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Seadrill Limited (SDRL) - Third quarter 2016 results

November 22, 2016 - Seadrill Limited ("Seadrill" or "the Company"), a world leader in offshore drilling, announces its third quarter results for the period ended September 30, 2016.

Highlights

•

Revenue of $743 million

•

Operating income of $247 million

•

EBITDA1 of $441 million

•

95% economic utilization2

•

Reported Net Loss of $656 million and diluted loss per share of $1.29, reflecting an $882 million non-cash impairment to investments primarily relating to Seadrill Partners.

•

Underlying Net Income3 , excluding non-recurring items and non-cash mark to market movements on derivatives,was $135 million and earnings per share was $0.28.

•

Cash and cash equivalents of $1.3 billion

•

Seadrill Limited orderbacklog of approximately $3.0 billion

Commenting today, Per Wullf, CEO and President of Seadrill Management Ltd., said: "The offshore drilling market continues to be challenging however we are seeing an improvement in the level of bidding activity.  Most of the new work is for short term contracts at or near cash flow breakeven levels, and 2017 is expected to remain challenging. However, we expect the market to gradually improve as costs have been reset across the value chain and more drilling activity will be needed to avoid accelerated production declines."

--------------------------------------

1

EBITDA is defined as 'Earnings Before Interest, Tax, Depreciation and Amortization'  and has been calculated by taking operating income plus depreciation and amortization but excluding gains or losses on disposals and impairment charges against goodwill. Contingent consideration realized relates to Seadrill's ongoing residual interest in the West Vela and West Polaris customer contracts, and has been included within EBITDA. Additionally, in any given period the Company may have significant, unusual or non-recurring gains or losses which it may exclude from its Non GAAP earnings for that period. When applicable, these items would be fully disclosed and incorporated into the required reconciliations from US GAAP to Non GAAP measures. Refer to Appendix for the reconciliation of Operating Income to EBITDA, as Operating income is the most directly comparable US GAAP measure.

2	Economic utilization is calculated as total revenue, excluding bonuses, for the period as a proportion of the full operating dayrate multiplied by the number of days on contract in the period.

3	Underlying is defined as reported results, adjusted for certain non-recurring items and other exclusions as discussed in the Appendix. These numbers are reconciled to the US GAAP reported results for corresponding periods in the Appendix.

Sequential Financial Results

Revenues of $743 million for the third quarter (Q2 2016: $868 million) were down approximately 14% primarily due to six additional idle units and dayrate reductions.  During the quarter, the West Orion, West Phoenix, West Alpha, West Pegasus and Sevan Driller became idle.  The West Hercules, West Castor and West Prospero had a full quarter of idle time.  The West Freedom operated the full quarter in flotel mode and two of our AOD rigs were extended at reduced dayrates. The reductions to revenue were partially offset by the agreement of a $17 million de-winterization payment for the West Alpha and the commencement of operations on the West Eclipse and West Vigilant.

Net operating income for the quarter was $247 million (Q2 2016: $364 million). The decrease primarily reflects lower revenues in the quarter, partially offset by lower operating and overhead costs.

Net financial and other items for the quarter resulted in an expense of $854 million (Q2 2016: expense of $32 million).  The increase in the expense primarily relates to an impairment charge on investments in Seadrill Partners and Seamex and the absence of a gain on debt extinguishment recognized in the prior period, partially offset by the revaluation of the derivative hedge book.

Impairments to Investments

Under US GAAP the Company is required to determine whether a decline in the value of its marketable securities and equity method investments represents an 'other than temporary impairment'. The Company has recognized $882 million of non-cash impairment charges related to its investments in Seadrill Partners and Seamex. $806 million of the non-cash impairment charge relates to our investment in Seadrill Partners with the balance relating to our investment in Seamex.

Income taxes for the third quarter were $49 million, (Q2 2016: $56 million) mainly reflecting the decrease in operating income, partly offset by additional deferred tax balances recognized in the quarter.

Net loss for the quarter was $656 million mainly attributable to the non-cash impairment charge (Q2 2016: net income of $276 million) resulting in basic and diluted loss per share of $1.29.

Balance sheet

As of September 30, 2016, total assets were $22.0 billion (Q2 2016: $23.0 billion).

Total current assets were $2.9 billion (Q2 2016: $3.1 billion). The main movements during the quarter were a reduction in the value of our marketable securities related to Seadrill Partners and a reduction in accounts receivable as more rigs became idle.

Cash and cash equivalents decreased by $37 million, reflecting lower revenues for the quarter, partially offset by working capital movements.

Total non-current assets were $19.1 billion (Q2 2016: $20.0 billion).  The main movements during the quarter were a decline in investments in associated companies related to non-cash impairment charges and a decline in the value of drilling units due to normal quarterly depreciation.

Total current liabilities were $4.9 billion (Q2 2016: $4.3 billion). The $600 million increase is mainly attributable to the reclassification from non-current to current of $843 million of debt maturing in September 2017, partially offset by a gain on derivatives, lower tax liabilities and some movements in related party payables.

Total non-current liabilities were $7.4 billion (Q2 2016: $8.4 billion). The main movement was related to the reclassification of $843 million in debt as noted above, and debt repayments of $232 million.

Over the course of the quarter total net interest bearing debt (including related party debt and net of cash and cash equivalents) was $8.9 billion (Q2 2016: $9.1 billion), reflecting normal quarterly installments.

Total equity was $9.8 billion as of September 30, 2016 (Q2 2016: $10.3 billion).

Cash flow

As of September 30, 2016, cash and cash equivalents were $1.3 billion (Q2 2016: $1.3 billion).

Net cash provided by operating activities for the three month period ended September 30, 2016 was $242 million, net cash used in investing activities was $4 million, and net cash used in financing activities was $274 million.  Net cash provided by operating activities for the three month period ended June 30, 2016 was $303 million, net cash provided by investing activities was $259 million, and net cash used in financing activities was $366 million.

Cost Reduction

Operating costs for rigs in operation, including overhead, on our floater fleet have been reduced from $200k per day in 2014 to $145k per day currently, a 28% reduction.  Operating costs for rigs in operation, including overhead, on our jack-up fleet have been reduced from $90k per day in 2014 to $63k per day today, a 29% reduction.

This year we have reduced headcount from 7,100 to 5,500 a 23% reduction.  Onshore headcount has been reduced from 1,200 to 850 and offshore from 5,900 to 4,650.

G&A costs for full-year 2016 are projected to be approximately $220 million, down from $248 million in 2015 and $315 million in 2014.

Newbuilding Program

We continue to make good progress on deferring newbuild deliveries.  During the third quarter and for the fourth quarter to date we have concluded the following agreements:

1.

During October North Atlantic Drilling announced an amendment to the agreement for the West Rigel with Jurong Shipyard Pte Ltd ("Jurong"), which extends the delivery deferral period to January 6, 2017. The extension allows the parties to continue to explore commercial opportunities for the unit. In the event no employment is secured for the unit and no alternative transaction is completed, the Company and Jurong will form a Joint Asset Holding Company for joint ownership of the unit, to be owned 23% by the Company and 77% by Jurong.

2.

During October Sevan Drilling Ltd ("the Company") and Cosco agreed to exercise the third six-month option to extend the deferral agreement to 15 April 2017. Cosco will refund $26.3 million, or 5% of the contract price, plus other associated costs during the Fourth Quarter of 2016. The final delivery installment has been amended to $499.7 million, representing 95% of the $526.0 million contract price.

Discussions continue to progress with the shipyards regarding further deferments.

Operations

During the third quarter economic utilization was 95% (Q2 2016: 98%).  The West Orion, West Phoenix, West Alpha, West Pegasus and Sevan Driller completed their contracts, while the West Eclipse and West Vigilant returned to service.

The third quarter status and performance of the Group's delivered rig fleet is as follows:\

 

Commercial Developments

During the third quarter:

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The jack-ups AOD I and AOD II received three year contract extensions from Saudi Aramco expiring in June 2019 and July 2019, respectively. The extensions are in direct continuation of the current contracts and have added approximately $225 million in contract backlog.

•

The West Castor secured a new one-year contract with ENI in Mexico commencing in December 2016, resulting in a $40 million increase in backlog which includes the provision of onshore logistics services.

•

The West Vigilant secured a 3 month contract under the existing agreement with Repsol in Malaysia commencing in August, resulting in a $10 million increase in backlog.

•

The jack-up AOD III received an 83 day contract extension from Saudi Aramco expiring in December 2016, resulting in a $9 million increase in contract backlog.

•

The West Ariel was moved to non-operating flotel mode and the dayrate was reduced to $120,000 per day from July 2016 through the remainder of its contract term, ending in February 2018, resulting in a $20 million reduction in backlog.

•

The West Freedom backlog was reduced by $16 million resulting from a discounted rate in 2016 related to non-operating flotel period. The West Freedom also received an extension to June 30, 2017, which is included in the backlog reduction, Cardon IV expect to recommence operations at a rate of $225,000 per day in early 2017.

•

The West Pegasus received a notice of termination from Pemex for the drilling contract effective August 16, 2016 resulting in a potential backlog reduction of $266 million. Seadrill has disputed the grounds for termination and is reviewing its legal options.

•

The West Epsilon received notice of cancellation from Statoil effective mid-October 2016.  The unit was previously contracted until the end of December 2016.  In accordance with contractual terms, a lump sum payment of approximately $11 million is payable by Statoil.

Additionally, during the fourth quarter to date we have concluded the following commercial agreements:

•

The West Phoenix was awarded a 90 day contract with Total in the UK, West of Shetland. The backlog for the contract is estimated at $17 million.

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The West Saturn was awarded a one well contract at $225,000 per day with ExxonMobil in Liberia. This is in direct continuation of its current contract with ExxonMobil in Nigeria, which was due to end on December 8, 2016.  This results in an estimated total contract backlog increase of $9 million.

•

Cardon IV exercised their option on the West Freedom to extend the non-operating flotel period by three months to March 31, 2017.  Operations will recommence on April 1, 2017, and will extend to September 30, 2017, at a rate of $225,000 per day.

•

We have agreed to reduce the total remaining contract value on the West Jupiter by $144 million.  The duration of the contract remains unchanged. As part of the agreement, the contract has been amended such that the compensation due in the event Total elected to terminate for convenience would ensure that the Company's backlog remained materially intact. The West Jupiter is currently contracted with Total in Nigeria until December 2019.

Seadrill's order backlog as of November 22, 2016 is $3.0 billion, comprised of $2.2 billion for the floater fleet and $0.8 billion for the Jack-up fleet. The average contract duration is 16 months for floaters and 15 months for Jack-ups.

For the Seadrill Group, total order backlog is $7.0 billion.

Commercial contract renegotiation discussions continue to advance with some customers and the Company continues to look toward finding commercial agreements that are beneficial to both parties in order to be better positioned for future contract awards.

Market Development

While our long term view of the market for high specification drilling rigs remains positive, in the near term the offshore drilling sector remains extremely challenging. Oil prices remained in the $40-50 range during the third quarter, a level that is not sufficient to reverse the declines in oil companies' upstream spending.  It is expected that upstream spending will again decline in 2017, albeit less than the reductions of approximately 27% in 2016 and 24% in 2015.  While the forecasted decline in spending sets the stage for another challenging year in the offshore drilling industry, it is important to recognize that the resetting of costs across the value chain may facilitate increased activity with only a marginal increase in commodity prices.

Oil companies continue to be focused on preserving cash, in some cases consciously allowing the decline rate on producing fields to accelerate as a result of reduced infill drilling and well intervention. Based on the past years of underinvestment and the forecast for 2017, it is expected that decline rates will continue to accelerate.  The longer the period of underinvestment and accelerated decline persists, the more new projects and infill drilling will be required to replace this lost production.

Offshore barrels continue to be competitive from a cost perspective with other sources of supply.  Oil companies are highly invested in offshore and it is a matter of when, rather than if, offshore spending recovers.   Although in the short run incremental oil company spending may be directed to short cycle barrels, including onshore, the full cycle economics of offshore is competitive and will be required to reverse the effects of the last two years of under investment and meet future production requirements.

Floaters

The activity level in the floater market has increased, albeit primarily for short term work at extremely competitive dayrates.  This improvement is from a very low base and utilization in the floater market is expected to get worse before it improves. Older units rolling off contract that are due for a periodic survey and / or require significant capital expenditure to return to the working fleet are likely to be cold stacked and ultimately scrapped. Since the beginning of this downturn 68 floaters have been scrapped and it is reasonable to expect that a significant portion of older units becoming idle over the next months are also ultimately destined for the scrap yard.

The combination of volume returning to the market at a measured pace and accelerated scrapping activity is expected to  lead to a balanced market at some point.  Based on the expected level of scrapping activity and the number of units that are anticipated to be cold stacked, a relatively small increase in spending could meaningfully tighten the floater market.

Jack-ups

The market for high specification jack-ups is expected to bottom earlier than the floater market due to generally shorter contract durations, shorter contract lead times and shelf production being more oriented towards development drilling.  Utilization continues to decline as more units roll off contract than are being contracted for new work, however there continues to be an active spot market centered around Southeast Asia and the Middle East.

Scrapping activity has been relatively modest since the beginning of the current downturn with approximately 5% of the fleet being retired. Over time many older inactive units may ultimately be scrapped however the low carrying cost of idle jack-ups does not compel many rig owners to scrap these units.

With an orderbook of over 100 units and muted scrapping activity, it may be take some time for the jack-up market to return to a healthy utilization level.  Having premium rigs with strong customers is a differentiating factor that can lead to attractive pricing dynamics in some instances.  Premium contractors with an installed base and a demonstrated operational track record are in a beneficial position relative to low specification operators and speculators without an operating history.

Financing Update

Good progress has been made on the overall terms and structure of an agreement with our banks that would re-profile all secured credit facilities to mature in the period from 2020 to 2023, reduce our fixed amortization obligations and amend financial covenants.  We have initiated engagement with bond holders and potential providers of new capital on the other key elements of the plan.

In November 2016, we announced a maturity extension for the West Eminence credit facility from December 31, 2016 to April 30, 2017.  This extension ensures no debt maturities until April 2017 and time to continue negotiations with banks, bondholders and new capital participants as well as time to implement the agreement.

 

Guidance

Fourth Quarter 2016

With a number of our units coming off contract and the impact of lower day rates, EBITDA will be lower for the fourth quarter, at around $340 million.  This is based on fourth quarter expected Operating Income of $146 million.

The following units are expected to have a full quarter of idle time during the fourth quarter:

 

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West Orion

•

West Alpha

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West Hercules

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Sevan Driller

•

West Phoenix

•

West Pegasus

•

West Epsilon

The following units will have lower dayrates compared to the third quarter:

•

West Jupiter

•

AOD III

These reductions will be partially offset by the expected contract commencement of the West Castor in December

Operationally, performance in the fourth quarter is strong with 98% utilization quarter to date.

Forward-Looking Statements

This news release includes forward-looking statements. Such statements are generally not historical in nature, and specifically include statements about the Company's plans, strategies, business prospects, changes and trends in its business and the markets in which it operates.  These statements are made based upon management's current plans, expectations, assumptions and beliefs concerning future events impacting the Company and therefore involve a number of risks, uncertainties and assumptions that could cause actual results to differ materially from those expressed or implied in the forward-looking statements, which speak only as of the date of this news release. Important factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to offshore drilling market conditions including supply and demand, day rates, customer drilling programs and effects of new rigs on the market, contract awards and rig mobilizations, contract backlog, dry-docking and other costs of maintenance of the drilling rigs in the Company's fleet, the cost and timing of shipyard and other capital projects,  the performance of the drilling rigs in the Company's fleet, delay in payment or disputes with customers, our ability to successfully employ our drilling units, procure or have access to financing, ability to comply with loan covenants, liquidity and adequacy of cash flow from operations, fluctuations in the international price of oil, international financial market conditions changes in governmental regulations that affect the Company or the operations of the Company's fleet, increased competition in the offshore drilling industry, and general economic, political and business conditions globally.  Consequently, no forward-looking statement can be guaranteed.  When considering these forward-looking statements, you should keep in mind the risks described from time to time in the Company's filings with the SEC, including its Annual Report on Form 20-F.

The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict all of these factors. Further, the Company cannot assess the impact of each such factors on its business or the extent to which any factor, or combination of factors, may cause actual results to be materially different from those contained in any forward-looking statement.

November 22, 2016

The Board of Directors

Seadrill Limited

Hamilton, Bermuda

Questions should be directed to Seadrill Management Ltd. represented by:

Media contacts:

Iain Cracknell

Director of Communications

Seadrill Management Ltd.

+44 (0) 2088 114700

Bell Pottinger +44 (0) 2037 722500

Appendix - Reconciliation of certain underlying financial measures with the reported results

EBITDA is defined as 'Earnings Before Interest, Tax, Depreciation and Amortization'  and has been calculated by taking operating income plus depreciation and amortization but excluding gains or losses on disposals and impairment charges against goodwill. Contingent consideration realized relates to Seadrill's ongoing residual interest in the West Vela and West Polaris customer contracts, and has been included within EBITDA. Additionally, in any given period the Company may have significant, unusual or non-recurring gains or losses which it may exclude from its Non GAAP earnings for that period. When applicable, these items would be fully disclosed and incorporated into the required reconciliations from US GAAP to Non GAAP measures.

 

(in $ million)			Q3 2016
Net loss			(656	)
Add back:
Impairment of investments			882
Non-cash mark to market movements on derivatives			(91	)
Net income excluding non-recurring items and non-cash mark to market movement on derivatives			135
Attributable to NCI			(6	)
Attributable to parent			141
Underlying basic and diluted weighted average shares in issue (million)			507
Underlying basic and diluted EPS excluding non-recurring items and non-cash mark to market movement on derivatives ($ per share)		$	0.28

 

There were no exclusions for Q3 2016.

Q3 2015 Underlying represents reported numbers adjusted for non-recurring items, for the purposes of comparability. The adjustments made are as follows:

•

Operating loss: exclusion of goodwill impairment of $563 million and loss on disposals $82 million.

There were no exclusions for Q2 2016.

Seadrill Limited

INDEX TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Seadrill Limited

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

for the three and nine months ended September 30, 2016 and 2015

* Includes transactions with related parties. Refer to Note 17.

See accompanying notes that are an integral part of these Consolidated Financial Statements.

Seadrill Limited

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

for the three and nine months ended September 30, 2016 and 2015

See accompanying notes that are an integral part of these Consolidated Financial Statements.

Seadrill Limited

UNAUDITED CONSOLIDATED BALANCE SHEETS

as of September 30, 2016 and December 31, 2015

See accompanying notes that are an integral part of these Consolidated Financial Statements.

Seadrill Limited

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

for the nine months ended September 30, 2016 and 2015

Seadrill Limited

UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS

for the nine months ended September 30, 2016 and 2015

See accompanying notes that are an integral part of these Consolidated Financial Statements.

Seadrill Limited

UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

for the nine months ended September 30, 2016 and 2015

See accompanying notes that are an integral part of these Consolidated Financial Statements.

Seadrill Limited

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 – General information

 

Seadrill Limited is incorporated in Bermuda and is a publicly listed company on the New York Stock Exchange and the Oslo Stock Exchange. We provide offshore drilling services to the oil and gas industry. As of September 30, 2016 we owned and operated 38 offshore drilling units, had 13 units under construction and an additional unit classified as held for sale. Our fleet consists of drillships, jack-up rigs and semi-submersible rigs for operations in shallow and deepwater areas, as well as benign and harsh environments.

As used herein, and unless otherwise required by the context, the term "Seadrill" refers to Seadrill Limited and the terms "Company", "we", "Group", "our" and words of similar import refer to Seadrill and its consolidated companies. The use herein of such terms as group, organization, we, us, our and its, or references to specific entities, is not intended to be a precise description of corporate relationships.

Basis of presentation

 

The accompanying unaudited interim consolidated financial statements have been prepared on the same basis as the Company's audited financial statements and, in the opinion of management, include all material adjustments, consisting only of normal recurring adjustments that are considered necessary for a fair statement of the Company's financial statements in accordance with generally accepted accounting principles in the United States of America ("US GAAP"). The accompanying unaudited interim consolidated financial statements do not include all of the disclosures required in complete annual financial statements. These interim financial statements should be read in conjunction with our annual financial statements filed with the SEC on Form 20-F for the year ended December 31, 2015. The amounts are presented in United States dollar ("US dollar") rounded to the nearest million, unless stated otherwise.

Significant accounting policies

 

The accounting policies adopted in the preparation of the unaudited interim financial statements are consistent with those followed in the preparation of our annual audited consolidated financial statements for the year ended December 31, 2015 except as discussed below or unless otherwise included in these unaudited interim financial statements as separate disclosures.

Dividends from Seadrill Partners Common Units

 

Historically the Company presented the dividend income received from Seadrill Partners Common Units within "Share in results from associated companies". From the period ended September 30, 2015, the Company has elected to present this income separately within "Other financial items" in order to distinguish the income from Seadrill Partners Common Units, which is accounted for as a "Marketable Security", to income from the Company's other investments in Seadrill Partners, which are accounted for as "Investment in associated companies" under the equity method and cost method. Accordingly the Company has re-presented income of $18 million for the three months ended September 30, 2015 and $55 million for the nine months ended September 30, 2015 from "Share in results from associated companies" to "Other financial items" on the statement of operations.

Note 2 – Recent Accounting Pronouncements

Recently Adopted Accounting Standards

 

In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, which changes guidance related to both the variable interest entity (VIE) and voting interest entity (VOE) consolidation models. With respect to the VIE model, the standard changes, among other things, the identification of variable interests associated with fees paid to a decision maker or service provider, the VIE characteristics for a limited partner or similar entity, and the primary beneficiary determination. With respect to the VOE model, the ASU eliminates the presumption that a general partner controls a limited partnership or similar entity unless the presumption can otherwise be overcome. Under the new guidance, a general partner would largely not consolidate a partnership or similar entity under the VOE model. The Company adopted this ASU effective January 1, 2016. The adoption of this ASU did not impact the Company's consolidated financial statements and related disclosures.

In April 2015, the FASB issued ASU 2015-05, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement, which provides explicit guidance about a customer's accounting for fees paid in a cloud computing arrangement. Under the ASU, if a cloud computing arrangement includes a software license, then the software license element of the arrangement should be accounted for consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the arrangement should be accounted for as a service contract. The Company adopted this ASU prospectively to arrangements entered into, or materially modified beginning January 1, 2016. The adoption of this ASU did not impact the Company's consolidated financial statements and related disclosures.

In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. The amendments in this update require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The guidance further requires that the acquirer record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date and present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The Company adopted this ASU effective January 1, 2016 with prospective application. The adoption of this ASU did not impact the Company's consolidated financial statements and related disclosures.

Recently Issued Accounting Standards

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which provides new authoritative guidance on the methods of revenue recognition and related disclosure requirements.  This new standard supersedes all existing revenue recognition requirements, including most industry-specific guidance. The new standard requires a company to recognize revenue when it transfers goods or services to customers in an amount that reflects the consideration that the company expects to receive for those goods or services. The new standard also requires additional qualitative and quantitative disclosures. In April 2015 the FASB proposed to defer the effective date of the guidance by one year.  Based on this proposal, public entities would need to apply the new guidance for annual and interim periods beginning after December 15, 2017,  and shall be applied, at the Company's option, retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption.  Early adoption is not permitted until periods beginning after December 15, 2016. The Company is in the process of evaluating the impact of this standard update on its consolidated financial statements and related disclosures.

In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern, which provides new authoritative guidance with regards to management's responsibility to assess an entity's ability to continue as a going concern, and to provide related footnote disclosures in certain circumstances. The ASU will be effective for all entities in the first annual period ending after December 15, 2016 (December 31, 2016 for calendar year-end entities) and early adoption is permitted. The Company is in the process of evaluating the impact of this standard update on its consolidated financial statements and related disclosures.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which made targeted improvements to the recognition and measurement of financial assets and financial liabilities. The update changes how entities measure equity investments that do not result in consolidation and are not accounted for under the equity method and how they present changes in the fair value of financial liabilities measured under the fair value option that are attributable to their own credit. The new guidance also changes certain disclosure requirements and other aspects of current US GAAP. The guidance will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years and early adoption is permitted in some cases. The Company is in the process of evaluating the impact of this standard update on its consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The update requires an entity to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. It also offers specific accounting guidance for a lessee, a lessor and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. The guidance will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years and early adoption is permitted. The Company is in the process of evaluating the impact of this standard update on its consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-07, Investments-Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting. The update eliminates the requirement that an investor retrospectively apply equity method accounting when an investment that it had accounted for by another method initially qualifies for use of the equity method. The guidance will be effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years and early adoption is permitted. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). The update clarifies principal vs agent accounting of the new revenue standard. The guidance will be effective for annual and interim periods beginning after December 15, 2017, and shall be applied, at the Company's option, retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption.  Early adoption is not permitted until periods beginning after December 15, 2016. The Company is in the process of evaluating the impact of this standard update on its consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The update simplifies the accounting for share based payment transactions. The guidance will be effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years and early adoption is permitted. The Company does not expect the adoption of this standard to have a material impact on its consolidated financial statements and related disclosures.

In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing. The update provides more clarification about identifying performance obligations and licensing. The guidance will be effective for annual and interim periods beginning after December 15, 2017, and shall be applied, at the Company's option, retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption.  Early adoption is not permitted until periods beginning after December 15, 2016. The Company is in the process of evaluating the impact of this standard update on its consolidated financial statements and related disclosures.

In May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients. The update provide some further guidance on assessing the collectability criteria, presentation of sales tax and other similar taxes collected from customers, noncash considerations and certain other matters related to transition and technical corrections. The guidance will be effective for annual and interim periods beginning after December 15, 2017, and shall be applied, at the Company's option, retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption.  Early adoption is not permitted until periods beginning after December 15, 2016. The Company is in the process of evaluating the impact of this standard update on its consolidated financial statements and related disclosures.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which revises guidance for the accounting for credit losses on financial instruments within its scope. The new standard introduces an approach, based on expected losses, to estimate credit losses on certain types of financial instruments and modifies the impairment model for available-for-sale debt securities. The guidance will be effective January 1, 2020, with early adoption permitted. Entities are required to apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. The Company is in the process of evaluating the impact of this standard update on its consolidated financial statements and related disclosures.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments based on a consensus of the Emerging Issues Task Force (EITF), to address the classification of certain cash receipts and cash payments on the statement of cash flows. The new guidance also clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. The guidance will be effective for annual and interim periods beginning after December 15, 2017, with early adoption permitted. Entities are required to apply the guidance retrospectively. The Company is in the process of evaluating the impact of this standard update on its consolidated financial statements and related disclosures.

Note 3 – Segment information

Operating segments

 

The Company provides offshore drilling services to the oil and gas industry. Our business has been organized into segments based on differences in management structure and reporting, economic characteristics, customer base, asset class, and contract structure. We currently operate in the following segments:

Floaters: Services encompassing drilling, completion and maintenance of offshore exploration and production wells. The drilling contracts for this segment relate to semi-submersible rigs and drillships for harsh and benign environments in mid-, deep- and ultra-deep waters.

Jack-up rigs: Services encompassing drilling, completion and maintenance of offshore exploration and production wells. The drilling contracts for this segment relate to jack-up rigs for operations in harsh and benign environments.

Other: Primarily consists of rig management services.

Segment results are evaluated on the basis of operating profit, and the information given below is based on information used for internal management reporting. The accounting principles for the segments are the same as for our consolidated financial statements.

Total revenue

Depreciation and amortization

Operating income - Net Income

Drilling Units and Newbuildings - Total Assets

Capital expenditures – fixed assets

Note 4 - (Loss)/gain on disposals and contingent consideration

 

Nothing to report for this period.

West Rigel

 

On December 2, 2015, the West Rigel was classified as an Asset held for sale.  As at the transfer date the West Rigel held assets at its book value of $210 million and a loss on disposal of $82 million was recognized. Please refer to Note 20 for more details. The expected recoverable value of $128 million is classified as an Asset held for sale on the Balance Sheet for the period ended September 30, 2016.

Cancellation of the West Mira

 

On September 14, 2015, the Company cancelled the construction contract for the West Mira with Hyundai Samho Heavy Industries Co Ltd. ("HSHI"), due to the Shipyard's inability to deliver the unit within the timeframe required under the contract. The carrying value of the newbuild at the date of cancellation was $315 million, which included $170 million of pre-delivery installments paid to HSHI, with the remainder relating to purchased equipment, internally capitalized construction costs and capitalized interest. Under the contract terms, the Company has the right to recoup the $170 million in pre-delivery installments, plus accrued interest.

On October 12, 2015, HSHI launched arbitration proceedings under the contract.  HSHI have claimed that Seadrill's cancellation was a repudiatory breach and claim they were due various extensions of time.  The Company refutes this vigorously, and believes it has the contractual right to recover the $170 million in pre-delivery installments, plus accrued interest and legal costs. The recovery is however now not expected until the conclusion of an arbitration process under English law, which is expected to take up to two years.

Based both on management's assessment of the facts and circumstances, and advice from external counsel, who have been engaged for the arbitration process, the Company believes the recovery of the installment, plus accrued interest, is probable, as defined by US GAAP.  As such, the Company has reclassified from "Newbuildings", a receivable of $170 million plus accrued interest of $29 million, which is presented in "Other non-current assets" on the balance sheet.  The Company will continue to assess the recoverability throughout the arbitration process.

The Company redeployed a portion of equipment, totaling $48 million, within Seadrill's remaining fleet, and did not write off these amounts. The resulting net loss on disposal recognized was $80 million, which is included in "(Loss)/gain on disposals" in the Statement of Operations.

Disposal of the West Polaris

 

On June 19, 2015, the Company sold the entities that owned and operated the West Polaris (the "Polaris business"), to Seadrill Operating LP ("Seadrill Operating"), a consolidated subsidiary of Seadrill Partners LLC and 42% owned by the Company. The entities continue to be related parties subsequent to the sale.

The purchase price consisted of an initial enterprise value of $540 million, less debt assumed of $336 million. The fair value of consideration recognized on disposal was $235 million, which comprised of $204 million of cash consideration, and a working capital adjustment of $31 million, due to the net working capital of the Polaris business being greater than the required working capital prescribed in the sale and purchase agreement.

Additional contingent consideration in the form of a seller's credit of $50 million is also potentially due from Seadrill Partners in 2021, which will carry interest at a rate of 6.5% per annum. The repayment of the seller's credit is contingent on the future re-contracted day rate.  During the three year period following the completion of the current customer contract, the final amount payable will be adjusted downwards to the extent the average re-contracted operating day rate (net of commissions), adjusted for utilization over the period, is less than $450 thousand per day. If the rig is off contract during this period, the reduction is equal to $450 thousand per day.

In addition, the Company may be entitled to receive further contingent consideration from Seadrill Partners, consisting of (a) any day rates earned by Seadrill Partners in excess of $450 thousand per day, adjusted for daily utilization, tax and agency commission for the remainder of the ExxonMobil contract completing in March 2018 and (b) 50% of any day rate earned above $450 thousand per day, adjusted for daily utilization, tax and agency commission fee after the conclusion of the existing contract until 2025. In February 2016, the drilling contract with ExxonMobil was amended such that the day rate for the West Polaris was reduced from $653 thousand per day to $490 thousand per day, effective January 1, 2016.

The Company's accounting policy is not to recognize contingent consideration before it is considered realizable and has therefore not recognized on disposal any amounts receivable relating to the elements of consideration which are contingent on future events.  From the disposal date of the West Polaris on June 19, 2015 to September 30, 2016, the Company has recognized $38 million in contingent consideration, as it became realized, within "Contingent consideration realized" included within operating income.

The loss recognized at the time of disposal of the Polaris business was $75 million, after taking into account a goodwill allocation of $41 million. The loss has been presented in our consolidated statement of operations, under "(Loss)/gain on disposals" included within operating income and attributable to the floaters segment.

Under the terms of various agreements between Seadrill and Seadrill Partners LLC, entered into in connection with the initial public offering of Seadrill Partners LLC, Seadrill will continue to provide management, technical and administrative services to the Polaris business.  See further discussion in Note 17 to the consolidated financial statements for details of these services and agreements.

The sale of the Polaris business does not qualify for reporting as a discontinued operation as the sale of the Polaris business is not considered to represent a strategic shift expected to have a major effect on the Company's operations and financial results.

*	During the second half of 2015, subsequent to the deconsolidation, certain immaterial measurement period adjustments were made to the values of the net assets as at the date of disposal, which increased the initial loss recognized by $2 million.

 

SeaMex Limited

 

During the year ended December 31, 2014, the Company entered into a joint venture agreement with an investment fund controlled by Fintech Advisory Inc. ("Fintech"), for the purpose of owning and managing certain jack-up drilling units located in Mexico under contract with Pemex. The West Oberon, West Intrepid, West Defender, West Courageous and West Titania jack-up drilling rigs ("the jack-up drilling rigs") were included within the joint venture. The transaction was completed on March 10, 2015, when Fintech subscribed for a 50% ownership interest in the joint venture company, SeaMex Limited ("SeaMex"), which was previously 100% owned by the Company, and SeaMex simultaneously purchased the jack-up drilling rigs from Seadrill Limited.

As a result of the transaction the Company no longer controls the entities that own and operate these jack-up drilling units (the "Disposal Group"), and accordingly the Company has deconsolidated certain entities as of March 10, 2015, and has recognized its remaining 50% investment in the joint venture at fair value.  The fair value of the retained 50% equity interest in the SeaMex joint venture was determined by reference to the price paid by Fintech to obtain a 50% equity interest in the Disposal Group from Seadrill.  Seadrill accounts for its 50% investment in the joint venture under the Equity Method.

Total consideration in respect of the Disposal Group was $1,077 million from SeaMex to Seadrill.  This was comprised of net cash of $586 million, a Seller's credit receivable of $250 million, short term related party receivable balances of $90 million and direct settlement of Seadrill's debt facilities relating to the West Oberon amounting to $150 million.   Subsequently, $162 million of related party balance was received when the West Titania was refinanced.  The Seller's credit bears interest at a rate of LIBOR plus a margin of 6.50% and matures in December 2019.  See Note 17 to the consolidated financial statements for further details on the related party balances.

Seadrill utilized the cash consideration to repay outstanding debt facilities in respect of the West Courageous, West Defender, West Intrepid and West Titania. See further details in Note 12 to the consolidated financial statements.

The total recognized gain on disposal was $186 million, after taking into account a goodwill allocation of $49 million, which has been presented in our consolidated statement of operations, under "(Loss)/gain on disposals" included within operating income.

The Company has not presented this Disposal Group as a discontinued operation in the statement of operations as it does not represent a strategic shift that has (or will have) a major effect on the Company's operations and financial results.

In connection with the JV agreement, SeaMex entered into a management support agreement with Seadrill Management Ltd, a wholly owned subsidiary of the Company, pursuant to which Seadrill Management Ltd. provides SeaMex with certain management and administrative services. The services provided by Seadrill Management Ltd. are charged at cost plus management fee of 8% of Seadrill's costs and expenses incurred in connection with providing these services. The agreement can be terminated by SeaMex by providing 120 days written notice.

*	During the second half of 2015, subsequent to the deconsolidation, certain immaterial measurement period adjustments were made to the values of the net assets as at the date of deconsolidation, which reduced the initial gain recognized by $5 million.

 

Note 5 – Taxation

The effective tax rate for the nine months ended September 30, 2016 and 2015 was (183.5)% and (15.4)%, respectively. The income tax expense increased $52 million for the nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015. The changes are primarily attributable to a change in balance of the relative components of our estimated 2016 earnings, with more earned in jurisdictions with higher tax rates. In addition, book discrete losses, for which no benefits were recognized, were higher during 2016. The Company has also recognized liabilities related to uncertain tax positions and other adjustments associated with prior periods.

Note 6 – Earnings per share

The computation of basic earnings per share ("EPS") is based on the weighted average number of shares outstanding during the period. Diluted EPS includes the effect of the assumed conversion of potentially dilutive instruments.

The components of the numerator for the calculation of basic and diluted EPS are as follows:

The components of the denominator for the calculation of basic and diluted EPS are as follows: