Diamond Offshore Drilling Inc

NYSE:DO

Earnings Call Transcript 2023-Q1

[Operator]

Good morning, and thank you for standing by. Welcome to the First Quarter 2023 Diamond Offshore Drilling Earnings Conference Call. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Kevin Bordosky, Senior Director of Investor Relations. Please go ahead.

[Kevin Bordosky, Senior Director, IR]

Thank you, Michelle. Good morning or afternoon to everyone, and thank you for joining us. With me on the call today are Bernie Wolford, President and Chief Executive Officer; and Dominic Savarino, Senior Vice President and Chief Financial Officer. Before we begin our remarks, I remind you that information reported on this call speaks only as of today, and therefore, time-sensitive information may no longer be accurate at the time of any replay of this call.

Some of the information referenced on our call today is included in a slide presentation that you can find in the Investor Relations section of our website under Calendar of Events. In addition, certain statements made during this call may be forward-looking in nature. These statements are based on our current expectations and include known and unknown risks and uncertainties, many of which we are unable to predict or control. These risks and uncertainties may cause our actual results or performance to differ materially from any future results or performance expressed or implied by these statements. These risks and uncertainties include the risk factors disclosed in our 10-K and 10-Q filings with the SEC.

Further, we expressly disclaim any obligation to update or revise any forward-looking statements. Refer to the disclosure regarding forward-looking statements incorporated in our press release issued yesterday evening, and please note that the contents of our call today are covered by that disclosure. In addition, please note that we will be referencing non-GAAP figures on our call today. You can find a reconciliation to GAAP financials in our press release issued yesterday. And now I will turn the call over to Bernie.

[Bernie Wolford, President, CEO & Director]

Thanks, Kevin. Good morning or afternoon to everyone, and thank you for your interest in Diamond Offshore as we present our results for the first quarter of 2023. I'd like to start by recognizing that during the first quarter, Diamond reached its 1-year anniversary of relisting on the New York Stock Exchange. Since relisting, we have seen significant trading liquidity in our shares and our shareholder base has grown to nearly 200 institutional investors.

Today, I will cover financial and operating highlights for the first quarter. Our operational outlook for the remainder of 2023 and our view on the market for our services. I'll also provide more detail on our commercial successes achieved after the first quarter and then turn it over to Dominic to provide a review of our first quarter financials as well as guidance for the upcoming quarter.

Our results for the quarter reflect growth in both revenue and adjusted EBITDA. Total revenue and adjusted EBITDA for the quarter were $232 million and $21.7 million, respectively. These improvements were driven primarily by the Ocean BlackHornet moving to a substantially higher dayrate during the first quarter. The first quarter was an active one for our company.

I'm pleased to report that our recrews and operation support team delivered revenue efficiency of 95.9% across our fleet during the quarter. This efficiency number is notable considering the start-up of the Ocean GreatWhite, which safely commenced operations west of the Shetlands in late March and the redelivery of the Endeavor following completion of its special survey. These important milestones give us 3 harsh environment rigs working in the region and are a testament to our team's project management capability. In addition, we successfully commenced operations with a new client in the U.S. Gulf of Mexico, utilizing the seventh generation drillship Vela, and we received a well-based performance bonus in Senegal for the third consecutive quarter.

Our industry-leading safety excellence was recognized by the IADC North Sea chapter, as it recently declared Diamond Offshore, the winner in 2 categories among the active rig fleets in the North Sea. We won Best Safety Performance in the floating rigs category and also Best Safety Performance for an individual floating rig, the Ocean Patriot. These awards demonstrate the company's commitment to honor safety and protect all and are a direct result of the hard work and dedication of the men and women who crew and support the Diamond Offshore fleet in the U.K.

Finally, at quarter end, we made the determination to categorize the Ocean Monarch as held for sale. This decision reflects our continuing commitment to capital discipline and our strategic focus on maximizing shareholder returns.

Turning to the market outlook. We maintain our constructive outlook for our business as the up cycle in the offshore drilling sector continues to be supported by strong cash flows realized by oil and gas companies, continued evidence of growing demand and oil price forecast well above production breakeven costs and FID hurdles. These factors have prompted a significant recovery in offshore upstream capital expenditures. According to S&P Global, new tender demand for floating drilling rigs for the 12 months ended March 31, 2023, was at its highest level since 2012. Industry analysts expect offshore upstream CapEx spend to grow approximately 10% year-over-year on average from 2023 to 2025, approaching $200 billion by 2025.

We anticipate these investments will grow further as the pursuit of supply diversity remains a global priority and gains further momentum. The ongoing pivot to offshore basins as a source of incremental supply is driving the market for our services. Additional capital being deployed for exploration and appraisal may further extend this cycle of investment.

Next, I would like to offer comments regarding the markets where we compete. Starting with the North Sea. The U.K. government's energy profits levy, or EPL continues to impact brownfield prospects offshore the U.K. However, there are a number of shorter-term programs starting later this year and early next, plus up to 2 significant new programs offshore in the U.K. starting in '24 or '25.

Overall, for the U.K., we expect 1 additional semisubmersible to be contracted in 2023 and an additional unit late in 2024. Although positive signs have emerged on the back of recent contract announcements in Norway, demand there remains relatively soft in 2023. This has prompted a number of high-specification rigs to leave the region for attractive opportunities in other areas, a trend that continues with the recent award in the news for work offshore Namibia. In Australia, a consortium for work offshore of the Southeast Coast and a development campaign on the Northwest Shelf will likely add a further 2 rig years of demand in the region. Also, owing to a mix of P&A, development and exploration work commencing later in 2024, a further 3 rig years of demand may materialize.

Southeast Asia remains relatively flat with incremental demand for 1 to 2 floaters late this year and into 2024. We expect India to grow modestly adding 1 semisubmersible and 1 drillship in 2024. West Africa is emerging as one of the key areas driving future demand growth. West Africa semisubmersible demand is being driven primarily by opportunities in Namibia, Equatorial Guinea and Nigeria. We expect semisubmersible demand to grow by up to 2 units in 2024. Drillship demand in the region is expected to grow by up to 3 rigs in 2024, driven primarily by activity in Angola, the Ivory Coast, Namibia, Ghana and Equatorial Guinea. East Africa, particularly Mozambique, has the potential for further upside to drillship demand.

We see modest increases in semisubmersible demand in the Mediterranean and Black Sea with potentially 1 incremental unit through 2024. Drillship demand in the region is expected to be relatively flat.

South America is the other corner of the Golden Triangle driving demand growth. In Latin and South America, drillship demand could grow by 8 or more rigs through 2024. Brazil is driving the bulk of this new demand with Guyana, Suriname and Colombia contributing. We expect Mexico and the rest of the Latin American region to remain relatively flat through 2024.

Finally, in North America, we see drillship demand remaining relatively flat with one incremental program in 2023 and possibly another in 2024. It is worth noting that dayrates in the region remain biased to the upside due to the likely exodus of certain 6 and seventh generation units for opportunities in Brazil and West Africa. Canadian harsh environment semisubmersible demand remains a wildcard but with upside potential subject to exploration success in the region.

Translating this to a global perspective and factoring in some conservatism to allow for slippage and start dates, options not exercised and potential adverse final investment decisions, we foresee incremental demand for semisubmersibles growing by 4 to 6 units through 2024 and incremental demand for drillships growing by 7 to 10 units through the same period. A portion of this demand is already reflected in the number of open tenders we have in-house today.

Speaking of the strength in the markets, we have had great success in securing additional contract backlog. Yesterday, we announced $212 million of new contract awards across multiple geographies and rig types. These new contracts are in addition to our $1.6 billion backlog reported as of April 1, 2023.

With these commitments, we are now -- we now have 59% of 2024 marketed capacity contracted. This excludes priced options, which could take our 2024 commitments to 70%. These awards reflect not only the continued strength of the drillship in semi markets, but also Diamond Offshore's reputation for performance and our strategic approach to the markets.

Starting with the Ocean BlackHawk. We have secured work with Anadarko Petroleum Corporation, a wholly owned subsidiary of Occidental in the U.S. Gulf of Mexico. The rig was awarded a 1-year contract with a 1-year priced option and is expected to commence mid-fourth quarter of 2023 after conclusion of the rig's current contract expected to be in early July, followed by a 5-year regulatory surveys, new contract preparations, including the installation of an MPD system and mobilization from Las Palmas.

Total firm term contract value, including mobilization, but excluding any managed pressure drilling services, is expected to be approximately $162 million. Occidental previously utilized the Ocean BlackHawk for 8 years prior to the rig working for Woodside on its current campaign in Senegal. It should also be noted that the rig should see a reduction in base operating expense of at least $30,000 per day as compared to current levels in Senegal.

Diamond also had contracting success in the U.K. North Sea with the Ocean Patriot securing a 2-well contract with an estimated duration of 60 days and a total contract value of approximately $10 million. The contract is expected to commence in September of this year. A potential second new contract currently under negotiation would fill out the remaining availability in late 2023 and keep the rig contracted through the winter season.

The Ocean Endeavor was awarded an extension covering 2 wells with an estimated duration of 120 days with its current client. Total contract value for the extension is approximately $24 million and is expected to commence mid-contract in early November 2023, after which we will revert to the current contract rate for the balance of the contract term. Further, the Ocean GreatWhite had its first option well exercised by its current client with an estimated duration of 60 days. Total contract value for the option well is approximately $16 million and is expected to commence in mid-January 2024 after completion of the initial 5-well firm period.

There are priced options for up to 7 additional wells remaining. Securing these wins at improved dayrates with quality customers further demonstrates the strength in the market and the value our team is delivering to clients and shareholders. I would like to thank all Diamond employees, both onshore and offshore for going above and beyond in securing this backlog.

The continued strength in global markets provides Diamond Offshore further upside opportunities in 2024. Our next drillship up for repricing will be the Ocean BlackRhino, currently working offshore Senegal, with anticipated availability late in the second quarter of 2024.

Given the continued demand for top-tier drillships and relatively constrained supply, great opportunities exist for the Ocean BlackRhino to secure work at rates that are significantly higher than the rig's current contract. Also, as previously mentioned, we are pursuing multiple opportunities for the Ocean Onyx in Southeast Asia and Australia. Commencement for these projects is anticipated to take place in the first half of 2024.

Growing demand in Brazil, West Africa and Australia continue to put upward pressure on dayrates while providing substantial opportunities for drillships and semisubmersibles alike. Through the first quarter, the resilience, breadth and depth of the upcycle has only become more evident. With that, I will turn the call over to Dominic before returning with some concluding remarks.

[Dominic Savarino, SVP & CFO]

Thanks, Bernie, and good morning or afternoon to everyone. In my prepared remarks this morning, I'll provide a recap of our results for the first quarter, discuss the outlook for the second quarter and full year 2023 as well as provide some comments on our capital structure. And as Kevin alluded to in his opening remarks, we have a presentation on our website that includes some of the financial information I will refer to today. For the first quarter, we reported net income of $7.2 million or $0.07 per diluted share.

The reported income consists of a net loss before tax of $18.4 million and a recorded tax benefit of $26 million. The tax benefit recorded in the first quarter is based on the computation and application of the company's annual effective tax rate in accordance with U.S. GAAP accounting standards adjusted for discrete items. Taxes will continue to swing significantly quarter-to-quarter as our earnings before tax move from a net loss position to a net profit position over the course of the year. Despite these big swings, our total cash outlay for income taxes this year is expected to be below $10 million.

The results for the first quarter included a reported adjusted EBITDA of $21.7 million as compared to adjusted EBITDA of $12.5 million reported in the fourth quarter of 2022. Excluding reimbursable revenue, revenue for the first quarter was $214 million, up from $208 million in the prior quarter primarily as a result of the Ocean BlackHornet rolling over to a new contract at higher dayrates. Both our revenue and EBITDA came in above our prior guidance for the quarter, largely as a result of timing effects, including the Apex having more revenue earning days than anticipated before the start of the shipyard project, partially offset by later than anticipated deliveries of the Ocean Endeavor and Ocean GreatWhite.

It should be noted, however, that despite being later than originally anticipated, the Ocean GreatWhite reactivation was the shortest duration and lowest cost reactivation of any high specification floater that we're aware of.

Contract drilling expense decreased to $173 million for the quarter compared to $178 million for the prior quarter, primarily as a result of the Ocean Onyx being cold stacked for the full quarter and the annual Pressure Control by the Hour bonus expense being included in the prior quarter results. We used approximately $12 million in operating cash for the quarter, driven by a change in working capital with negative free cash flow of $41 million after considering CapEx expenditures of $29 million in the quarter.

In contrast, our fourth quarter 2022 free cash flow generation of $15 million was largely a result of working capital swings in the other direction and lower CapEx expenditures.

Looking ahead to the second quarter, we expect contract drilling revenue excluding reimbursables, of $240 million to $250 million and adjusted EBITDA of $20 million to $25 million. While the Ocean GreatWhite and Ocean Endeavor have returned to work and should contribute with a full quarter of activity, that growth in EBITDA is offset by the Ocean Apex spending the second quarter in the shipyard for its special hull survey and certain upgrades returning to work in early Q3. And consistent with my comments from last quarter, adjusted EBITDA for Q2 is still anticipated to be quite similar to Q1 adjusted EBITDA before rising substantially in the second half of the year as a result of having more operating days at higher dayrates.

I would also like to reiterate our full year 2023 guidance for contract drilling revenue, excluding reimbursables, of $950 million to $990 million, and adjusted EBITDA of $160 million to $180 million as found on Page 7 of our earnings presentation. Our CapEx guidance for 2023 has increased to $120 million to $135 million as a result of the contract award we announced yesterday for the Ocean BlackHawk and the requirement to install a managed pressure drilling system. And as a reminder, our CapEx expenditure guidance for 2023 does not include any CapEx for the reactivation of the Ocean Onyx should it win a contract later this year.

Our new contract awards of $212 million, plus our backlog as of April 1, totals $1.8 billion. As a result of these new contracts, the average dayrate in our 2024 backlog has increased to approximately $320,000 per day as compared to $283,000 per day for the 2023 backlog. With the average dayrate for our owned and managed drillships for 2024 currently sitting at $366,000 per day. These new contracts award also increased our contract coverage in 2023 to 89% and 59% in 2024, as represented on Slide 5 in our earnings presentation. This level of contract coverage gives us greater visibility and certainty into our results for this year and next, yet still provides ample opportunity for contract awards at higher dayrates to fill out the calendar for 2024 and beyond.

Moving to some comments on our balance sheet. Our net debt, excluding our finance lease liability and restricted cash stands at $327 million with a weighted average coupon rate of approximately 9.5%. And our total liquidity is $280 million as we exited the quarter. On the back of the continued improvement in the market and our own results, including the award of the new contracts we announced yesterday, we are evaluating opportunities to enhance our capital structure and establish regular way financing that provides more flexibility than our current post-emergence debt instruments. To be clear, we are not under any pressure to refinance our outstanding debt, given that maturities are still 3 and 4 years away in 2026 and '27, not to mention the increasing liquidity profile we anticipate as we exit '23 and move through 2024.

However, should we be able to simplify our debt stack, increase our liquidity, reduce our cost of capital, increase our weighted average time to maturity and maintain our revolving credit facility, we would opportunistically entertain a refinancing transaction or a series of transactions. Of course, the sizing, pricing and terms of such transactions would have to be attractive, and we would need modification to certain covenants and restrictions in our revolver to help facilitate this.

Overall, it was a great quarter for the company, and we remain on track to deliver our forecasted results. That concludes my prepared remarks. I will now hand it back to Bernie for some closing comments before we go into Q&A.

[Bernie Wolford, President, CEO & Director]

Thank you, Dominic. At Diamond, we have maintained -- we have remained productive since the beginning of the year, executing an important shipyard project delivering a relatively low-cost rig reactivation for a key client and securing significant new backlog with higher margins, all while continuing to deliver industry-leading operational excellence for our customers, and never compromising on safety. We appreciate your interest in Diamond Offshore and we'll now open the call for questions.

[Operator]

[Operator Instructions]. The first question comes from Eddie Kim with Barclays.

[Eddie Kim, Barclays Bank]

Congratulations on the contracts, for the Ocean BlackHawk, which is one we've been keeping an eye on for a while. And that $152 million of firm backlog you mentioned in the prepared remarks would imply something around kind of $440,000 to $455,000 a day, which is right in line with what leading edge dayrates are today. So you mentioned that the BlackRhino is the next drillship to come off contract in the second quarter of 2024. So just based on where dayrates are trending, would you expect that rig to be signed at a higher level than what you just secured for the BlackHawk? And when should we expect a contract announcement for that rig?

[Bernie Wolford, President, CEO & Director]

Thanks for the question, Eddie. So looking at the BlackRhino, I mean, as of today, we have it bid across the Golden Triangle. So certainly, the rates will be impacted by the location that the rig ultimately finds work in. As you know, rates for Petrobras in Brazil generally include a service provision that can cost anywhere from $30,000 to $60,000 a day for additional services. And so those rates are naturally somewhat inflated compared to similar rates earning the exact same margins in other regions. With regard to what rates we expect, we do expect rates marginally higher than what was awarded to the BlackHawk.

The current rate structure today, we feel like it's sort of in the $420,000 to $460,000 range on a clean basis. We've seen rates as low as $380,000, but that's a somewhat special case and special relationship and we've seen the highest clean rate closer to $460 to date. We understand there may be a fixture announced later this year at or around $500,000 per day but understand it will be inclusive of services. So long answer to your short question, we would see rates marginally higher than those of the BlackHawk as the most likely. In terms of when we would expect to secure a commitment for that rig, I would say it'd be approximately 6 months from now, just as a general guide, Eddie.

[Eddie Kim, Barclays Bank]

Got it. Got it. Okay. Great. That's great to hear. But my follow-up is just on the pace of drillship reactivations industry-wide, that there are a couple of reactivations going on currently. Some of your peers have recently alluded to the potential for additional reactivations later in the year. You, of course, don't have the cold-stacked drillship. But just is the pace of reactivations across the industry, something that concerns you in terms of potentially keeping a lid on dayrate progression over the next 6 to 12 months, based on your response just now it doesn't seem like it. Or is the demand strength right now, especially in places like Brazil and West Africa kind of more than enough to absorb the impact of these reactivations?

[Bernie Wolford, President, CEO & Director]

Yes, Eddie, I would say a couple of things on that. First of all, quite frankly, if it wasn't for the reactivations and anticipated reactivations, we would already be solidly into the $500,000 today. I mean, in my mind, there's no doubt about that. There is sufficient demand to absorb the reactivations. And I continue to believe that, on average, from contract commitment to reactivation completion, delivery and first day of dayrate is going to range somewhere between 12 to 15 months.

So the pace, although it's quite obvious in some of the public tenders that we see currently in Brazil, it's not at an alarming rate, but it is preventing us from moving to the $500,000 sooner rather than later. So I think it does to a certain extent, keep rates in the high 400s longer on average than we would have otherwise anticipated, but it doesn't drive any significant gaps in utilization.

[Operator]

[Operator Instructions]. The next question comes from Frederick Stein with Clarksons Securities.

[Unidentified Analyst]

I wanted to touch a bit on the new contracts or 2 things. First, just on -- I think this question and you obviously there gave some good color. But as you kind of move forward, you tie up more and more capacity, and I think you mentioned close to 70% for 2024 if we assume that fixed price options are taken. How is your approach to fixing the remainder there? Has that changed over time? Are you willing to take more risk? Or do you think that fixing terms similarly to what you did now yesterday with 1 year and potentially fixed price options thereafter is the way to go also if you're potentially looking to optimize/simplify the balance sheet -- just for the visibility part of it.

[Bernie Wolford, President, CEO & Director]

Thanks, Frederick. Yes, I would say that generally speaking, our approach will be fairly similar. I mean, in the case of the BlackHawk, I believe we were pursuing 8 or 9 opportunities for that rig. We always look at what the bottom line margin is going to be for a project after consideration for all expenses associated with start-up, delivery and any associated services. And we're looking to maximize that margin and positive cash flow to the company.

In terms of what kind of durations we're looking for I would say, right now, 1 to 2 years is sort of the sweet spot for us in terms of what we're looking for, although we definitely bid the rig on longer-term projects as well, like you've seen in the Petrobras public tenders. But not much change in our approach, generally speaking. I mean, utilization is important, but full utilization is not absolutely critical. Instead, we're really focused on what's going to give us the highest margin and the best EBITDA for the forward-looking periods.

[Unidentified Analyst]

Perfect. And second question, you updated your CapEx guidance feature doing the MPD on the BlackHawk. Just on a general basis, I'm tying this to the comments from the written report as well about EBITDA and cash flow development through '23 and 2024. Are you able to give any comments on the pace of that slope and/or if you think it's going to be call it, a bumpy ride, but still with underlying improvements on average at least quarter-over-quarter going forward?

[Dominic Savarino, SVP & CFO]

Yes, Frederick, this is Dominic. Yes, looking out into the future, I mean as I alluded to, we're going to have obviously significant EBITDA uptick in Q3 and Q4 to achieve our results for the year given where we have been for -- in terms of Q1 and what we're forecasting for Q2. But I would say that Q3 is going to be incrementally more than Q2 and then Q4 should be probably, again, incrementally more than that. So the EBITDA profile certainly grows quarter-to-quarter as we reap the benefit of being on higher dayrates for full contracts. So as the Apex comes back, as we get the Courage on contract later in the fourth quarter as well as the BlackHawk, you'll see an increase in EBITDA quarter-over-quarter starting in Q3.

[Bernie Wolford, President, CEO & Director]

And Frederick, I would add to that from a capital expenditure point of view. By the end of this year, we will have the Endeavor, Apex, Courage and BlackHawk behind us. So going into '24, we have the Ocean BlackHornet and the BlackRhino scheduled for their SPSs and then in '25, the Ocean BlackLion. So this is probably one of our higher cost years when it comes to SPSs with next year being similar but somewhat less.

[Operator]

I show no further questions at this time. I would now like to turn the call back to Bernie Wolford for closing remarks.

[Bernie Wolford, President, CEO & Director]

Thanks to all for joining the call today, and we look forward to speaking to you again next quarter. Have a good day all. Bye-bye.

[Operator]

This concludes today's conference call. Thank you for participating. You may now disconnect.