Sinking Costs Keep Atwood Oceanics, Inc.'s Earnings Afloat

The storm in the offshore drilling market continues to rage, which is causing Atwood Oceanics' (ATW) revenue to sink because od idled rigs and lower dayrates. Yet the company's profits are staying afloat largely because of its ability to keep its costs in check, as well as its ability to take advantage of the dislocation in the credit markets to repurchase some of its debt at a steep discount. These positives are helping offset what is clearly still a very tough operating environment for the company.

Atwood Oceanics results: The raw numbers

Data source: Atwood Oceanics,

What happened with Atwood Oceanics this quarter? 
Atwood Oceanics' earnings are holding up thanks to sinking costs:

• Atwood's revenue sank 14.4% year over year, because of slumping revenue from its deepwater drillships and its jackups, which were down 28% and 53.4% respectively. That's due to lower dayrates on some of its vessels as well as idled vessels. On a more positive note, ultra-deepwater revenue increased to $189 million, up 3.3%.
• Meanwhile, earnings stayed afloat largely because of falling costs. The company's drilling costs fell across all three of its drilling classes, with ultra-deepwater costs sinking 20.6%, while deepwater costs fell 40.6% and jackup costs dropped 36.7%. Even general and administrative expenses were down sharply, dropping 22% year over year
• Atwood Oceanics took advantage of a significant decline in its bond prices to repurchase bonds on the open market. During the quarter it repurchased $13.5 million in principal for just $5.1 million, which is an average discount of 62.2%. As a result, the company recognized a gain of $8.4 million, or $0.13 per share, during the quarter.
• The company has continued its debt repurchases in the current quarter, buying back $140.7 million of debt last month for just $94 million, which represented an average discount of 34.8%.

What management had to say 
CEO Robert Saltiel, commenting on the company's results on its quarterly conference call, said:

Our strong net income in the second quarter clearly benefited from realization of cost reduction initiatives at the headquarters and field support levels that were implemented during recent quarters. Our general and administrative expenses have moved downward in concert with our reduced fleet activity, and we are now forecasting approximately 50% lower G&A costs for the fiscal year versus our budget. In addition, our onshore support costs, which are reflected in contract drilling costs, are down more than 20% from our budgeted numbers. 

As Saltiel notes, Atwood has worked hard to reduce costs to size its business for the current market environment. Those efforts are paying off, with the company's costs falling below what it had budgeted. 

Looking forward 
Despite the solid quarter, operating conditions are still tough. Saltiel said on the conference call that the "offshore drilling market ... continues to be very difficult at best." He continued:

However, the recent rise in oil prices has provided a welcome respite for what has been exclusively a doom-and-gloom year thus far for our industry. Higher oil prices are a necessary condition for a recovery in our business, and offshore drilling activity is a derivative of the oil price. We are hopeful that oil prices will continue to move higher through 2016 in accordance with an increasing number of consensus predictions on sharp production declines outside of OPEC. If the more optimistic price predictions prove correct, then we are more likely to see offshore drilling with its newly deflated cost structure to play a role in 2017 CapEx budgets for more E&P operators. Until then, we will muddle through 2016 as the number of working offshore rigs continues to contract.

While there's a bit more optimism in the sector right now, it has yet to lead to firm contract extensions for the rigs Atwood has coming off contract over the next year. Saltiel did, however, say:

Despite the fact that we have not had any recent contract news to announce ... our marketing team is working on potential opportunities for most of our active rigs. Most of these are blend-and-extend deals with existing clients for program extensions, but some represent new opportunities with new clients. We expect all new offshore programs to be heavily contested, so I won't be able to provide much color on these opportunities.

In other words, the company is working hard to make sure its rigs keep working, but so are all of its competitors. That leaves investors with limited visibility right now, with there being no guarantees that the company will be able to keep any of its rigs working when those contracts expire over the next year.