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PACIFIC DRILLING S.A. (NYSE:PACD)
Q4 2019 Earnings Call
Mar 12, 2020, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Hello, and welcome to the Fourth Quarter and Full Year 2019 Results Call. My name is Dan, and I will be coordinator for today's event. [Operator Instructions]

I will now hand you over to your host, Lisa Buchanan to begin today's conference. Thank you.

Lisa Manget Buchanan -- Senior Vice President and General Counsel

Thank you, Dan, and welcome everyone to Pacific Drilling's fourth quarter and full year 2019 earnings call. Before I turn the call over to Bernie, I would like to remind everyone that any statements we make during this call about our plans, expectations, estimates or predictions about the future, including those concerning our future, financial and operating performance, our earnings expectations, our beliefs and estimates regarding our relative valuation in the market, our market outlook including our views of future contract dayrates and our business strategies and plans 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 our actual results could differ materially from any forward-looking statements made during this call, due to a variety of factors, including those described in the Risk Factors section of our 2018 Form 20-F and other filings with the U.S. Securities and Exchange Commission, which you can find on our website.

You should 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 earnings release, which is available on our website.

I will now turn the call over to Bernie Wolford, Chief Executive Officer of Pacific Drilling.

Bernie G. Wolford -- Chief Executive Officer

Thanks, Lisa, and good morning, everyone. Welcome to our fourth quarter 2019 earnings call. I sincerely appreciate your participation today. Joining me in addition to Lisa are Jim Harris, our Chief Financial Officer and Michael Acuff, Senior Vice President of Commercial. Michael is out of the office since, Jim will be covering the marketing portion with Michael available for Q&A.

These are extraordinary times. The coronavirus outbreak has caused significant disruptions in the daily lives of millions of people, as well as impacting international economies and financial and all markets. We are actively monitoring this evolving situation with our highest priority being the health and well-being on our employees, both offshore and onshore. We are addressing this through a number of mitigations and preparations, while continuing to focus on delivering exceptional services to our clients.

I will now provide an update on our business. First, the Pacific Khamsin returned to work starting a new contract with Equinor in the U.S. Gulf of Mexico. The crew and rig have performed incredibly well and demonstrated that we can return a smart-stacked rig to active service with performance more typical and hot grade. Our safety performance has been exemplary with good revenue efficiency. Two aspects of our work that are critically important to our clients. Our reputation for operational excellence and customer service supported the establishment of a new relationship with Murphy Oil and securing work for the Pacific Sharav in Mexico, both are new clients and a new country of operations for Pacific.

On the topic of new country operations, our work for ENI Oman with Bora is progressing well, further building the Bora's reputation for delivering solid performance across a broad swath of the globe. As announced in January, we were surprised and disappointed with arbitration tribunal's decision related to the contracting of the Pacific Zonda.

As previously disclosed, our two subsidiaries involved in this -- in the dispute [Indecipherable] have filed an application for permission to appeal the decision in the High Court in London. Separately, we are pleased to have secured the recently announced $50 million revolving credit facility, allowing us the financial flexibility to pursue new opportunities as we bolster our balance sheet.

Turning to the market for our fleet of sixth and seventh generation drillships, although our discussions with current and prospective clients remained constructive and the number of opportunities before us are unprecedented in recent times, we are clearly in a period where global equity in all markets are impacted by ongoing disruption related both to the novel coronavirus and the associated displacement in all demand and pricing, as well as market changes related to OPEC production and supply.

To provide context regarding open demand, in the fourth quarter, we received 11 new tenders or bid opportunities as compared to the same period in the previous year when we received seven new tenders. More importantly, since the start of the year, we have received eight new tenders and another eight requests for information, several of which are longer term, representing a very strong start of the year. Recognizing that our clients may moderate their plans in lot of emerging events, this tender inflow is nonetheless a relative positive.

Turning to liquidity, at the end of the fourth quarter, our unrestricted cash balance was $279 million. This, plus our $50 million revolving credit facility allow us to continue to pursue additional rig contract opportunities, while we exercise an appropriate level of discipline. Turning to the recent meltdown in market cap across the offshore driller space, it is clear that confidence in this sector has eroded. For our part, we remain focused on delivering exceptional service to our clients, while providing a safe workplace for our crews and creating value for our shareholders.

We are actively pursuing a number of important contract opportunities with the potential to meaningfully build backlog. We have implemented coronavirus-related risk mitigations and prepared for a number of scenarios which might require temporary office closures or rig side case management. We have actively worked these scenarios internally with each of our clients. At present, all our active rigs are progressing their respective well programs and each have adopted measures to preserve our ability to continue to do so. All-in, we progressed on a number of important fronts in 2019. Most notably, putting four rigs to work for clients across the globe, while acting to strengthen our balance sheet.

I want to remind our listeners that to continued diligence, dedication and performance of our excellent rig crews and their unwavering commitment to safety are the key to our current operational performance and directly responsible for opening doors to new clients and future contracts. I thank each and every one of you for delivering on our mission, to exceed customer expectations by delivering the safest, most efficient and reliable deepwater drilling services in the industry.

I will now turn the call over to Jim for a review of our fourth quarter results.

James W. Harris -- Chief Financial Officer

Thank you, Bernie, and good morning, everyone. I will provide more details on our fourth quarter results, give guidance on our outlook for 2020 and provide context on actions we are taking to further strengthen our balance sheet to bridge the positive free cash flow. The Khamsin commenced work for Equinor in the Gulf of Mexico in December and the Santa Ana started back working for Petronas in Mauritania, also in December. The Sharav continued its long record of service for Chevron in the Gulf of Mexico, achieving consistently high revenue efficiency levels. The Bora also mobilized in the fourth quarter to Oman to start working for ENI in February.

We achieved fourth quarter revenue of $33.1 million at the low-end of our guidance and down $1.2 million from the third quarter. The decrease in revenue resulted primarily from the Sharav coming off its higher legacy dayrates at the end of August and continuing to work for Chevron at lower current market rate. The Santa Ana was also off hire for two months returning to Las Palmas temporarily for a full thruster exchange and other maintenance projects. These decreases in revenue were partially offset by the Khamsin's commencement of contract operations.

Our operating expenses in the fourth quarter of $63.3 million were in line with our expectations and up $2.9 million from the third quarter. The sequential increase in expenses was attributable to the maintenance cost on the Santa Ana, while transitioning from work completed in the third quarter with Total to the start of operations with Petronas in the fourth quarter.

We deferred $15.5 million in cash operating cost incurred in preparation for contract fulfillment on the Bora and Khamsin, as required under the new revenue recognition accounting standard. These costs will be aided by an operating expense over the associated contract terms. Our shore based ops and operations support costs were $6.8 million for the fourth quarter, slightly higher than the third quarter.

Total general and administrative costs came in lower than our estimates at $8.2 million and were lower sequentially by $700,000. Our adjusted EBITDA for the fourth quarter was negative $36.8 million, which is about $1 million unfavorable compared to our estimates, represents a decline of $23 million from the third quarter as anticipated from the changes outlined in revenue and operating expense. Capital expenditures for the fourth quarter were $4 million including $2.2 million for sustaining items and $1.8 million for rig enhancements.

We closed the fourth quarter with $278.6 million in unrestricted cash as compared to our September 30, 2019 balance of $355.9 million. The use of cash in the quarter of $77.3 million primarily funded the adjusted negative EBITDA, the semi-annual October cash interest payment, deferred contract preparation expenses and capital expenditures, all offset by a reduction in net working capital.

While the tribunal's decision related to the Zonda arbitration was negative, we have always planned our base case cash flow expectations exclusive of any Zonda outcome. The Zonda loss recognized in the fourth quarter of $217.6 million is a non-cash charge. The two subsidiaries that were party to the arbitration are not included in our consolidated financial results as both companies remain in bankruptcy. As a result, the $4.5 million of cash held by these subsidiaries has not been included in the consolidated balances that we have been reporting.

While we have filed for the right to appeal, our liquidity planning is unaffected by the tribunal's decision. In February 2020, we closed on a $50 million first-lien super-priority revolving credit agreement. This three year facility will provide us with added financial flexibility over its term as we continue to invest and to put our rigs to work. As we look ahead, to deal with the increased market uncertainty caused by coronavirus concerns, we are exploring avenues permitted under our bond indentures that might further increase our liquidity, including a possible capital lease facility of up to $50 million.

In the first quarter of 2020, the Sharav will operate with Chevron for the full quarter. The Bora went on contract with ENI for one well in Oman in February that should last at the end of the quarter. The Khamsin commenced work in the Gulf of Mexico in December and is completing its first well with Equinor before moving to work the next well for Total. And the Santa Ana is working now with Petronas in Mauritania, which is anticipated to last into the fourth quarter.

This quarter is the first time in over three years that the company has had four rigs operating at the same time. With these fleet status changes, we expect first quarter 2020 revenue to recover to be between $83 million and $90 million. First quarter operating expenses should be between $90 million and $95 million, up from the fourth quarter levels with increased operating days under contract and lower amounts of cost deferred. Operating expenses for the year should be within the range $325 million to $345 million.

Operating loss includes amortization of deferred revenue and deferred cost, the net amortization expense is expected to be around $6 million in the first quarter and about $12 million for the full year 2020. We expect first quarter general and administrative expense to be approximately $9 million and cash income taxes around $2 million. Depreciation and interest expense should be in line with fourth quarter results.

For the year, cash income taxes are estimated to be approximately $11 million. Sustaining capex for 2020 should be approximately $21 million. And with the final installment on the MPD system installed on the Khamsin in 2019, total capex for the year should be about $56 million [Phonetic]. For the first quarter, sustaining capex should come in about $4 million. The average contract base dayrates for our four operating vessels in 2020 excluding third-party infraservices including our MPD services is approximately $190,000 a day.

As we roll-off legacy dayrate contracts negotiated near the bottom of the cycle, we expect our base dayrates in 2021 to average closer to the mid $200,000 range. If we are successful putting our premier vessel Meltem to work and with five rigs working in 2021, the required dayrate to achieve enterprise level breakeven free cash flows is approximately $255,000. We anticipate reaching or at least approach these levels in the second half of 2021.

The Meltem left anchor in Las Palmas on March 1 and is currently moving to the Gulf of Mexico. We have commenced a soft ramp-up of the vessels by ordering long lead items and start the work on reactivation. Once we have a contract for the Meltem, the total cost to put the vessel into a ready-to-drill state with fully trained crew will be approximately $50 million. In the absence of a suitable contract, we plan to anchor the vessel in the Gulf of Mexico where the stacking costs will be less than leaving the ship and anchor in Las Palmas. And we expect that we'll likely work in the Gulf given the [Indecipherable] vessels.

The cost estimates includes operating expenses for prudent fuel, casual major maintenance projects and destocking necessary supplies on board. We also anticipate the working capital build during the year of approximately $15 million due to the higher activity levels. We have posted our 2020 earnings guidance in the Results section of the Investor Relations tab on our website.

In closing, the fourth quarter was about positioning our fleet for success in 2020 and beyond. The investments we have made in our vessels and operations are expected to yield improving results through the year, enabling the company to inflect positive free cash flows by mid-2021.

I will now move on to marketing section. Given the last few days, there is a significant amount of uncertainty with respect to the impact of the recent oil price drop will have on the market and how long we will fold the effects. We will have to wait and see over the next several months. But prior to this event, the market was continuing to strengthen in the high specification drillship space on its road to recovery.

We continue to see several positive trends develop as dayrate fixtures are solidly in the 200s for the first half of 2020 to serve markets posting rates from $225,000 to $240,000 per day. The tendering pace for the second half of 2019 resulted in a total of 27 drillships tender issued and remained strong going into 2020, averaging five new opportunities for us.

We continue to see more programs with durations of one year or more come to the market with 2021 start dates. Currently, there are several longer term programs outstanding, including Murphy, U.S. Gulf of Mexico, Equinor Brazil, Petrobras Brazil, Total Nigeria, ExxonMobil Nigeria with the few others scheduled to come to mark later this year.

Turning to the supply, for the sixth and seventh generation drillship segment, we see effective utilization of the market fleet improving from 86% to 91% since our last call with 70 high-spec drillships on contract as of February 2020. This number consists of 40 seventh gens and 30 sixth gens with three and four market units available respectively. As we look forward through 2020 that remain, this 4.1 rig years available to the marketed fleet for the year. With the predicted increase in demand based on current outstanding opportunities, we expect the high-spec drillship market utilization to remain over 90% in the foreseeable future.

Looking at the demand this past quarter, we received 11 new tenders, representing 8.4 rig years of firm work and 6.8 years of associated options as compared to the third quarter when we received 14 new tenders, representing 7.1 rig years of firm work and 9.9 years associated options. In addition, in Q4, we received 10 RFIs or request for information for contemplated drilling programs compared to 19 RFIs in Q3. We currently have 28 high-spec drillship opportunities in the active procurement stage compared to 26 last quarter and -- with 14 scheduled for 2020 starts and 14 planned for 2021.

Looking at the individual high specification markets around the world, Southeast Asia remains a balanced market today with only few units having availability in 2020. With five visible opportunities in the market, four starting in the second half of 2020 and one in 2021, we anticipate this region to remain strong with the likelihood of additional rig or two mobilizing to the area to satisfy predicted demand.

In the Mediterranean and African region, we see our four marketed high-spec units, plus a couple of potential farm-out rigs currently competing for new work. Though there is a current oversupply, we see this market continuing to slowly improve with eight new opportunities for starts in 2020. Forecasting the timing for these programs is always a challenge, particularly for West Africa, demand in this region is expected to increase in 2020 and 2021 with several term programs scheduled to kick off in Nigeria, Angola, Mauritania and Ghana.

In South America, Guyana, Surinam, Colombia region remained strong with the predicted demand for five to six rigs on a continuous basis later this year and into 2021. Additionally, Brazil is slowly moving forward with its recovery in activity. Petrobras is currently out with two opportunities for up to two high-spec drillships each, which is in line with the expectation of an incremental four to six rigs over the next 12 months.

For the most recent high-spec drillship tender, Petrobas is prepared to contracting rigs for up to three years, each of which is positive to see that the longer term commitments and with respect to the markets. This region [Indecipherable] from the international oil companies such as ExxonMobil and Equinor reinforce our long-term positive view for future deepwater activity in Brazil. We see the Brazilian market in balance now with all of the contractor space fully utilized.

We expect all new opportunities to be fulfilled by international contractors, mobilize rigs into Brazil which should help balance the global supply demand and a privilege to the Brazilian market.

Finally, turning to the U.S. Gulf of Mexico, the region remains the tightest deepwater basin globally, only a few rig months available for the remainder of 2020. With the developing demand we see in the U.S. and Mexico for 2021, if that oil price can return to more stable levels at $55 to $65 per barrel, we believe demand will remain strong in the region and dayrates can maintain their current level at $220,000 to $240,000 per day.

Turning to our fleet update, we are excited to announce the Pacific Sharav contract with Murphy Mexico for two firm wells plus an option well, starting in November of this year that's $230,000 per day. This will be our first contract with Murphy Oil Company, as well as our first opportunity to drill in the developing and promising Mexican deepwater market. We're very excited about this opportunity to solve future relationships with Pacific Drilling.

Operationally, the Sharav has recently began drilling on the third well, including well contract extension Chevron in the U.S. Gulf expected to last until at least early May. Currently, there is a projected five month gap for the rig before starting the Murphy Mexico work, and we are pursuing opportunities with a couple of contractors to secure at least one well. Let me say, though we are sad to see Sharav's long and successful secure run with Chevron end, we are very excited for the rig to start a new chapter working for a strong deepwater player like Murphy.

Moving to the Pacific Khamsin, it continues successfully drilling the initial well of the three firm wells plus one well option contract with Equinor in the U.S. Gulf of Mexico. We expect to complete this well some time later this month and move over to spud Total's South Platte exploration target. Based on the current schedule, we expect the rig to be occupied until at least October 2020 with one additional option remaining on the contract.

The Pacific Santa Ana continues its stellar work on Phase 2 of the Petronas' permanent abandonment program in the Chinguetti Field. As stated, before this program -- this program should occupy the rig through most of the year with options for two additional wells with Total on the scale. The Pacific Bora is currently drilling the first deepwater well in Oman for ENI, which is expected to last until the end of this month. As you may recall, the ENI Oman contract includes a $5 million paid demobilization plus fuel costs that allows us to return the rig to a location of our choice.

With respect to the smart-stacked rigs, we recently made the strategic decision to mobilize the Pacific Meltem to the U.S. Gulf of Mexico and it is currently under way to the region. Being our highest specification unit and one of the latest generation drillships in the world, we believe it will be very competitive in this strategic market going forward. With our proven ability to reactivate our smart-stacked drillships, as seen with the Khamsin, we believe that the Meltem will be a very attractive alternative for customers who need the highest technical capabilities that only come with a top-tier drillship. Our priority remains to secure work for the Sharav, after which, the Meltem is our next available rig.

Regarding the Scirocco, currently in Las Palmas, we see several longer term opportunities in West Africa, for which it should be a great fit and we'll bid accordingly where it makes sense both strategically and economically. Mistral all is also smart-stacked in Las Palmas where we are continuously evaluating strategic opportunities. Currently, there are no market opportunities that justify reactivating the rig, so we continue to focus on minimizing costs, while preserving optionality.

In summary, prior to the last few days, we were excited by the developments in the deepwater market and the improving outlook for 2020 and 2021. However, we, like most in the market, will be watching keenly the future price of oil and how our customers react to both the recent drop in price, as well as the expected decrease in demand from the coronavirus pandemic. These are clearly unique times and we remain vigilant in our analysis of an adaptiveness to the changing market conditions.

With that, I will now turn the call back over to Bernie.

Bernie G. Wolford -- Chief Executive Officer

Thanks, Jim. In closing, we remain focused, opportunistic and disciplined in our execution and strategy as we navigate the challenges before us to a person we are committed to delivering the value that Pacific Drilling uniquely represents.

With that, I will now hand the call back to the operator to build the queue and open the call for any Q&A.

Questions and Answers:

Operator

Thank you, sir. [Operator Instructions] And we do have our first question in the queue. The first caller is Devon Xu from Wells Fargo. Devin, when you are ready, please go ahead.

Devon Xu -- Wells Fargo -- Analyst

Hey guys. Thanks for taking my question. Congrats on the new relationship with Murphy. I just -- they also mentioned that they were cutting capex in the region. I guess, could you comment on given that news what the opportunity is for potential further contracts after that?

Michael D. Acuff -- Senior Vice President-Commercial

Yeah, Devin. Hey, this is Michael here. I would say that obviously it's very early, the news was just out this morning. We have the contract for Mexico with them that we announced today. We are in discussions on potentially other potential contracts or work that they have in the future. We'll have to analyze that and see where they are there. But my guess is it would probably push work to the right a bit, if that's the case. But we again, have to have those discussions.

Devon Xu -- Wells Fargo -- Analyst

Got it. And then with the Bora and ENI, what are the -- I guess, what are the chances that it continues work given the high uncertainty right now?

Michael D. Acuff -- Senior Vice President-Commercial

Well, so when we finish this well, as we said in our comments, we'll be mobilizing the rig. We're currently in discussions on a couple of opportunities there. We can't really comment at this time on that. But I will say that you've probably got at least 30 days of mobilization regardless of where we take the rig. So we'll hopefully update you in the near future on contracts.

Devon Xu -- Wells Fargo -- Analyst

Got it. And then in terms of the Meltem, is there larger step-ups throughout the year, largely because of the expenses related to that? And kind of what daily expense are you expecting for that rig?

James W. Harris -- Chief Financial Officer

So on the Meltem, we are -- we have ordered long lead items as we talked about and we're doing some basic reactivation. But we won't enter into a full reactivation and include those costs in the estimate. So it would be 24 activations, the cost is [Indecipherable] investment, but that will be all inclusive of the operating expenses for the crew, the trucking, major maintenance projects, sustaining capex and we would do all major maintenance projects that would be -- that we'd otherwise have to do in the term of its initial contracts so that would be no interruption to the revenues. There is some acceleration there. And also restocking all the supplies on the vessels so that it's in the ready-to-drill state.

Devon Xu -- Wells Fargo -- Analyst

I guess, previously the kind of estimate was maybe $40,000 a day in expenses. As it moves to the Gulf of Mexico, does that go up as it's getting semi-ready for work?

Bernie G. Wolford -- Chief Executive Officer

We expect the cost to be roughly $40,000 a day here in the Gulf of Mexico. They may be slightly lower, but in that column. And Devin, if you don't mind I'll have to limit you to one more follow-on question as we have others in the queue.

Devon Xu -- Wells Fargo -- Analyst

Absolutely. The final question is just on the current spot market. What do you guys think that dayrates look like given the uncertainty? Is there a risk that the spot market will be significantly weaker?

Bernie G. Wolford -- Chief Executive Officer

I don't think we have measured that as we speak today because the situation has evolved incredibly quickly over the last week. The only real indication we have is our recent fixture for the Sharav with Murphy in Mexico. And I'm sure that many will be watching this space to see what the near-term impacts are. But in the very near-term, I think we may see a quiet period. While our clients consider the forward spend, before we really see what the indication is of future spot rates.

Operator

And our next question on the phone comes from the line of [Indecipherable] when you're ready, please go ahead.

Unidentified Participant

Thank you very much. Can you hear me well, gentlemen?

Bernie G. Wolford -- Chief Executive Officer

We can.

Unidentified Participant

Okay. I have two questions, and thank you for the call. One, can you please give us an idea of the flexibility in the opex you mentioned, I think you said $325 million to $345 million. Again, we are talking about a very fluid environment for the rest of the year. And I know this is a range, but it's a rather narrow range. So how much flex do you have to cut it lower if you need to? That's question number one. And question number two is, can you give us an idea about the rig supply you are seeing for the rest of the year? We don't -- we are not sure about the demand, obviously. But with respect to rig supply in the second, third, fourth quarters, do you have some numbers before you as to how many rigs are going to end their contracts and look forward?

Bernie G. Wolford -- Chief Executive Officer

Thanks for the question. And with regard to flex in the operating expenses, first let me point out that those operating expenses include assumptions for further work for certain rigs that is currently not contracted. And so therefore, they're very much reflective of additional work, higher levels of activity, etc. In the event that for whatever reason that work doesn't materialize, there would certainly be flex to the lower -- below that range. However, we give you that range on the basis of our expectation for filling gap work for the Bora and filling the gap work for the Sharav.

Unidentified Participant

Got it.

Bernie G. Wolford -- Chief Executive Officer

With regard to availability of sixth and seventh generation ships for the balance of the year, there are currently 4.1 rig years available in the balance of the year with the bulk of that falling in the fourth quarter across a number of available rigs where the contracts will be expiring in October or November of the year. So there's actually very little unbooked work at this time toward -- for 2020. Having said that, there are a number of options that prior to the recent events, we fully expect it to be exercised. And our statistics reflect certain assumptions around which of those options will be exercised and which may be not. So our best estimate, as it stands today, is there's just over 48 months worth of rig work available on the market in 2020 this year.

Unidentified Participant

Thank you.

Operator

And that's all the questions I have in the queue. So I will return the call to your hosts for any closing remarks.

Bernie G. Wolford -- Chief Executive Officer

We thank you all for your interest in Pacific Drilling. And wish you all the best of success as we watch how the world emerges from our recent challenges. Thank you very much, and good day.

Operator

[Operator Closing Remarks]

Duration: 37 minutes

Call participants:

Lisa Manget Buchanan -- Senior Vice President and General Counsel

Bernie G. Wolford -- Chief Executive Officer

James W. Harris -- Chief Financial Officer

Michael D. Acuff -- Senior Vice President-Commercial

Devon Xu -- Wells Fargo -- Analyst

Unidentified Participant

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