4.3.2Operating Segments and Directional Reporting

Operating segments

The Company ’s reportable operating segments as defined by IFRS 8 ‘Operating segments’ are:

• Lease and Operate;
• Turnkey.

Directional reporting

Strictly for the purposes of this note, the operating segments are measured under Directional reporting, which in essence follows IFRS, but deviates on two main points:

• All lease contracts are classified and accounted for as if they were operating lease contracts under IFRS 16. Some lease and operate contracts may provide for defined invoicing (‘upfront payments’) to the client occurring during the construction phase or at first-oil (beginning of the lease phase), to cover specific construction work and/or services performed during the construction phase. These ’upfront payments’ are recognized as revenues and the costs associated with the construction work and/or services are recognized as ’Cost of sales’ with no margin during the construction. As a consequence, these costs are not capitalized in the gross value of the assets under construction. 
• All investees related to Lease and Operate contracts are accounted for at the Company’s share as if they were classified as Joint Operation under IFRS 11, using the proportionate consolidation method (where all lines of the income statement, statement of financial position and cash flow statement are consolidated for the Company’s percentage of ownership). Yards and installation vessel related joint ventures remain equity accounted.
• All other accounting principles remain unchanged compared with applicable IFRS standards.

The above differences to the consolidated financial statements between Directional reporting and IFRS are highlighted in the reconciliations provided in this note on revenue, gross margin, EBIT and EBITDA as required by IFRS 8 ’Operating segments’. The Company also provides the reconciliation of the statement of financial position and cash flow statement under IFRS and Directional reporting. The statement of financial position and the cash flow statement under Directional reporting are evaluated regularly by the Management Board in assessing the financial position and cash generation of the Company. The Company believes that these additional disclosures should enable users of its financial statements to better evaluate the nature and financial effects of the business activities in which it engages, while facilitating the understanding of the Directional reporting by providing a straightforward reconciliation with IFRS for all key financial metrics.

Segment highlights

In 2019, the Turnkey segment was not impacted by any non-recurring material item and benefited from the progress made on the Johan Castberg Turret Mooring System EPC project, in addition to a general ramp-up of Turnkey activities. This includes (i) the construction activities on FPSO Sepetiba, which started to contribute to Directional revenue thanks to the disposal of the minority share of 35.5% to MC and NYK and ii) the contribution of upfront payments related to specific construction work before the commencement of the lease on the Liza projects.

The Lease and Operate segment was impacted by a total impairment of US$(25) million in 2019 relating to two, individually not material, impairments of property, plant and equipment (please refer to note 4.3.13 Property, Plant and Equipment. Safe from any impact of impairment, Directional Lease and Operate revenue and EBITDA increased versus the year ago period. The impact of units leaving the fleet in 2018 (Turritella (FPSO), FSO Yetagun and FSO N'Kossa II) was indeed more than offset by a reduction in planned maintenance, an overall improvement in performance of the fleet and the first contribution of FPSO Liza Destiny after achieving first oil at the end of 2019.

The non-recurring gain of US$90 million on the purchase of additional shares in the five Brazilian vessels is presented in 'Other'. Refer to note4.3.1 Financial Highlights for the full details on the treatment of this transaction under Directional reporting.

2019 operating segments (Directional)

• ¹ Mainly includes a gain of US$90 million on the purchase of additional shares in Cidade de Paraty, Cidade de Ilhabela, Cidade de Marica, Cidade de Saquarema and Capixaba.
• ² Includes net impairment losses on financial and contract assets.

Reconciliation of 2019 operating segments (Directional to IFRS)

• ¹ Includes the removal of a gain of US$90 million on purchase of shares in Cidade de Paraty, Cidade de Ilhabela, Cidade de Marica, Cidade de Saquarema and Capixaba.

The reconciliation from Directional reporting to IFRS comprises two main steps:

• In the first step, those lease contracts that are classified and accounted for as finance lease contracts under IFRS are restated from an operating lease accounting treatment to a finance lease accounting treatment.
• In the second step, the consolidation method is changed i) from proportional consolidation to full consolidation for those Lease and Operate related subsidiaries over which the Company has control and ii) from proportional consolidation to the equity method for those Lease and Operate related investees that are classified as joint ventures in accordance with IFRS 11.

Impact of lease accounting treatment

For the Lease and Operate segment, the restatement from an operating to a finance lease accounting treatment has the main following impacts for the 2019 period:

• Revenue is reduced by US$261 million. During the lease period, under IFRS, the revenue from finance leases is limited to that portion of charter rates that is recognized as interest using the interest effective method. Under Directional reporting, in accordance with the operating lease treatment, the full charter rate is recognized as revenue, on a straight-line basis. Lease and Operate EBITDA is similarly impacted (reduction of US$257 million) for the same reasons.
• Gross margin decreased by US$4 million and EBIT increased by US$4 million. As the current Company’s finance lease fleet is still relatively young, the amount of the (declining) interest recognized under IFRS is still in line with the linear gross margin recognized under Directional for the related vessels. Under IFRS, gross margin and EBIT from finance leases equal the recognized revenue, therefore following the declining profile of the interest recognized using the interest effective method. On the other side, under the operating lease treatment applied under Directional, the gross margin and the EBIT correspond to the revenue and depreciation of the recognized PP&E, both accounted for on a straight-line basis over the lease period.

For the Turnkey segment, the restatement from operating to finance lease accounting treatment had the following impacts over the 2019 period:

• Revenue and gross margin increased by US$1,202 million and US$240 million respectively, mainly due to the accounting treatment of FPSO Liza Destiny, Liza Unity and Sepetiba as a finance lease under IFRS: under IFRS, a finance lease is considered as a virtual sale of the asset leading to recognition of revenue during the construction of the asset corresponding to the present value of the future lease payments. This (non-cash) revenue is recognized within the Turnkey segment.
• The basic impact on Turnkey EBIT and EBITDA is largely in line with the impact on gross margin.

As a result, the restatement from operating to finance lease accounting treatment results in an increase of net profit of US$216 million under IFRS when compared with Directional reporting.

Impact of consolidation methods

The impact of consolidation methods in the above table describes the net impact from:

• Proportional consolidation to full consolidation for those Lease and Operate related subsidiaries over which the Company has control, resulting in an increase of revenue, gross margin, EBIT and EBITDA;
• Proportionate consolidation to the equity accounting method for those Lease and Operate related investees that are classified as joint ventures in accordance with IFRS 11, resulting in a decrease of revenue, gross margin, EBIT and EBITDA.

The impact of the changes in consolidation methods results in a net increase of revenue, gross margin, EBIT, EBITDA and net profit under IFRS when compared Directional reporting. This reflects the fact that the majority of the Company’s FPSOs, that are leased under finance lease contracts, are owned by subsidiaries over which the Company has control and which are consolidated using the full consolidation method under IFRS.

2018 operating segments (Directional)

• ¹ Mainly includes net gain on disposal of Turritella (FPSO) for US$217 million and net impact of additional settlement reached with insurers on Yme project claim for US$37 million.
• ² Mainly relates to the additional provision of US$43 million (200 million Brazilian Reais) for settlement with the Brazilian Federal Prosecutor’s Office (Ministério Público Federal – 'MPF') approved by the Fifth Chamber of the MPF.

Reconciliation of 2018 operating segments (Directional to IFRS)

• ¹ Includes the removal of a gain on disposal of Turritella (FPSO) for US$217 million.

Reconciliation of 2019 statement of financial position (Directional to IFRS)

• ¹ Under Directional, the cost related to the Brazilian local content penalty is capitalized in line with construction progress of related assets and presented in the statement of financial position under 'Property, plant and equipment and Intangible assets'.
• ² Includes US$1,537 million related to (i) FPSO Liza Destiny (ii) units under construction (i.e. FPSO Liza Unity, Prosperity and Sepetiba) and (iii) Gene tanker.
• ³ Includes US$2,851 million non-recourse debt and US$173 million lease liability

Consistent with the reconciliation of the key income statement line items, the above table details:

• The restatement from the operating lease accounting treatment to the finance lease accounting treatment for those lease contracts that are classified and accounted for as finance lease contracts under IFRS; and
• The change from proportional consolidation to either full consolidation or equity accounting for investees related to Lease and Operate contracts.

Impact of lease accounting treatment

For the statement of financial position, the main adjustments from Directional reporting to IFRS as of December 31, 2019 are:

• For those lease contracts that are classified and accounted for as finance lease contracts under IFRS, de-recognition of property, plant and equipment recognized under Directional reporting (US$4,896 million) and subsequent recognition of (i) finance lease receivables (US$5,214 million) and (ii) construction work-in-progress (US$803 million) for those assets still under construction.
• For operating lease contracts with non-linear bareboat day rates, a deferred income provision is recognized to show linear revenues under Directional reporting. This balance (US$374 million) is derecognized for the contracts that are classified and accounted for as finance lease contracts under IFRS.
• Restatement of the provisions for demobilization and associated non-current receivable assets, mainly impacting other financial assets (US$180 million) and provisions (US$150 million).

As a result, the restatement from operating to finance lease accounting treatment gives rise to an increase of equity of US$1,532 million under IFRS compared with Directional reporting. This primarily reflects the earlier margin recognition on finance lease contracts under IFRS compared to Directional reporting.

Impact of consolidation methods

The above table also describes the net impact of moving from proportionate consolidation to either full consolidation, for those lease related investees in which the Company has control, or equity accounting, for those investees that are classified as joint ventures under IFRS 11. The two main impacts are:

• Full consolidation of asset specific entities that mainly comprise finance lease receivables (representing the net present value of the future lease payments to be received) and non-recourse project debts.
• Derecognition of the individual line items from the statement of financial positions for those entities that are equity accounted under IFRS, rolling up in the line item ’Investment in associates and joint ventures’.

Reconciliation of 2019 cash flow statement (Directional to IFRS)

• ¹ Includes a gain of US$90 million on the purchase of additional shares in Cidade de Paraty, Cidade de Ilhabela, Cidade de Marica, Cidade de Saquarema and Capixaba.
• ² Includes US$149 million for the purchase of shares in Cidade de Paraty, Cidade de Ilhabela, Cidade de Marica, Cidade de Saquarema and Capixaba net of aquired cash.
• ³ Includes US$149 million for the purchase of shares in Cidade de Paraty, Cidade de Ilhabela, Cidade de Marica, Cidade de Saquarema and Capixaba.

Impact of lease accounting treatment

At net cash level, the difference in lease accounting treatment is neutral. The impact of the different lease accounting treatment under Directional reporting versus IFRS is limited to reclassifications between cash flow activities.

Capital expenditures (US$725 million) are reclassified from investing activities under Directional, to net cash flows from operating activity under IFRS, where finance lease contracts are accounted for as construction contracts. Furthermore the interest expense which is capitalized under Directional as part of asset under construction (and therefore presented in investing activities) is reclassified to financing activities under IFRS.

The impact of the change of lease accounting treatment at EBITDA level is described in further detail in the earlier reconciliation of the Company’s income statement.

Impact of consolidation methods

The impact of the consolidation method on the cash flow statement is in line with the impact described for the statement of financial position. The full consolidation of asset specific entities, mainly comprising finance lease receivables and the related non-recourse project debts, results in increased repayments of borrowings under IFRS versus Directional.

Reconciliation of 2018 statement of financial position (Directional to IFRS)

• ¹ Including US$2,821 million non-recourse debt and US$189 million lease liabilities.

Reconciliation of 2018 cash flow statement (Directional to IFRS)

• ¹ Mainly includes net gain on disposal of Turritella (FPSO) for US$(217) million.
• ² Includes US$(196) million payment for the settlement with Brazilian authorities and Petrobras and US$(80) million compensation paid to the partners in the investee owning the Turritella (FPSO) before acquisition by Shell.
• ³ Includes the Company 55% share in purchase price acquisition of Turritella (FPSO) by Shell for US$543 million reclassified from investing activities.
• ⁴ Includes US$987 million purchase price acquisition of Turritella (FPSO) by Shell.
• ⁵ Mainly includes the Company 55% share in the proceeds from the sale of Turritella (FPSO) for US$544 million.
• ⁶ Includes the Company 55% share in the redemption of Turritella (FPSO) project financing loan for US$(398) million.

Deferred income (Directional)

The deferred income is mainly related to the revenue of those lease contracts which include a decreasing day-rate schedule. As income is shown in the income statement on a straight-line basis with reference to IFRS 16 ‘Leases’, the difference between the yearly straight-line revenue and the contractual day rates is included as deferred income. The deferral will be released through the income statement over the remaining duration of the relevant lease contracts.

Geographical Information

The classification by country is determined by the final destination of the product for both revenues and non-current assets.

The revenue by country is analyzed as follows:

2019 geographical information (revenue by country and segment)

2018 geographical information (revenue by country and segment)

The non-current assets by country are analyzed as follows:

Geographical information (non-current assets by country)

Reliance on Major Customers

Under Directional, three customers each represent more than 10% of the consolidated revenue. Total revenue from these three major customers amounts to US$ 1,339 million (US$703 million, US$385 million and US$250 million, respectively). In 2018 the revenue related to the two major customers was US$673 million (US$454 million and US$219 million, respectively). In 2019 and 2018, the revenue of these major customers was predominantly related to the Lease and Operate segment.

Under IFRS, two customers each represent more than 10% of the consolidated revenue. Total revenue from these major customers amounts to US$ 2,393 million (US$1,450 million and US$943 million respectively). In 2018 three customers accounted for more than 10% of the consolidated revenue (US$1,254 million), respectively for US$615 million, US$334 million and US$305 million.