Pacific Drilling S A : Second-Quarter 2020 Earnings Conference Call Transcript

Pacific Drilling Second-

Quarter 2020 Earnings

Call

Friday, 7th August 2020

Pacific Drilling Second-Quarter 2020 Earnings Call

Friday, 7th August 2020

Pacific Drilling Second-Quarter 2020 Earnings Call

Participants

Michael Acuff, SVP Commercial

Lisa Buchanan, SVP & General Counsel

James Harris, CFO

Bernie Wolford, CEO

Operator: Hello, and welcome to the Pacific Drilling Second quarter 2020 earnings call. My name is Dan and I will be your coordinator for today's event. Please note this conference is being recorded and for the duration of the call, your lines will be on listen only. If you require assistance at any time, please press star zero on your telephone keypad to be connected with an operator. I will now hand you over to your host, Lisa Buchanan, to begin today's conference. Thank you.

Lisa Buchanan: Thank you, Dan, and welcome everyone to Pacific Drilling's second quarter 2020 earnings call. Before I turn the call over to Bernie, I'd like to remind everyone that any statements we make during this call that are not historical in nature are all forward looking statements that are made pursuant to the safe Harbour provisions of the private securities litigation reform act of 1995. Forward looking statements are generally identifiable by the use of words, such as anticipate, believe, expect, project or other similar words and include any statements we may make concerning the future impact of the COVID-19 pandemic on our business, our future financial and operational performance cash balances and earnings expectations, potential outcome of our discussions with our creditors and evaluation of our alternatives regarding our liquidity outlook and capital structure and our market outlook, including forecast of trends, future client contract opportunities and day rates.

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 factor section of our 2019 form 10 K and other filings with the U S securities and exchange commission, which you can find on our website at www.pacific drilling.com. 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 measure and associated reconciliation in our earnings release, which is available on our website.

Please note that we will not be taking questions at the conclusion of our prepared remarks today. We refer you to our second quarter 2020 form 10-Q, which we will file with the SEC later today and which you will be able to find on our website. I will now turn the call over to Bernie Wolford, Chief Executive Officer of Pacific Drilling.

Bernie Wolford: Thanks, Lisa. And good morning, everyone. Welcome to our second quarter 2020 earnings call. Joining me today, in addition to Lisa, are Jim Harris, our Chief Financial Officer and Michael Acuff, Senior Vice President of Commercial. We are conducting this call remotely today, as we continue to mitigate the risk of COVID-19 exposures through social distancing. COVID-19 and the associated economic and energy impacts related to measures

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being taken to limit exposure, continue to have severe negative impacts on the demand for our services. Despite these challenges, the Pacific Drilling team continues to respond in an unprecedented manner to deliver safe and efficient services to our clients, protect health, and provide for seamless business continuity. I want to reiterate my appreciation for the dedication and commitment of our office team and rig-based crews who continue to manage significant logistical travel and safety challenges with enthusiasm and professionalism.

The outlook for our industry turned decidedly downward in March of this year. Over the intervening months, we have witnessed further deterioration in demand, a significant number of contract cancellations, rig stacking, and rig retirements. We continue to expect reduced demand for our services for the balance of 2020, next year and possibly beyond. Over the quarter, we took a number of measures to significantly reduce our spending in light of reduced demand and our limited contract opportunities while preserving our capacity for operational excellence. These measures have significantly reduced our cash burn rate and meaningfully extended our liquidity runway. As noted in our earnings release, we finished the quarter with $252 million of cash due to the dramatic reduction in contract drilling demand. And despite our actions to reduce costs, we do not believe our current capital structure will be sustainable and have engaged financial and legal advisors to assist us in evaluating alternatives to address our capital structure, which may result in a negotiated restructuring of our debt that is implemented under the protection of chapter 11 of the US bankruptcy code.

Capital structure challenges aside, Pacific's operational platform, management systems, assets, and people continue to deliver world class services in a safe and efficient manner, all on a cost competitive basis. As difficult as the market is today, our track record for operational excellence has enabled us to secure a new term contract for the Pacific Sharav with Murphy expected to start in Q two of 21. Both our operations and commercial teams were instrumental in securing this work with a key client. Through the quarter, the Pacific Khamsin transitioned from Equinor's Monument Well to Total's South Platte Well where the rig continues to perform at a very high level. The Pacific Santa Ana remains on standby for the Petronas Mauritania program and is expected to resume operations in January of 2021. Rounding out the fleet, the Meltem, Mistral and Scirocco are smart-stacked in Las Palmas, and the Bora is dockside in Oman. We have implemented additional measures on each of these rigs to further reduce carrying costs while enhancing preservation.

Looking at the broader market and the deep-water sector in particular, we have seen several of our peer companies file for bankruptcy and anticipate others will follow in the near term. These events, coupled with asset retirements year to date, our expectation for more retirements over the balance of this year, as well as generally expected industry consolidation should in time support progress towards a more balanced market. In the interim, we will continue to deliver top tier drilling services and rationally compete for the work available while preserving cash and our assets. In addition, and importantly, we will continue to respond to the COVID- 19 pandemic in a thoughtful manner to protect our employees and support broader community and governmental responses to restore economic activity.

Before handing over to Jim for a review of our second quarter results. I'm very pleased to announce that Jim has withdrawn his previously announced resignation, and as our CFO will be a key part of the PACD team going forward. Having never left, I know who he will continue to

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be a major contributor to our success as we navigate the challenges before us. And with that over to you, Jim.

James Harris: Thank you, Bernie, and good morning, everyone. I will provide more details on our second quarter results and an update on our outlook. We started the quarter with four rigs operating and ended with one rig working, the Khamsin in the Gulf of Mexico for Total, and another rig on paid standby, the Santa Ana, with the expectation of it returning to work for Petronas in Mauritania after the pandemic-related travel restrictions ease. Murphy Oil has contracted the Sharav for a 10 well program in the Gulf of Mexico commencing in the second quarter of next year with an option for five more wells. We were recently notified by Equinor that they were terminating their previously exercised second option on the Khamsin, which means that the rig will come off contract now in September. Murphy terminated its two well contract for the Sharav in Mexico scheduled to start drilling in the fourth quarter of this year. We will receive compensation for both of these contract terminations, expected to be collected this quarter.

Our second quarter revenue was $38.9 million, down $50.5 million sequentially as the Sharav and the Bora completed their contracts in early April and the Santa Ana earned a lower force majeure rate in April and a further reduced standby rate, which is sufficient to cover our interim operating costs for the remainder of the second quarter.

Our operating expenses for the second quarter of $61.9 million were down $24.6 million or 28% compared to the first quarter, mainly due to rigs transitioning from operating to standby and idle status and other cost saving measures undertaken in the quarter.

Recognizing the expected lower rig utilization challenge facing our industry and the company, we moved quickly to reduce all ongoing expenditures, including rig operations and CAPEX, shore-base and operations support and G&A. On a run rate basis, we have reduced total overhead costs by 35% or over $22 million, primarily through our reduction in force in May and an across the board pay cut for all employees. We also deferred or canceled plan 2020 capital projects, totaling $17 million for a 55% reduction in the budget. These prudent and proactive actions were all difficult to achieve and should demonstrate our commitment to being good capital stewards, focusing on preserving cash and extending the company's liquidity.

Our shore-based offices and operations support costs were $5.9 million for the second quarter, down $1.1 million or 16% sequentially. Excluding advisory fees of $2.6 million and severance of $300,000, G&A costs were lower by $1.6 million or 17%. We incurred an additional $2.2 million in severance included in operating costs.

Our adjusted EBITDA for the second quarter was negative $31.1 million compared to negative $1.8 million for the first quarter, down sequentially as a result of fewer contracted rig days.

Our operating cash outflow for the second quarter was $26.5 million, which was an improvement over the first quarter's outflow of $46.8 million as the current quarter benefited from net collections on accounts receivable. Capital expenditures for the second quarter were $1 million, significantly down sequentially as our CapEx plans have been reduced and deferred except essential sustaining requirements. For the remainder of the year we estimate capital expenditures of about $8 million.

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We closed the second quarter with $252 million in cash as compared to our March 31, 2020 balance of $280 million.

We continue to work diligently to implement the most cost-efficient locations and stacking configurations to minimize the carrying cost of idle vessels while preserving the overall value of our fleet.

As we indicated in the earnings release, we have sufficient cash to run the company and to pay the interest on our first lien bonds for at least another year, while we expect to have sufficient liquidity runway to carry the company up to the fourth quarter 2021. Given current market conditions, we have concluded that our capital structure is not sustainable or competitive. Therefore we engaged financial and legal advisors during the second quarter to assist us in negotiating and implementing a plan to restructure our debt obligation. Any agreement with our creditors may include full equitization of our first and second lien bonds, which would put our common shareholders at risk of losing all of their interest in the company. We continue to work to best position the company for the industry consolidation that we continue to believe is inevitable. Our fleet of modern sixth and seventh generation high specification drillships represent compelling value and a future rationalized global rig fleet when the market eventually recovers. And with that, I'll turn the call over to Michael for an update on the market and commercial prospects.

Michael Acuff: Thank you, Jim and good morning, everyone. The offshore deepwater drilling market remains challenging in the wake of the extraordinary events that transpired earlier this year with respect to COVID-19 and the resulting commodity price decline. We continue to see the effects of the operators' quick response, as they announced deep capital cuts to their planned upstream budgets on the order of 25 to 30%. Though we have seen improvement in the price of oil, as it has returned above the $40 per barrel mark over the past few months, indications of additional spending have not returned to the offshore space for 2020 or early 2021. However, indications are that most previously sanctioned development programs and those planned for upcoming FIDs will go forward. We're already seeing customers contract rigs for the second quarter of next year, such as the Pacific Sharav for Murphy's US Gulf of Mexico development, as well as several inquiries for programs that start in the second half of 2021. If you recall, we had 24 visible opportunities in early March, of which 14 were delayed, and six were cancelled. Today, we have 22 opportunities in the pipeline with 17 scheduled for second quarter 2021 and beyond. In the near term, there remain a couple of opportunities with earlier start dates, but they are primarily Q1 commencements with shorter durations.

The sixth and seventh generation drillship segment of the market is currently at an effective marketed utilization of 75%, down from 86% at the time of our last call and expected to fall further to something near 70% later this year, as we expect eight high-spec drillships to roll off their current contracts. In addition, we have seen early terminations or cancellations of eight units to date adding to the surplus of the supply. There are currently 58 high-spec drillships on contracts with expectations that we will dip to a demand level of 50 units working by the end of 2020 or early 2021. On the last call, we stated that there are 18 high specification units available for work for the remainder of this year. Up from eight, the previous quarter, that number has since jumped to 26. Under this additional near-term active supply we have seen a total of five drill ship retirements and an additional nine drillships identified for cold stacking this year. We expect to see at least 10 additional units scrapped over the balance of 2020 and

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into 2021, further aligning the supply with our projected demand scenarios. Lastly, I would like to also point out that we are confident that there will be no new supply from the stranded newbuilds added to the market in 2021, besides the already contracted 20 K rig scheduled for delivery. We believe the stackings and delay in newbuilds are prudent and critical to balance supply with demand and accelerate a future market recovery.

Since our last call, we have received five new tenders and seven RFIs representing 6.8 rig years of firm work and a possible 2.1 years of additional work to the RFS become tenders. However, the composition of these new opportunities reinforces my earlier comment, as most are slated for the second half of 2021 starts. With respect to the overall work in the opportunity pipeline today, the total offered term equates to 18 rig years with an average of 300 days per opportunity. Of the 22 jobs, eight are for longer term development projects in Brazil or West Africa. We expect to have better insight into this demand in the next few months as customers start their budgeting process for 2021.

With respect to the Pacific fleet, the Pacific Khamsin is currently drilling Total's initial South Platte exploration well, which is projected to be completed sometime in September. As we have announced in our fleet status report, the third from well with Equinor was recently cancelled via termination fee marking the end of this two well contract. We are currently in discussions for work with the Khamsin in early 2021 and continue to pursue opportunities to bridge the gap until that time. As one of the highest specifications, seventh gen rigs with MPD capability in the U S Gulf of Mexico, we are confident that we will secure work for the rig.

Our other high spec rig in the us Gulf of Mexico, the Pacific Sharav, was recently awarded a 10 well plus five option well contract with Murphy Oil to drill and complete the Khaleesi/Mormont/ Samurai or KMS development program. This program is scheduled to start in April 2021 and will return this high-performing, currently stacked unit to service in the U S Gulf of Mexico, where it has drilled some of the most challenging wells. As part of this transaction, Murphy decided to cancel the previously signed Mexico contract for two wells plus one option well and pay a termination fee. We are very excited to expand the relationship with Murphy and appreciate the confidence they have shown in the Sharav and its past performance.

The Pacific Santa Ana continues in standby mode and Las Palmas under an extended suspension rate of $104,000 per day, awaiting notification to resume the work on phase two of the Petronas permanent abandonment program in the Chiguetti field. We continue to plan with Petronas for the restart of the program, and currently expect the rig to return to operating mode sometime in early Q1 2021. We will update you as soon as we are officially notified by Petronas, but given the extended standby period, we project the Santa Ana to remain on this contract until at least August 2021.

The remaining rigs continue to be stacked in Los Palmas in Oman, where we have taken additional measures to significantly reduce costs. We continue to market these rigs where it makes sense and will evaluate other strategic options.

In summary, we see customer project timeline shifted into the future by 12 to 18 months compared to their previous plans. This delay will result in the remainder of 2020 and 2021 continuing to be an extremely challenging market. And with that, I will now turn the call back over to Bernie.

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Bernie Wolford: Thanks, Michael. I want to reiterate my appreciation for the entire Pacific Drilling team. Their response to recent unprecedented events and the measures taken to assure the health and safety of our employees and partners have sustained our reputation for superior service delivery, despite all challenges. Thanks also to those on the call today for your interest in Pacific Drilling. We refer you to our website where we will post our form 10 Q later today. This concludes our call. Operator, you may now close the call.

Operator: Thank you all for joining today's conference. You may now disconnect your lines. All hosts, please remain connected.

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