Pacific Drilling SA (NYSE:PACD)
Q4 2016 Earnings Conference Call
February 24, 2017 10:00 ET
Lisa Buchanan - Secretary, SVP & General Counsel
Chris Beckett - Director & CEO
Paul Reese - EVP & CFO
Michael Acuff - SVP, Commercial
Ceki Medina - Southpaw Asset Management
Mike Urban - Deutsche Bank
Gregory Lewis - Credit Suisse
Mark McCabe - KDB Investment Advisors
Mark Brown - Seaport Global Securities
Good day, everyone, and welcome to the Pacific Drilling Fourth Quarter and Full Year 2016 Results Conference Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to Senior Vice President, General Counsel, Lisa Buchanan. Please go ahead.
Thank you, Jenny. And welcome, everyone, to Pacific Drilling's fourth quarter and full year 2016 results conference call. Joining me on this morning's call are Chris Beckett, our CEO; Paul Reese, our CFO; Michael Acuff, our Senior Vice President, Commercial; and John Boots, our Senior Vice President, Finance and Treasurer, who is also responsible for Investor Relations.
Before I turn the call over to Chris, I'd like to remind everyone that any statements we make about our plans, expectations, estimates, predictions or other statements about the future including those concerning our future financial and operating performance, our earnings expectations and plans and objectives of management for future operations are all forward-looking statements that are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of future performance and are subject to risks and uncertainties. Our actual results could differ materially from any forward-looking statements made during this call due to a variety of factors.
For information regarding important factors that could cause our actual results to differ from our expectations, we refer you to our filings with the U.S. Securities and Exchange Commission, which are posted on our website. Also note that we use certain non-GAAP financial measures during this call. You will find the required supplemental disclosure for these measures, including the most directly comparable GAAP measures and associated reconciliation in our results news release which is available on our website.
I'll now turn the call over to Chris Beckett, CEO of Pacific Drilling.
Thank you, Lisa, and good morning to all of those on the call. At the last couple of earnings call, we stated that we believe that demand was showing signs of having dropped, albeit at very low levels and we continue to believe that the market is developing as we anticipated.
Michael will give more specific insight into our market view but suffice to say that we believe that we see signs of returning demand that should lead to an improvement of utilization of actively marketed rigs through 2018 and the recovery of pricing maybe as soon as 2019. This will be driven as it always has been by effective utilization of those assets actually being marketed, not by the total utilization including rigs that are effectively out of the market due to being cold-stacked or formally scrapped.
Now I have no doubt that some will consider our outlook overly optimistic, therefore we make these statements only after full consideration, constructive discussions with our clients, and a lot of analysis of the actual supply base. We're strong believers that older rigs that are cold-stacked are merely delaying the inevitable permanent retirement from the market. Some time ago we changed the description of our fleet from ultra deepwater to high specification floating rigs. This was a deliberate decision to recognize that water depth distinctions are increasingly redundant.
We see demand for our assets in all water depths and our drill ships have successfully operated in less than a 1,000 feet of water, upto 10,000 feet of water. The reality of today's floating rig market is the drilling efficiency, well depth, and complexity are the governing factors determining demand for specific assets and our fleet of self-generation rigs are increasingly the minimum requirement in all water depths. Global utilization levels of high specification floating rigs stands at about 71%, despite a growing supply base. While the utilization of lower spec rigs is below 50% despite a shrinking supply base which is in fact shrunk by over 140 rigs or more than 65% of the total since January 2014.
So it's clear that lower spec rigs are no longer desired outside of a few niche markets like the North Sea. As an industry we've all been focused on optimizing our cost structures for the downturn with each competitor making their own determination on how best to do that. At Pacific Drilling we've kept an eye on the future and made those difficult decisions with a view that we must be ready to respond to the recovery when it comes and we've refined our approach to cost management on that basis. At this point of the cycle we start to see investors worrying about the ability to redeploy idled rigs. So I want to address how we prepare for that at Pacific.
Over the course of this quarter's earnings calls we've seen analysts focus more on the marketability of the idle fleet and an increasing recognition the novel idle rigs are equal. We've even heard some of our peer management team suggest that they doubt there are smarter ways to manage idle rigs than the Old School Park and abandon approach. Notwithstanding that skepticism, it's clear that necessity is the mother of invention and all contractors with six-generation rigs facing idle time have tried to develop better ways to maintain those assets through the idle periods.
Historically drilling contractors have chosen to reclassify the idle rigs to laid up status by default; especially if they were expected to be out of service for an extended period. And they therefore put on hold the class survey requirements. For Pacific Drilling we have an enormous advantage of having managed the maintenance of our rigs differently from day one. We reimagine the asset integrity and maintenance systems that the industry has historically followed as part of our comprehensive approach to building a new contract. We were not locked into that this is how we've always done it mindset which allows us to take an approach that yields clear cost benefits through the lifecycle of the rigs.
Our approach to continuous maintenance rather than periodic approach taken by many of our competitors has resulted in much lower special survey costs without the typical out-of-service plan required for shipyard visits while still delivering competitive operating costs between surveys. We'd like to be completed our five-year SPS surveys on those of our rigs that have reached that age with no incremental added service time and limited to no incremental costs beyond the $1 million or $2 million required for the survey itself.
This approach also means that when we faced with idle time on our rigs, wherever possible we ensure all maintenance is up-to-date before smart stacking the rate [ph]. Hence we do not need to catch up on deferred maintenance to resume operations. In effect, we do not have to reactivate the rig since it's kept in a perpetual state of readiness and we maintain the in-operation class status. In fact we only elect to use laid out stages when faced with unavoidable delays in the necessary repair material or services.
The operating cost to do this is a modest premium to traditional stacking but yields the benefits of a hot rig at a fraction of the cost. By using our own stuff rather than third-party providers we both maintain the employment of our highly skilled workforce and reduce the cost of restarting operations dramatically. In Q4 2016 we proved this concept by restarting operations for the Total in the Pacific Scirocco after a period of five months since months back mode. The rig was DMO from operations with total made the full; down minutes of call crude complements and transfer to tannery for smart stacking. We've completed the transition to smart stacking only to be called back to work immediately when we began the ramp back up to operations on August 30.
Having remained the rig and completed maintenance requirements; we sell back to Nigeria to restart operations. The client total rebooted the raid on September 30 and after performing typical start of acceptance testing, the rig began drilling operations on October the 11, 45 days after the instruction to remove blinds the rig.
Pacific Scirocco then deliver the required well over a 65-day period with settled downtime from restart of 34 hours representing 98% plan. We're advised that this was the fastest well drilled and completed in the history of the field. The total cash cost of the idle period from May through September during -- including the cost of completing the five year SBS was only $16 million, this excludes the fuel for transit. That's in line with our previously stated small stack cost estimates. In other words, we believe that this proves the smarts that concept works.
We subscribe to the view that failure to maintain rigs on a continuous basis exclusive Reliance on third-party maintenance providers only manage ideal costs and idle periods and copes that he may require many months and high cost to reactivate a rig and achieve acceptance by clients. We're proud to have developed a smaller approach which minimizes costs, maximizes rig condition and enables optimal rig started operations with no major maintenance due for 24 months after that restart.
We're visits that this have been recognized during visits to both the Pacific [indiscernible] and the Pacific meltdown by potential clients. And after specific review of our stacking process and the status of our rigs, our smart-stack rigs have been included in tenders requiring effectively halt rigs. In conclusion, we believe that our focus on long-term cost management rather than minimizing the single quarter's cost positions, positions us well to maximize the benefit of our market.
Now turning to our results, our strong focus on revenue efficiency and cost management delivered almost 54% EBITDA margin in 2016. Our cost base continues to show the benefits of previous actions declining to $129,000 a day for operating rigs and $28,000 a day for smart-stacked rigs. We believe that this probably represents the full for operating costs and anticipate maintaining this approximate level for 2017. Paul will go into our financial results in more detail next.
With respect to our capital structure, we continue to be actively engaged with our banks and other lenders with a view to amending the terms of our debt. Earlier this year we obtained various waivers from governments with our bank lenders that should provide time to negotiate an acceptable outcome for all stakeholders. Our outlook anticipates 2017 and 2018 to be financially challenging due to weekday rates leading to breakeven cash generation excluding debt service.
So in a nutshell, our challenge is managing debt service against all liquidity until an anticipated cash flow recovery in 2019. How successful we will be in addressing these remains to be seen and we cannot rule out the option to use the Chapter 11 process to ensure that we emerge from this downturn as an even stronger competitor.
With that I'll hand it over to Paul.
Thank you, Chris. Good morning everyone. I'll begin by providing an overview of our fourth quarter financials before discussing our liquidity. Beginning with fourth quarter highlights our fleet of seven drill ships delivered another strong financial quarter with EBITDA of $92.9 million, and EBITDA margin of 52.2% which was driven by a record revenue efficiency of 99.2% and continued fleet wide cost saving measures. This represents our fifth consecutive quarter of 97% or greater revenue efficiency and 11 consecutive quarter of reducing operating costs on a per rig per day basis.
The net loss for the quarter was $43 million or $2.03 per diluted share. Contract drilling revenue for the fourth quarter decreased over the prior quarter by $4.5 million to $178 million. On December 9, 2016 the contract with Chevron was amended to change the contract end date for the Pacific Santa Ana from April 28, 2017 to January 31, 2017 in exchange for a fee of $35.2 million. This fee was recognized ratably over the remaining term of the amended contract.
On December 17, 2016 Pacific Scirocco completed all contractual obligations for Total which resulted in our recognizing revenue at 80% of its day rate of $489,000 for the remaining contractual days. The revenues for fourth quarter 2016 benefited from the Pacific Santa Ana contractual amendment, the Pacific Scirocco of contract completion and also from an overall 2.2% improvement in revenue efficiency during the quarter. These revenue increases were more than offset by the completion of the Pacific board contract on September 27, 2016.
Operating expenses for the fourth quarter totaled $66.5 million including $3.4 million of reimbursable expenses, $7.2 million for shore base and other support costs and $4.1 million in amortization of deferred expenses.
Direct rig related daily operating expenses for the three operating rigs, excluding reimbursable cost average $128,900 per rig in the fourth quarter 2016, which compares favorably to $130,600 for the third quarter 2016. Direct rig related daily operating expenses for the Pacific Bora while on standby in anticipation of the fossil contract, which commenced in early February 2017 averaged $88,000 in fourth quarter 2016.
Direct rig related daily expenses for the three non-operating rigs averaged $27,800 per day for rig, during the quarter compared to the average of $32,800 or third quarter 2016. These daily expense figures for both the operating and idle rigs represent record low levels for the Pacific drilling fleet.
General and administrative expenses came in at $18.9 million an increase of $3.7 million from the prior quarter. Primarily as a result of increased legal advisory costs, excluding the legal costs associated with the arbitration proceeding and patent litigation and legal advisory expenses related to our ongoing debt restructuring efforts, our corporate overhead decreased $6.7 million year-over-year as a result of our cost saving measures.
Interest expense for the fourth quarter was $51.5 million compared to $45.9 million in the third quarter of 2016. The quarter-over-quarter increase was a result of the drawdown of the remaining availability under our 2013 revolving credit facility.
Income tax expense for fourth quarter 2016 was $14.5 million compared to $4.3 million for the prior quarter. Primarily as a result of applying the full year 2016 tax provision based on our actual operating results. Full year 2016 tax as a percentage of revenue was in line with our expectations at 2.9%. We have updated our investor tool kit which is post on our website under investor relations in the section titled quarterly and annual results.
I will now turn to our liquidity. Cash flow from operations for the fourth quarter was $40.7 million. Bring in the full year 2016 cash flow from operations to $249.1 million. As of December 31, 2016, we have $586 million in cash and cash equivalents and $40.2 million in restricted cash pledge to the lenders and our senior secured credit facility as task collateral.
Subsequent to year end 2016. The 2013 revolving credit facility and SSCF [ph] were amended to waive the leverage ratio covenant and modify the net debt per rig cabinet for the quarter's ending March 31, 2017and June 30, 2017 under both facilities. And a way of the loan to value covenant on the next valuation date of June 30, 2017 under the SSCF [ph]. In consideration, we currently repaid $25 million under the RCS and apply $31.7 million of cash collateral are already pledged to the SSCF lenders against the next principal installments do under this facility in May 2017.
The amendment to the RCF also restricts the company's ability to grant additional liens to refinance certain existing indebtedness, and to change certain terms of existing debt during the waiver period. Concurrently with the execution of the amendments in accordance with our obligation to maintain the loan to rig value covenant in the SSCF at the required level as of December 31, 2016 we made a $76 million prepayment of this facility. These waivers with our bank group allow us to continue to have a constructive dialogue with our stakeholders regarding an appropriate capital structure. We continuing to engage with our bank lenders and note holders, recognizing there's still a lot of work to do.
And with that I will turn the call over to Michael.
Thank you, Paul; and good morning everyone. As we start the New Year the high specification floating rig market continues to experience challenging times with intense competition for work in a weakening they rate environment. That we believe this will continue for the remainder of 2017 we're starting to see signs that the market has reached a low point with respect to demand for our assets. In the first two months of the year the number of inquiries for rig programs has increased significantly, many of these opportunities continue to be per work in 2018, but are an early indication that projects are starting to move forward and capital will eventually be redeployed into the offshore deepwater space.
As we've stated before, all price stability not just price is the key signpost to watch for most of our customers and with the $55 per barrel pricing ban holding over the past few months. Customer sentiment is beginning to turn. Additionally, analysis shows that as expected, we should begin to experience an oil supply deficit in the second half of 2017 which would further support the commodity price going forward. We believe the supply deficit is now starting to reveal itself but has been in the making for the past few years, due to a lack of capital investment in exploration and the deferral of significant development project approvals.
Many analysts and customers have been focused on the near-term attractive returns of the shale plays. However, even with their prolific results we believe they will only provide a fraction of the required supply in the next few years to meet the consistently growing global demand. In fact, we project a 5 million barrel per day supply gap in 2018 that could grow to 14 million barrels per day by 2020. If that is the case even an aggressive projected increase of 1 million to 2 million barrels per day of production from shale will only make a small contribution to meeting that requirement. This would require that production grows as fast, if not faster than the last up cycle where shale produced 4 million barrels per day after a five year build up.
We believe that is all companies move out of their core 30% to 40% of their holdings into more marginal wells and higher costs flow back into the supply chain, we will see the rate of production increase begin to slow. Therefore, we believe the offshore space will gain momentum but being both cost competitive and a significant source of future production. Though this should be positive for the rig demand side of the equation, there's still work to be done on the supply side. With respect to the offshore fully, we currently remain oversupplied as an industry. But when you begin to dig a bit deeper into the numbers and analyze the market it high specifications loading fleet that is currently competing in the marketplace, you realize that many observers generically include the currently cold stacked rigs in their analysis; therefore overstating the supply side.
We look at that a little differently and know that effectively there are only about 25 to 35 high specification rigs, that are truly being marketed and currently competing in tenders, we believe that only hot or warm stacked rigs will be considered in the near future and that currently cold stacked rigs will have to endure years before they return to the market. When you compare the number of marketed rigs to the visible opportunities we see in the market for 2018 and beyond, this supports our thesis that we will see a return to balance in 2018 for high specification rigs that are currently active hot or warm stacks. This then leads you to the potential for pricing increases as early as 2019 as customers and contractors evaluate the economics of higher day rates, versus investing significant capital into a cold-stacked rig and assuming the start-up risk that comes with that.
Turning to our fleet activity, the Pacific Bora has recently begun its two well contracts in Nigeria with follow EU [ph] Services Ltd with the potential for an additional Well option well to be exercised. Additionally, we believe that there will be follow on work for the rig in Nigeria that could utilize the rig through the first half of the year and into the third quarter. The Pacific Scirocco is currently standing by in Ivory Coast in preparation for its upcoming hybrid dynamics program offshore Guinea, which starts in early April. As we've previously announced this contract is for one firm well with three option Wells initially expect to take 60 days but have the potential for lasting up to 240 days for the total program.
We are also participating in opportunities that could use the Scirocco following the hyper dynamics project and extended through the end of 2017. Pacific Santa Ana's currently high stack off shore Louisiana, after recently completing its initial long term contract, the recruits performing preventive maintenance and preparing to rig for its next opportunity. We currently see a couple wells in the market that would begin in the second and third quarters of the year that this year that the Santa Ana would be a candidate to drill.
Finally, the Pacific Khamsin and continues to be smart stacked off Cyprus, where we are marketing her for future opportunities in the eastern Med, we expect a start date for these projects are in the second half of 2017 and early 2018.
With that I will now turn the call back over to Lisa.
Thank you. Operator, we'll now open the call to questions.
Thank you. [Operator Instructions] We have our first question from Ceki Medina of Southpaw Asset Management.
Good morning, thank you very much. Just a quick question on your view on rig demand going forward what percent of rig demand would you expect to come from exploration versus development in the next few years.
You know we can see probably like 15 to 20 projects from a development standpoint. It's difficult to say because there's been a real lack of exploration over the past three to four years. So we think there's going to be significant exploration coming up and we see that already in the market, to put a percentage on it you know I think it's probably 40 exploration and 60 development, if I had to put a number on it but that's difficult to say at this time.
I'll answer to that, that would be fairly consistent with history, the reality what we've seen today is the development opportunities begin to go forward as some of the larger players get more comfort with the idea of moving the projects. The exploration focus right now is really with much smaller companies who both may be less physical players in the space but also able to move much quicker. So they tend to sort of come to the market in fruition much faster, it is a little hard to forecast exactly how it will shake out.
And as a reminder it is star one to signal for questions at this time. That is star one. And we'll hear next from Mike Urban of Deutsche Bank.
Good morning. I don't know how much you have the luxury of thinking kind of longer term and what the marketplace looks like down the road and how much is just a let's make it to the next month and the next year but you know clearly you know if and when you're able to kind of work through your capital structure issues and as the market begins to recover, I think everybody would agree that it doesn't look much like the market when you put the company together a number of years back. I guess the question is how do you see that marketplace longer term from the perspective of a company of your size, you think given that you know you have the you know a very high quality asset base that you know there's still a niche for a company of your size and your focus or is it just there's overarching need to consolidate you know across the space to really ever make this a kind of healthy marketplace again and recognizing it's difficult to answer but just be interested in your thoughts on what this all looks like at the end of the day.
Hey Mike, I will give you some thoughts one that. The good thing about strategy is it doesn't change week to week, and our strategy has always been that there's an optimal size that is 10 to 12 rig company that allows you to be as effective and efficient in service provision as you can be with the best managed costs and so on. I don't think that's changed and I don't think in a general sense is that any less valid now than it was nine years ago when we -- when we started. Clearly the market has been through a couple of interesting cycles is we since we first founded Pacific Drilling and started this journey and the only thing we know we certainly every day brings a new challenge, but our general view of what's the right strategy in the space hasn't changed, if that answers the question I think that our view is yes the market changes but not to the point where our strategy should change.
Okay, that was all for me, thank you.
And we'll take our next question from Gregory Lewis of Credit Suisse.
Hey morning everybody. Just going back to the Santa Ana you know potential opportunities, I mean that was the rig that has the door gradient drilling package, is that is that part of the reason why maybe there could be some opportunities there, is a more just is are should I say that functionality on the rig sort of part of the driver whether there could be some opportunities or is it more just the location of the rig where it is.
Greg, its Michael it's more about the location is not really a DGD opportunity, it's just you know there's an opportunity in the Gulf and now we're seeing some and Brazil and so you know its more rounds geography.
Mike's right, we are not anticipating seeing DGD specific opportunity but the interesting thing about the upgrades we put on rigs to be able to do DGD is it makes it extremely capable for all sort of other things, it is a rig [indiscernible] more pumping capacity than almost any other rig in Gulf and Mexico, it's a very high specification rig outside of its capabilities.
Okay, great. And then just since you guys mentioned much in Brazil. I mean I guess there is some positive news that came out just two days ago now, on sort of the local content. Are the lack of need for local content it in that market. You know I mean clearly you've been in Brazil before or not or not there at the moment. How do you as you think about you know the opportunities in Brazil maybe from non-Brazilian companies. You know, any sort of use on that and more importantly I guess is there any sort of time of potential opportunities down there is that is that you know a twelve month potential or is that more like a while longer two, three, four year opportunity.
Well, I think when you look at it it's a couple of different segments. When you talk about international companies I assume you mean operators. And so we're now starting to see a few of the operators have some interest in starting up some four to five well programs right. And I think those are near 12 to 18 months' time frame, from a [indiscernible] standpoint you know we still believe it may be a couple years it's further in the future. We don't see anything really immediate with respect to us but I think the international oil companies are going to really be the trigger that comes in and be the early entry guys to kick things off here in the market down there. I mean I by no means are we seeing a huge wave or anything is just some activity starting now which like I say over the next 18 months we expect to progress.
Great. Okay guys, thank you very much for the time.
[Operator Instructions] And we'll hear next from Mark McCabe of KDB Investment Advisors.
Thanks for taking my call. I have one quick question. You guys are about $600 million of cash in your balance sheet and my understanding that you guys have -- somewhat -- what you can do with the cash? To certain extent I mean -- are you able -- if want to, could you go out and buy back some of your debt on the open market or can't you do that?
Yes, I can take that Mark. Yes, I think in theory we could go out and buy some debt on the open market. Not a lot but I don't think it's something that we are currently considering doing here in the near term. Right now as Chris indicated in his comments, though we have quite a bit of cash, you know the market for the next year and a half two years is going to be very challenging from additional cash flow generation, we have more than enough cash to handle the operating needs we have but we have a lot of needs from a debt service standpoint, and that's what we're currently working through. So at this point liquidity is king and keeping all the resources we have available to us to see us through that is priority.
So you guys have $475 million due this year as I believe in December and as you were trading right now, but I mean there was trading -- trading somewhere $1.50 I mean -- I mean you guys could theoretically actually put a big debt in that debt and then push back a maturity wall for you for at least a year or so, but I thought that something you think of doing.
Well, actually that would push back if we took care of you know in that theory the entirety of the 2017 maturity which is about $440 million left. We don't have the maturity of the 2018 TLB in mid-June of 2018. As well as the maturity of our revolving credit facility, so that and totals another $1.2 million plus. Utilizing a significant amount of cash to take care of a maturity that is buys us five to six months of runway is not a very attractive thing right now. And so that's why we're looking at the entire structure and seeing what we need to do to really expand as a runway to the ultimate return into 2019 or 2020 and beyond. It's not about just seeing us through mid-eighties.
Okay, thank you.
And our next question comes from Mark Brown of Seaport Global.
Hey guys I just wanted to ask a couple quick questions. What's the status of the Pacific on the arbitration proceedings, I think you had spoken in the past that might take a while they work through but at the end of the day you felt pretty confident that you claw back some of the capital that you put in the rig.
Yes, Mark I don't think that fundamentally it would change much but it is going to take a while to get there, and we don't say too much about it at this point but it's progressing and our outlook hasn't really changed.
Okay, it's also curious if you could talk a little bit about the Gulf of Mexico floater market. What sort of breakeven oil price would start to stimulate some new interest from deepwater drillers and sort of where that breakeven is today, where you see that breakeven going in the next 12 to 18 months.
You know Mark I think this is one of those how long the piece strength questions, it's it really does depend on the project in way on the well. Gulf of Mexico we're told by clients of the they believe that they can be economical on their most attractive prospects of $40 to $45 a barrel, that's not a by any means a weighted average and it point the weighted average is probably $55 to $65 and it's a relatively broad range of that depends very much on how much infrastructure is already in place. And the well as and obviously dependent on if everything goes perfectly during the development process, it's a lot less expensive than if you had any smack.
So I think what all of that really means is we're starting to see people look at where they should spend money, but we're still a little ways off them committing to do so, I think the most attractive regions of the world right now from a deepwater economic standpoint as we understand is the African trends well margins is it is relatively deep water, shallow wells and they're all relatively inexpensive well, they're economics are coming in at $35 to $45 a barrel and so that stuff's in the money now, which is why we're seeing what an uptick in interest in exploration in that part of the world. Gulf of Mexico is kind of meant packed in terms of pricing I would say today.
Okay, good. Well, thank you very much.
Thank you, Mark.
And this time there are no further questions in the queue. And ladies and gentlemen, that does conclude today's call. We do thank you for your participation. And you may now disconnect.
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