Paragon Offshore Plc (OTCPK:PGNPQ) Q2 2016 Earnings Conference Call August 9, 2016 9:00 AM ET
Lee Ahlstrom - SVP, IR, Strategy and Planning
Randall Stilley - President and CEO
Steven Manz - CFO
Andrew Tietz - SVP, Marketing and Contracts
Welcome to the Paragon Offshore Second Quarter 2016 Earnings Conference Call. My name is Beyank [ph], and I'll be your operator for today. At this time, all participants are in a listen-only mode. Please note, that this conference call is being recorded.
I'll now turn the call over to Lee Ahlstrom. Mr. Ahlstrom, you may begin.
Thank you. Good morning, and welcome to Paragon Offshore's second quarter 2016 earnings call. A copy of our earnings press release with supporting schedules along with our latest fleet status report was posted to our website yesterday after market closed at www.paragonoffshore.com under our Investor Relations page. For those of you who would like the release in a PDF format, we've posted that, and following the call, we'll post a couple of slides that reconcile some of the non-GAAP metrics we may discuss on the call today to GAAP.
Before I turn the call over to Randy, I would like to make you aware that we will be making forward-looking statements today. Any statements that are not historical facts including statements related, but not limited to our restructuring, market conditions and expectations, and future plans are forward-looking statements that involve certain risks, uncertainties and assumptions.
These include, but are not limited to risks associated with the general nature of the oil and gas industry, risks associated with the operation of Paragon as a publicly traded company, actions by regulatory authorities, customers and other third-parties, compliance with financial covenants, ability to achieve value to our proposed restructuring transaction, the status of our cases under Chapter 11 of the U.S. Bankruptcy Code, our capital structure following emergence from Chapter 11 and other factors detailed in the Risk Factors section of Paragon's most recent Annual Report on Form 10-K, and on our most recent Quarterly Report on Form 10-Q which we expect to file today, as well as in Paragon's other filings with the Securities and Exchange Commission.
Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those indicated. Paragon disclaims any duty to update the information presented on this call. In addition, given where we are in our restructuring process, on today's call, we will only offer prepared remarks.
And now, I'd like to turn the call over to Randy Stilley, Paragon's President and Chief Executive Officer. Randy?
Thank you, Lee and good morning. With me today are Steve Manz, our CFO; and Andrew Tietz, Senior VP of Marketing and Contracts. Given the restructuring process we are undergoing, we will not be taking any question following the prepared remarks.
Before Steve discusses our quarterly result and Andrew provide details on our marketing plan, let me give you an update on our restructuring process. On Friday, we filed a supplement to our April disclosure statement in order to present downside sensitivity to our base business plan. We also filed a revised restructuring plan and provided more details in our press release yesterday morning.
I would like to go through the dynamics that led us to revise the restructuring plan and the main differences between the original and revised plan. But I think that many of you may be wondering what led us to take these steps in the first place.
As you know, our confirmation hearing for the original plan commenced in late June. During that hearing, our plan was challenged by the term loan lenders who objected to their treatment under the plan which led to reinstate them.
In other word, the term loan lenders would not receive anything additional as part of our restructuring and would be in exactly the same position after our restructuring as they were before. The term loan lenders objected to this treatment and challenge the feasibility of our plan and specifically our financial projection due to the industry downturn.
While we believe our business plan is feasible, since our confirmation hearings, our original planned commenced in June, there were a number of developments over the course of our hearings that weight on the processing.
First, oil prices have pulled back to the levels we haven’t seen since April, with the WTI dropping below $40 per barrel last week after getting at peak of over $61 per barrel in June before the hearing commenced.
Although, we are confident that this higher demand imbalance is tightening and will ultimately drive commodity prices higher in the long term, short term pressures have push prices back down.
Natural production decline and lower drilling activity are removing the oversupply of oil and oil prices will begin to recover. In the short term, however, we expect to see continued volatility in commodity prices.
Second, industry dynamic has continued to worsen for offshore drillers. During the quarter, there were additional contract cancellations among our competitors and very few new contract fixtures. This is not surprising as capital spending for E&P companies is still constrained by reduced cash flows.
As we mentioned on our last call, we are not projecting any significant activity increases in 2016 and the lack of green sheets in our business is still having a negative impact. Finally, industry saw one of our competitors reentered a restructuring process with an intent to liquidate causing uncertainty related to companies under going financial restructurings in our space, but we won't comment on competitors. But we can say is that our restructuring process is progressing on a more constructive path, and we believe comparisons between Paragon and those other companies are invalid.
With these considerations in mind, we decided to present a downside sensitivity that illustrated the liquidity and financial flexibility we would need in order to operate in an environment with industry recovery was delayed by an additional 12 to 18 months. As part of that sensitivity, we added delays to the number of rigs we have projected returning to work and we reduced projected day rate versus the base business plan.
The impacts to revenues and EBITDA in the downside sensitivity were significant. Accumulatively, over the period of 2016 to 2019 revenues were down 23% and EBITDA was 44% lower. We also included our actual results regime in this analysis which has been better than forecast. Steve will provide some color around our out performance to date.
With lower revenues in EBITDA, the downside sensitivity analysis we posted on Friday indicated that starting with an additional $60 million in cash, a modest reduction in the minimum quantity requirement, a delay in the reintroduction of covenants, and a modification of the leverage ratio and interest coverage covenants will give us an adequate cushion to manage through a significant downside environment should have developed.
With these results, we approached our bondholders and revolver lenders and propose that we make appropriate changes to the restructuring plan to account for a more difficult and prolonged downturn if necessary. After negotiating with our bondholders and revolver lenders, we believe we have reached an agreement in principal that is to the benefit of all stakeholders, and we expect to get the requisite signatures to that agreement shortly.
Here is a summary of the changes between the original plan and our revised plan. More detail can be found in both the press release from yesterday and our filings. On the revolver side, the minimum liquidity requirement is reduced to $103 million from $110 million. Additionally, the net leverage and interest coverage covenants don't kick in until the first quarter of 2019, a four-year delay from the original plan, and there is attrition built into the covenants based on the downside sensitivity not the base business plan.
The revolver lenders will still receive $165 million in cash and the balance of approximately $631 million including letters of credit will still be converted to a new term loan. The bondholders have agreed to give back $60 million, making their cash pay down $285 million instead of $345 million as originally planned. They also agreed to eliminate the contingent payments in both 2016 and 2017 which could have totaled up to $50 million.
In return we put in place a $60 million note due in 2021 after the new revolver term loan is due. The note will have interest payable semi-annually at a rate of 12% paid in cash or equity or 15% paid in hand.
The revised plan also grants our bondholders additional equity. As we said throughout this entire process we fought for shareholders to retain as much value as possible. There was no appetite at Paragon to wipe out common equity.
As part of this agreement, we also needed to provide bondholders additional equity and their steak after the implementation of the plan will increase from 35% to 47%. This still leaves existing shareholders with the majority equity ownership of the company.
It's important to remember two things. One, it continue to be a unique case for shareholders retain a significant portion of the company; and two, we're making these revisions to the plan in order to ultimately gain approval and allow our shareholders to recruit some of the value of their investment. In the longer term we believe the value of our equity will be enhanced.
One other important note. Noble has agreed to give us the option of paying any expenses due under our tax sharing agreement related to assessments in Mexico by means of a note instead of cash. If we choose to avail ourselves of this option, the note would have a maximum value of $5 million, potentially allowing us to preserve additional liquidity if needed. That would be doing four years from the effective date of our plan and carry interest similar to the note given to the bondholders.
We are working as quickly as possible to get through this process. Many of our customers have been incredibly supportive throughout the process and we cannot thank them enough. Unfortunately, despite our demonstrated ability to continue to delivering excellent service, some customers have been more reticent to consider us for contract opportunities and been unwilling to award work to us while under the shadow of restructuring. That's one reason why it's important for us to conclude this process as quickly as possible.
Let me give you a brief update on the inspected schedule. For all the 2016, there will be a hearing to approve the disclosure statement supplement. We expect this to be approved and that we will be able to begin to solicit votes almost immediately. Since the terms of the plan has changed, a vote by the impacted parties is required.
Since it is the continuation of process, only those bondholders and revolver banks of record as of April 6, 2016 will be entitled to vote. The company has received in escrow signatures to the immediate plans support agreement from holders of approximately 69% in principal amount to the bondholders, subject to receive signatures from the requisite revolver lenders. As I mentioned we believe we will see those signatures shortly.
On September 8, there will be a hearing to allow testimony about the Noble settlement. Then on September 27, the court will resume the confirmation hearing. We will present testimony on the downside scenario and the changes to our restructuring plan. Following this, we expect the judge to issue a ruling and pending a positive result to emerge from Chapter 11 sometime in October.
While we have continued discussions with the term loan lenders, we have not reached the settlement, and under the revised plan we expect them to reinstated as they would have been under the original plan. Our goal is to put forth a plan which we believe we will see the positive ruling when the confirmation hearing resumed that will allow us to emerge from Chapter 11 as soon as possible and position us to create long term shareholder value.
It is important to us to be as transparent as possible, including regularly posting [indiscernible] on our website. We will continue to keep you informed and provide updates as often as we can through this process.
Finally, let me thank everyone who has supported us throughout this ordeal, but specifically our employees, our customers, our suppliers, our board and our shareholders. We very much appreciate your support.
And now I will turn it over to Steve to make a few comments about our financial results.
Thank you, Randy and good morning to everyone. Last night we've released our second quarter results and despite the very difficult market conditions we continue to perform in a high level. We continue to generate positive cash flow and we ended the quarter with more liquidity than we started.
Before I start, I recommend that you look at the financial schedules in the earnings release on our website. Since I will be using the numbers in my comment, I won't provide any new guidance and I recommend that you reread the disclosure statement filed in March. Also, I won't be commenting on the information in the planned amendment that was filed last Friday.
Before I talk about the second quarter results, I would like to highlight a minor change we made in the balance sheet. This quarter we separated $44 million in restricted cash from the other long term assets. This represented the lease reserve accounts for the Prospector sale lease back and also cash collateral for performance bonds required for a couple of contract. If you combine the cash and cash equivalents and all of the restricted cash balances, our total cash balance as of June 30 was $936 million.
Now I move ahead to talk about the second quarter results. Yesterday we reported a net loss of $25 million or $0.29 per share in the second quarter. There were no significant non-cash or material one-time item and adjusted EBITDA was $66 million.
The total revenues were approximately $185 million as compared to $265 million in the first quarter. The decrease of $80 million was a result of a lower fleet utilization which dropped from 48% in the first quarter to 34% in the second quarter. The utilization was impacted by several rigs rolling up contract in the North Sea, Brazil and West Africa.
Fortunately, the lower revenues were partially offset by lower contract join costs and G&A expenses. Our second quarter contract drilling costs $92 million, which is 19% lower than the $113 million in the first quarter. Of the $21 million decrease, approximately one-third was the result of having fewer rigs working in the quarter. The rest of the decrease is for lower operating costs for our working rigs and recoveries of receivables written off last year.
We've been successful in reducing almost all the components of our operating in second class and we haven't had to sacrifice total up time for safety on the rig. Our goal is to make permanent changes in our cost structure so when the market starts to recover our margins should be higher than before the downturn.
A great example is our maintenance in procurement process. Over the past several quarters we moved a lot of the drilling equipment and spare parts inventory from our spec rig to central location. As you recall two years ago we had 40 rigs working, that will spend a lot of money buy new equipment for the Paragon fleet before the spin-off in 2014. Our rigs used similar equipment so we can swap spare parts and equipment from one rig to another and we can deliver quicker because we don't have to wait for a vendor. As a result our repair and maintenance expense and our CapEx cost were lower than last year
Another example is our labor cost. Historically, our labor cost represent more than 50% of the total operating expenses, so a significant drop in headcount or personnel cost reduction creates a major impact on our bottom line. In the last several quarters, we've dramatically reduced shore-based headcounts in Mexico, in West Africa and are in the process of closing our Brazilian shore-based.
We eliminated all unnecessary third-party contractors and reduced our expat costs. In addition to our cost reductions, we've been very active in selling surplus equipment and chasing our receivables and tax refund. Last year we recorded approximately $40 million in contract drilling costs and bad debt expense for contract disputes with several customers.
In the second quarter we received a series of payments from one of the customers in India and we reversed approximately $6 million in bad debt expense. We recorded as a credit to the second quarter contract drilling costs. We've also continue to reduce our overhead costs.
Our second quarter G&A expense was $9.8 million which compares the $12.2 million in the first quarter. The $2.4 million decrease was the result of headcount reduction, lower consulting fees and other support costs.
Looking ahead by the third quarter, we don't expect to have any rigs working in Brazil, Mexico or South Africa, and we were not awarded the extension for the labor contracts on the Hibernia platform in Canada. As a result, we are in the process of right-sizing our cost structure to support a smaller operational footprint in a couple regions. We're also centralizing a number of the operation support functions and the corporate office which allow us to react more quickly to new opportunities and be more cost efficient.
This is a step change from the past, since historically our operations, marketing and back-office support functions were much more decentralized. Since we have fewer rigs working and contract terms are getting shorter, we have to be more nimble.
And on the balance sheet, I mentioned earlier that our liquidity position continue to improve in the second quarter. Our cash and cash equivalents balances were $889 millions as compared to $835 million in the first quarter. The net cash provided by operating activities was approximately $101 million which is a slight decrease over the first quarter with cash flow.
As of June 30 our account receivable balance was $193 million which is down from the $243 million at March 31. We received payments of $24 million from Pemex and $44 million from Petrobras in the quarter. In addition, we received approximately $9 million in net tax refunds year-to-date.
CapEx was approximately $12 million in the second quarter compared to $18 million in the first quarter. The only shipyard project schedule for the remainder this year is the MSS1 and we expect to finish it later this month. Once the project is done, the only remaining 2016 CapEx is the ongoing maintenance CapEx for the operating rigs under contract.
This concludes my comments, and I'll turn over to Andrew now to discuss the current market. Andrew?
Thank you, Steve. The second quarter of 2016 continued the trend of weak contracting activity in the offshore drilling spaces. While oil prices have recovered sharply from their lows earlier in the year, confidence in the recovery is still fragile and the pullback in prices from June highs could prove troublesome as we enter the 2017 capital budgeting season.
During the past quarter only about $600 million of new backlog was awarded in the jackup market, split more or less equally between standard and high spec unit. For established drilling contractors one positive aspect of the depressed market is that it's keeping most of the undelivered new-build jackups on the sideline, which is a trend that could continue for the foreseeable future.
It is important to remember that putting these new builds to work requires not only the financial payment to the yard, but additional cash in terms of spares, mobilization, crew training, and other elements that could easily total $20 million or more. In our view many of these speculative rigs may never enter the market because they'll become more and more impaired from a competitive and economic standpoint the longer they sit idle.
With so much availability among the existing jackup fleet and more cost conscious customers seeking to avoid the frustration of breaking in all respect new build rigs, there will be a very high threshold to meet in order to justify delivery of units still in the shipyard, particularly if the owner is untested as a real drilling contractor.
Now for a brief overview of developments in our key markets around the world. Starting in the North Sea, we're very pleased that we were successful in securing a new contract for the MSS1 with Nexen. While it is only a one well commitment, we're hopeful that they will exercise their options for additional well. The rig has worked for Nexen during much of the past three years and as rewarding to see that they continue to demonstrate confidence in Paragon's ability to consistently deliver safe, reliable and efficient operations.
In anticipation of the new contract the MSS1 recently completed a five-year SPS and associated repairs on time and under budget. Total capital expenditures for this project were approximately $7 million, much lower than many skeptics have predicted for over-floating unit and is a testament to the ongoing care and maintenance of Paragon fleet. We expect to commence the contract later this month.
Like the rest of the world the European jackup market remains challenged, with supply far exceeding demand. Complicating matters is the fact that numerous long-term HD-HE [ph] contracts are coming to an end with virtually no demand visible for HD-HE capability. These rigs are being forced to compete in the standard spec market.
The Middle East remains quiet for Paragon. We're continuing discussion with Abu Dhabi's National Drilling Company regarding the status of the M1162, but don't have any new developments to report.
Saudi Arabia remains bright spot in the industry as Saudi Aramco has generally maintained their jackup rig count and recently awarded some contract extensions at attractive terms. We view Saudi Arabia as a promising long-term opportunity for Paragon, and we're in the process of getting prequalified to work for Aramco.
We're also watching the Indian jackup market with guarded optimism as ONGC reportedly prepared to issue number of new jackup tenders.
Moving to Brazil, we have no new developments to announce at this time. Petrobras has moved forward with their plan release of the DPDS3 in accordance with their interpretation of the contract. We do not agree with this interpretation and will pursue all legal remedies available to us under both the DPDS2 and DPDS3 contracts. As you will know we remove the contested backlog from a reported total to provide a better overall view of our current commitments. We do expect that any dispute over the contested backlog could take substantial time to resolve in the Brazilian port system.
There's nothing new to report on the jackup market in Mexico and West Africa where activity remains very low. As a market downturn endure we continue to be driven to respond by focusing on what we can control, limiting downtime by maximizing operational efficiency, strategically reducing operating and capital costs, and streamlining business functions.
Year-to-date through July 2016, our fleet downtime was less than 1%, and in the month of July we have less than one half of 1% of downtime. As evidenced by our financial results, we have been successful in reducing our expenses in our head office, our shore basis and on our rigs.
Additionally, we have introduced several business process improvements that will result in continuing cost savings in the future. Across the fleet, these kinds of efficiencies are meaningful improvement. Moving forward, we will continue to drive cost inefficiencies of a business, but never at the expense of safety of our crew or the environment in which we operate.
And now, I will turn the call back over to Lee.
All right. Thanks, Andrew. Again, as I mentioned at the beginning of the call, we will not be hosting our normal Q&A session in light of our current status. But we would like to thank everyone for joining us on Paragon's second quarter 2016 earnings call and we invite you to join us again when we report our third quarter results in November.
Thank you and have a good day.
End of Q&A
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.
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