Diamond Offshore Drilling, Inc. (NYSE:DO) Q3 2023 Earnings Call Transcript November 7, 2023
Diamond Offshore Drilling, Inc. misses on earnings expectations. Reported EPS is $-1.36 EPS, expectations were $-0.32.
Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Third Quarter 2023 Diamond Offshore Drilling, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would like now to turn the conference over to, Kevin Bordosky, Senior Director of Investor Relations. Please go ahead.
Kevin Bordosky: Thank you, Mitchelle. 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: Thanks, Kevin. Good day to everyone, and thank you for your interest in Diamond Offshore as we present our results for the third quarter of 2023. Today, I will cover recent contract awards, highlights for the third quarter, and perspectives on the market. Dominic will walk through our financial results, operations highlights for the quarter, and guidance for the fourth quarter and full year before I wrap up and open the floor for questions. I am pleased to report that our rig crews and operations support team delivered exceptional safety results, with revenue efficiency of 95% across our fleet during the quarter. This efficiency number is notable, given the high number of transitions within the fleet as some rigs departed shipyards and commenced new contracts, while others finished contracts and commenced shipyard projects.
A big thank you to our teams for their commitment to our safety pledge on our safety to protect all. Also, we achieved a significant financing milestone during the quarter. As previously announced, we closed a $550 million bond offering that replaced our previous debt at a lower interest rate. Our balance sheet is now stronger with debt maturities extending to 2030. I couldn’t be proud of our finance team for delivering this improved capital structure. Today, I will highlight four key strengths that underpin Diamond’s opportunities for success. First, we are positioned to deliver increased value from our harsh environment assets, both DP and moored as markets for those units continue to improve. Second, our better-than-forecast Q3 financial performance will improve our full year results, so we are raising full year guidance.
Third, our lower anticipated shipyard days in 2024 versus 2023 set the stage for improved financial performance through more available revenue days at higher rates. And fourth, we remain well-positioned for multiple opportunities with our top tier MPD-equipped 7th generation drillships rolling off contract in the second half of 2024. Let’s dive deeper into each of these, starting with the first point, delivering increased value from our harsh environment assets. Yesterday, we announced $240 million in new contract awards. After the quarter end, we were awarded a long-term plug-in abandonment, our P&A campaign for our moored harsh environment semi, the Patriot, and our customer exercised their third option well for the GreatWhite, following the exercise of their second option well earlier in Q3.
The new Patriot contract, which commences in early 2025 comes with both a higher dayrate and significant term. With contract duration based on 35 wells, the contract represents roughly three years of firm work with priced options that could extend it to four years in total. Both the contract execution lead time and term of the Patriot award are notable, and we believe indicative of future market tightness in the UK region. Regarding my second point, our Q3 financial performance, total revenue and adjusted EBITDA for the quarter were $245 million and $28 million, respectively. These results were above our guidance for the quarter, primarily due to an additional 17 days of work for the Courage prior contract end, and one well early termination fee on Apex, which subsequently proceeded in direct continuation to its next contract, commendable rig level expense management and the deferral of certain contract prep costs for the BlackHawk.
This beat should translate into improved performance relative to our prior guidance for the full year 2023. Dominic will provide further detail on these results and guidance in his remarks. Referring now to my third point, lower shipyard days in 2024 as compared to 2023. At the conclusion of 2023, 5 out of our 10 actively-marketed owned rigs will have completed their five-year special periodical surveys or SPSs in the last 18 months. Looking forward, we have only two rigs with these surveys due in 2024, the BlackRhino and BlackHornet, and one rig, the BlackLion with an SPS due in 2025. As a result, we plan to spend significantly less time in the yard next year, and thus benefit from more days available to earn higher dayrates. Now to my fourth and final point, we are well-positioned for multiple opportunities in 2024.
The upcycle and offshore drilling sector continues to be supported by persistent, strong commodity prices and projections for significant year-on-year growth in final investment decisions or FIDs. This optimistic outlook continues to be confirmed by subsea tree award in the third quarter. Additionally, we anticipate that the number of exploration wells drilled in 2024 will increase by approximately 20% as compared to 2023, which is indicative of our client’s commitment to investment in deepwater. Taken together, these strengths set the stage for continued improvement in our financial performance for the next few years. I would now like to turn to the markets more generally and look ahead to opportunities for future contracts in the near-term.
In the UK sector or the North Sea, there have been a number of positive developments. Last week, the UK government awarded 27 new licenses in the 33rd oil and gas licensing round for areas that have the potential to be brought into production quickly. Also, we have seen a surge in P&A campaign tenders over the past several months. Today, we have visibility of some 4,000 days of uncontracted P&A demand scheduled to commence before the end of 2025. More recently, a number of drilling and P&A opportunities have emerged with 2024 start dates, in part due to the scarcity of available supply anticipated for 2025. We are pursuing multiple opportunities for the Patriot with commencement dates in 2024 and are optimistic that we will secure one or more of these prior to its long-term P&A contract.
Turning to drillship opportunities. Later in the second half of 2024, we will have two MPD-equipped seventh-generation drillships with availability for contracts at higher dayrates. The BlackRhino is currently working for Woodside offshore Senegal with the end of its campaign anticipated in early July of next year, to be closely followed by its SPS and MPD upgrade project. Next up, the BlackLion, which is currently working for BP in the U.S. Gulf of Mexico, will have availability commencing in the fourth quarter of 2024. The rig has a great performance record and is ideally suited for opportunities in the U.S. Gulf of Mexico commencing in that timeframe. All in, we are tracking 10 opportunities for these rigs, all with commencement dates in the back half of ‘24, and expect to secure contracts for both in that timeframe.
Wrapping up, we continue to see contracting lead times increasing and average contract durations currently standing at 360 days are at their highest point in over five years. The industry remains in a period of demand expansion, and Diamond is ideally positioned to capitalize on these opportunities. I’ll now turn the call over to Dominic before returning with some concluding remarks.
Dominic Savarino : Thanks Bernie, and good morning or afternoon to everyone. In my prepared remarks this morning, I’ll recap our results for the third quarter, including some operational highlights and additional details on our recent contract awards, discuss our outlook for the fourth quarter and provide some brief remarks regarding 2024. I will also talk through some of the details of our refinancing transaction, undertaken in the third quarter, and what it means for us going forward. And as Kevin alluded to in his opening remarks, we have a presentation on our website that includes some of the financial information I’ll refer to today. For the third quarter, we reported a net loss of $145 million or $1.42 per diluted share.
Our adjusted net loss normalized for one-time non-recurring items was $138.8 million, after adjusting for the non-recurring $6.2 million after tax loss on the extinguishment of debt. The reported loss consists of a net loss before tax of $20 million and a recorded tax expense of $125 million. The tax expense recorded is based on the computation and application of our annual effective tax rate in accordance with U.S. GAAP accounting standards adjusted for discrete items. As I have discussed in prior quarters, taxes will continue to fluctuate quarter to quarter this year, and the tax expense recorded this quarter is a partial reversal of the second quarter’s tax benefit. Additional reversal of the prior tax benefit is expected in the fourth quarter as our tax expense continues to normalize.
Our total cash outlay for income tax this year net of tax refunds is expected to be below $5 million. Excluding reimbursable revenue, revenue for the third quarter was $225 million, down from $265 million in the prior quarter, primarily as a result of the BlackHawk completing its contract in Senegal and being in the shipyard undergoing its managed pressure drilling or MPD upgrade, its five year SPS and contract preparations. The Patriot being off contract for the full quarter, partially offset by the Apex going back to work after spending the prior quarter in the shipyard conducting its SPS and upgrades. Our third quarter revenue exceeded the high end of our prior guidance of $215 million, largely due to the Courage being on contract for 17 days longer than anticipated, the Apex recognizing a portion of the early termination fee from Woodside for one well due to permitting issues, and the receipt of a performance bonus for efficient injury-free operations in Senegal.
Contract drilling expense decreased to $182 million for the quarter, compared to $213 million for the prior quarter, primarily as a result of lower operating costs, lower repair and maintenance costs, as well as the deferral of certain contract preparation expenses for the BlackHawk. Consequently, as a result of these positive revenue and cost drivers, our reported adjusted EBITDA of $28 million for the third quarter was above our breakeven guidance for the quarter and will contribute to improved results for the full year. We generated approximately $4 million in operating cash for the quarter with negative free cash flow of $48 million after taking into account capital expenditures of approximately $41 million and other working capital movements.
Elaborating a bit more on the third quarter operational highlights and results across the regions. In the UK, the Patriot commenced its two-well P&A campaign with Repsol and the GreatWhite secured another one well option. In West Africa, the BlackHawk and BlackRhino combined efforts to earn a $1.9 million performance bonus, representing the seventh bonus achieved during the Senegal campaign. The BlackHawk’s excellent performance during its campaign has set the stage for future bonus potential as wells are completed by the BlackRhino. Also, the BlackHawk completed its five-year SPS along with certain regulatory and customer required upgrades, including the installation of an MPD system. Following its mobilization to the U.S. Gulf of Mexico in October, the BlackHawk commenced its one-year campaign for our customer last week on the 2nd of November.
In Brazil, the Courage finished its current Petrobras campaign and mobilized to Guanabara Bay to commence its SPS and contract prep work for its next contract with Petrobras, which is expected to commence in December. Finally, in Australia, the Apex completed its campaign with Woodside, after the last well in the contract was cancelled and paid out. Subsequently, in direct continuation, we kicked off our campaign with Apex at a higher day rate. As a reminder, the Apex is firmly committed to a number of clients through the first quarter of 2025 with the potential for options that extend into the third quarter of 2025. As Bernie referenced in his remarks, we also had some commercial successes during the third quarter and subsequent to the close of the quarter, securing contracts valued at approximately $240 million.
Our customer in the North Sea exercised the second and third option wells for the GreatWhite at a slightly higher rate than its original term, adding 120 days of activity in 2024 with a total contract value of over $30 million. The rig is now firmly contracted through August 2024. This leaves five additional option wells that could potentially be exercised as the GreatWhite continues to progress her operations. Additionally, the Patriot was successful in its pursuit of a long-term P&A campaign with Taqa, commencing in early 2025 with a total contract value of approximately $210 million. The contract is for 35 P&A wells representing approximately three years of firm term, plus up to additional 17 option wells that could extend the term to four years in total.
This contract will allow the Patriot to earn approximately $35 million of fully burdened EBITDA per year for the life of the contract. The option exercises for the GreatWhite and the new contract award for the Patriot clearly reflect our capabilities and track record of successful operations in the North Sea. And when combined with our already robust $1.4 billion of backlog reported as of October 1st, these additional contract awards lay the foundation for strong financial performance over the next several years. Now, I would like to shift to a discussion of our fourth quarter outlook. Looking ahead to the fourth quarter, we expect contract drilling revenue excluding reimbursables of $265 million to $275 million, slightly higher than prior guidance for the quarter.
The increase in revenue compared to the third quarter is largely activity driven, with the BlackHawk, Courage and Patriot being on contract during the quarter, executing their new contracts at higher day rates. This results in expected revenue for the full year 2023 of $970 million to $980 million. EBITDA for the fourth quarter is anticipated to be between $50 million to $60 million, in line with prior guidance for the quarter and would be our highest recorded quarterly EBITDA since mid-2018. This leads to expected full year EBITDA of $135 million to $145 million, an approximately 25% increase over prior guidance, due to our favorable third quarter results carrying over to the full year. CapEx for Q4 is expected to be between $35 million to $40 million as we wrap up the BlackHawk MPD installation and Courage contract preparation and SPS, resulting in expected full year CapEx of $130 million to $135 million, consistent with my prior remarks that we would exit the year at the higher end of our previously guided range.
As a result of contract preparation activities and CapEx expectations, we expect free cash flow for Q4 to be generally consistent with the third quarter. I would now like to provide some brief remarks regarding our 2024 outlook. We plan to provide specific guidance for 2024 during our Q4 earnings call early next year as we are currently working through a number of opportunities that could positively influence our guidance. In the meantime, as I shared last quarter, we are positioned for a significant step-up in EBITDA and cash flow generation in 2024. We expect to incur only 100 days in a shipyard in 2024 for rig upgrades, contract preparation activities and SPSs, excluding mobilization, as compared to approximately 450 days off contract in 2023, leading to more revenue generating days and higher dayrates.
The BlackHawk’s operating cost should go down significantly as it begins work in a lower cost region, not to mention its significantly higher dayrate. And our CapEx expenditures should decrease meaningfully as a result of two SPSs, as compared to five this past year. All of these factors combined provide the foundation for 2024 to continue the improved financial performance that we expect to begin in the fourth quarter of this year. And finally, this morning, I wanted to provide some additional information about our previously annualized refinancing transaction that took place during the third quarter. We completed the refinancing of our post-emergence capital stack through the issuance of $550 million of senior secured second lien notes due 2030 with a coupon of 8.5%.
A portion of the proceeds from the bond offering was used to extinguish the borrowings under our revolving credit agreement, our $100 million term loan, and $85 million first lien notes. The remainder of the proceeds will be used for general corporate purposes. The 8.5% coupon secured for the bonds meaningfully lowers the weighted average interest rate of 9.9% associated with our prior capital structure. In conjunction with the offering, we also amended our $400 million revolving credit facility due 2026 to provide more operational and financial flexibility in exchange for a reduction in capacity to $300 million. As a result of the refinancing, our liquidity grew by approximately $200 million and stood at $440 million at the end of Q3 through a combination of cash on the balance sheet and $298 million of available capacity on the revolver.
The terms of the indenture and the amended revolving credit facility give us greater flexibility with regard to capital return to shareholders via dividends and/or share buybacks. As we continue to transition to higher dayrate contracts and increased EBITDA and cash flow generation in Q4 of this year and throughout 2024, we will grow into our ability to return capital to shareholders vis-à-vis the covenants and the indenture and the revolver, and anticipate being in position to do so subject to Board approval as we move into 2025. We are very pleased to have secured the financing at favorable terms during this volatile time in the capital markets. This concludes my prepared remarks. I’ll now hand it back to Bernie for some closing comments before we move into Q&A.
Bernie Wolford: Thank you, Dominic. Our near term focus remains on the safe and timely startup of the Courage’s four-year campaign with Petrobras, which is anticipated in December. As the Courage rose to this higher dayrate, we will have four rigs on improved market rates with a fifth, the Patriot, contracted at a higher rate for long-term work commencing in 2025. The supply-demand picture in the UK sector has improved materially, which bodes well for the Patriot in 2024 and subsequently, opportunities for both the Endeavor and GreatWhite in 2025. We’re well positioned for multiple opportunities for our two high-spec seventh-gen drill ships with availability in the back half of ‘24, which aligns favorably with visible demand in that same period.
These factors combined with a significant decrease in planned shipyard days next year, position us to deliver significant growth in both EBITDA and cash flow while we benefit from further upside in the market as we progress through 2024. We appreciate your interest in Diamond Offshore, and will now open the call for questions.
Operator: Thank you. [Operator Instructions] Our first question comes from Eddie Kim with Barclays. Your line is open.
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Q&A Session
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Eddie Kim: Hi. Good morning. Just wanted to ask about the BlackRhino and BlackLion, both those rigs going to be available in the back half of next year. Are those rigs being actively bid into tenders today? I think you said there were 10 opportunities you were tracking for those rigs. And separately, there’s been some commentary recently from your peers about potential white space between contracts next year. Do you expect that to be the case for these two drillships, or do you think we’re likely to see a fairly seamless transition?
Bernie Wolford: Hey. Thanks for the question, Eddie. Both the BlackRhino and BlackLion are being actively bid now for various opportunities, with the primary focus on the BlackRhino. We don’t expect white space for those units as they roll off contracts on to new contracts. We do recognize kind of where the market is in terms of demand and do believe some non-hot or less capable rigs, we’ll see some white space next year. But for these two rigs, given their MPD and their capabilities and how well they’re placed in the market relative to opportunities, we don’t anticipate any white space.
Eddie Kim: Okay. Got it. That’s great to hear. My follow up is just on cost inflation for next year. We’ve heard from one of your peers last week who said they expect cost inflation in kind of the mid-single digits range. What are you expecting to see next year across your fleet and what areas do you expect will be the biggest pinch points?
Dominic Savarino: Hey Eddie, this is Dominic. Thanks for the question. Yes. That’s consistent with what we’re anticipating as well. Our cost base is generally essentially 50% labor and 50% other operating costs such as supplies, materials, services, and repairs and maintenance. We have had one of our largest suppliers indicate that that services are going up 3% and equipment pricing is going up 6% next year, as one particular data point, as well as other sources that we monitor have suggested that equipment and services globally may increase in excess of 4% with certain regional differences. All-in though, we do anticipate that we will have lower inflation offshore than we’ve seen in 2022 and 2023 where certain goods and services had double digit inflation.
So, it’s going to vary region by region. We will also an anticipate some wage increases that’ll be region specific based on reactivations and pressure that that may come from that. But all-in I think that mid-single-digits when you consider the weighted average result of all the various components is not an unreasonable expectation.
Operator: [Operator Instructions] Our next question comes from David Smith with Pickering Energy Partners. Your line is open.
David Smith: So, I know we’re not getting specific ‘24 guidance until the next call, but wanted to ask if it’s fair to assume the main factors and where that guidance would shake out are just potential time between contracts for the Rhino and the Lion. And I appreciate your expectation for limited downtime. But, presumably, the Rhino might have some downtime just for transit, right, in addition to the shipyard time.
Bernie Wolford: Actually, the main factor at this stage would be the Patriot and the opportunities that we are currently pursuing for that rig. I think, we are pursuing today three or four opportunities for the Patriot, all with commencement dates in 2024. With regard to the BlackRhino, we would expect any mobilization to be paid. And so, the only out-of-service time we are expecting for the Rhino is the time to conduct the SPS and install the new MPD system. We don’t expect any white space on the Rhino or the Lion for that matter. So, it’s really the Patriot is the number one needle mover we have today, as well as, just how we position our forecast relative to the options that will likely be exercised on the GreatWhite, which at this stage, we expect most, if not all of those options to be exercised.
