Transocean Ltd. quarterly report, Q2 FY2011

Transocean Ltd. Form 10-Q Summary

Business context and reporting period

Transocean Ltd. is a Swiss-based international offshore contract drilling company specializing in deepwater and harsh-environment drilling. At June 30, 2011, it owned or partly owned and operated 136 mobile offshore drilling units, including 48 high-specification floaters, 25 midwater floaters, nine high-specification jackups, 51 standard jackups and three other rigs, with four high-specification jackups under construction. The filing covers the three and six months ended June 30, 2011; financial statements are unaudited and prior periods were adjusted for discontinued operations and presentation reclassifications.

Financial performance and key metrics

Metric	Q2 2011	Q2 2010	Six months 2011	Six months 2010
Total operating revenues	$2.334 billion	$2.479 billion	$4.478 billion	$5.058 billion
Operating income	$391 million	$949 million	$763 million	$1.891 billion
Income from continuing operations	$162 million	$712 million	$326 million	$1.395 billion
Net income	$164 million	$720 million	$504 million	$1.405 billion
Net income attributable to controlling interest	$155 million	$715 million	$465 million	$1.392 billion
Diluted EPS	$0.48	$2.22	$1.44	$4.31
Cash flow from operating activities	$340 million	$1.269 billion	$730 million	$2.441 billion

Operating margin was approximately 16.8% in Q2 2011 versus 38.3% in Q2 2010, and approximately 17.0% for the first six months versus 37.4% in the prior-year period. Net margin attributable to controlling interest was approximately 6.6% in Q2 2011 versus 28.8% in Q2 2010. The filing does not present EBITDA as a reported measure.

Contract drilling revenue declined 8% in Q2 and 14% for the six months, primarily because of lower utilization, stacked or idle rigs, shipyard and maintenance downtime, enhanced regulatory requirements and the lost Deepwater Horizon contract.
Average daily revenue increased to $312,100 in Q2 from $285,200, while fleet utilization declined to 55% from 64%. First-half average daily revenue was $302,400 versus $292,500, while utilization declined to 55% from 65%.
Operating and maintenance expense increased 11% in Q2 and 13% for the first six months, reflecting shipyard and maintenance activity, drilling management services and newbuilds. General and administrative expense increased 14% in Q2 and 10% for the six months.
Depreciation and amortization decreased 9% in Q2 and 7% for the six months, primarily because of the 2010 impairment of the standard jackup asset group, partly offset by newbuild depreciation.
The company recorded a $25 million impairment loss in Q2 related to three standard jackups held for sale. First-half gain on asset disposals was $7 million versus $254 million in the prior-year period, which included a $267 million gain related to insurance recoveries for Deepwater Horizon.

Cash flow, balance sheet, debt and liquidity

Cash and cash equivalents were $3.389 billion at June 30, 2011, broadly unchanged from $3.394 billion at December 31, 2010. Total assets were $36.936 billion and total equity was $20.873 billion.
Total debt was $11.081 billion, including $1.916 billion due within one year and $886 million of debt held by consolidated variable-interest entities. Long-term debt was $9.165 billion, including variable-interest-entity debt.
Net cash used in investing activities was $289 million for the first six months, including $533 million of capital expenditures and $259 million of proceeds from the Trident 20 disposal. Net cash used in financing activities was $446 million, including $249 million of debt repayments and a $254 million shareholder distribution.
The company had a $2.0 billion revolving credit facility, no borrowings under it, approximately $1.9 billion of available capacity and $41 million of outstanding letters of credit at June 30, 2011. Commercial paper outstanding was $144 million.
Shareholders approved a $3.16-per-share distribution of qualifying additional paid-in capital. The first $254 million installment was paid in June; $762 million remained payable at June 30, 2011.
Management expected approximately $1.1 billion of 2011 capital expenditures, including approximately $443 million for major construction projects. Remaining estimated costs for identified construction projects and related capital additions were $502 million.

Material changes versus prior comparable periods

First-half revenue fell $580 million, operating income fell $1.128 billion and controlling-interest net income fell $927 million versus the adjusted prior-year period.
The comparison was materially affected by the absence of the prior-year $560 million insurance recovery for Deepwater Horizon and the related $267 million disposal gain, as well as lower drilling activity and utilization in 2011.
Operating cash flow fell $1.711 billion, primarily because of lower earnings and a $727 million adverse change in operating assets and liabilities.
Newbuilds partially offset weaker activity, contributing approximately $115 million of incremental Q2 contract drilling revenue and approximately $255 million for the first six months.
Discontinued operations contributed $178 million in the first six months of 2011, principally the $173 million gain on the sale of the Caspian Sea operation, compared with $10 million in the prior-year period.

Guidance, outlook, risks and unusual items

Management expected total 2011 revenue to be generally stable versus 2010, with lower activity, downtime and dayrates offset by new ultra-deepwater units and increased drilling management services. Operating and maintenance expense was expected to increase.
Management expected favorable commodity prices to support contracting opportunities, utilization and dayrates in 2011 and 2012. Contract backlog was $23.6 billion as of July 13, 2011, down from $24.6 billion on April 14, 2011.
Management expected incremental 2011 Macondo-related operating costs of approximately $100 million to $150 million, primarily legal expenses net of expected insurance recoveries.
The Macondo well incident remained the principal contingency. At June 30, 2011, the company had recorded an estimated liability of approximately $217 million and an estimated insurance recovery asset of $183 million. The ultimate liability and insurance recovery remained uncertain.
BP, well-interest owners, Halliburton, Cameron and other parties asserted claims for contribution, indemnity, negligence or related relief. Transocean filed cross-claims and counterclaims and continued to assert contractual indemnity rights against the operator.
Insurers filed an interpleader action concerning the first $150 million layer of the company’s $950 million excess liability program. The company warned that insurance disputes could restrict recoveries and materially affect future cash flows or results.
Significant tax matters included U.S. proposed adjustments, Norwegian assessments and criminal indictments, and Brazilian assessments. Unrecognized tax benefits including interest and penalties totaled $756 million. Norwegian authorities could require financial security of up to $1.1 billion, and Brazilian assessments included $125 million of tax, a $94 million penalty and $159 million of interest through June 30, 2011.
In June 2011, the company’s internal investigation concluded that the Macondo incident resulted from interrelated well design, construction and temporary-abandonment decisions that compromised well integrity.
In July 2011, after the quarter, Transocean sold GSF Labrador and Searex IV for net proceeds of $54 million and $9 million, respectively, and sold its 50% interest in Overseas Drilling Limited for $22 million.

Important facts for investors to verify

Progress, reserves and insurance recoverability related to Macondo litigation, indemnity claims, government investigations and the insurer interpleader proceedings.
Timing and funding of the $762 million remaining shareholder distribution and the expected December 2011 repurchase obligation for Series B convertible notes.
Cash generation, rig utilization, stacked-rig reactivations, dayrates and backlog conversion, particularly in the U.S. Gulf of Mexico.
Actual 2011 capital expenditures and construction costs compared with the $1.1 billion forecast and remaining project estimates.
Potential cash exposure from U.S., Norwegian and Brazilian tax disputes, including possible security requirements and penalties.
Whether further impairment charges arise for standard jackups, other assets held for sale or goodwill if utilization and dayrates remain weak.