Review of financial reporting Polarcus DMCC
Publisert: 18. april 2016
Sist endret: 21. april 2017
Att. Board of Directors
Almas Tower. Level 32
Jumeirah Lakes Towers
UNITED ARAB EMIRATES
Enquiries to: Anna Frantzen
Dir. line +47 22 93 97 46
Our reference: 15/7029
In accordance with the Securities Trading Act section 15-1 subsection (3), Finanstilsynet has reviewed certain accounting topics related to the financial reporting of Polarcus Limited ("Polarcus"). Reference is made to previous correspondence and meeting, most recently the issuer's reply of 15 February 2016.
Below is a summary of the topics addressed by the review. The review is hereby considered closed.
Polarcus is a marine geophysical company delivering towed streamer data acquisition and imaging services. The seismic market and the company's financial position weakened during the second half of 2014 and 2015. Polarcus completed the restructuring plan by the end of February 2016. The review focuses mainly on disclosures related to the going concern assumption and corresponding disclosures in the annual report for 2014 and interim reports for the second and third quarters of 2015. Finanstilsynet's assessment is that in view of the company's situation these disclosures should have been more specific and comprehensive. Other topics under review are vessel impairment and the summary of significant accounting policies.
2. Going concern assumption
2.1. Annual Report 2014
Polarcus prepared the consolidated financial statements for the year ended 31 December 2014 based on the going concern assumption. However, this assumption was subject to material uncertainty. The Auditor's Report for 2014 includes an emphasis of matter relating to the going concern assumption.
IAS 1 Presentation of Financial Statements paragraph 25 requires management, when preparing
financial statements, to assess the entity's ability to continue as a going concern. Where management is aware of material uncertainties related to events or conditions that may cast significant doubt upon the entity's ability to continue as a going concern, the entity shall disclose those uncertainties. This applies both when preparing annual and interim financial statements; see IAS 1.4.
IAS 1.26 provides supplementary guidance on how management should assess the appropriateness of the going concern assumption. Management should take into account all available information about the future, and the scope of the analyses required will depend on entity-specific factors relating to current and expected profitability. An entity whose ability to continue as a going concern is in doubt will be expected to have conducted extensive analyses of those factors.
An entity must disclose the judgements that management has made in assessing the entity's ability to continue as a going concern, see IAS 1.122. Disclosures must be entity-specific and detailed, so that any user of the financial statements is able to understand clearly the assumptions on which the going concern assumption rests.
Finanstilsynet is of the opinion that the company has failed to give a sufficiently precise and full explanation of events and transactions that are significant to understanding the assessment of the uncertainties related to the going concern assumption in the 2014 Annual Report. Finanstilsynet notes that more information is given in presentation materials related to quarterly reporting, but emphasises that other ongoing disclosures cannot be considered to fulfil the information requirements for periodic financial reporting.
In Finanstilsynet's opinion, the company should be more specific on for example backlog and pre-funding rate and should state monetary amounts wherever possible. The company agrees that disclosing the monetary and relative amounts of the company's overall backlog, as well as the pre-funding rate for the secured multi-client work, would have added information that would enable the reader of the financial statements to understand quantitatively the impact of the company's working capital build up. Finanstilsynet notes this for the record.
The company's presentation of 8 January 2015 contains information that is relevant for an assessment of the going concern assumption and should have been included in notes to the 2014 Annual Report. The presentation material mentions "navigating a challenging market environment" and gives some indications of how the company intends to do this. Relevant information included in the presentation is:
- A cost management plan of USD 35m including organisational streamlining and cost reductions, supply chain improvements and operational efficiency initiatives;
- Projected annual revenues of USD 12-15m due to cutting exploration time and mitigation of drilling risk for clients.
The company acknowledges that in hindsight it would have helped the reader of its 2014 Annual Report to assess the company's going concern status more accurately if the company had included a reference to its reduced cost base from 2015 onwards that was expected to result from the cost management plan as well as a new revenue stream from fast track processing. Finanstilsynet notes this for the record.
2.2. Quarterly Reports for the second and third quarters of 2015
An entity shall include in its interim financial reporting an explanation of events and transactions that are significant to an understanding of the changes in financial position and performance of the entity since the end of the last annual reporting period; see IAS 34 Interim Financial Reporting paragraph 15. Where the ability to continue as a going concern is highly uncertain, it is in Finanstilsynet's assessment imperative that the information provided in interim financial reports on such matters is precise and adequate.
Finanstilsynet notes that the company's disclosures surrounding the going concern risk were more comprehensive in the Q2 and Q3 reports for 2015 than in the Annual Report for 2014. In general, disclosures about the going concern risk are improved in the later financial reports. Additional information is presented about action taken by the company to strengthen its financial position and its ability to continue as going concern. In Finanstilsynet's view, however, the company still needs to provide more detailed information about the current situation and as far as possible its view of future prospects.
In the following Finanstilsynet will focus on the Q3 report for 2015. This is the most recent financial report published under the going concern assumption being subject to material uncertainty and reviewed by Finanstilsynet.
After reviewing minutes of board meetings/calls and other documentation received from the company, Finanstilsynet concludes that Polarcus' financial situation is not fully reflected in its financial reporting. Users of financial statements must be able to understand the company's financial position.
The Q3 2105 presentation contains information that is useful for assessing the company's ability to continue as a going concern. Some of this information should be included in the notes to the Q3 report. Finanstilsynet lists examples of such disclosures in the following:
Note 1.1 in the Q3 2015 report mentions the cold stacking of one vessel. The presentation material for the quarter includes a cost saving of USD 10.5m due to cold stacking of Polarcus Nadia. In addition, other cost management actions focusing for example on targeted cost management, human capital cost, operation cost, operation efficiency and CAPEX reduction with specific numbers are included in the presentation. In Finanstilsynet's view, this information should be presented in the Q3 report itself. The company acknowledges that this information should be included in the note on the material uncertainty of the going concern assumption. Finanstilsynet notes this for the record.
The company presents selected financial covenants in note 1.1 to the third quarter report 2015. The debt service ratio (DSR) is not presented in the note. This covenant, both historically and projected forward, is presented in the quarterly presentation. Headroom presented there is important to understanding the company's financial position. In Finanstilsynet's view this should be included in the notes to the quarterly report. The company acknowledges that in hindsight it would have been useful to include information regarding the DSR covenant in the going concern note. The company notes that comprehensive data on this covenant were included on page 5 of its Q3 2015 report but not as a part of the going concern note. Finanstilsynet notes this for the record and points out that the DSR covenant projected forward was not presented in the Q3 report even though it is useful information for the users of financial statements. DSR in 2016 is 2 times EBITDA divided by interest and debt amortisation. To comply with this requirement, Polarcus needs to achieve an EBITDA of approximately USD 200m. Analysts appear to cast doubt on whether it is realistic to expect such a level of EBITDA in 2016 in a situation where market contract rates are around cash break even. Some analysts believe this covenant might be breached as early as in Q1 2016. Finanstilsynet understands that it is neither possible nor reasonable for the company to give detailed assumptions, and future prospects are subject to uncertainty. Finanstilsynet nevertheless expects certain information to be disclosed in the notes such as the minimum utilisation forward, and the minimum day rates forward, that are needed to comply with this covenant. The factors Polarcus considers are present to achieve such parameters should also be included in the notes.
Page 12 of the Q3 2105 report states: "The company’s financial projections are based on certain assumptions, including those related to contract wins, contract pricing and utilization in the future (“backlog”)." Current backlog per future quarters in 2015 and 2016 is shown in the presentation of the quarter. This information is very useful to users of the financial statements and should be presented in the notes. If the company considered it probable by the time it published the quarterly report that some of the covenants would be breached in the near future, the action the company is planning to take to rectify the situation should be addressed in the notes.
If the company prepares its future financial statements using the going concern assumption and this assumption remains subject to material uncertainty, Finanstilsynet expects the company to give full disclosures to enable the users to assess the company's current situation.
The company informed Finanstilsynet that in the future it will be attentive as to what specific information should be included in a going concern assessment, particularly with regard to which disclosures should be included when there is a material uncertainty as to the going concern assumption. Further, the company will be mindful as to whether information given in company presentations and other published material may also be relevant for financial statements. Finanstilsynet notes this for the record.
3. Liquidity risk
Finanstilsynet commented that Polarcus has failed to present information detailed enough to address the company's increased liquidity risk and challenging position in its 2014 Annual Report. In Finanstilsynet's opinion, the reported maturity profile of the company's financial liabilities is insufficiently relevant and detailed. Given the negative impact on the company's earnings in the fourth quarter 2014 and the uncertainty regarding the going concern assumption, a maturity profile presenting shorter intervals will be essential to enable the user of financial statements to evaluate the company's financial situation. According to IFRS 7.34 letter a) the disclosure shall be based on information provided internally to key management personnel. The level of detail will be dependent on the materiality of liquidity risk, corresponding to the description of liquidity risk management under IFRS 7.39(c). IFRS 7.7 contains a general requirement to disclose information that enables users to evaluate the significance of financial instruments for its financial position and performance.
In its 2014 financial statements the company highlights liquidity risk in Note 1.1 and Note 3. In addition, the company provides detailed disclosure of due dates, repayment terms, interest rates and liquidity matters on its main financial liabilities in Notes 16, 17, 18, 19, and 20. The company is of the opinion that the liquidity related information it provides in notes 16 to 20 is detailed, specific and in compliance with IFRS. The company is of the opinion that a reader of its 2014 Financial Statements could identify the liquidity related information, such as payment dates and amounts, in Notes 16 to 20 and could, in combination with the liquidity table in Note 3.1.3, identify the maturity profile in shorter intervals if the reader deemed it to be necessary.
In accordance with the requirements of IFRS 7.39(a), the company disclosed a table showing the maturity of its financial liabilities in Note 3.1.3, splitting the maturity buckets into the following periods: below 1 year, 1 – 2 years, 2 – 5 years, and above 5 years. The company did not split the maturity of the financial instruments falling due within 1 year into quarterly periods.
The company evaluated in the period up to approval of the 2014 Financial Statements the need to include a maturity table of shorter periods. On 25 March 2015 the company announced that it had secured improved terms for its fleet loan facility and on 14 April 2015, before release of its 2014 Financial Statements, the company announced that bondholders of the company’s USD 125m convertible loan had agreed to an extension of the maturity. A detailed description of these events is given in Note 32.2 in the 2014 Financial Statements. Together, these amended financing arrangements significantly strengthened the going concern assumption and reduced the liquidity risk of the company. At the time, the company made an evaluation and believed the financing arrangement reduced the need for a maturity analysis in shorter intervals. However, the company acknowledges that in hindsight it should have included a shorter maturity analysis.
The company believes that the requirement to provide a maturity analysis with shorter intervals is subject to an element of judgement and will need evaluating at each reporting date. The company points out that its Q2 2015 report included expanded liquidity risk disclosures, including maturity tables showing contractual maturities in time periods split into quarters. This was due to the financial situation and outlook for the company having deteriorated since the period of publication of the 2014 Financial Statements.
Finanstilsynet notes for the record the comments from the company and is of the opinion that disclosures in the 2014 Annual Report regarding liquidity risk were insufficient. The company presented a maturity analysis with shorter intervals such as per quarter in its Q2 and Q3 reports for 2015. The company included quantitative and qualitative disclosures explaining how the financial liabilities will be met, including comments as to whether current assets and secured backlog are sufficient to cover the company's financial liabilities and future liquidity needs, immediately after the maturity table. Liquidity risk disclosures are presented after going concern assumption disclosures, making it easier for the user of the financial statements to understand the financial position of the company. Finanstilsynet notes this for the record.
Finanstilsynet would emphasise the importance of disclosures on the management of inherent liquidity risk, IFRS 7.39(c) as mentioned in Finanstilsynet's circular 31/2011.
The company has noted the comments from Finanstilsynet.
4. Impairment of vessels and seismic equipment
At the reporting date the carrying amount of vessels, seismic equipment and the streamer licence constitute approximately 77% of the total assets of the company. In note 4.1 Assessment of Impairment, Polarcus discloses information relating to the impairment assessment of its vessels, seismic equipment and the streamer steering licence. No impairment was recorded in 2014 as the recoverable amounts of the assets were higher than their carrying values. The company estimates both fair value less costs to sell and value in use. The company's auditor has an emphasis of matter relating to Polarcus' impairment assessment in the Auditor's Report 2014.
As the fair value less costs to sell impairment test supported the carrying values per 31 December 2014, no further impairment testing was found necessary by Polarcus. However, for the purposes of sensitivity analysis and as further support for and comparison with the fair value less costs to sell test, the company also performed a value in use test.
Finanstilsynet received the impairment test based on value in use performed for 2014. As this test is performed solely for the purposes of sensitivity analysis, Finanstilsynet did not review this further.
Finanstilsynet received copies of independent valuers' appraisal valuations per year end 2014 and second quarter 2015. Finanstilsynet notes that the seismic market weakened during the second half of 2014 and 2015. As far as Finanstilsynet is informed, there were fewer transactions in the market on which valuer's valuations could be based.
Finanstilsynet is of the opinion that additional attention is needed from companies that use third party valuations in such periods. Finanstilsynet encourages companies to request more supplementary information about the assumptions that are used in valuations and to be especially attentive in assessing whether external valuations are prepared in accordance with requirements of IFRS 13.
The company issued a stock exchange notice on 6 January 2016:
"…On 29 December 2015 the Company received a preliminary assessment of the review. In the preliminary assessment, Finanstilsynet notes that as the seismic market has weakened during the second half of 2014 and 2015, additional attention is demanded from companies that use 3rd party valuations during such periods. As Polarcus uses 3rd party independent valuations, this could lead to impairments in the Company's 2015 financial results regardless of the outcome of the restructuring".
Polarcus announced non-cash impairment charges impacting the fourth quarter of 2015 on 9 February 2016. The company performed its impairment review using a value in use test based on discounted cash flows. As a result, the company will record non-cash charges of approximately USD 242m that will materially impact the financial statements for the fourth quarter of 2015 and are related to the following two asset classes:
An impairment of intangible assets of approximately USD 27m;
An impairment of the carrying value of the vessels and seismic equipment of approximately USD 215m.
The impairments were driven by the weak market fundamentals with falling day rates.
Finanstilsynet notes this for the record.
5. Summary of significant accounting policies
According to IAS 1 Presentation of Financial Statements (IAS 1), the notes shall present information about the basis of preparation of the financial statements, disclose the information required by IFRS and provide information that is relevant to an understanding of the financial statements (IAS 1.112). Finanstilsynet pointed out the importance of ensuring that the information disclosed in the notes is tailored to the issuer and that the notes give prominence to and adequate information about factors important for an understanding of the entity’s financial position, performance and cash flows. Detailed notes about immaterial matters and matters not relevant for the company may result in necessary information failing to come across with sufficient clarity. For example, note 2.17 describes principles for hedge accounting that are not applied by Polarcus: a description of the evaluation of whether or not a financial derivative qualifies for hedge accounting and subsequent accounting is not needed in the 2014 Annual Report. The company agrees with Finanstilsynet.
The company informed Finanstilsynet that it would continue to evaluate for each financial reporting period what disclosures are necessary to comply with IFRS, and will continue to apply the materiality threshold to disclosures. The company will in future ensure that extra attention is given to the wording, detail and length of the significant accounting policies. Finanstilsynet notes this for the record.
Finanstilsynet has not considered whether the above matters come under the securities legislation's provisions regarding the requirement to disclose inside information in accordance with the Securities Trading Act section 5-2 subsection (1) and section 3-2. Finanstilsynet expects the company to consider its requirement to disclose inside information on a continuous basis.
Finanstilsynet has forwarded a copy of this letter to the issuer's appointed auditor and to Oslo Børs.
On behalf of Finanstilsynet
Christian Falkenberg Kjøde
Head of section
Ernst & Young AS