Transocean Ltd. quarterly report, Q2 FY2017

Transocean Ltd. 2017 Q2 Form 10-Q Summary

Business context and reporting period

Transocean provides offshore contract drilling services, primarily on a dayrate basis, with a focus on deepwater and harsh-environment operations. For the quarter ended June 30, 2017, the company owned or operated 44 mobile offshore drilling units and had four ultra-deepwater drillships under construction or contracted for construction. The filing presents unaudited results for the three and six months ended June 30, 2017, compared with the corresponding 2016 periods.

On May 31, 2017, Transocean sold 10 high-specification jackups and novated construction contracts for five additional jackups. It continued operating two of the sold rigs while their contracts were completed or novated.

Financial performance and key metrics

Metric	Three months ended June 30	Six months ended June 30
Total operating revenues	$751 million, down 20%	$1.536 billion, down 33%
Contract drilling revenues	$705 million, down 23%	$1.443 billion, down 29%
Operating income (loss)	$(1.544) billion	$(1.371) billion
Net income (loss) attributable to controlling interest	$(1.690) billion	$(1.599) billion
Diluted loss per share	$(4.32)	$(4.09)
Net cash provided by operating activities	Not separately provided for the quarter	$503 million, down from $838 million

Approximate operating margins were negative 206% for the quarter and negative 89% for the six-month period; approximate net margins attributable to controlling interest were negative 225% and negative 104%, respectively. These margins were heavily affected by noncash and unusual charges.

The second-quarter loss included a $1.595 billion net loss on asset disposals, primarily related to the jackup transaction, and $113 million of impairment losses, including $96 million on a midwater floater asset group.
Interest expense increased to $129 million in the quarter and $256 million in the first six months, compared with $98 million and $187 million, respectively, in the prior-year periods.
At June 30, 2017, cash and cash equivalents were $2.471 billion, down from $3.052 billion at December 31, 2016. Restricted cash totaled $537 million on the balance sheet.
Total debt carrying amount was $7.390 billion, compared with $8.464 billion at year-end 2016, including $865 million due within one year. The company had no borrowings or letters of credit outstanding under its $3.0 billion revolving credit facility.
Debt to tangible capitalization, as defined under the revolving credit facility, was 0.34 to 1.0 versus a maximum covenant ratio of 0.60 to 1.0.
Total assets declined to $23.847 billion from $26.889 billion, while total equity declined to $14.209 billion from $15.805 billion.

Cash flow, capital spending and debt activity

Operating cash flow was $503 million, reflecting lower operating activity and $168 million less cash received from customers for early contract terminations or cancellations.
Investing activities provided $56 million, compared with $811 million used in the prior-year period. Capital expenditures were $258 million, down from $826 million, while asset-disposal proceeds were $329 million.
Financing activities used $1.140 billion, principally because of $1.533 billion of debt repayments, partly offset by $403 million of net proceeds from issuing 5.52% senior secured notes due 2022.
On July 11, 2017, after quarter-end, the company completed tender offers for approximately $1.2 billion principal amount of debt and paid approximately $1.3 billion. It expects to recognize an aggregate net loss of approximately $48 million related to the tendered notes.
Contractual obligations totaled $12.350 billion, including $6.923 billion of debt, $4.523 billion of interest on debt and $904 million of purchase obligations.

Material changes versus the prior comparable period

Revenue declined primarily because more rigs were idle or stacked, rigs were sold or classified as held for sale, and dayrates decreased. Six-month contract drilling revenue reductions were approximately $375 million from idle or stacked rigs, $270 million from disposals or held-for-sale rigs and $120 million from lower dayrates.
Total fleet average daily revenue fell to $329,900 in the quarter from $352,500, while utilization declined to 44% from 47%. Revenue efficiency improved to 97% from 96%.
Operating and maintenance expense declined 33% in the quarter and 41% for the six months, reflecting fewer operating rigs, asset disposals and cost optimization.
The company moved from a $163 million operating profit in second-quarter 2016 to a $1.544 billion operating loss in second-quarter 2017, primarily because of the jackup disposal loss and higher impairment charges.
The estimated effective tax rate excluding discrete items increased to 74.0% in the quarter and 78.0% for the six months, from 14.1% and 25.7%, respectively, due mainly to the geographic mix of income and valuation allowances on deferred tax assets. Discrete tax items produced a $70 million quarterly benefit and a $147 million six-month benefit.
In 2017, the company reduced construction-related capital spending and paused progress on two uncontracted newbuilds; interest capitalization on those units ceased as of June 30.

Guidance, outlook, risks and unusual items

Management described the near-term offshore drilling outlook as cautious. The floater market remained oversupplied and new contract dayrates were challenged, although the number of floater fixtures awarded in the first half of 2017 exceeded the full-year 2016 total. Management retained a positive longer-term view, particularly for high-specification floaters, assuming improved oil-market supply and demand conditions.

Contract backlog was $10.160 billion as of July 25, 2017, down from $10.753 billion on April 24, 2017 and $11.251 billion on February 9, 2017. Management cautioned that backlog is subject to delays, renegotiations, early termination and cancellation.
No customer early terminations or cancellations were reported during the first half of 2017, but the filing identifies contract loss, low utilization, lower dayrates, additional stacking and impairment as significant risks.
Uncommitted fleet rates for the remainder of 2017 were 57% for ultra-deepwater floaters, 18% for harsh-environment floaters, 33% for deepwater floaters and 50% for midwater floaters. Rates rise materially in later years.
Expected costs at completion for four major construction projects totaled approximately $3.360 billion, including two contracted drillships expected to commence operations in late 2017 and early 2018 and two uncontracted drillships targeted for delivery in 2020.
Macondo-related probable loss contingencies were $244 million at June 30, 2017. The company had $237 million in restricted cash escrowed for the approved Plaintiff Steering Committee settlement. Further claims remain, including claims by 30 settlement-class opt-outs and claims by the Mexican government.
Insurance recoveries beyond the first four exhausted excess-liability layers are uncertain. The company received $10 million during the first half of 2017 from settlements with two insurers in the remaining layer.
Brazilian tax assessments totaled approximately $297 million in aggregate, including approximately $254 million related to 2000–2004 returns and $43 million related to 2009–2010 returns. The company is contesting the assessments.
Disclosure controls were not effective as of June 30, 2017 because of a material weakness in income-tax accounting controls involving deferred taxes, pension-related other comprehensive income and deferred-tax-asset valuation allowances. Management stated that the financial statements were fairly presented after additional procedures and described remediation efforts.
The EPA Agreement was terminated effective June 21, 2017. The company remains subject to other regulatory, environmental, litigation and tax matters.

Important facts for investors to verify

Whether offshore drilling utilization, dayrates and backlog stabilize or continue to decline.
The timing and economics of contracted newbuild deliveries, and potential additional costs or impairments on uncontracted units.
Liquidity after the post-quarter-end $1.3 billion debt tender payment and the company’s ability to manage near-term maturities and interest obligations.
Whether the income-tax internal-control material weakness is remediated and whether further accounting corrections or valuation allowances are required.
The ultimate amount and timing of remaining Macondo, Brazilian tax, insurance-recovery and other litigation exposures.
Whether additional rig disposals or scrap sales generate further material losses.