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ATW > SEC Filings for ATW > Form 10-K on 15-Nov-2016All Recent SEC Filings

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Form 10-K for ATWOOD OCEANICS INC


15-Nov-2016

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is intended to assist in understanding our financial position as of September 30, 2016 and 2015 and our results of operations for the fiscal years ended September 30, 2016, 2015 and 2014 and should be read in conjunction with the accompanying consolidated financial statements and related notes in Item 8 of this Form 10-K. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth under Item 1A "Risk Factors" and elsewhere in this Form 10-K. See "Forward-Looking Statements".

OVERVIEW

Financial and operating results for the fiscal year ended September 30, 2016,
include:
         Operating revenues totaling $1.0 billion on 2,776 operating days as
          compared to operating revenues of $1.4 billion on 4,015 operating days
          for the fiscal year ended September 30, 2015;


         Net income of $265.3 million as compared to net income of $432.6
          million for the fiscal year ended September 30, 2015;


         Diluted earnings per share of $4.09 as compared to diluted earnings per
          share of $6.65 for the fiscal year ended September 30, 2015;


         Net cash provided by operating activities of $625.0 million as compared
          to net cash provided by operating activities of $604.3 million for the
          fiscal year ended September 30, 2015;


         Increase in cash on hand of $31.4 million for the fiscal year ended
          September 30, 2016;


         Capital expenditures of $223.7 million for the fiscal year ended
          September 30, 2016, as compared to capital expenditures of $448.0
          million for the fiscal year ended September 30, 2015;

Debt to book capitalization ratio of 28% as of September 30, 2016.

MARKET OUTLOOK
Industry Conditions
The level of activity in the offshore drilling industry, which affects the sector's profitability, is cyclical and highly dependent on the offshore capital expenditure levels of E&P companies. In turn, E&P company offshore drilling expenditures are influenced by the current prices of oil and gas, expectations about future prices, company-specific cash flow levels, historical project returns and other capital allocation strategies (e.g., onshore versus offshore drilling).
The offshore drilling industry is in the midst of a very severe downturn that began in the second half of calendar year 2014. Since that time, the industry has experienced declining demand for drilling rigs that has been exacerbated by a sharp decline in oil prices. E&P companies generally reduced their offshore capital spending in 2015 and 2016 by canceling or deferring planned drilling programs. Since declining to multi-year lows below $30 per barrel in January 2016, oil prices have recovered to approximately $50 per barrel in October 2016. However, we expect offshore rig demand to decline further into the first half of calendar year 2017 due to increased rig supply as offshore rigs complete existing contracts or have their contracts shortened or canceled at a faster rate than new drilling programs are initiated. Declines in offshore drilling demand and the associated reductions in rig utilization and day rates could materially and adversely affect our financial position, results of operation or cash flows. See "Our business depends on the level of activity in the oil and natural gas industry, which is significantly impacted by the volatility in oil and natural gas prices" under "Risk Factors" Item 1A of this Form 10-K. Even as offshore rig demand declined from the peak levels in calendar year 2014, some drilling contractors continued to take delivery of new, more capable rigs that were ordered prior to the current industry downturn. However, over the past year drilling contractors have generally delayed further rig deliveries, especially for uncontracted rigs, through renegotiation of terms with the shipyards that are constructing these rigs. Due to the confluence of an oversupply of offshore rigs and declining rig demand, a lower percentage of marketed rigs are being re-contracted, and day rates and utilization have declined sharply across all offshore rig classes. While clients generally prefer newer, high specification rigs over older, less capable rigs, many newer floaters and jackups have been idled or cold-stacked as drilling demand has declined across all regions, water depths and rig classes. The bifurcation trend of higher utilization rates for newer rigs has been generally muted, and maintained more consistently for floaters than for jackups.


Due to the uncertain duration of the current industry downturn, a growing number of older, less capable rigs have been scrapped or announced for scrapping, and this trend has accelerated throughout calendar year 2016. Even with the removal of approximately 39 floaters and 38 jackups from the supply stack since the beginning of calendar year 2016, further declines in rig utilization and day rates are possible due to the persistent oversupply of offshore rigs relative to demand.
Consistent with our policy, we evaluate our drilling rigs and related equipment for impairment whenever events or changes in circumstances indicate the carrying value of these assets may exceed the estimated future net cash flows. Our evaluation, among other things, includes a review of external market factors and an assessment on the future marketability of a specific drilling unit. Further declines in offshore drilling demand, and/or a lack of improvement in drilling activity or day rates, may result in potential impairments to our drilling rigs and related equipment in the future. See "We may be required to record impairment charges with respect to our rigs" under "Risk Factors" Item 1A of this Form 10-K.
A current trend of some E&P companies to cancel, renegotiate, or repudiate existing drilling contracts has continued throughout 2016 as rig demand and market day rates have declined further. In fiscal year 2015, we renegotiated four drilling contracts with respect to the Atwood Osprey, Atwood Beacon, Atwood Achiever and the Atwood Orca. These four agreements incorporated reduced day rates for some portion of the existing term in exchange for the extensions in the terms of the contracts. In March 2016, we negotiated with a client to shift its remaining contract backlog from the Atwood Eagle to the Atwood Osprey in order to preserve the continuity of operations for the Atwood Osprey. Some of our contracts with clients may be canceled at the option of the client upon payment of a termination fee which may not fully compensate us for the loss of the contract and may result in a rig being idled for an extended period of time. In addition, some of our clients could experience liquidity or solvency issues or could otherwise be unable or unwilling to perform under a contract, which could ultimately lead a client to enter bankruptcy or otherwise encourage a client to seek to repudiate, cancel or renegotiate a contract. Further deterioration in cash flow generation by E&P companies may accelerate these trends. If our clients seek to cancel or renegotiate our significant contracts and we are unable to negotiate favorable terms or secure new contracts on substantially similar terms, or at all, our revenues and profitability could be materially reduced. See "Our business may experience reduced profitability if our clients terminate or seek to renegotiate our drilling contracts" under "Risk Factors" Item 1A of this Form 10-K.
Ultra-deepwater and Deepwater Rig Markets Both the ultra-deepwater and deepwater rig markets are experiencing declining demand, utilization and day rates. As of November 2, 2016, 97 ultra-deepwater rigs were under contract industry-wide (versus 128 on November 4, 2015) representing 74% utilization of a total of 131 actively marketed rigs. The number of marketed deepwater rigs under contract decreased to 21 (from 35 on November 4, 2015), which represents 57% utilization of the 37 active rigs. Declines in the percentage of marketed rigs under contract have been driven by reduced rig demand across all geographic regions coupled with an increase in marketed supply due to deliveries of newbuild rigs, primarily from South Korean and Singaporean shipyards.
As of November 2, 2016, 31 ultra-deepwater floaters were under construction with scheduled deliveries through September 2020, eight of which were contracted. However, this figure includes five floaters under long-term contracts with Petrobras, some or all of which may be delayed, repudiated, or canceled due to the extensive financial difficulties of the primary Brazilian rig-owning entity. In response to reduced rig demand and lack of suitable drilling programs, we and other drilling contractors have delayed delivery of uncontracted ultra-deepwater rigs under construction. Three ultra-deepwater rigs are scheduled for delivery during the remainder of calendar year 2016, 19 are scheduled for delivery in calendar year 2017 and an additional nine units are scheduled for delivery in calendar year 2018 and beyond.
The number of idle offshore rigs being cold-stacked and scrapped has continued to increase due to the challenging market conditions. During calendar year 2016, 26 ultra-deepwater rigs and 13 deepwater rigs have been announced for cold-stacking, retirement or scrapping and are no longer being actively marketed. We expect accelerated attrition of marketed supply to continue into calendar year 2017 as there will be limited re-contracting of floaters that complete their drilling programs, leading to a growing supply of idle rigs.


Our Ultra-deepwater Rigs and Deepwater Rigs The Atwood Achiever, a dynamically positioned, ultra-deepwater drillship, is operating offshore Northwest Africa and is contracted through approximately November 2018. The client has an option, exercisable by February 2017, to revert the contract to its original end date of November 2017 by making a payment approximately equal to the difference in the original day rate for the time periods for which the current reduced operating day rate was invoiced. The Atwood Advantage, a dynamically positioned, ultra-deepwater drillship, completed operations in the U.S. Gulf of Mexico in September 2016, after which it mobilized to the Mediterranean Sea to resume operations under its existing contract through August 2017.
The Atwood Condor, a dynamically positioned, ultra-deepwater semisubmersible, is operating in the U.S. Gulf of Mexico and is contracted into January 2017. The Atwood Osprey, an ultra-deepwater semisubmersible, and the Atwood Eagle, a deepwater semisubmersible, were both operating offshore Australia at the beginning of calendar 2016. On March 19, 2016, the Atwood Eagle's drilling services contract with Woodside Energy Ltd. was mutually amended to assign and utilize the Atwood Osprey to perform drilling services for the remaining 165 days under contract. The Atwood Osprey is currently drilling the assigned program for Woodside Energy Ltd., and the material contractual terms and conditions of the Atwood Eagle's original drilling services contract, including day rate, have remained unchanged. The Atwood Eagle was mobilized to Singapore where the rig is currently idle and being actively marketed for a new drilling contract.
The Atwood Admiral and Atwood Archer are DP-3 dynamically-positioned, dual derrick, ultra-deepwater drillships rated to operate in water depths up to 12,000 feet and are currently under construction at the DSME shipyard in South Korea. These drillships will have enhanced technical capabilities, including two seven-ram BOPs, three 100-ton knuckle boom cranes, a 165-ton active heave "tree-running" knuckle boom crane and 200 person accommodations. Total cost, including capitalized interest, project management, drilling and handling tools and spares, is approximately $635 million per drillship.
The Atwood Admiral and Atwood Archer were originally scheduled to be delivered in March 2015 and December 2015, respectively. Due to lack of suitable drilling programs, we have not yet secured the initial drilling contracts for these rigs. As a result, we have entered into amendments to our construction contracts with DSME to delay the required delivery date of these two rigs to September 30, 2017 and June 30, 2018, respectively. We are unable to provide any assurance that we will obtain drilling contracts for these rigs prior to their delivery. See Note 3 to our Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K for further details of these amendments. Jackup Rig Market
The jackup market is experiencing similar utilization, demand and day rate challenges as the floater market. Declining rig demand coupled with delivery of newbuild rigs, primarily from shipyards in China and Singapore, have negatively impacted the jackup rig supply and demand balance worldwide. In the current market downturn, all classes of jackup rigs have experienced lower day rates and utilization. The bifurcation trend that has historically favored utilization of new, higher specification jackups at the expense of older, lower specification jackups is not currently being maintained as clients have become much more price sensitive and are drilling fewer technically challenging wells. As of November 2, 2016, the percentage of marketed high specification jackup rigs (i.e., rigs equal to or greater than 350-foot water depth capability) under contract was approximately 63%, as compared to 69% for the remainder of the global jackup fleet.
We expect that the potential for further increases in global jackup supply due to delivery of high specification newbuild rigs may put additional pressure on jackup rig utilization and day rates. As of November 2, 2016, there were 106 newbuild jackup rigs under construction (from 125 on November 4, 2015), most of which are being constructed in China and many of which are owned by speculators or the constructing shipyards. Of the 23 jackup rigs scheduled for delivery in the remainder of calendar year 2016, only three are contracted, while the remaining 83 rigs are scheduled for delivery primarily in calendar year 2017 and beyond. Similar to what has occurred with newbuild floaters, many of these scheduled jackup deliveries are expected to be delayed and/or canceled. Absent a strong recovery in high specification jackup rig demand and/or a significant reduction in jackup rig supply due to cold-stacking, scrapping or retirements, the marketed supply of jackups is likely to exceed client requirements well into calendar year 2017.
Through November 2, 2016, 13 high specification jackups and 25 standard jackups, were cold-stacked, scrapped or retired during calendar year 2016. This trend of accelerating marketed supply attrition is expected to continue into calendar year 2017 as older rigs face further declines in overall jackup demand and increased competition from newer, more capable rigs.


Our High Specification Jackup Rigs
The Atwood Mako and Atwood Manta, both 400-foot water depth Pacific Class jackup rigs, operated offshore Vietnam through September 2015 and offshore Thailand through October 2015, respectively. Both were idled in October 2015 after they completed their contracts and were unable to obtain follow-on work. We are continuing to actively market these high-specification jackup rigs while they are idle.
The Atwood Aurora, a 350-foot water depth jackup, completed operations offshore West Africa in September 2016 and is scheduled to relocate to Ghana where it will be idled. The Atwood Beacon, a 400-foot water depth jackup, completed operations in the Mediterranean Sea in July 2016 and is currently idle in Malta. The Atwood Orca, a 400-foot water depth Pacific Class jackup completed operations in offshore Thailand in October 2016 and is scheduled to relocate to Singapore where it will be idled. All three of these rigs will be actively marketed while idle.
Sale of Rigs
The Atwood Falcon, a deepwater semisubmersible, was operating offshore Australia through March 2016. Following contract completion and mobilization of the vessel to international waters, on March 24, 2016, we executed a sale and recycling agreement with a third party buyer for the purpose of selling the Atwood Falcon. The agreement required the buyer to demolish and recycle the vessel and associated equipment/machinery. On April 13, 2016, the Atwood Falcon sale and recycling transaction closed and title of the vessel and associated equipment and machinery transferred to a third party buyer.

In December 2014, we completed the sale of our last mid-water floater semisubmersible, the Atwood Southern Cross. The Atwood Hunter, a deepwater semisubmersible, was idled in December 2014 and in January 2015, we made the decision to scrap and recycle the rig. In August 2015, we completed the sale of the Atwood Hunter for recycling.
Contract Backlog
We maintain a backlog of commitments for contract drilling revenues. Our contract backlog as of September 30, 2016 was approximately $0.8 billion representing a 50% decrease compared to our contract backlog of $1.6 billion as of September 30, 2015 primarily due to realization of contract backlog. We calculate our contract backlog by multiplying the day rate under our drilling contracts by the number of days remaining under the contract, assuming full utilization. The calculation does not include any revenues related to mobilization, demobilization, contract preparation, and billing our clients for reimbursable items or bonuses. The amount of actual revenues earned and the actual periods during which revenues are earned will be different from the amounts disclosed in our backlog calculations due to a lack of predictability of various factors, including newbuild rig delivery dates, client-elected standby periods, unscheduled repairs, maintenance requirements, weather delays and other factors. Such factors may result in lower applicable day rates than the full contractual day rates and/or delays in receiving the full contractual operating rates. In addition, under certain circumstances, our clients may seek to terminate, repudiate or renegotiate our contracts, which could have the effect of reducing our contract backlog. See "Our business may experience reduced profitability if our clients terminate, repudiate, or seek to renegotiate our drilling contracts" under "Risk Factors" Item 1A of this Form 10-K.

The following tables set forth the amount of our contract drilling revenue backlog and the percentage of available operating days committed for our fleet, excluding drilling units under construction, for the periods indicated as of September 30, 2016.

Contract Drilling                                                                                 Fiscal 2021
Revenue Backlog           Fiscal 2017       Fiscal 2018       Fiscal 2019       Fiscal 2020      and thereafter      Total
(In millions)
Ultra-deepwater         $         429     $         233     $          89     $            -     $          -     $      751
Deepwater                           -                 -                 -                  -                -              -
Jackups                             2                 -                 -                  -                -              2
                        $         431     $         233     $          89     $            -     $          -     $      753


Percentage of Available                                                                          Fiscal 2021 and
Operating Days Committed      Fiscal 2017     Fiscal 2018     Fiscal 2019      Fiscal 2020         thereafter
(In millions)
Ultra-deepwater                    62 %            44 %            27 %             - %                    - %
Deepwater                           - %             - %             - %             - %                    - %
Jackups                             2 %             - %             - %             - %                    - %
                                   25 %            17 %            11 %             - %                    - %

RESULTS OF OPERATIONS
Fiscal Year 2016 versus Fiscal Year 2015 Revenues-Revenues for fiscal year 2016 decreased $375 million, or 27%, compared to the prior fiscal year. Fiscal year 2016 included 2,776 operating days versus 4,015 operating days in fiscal year 2015. A comparative analysis of revenues for fiscal years 2016 and 2015 is as follows:

                                    REVENUES
(In millions)      Fiscal 2016      Fiscal 2015      Variance
Ultra-Deepwater   $         708    $         721    $     (13 )
Deepwater                   131              336         (205 )
Jackups                     138              285         (147 )
Reimbursable                 44               54          (10 )
                  $       1,021    $       1,396    $    (375 )

Our ultra-deepwater fleet realized average revenues of $495,000 per day on 1,430 operating days for fiscal year 2016, as compared to $501,000 per day on 1,440 operating days for fiscal year 2015. The decrease in revenues for the ultra-deepwater fleet for fiscal year 2016 was primarily due to the commencement of the Atwood Advantage P&A well program at a lower day rate in late 2016 and the rig's 13 days at zero rate to mobilize to Israel for the remainder of the drilling contract.

The deepwater fleet realized average revenues of $426,000 per day on 307 operating days as compared to $425,000 per day on 790 operating days for fiscal year 2016 and 2015, respectively. The decrease in operating days and revenue for fiscal year 2016, compared to fiscal year 2015, is primarily due to the Atwood Falcon and Atwood Eagle completing their contracts in the first half of fiscal year 2016. None of the rigs in our deepwater fleet operated in the second half of fiscal year 2016.

Our jackup fleet realized average revenues of $133,000 per day on 1,039 operating days for fiscal year 2016, as compared to $160,000 per day on 1,785 operating days for fiscal year 2015. The jackup fleet realized lower revenue and operating days for fiscal year 2016, as compared to fiscal year 2015 primarily due to the Atwood Manta and the Atwood Mako being idled early in fiscal year 2016.

Revenue related to reimbursable expenses is primarily driven by our clients' requests for equipment, fuel, services and/or personnel that are not included in the contractual operating day rate. Thus, these revenues vary depending on the timing of the clients' requests and the work performed. Additionally, as a result of a number of our rigs being idled, reimbursable revenues naturally decline while the rigs remain un-contracted. Changes in the amount of revenue related to reimbursable expenses generally do not have a material effect on our financial position, results of operations, or cash flows.


Drilling Costs-Drilling costs for fiscal year 2016 decreased $152 million, or 27%, compared to the prior fiscal year. Fiscal year 2016 included 2,776 operating days versus 4,015 operating days in fiscal year 2015. A comparative analysis of drilling costs for fiscal years 2016 and 2015 is as follows:

                                 DRILLING COSTS
(In millions)      Fiscal 2016      Fiscal 2015      Variance
Ultra-Deepwater   $         225    $         264    $     (39 )
Deepwater                    73              127          (54 )
Jackups                      79              126          (47 )
Reimbursable                 28               39          (11 )
Other                         2                3           (1 )
                  $         407    $         559    $    (152 )

Ultra-deepwater drilling costs decreased during fiscal year 2016, as compared to fiscal year 2015. Average drilling costs per calendar day for our ultra-deepwater rigs decreased from approximately $182,000 for fiscal year 2015, to approximately $154,000 for fiscal year 2016. Drilling costs for our ultra-deepwater rigs were lower in 2016 due to cost saving initiatives executed on payroll and repairs and maintenances costs. Additionally, repair costs in fiscal year 2015 were higher due to the unplanned repair costs incurred on the Atwood Osprey as a result of damages from Tropical Cyclone Olwyn.

Deepwater drilling costs decreased during fiscal year 2016, as compared to fiscal year 2015. Average drilling costs per calendar day for our deepwater rigs decreased from approximately $154,000 for fiscal year 2015, to approximately $130,000 for fiscal year 2016. This decrease is primarily due to the Atwood Falcon and Atwood Eagle completing their contracts in the first half of fiscal year 2016.

Jackup drilling costs decreased during fiscal year 2016, as compared to fiscal year 2015, primarily due to the Atwood Mako and Atwood Manta being idled in October 2015. Also due to the idling of these rigs, the average drilling cost per calendar day decreased approximately $26,000 from fiscal year 2015.

Reimbursable costs are primarily driven by our clients' requests for equipment, fuel, services and/or personnel that are not typically included in the contractual operating day rate. Thus, these costs vary depending on the timing of the clients' requests and the work performed. Additionally, as a result of a number of our rigs being idled, reimbursable costs naturally decline while the rigs remain un-contracted. Changes in the amount of reimbursable costs generally do not have a material effect on our financial position, results of operations or cash flows.

During the three and twelve months ended September 30, 2016, we recorded a non-cash charge of $3.9 million, which is reported in Contract Drilling costs to increase our reserve for excessive and/or obsolete materials and supplies. This charge included inventory items throughout our drilling rig fleet.
Depreciation-Depreciation expense for the fiscal year 2016 decreased $6 million, or 3%, compared to the prior fiscal year. A comparative analysis of depreciation expense for fiscal years 2016 and 2015 is as follows:

                               DEPRECIATION EXPENSE
(In millions)       Fiscal 2016      Fiscal 2015       Variance
Ultra-Deepwater   $    116          $         113  3  $     3
Deepwater                8                     17          (9 )
Jackups                 35                     36          (1 )
Other                    7                      6           1
                  $    166          $         172     $    (6 )

Deepwater depreciation decreased $9 million for fiscal year 2016, as compared to fiscal year 2015 due to the impairment of the Atwood Falcon in December 2015.

The amount of depreciation expense we record is dependent upon certain assumptions, including an asset's estimated useful life, rate of consumption and salvage value. We periodically review these assumptions and may change one or more of these assumptions. Changes in our assumptions may require us to recognize, on a prospective basis, increased or decreased depreciation


expense. As of September 30, 2016, we shortened the estimated useful life of the Atwood Eagle and as a result, relative to its previous deprecation schedule, this will increase the depreciation expense over the next four fiscal years by $5.8 million per fiscal year, and will decrease by $1.9 million fiscal year 2021.

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