Transocean Ltd. quarterly report, Q3 FY2014

Transocean Ltd. 2014 Q3 Form 10-Q Summary

Business context and reporting period

Transocean is an international offshore contract drilling company focused on deepwater and harsh-environment operations. For the quarter ended September 30, 2014, the company operated 79 mobile offshore drilling units: 48 high-specification floaters, 21 midwater floaters and 10 high-specification jackups. Seven ultra-deepwater drillships and five high-specification jackups were under construction or contract to be constructed. The unaudited results cover continuing operations, with standard jackup, swamp barge and drilling-management activities reported as discontinued operations.

Financial performance and liquidity

Metric	Q3 2014	Q3 2013	9M 2014	9M 2013
Total revenues	$2.270 billion	$2.449 billion	$6.937 billion	$6.997 billion
Contract drilling revenues	$2.215 billion	$2.402 billion	$6.785 billion	$6.868 billion
Operating income (loss)	$(2.168) billion	$738 million	$(731) million	$1.819 billion
Net income (loss)	$(2.263) billion	$548 million	$(1.200) billion	$1.172 billion
Net income (loss) attributable to controlling interest	$(2.217) billion	$546 million	$(1.174) billion	$1.174 billion
Diluted EPS	$(6.12)	$1.50	$(3.24)	$3.23
Operating cash flow	$882 million	$623 million	$1.654 billion	$1.145 billion

The reported operating margin was approximately (95.5)% in Q3 and (10.5)% for the first nine months, primarily because of impairment charges. Excluding impairment and disposal gains or losses, operating income was approximately $612 million in Q3 and $2.116 billion for 9M, or roughly 27% and 31% of revenue, respectively; these are derived measures and are not company-reported non-GAAP metrics.

Q3 fleet utilization declined to 75% from 83%; revenue efficiency declined to 93% from 94%. Average daily revenue increased to $409,900 from $392,400.
For 9M, utilization declined to 77% from 81%, while average daily revenue increased to $411,000 from $378,900 and revenue efficiency improved to 95% from 92%.
Q3 operating and maintenance expense decreased 5% to $1.318 billion; general and administrative expense decreased 22% to $52 million. Depreciation increased 5% to $288 million.
Q3 included $2.768 billion of impairment charges, comprising approximately $2.0 billion of goodwill impairment, $788 million for the Deepwater Floater asset group and $7 million related primarily to assets held for sale.
Cash and cash equivalents were $2.873 billion at September 30, down from $3.243 billion at December 31, 2013. Management estimated approximately $1.5 billion was required for working capital and operating needs.
Net cash used in investing activities was $1.523 billion, including $1.847 billion of capital expenditures. Net cash used in financing activities was $501 million, including $746 million of shareholder distributions and $318 million of debt repayments.
Total debt was $10.353 billion, including $362 million due within one year. Long-term debt was $9.991 billion. The company had a $3.0 billion unsecured revolving facility, no borrowings under it and $3.0 billion of available capacity at September 30.
The debt-to-tangible-capitalization covenant ratio was 0.4 to 1.0 versus a maximum of 0.6 to 1.0. Outstanding letters of credit totaled $418 million.

Material changes versus the prior comparable period

Revenue declined 7% in Q3 and 1% for 9M, primarily from lower utilization, more idle rigs, mobilization and shipyard time, certifications, and asset divestitures. Higher dayrates, improved revenue efficiency and newbuild operations partially offset those effects.
Reported results shifted from profitability to substantial losses because of the 2014 impairment charges. The goodwill charge reduced goodwill from $2.987 billion at year-end 2013 to $1.014 billion at September 30, 2014.
Operating cash flow increased $509 million for 9M despite the net loss, principally because impairment charges were non-cash and working-capital movements improved.
Capital expenditures increased $557 million to $1.847 billion, while debt repayments decreased from $1.673 billion to $318 million.
Transocean completed the IPO of a 29.2% noncontrolling interest in Transocean Partners, receiving approximately $416 million net proceeds. Transocean retained a 70.8% interest.
Shareholder distributions increased to $3.00 per share for 2014, with $544 million paid during the first nine months and $544 million remaining payable at September 30.
The company repaid $163 million of ADDCL borrowings, replaced its former revolving facilities with the $3.0 billion five-year facility and planned to redeem $207 million of 4.95% senior notes in November 2014.

Guidance, outlook, commentary and risks

Management expected 2014 revenue to be below 2013 and 2015 revenue to be below 2014, primarily because of lower floater utilization, increased idle time and lower dayrates on new contracts. Management expected operating and maintenance expense to decline in both years, subject to market activity, stacking, regulatory requirements and cost initiatives.
Contract backlog was $23.6 billion at October 15, 2014, down from $25.0 billion at July 16, 2014 and $26.1 billion at April 17, 2014. Uncommitted fleet rates for 2015 were 41% for high-specification floaters, 50% for midwater floaters and 22% for high-specification jackups.
Management described near- to mid-term offshore drilling conditions as challenging, with excess capacity, delayed customer programs, lower oil and gas prices, declining dayrates and increased competition. High-specification jackups were comparatively stronger, but more than 40 uncontracted newbuild jackups were expected to enter the market in 2015.
Subsequent to quarter-end, market conditions continued to deteriorate. The company expected to reevaluate goodwill in Q4 2014 and warned that additional potentially significant impairment losses could result.
Macondo-related liabilities considered probable and estimable were $431 million at September 30, with an insurance recoverable asset of $34 million. Remaining scheduled settlement obligations were $380 million excluding interest, including $200 million under the Consent Decree and $180 million under the Plea Agreement.
The MDL Court found BP 67% at fault, Transocean 30% at fault and Halliburton 3% at fault in the Phase One findings, determined that Transocean was negligent but not grossly negligent, and upheld BP indemnity for compensatory damages. BP filed a motion seeking amendment, alteration or a new trial; the court had not ruled as of the filing.
Material tax contingencies included a U.S. assessment involving approximately $290 million of potential additional taxes, Brazilian assessments including a $59 million 2009–2010 assessment, and Norwegian tax matters. The Norwegian authorities dismissed the remaining migration-related claims in October 2014 and the related parent guarantee was terminated.
The company was exposed to interest-rate risk, with approximately $1.5 billion of variable-rate exposure after hedging; a one-percentage-point rate change would have affected annual interest expense by approximately $15 million based on September 30 balances.

Most important facts for an investor to verify

Whether the deteriorating floater market produces additional goodwill or long-lived-asset impairments after September 30, 2014.
The timing, enforceability and ultimate cash impact of Macondo litigation, indemnity claims, insurance recoveries and remaining settlement payments.
Backlog conversion, contract cancellations, dayrate resets and utilization trends, particularly for high-specification and midwater floaters.
Whether the company can fund approximately $2.3 billion of projected 2014 capital expenditures, shareholder distributions, debt maturities and regulatory or settlement obligations without increasing leverage.
The outcome of U.S. and Brazilian tax disputes and the future treatment of uncertain tax liabilities totaling approximately $459 million.
Delivery timing, contract coverage and economics of the substantial newbuild program, including units without drilling contracts.
The company’s ability to remain within the 0.6-to-1.0 debt-to-tangible-capitalization covenant and preserve access to its $3.0 billion revolving facility.