanding on these claims. There
were no other reserves recorded during the first six months
of 2004.

We negotiate change orders and unapproved claims
with our customers. In particular, unsuccessful negotiations
relating to unapproved claims would result in decreases in
estimated contract profit or additional contract losses, while
successful claims negotiations would result in increases in
estimated contract profit or recovery of previously recorded
contract losses. Any future significant losses on receivables
would adversely affect our financial position, results of
operations and our overall liquidity.



| |                
| | ---------------
| | Restricted Cash

Restricted cash represents amounts used to
establish an escrow account of $5.3 million to secure a
performance bond for our current contract with Pemex and
$9.1 million cash used to secure a letter of credit under
the Israel Electric Corporation (IEC) contract. We were required
to use cash to secure the performance bond and letter of credit.
In the past, we have been able to obtain similar performance
bonds and letters of credit without cash collateral. Amounts
restricted under the performance bond will be used to secure a
warranty bond after the completion and acceptance of the Pemex
project, which is estimated to occur in the fourth quarter of
2004. Upon satisfactory completion of the twelve-month warranty
period, the restriction on these funds will be released.
Twenty-five percent of the amounts restricted under the IEC
letter of credit will be released two months after the
satisfactory completion of the IEC project, which is estimated
to be in the fourth quarter of 2004. The remaining amount will
be released twelve months after satisfactory completion of this
project. The $5.3 million escrow account and the cash used
to secure the $9.1 million letter of credit also secure the
16% Subordinated Notes and the 18% Subordinated Notes.
See Note 5. These amounts will be remitted as a prepayment
of the 16% and 18% Subordinated Notes upon release of the
restriction on the funds. Restricted cash is not considered as
cash or cash equivalents for purposes of the accompanying
consolidated balance sheets and statements of cash flows.



| |             
| | ------------
| | Other Assets

Other assets consist principally of capitalized
dry-dock costs, deferred loan fees, deposits and
$1.0 million of goodwill.

Dry-dock costs are direct costs associated with
scheduled major maintenance on our marine vessels and are
capitalized and amortized over a five-year cycle. We incurred
and capitalized dry-dock costs of $11.8 million for the six
months ended June 30, 2004 and $1.4 million for the
six months ended June 30, 2003. The significant dry-dock
costs capitalized for the first six months of 2004 relate
primarily to the vessels utilized to perform the work awarded
under the IEC and Pemex contracts. Major maintenance on the
Canyon Horizonprior to its mobilization to Israel, as
well as regulatory dry-dockings for the American Horizonand the Pecos Horizonrequired by the U.S. Coast
Guard and the American Bureau of Shipping, were completed during
the first half of 2004. As of June 30, 2004, capitalized
dry-dock costs totaled $19.7 million.

Loan fees paid in connection with new loan
facilities are deferred and amortized over the term of the
respective loans. The amortization of the deferred loan fees is
recorded as interest expense in the accompanying consolidated
statements of operations. In connection with the issuance of the
16% Subordi-

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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

nated Notes, we incurred and capitalized loan
fees of $6.3 million. Additionally, we incurred and
capitalized loan fees of $4.2 million in connection with
the issuance of the 18% Subordinated Notes. See Note 5.



| |          
| | ---------
| | Inventory

Inventory consists of production platforms and
other marine structures received from time to time as partial
consideration from salvage projects performed in the
U.S. Gulf of Mexico. No significant non-cash consideration
was received during the three and six months ended June 30,
2004 and 2003. These structures are held for resale. The
inventory is valued at amounts not in excess of the fair value
of services provided. We assess the net realizable value of our
inventory items at each balance sheet date. Inventory is
classified as long-term due to the uncertain timing of its sale.
There were no significant sales of inventory during the three
and six months ended June 30, 2004 or for the year ended
December 31, 2003.



| |                         
| | ------------------------
| | Stock-Based Compensation

At June 30, 2004, we had two stock-based
compensation plans. Pursuant to SFAS No. 123,
Accounting for Stock-Based Compensation, as amended
by SFAS No. 148, Accounting for Stock-Based
Compensation  Transition and Disclosure 
an amendment of SFAS No. 123, we have elected to
account for stock-based employee compensation under the
recognition and measurement principles of Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations. In
January 2003, we granted options to three former directors to
purchase 15,320 shares of common stock at an exercise price
equal to the market price of the common stock on the date of
grant. These options vested immediately, and $56,000 was
recorded as compensation expense in the statements of operations
during the first quarter of 2003. Also, we recorded $156,000 as
compensation expense in the statements of operations during the
second quarter of 2003 related to the remeasurement of options
in connection with the resignation of a key employee. Except for
the compensation expense recorded above, no stock-based employee
compensation cost is reflected in net loss, as all options
granted under those plans had an exercise price equal to the
market value of the underlying common stock on the date of
grant. For stock-based compensation grants to non-employees, we
recognize as compensation expense the fair market value of such
grants as calculated pursuant to SFAS No. 123,
amortized ratably over the lesser of the vesting period of the
respective option or the individuals expected service
period. The following table illustrates the effect on net loss
and earnings per share if we had applied the fair value
recognition provisions of SFAS No. 123 to stock-based
employee compensation (in thousands, except per share data).

|                                                                                                                                           |             |                    |         |                  |   |      |        |       |   |   |         |       |   |   |        |       |  
|------------------------------------------------------------------------------------------------------------------------------------------ | ----------- | ------------------ | ------- | ---------------- | - | ---- | ------ | ----- | - | - | ------- | ----- | - | - | ------ | ----- | -
|                                                                                                                                           |             |                    |         |                 
|                                                                                                                                           |             | Three Months Ended |         | Six Months Ended
|                                                                                                                                           |             | June 30,           |         | June 30,        
|                                                                                                                                           |             |                    |         |                 
|                                                                                                                                           |             | 2004               |         | 2003             |   | 2004 |        | 2003 
|                                                                                                                                           |             |                    |         |                  |   |      |        |      
|Net loss, as reported                                                                                                                      |             | $                  | (16,195 | )                |   | $    | (4,057 | )     |   | $ | (26,893 | )     |   | $ | (7,005 | )    
|Add: Total stock-based compensation cost, net of
    related tax effects, included in net loss                                             |             |                    |        |                  |   |      | 103    |       |   |   |        |       |   |   | 140    |      
|Deduct: Total stock-based compensation expense
    determined under fair value based method for all awards, net of
    related tax effects |             |                    | (208    | )                |   |      | (566   | )     |   |   | (614    | )     |   |   | (1,085 | )    
|                                                                                                                                           |             |                    |         |                  |   |      |        |       |   |   |         |       |   |   |        |      
|Pro forma net loss                                                                                                                         |             | $                  | (16,403 | )                |   | $    | (4,520 | )     |   | $ | (27,507 | )     |   | $ | (7,950 | )    
|                                                                                                                                           |             |                    |         |                  |   |      |        |       |   |   |         |       |   |   |        |      
|Earnings per share  Basic and Diluted:                                                                                                    |             |                    |         |                  |   |      |        |       |   |   |         |       |   |   |        |      
|                                                                                                                                           | As reported |                    | $       | (0.60            | ) |      | $      | (0.15 | ) |   | $       | (1.00 | ) |   | $      | (0.27 | )
|                                                                                                                                           | Pro forma   |                    | $       | (0.61            | ) |      | $      | (0.17 | ) |   | $       | (1.03 | ) |   | $      | (0.30 | )

9



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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

To determine pro forma information as if we had
accounted for employee stock options under the fair-value method
as defined by SFAS No. 123, we used the Black-Scholes
method, assuming no dividends, as well as the weighted average
assumptions included in the following table:

|                                |  |              |      |            |  |      |      |      |  |  |      |   |  |  |      |  
|------------------------------- |  | ------------ | ---- | ---------- |  | ---- | ---- | ---- |  |  | ---- | - |  |  | ---- | -
|                                |  |              |      |           
|                                |  | Three Months |      | Six Months
|                                |  | Ended        |      | Ended     
|                                |  | June 30,     |      | June 30,  
|                                |  |              |      |           
|                                |  | 2004         |      | 2003       |  | 2004 |      | 2003
|                                |  |              |      |            |  |      |      |     
|Expected option life (in years) |  |              | 7    |            |  |      | 7    |      |  |  | 7    |   |  |  | 7    |  
|Expected volatility             |  |              | 78.1 | %          |  |      | 77.5 | %    |  |  | 78.1 | % |  |  | 77.5 | %
|Risk-free interest rate         |  |              | 4.13 | %          |  |      | 3.52 | %    |  |  | 3.86 | % |  |  | 3.52 | %

The FASB has proposed to mandate expense
recognition for stock options and other types of equity-based
compensation based on the fair value of the options at the grant
date. Additionally, the FASB is evaluating how to develop a
measure of the fair value of an option. Based on the final
outcome of the FASB proposal, we may be required to recognize
expense related to stock options and other types of equity-based
compensation in future periods. Additionally, we may be required
to change our method for determining the fair value of stock
options.



| |             
| | ------------
| | Income Taxes

We account for income taxes in accordance with
SFAS No. 109, Accounting for Income Taxes,
which requires the recognition of income tax expense for the
amount of taxes payable or refundable for the current year and
for deferred tax liabilities and assets for the future tax
consequences of events that have been recognized in an
entitys financial statements or tax returns. We must make
significant assumptions, judgments and estimates to determine
our current provision for income taxes and also our deferred tax
assets and liabilities and any valuation allowance to be
recorded against our net deferred tax asset. The current
provision for income tax is based upon the current tax laws and
our interpretation of these laws, as well as the probable
outcomes of any foreign or domestic tax audits. The value of our
net deferred tax asset is dependent upon our estimates of the
amount and category of future taxable income and is reduced by
the amount of any tax benefits that are not expected to be
realized. For the three and six months ended June 30, 2004,
a valuation allowance of $4.7 million and
$8.7 million, respectively, was charged as income tax
expense against the net deferred tax assets that are not
expected to be realized due to the uncertainty of future taxable
income. Our valuation allowance as of June 30, 2004 is
approximately $31.8 million. Actual operating results and
the underlying amount and category of income in future years
could render our current assumptions, judgments and estimates of
recoverable net deferred taxes inaccurate, thus materially
impacting our financial position and results of operations.



| |                  
| | -----------------
| | Reclassifications

Certain prior period amounts have been
reclassified to conform to the presentation shown in the
consolidated interim financial statements as of June 30,
2004. Reclassifications in 2003 had no effect on net income
(loss) or total shareholders equity and relate all within
cash used in operating activities in the consolidated statement
of cash flows.

10



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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                       
|-- | ----------------------
|2. | Property and Equipment

Property and equipment consists of the following
(in thousands):

|                                       |  |          |         |              |  |   |         |  
|-------------------------------------- |  | -------- | ------- | ------------ |  | - | ------- | -
|                                       |  | June 30, |         | December 31,
|                                       |  | 2004     |         | 2003        
|                                       |  |          |         |             
|Barges, vessels, and related equipment |  | $        | 220,164 |              |  | $ | 256,653 |  
|Land and buildings                     |  |          | 19,642  |              |  |   | 19,732  |  
|Machinery and equipment                |  |          | 245     |              |  |   | 245     |  
|Office furniture and equipment         |  |          | 6,257   |              |  |   | 6,116   |  
|Leasehold improvements                 |  |          | 4,209   |              |  |   | 4,191   |  
|                                       |  |          |         |              |  |   |         |  
|                                       |  |          | 250,517 |              |  |   | 286,937 |  
|Less  accumulated depreciation        |  |          | (45,464 | )            |  |   | (47,526 | )
|                                       |  |          |         |              |  |   |         |  
|Property and equipment, net            |  | $        | 205,053 |              |  | $ | 239,411 |  
|                                       |  |          |         |              |  |   |         |  

During the six months ended June 30, 2004,
we incurred $4.3 million of capital expenditures primarily
related to the upgrades of the Sea Horizonand Canyon
Horizonprior to mobilization of these vessels to Israel.

We use the units-of-production method to
calculate depreciation on our major barges, vessels and related
equipment to accurately reflect the wear and tear of normal use.
The useful lives of our major barges and vessels range from
15 years to 18 years. Depreciation expense calculated
under the units-of-production method may be different than
depreciation expense calculated under the straight-line method
in any period. The annual depreciation based on utilization of
each vessel will not be less than 25% of annual straight-line
depreciation, and the cumulative depreciation based on
utilization of each vessel will not be less than 50% of
cumulative straight-line depreciation. If we alternatively
applied only a straight-line depreciation method, less
depreciation expense would be recorded in periods of high vessel
utilization and more depreciation expense would be recorded in
periods of low vessel utilization.

When events or changes in circumstances indicate
that assets may be impaired, we evaluate the carrying value of
the asset. Changes in our business plans, a change in the
physical condition of a long-lived asset or the extent or manner
in which it is being used, or a severe or sustained downturn in
the oil and gas industry are considered triggering events. The
carrying value of each vessel is compared to the estimated
undiscounted future net cash flows for that vessel. If the
carrying value of any vessel is more than the estimated
undiscounted future net cash flows expected to result from the
use of the vessel, a write-down of the vessel to estimated fair
market value must be made. When quoted market prices are not
available, fair value must be determined based upon other
valuation techniques. This could include appraisals or present
value calculations of estimated future cash flows. In the
calculation of fair market value, including the discount rate
used and the timing of the related cash flows, as well as
undiscounted future net cash flows, we apply judgment in our
estimates and projections, which could result in varying levels
of impairment recognition. For the three and six months ended
June 30, 2004 and 2003, there were no losses on impairment
of long-lived assets included in net property and equipment.

In May 2004, our pipelay barge, the Gulf
Horizoncaught fire while on tow from the U.S. Gulf of
Mexico to Israel. In accordance with Financial Accounting
Standards Board (FASB) Interpretation No. 30
(FIN 30), Accounting for Involuntary Conversions of
Non-Monetary Assets to Monetary Assets, as of
June 30, 2004, we wrote off the net book value of the
Gulf Horizonand related assets of $22.3 million and
reimbursable sue and labor costs of $1.1 million incurred
through June 30, 2004 to an insurance receivable because we
expect the vessel to ultimately be declared a constructive total
loss. We purchased a policy of marine hull insurance that covers
physical damage to the vessel. We currently estimate that the
insured value of this property will exceed its net book value,
resulting in a gain. We will record this gain, if any, once final

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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

insurance amounts are determined. All proceeds
received from the insurance company will be used to repay our
term loan with CIT Group. See Note 8.



| |                     
| | --------------------
| | Assets Held for Sale

During the second quarter of 2004, management
committed to a plan to sell three of our marine construction
vessels and a cargo barge due to the sustained difficult
economic environment and depressed market for the marine
construction industry throughout 2003 and the first half of
2004. We continue to experience lower levels of vessel
utilization due to competitive conditions in this depressed
market, and management believes that the disposition of these
assets and associated debt reduction will improve our financial
position, as well as our utilization. We have listed these
assets for sale and are actively locating and negotiating with
potential buyers. In accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived
Assets, we reclassified these assets from property and
equipment to assets held for sale in the accompanying
consolidated balance sheet as of June 30, 2004 and ceased
depreciation on the assets. As required by
SFAS No. 144, in order to classify these assets as
held for sale, it must be probable that these assets will be
sold within one year unless certain criteria are met. We are
also required to measure these assets at the lower of their
carrying amount or fair value, less cost to sell the asset.
Based upon our marketing of these assets for sale, discussions
with potential buyers have indicated a decline in market value
of two of the marine vessels held for sale. Accordingly, we
recorded a charge of $2.6 million as impairment loss on
assets held for sale during the second quarter of 2004 to reduce
the net carrying value of the assets to the fair value, less the
cost to sell the assets. Management believes the fair value of
the assets held for sale approximates their current carrying
value of $10.1 million.



|   |                     
|-- | --------------------
|3. | Stockholders Equity

During our 2004 Annual Meeting of Stockholders
held on July 28, 2004, our stockholders voted to approve
the amendment to our amended and restated articles of
incorporation to increase our authorized shares of common stock
from 35,000,000 shares to 100,000,000 shares of common
stock (all of which have voting rights).



| |                   
| | ------------------
| | Earnings Per Share

Earnings per share data for all periods presented
have been computed pursuant to SFAS No. 128,
Earnings Per Share that requires a presentation of
basic earnings per share (basic EPS) and diluted earnings per
share (diluted EPS). Basic EPS excludes dilution and is
determined by dividing income available to common stockholders
by the weighted average number of common shares outstanding
during the period. Diluted EPS reflects the potential dilution
that could occur if securities and other contracts to issue
common stock were exercised or converted into common stock. As
of June 30, 2004, we had outstanding options covering an
aggregate of 3,292,000 shares of common stock, of which
2,665,427 shares were exercisable. We also had outstanding
warrants covering an aggregate of 4,732,956 shares of
common stock, all of which were exercisable. Excluded from the
computation of diluted EPS for the three and six months ended
June 30, 2004 are 4,732,956 outstanding warrants, each with
a remaining exercise price of $0.01, and options to
purchase 3,292,000 shares of common stock at a
weighted average price of $7.22 per share as they would be
anti-dilutive. Excluded from the computation of diluted EPS for
the three and six months ended June 30, 2003 are options to
purchase 3,495,718 shares of common stock at a
weighted average price of $7.35 per share, as they would be
anti-dilutive.



| |         
| | --------
| | Warrants

On March 11, 2004, we issued
$65.4 million principal amount of 16% Subordinated
Notes due March 31, 2007 to a group of investors in a
private placement. In connection with this issuance, we issued
to the holders

12



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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

of the 16% Subordinated Notes warrants to
purchase an aggregate of 5,283,300 shares of our common
stock for an exercise price of $1.00 per share, expiring
March 11, 2009, of which 550,344 warrants have been
exercised as of June 30, 2004. Holders paid the initial
exercise price of $0.99 per share upon issuance of the
warrants and may fully exercise them by paying the remaining
$0.01 of the per share exercise price.

The 16% Subordinated Notes were initially
recorded net of a discount totaling approximately
$17.3 million, which represents the fair value of the
warrants issued determined using the Black-Scholes method,
assuming no dividends, as well as the following weighted average
assumptions:

|                        |  |  |          |  
|----------------------- |  |  | -------- | -
|Warrant life            |  |  | 5  years |  
|Expected volatility     |  |  | 76.6     | %
|Risk-free interest rate |  |  | 2.66     | %

The discount, plus the discount related to
offering costs, are amortized as a non-cash charge to interest
expense over the term of the 16% Subordinated Notes using
the effective interest rate method.



| |               
| | --------------
| | Treasury Stock

During the six months ended June 30, 2004,
we contributed 123,243 shares of treasury stock to our
401(k) Plan. As of June 30, 2004, our treasury stock
consisted of 686,026 shares at a cost of $4.5 million.



|   |                           
|-- | --------------------------
|4. | Related Party Transactions

In August 1998, we entered into a master services
agreement with Odyssea Marine, Inc. (Odyssea), an entity
wholly-owned by Elliott Associates and Elliott International,
L.P., collectively our largest stockholder, to charter certain
marine vessels from Odyssea. As of June 30, 2004, we owed
Odyssea $0.2 million for charter services compared to
$0.8 million at June 30, 2003. Odyssea billed Horizon
and Horizon paid Odyssea for services rendered under the
agreement as follows (in millions).

|                         |  |            |     |      |  |   |      | 
|------------------------ |  | ---------- | --- | ---- |  | - | ---- | 
|                         |  |           
|                         |  | Six Months
|                         |  | Ended     
|                         |  | June 30,  
|                         |  |           
|                         |  | 2004       |     | 2003
|                         |  |            |     |     
|Amount billed to Horizon |  | $          | 4.0 |      |  | $ | 10.7 | 
|Amount paid to Odyssea   |  | $          | 4.9 |      |  | $ | 14.1 | 

At June 30, 2004, we also owed Odyssea
approximately $5.6 million for materials it purchased on
our behalf for use on our current Pemex project offshore Mexico,
which is included in accrued job cost in the accompanying
consolidated balance sheet. In July 2004, we owed Odyssea an
additional $2.5 million for purchased materials. In August
2004, we paid Odyssea $8.1 million for all amounts owed for
these materials, which Odyssea made approximately $400,000
profit on this transaction.

In June 2003, we secured a $15.0 million
term loan due June 30, 2004 from Elliott Associates. All
amounts of principal and interest under this loan were repaid in
March 2004 with a portion of the proceeds received from the
issuance of the 16% Subordinated Notes. Of the
$65.4 million principal amount of the 16% Subordinated
Notes issued, Elliott Companies purchased $15.0 million
aggregate principal amount.

On May 27, 2004, we issued
$18.75 million of 18% Subordinated Notes in another
private placement, of which, the Elliott Companies purchased
$5.3 million aggregate principal amount. See Note 5.

On May 1, 2004, we amended our consulting
agreement with Edward L. Moses, Jr., one of our directors.
Under the terms of this amended agreement, Mr. Moses will
serve as a liaison with the senior management of Pemex on the
collection of our contractual claims against Pemex. We will pay
Mr. Moses an aggregate $125,000 for his services for the
remainder of the agreement which expires on September 30,
2004.

13



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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |     
|-- | ----
|5. | Debt

At June 30, 2004, we had approximately
$224.5 million in total outstanding debt before debt
discount of $19.4 million. This represents an approximate
increase of $53.0 million from December 31, 2003. This
increase in debt is primarily due to the 16% and
18% Subordinated Notes that were issued in March and May
2004, respectively, to meet working capital needs. A portion of
the proceeds from the issuance of the subordinated notes was
used to repay our $15.0 million term loan with Elliott
Associates that was originally due June 30, 2004 and to
secure a $9.1 million letter of credit for our IEC contract
offshore Israel. The remainder was used for immediate working
capital needs and included repayments under our three revolving
credit facilities. These funds were subsequently re-borrowed to
fund activities for significant projects for IEC and for Pemex.
Of the $205.1 million of outstanding net debt reflected in
the accompanying consolidated balance sheet at June 30,
2004, $57.9 million represents borrowings on our three
revolving credit facilities, $75.6 million represents
outstanding balances on eight term-debt facilities and
$71.6 million represents the outstanding balance on our 16%
and 18% Subordinated Notes (net of $19.4 million
representing the unamortized portion of both the original
$17.3 million debt discount recorded related to the
warrants issued with the 16% Subordinated Notes and
$3.75 million debt discount for the 18% Subordinated
Notes). Our total obligation under our 16% and
18% Subordinated Notes at June 30, 2004 was
$91.0 million, including interest paid in-kind and before
debt discount. At June 30, 2004, we had no additional
available borrowing capacity under our revolving credit
facilities. Our available borrowing capacity continues to be
limited as a result of decreased levels of project activity and
associated customer billings and the exclusion of certain
significantly aged receivables from our borrowing base
calculation. We need to increase our cash flows from operations
by generating increased revenues and associated billings from
increased domestic and international project activity to provide
us access to the entire borrowing capacity of our revolving
credit facilities. Interest rates vary from the one-month
commercial paper rate plus 2.45% to 18%, and our average
interest rate at June 30, 2004, including amortization of
the debt discount on our 16% and 18% Subordinated Notes,
was 12.6%. Our term-debt borrowings currently require
approximately $804,000 in total monthly principal payments.

On March 11, 2004, we issued
$65.4 million principal amount of 16% Subordinated
Notes to a group of investors in a private placement in order to
meet our immediate working capital needs. We received net
proceeds of approximately $44.9 million, which included
$16.6 million, net of $0.7 million issuance costs,
allocated to warrants issued in connection with the issuance of
16% Subordinated Notes. These proceeds are net of both
offering costs and amounts used to repay all principal and
interest under the $15.0 million term loan from Elliott
Associates. Elliott Companies purchased $15.0 million
aggregate principal amount of the 16% Subordinated Notes.
We also substantially reduced our indebtedness under our
revolving credit facilities with Southwest Bank; however, we
re-borrowed these funds during the second quarter of 2004.

On May 27, 2004, we issued
$18.75 million principal amount of 18% Subordinated
Notes due March 31, 2007 in another private placement to
Elliott Companies and other holders of the 16% Subordinated
Notes. The 18% Subordinated Notes were purchased at a 20%
discount, for $15.0 million, resulting in net proceeds of
approximately $14 million after offering costs.
Approximately $9.1 million of these net proceeds were used
to collateralize a letter of credit required for our contract
with IEC. The balance of these proceeds was used for immediate
working capital needs. In connection with this issuance, we paid
the holders of the 16% Subordinated Notes a consent fee of
$3.4 million to release their first priority security
interest in the Pemex EPC 64 claim not related to interruptions
due to adverse weather conditions. Holders of the
16% Subordinated Notes retained a second priority security
interest in these claims. This consent fee was paid in-kind with
the issuance of additional 16% Subordinated Notes having
the same terms as the original 16% Subordinated Notes
issued in March 2004. The first priority security interest in
the Pemex EPC 64 claim not related to interruptions due to
adverse weather conditions secures the 18% Subordinated
Notes. Additionally, the 18% Subordinated Note holders have
an option to purchase up to an additional $6.25 million of
18% Subordinated Notes at a 20% discount of the principal
amount, which would result in additional gross proceeds of up to
$5.0 million. See Note 10.

14



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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The 18% Subordinated Notes essentially have
the same terms as the 16% Subordinated Notes. Interest on
the 16% and 18% Subordinated Notes is due quarterly
beginning June 30, 2004. We are required by our existing
loan agreements to issue to the 16% and 18% Subordinated
Note holders additional subordinated secured notes equal to the
amount of interest due on any quarterly payment date beginning
June 30, 2004. On June 30, 2004, we issued an
aggregate of $3.5 million of additional 16% and
18% Subordinated Notes for this paid in-kind interest
incurred. Upon an event of default under the 16% and
18% Subordinated Notes, the interest on the subordinated
notes increases 2%.

The 16% and 18% Subordinated Notes are
collateralized by the Pemex, Williams and $6.25 million of
the Iroquois receivables and claims, a second priority security
interest in both the $5.3 million escrow account related to
the Pemex bond and the $9.1 million cash securing the
letter of credit for the IEC contract, a second lien on the
Pecos Horizon, a second mortgage on our Port Arthur
marine base and certain other assets. The 16% and
18% Subordinated Notes are subordinate and junior to our
existing debt. Collections on the Pemex, Williams and Iroquois
receivables and claims must be remitted immediately upon
collection as a prepayment of the 16% and 18% Subordinated
Notes. The $5.3 million escrow related to the Pemex bond
and the cash securing the $9.1 million letter of credit
related to the IEC contract will be remitted immediately upon
the release of the restriction on these funds as a prepayment of
the 16% and 18% Subordinated Notes. Although the 16% and
18% Subordinated Notes mature in 2007, the portion
equivalent to the carrying value of the pledged Pemex, Williams
and Iroquois receivables and claims will be classified as
current until these amounts are collected. At June 30,
2004, $37.2 million was classified as current related to
the portion of the 16% and 18% Subordinated Notes
collateralized by our Pemex, Williams and Iroquois receivables
and claims.

The 16% and 18% Subordinated Notes have
covenants that restrict our ability to enter into any other
agreements which would prohibit us from prepaying the 16% and
18% Subordinated Notes from the proceeds of an equity
offering, entering into certain affiliate transactions,
incurring additional indebtedness other than refinancing our
existing term and revolving debt, and disposing of assets other
than in the ordinary course of business, and would also prohibit
our subsidiaries from making certain payments. In addition, in
connection with our 16% Subordinated Note offering in March
2004, we amended the financial covenants in all of our existing
loan agreements. At June 30, 2004, we were in compliance
with all the financial covenants required by our credit
facilities. Our credit facilities require:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a ratio of current assets to current liabilities
    of 0.90 to 1 for the period ending June 30, 2004 (actual
    was 1.05 at June 30, 2004), 1.05 to 1 for the period ending
    September 30, 2004, 1.10 to 1 for the period ending
    December 31, 2004 and 1.10 to 1 for the period ending
    March 31, 2005 and each period thereafter, each computed by
    excluding our revolving credit facilities from current
    liabilities;                                                                                                                                                                                                                                                                                                                   
|
| |  | a fixed charge coverage ratio of 1.50 to 1 for
    the three-month period ending September 30, 2004,
    1.40 to 1 for the six-month period ending December 31,
    2004, 1.33 to 1 for the nine-month period ending
    March 31, 2005, and 1.33 to 1 for each period
    thereafter on a rolling four quarter basis;                                                                                                                                                                                                                                                                                                                                                                                                                                        
|
| |  | a tangible net worth in an amount not less than
    the sum of $110 million plus 75% of our consolidated net
    income for each fiscal quarter which has been completed as of
    the date of calculation, commencing with the fiscal quarter
    ending March 31, 2004 plus 90% of the net proceeds of any
    common stock or other equity issued after December 31, 2003
    (actual was $121 million at June 30, 2004); and                                                                                                                                                                                                                                                                                                                              
|
| |  | the sum of our net income before gains and losses
    on sales of assets (to the extent such gains and losses are
    included in earnings), plus interest expense, plus tax expense,
    plus depreciation and amortization, plus restructuring charges,
    (including costs of our and our lenders or other
    creditors professional advisors not to exceed $1,600,000
    for the fiscal year ended December 31, 2004) to be greater
    than negative $(4.5) million for the six-month period
    ending June 30, 2004 (actual was negative
    $(3.6) million at June 30, 2004), positive
    $8 million for the nine-month period ending
    September 30, 2004, and positive $20 million for the
    twelve-month period ending December 31, 2004.

15



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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Based on managements current projections
and successful execution and completion of our current
contracts, we expect to be in compliance with our debt covenants
through December 31, 2004, and if successful in refinancing
our Southwest Bank revolving credit facilities prior to their
maturity in January 2005 and extending the maturity date of our
revolving credit facility with CIT Group, for at least the next
twelve months. However, in the event that we do not meet our
financial covenants in the future, and we are unsuccessful in
obtaining waivers of any future non-compliance that might arise,
our lenders would have the right to accelerate our debt with
them, and cross-default provisions could result in acceleration
of our other indebtedness, including the 16% and
18% Subordinated Notes.

Events of default under the 16% and
18% Subordinated Notes occur upon our failure to pay
principal and interest under the 16% and 18% Subordinated
Notes, our insolvency, a change of control or breach of the 16%
and 18% Subordinated Note covenants and our other debt
covenants, including the financial covenants described above.
Three holders of the 16% and 18% Subordinated Notes each
have the right to designate one observer to our board of
directors and its committees. None of the observers shall have
any right to vote at any such board or committee meetings. Two
holders of the 16% and 18% Subordinated Notes also have the
right to each designate one individual to be nominated by our
board of directors as a member of our board. One of these
holders designated a nominee who was elected to our board of
directors at our 2004 Annual Meeting of Stockholders held on
July 28, 2004.

In March 2004, we extended the maturity of our
revolving credit facilities with Southwest Bank to January 2005.
Based on the maturity of these facilities, this debt is
classified as current as of June 30, 2004. We must secure
an alternate credit facility to replace the Southwest Bank
credit facilities by January 21, 2005, the extended
maturity date, in order to repay these borrowings when they
become due. Prior to being able to refinance our existing
revolving credit facilities, management believes that we will
need to increase our equity through the consummation of an
equity or exchange offering or other transaction in order to
refinance all or a portion of the 16% and 18% Subordinated
Notes. We are in discussions with the holders of the 16% and
18% Subordinated Notes regarding the terms and structure of
such refinancing. Management believes that it can obtain
replacement financing in an amount that will be sufficient to
meet our future needs in the fourth quarter of 2004. However,
there can be no assurance that we will be successful in this
regard. In addition, our revolving credit facility with CIT
Group is also classified as current as of June 30, 2004
based on its maturity in May 2005.

Our loans are collateralized by mortgages on all
of our vessels and property and by accounts receivable and
claims. Advances under our revolving credit facilities with
Southwest Bank may be obtained in accordance with a borrowing
base defined as a percentage of accounts receivable balances and
costs in excess of billings. Our loans contain customary default
and cross-default provisions and some require us to maintain
financial ratios at quarterly determination dates. The loan
agreements also contain covenants that limit our ability to
incur additional debt, pay dividends, create liens, sell assets
and make capital expenditures.

During the second quarter of 2004, our liquidity
was impacted by continued low utilization levels of our vessels,
unusually adverse weather conditions in the U.S. Gulf of
Mexico, a fire aboard the Gulf Horizonwhile en route to
Israel for the IEC project and costs incurred in connection with
the start-up of our project offshore Mexico for Pemex. The
timing of the collection of progress payments on customer
contracts and our ability to stay on budget and meet our cash
flow forecasts for our projects are of critical importance to
provide cash from operations. Our ability to continue as a going
concern is dependent on generating sufficient cash flows from
operations for meeting our liquidity needs, servicing our debt
requirements and meeting financial covenants. Accordingly, if we
are unable to generate sufficient cash flows from operations, we
may have to consider alternatives to settle our existing
liabilities with our limited resources, including a potential
restructuring of our company or seeking protection from
creditors through bankruptcy proceedings.

16



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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                            
|-- | ---------------------------
|6. | Loss on Debt Extinguishment

Loss on debt extinguishment relates to the
write-off of deferred loan fees of $165,000 for the early
payment of our $15.0 million term loan with Elliott
Associates during the first quarter of 2004 in connection with
the issuance of the 16% Subordinated Notes. Loss on debt
extinguishment for the second quarter of 2003 relates to a
prepayment penalty of $569,000 and the write-off of deferred
loan fees of $299,000 for the early retirement of debt. In June
2003, we refinanced the Sea Horizonwith another lender
and used a portion of the proceeds to repay and extinguish our
previous lenders debt resulting in the loss on debt
extinguishment.



|   |                  
|-- | -----------------
|7. | Severance Charges

During the second quarter of 2003, we incurred
approximately $680,000 in charges related to severance and other
costs in connection with the resignation of a key employee,
which was reflected in selling, general and administrative
expenses in the consolidated statements of operations in the
second quarter of 2003. We recorded liabilities of $382,000 for
severance and other benefits to be paid pursuant to the
employees separation agreement through August 31,
2004. This amount is to be paid ratably each month through the
term of the agreement. In addition, we incurred a non-cash
charge of approximately $156,000 related to the remeasurement of
the employees options and a non-cash charge of
approximately $142,000 related to the forgiveness of the
employees loan pursuant to conditions in his separation
agreement. In May 2004, we determined that this key employee was
in violation of the non-compete clause of his severance
agreement; and accordingly, we have ceased the monthly severance
payment under this agreement. Although the employee has not
filed arbitration proceedings seeking payment, we continue to
reflect the remaining liability under the severance agreement in
the accompanying consolidated balance sheet as of June 30,
2004. For the first six months of 2004, we paid $100,000 of the
recorded liability resulting in a $131,000 remaining liability
at June 30, 2004. All charges are reflected in our domestic
region.



|   |                     
|-- | --------------------
|8. | Insurance Receivable

On May 18, 2004, our pipelay barge, the
Gulf Horizon,caught fire while on tow from the U.S. Gulf
of Mexico to Israel to perform the IEC project. The vessel was
recovered 400 miles off the coast of Georgia and was towed
to a shipyard in South Carolina. A damage assessment was
performed, and we are evaluating repair bids obtained from three
U.S. shipyards. If those repair estimates are accurate, the
repair costs will equal or exceed the $28.0 million insured
value of the vessel and it may ultimately be declared a
constructive total loss. However, the underwriters on the policy
of marine hull insurance that we purchased to cover physical
damage to the vessel have asked for additional repair estimates.
Because the three repair estimates we have received to date
approach the insured value of the vessel, we have written off
the value of the Gulf Horizon and related assets and
booked a receivable in an amount equal to the net book value of
$22.3 million of the vessel and related assets and
$1.1 million of sue and labor costs we incurred through
June 30, 2004 that we believe are reimbursable under the
insurance policy in addition to the insured value. The insurance
receivable is classified as a current receivable in the
accompanying consolidated balance sheet as of June 30,
2004. All proceeds received from the insurance company will be
used either to repair the vessel, or if the vessel ultimately is
determined to be beyond repair, to repay our term loan with CIT
Group, which has an outstanding balance of $27.1 million at
June 30, 2004. Accordingly, we have classified the CIT
Group term loan as current in the accompanying consolidated
balance sheet as of June 30, 2004. We are in discussions
with underwriters on the policy. We believe that the collection
of the receivable is probable, however, the process of
collecting any insurance proceeds may involve extensive
negotiations with our insurance carrier, which may result in
significant delays in collection and a variance in the amount
collected from the insured value. As a result, we cannot
guarantee the sufficiency of any insurance proceeds that we may
ultimately receive, which may be more or less than the amount of
the receivable that we have booked. If the recovery differs from
the amount booked, we will record a gain or loss in the period
in which it is incurred.

17



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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                       
|-- | ----------------------
|9. | Geographic Information

Horizon operates in a single industry segment,
the marine construction services industry, and currently
operates in five geographic segments. Information relating to
Horizons geographic segments follows (in millions):

|              |                |              |   |            |      |      |   |      |      |   |   |      |      |   |   |      |       | 
|------------- | -------------- | ------------ | - | ---------- | ---- | ---- | - | ---- | ---- | - | - | ---- | ---- | - | - | ---- | ----- | 
|              |                |              |   |           
|              |                | Three Months |   | Six Months
|              |                | Ended        |   | Ended     
|              |                | June 30,     |   | June 30,  
|              |                |              |   |           
|              |                | 2004         |   | 2003       |      | 2004 |   | 2003
|              |                |              |   |            |      |      |   |     
|Revenues:     |                |              |   |            |      |      |   |      |      |   |   |      |      |   |   |     
|              | Domestic       |              | $ | 13.2       |      |      | $ | 44.0 |      |   | $ | 34.4 |      |   | $ | 96.1 |      
|              | Latin America  |              |   | 10.6       |      |      |   |     |      |   |   | 15.9 |      |   |   | 3.6  |      
|              | West Africa    |              |   | 2.5        |      |      |   | (1.3 | )    |   |   | 13.5 |      |   |   | 5.6  |      
|              | Southeast Asia |              |   | 2.2        |      |      |   | 15.1 |      |   |   | 7.2  |      |   |   | 19.2 |      
|              | Mediterranean  |              |   | 16.4       |      |      |   |     |      |   |   | 16.4 |      |   |   |     |      
|              | Other          |              |   |           |      |      |   | 0.1  |      |   |   |     |      |   |   | 0.5  |      
|              |                |              |   |            |      |      |   |      |      |   |   |      |      |   |   |     
|              |                | Total        |   | $          | 44.9 |      |   | $    | 57.9 |   |   | $    | 87.4 |   |   | $    | 125.0 | 
|              |                |              |   |            |      |      |   |      |      |   |   |      |      |   |   |     
|Gross Profit: |                |              |   |            |      |      |   |      |      |   |   |      |      |   |   |     
|              | Domestic       |              | $ | (5.1       | )    |      | $ | 0.6  |      |   | $ | (6.0 | )    |   | $ | 1.6  |      
|              | Latin America  |              |   | 1.4        |      |      |   | (0.6 | )    |   |   | 0.3  |      |   |   | (0.9 | )    
|              | West Africa    |              |   | (0.1       | )    |      |   | (2.7 | )    |   |   | 0.8  |      |   |   | (1.2 | )    
|              | Southeast Asia |              |   | (1.3       | )    |      |   | 2.4  |      |   |   | (0.4 | )    |   |   | 2.5  |      
|              | Mediterranean  |              |   | 4.1        |      |      |   |     |      |   |   | 4.1  |      |   |   |     |      
|              | Other          |              |   |           |      |      |   | (0.5 | )    |   |   |     |      |   |   | (0.2 | )    
|              |                |              |   |            |      |      |   |      |      |   |   |      |      |   |   |     
|              |                | Total        |   | $          | (1.0 | )    |   | $    | (0.8 | ) |   | $    | (1.2 | ) |   | $    | 1.8   | 
|              |                |              |   |            |      |      |   |      |      |   |   |      |      |   |   |     

|                           |                |          |   |              |       |  |   |       |       | 
|-------------------------- | -------------- | -------- | - | ------------ | ----- |  | - | ----- | ----- | 
|                           |                |         
|                           |                | As of   
|                           |                |         
|                           |                | June 30, |   | December 31,
|                           |                | 2004     |   | 2003        
|                           |                |          |   |             
|Property and Equipment(1): |                |          |   |              |       |  |   |      
|                           | Domestic       |          | $ | 123.4        |       |  | $ | 171.7 |      
|                           | Latin America  |          |   | 0.2          |       |  |   | 0.2   |      
|                           | West Africa    |          |   | 19.1         |       |  |   | 19.7  |      
|                           | Southeast Asia |          |   | 0.2          |       |  |   | 40.1  |      
|                           | Mediterranean  |          |   | 62.2         |       |  |   |      |      
|                           | Other          |          |   |             |       |  |   | 7.7   |      
|                           |                |          |   |              |       |  |   |      
|                           |                | Total    |   | $            | 205.1 |  |   | $     | 239.4 | 
|                           |                |          |   |              |       |  |   |      



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Property and equipment includes vessels, property
    and related marine equipment. Amounts reflect the location of
    the assets at June 30, 2004 and December 31, 2003.
    Equipment location changes as necessary to meet working
    requirements. Other identifiable assets include inventory and
    other long-term assets, and are primarily located in the
    domestic region. Goodwill is associated with the Latin America
    region.

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##### Table of Contents



HORIZON OFFSHORE, INC. AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                  
|--- | -----------------
|10. | Subsequent Events

We had an operating loss for the first six months
of 2004 and negative cash flows from operations which has
significantly impacted our liquidity. In order to meet immediate
working capital needs for the first six months of 2004 and
secure a $9.1 million letter of credit for the IEC
contract, we issued $65.4 million principal amount of
16% Subordinated Notes in March 2004 and
$18.75 million principal amount of 18% Subordinated
Notes in May 2004 at a 20% discount, for $15.0 million.
Additionally, the 18% Subordinated Note holders have an
option to purchase up to an additional $6.25 million of
18% Subordinated Notes at a 20% discount for
$5.0 million. We are pursuing additional financing from the
18% Subordinated Note holders and are in negotiations with
such holders regarding the terms of such financing. We have
obtained a consent from the Export-Import Bank of the United
States (EXIM), which guarantees one of our revolving credit
facilities with Southwest Bank, to release a portion of the
Iroquois claim from its collateral, which, together with the
other collateral that already secures the 18% Subordinated
Notes, would provide additional security for this indebtedness.
Upon obtaining EXIMs consent, we were required to reduce
the borrowing capacity under our domestic revolving credit
facility with Southwest Bank from $20 million to
$15 million, and the interest rate for such facility was
increased by 1% to Southwest Banks prime rate plus 2%.

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##### Table of Contents








|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 2. | Managements Discussion and Analysis
    of Financial Condition and Results of Operations

You should read the following discussion and
analysis together with our consolidated financial statements and
notes thereto and the discussion Managements
Discussion and Analysis of Financial Condition and Results of
Operations included in our 2003 Annual Report on
Form 10-K. The following information contains
forward-looking statements, which are subject to risks and
uncertainties. Should one ormore
of these risks or uncertainties materialize, actual results
may differ from those expressed or implied by the
forward-looking statements.

General

We provide marine construction services for the
offshore oil and gas and other energy related industries in the
U.S. Gulf of Mexico, Northeastern U.S., Latin America,
Southeast Asia, West Africa and have recently expanded our
operations to the Mediterranean to perform work under a new
contract that we were awarded in March 2004. We have nine
operational vessels in our marine fleet, including four pipelay
and pipebury vessels, one diving support vessel, one dedicated
pipebury vessel, two derrick barges and one combination pipelay
and derrick vessel.

Our primary services include:



| |   |                                                                           
| | - | --------------------------------------------------------------------------
| |  | installing pipelines;                                                     
|
| |  | providing pipebury, hook-up and commissioning
    services;               
|
| |  | installing production platforms and other
    structures; and             
|
| |  | disassembling and salvaging production platforms
    and other structures.

The demand for offshore construction services
depends largely on the condition of the oil and gas industry
and, in particular, the level of capital expenditures by oil and
gas companies for developmental construction. These expenditures
are influenced by:



| |   |                                                                                  
| | - | ---------------------------------------------------------------------------------
| |  | the price of oil and gas and industry perception
    of future prices;           
|
| |  | the ability of the oil and gas industry to access
    capital;                   
|
| |  | expectations about future demand and prices;                                     
|
| |  | the cost of exploring for, producing and
    developing oil and gas reserves;    
|
| |  | sale and expiration dates of offshore leases in
    the United States and abroad;
|
| |  | discovery rates of new oil and gas reserves in
    offshore areas;               
|
| |  | local and international political and economic
    conditions;                   
|
| |  | governmental regulations; and                                                    
|
| |  | the availability and cost of capital.                                            

Historically, oil and gas prices and the level of
exploration and development activity have fluctuated
substantially, impacting the demand for pipeline and marine
construction services. Factors affecting our profitability
include competition, equipment and labor productivity, contract
estimating, weather conditions and other risks inherent in
marine construction. The marine construction industry in the
U.S. Gulf of Mexico and offshore Mexico is highly seasonal
as a result of weather conditions with the greatest demand for
these services occurring during the second and third calendar
quarters of the year. International shallow water areas offshore
Southeast Asia is less cyclical and is not impacted seasonally
to the degree the U.S. Gulf of Mexico and offshore Mexico
is impacted. The West Africa work season helps to offset the
decreased demand during the winter months in the U.S. Gulf
of Mexico.

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Overview

We had an operating loss for the first six months
of 2004 of $(15.0) million and negative cash flows from
operations of $(36.7) million. The operating loss was
$(9.0) million for the quarter ended June 30, 2004.
The increased operating loss for the first six months of 2004 is
due to a number of factors. We continue to experience lower
levels of vessel utilization due to competitive conditions in
the marine construction industry. The gross loss for the six
months ended June 30, 2004 is primarily attributable to
losses generated by our domestic operations, as we did not have
a sufficient level of contract activity and associated revenues
to support our operating cost structure in this geographic area.
The continuing low levels of vessel utilization due to
competitive market conditions and unusually adverse weather in
the U.S. Gulf of Mexico during the first half of 2004 were
contributing factors to the loss from our domestic operation.
Also, productivity on the execution of certain projects during
the first quarter of 2004 was less than initially estimated when
the projects were bid. During the second quarter of 2004,
management committed to a plan to sell three of our marine
construction vessels and a cargo barge in response to the lower
levels of utilization. Discussions with potential buyers have
indicated a decline in market value of two of the marine vessels
held for sale; accordingly, we recorded a $2.6 million
impairment loss on assets held for sale during the quarter ended
June 30, 2004. Management believes the fair value of the
assets held for sale approximates their current carrying value
of $10.1 million.

A fire on the Gulf Horizonon May 18,
2004 while on tow from the U.S. Gulf of Mexico to Israel
also contributed to the increased operating loss. The Sea
Horizon, our combination pipelay and derrick vessel located
in Southeast Asia, replaced the Gulf Horizonto allow the
IEC contract to stay on schedule. The diversion of the Sea
Horizonfrom its scheduled work in Southeast Asia and the
loss of this work in June 2004 adversely affected our operations
in this geographic area for the quarter and will result in the
loss of revenues forecasted for the second half of 2004. The
Sea Horizonis expected to return to Southeast Asia after
completion of the IEC project.

The Gulf Horizonis currently at a
shipyard in South Carolina where a damage assessment was
performed and three repair bids were obtained. We purchased a
marine hull insurance policy to cover physical damage to the
Gulf Horizonwhile being towed to Israel. We expect the
vessel to ultimately be declared a constructive total loss.
Accordingly, we wrote off the net book value of the Gulf
Horizonand related assets of $22.3 million and
reimbursable sue and labor costs of $1.1 million incurred
through June 30, 2004 to an insurance receivable. We
currently estimate that the insured value of this property will
exceed the net book value, and may result in a gain once final
insurance amounts are determined.

We used $9.1 million cash to secure a letter
of credit for the IEC contract with proceeds from the issuance
of the 18% Subordinated Notes on May 27, 2004. The
Sea Horizonand the Canyon Horizonmobilized to
Israel and arrived at the end of July 2004 to begin work on the
installation of a 40 diameter natural gas transmission
pipeline. During the second quarter, we recognized
$16.4 million in contract revenues and gross profit of
$4.1 million related to the mobilization phase of this
project. This project is estimated to be substantially complete
by the end of 2004.

Our Latin America operations improved during the
second quarter as we have begun work on a contract for the
construction and installation of several pipelines in the Bay of
Campeche for Pemex. We completed the engineering and the
procurement of 24 diameter pipe required for the project
during the first half of 2004. The Lone Star Horizonmobilized and began work in late July 2004 to lay and trench
pipelines ranging in size from 10 diameter to 24
diameter and will perform one shore approach. The Atlantic
Horizonis expected to mobilize in mid August 2004 to
complete minor trenching and perform tie-ins on the Pemex
project, which will be substantially completed during the fourth
quarter of 2004.

For the six months ended June 30, 2004,
revenues related to our IEC contract accounted for 19% and the
Pemex contract accounted for 18% of our consolidated revenues.
Construction activities related to the two-year pipeline and
structural installation program in Nigeria were substantially
complete at March 31, 2004 and accounted for 16% of our
consolidated revenues for the first half of 2004. Our customer
in Nigeria has an option, expiring in September 2004 pursuant to
the contract, for a third year of work which would begin in

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October 2004. Our customer requested and is
currently reviewing our pricing submitted to perform this work,
but has not yet exercised its option.


In addition to the recent events described above,
our inability to collect significant outstanding receivables and
claims from Pemex, Iroquois and Williams has continued to impact
our liquidity and caused us to closely manage cash. We were able
to meet cash needs through the second quarter of 2004 from the
financing secured with proceeds of $59.9 million from the
issuance of 16% and 18% Subordinated Notes in March and May
2004, respectively. It is critical for us to stay on budget and
meet our cash flow forecasts for our projects in order to
provide sufficient cash from operations to meet our liquidity
needs for the remainder of 2004. For discussion of our current
liquidity position, see Liquidity and Capital
Resources herein.

We continue to negotiate and use our best efforts
to resolve our EPC 64 contract claims with Pemex. The total
claims that we submitted to Pemex approximated $78 million
and included unapproved claims for extra work related to
interferences, interruptions and other delays as well as claims
for additional scope of work performed. The unapproved claims
recorded as revenue to the extent of costs incurred through
December 31, 2002 do not include any profit and are
substantially less than the actual claims submitted to Pemex. Of
the $78 million of claims submitted, the carrying value at
June 30, 2004 is $25.5 million and is included in
costs in excess of billings. If we are unsuccessful in resolving
our EPC 64 contract claims against Pemex, we intend to submit
some or all of the claims to arbitration in Mexico in accordance
with the Rules of Arbitration of the International Chamber of
Commerce. Our reserved net claim receivable as of June 30,
2004 of approximately $25.5 million is our best estimate of
the amount we believe we will collect on our EPC 64 contract
claims. A failure to recover any amount from Pemex in
negotiations or possible arbitration could result in a loss of
up to our carrying value of $25.5 million. It is possible
that the EPC 64 claim could be settled for an amount in
excess of our recorded balance, which could result in a recovery
of our reserve in the period settlement is reached. The process
for resolving these claims could continue into 2005 and beyond.
Collection of amounts related to these claims would be remitted
directly as prepayment of the 16% and 18% Subordinated
Notes.

As of August 1, 2004, our backlog totaled
approximately $133 million compared to our backlog at
August 1, 2003 of approximately $88 million. The IEC
contract and the Pemex contract have increased our backlog. Of
the total backlog as of August 1, 2004, approximately
$23 million is not expected to be earned until after
June 2005.

Critical Accounting Policies

Our discussion and analysis of our financial
condition and results of operations are based upon our
consolidated financial statements. The preparation of financial
statements in conformity with accounting principles generally
accepted in the United States of America requires us to make
estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenue and expenses during the reporting
period. We must apply significant, subjective and complex
estimates and judgments in this process. Among the factors, but
not fully inclusive of all factors, that may be considered by
management in these processes are: the range of accounting
policies permitted by accounting principles generally accepted
in the United States; managements understanding of our
business; expected rates of business and operational change;
sensitivity and volatility associated with the assumptions used
in developing estimates; and whether historical trends are
expected to be representative of future trends. Among the most
subjective judgments employed in the preparation of these
financial statements are estimates of expected costs to complete
construction projects, the collectibility of contract
receivables and claims, the fair value of salvage inventory, the
depreciable lives of and future cash flows to be provided by our
equipment, the amortization period of maintenance and repairs
for dry-docking activity, estimates for the number and related
costs of insurance claims for medical care and Jones Act
obligations, judgments regarding the outcomes of pending and
potential litigation and certain judgments regarding the nature
of income and expenditures for tax purposes. We review all
significant estimates on a recurring basis and record the effect
of any necessary adjustments prior to publication of our
financial statements. Adjustments made with respect to the use
of estimates often relate to improved information not previously
available. Because of the inherent uncertainties in this
process, actual future results could differ from those expected
at the reporting date.

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The accompanying consolidated financial
statements have been prepared in accordance with generally
accepted accounting principles, assuming Horizon continues as a
going concern. The financial statements do not include any
adjustments relating to the recoverability and reclassification
of recorded asset amounts or to amounts and classification of
liabilities that may be necessary should Horizon be unable to
continue as a going concern.

Our significant accounting policies are described
in Note 1 of our notes to consolidated financial
statements. We consider certain accounting policies to be
critical policies due to the significant judgments, subjective
and complex estimation processes and uncertainties involved for
each in the preparation of our consolidated financial
statements. We believe the following represent our critical
accounting policies.

We have discussed our critical accounting
policies and estimates, together with any changes therein, with
the audit committee of our board of directors.



| |                    
| | -------------------
| | Revenue Recognition

Contract revenues for construction contracts are
recognized on the percentage-of-completion method, measured by
the percentage of costs incurred to date to the total estimated
costs at completion for each contract. This percentage is
applied to the estimated revenue at completion to calculate
revenues earned to date. We consider the
percentage-of-completion method to be the best available measure
of progress on these contracts. We follow the guidance of AICPA
Statement of Position (SOP) 81-1, Accounting for
Performance of Construction-Type and Certain Production-Type
Contracts relating to the use of the
percentage-of-completion method, estimating costs and claim
recognition for construction contracts. Estimating costs to
complete each contract pursuant to SOP 81-1 is a
significant variable in determining the amount of revenues
earned to date. We continually analyze the costs to complete
each contract and recognize the cumulative impact of revisions
in total cost estimates in the period in which the changes
become known. In determining total costs to complete each
contract, we apply judgment in the estimating process. Contract
revenue reflects the original contract price adjusted for agreed
upon change orders and unapproved claims. For contract change
orders, claims or similar items, we apply judgment in estimating
the amounts and assessing the potential for realization. We
recognize unapproved claims only when the collection is deemed
probable and if the amount can be reasonably estimated for
purposes of calculating total profit or loss on long-term
contracts. We record revenue and the unbilled receivable for
claims to the extent of costs incurred and to the extent we
believe related collection is probable and include no profit on
claims recorded. Changes in job performance, job conditions and
estimated profitability, including those arising from claims and
final contract settlements, may result in revisions to estimated
costs and revenues and are recognized in the period in which the
revisions are determined. Provisions for estimated losses on
uncompleted contracts are made in the period in which such
losses are determined. The asset Costs in excess of
billings represents the costs and estimated earnings
recognized as revenue in excess of amounts billed as determined
on an individual contract basis. The liability Billings in
excess of costs represents amounts billed in excess of
costs and estimated earnings recognized as revenue on an
individual contract basis.

For certain service contracts, revenues are
recognized under SEC Staff Accounting Bulletin (SAB)
No. 101, Revenue Recognition in Financial
Statements, and No. 104, Revenue
Recognition, when all of the following criteria are met;
persuasive evidence of an arrangement exists; delivery has
occurred or services have been rendered; the sellers price
is fixed or determinable; and collectibility is reasonably
assured. Revenues from salvage projects sometimes include
non-cash values assigned to structures that are received from
time to time as partial consideration for services performed. In
assigning values to structures received, we apply judgment in
estimating the fair value of salvage inventory.

The complexity of the estimation process and all
issues related to the assumptions, risks and uncertainties
inherent with the application of the percentage of completion
methodologies affect the amounts reported in our consolidated
financial statements. If our business conditions were different,
or if we used different assumptions in the application of this
accounting policy, it is likely that materially different
amounts could be reported in our financial statements. If we
used the completed contract method to account for our revenues,
our results of operations would reflect greater variability in
quarterly revenues and profits as no revenues or

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costs would be recognized on projects until the
projects were substantially complete, which for larger contracts
may involve deferrals for several quarters.




| |                    
| | -------------------
| | Accounts Receivable

We have significant investments in billed and
unbilled receivables as of June 30, 2004. Billed
receivables represents amounts billed upon the completion of
small contracts and progress billings on large contracts in
accordance with contract terms and milestones. Unbilled
receivables on fixed-price contracts, which are included in
costs in excess of billings, arise as revenues are recognized
under the percentage-of-completion method. Unbilled amounts on
cost-reimbursement contracts represent recoverable costs and
accrued profits not yet billed. Allowances for estimated
nonrecoverable costs primarily provide for losses that may be
sustained on unapproved change orders and claims. We evaluate
our contract receivables and costs in excess of billings and
thoroughly review historical collection experience, the
financial condition of our customers, billing disputes and other
factors. During the fourth quarter of 2003, we recorded a
$33.1 million reserve for unapproved claims against Pemex.
During the first six months of 2004, there were no collections
on our Pemex unapproved claims, and there was no change in our
reserve for the Pemex unapproved claims.

We negotiate change orders and unapproved claims
with our customers. In particular, unsuccessful negotiations of
unapproved claims could result in decreases in estimated
contract profit or additional contract losses, while successful
claims negotiations could result in increases in estimated
contract profit or recovery of previously recorded contract
losses. Any future significant losses on receivables would
adversely affect our financial position, results of operations
and our overall liquidity.

Our reserved net claim receivable remaining from
Pemex at June 30, 2004 of approximately $25.5 million,
which includes approximately $19.1 million of unapproved
claims and $6.4 million of additional scope of work, is our
best estimate of the amount we believe we will collect on our
EPC 64 contract claims. Final resolution of this matter could
reasonably be expected to vary from $25.5 million. A
failure to recover any amounts from Pemex in negotiations or
possible arbitration could result in a further loss of up to our
carrying value of $25.5 million. It is possible that the
EPC 64 claim could be settled for an amount in excess of
our recorded balance, which could result in a recovery of our
reserve in the period settlement is reached. The process for
resolving these claims could continue into 2005 and beyond.
Collection of amounts related to these claims would be remitted
directly as prepayment of the 16% and 18% Subordinated
Notes.

At June 30, 2004, our reserved contract
receivables of $27.2 million from Iroquois is our best
estimate of the amount we believe we will collect. On
January 20, 2004, we filed a lawsuit for breach of contract
and wrongful withholding of amounts due to us for services
performed under our contract with Iroquois. Iroquois has filed
counter-claims against us for alleged damage to its pipeline,
extra costs to complete work due to alleged breach of contract,
indemnity for certain damage to third parties and alleged
failure to perform efficiently. We believe these counter-claims
have no merit and intend to vigorously defend against them. We
cannot predict whether a negotiated resolution of this dispute
will occur or, if such a resolution does occur, the precise
terms of such a resolution. We could incur a loss for
uncollectible amounts of up to the carrying value of
$27.2 million. Collection of the Iroquois contract
receivables at their recorded carrying value would provide net
proceeds of approximately $13 million after payments to
subcontractors on this project, of which $6.25 million
would be remitted directly as prepayment of the
18% Subordinated Notes.

At June 30, 2004, our reserved contract
receivables of $5.5 million from Williams is our best
estimate of the amount we believe we will collect. On
September 12, 2003, we filed a lawsuit for breach of
contract and wrongful withholding of amounts due to us for
services performed under our contract with Williams. Williams
has filed a counter-claim against us for alleged breach of
contract. We believe that this counter-claim has no merit and
intend to vigorously defend against it. We cannot predict
whether a negotiated resolution of this dispute will occur or,
if such a resolution does occur, the precise terms of such a
resolution. We could incur a loss for uncollectible amounts of
up to the carrying value of $5.5 million. Collection of
amounts related to these receivables would be remitted directly
as prepayment of the 16% Subordinated Notes.

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| |             
| | ------------
| | Other Assets

Other assets consist principally of capitalized
dry-dock costs, deferred loan fees, deposits and goodwill.

Dry-dock costs are direct costs associated with
scheduled major maintenance on our marine vessels and are
capitalized and amortized over a five-year cycle. We incurred
and capitalized dry-dock costs of $11.8 million for the six
months ended June 30, 2004 and $1.4 million for the
six months ended June 30, 2003. The significant dry-dock
costs capitalized for the first six months of 2004 relate
primarily to the vessels utilized to perform the work awarded
under the IEC and Pemex contracts. Major maintenance on the
Canyon Horizonprior to its mobilization to Israel, as
well as regulatory dry-dockings for the American Horizonand the Pecos Horizonrequired by the U.S. Coast
Guard and the American Bureau of Shipping, were completed during
the first half of 2004. As of June 30, 2004, capitalized
dry-dock costs totaled $19.7 million.

Loan fees paid in connection with new loan
facilities are deferred and amortized over the term of the
respective loans. The amortization of the deferred loan fees is
recorded as interest expense in the accompanying consolidated
statements of operations. In connection with the issuance of the
16% and 18% Subordinated Notes, we incurred and capitalized
loan fees of $10.5 million during the six months ended
June 30, 2004.



| |                       
| | ----------------------
| | Property and Equipment

We use the units-of-production method to
calculate depreciation on our major barges and vessels to
approximate the wear and tear of normal use. The annual
depreciation based on utilization of each vessel will not be
less than 25% of annual straight-line depreciation, and the
cumulative depreciation based on utilization of each vessel will
not be less than 50% of cumulative straight-line depreciation.
Accelerated depreciation methods are used for tax purposes. The
useful lives of our major barges and vessels range from
15 years to 18 years. Upon sale or retirement, the
cost of the equipment and accumulated depreciation are removed
from the accounts and any gain or loss is recognized. If we
alternatively applied only a straight-line depreciation method,
less depreciation expense would be recorded in periods of high
vessel utilization and more depreciation expense would be
recorded in periods of low vessel utilization. We believe the
method we use better matches costs with the physical use of the
equipment.

When events or changes in circumstances indicate
that assets may be impaired, we evaluate the carrying value of
the asset. Changes in our business plans, a change in the
physical condition of a long-lived asset or the extent or manner
in which it is being used, or a severe or sustained downturn in
the oil and gas industry are considered triggering events. The
carrying value of each vessel is compared to the estimated
undiscounted future net cash flows for that vessel. If the
carrying value of any vessel is more than the estimated
undiscounted future net cash flows expected to result from the
use of the vessel, a write-down of the vessel to estimated fair
market value must be made. When quoted market prices are not
available, fair value must be determined based upon other
valuation techniques. This could include appraisals or present
value calculations of estimated future cash flows. In the
calculation of fair market value, including the discount rate
used and the timing of the related cash flows, as well as
undiscounted future net cash flows, we apply judgment in our
estimates and projections, which could result in varying levels
of impairment recognition.

On May 18, 2004, our pipelay barge, the
Gulf Horizon,caught fire while on tow from the
U.S. Gulf of Mexico to Israel to perform the IEC project.
The vessel was recovered 400 miles off the coast of Georgia
and was towed to a shipyard in South Carolina. A damage
assessment was performed, and we are evaluating repair bids
obtained from three U.S. shipyards. If those repair
estimates are accurate, the repair costs will equal or exceed
the $28.0 million insured value of the vessel and it may
ultimately be declared a constructive total loss. However, the
underwriters on the policy of marine hull insurance that we
purchased to cover physical damage to the vessel have asked for
additional repair estimates. Because the three repair estimates
we have received to date approach the insured value of the
vessel, we have written off the value of the Gulf Horizonand related assets and booked a receivable in an amount
equal to the net book value of $22.3 million of the vessel
and related assets and $1.1 million of sue and labor costs
we incurred through June 30, 2004 that we believe are
reimbursable under the insurance policy in addition to the
insured value. The insurance receivable is classified as a
current receivable in the accompanying consolidated balance
sheet as of June 30, 2004. All proceeds

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received from the insurance company will be used
either to repair the vessel, or if the vessel ultimately is
determined to be beyond repair, to repay our term loan with CIT
Group, which has an outstanding balance of $27.1 million at
June 30, 2004. Accordingly, we have classified the CIT
Group term loan as current in the accompanying consolidated
balance sheet as of June 30, 2004. We are in discussions
with underwriters on the policy. We believe that the collection
of the receivable is probable, however, the process of
collecting any insurance proceeds may involve extensive
negotiations with our insurance carrier, which may result in
significant delays in collection and a variance in the amount
collected from the insured value. As a result, we cannot
guarantee the sufficiency of any insurance proceeds that we may
ultimately receive, which may be more or less than the amount of
the receivable that we have booked. If the recovery differs from
the amount booked, we will record a gain or loss in the period
in which it is incurred.


During the second quarter of 2004, management
committed to a plan to sell three of our marine construction
vessels and a cargo barge due to the sustained difficult
economic environment and depressed market for the marine
construction industry throughout 2003 and the first half of
2004. We continue to experience lower levels of vessel
utilization due to competitive conditions in this depressed
market, and management believes that the disposition of these
assets and associated debt reduction will improve our financial
position, as well as our utilization. We have listed these
assets for sale and are actively locating and negotiating with
potential buyers. In accordance with SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived
Assets, we reclassified these assets from property and
equipment to assets held for sale in the accompanying
consolidated balance sheet as of June 30, 2004 and ceased
depreciation on the assets. As required by
SFAS No. 144, in order to classify these assets as
held for sale, it must be probable that these assets will be
sold within one year unless certain criteria are met. We are
also required to measure these assets at the lower of their
carrying amount or fair value, less cost to sell the asset.
Based upon our marketing of these assets for sale, discussions
with potential buyers have indicated a decline in market value
of two of the marine vessels held for sale. Accordingly, we
recorded a charge of $2.6 million as impairment loss on
assets held for sale during the second quarter of 2004 to reduce
the net carrying value of the assets to the fair value, less the
cost to sell the assets. Management believes the fair value of
the assets held for sale approximates their current carrying
value of $10.1 million.



| |                         
| | ------------------------
| | Stock-Based Compensation

We have elected the method that requires
disclosure of stock-based compensation pursuant to
SFAS No. 123, Accounting for Stock-Based
Compensation. Because of this election, we account for
stock-based employee compensation under the recognition and
measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and
related interpretations. No stock-based employee compensation
cost is reflected in net loss, except for the compensation
expense recorded below, as all options granted had an exercise
price equal to the market value of the underlying common stock
on the date of grant. Additionally, for stock-based compensation
grants to non-employees, we recognize as compensation expense
the fair market value of such grants as calculated pursuant to
SFAS No. 123, amortized ratably over the lesser of the
vesting period of the respective option or the individuals
expected service period.

In January 2003, we granted options to three
former directors to purchase 15,320 shares of common
stock at an exercise price equal to the market price of the
common stock on the date of grant. These options vested
immediately, and $56,000 was recorded as compensation expense in
the consolidated statement of operations during the first
quarter of 2003. Also, we recorded $156,000 as compensation
expense in the consolidated statements of operations during the
second quarter of 2003 related to the remeasurement of options
in connection with the resignation of a key employee.

The FASB has proposed to mandate expense
recognition for stock options and other types of equity-based
compensation based on the fair value of the options at the grant
date. Additionally, the FASB is evaluating how to develop a
measure of the fair value of an option. Based on the final
outcome of the FASB proposal, we may be required to recognize
expense related to stock options and other types of equity-based
compensation in future periods. Additionally, we may be required
to change our method for determining the fair value of stock
options.

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| |             
| | ------------
| | Income Taxes

We account for income taxes in accordance with
SFAS No. 109, Accounting for Income Taxes,
which requires the recognition of income tax expense for the
amount of taxes payable or refundable for the current year and
for deferred tax liabilities and assets for the future tax
consequences of events that have been recognized in an
entitys financial statements or tax returns. We must make
significant assumptions, judgments and estimates to determine
our current provision for income taxes and also our deferred tax
assets and liabilities and any valuation allowance to be
recorded against our net deferred tax asset. The current
provision for income tax is based upon the current tax laws and
our interpretation of these laws, as well as the probable
outcomes of any foreign or domestic tax audits. The value of our
net deferred tax asset is dependent upon our estimates of the
amount and category of future taxable income and is reduced by
the amount of any tax benefits that are not expected to be
realized. For the three and six months ended June 30, 2004,
a valuation allowance against the net deferred tax assets that
are not expected to be realized due to the uncertainty of future
taxable income in the amount of $4.7 million and
$8.7 million, respectively, was charged as income tax
expense. Our valuation allowance as of June 30, 2004 is
approximately $31.8 million. Actual operating results and
the underlying amount and category of income in future years
could render our current assumptions, judgments and estimates of
recoverable net deferred taxes inaccurate, thus materially
impacting our financial position and results of operations.

Results of Operations

Information relating to Horizons operations
follows (in millions):

|              |                |              |   |            |      |      |   |      |      |   |   |      |      |   |   |      |       | 
|------------- | -------------- | ------------ | - | ---------- | ---- | ---- | - | ---- | ---- | - | - | ---- | ---- | - | - | ---- | ----- | 
|              |                |              |   |           
|              |                | Three Months |   | Six Months
|              |                | Ended        |   | Ended     
|              |                | June 30,     |   | June 30,  
|              |                |              |   |           
|              |                | 2004         |   | 2003       |      | 2004 |   | 2003
|              |                |              |   |            |      |      |   |     
|Revenues:     |                |              |   |            |      |      |   |      |      |   |   |      |      |   |   |     
|              | Domestic       |              | $ | 13.2       |      |      | $ | 44.0 |      |   | $ | 34.4 |      |   | $ | 96.1 |      
|              | Latin America  |              |   | 10.6       |      |      |   |     |      |   |   | 15.9 |      |   |   | 3.6  |      
|              | West Africa    |              |   | 2.5        |      |      |   | (1.3 | )    |   |   | 13.5 |      |   |   | 5.6  |      
|              | Southeast Asia |              |   | 2.2        |      |      |   | 15.1 |      |   |   | 7.2  |      |   |   | 19.2 |      
|              | Mediterranean  |              |   | 16.4       |      |      |   |     |      |   |   | 16.4 |      |   |   |     |      
|              | Other          |              |   |           |      |      |   | 0.1  |      |   |   |     |      |   |   | 0.5  |      
|              |                |              |   |            |      |      |   |      |      |   |   |      |      |   |   |     
|              |                | Total        |   | $          | 44.9 |      |   | $    | 57.9 |   |   | $    | 87.4 |   |   | $    | 125.0 | 
|              |                |              |   |            |      |      |   |      |      |   |   |      |      |   |   |     
|Gross Profit: |                |              |   |            |      |      |   |      |      |   |   |      |      |   |   |     
|              | Domestic       |              | $ | (5.1       | )    |      | $ | 0.6  |      |   | $ | (6.0 | )    |   | $ | 1.6  |      
|              | Latin America  |              |   | 1.4        |      |      |   | (0.6 | )    |   |   | 0.3  |      |   |   | (0.9 | )    
|              | West Africa    |              |   | (0.1       | )    |      |   | (2.7 | )    |   |   | 0.8  |      |   |   | (1.2 | )    
|              | Southeast Asia |              |   | (1.3       | )    |      |   | 2.4  |      |   |   | (0.4 | )    |   |   | 2.5  |      
|              | Mediterranean  |              |   | 4.1        |      |      |   |     |      |   |   | 4.1  |      |   |   |     |      
|              | Other          |              |   |           |      |      |   | (0.5 | )    |   |   |     |      |   |   | (0.2 | )    
|              |                |              |   |            |      |      |   |      |      |   |   |      |      |   |   |     
|              |                | Total        |   | $          | (1.0 | )    |   | $    | (0.8 | ) |   | $    | (1.2 | ) |   | $    | 1.8   | 
|              |                |              |   |            |      |      |   |      |      |   |   |      |      |   |   |     

Quarter Ended June 30, 2004 Compared to
the Quarter Ended June 30, 2003

Contract Revenues.Contract revenues were $44.9 million for the quarter ended
June 30, 2004, compared to $57.9 million for the
quarter ended June 30, 2003. The sustained difficult
economic environment and depressed market in the marine
construction industry, along with the accompanying decrease in
pricing of services for marine construction in the
U.S. Gulf of Mexico, have continued to impact domestic
revenues. In addition, we experienced unusually adverse weather
conditions in the U.S. Gulf of Mexico during the second

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quarter of 2004, which further reduced both
domestic revenues and profit. Our lack of work in the
Northeastern U.S. during 2004 compared to 2003 was
partially offset by revenues recognized on the IEC and Pemex
contracts during the quarter ended June 30, 2004. Revenues
on the IEC project accounted for 37% and the Pemex project
accounted for 23% of consolidated revenues for the second
quarter of 2004. The diversion of the Sea Horizonfrom
its scheduled work in Southeast Asia to substitute for the
Gulf Horizonon the IEC contract has adversely impacted
revenues and gross profit for the second quarter of 2004.
Construction activities related to the two-year pipeline and
structural installation program in Nigeria were substantially
complete at March 31, 2004 and accounted for 5% of our
consolidated revenues for the second quarter of 2004.


Gross Profit.Gross
profit was a $(1.0) million loss for the quarter ended
June 30, 2004, compared to a $(0.8) million loss for
the same quarter of 2003. Our domestic operations generated
losses as we did not have a sufficient level of contract
activity and associated revenues to support our operating cost
structure. In addition, domestic gross profit was negative as a
result of the continuing low levels of vessel utilization due to
competitive market conditions and unusually adverse weather
conditions in the U.S. Gulf of Mexico during the second
quarter of 2004. During the second quarter, we recognized gross
profit of $4.1 million related to the mobilization phase of
the IEC project. We also recognized gross profit of
$1.4 million on the Pemex project during 2004, as we
completed the engineering and the procurement of pipe required
for the project. The substantial completion of our project in
Nigeria during the first quarter of 2004 and the subsequent lack
of work in the second quarter of 2004 resulted in a gross loss
from our West Africa operations for the quarter ended
June 30, 2004.

Selling, General and Administrative
Expenses.Selling, general and
administrative expenses were $5.4 million (12.1% of
contract revenues) for the three months ended June 30,
2004, compared with $6.5 million (11.2% of contract
revenues) for the first quarter of 2003. Selling, general and
administrative expenses decreased for the three months ended
June 30, 2004 compared to the same quarter last year as we
recorded charges of $680,000 related to severance and other
costs in connection with the resignation of a key employee and
costs related to the consulting firm in Mexico to assist us in
the administration of our Pemex claims during 2003. The decrease
was partially offset by an increase in expenses for the second
quarter of 2004 related to legal costs associated with our
ongoing contract disputes and related litigation, professional
advisor fees and costs incurred as we implement Section 404
of the Sarbanes-Oxley Act.

Impairment loss on assets held for
sale.During the second quarter of
2004, management committed to a plan to sell three of our marine
construction vessels and a cargo barge due to the sustained
difficult economic environment and depressed market for the
marine construction industry throughout 2003 and the first half
of 2004. Management believes that the disposition of these
assets and associated debt reduction will improve our financial
position. We have listed these assets for sale and are actively
locating and negotiating with potential buyers, and discussions
with potential buyers have indicated a decline in market value
of two of the marine vessels held for sale. Accordingly, we
recorded a charge of $2.6 million as impairment loss on
assets held for sale during the second quarter of 2004 to reduce
the net asset carrying value to the fair value, less the cost to
sell the assets. There were no impairment losses on property and
equipment for the quarter ended June 30, 2003.

Interest Expense.Interest expense was $6.7 million for the three months
ended June 30, 2004 and $2.1 million for the same
period last year. Our total outstanding debt was
$224.5 million before debt discount of $19.4 million
at June 30, 2004, compared to $153.1 million at
June 30, 2003. Interest expense increased due to higher
average outstanding debt balances, higher interest rates and
other financing costs. Interest expense also increased due to
the amortization of the debt discount associated with the 16%
and 18% Subordinated Notes and additional amortization of
deferred loan fees related to these subordinated notes.

Interest Income.Interest income on cash investments for the three months ended
June 30, 2004 was $14,000 compared to $10,000 for the three
months ended June 30, 2003. Cash investments consist of
interest bearing demand deposits.

Loss on Debt
Extinguishment.There was no loss on
debt extinguishment during the second quarter of 2004. Loss on
debt extinguishment for the second quarter of 2003 relates to a
prepayment penalty of $569,000 and the write-off of deferred
loan fees of $299,000 for the early retirement of debt. In June
2003, we

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refinanced the Sea Horizonwith another
lender and used a portion of the proceeds to repay and
extinguish our previous lenders debt resulting in the loss
on debt extinguishment.


Other Income (Expense),
Net.Other income (expense) for
the quarter ended June 30, 2004 primarily consisted of
approximately $82,000 of foreign currency gain due to activity
in West Africa denominated in Nigerian naira and an increase of
the U.S. dollar compared to the Nigerian naira. Other
income (expense) for the three months ended June 30,
2003 primarily consisted of $89,000 of net foreign currency loss
due to activity in Mexico denominated in Mexican pesos and a
decline of the U.S. dollar compared to the Mexican peso.

Income Taxes.We use
the liability method of accounting for income taxes. For the
quarter ended June 30, 2004, we recorded an income tax
provision of $0.5 million on pre-tax loss of
$(15.7) million. The provision for 2004 relates to foreign
taxes on income generated from international operations. There
was no tax benefit recorded on pre-tax losses due to the
recording of additional valuation allowance of $4.7 million
for the second quarter of 2004 to fully offset our net deferred
tax assets that are not expected to be realized due to the
uncertainty of future taxable income. For the quarter ended
June 30, 2003, we recorded a federal income tax benefit of
$(6.2) million, at a net effective rate of 60.6% on pre-tax
loss of $(10.3) million. The difference in the effective
tax rate and the statutory tax rate is primarily due to the tax
benefit recognized for the quarter ended June 30, 2003
attributable to a research and development credit of
$(3.0) million.

Net Loss.Net loss
for the quarter ended June 30, 2004 was
$(16.2) million, or $(0.60) per share-diluted. This
compares with net loss of $(4.1) million, or $(0.15) per
share-diluted for the quarter ended June 30, 2003.

Six Months Ended June 30, 2004 Compared
to the Six Months Ended June 30, 2003

Contract Revenues.Contract revenues were $87.4 million for the six months
ended June 30, 2004, compared to $125.0 million for
the six months ended June 30, 2003. The decline in revenues
is primarily a result of a decrease in domestic revenues due to
the sustained difficult economic environment and depressed
market in the marine construction industry for the
U.S. Gulf of Mexico. We have experienced a decrease in
pricing of services for marine construction in the
U.S. Gulf of Mexico due to the highly competitive market.
Our domestic revenues and gross profits were further reduced by
unusually adverse weather conditions during the first half of
2004. Revenues related to the IEC contract accounted for 19% and
the Pemex contract accounted for 18% of consolidated revenues
for the six months ended June 30, 2004, which partially
offset our lack of work in the Northeastern U.S. during
2004 compared to 2003. For the first six months of 2003,
revenues generated in the Northeastern U.S. accounted for
45% of consolidated revenues. Construction activities related to
our project in West Africa accounted for 16% of our consolidated
revenues for the first half of 2004.

Gross Profit.Gross
profit was a $(1.2) million loss for the six months ended
June 30, 2004, compared to gross profit of
$1.8 million (1.4% of contract revenues) for 2003. Our
domestic operations generated losses as we did not have a
sufficient level of contract activity and associated revenues to
support our operating cost structure. In addition, domestic
gross profit was negative as a result of the continuing low
levels of vessel utilization due to competitive market
conditions in the U.S. Gulf of Mexico. Also, productivity
on execution of projects during the first six months of 2004 was
less than initially estimated when the work was bid. During the
second quarter, we recognized gross profit of $4.1 million
related to the mobilization phase of the IEC project. Gross
profit for Latin America improved due to the Pemex project. The
construction activities related to the two-year pipeline and
structural installation program in Nigeria resulted in
$0.8 million gross profit for this region for the first six
months of 2004. Gross profit for Southeast Asia declined as the
Sea Horizonwas mobilized to work on the IEC contract
offshore Israel.

Selling, General and Administrative
Expenses.Selling, general and
administrative expenses were $11.3 million (12.9% of
contract revenues) for the six months ended June 30, 2004,
compared with $11.9 million (9.5% of contract revenues) for
the first six months of 2003. Selling, general and
administrative expenses decreased for the six months ended
June 30, 2004 compared to the same period last year as we
recorded charges of $680,000 related to severance and other
costs in connection with the resignation of a key

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employee and costs related to the consulting firm
in Mexico to assist us in the administration of our Pemex claims
during the first half of 2003. The decrease was partially offset
by expenses incurred during the first six months of 2004 related
to legal costs associated with our ongoing contract disputes and
related litigation, professional advisor fees and costs incurred
as we implement Section 404 of the Sarbanes-Oxley Act.


Impairment loss on assets held for
sale.During the second quarter of
2004, management committed to a plan to sell three of our marine
construction vessels and a cargo barge due to the sustained
difficult economic environment and depressed market for the
marine construction industry throughout 2003 and the first half
of 2004. Management believes that the disposition of these
assets and associated debt reduction will improve our financial
position. We have listed these assets for sale and are actively
locating and negotiating with potential buyers, and discussions
with potential buyers have indicated a decline in market value
of two of the marine vessels held for sale. Accordingly, we
recorded a charge of $2.6 million as impairment loss on
assets held for sale during the second quarter of 2004 to reduce
the net asset carrying value to the fair value, less the cost to
sell the assets. There were no impairment losses on property and
equipment for the six months ended June 30, 2003.

Interest Expense.Interest expense was $10.5 million for the six months ended
June 30, 2004 and $3.6 million for the same period
last year. Our total outstanding debt was $224.5 million
before debt discount of $19.4 million at June 30,
2004, compared to $153.1 million at June 30, 2003.
Interest expense increased due to higher average outstanding
debt balances, higher interest rates and other financing costs.
Interest expense also increased due to the amortization of the
debt discount associated with the 16% and 18% Subordinated
Notes and additional amortization of deferred loan fees of these
subordinated notes.

Interest Income.Interest income on cash investments for the six months ended
June 30, 2004 was $28,000 compared to $21,000 for the six
months ended June 30, 2003. Cash investments consist of
interest bearing demand deposits.

Loss on Debt
Extinguishment.Loss on debt
extinguishment relates to the write-off of deferred loan fees of
$165,000 for the early payment during the first quarter of 2004
of our $15.0 million term loan with Elliott Associates. In
March 2004, we issued $65.4 million of
16% Subordinated Notes and used a portion of the proceeds
to repay our outstanding loan with Elliott Associates. Elliott
Companies purchased $15.0 million aggregate principal
amount of the 16% Subordinated Notes. Loss on debt
extinguishment for 2003 relates to a prepayment penalty of
$569,000 and the write-off of deferred loan fees of $299,000 for
the early retirement of debt. In June 2003, we refinanced the
Sea Horizonwith another lender and used a portion of the
proceeds to repay and extinguish our previous lenders debt
resulting in the loss on debt extinguishment.

Other Income (Expense),
Net.Other income (expense) for
the six months ended June 30, 2004 primarily consisted of
approximately $10,000 of net foreign currency gain due to
activity in West Africa denominated in Nigerian naira and an
increase of the U.S. dollar compared to the Nigerian naira.
Other income (expense) for the six months ended
June 30, 2003, primarily consisted of $136,000 of net
foreign currency loss due to activity in Mexico denominated in
Mexican pesos and a decline of the U.S. dollar compared to
the Mexican peso.

Income Taxes.We use
the liability method of accounting for income taxes. For the six
months ended June 30, 2004, we recorded an income tax
provision of $1.3 million on pre-tax loss of
$(25.6) million. The provision for 2004 relates to foreign
taxes on income generated from international operations. There
was no tax benefit recorded on pre-tax losses due to the
recording of additional valuation allowance of $8.7 million
for the six months ended June 30, 2004 to fully offset our
net deferred tax assets that are not expected to be realized due
to the uncertainty of future taxable income. For the six months
ended June 30, 2003, we recorded a federal income tax
benefit of $(7.7) million, at a net effective rate of 52.5%
on pre-tax loss of $(14.7) million. The difference in the
effective tax rate and the statutory tax rate is primarily due
to the tax benefit recognized for the six months ended
June 30, 2003 attributable to a research and development
credit of $(3.0) million.

Net Loss.Net loss
for the six months ended June 30, 2004 was
$(26.9) million, or $(1.00) per share-diluted. This
compares with net loss of $(7.0) million, or $(0.27) per
share-diluted for the six months ended June 30, 2003.

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Liquidity and Capital Resources

During the past two years and for the first six
months of 2004, we have experienced operating and net losses.
Our liquidity is currently being significantly impacted by
several factors. We continue to experience lower levels of
vessel utilization due to competitive conditions in the marine
construction industry. The gross loss for the six months ended
June 30, 2004 is primarily attributable to losses generated
by our domestic operations, as we did not have a sufficient
level of contract activity and associated revenues to support
our operating cost structure in this geographic area, and to the
$2.6 million impairment loss on assets held for sale. We
also experienced a fire aboard the Gulf Horizonwhile en
route to Israel for the IEC project, and we incurred substantial
costs in connection with the start-up of our project for Pemex.
Additionally, we incurred significant dry-dock costs during the
first six months of 2004 for regulatory dry-dockings on three of
our vessels. Our inability to collect outstanding receivables
and claims from Pemex, Iroquois and Williams continues to impact
our liquidity. The timing of the collection of progress payments
and our ability to stay on budget and meet our cash flow
forecasts for our projects are of critical importance to provide
cash from operations. Our ability to continue as a going concern
is dependent on generating sufficient cash flows from operations
for meeting our liquidity needs, servicing our debt requirements
and meeting financial covenants.



| |              
| | -------------
| | Recent Events

On March 11, 2004, we issued
$65.4 million principal amount of 16% Subordinated
Notes to a group of investors in a private placement in order to
meet working capital needs. We received net proceeds of
$44.9 million, which included $16.6 million, net of
$0.7 million issuance costs, allocated to warrants issued
in connection with the issuance of 16% Subordinated Notes.
These proceeds are net of both offering costs and amounts used
to repay all principal and interest under our $15.0 million
term loan from Elliott Associates. Elliott Companies purchased
$15.0 million aggregate principal amount of the
16% Subordinated Notes. We also substantially reduced our
indebtedness under our revolving credit facilities with
Southwest Bank; however, we re-borrowed these funds during the
second quarter of 2004.

On May 27, 2004, we issued
$18.75 million principal amount of 18% Subordinated
Notes in another private placement to Elliott Companies and
other holders of the 16% Subordinated Notes. The
18% Subordinated Notes were purchased at a 20% discount,
for $15.0 million, resulting in net proceeds of
approximately $14 million after offering costs. The
18% Subordinated Notes essentially have the same terms as
the 16% Subordinated Notes. Approximately $9.1 million
of these net proceeds were used to collateralize a letter of
credit required for our IEC contract. The balance of these
proceeds was used for immediate working capital needs. In
connection with this issuance, we paid the holders of the
16% Subordinated Notes a consent fee of $3.4 million
to release their first priority security interest in the Pemex
EPC 64 claim not related to interruptions due to adverse weather
conditions. Holders of the 16% Subordinated Notes retained
a second priority security interest in these claims. This
consent fee was paid in-kind with the issuance of additional
16% Subordinated Notes having the same terms as the
original 16% Subordinated Notes issued in March 2004. The
first priority security interest in this Pemex EPC 64 secures
the 18% Subordinated Notes. Additionally, the
18% Subordinated Note holders have an option to purchase up
to an additional $6.25 million of 18% Subordinated
Notes at a 20% discount for $5.0 million. We are pursuing
additional financing from the 18% Subordinated Note holders
and are in negotiations with such holders regarding the terms of
such financing. We have obtained a consent from EXIM to release
a portion of the Iroquois claim from its collateral, which,
together with the other collateral that already secures the
18% Subordinated Notes, would provide additional security
for this indebtedness. Upon obtaining EXIMs consent, we
were required to reduce the borrowing capacity under our
domestic revolving credit facility with Southwest Bank from
$20 million to $15 million and the interest rate for
such facility was increased by 1% to Southwest Banks prime
rate plus 2%.

Our recent operating results will not support any
additional indebtedness. As a result, we need to increase our
cash flows from operations by generating increased revenues and
associated billings from increased project activity to provide
us access to the entire borrowing capacity of our existing
revolving credit facilities, which mature in January 2005 and
May 2005, and enhance our ability to refinance these facilities.
Prior to being able to refinance our existing revolving credit
facilities, management believes that we will need to increase
our equity through the consummation of an equity or exchange
offering or other transaction in order to refinance

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all or a portion of the 16% and
18% Subordinated Notes. We are in discussions with the
holders of the 16% and 18% Subordinated Notes regarding the
terms and structure of such refinancing.


Based on managements current projections
and successful execution and completion of our current
contracts, we expect to be in compliance with our debt covenants
through December 31, 2004, and if successful in refinancing
all or a portion of our 16% and 18% Subordinated Notes and
our Southwest Bank revolving credit facilities prior to their
maturity in January 2005 and extending the maturity date of our
revolving credit facility with CIT Group, for at least the next
twelve months. However, in the event that we do not meet our
financial covenants in the future, and we are unsuccessful in
obtaining waivers of any future non-compliance that might arise,
our lenders would have the right to accelerate our debt with
them, and cross-default provisions could result in acceleration
of our other indebtedness, including the 16% and
18% Subordinated Notes. In addition, if we are unable to
complete the successful refinancing of all or a portion of the
16% and 18% Subordinated Notes and our three revolving
credit facilities prior to their maturity, we may have to
consider alternatives to settle our existing liabilities with
our limited resources, including a potential restructuring of
our company or seeking protection from creditors through
bankruptcy proceedings. The consolidated financial statements do
not include any adjustments relating to the recoverability and
classification of recorded asset amounts or the amounts and
classification of liabilities that might be necessary in the
event of such an acceleration or if we are unable to continue as
a going concern.



| |           
| | ----------
| | Cash Flows

At June 30, 2004, we had $4.0 million
of cash and cash equivalents, and we had no additional available
borrowing capacity under our revolving credit facilities. Our
available borrowing capacity continues to be limited as a result
of decreased levels of project activity and associated customer
billings and the exclusion of certain significantly aged
receivables from our borrowing base calculation. We need to
increase cash flows from operations by generating increased
revenues and associated billings from increased domestic and
international project activity to provide access to the entire
borrowing capacity of our revolving credit facilities. In
addition, we will need to complete the refinancing of our
revolving credit facilities maturing in January 2005 and extend
the maturity of our revolving credit facility maturing in May
2005. Based on the maturity of the Southwest Bank revolving
credit facilities due in January 2005 and the CIT Group
revolving credit facility due in May 2005, these facilities are
classified as current at June 30, 2004. Our operating
results will not support any additional indebtedness.
Accordingly, management believes that we will need to consummate
an equity offering to refinance all or a portion of our 16% and
18% Subordinated Notes prior to their maturity in March
2007.

Cash used in operations was $(36.7) million
for the six months ended June 30, 2004 compared to cash
used in operations of $(33.0) million for the six months
ended June 30, 2003. Cash used in operations is primarily
attributable to our pre-tax loss of $(25.6) million for the
six months ended June 30, 2004, restricted cash of
$14.4 million related to the Pemex and IEC projects and
dry-docking costs of $11.8 million incurred and
capitalized. For the six months ended June 30, 2003, funds
used in operating activities is primarily attributable to the
decrease in accrued job costs and accrued liabilities as
projects were completed, delays in collections of revenues and
the net loss before income tax benefit of $(14.7) million.

Cash used in investing activities was
$(4.1) million for the six months ended June 30, 2004
compared to cash used in investing activities of
$(8.4) million for the same period of 2003. The decrease in
cash used in investing activities is attributable to a decline
in our capital expenditures during 2004 as compared to the
substantial completion of major upgrades on the Sea
Horizon during 2003.

Cash provided by financing activities was
$34.6 million for the six months ended June 30, 2004
compared to cash provided by financing activities of
$53.6 million for same period of 2003. Funds provided by
financing activities for the first six months of 2004 included
$59.9 million proceeds from the issuance of our 16% and
18% Subordinated Notes, offset by net $18.2 million
used to reduce our indebtedness under our three revolving credit
facilities. Funds provided by financing activities for the six
months ended June 30, 2003 is attributable to additional
term debt borrowed and net borrowings under our revolving credit
facilities to meet working capital needs.

32



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| |                
| | ---------------
| | Working Capital

As of June 30, 2004 we had a working capital
deficit of $(49.3) million compared to $26.1 million
of working capital at December 31, 2003. The decrease in
working capital was primarily attributable to our pre-tax loss
for the six months ended June 30, 2004, the current
classification of our revolving credit facilities maturing in
January 2005 and May 2005 and the current classification of a
portion of the 16% and 18% Subordinated Notes. Although our
16% and 18% Subordinated Notes mature in March 2007, the
portion collateralized by our Pemex, Williams and Iroquois
receivables and claims has been classified as a current
liability in the consolidated balance sheet as of June 30,
2004.



| |             
| | ------------
| | Indebtedness

At June 30, 2004, we had approximately
$224.5 million in total outstanding debt before debt
discount of $19.4 million. This represents an approximate
increase of $53.0 million from December 31, 2003. This
increase in debt is primarily due to the 16% and
18% Subordinated Notes that were issued in March and May
2004, respectively, to meet working capital needs. A portion of
the proceeds from the issuance of the subordinated notes was
used to repay our $15.0 million term loan with Elliott
Associates that was originally due June 30, 2004 and to
secure a $9.1 million letter of credit for our IEC contract
offshore Israel. The remainder was used for immediate working
capital needs and included repayments under our three revolving
credit facilities. These funds were subsequently re-borrowed to
fund activities for significant projects for IEC and for Pemex.
Of the $205.1 million of outstanding net debt reflected in
the accompanying consolidated balance sheet at June 30,
2004, $57.9 million represents borrowings on our three
revolving credit facilities, $75.6 million represents
outstanding balances on eight term-debt facilities and
$71.6 million represents the outstanding balance on our 16%
and 18% Subordinated Notes (net of $19.4 million
representing the unamortized portion of both the original
$17.3 million debt discount recorded related to the
warrants issued with the 16% Subordinated Notes and
$3.75 million debt discount for the 18% Subordinated
Notes). The total obligation under our 16% and
18% Subordinated Notes at June 30, 2004 was
$91.0 million, including interest paid in-kind and before
debt discount. At June 30, 2004, we had no additional
available borrowing capacity under our revolving credit
facilities. Our available borrowing capacity continues to be
limited as a result of decreased levels of project activity and
associated customer billings and the exclusion of certain
significantly aged receivables from our borrowing base
calculation. We need to increase cash flows from operations by
generating increased revenues and associated billings from
increased domestic and international project activity to provide
access to the entire borrowing capacity of our revolving credit
facilities. Interest rates vary from the one-month commercial
paper rate plus 2.45% to 18%, and our average interest rate at
June 30, 2004, including amortization of the debt discount
on our 16% and 18% Subordinated Notes, was 12.6%. Our
term-debt borrowings currently require approximately $804,000 in
total monthly principal payments.

Our loans are collateralized by mortgages on all
of our vessels and property and by accounts receivable and
claims. Advances under our revolving credit facilities with
Southwest Bank may be obtained in accordance with a borrowing
base defined as a percentage of accounts receivable balances and
costs in excess of billings. Our loans contain customary default
and cross-default provisions and some require us to maintain
certain financial ratios at quarterly determination dates. The
loan agreements also contain certain covenants that limit our
ability to incur additional debt, pay dividends, create liens,
sell assets and make capital expenditures.

For the quarter ended June 30, 2004, we were
in compliance with the covenants required by our credit
facilities. See Note 5 of our notes to consolidated
financial statements for details of our financial covenants.



| |                      
| | ---------------------
| | Claims and Litigation

We continue to negotiate with and use our best
efforts to resolve our EPC 64 contract claims against Pemex
but we have been unsuccessful in resolving these claims. The
total claims that we submitted to Pemex approximated
$78 million and included unapproved claims for extra work
related to interferences, interruptions and other delays as well
as claims for additional scope of work performed. The unapproved
claims recorded as revenue to the extent of costs incurred
through December 31, 2002 do not include any profit and

33



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##### Table of Contents



are substantially less than the actual claims
submitted to Pemex. Of the $78 million of claims submitted,
the carrying value at June 30, 2004 is $25.5 million
and is included in costs in excess of billings.


The carrying value at June 30, 2004 reflects
a $33.1 million reserve for the Pemex EPC 64 claims
recorded in the fourth quarter of 2003. If we are unsuccessful
in resolving our EPC 64 contract claims against Pemex, we intend
to submit some or all of the claims to arbitration in Mexico in
accordance with the Rules of Arbitration of the International
Chamber of Commerce. Our reserved net claim receivable as of
June 30, 2004 of approximately $25.5 million is our
best estimate of the amount we believe we will collect on our
EPC 64 contract claims. A failure to recover any amount from
Pemex in negotiations or possible arbitration could result in a
loss of up to our carrying value of $25.5 million. It is
possible that the EPC 64 claim could be settled for an
amount in excess of our recorded balance, which could result in
a recovery of our reserve in the period settlement is reached.
The process for resolving these claims could continue into 2005
and beyond. Collection of amounts related to these claims would
be remitted directly as prepayment of the 16% and
18% Subordinated Notes.

We continue to pursue collection of approximately
$27.2 million of reserved contract receivables from
Iroquois and $5.5 million of reserved contract receivables
from Williams. We have filed suit against Iroquois in the
Supreme Court of the State of New York, New York County, for
breach of contract and for damages for failure to pay for work
performed. We have filed suit against Williams in the 295th
Judicial District of the District Court for Harris County, Texas
for breach of contract and wrongful withholding of amounts due
to us for services. Both Iroquois and Williams have filed
counter-claims against us. If these counter-claims are decided
unfavorably to us, the result could either reduce our recovery
on our valid claims, or if all of our claims are unsuccessful,
result in a recovery by Iroquois or Williams, which would have a
material adverse impact on our results of operations and
financial position. Collection of the Iroquois contract
receivables at their recorded carrying value would provide net
proceeds of approximately $13 million after payments to
subcontractors on this project, which would be remitted directly
as prepayment of the 18% Subordinated Notes. Collection of
amounts related to the Williams receivables would be remitted
directly as prepayment of the 16% Subordinated Notes.



| |                                                     
| | ----------------------------------------------------
| | Contractual Obligations and Capital
    Expenditures

We have fixed debt service and lease payment
obligations under notes payable and operating leases for which
we have material contractual cash obligations. Interest rates on
our debt vary from vary from the one-month commercial paper rate
plus 2.45% to 18%, and our average interest rate at
June 30, 2004, including amortization of the debt discount
on our 16% and 18% Subordinated Notes, was 12.6%. The
following table summarizes our long-term material contractual
cash obligations (in millions):

|                                        |  |           |       |      |  |      |        |      |  |      |        |            |  |       |         |  |  |   |       |  |  |   |        |  |  |   |         | 
|--------------------------------------- |  | --------- | ----- | ---- |  | ---- | ------ | ---- |  | ---- | ------ | ---------- |  | ----- | ------- |  |  | - | ----- |  |  | - | ------ |  |  | - | ------- | 
|                                        |  | Remainder |       |      |  |      |        |      |  |      |        |            |  |      
|                                        |  | of 2004   |       | 2005 |  | 2006 |        | 2007 |  | 2008 |        | Thereafter |  | Total
|                                        |  |           |       |      |  |      |        |      |  |      |        |            |  |      
|Principal and interest payments on debt |  | $         | 7,440 |      |  | $    | 85,087 |      |  | $    | 17,370 |            |  | $     | 150,993 |  |  | $ | 5,493 |  |  | $ | 24,628 |  |  | $ | 291,011 | 
|Operating leases                        |  |           | 1,350 |      |  |      | 2,547  |      |  |      | 2,340  |            |  |       | 2,347   |  |  |   | 2,168 |  |  |   | 320    |  |  |   | 11,072  | 
|                                        |  |           |       |      |  |      |        |      |  |      |        |            |  |       |         |  |  |   |       |  |  |   |        |  |  |   |         | 
|                                        |  | $         | 8,790 |      |  | $    | 87,634 |      |  | $    | 19,710 |            |  | $     | 153,340 |  |  | $ | 7,661 |  |  | $ | 24,948 |  |  | $ | 302,083 | 
|                                        |  |           |       |      |  |      |        |      |  |      |        |            |  |       |         |  |  |   |       |  |  |   |        |  |  |   |         | 

We do not have any significant off-balance sheet
arrangements.

Planned capital expenditures for the remainder of
2004 are estimated to range from approximately $2 million
to $4 million primarily related to vessel improvements.
These expenditures will depend upon available funds, work
awarded and future operating activity. Despite our current
liquidity issues, our long-term strategy is to expand our
operating capabilities and operations into additional selected
international areas. To the extent we are successful in
identifying opportunities to expand our market share in those
areas, we will likely require additional equity.

34



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##### Table of Contents



Forward-Looking Statements

In addition to historical information,
Managements Discussion and Analysis of Financial Condition
and Results of Operations includes certain forward-looking
statements regarding events and financial trends that may affect
our future operating results and financial position. Some
important factors that could cause actual results to differ
materially from the anticipated results or other expectations
expressed in our forward-looking statements include the
following:



| |   |                                                                                                                                                                                                                                                                                                                                
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | our substantial current indebtedness could
    adversely affect our financial condition and the availability of
    cash to fund our operating needs;                                                                                                                                                                          
|
| |  | we will need additional financing in the future;                                                                                                                                                                                                                                                                               
|
| |  | closing additional financing from Elliott
    Companies and other 18% Subordinated Note holders;                                                                                                                                                                                                                               
|
| |  | we have had operating losses for 2002, 2003 and
    first half of 2004 and may incur additional operating losses in
    the future;                                                                                                                                                                                            
|
| |  | Pemexs approval of claims and the outcome
    of any claims submitted to arbitration;                                                                                                                                                                                                                                         
|
| |  | the outcome of litigation with Iroquois and
    Williams;                                                                                                                                                                                                                                                                      
|
| |  | industry volatility, including the level of
    capital expenditures by oil and gas companies due to
    fluctuations in the price, and perceptions of the future price
    of oil and gas;                                                                                                                                    
|
| |  | contract bidding risks, including those involved
    in performing projects on a fixed-price basis and extra work
    outside the original scope of work, and the successful
    negotiation and collection of such contract claims;                                                                                           
|
| |  | our ability to obtain performance bonds and
    letters of credit required to secure our performance under
    contracts;                                                                                                                                                                                                      
|
| |  | the highly competitive nature of the marine
    construction business;                                                                                                                                                                                                                                                         
|
| |  | operating hazards, including the unpredictable
    effect of natural occurrences on operations and the significant
    possibility of accidents resulting in personal injury and
    property damage;                                                                                                                          
|
| |  | seasonality of the offshore construction industry
    in the U.S. Gulf of Mexico;                                                                                                                                                                                                                                              
|
| |  | risks involved in the expansion of our operations
    into international offshore oil and gas producing areas, where
    we have previously not been operating including our recently
    awarded contract in the Mediterranean for the Israel Electric
    Corporation;                                                       
|
| |  | dependence on the continued strong working
    relationships with significant customers operating in the
    U.S. Gulf of Mexico;                                                                                                                                                                                              
|
| |  | ability to realize carrying values of salvaged
    structures;                                                                                                                                                                                                                                                                 
|
| |  | contract bidding risks;                                                                                                                                                                                                                                                                                                        
|
| |  | percentage-of-completion accounting;                                                                                                                                                                                                                                                                                           
|
| |  | continued active participation of our executive
    officers and key operating personnel;                                                                                                                                                                                                                                      
|
| |  | the effect on our performance of regulatory
    programs and environmental matters;                                                                                                                                                                                                                                            
|
| |  | risks involved in joint venture operations,
    including difficulty in resolving disputes with present partners
    or reaching agreements with future partners;                                                                                                                                                              
|
| |  | compliance with the Sarbanes-Oxley Act of 2002
    and the significant expansion of securities law regulation of
    corporate governance, accounting practices, reporting and
    disclosure that affects publicly traded companies, particularly
    related to Section 404 dealing with our system of internal
    controls;

35



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| |   |                                                                                                                                
| | - | -------------------------------------------------------------------------------------------------------------------------------
| |  | a possible terrorist attack or armed conflict
    could harm our business; and                                                 
|
| |  | the potential of receiving an audit opinion with
    a going concern explanatory paragraph from our
    independent auditors.

Many of these factors are beyond our ability to
control or predict. We caution investors not to place undue
reliance on forward-looking statements. We disclaim any intent
or obligation to update the forward-looking statements contained
in this report, whether as a result of receiving new
information, the occurrence of future events or otherwise.

These and other uncertainties related to the
business are described in detail under the heading
Cautionary Statements in our 2003 Annual Report on
Form 10-K.






|        |                                                               
|------- | --------------------------------------------------------------
|Item 3. | Quantitative and Qualitative Disclosures
    About Market Risk

Our market risk exposures primarily include
interest rate and exchange rate fluctuation on financial
instruments as detailed below. Our market risk sensitive
instruments are classified as other than trading.
The following sections address the significant market risks
associated with our financial activities during the six months
ended June 30, 2004. Our exposure to market risk as
discussed below includes forward-looking statements
and represents estimates of possible changes in fair values,
future earnings or cash flows that would occur assuming
hypothetical future movements in foreign currency exchange rates
or interest rates.

As of June 30, 2004, the carrying value of
our debt, including $0.2 million of accrued interest, was
approximately $205.3 million. The fair value of this debt
approximates the carrying value because most of the interest
rates are based on floating rates identified by reference to
market rates. We have $72.0 million of subordinated secured
notes at a fixed 16% interest rate and $19.1 million of
subordinated secured notes at a fixed 18% interest rate. A
hypothetical 1% increase in the applicable interest rates as of
June 30, 2004 would increase annual interest expense by
approximately $1.3 million.

We collect revenues and pay local expenses in
foreign currency. We manage foreign currency risk by attempting
to contract as much foreign revenue as possible in
U.S. dollars. Approximately 90% of revenues from foreign
contracts are denominated in U.S. dollars. We monitor the
exchange rate of our foreign currencies in order to mitigate the
risk from foreign currency fluctuations. We receive payment in
foreign currency equivalent to the U.S. dollars billed,
which is converted to U.S. dollars that day or the
following day. We recognized a $10,000 net foreign currency
gain due to activity in foreign areas denominated in local
currency and an incline of the U.S. dollar compared to
these local currencies for the six months ended June 30,
2004.

The level of construction services required by a
customer depends on the size of its capital expenditure budget
for construction for the year. Consequently, customers that
account for a significant portion of contract revenues in one
year may represent an immaterial portion of contract revenues in
subsequent years.






|        |                        
|------- | -----------------------
|Item 4. | Controls and Procedures

As of June 30, 2004, an evaluation was
performed under the supervision and with the participation of
our management, including our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures as defined
in Rule 13a-15(e) of the rules promulgated under the
Securities Exchange Act of 1934, as amended. Based on that
evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the design and operation of these
disclosure controls and procedures were effective to provide
reasonable assurance that such disclosure controls and
procedures will meet their objectives. There have been no
significant changes in our internal controls over financial
reporting or in other factors during our most recent fiscal
quarter ended June 30, 2004 that has materially affected,
or is reasonably likely to materially affect, these internal
controls over financial reporting.

Management, including our Chief Executive Officer
and Chief Financial Officer, do not expect that our internal
controls over financial reporting will prevent all error and all
fraud. A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance
that the objectives of the

36



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##### Table of Contents



control system are met due to numerous factors,
ranging from errors to conscious acts of an individual, or
individuals acting together. In addition, the design of a
control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered
relative to their costs. Because of inherent limitations in a
cost-effective control system, misstatement due to error and/or
fraud may occur and not be detected.





PART II. OTHER INFORMATION






|        |                                                         
|------- | --------------------------------------------------------
|Item 2. | Unregistered Sales of Securities and Use of
    Proceeds

On May 27, 2004, we issued
$18.75 million principal amount of 18% subordinated
secured notes at a 20% discount due March 31, 2007
(18% Subordinated Notes) to a group of accredited investors
in a private placement under Rule 506 of Regulation D
of the Securities Act of 1933. We received net proceeds of
$15.0 million from the offering of the
18% Subordinated Notes. We used a portion of the proceeds
to secure a $9.1 million letter of credit required under
our contract with the Israel Electric Corporation and used the
remainder for immediate working capital needs. Interest at 18%
on the subordinated notes is due quarterly beginning
June 30, 2004. We are required by our existing loan
agreements to issue to the 18% Subordinated Note holders
additional 18% Subordinated Notes equal to the amount of
interest due on any quarterly payment date. On June 30,
2004, we issued an aggregate of $0.3 million of additional
18% Subordinated Notes for this paid in-kind interest
incurred. Upon an event of default under the
18% Subordinated Notes, the interest on the subordinated
notes increases 2%.

In connection with the issuance of the
18% Subordinated Notes, we are prohibited from declaring,
paying or making any dividend or distribution (in cash, property
or obligations) on any shares of any class of our equity
securities or on any warrants, options or other rights in
respect of any class of our equity securities. We are prohibited
from applying any of our funds, property or assets to the
purchase, redemption, sinking fund or other retirement of any
shares of any class of our stock, or making any deposit for any
of the foregoing.






|        |                                     
|------- | ------------------------------------
|Item 6. | Exhibits and Reports on
    Form 8-K

(a) Exhibits

| |      |  |  |                                                                                                        
| | ---- |  |  | -------------------------------------------------------------------------------------------------------
| | 3.1  |  |  | Amended and Restated Certificate of Incorporation
    of the Company(1)                                
| | 3.2  |  |  | Bylaws of the Company(1)                                                                               
| | 3.3  |  |  | Certificate of Amendment to the Amended and
    Restated Certificate of Incorporation of the Company(2)
| | 31.1 |  |  | Certification Pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002(2)                         
| | 31.2 |  |  | Certification Pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002(2)                         
| | 32.1 |  |  | Certification Pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002(2)                         
| | 32.2 |  |  | Certification Pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002(2)                         



---



| | 
| | 
| | 



|    |                                                                                                                    
|--- | -------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to our Registration
    Statement on Form S-1 (Registration Statement
    No. 333-43965).
|   
|(2) | Filed herewith.                                                                                                    

(b) Reports on Form 8-K:



| |                                                                                                                                                                                                                                                                                         
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | On May 3, 2004, we filed a report on
    Form 8-K, announcing the election of Harry L. Max, Jr.
    to the Board of Directors under items 5 and 7.                                                                                                                                      
|
| | On May 11, 2004, we filed a report on
    Form 8-K, announcing the filing of a notification of
    delayed filing with the Securities and Exchange Commission on
    Form 12b-25 for our quarterly report on Form 10-Q for
    the quarter ended March 31, 2004 under items 5
    and 7.

37



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##### Table of Contents





| |                                                                                                                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | On May 18, 2004, we filed a report on
    Form 8-K, reporting results for the first quarter ended
    March 31, 2004 and the filing of our quarterly report on
    Form 10-Q under items 5, 7 and 12.                          
|
| | On May 18, 2004, we filed a report on
    Form 8-K, reporting that a fire broke out on one of our
    barges, the Gulf Horizon, while being towed approximately
    400 miles off the coast of Georgia under items 5
    and 7.
|
| | On May 24, 2004, we filed a report on
    Form 8-K, providing an update on the status of the Gulf
    Horizon, the pipelay barge that caught fire on Tuesday,
    May 18, 2004 under items 5 and 7.                            
|
| | On May 28, 2004, we filed a report on
    Form 8-K, reporting that we completed a financing
    transaction and providing an update on the status of the Israel
    Electric project under items 5 and 7.                      
|
| | On June 18, 2004, we filed a report on
    Form 8-K, announcing the resignation of our independent
    accountants under items 5 and 7.                                                                                        
|
| | On June 18, 2004, we filed a report on
    Form 8-K, regarding the resignation of our independent
    accountants under items 4 and 7.                                                                                         

38



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##### Table of Contents






SIGNATURES

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.



| |                                                         
| | --------------------------------------------------------
| | HORIZON OFFSHORE, INC.                                  
|
| | /s/ DAVID W. SHARP                                      
| |                                                         
| | David W. Sharp                                          
| | Executive Vice President and Chief Financial
    Officer

Date: August 9, 2004

39



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##### Table of Contents



INDEX TO EXHIBITS

|        |      |             |  |                                                                                                        
|------- | ---- | ----------- |  | -------------------------------------------------------------------------------------------------------
|Exhibit |      | Description
|        |      |            
|        | 3.1  |             |  | Amended and Restated Certificate of Incorporation
    of the Company(1)                                
|        | 3.2  |             |  | Bylaws of the Company(1)                                                                               
|        | 3.3  |             |  | Certificate of Amendment to the Amended and
    Restated Certificate of Incorporation of the Company(2)
|        | 31.1 |             |  | Certification Pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002(2)                         
|        | 31.2 |             |  | Certification Pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002(2)                         
|        | 32.1 |             |  | Certification Pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002(2)                         
|        | 32.2 |             |  | Certification Pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002(2)                         



---



| | 
| | 
| | 



|    |                                                                                                                    
|--- | -------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to our Registration
    Statement on Form S-1 (Registration Statement
    No. 333-43965).
|   
|(2) | Filed herewith.