Diamond Offshore Drilling, Inc. (NYSE:DO) Q4 2022 Earnings Call Transcript

Diamond Offshore Drilling, Inc. (NYSE:DO) Q4 2022 Earnings Call Transcript February 28, 2023

Operator: Good day and thank you for standing by. Welcome to the Q4 2022 Diamond Offshore Drilling Earnings Conference Call. 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: Thank you, Michelle. Good morning, 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. In addition, certain statements made during this call maybe 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 morning or afternoon to everyone and thank you for your interest in Diamond Offshore as we present our results for the fourth quarter of 2022. I’d like to start by thanking our crews around the world for delivering on our finish strong safety campaign in the fourth quarter, enabling us to achieve our best safety performance over the last 4 years. 2022 was a pivotal year for Diamond Offshore. We relisted on the New York Stock Exchange, secured $1.3 billion in new contract awards, successfully started up 2 managed drillships and secured work to reactivate the Ocean GreatWhite, all while continuing to deliver industry leading operational excellence for our customers. Today, I will cover financial and operational highlights for the fourth quarter, our operational outlook for 2023, and our view of the markets and the macro environment.

I will then turn it over to Dominic to provide a detailed look at our fourth quarter financials as well as guidance for 2023. We continued our high level of commercial success during the quarter, securing $482 million of backlog with associated commitments totaling more than 4.4 rig years. Adjusted EBITDA for the fourth quarter was $12.5 million on total revenue of $223.2 million. Dominic will provide further details on these results in his remarks. Turning to our operating highlights, I am pleased to report that our rig crews and operational support teams delivered revenue efficiency of 96% across our fleet during the quarter. This efficiency number is impressive, especially considering the integration and startup of the seventh generation drillship Vela, which performed at a high level on this first well under our management.

The fourth quarter was a busy one for Diamond Offshore. The Ocean GreatWhite arrived in Scotland to continue its preparation for the previously announced contract with BP. We signed a new 4-year contract for the Ocean Courage with Petrobras in Brazil and the Ocean BlackHawk and Ocean BlackRhino combined efforts to earn a well-based performance bonus for the second consecutive quarter. The first quarter of €˜23 has been productive for the company. The Ocean GreatWhite recently moved from Kishorn Port to nearby sheltered waters offshore of the West Coast of Scotland to commence sea trials and customer acceptance testing. We expect contract commencement to occur within the next month. Also, the Ocean Endeavor is expected to complete this shipyard scope next week when it will transit to its next well location for our customer.

Looking forward, in Australia, the Ocean Apex is scheduled to mobilize to Singapore late in March to undergo a 5-year special whole survey and certain regulatory and customer required upgrades. We currently estimate the out-of-service time for this project, including round trip transit to be approximately 110 days. Turning now to the market outlook, the Offshore Drilling sector continues to be supported by improving market fundamentals. Demand for oil and gas is expected to outpace supply through at least 2026. In addition, oil and gas companies have materially increased their capital budgets for 2023, and we expect a continuation of this trend over the next 3 years. These, combined with the effect of long-term stacking and years of rig retirements, have prompted a sustainable upcycle in the deepwater sector of offshore drilling, the likes of which we have not seen for the past 10 years.

For instance, in February 2023, outstanding tenders for deepwater rigs as reported by S&P Global represented 49 rig years of demand, a 63% increase as compared to 30 rig years of demand a year ago. Next up, I would like to offer comments regarding the markets where we compete, starting with the North Sea. The UK government’s energy profits levy, or EPL, has had an unsettling effect on Brownfield prospects to offshore the UK. In addition, Norwegian demand remained soft in 2023. This has prompted a number of high-specification rigs to leave the region for attractive opportunities in other areas, a trend we expect will continue through 2023. However, there are a number of shorter term programs starting later this year and early next, plus two significant new programs offshore UK, starting in 2024 or 2025.

These latter programs benefit from investment credits to offset the energy profits levy. Overall, for the UK, we expect 1 additional semi-submersible to be contracted in the region in 2023 and additional unit late in 2024. We recently announced our client’s intention to early terminate the Ocean Patriot contract and reallocate capital related to that program to other areas due to the energy profits levy tax changes in the UK. We expect the rig will remain on contract into early July of this year before being terminated. Our contract costs for a $12.5 million payment upon early termination. We are pursuing a number of attractive alternative work programs for the Ocean Patriot and are optimistic that the rig will find work commencing in the third or fourth quarter of 2023.

In Australia, we see two remaining semi-submersible opportunities yet to be awarded for commencement late in 2023, totaling 3 rig years of work. Looking forward into 2024, a consortium of work offshore of the East Coast and possible exploration opportunities on the Northwest shelf could add a further 3 combined rig years of demand. We are hearing our customers express some near-term concern related to the process of securing environmental permits and the related permit approval backlog, but envisage this to be resolved as we progress through 2023 and not impact demand in 2024. Southeast Asia remains relatively flat with incremental demand for 1 additional semi-submersible late this year and potentially one incremental drillship in 2024. We expect India to grow slowly, adding 1 semi-submersible and 1 drillship in 2024.

West Africa semi-submersible demand is being driven primarily by opportunities in Namibia, Equatorial Guinea and Nigeria. We expect demand to grow by up to 2 units in 2024. Drillship demand in the region is expected to grow by 2 to 4 rigs in 2024 driven primarily by activity in Angola, the Ivory Coast, Namibia, Ghana, and Mauritania. East Africa, particularly Mozambique, has potential for upside drillship demand as well. We see modest increases in semi-submersible 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. In Latin America, we expect semi-submersible demand to exceed regional supply by 2 units in 2024. Drillship demand could grow by 6 or more rigs over the same period.

Brazil is driving the bulk of the new demand in the region with Guyana, Suriname and Colombia contributing. We expect Mexico and the rest of Latin America region to remain relatively flat through 2024. Finally, in North America, we see drillship demand remaining relatively flat with 1 incremental rig in 2023 and possibly another in 2024. It is worth noting that the rates in the region are under pressure to the upside due to the potential exodus of certain sixth and seventh generation units for opportunities in Brazil and West Africa. Canadian harsh environment semi-submersible demand remains a wildcard, but with upside potential subject to commercial success in the region. Translating all of this to a global perspective and factoring in conservatism to allow for slippage and start dates, options not exercise and potential negative final investment decisions, we foresee incremental demand for semi-submersibles growing by 4 to 7 units through 2024 and incremental demand for drillships going by 6 to 10 units through the same period.

Increased rig demand is already being reflected in the number of currently open tenders and continued upward pressure on contract day rates. The strength in global market stands to materially benefit Diamond Offshore. The Ocean BlackHornet was the first of our 4 black ships to transition to a leading edge rate in February. Next up for repricing will be the Ocean BlackHawk, currently working offshore Senegal with anticipated availability in the fourth quarter of this year. Thereafter, the Ocean BlackRhino also working offshore Senegal will have access to reprice market rates when it rolls off contract in the second quarter of 2024. We are currently pursuing multiple opportunities for the Ocean BlackHawk in the Golden Triangle with commencements with commencement from the third quarter of 2023 onwards.

As previously mentioned, we are pursuing a number of opportunities for the Ocean Patriot. We are also pursuing multiple opportunities for the Ocean Onyx in Southeast Asia and Australia. Commencement for these projects, the majority of which are in the supply-constrained Australian market are anticipated to take place late in 2023 or early 2024. This is later than previously anticipated in part due to recent delays in regulatory approvals related to environmental permits. I will close by highlighting that the conditions are in place for a continuation of this upcycle, particularly four key indicators are signaling a continuation of this upcycle. First, relatively strong oil prices and long-dated futures; second, growth in the number of open rig tenders; third, year-on-year growth in our clients’ capital budgets; and lastly, continued growth in average rig contract durations.

Taken together, these bode well for a sustained cycle of increasing demand. I will now turn the call over to Dominic before returning with some concluding remarks. Over to you, Dominic.

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Dominic Savarino: 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 fourth quarter and some insight into our projected results for the first quarter and full year 2023. For the fourth quarter, we reported a net loss of $52.4 million or $0.52 per diluted share. The reported loss consists of a net loss before tax of $26.8 million and a non-cash tax expense of $25.7 million. The tax expense is attributable to our mix of earnings and the lack of benefit on losses in certain jurisdictions as well as the increase in certain tax reserves for potential tax exposures. The results for the fourth quarter included a reported adjusted EBITDA of $12.5 million as compared to adjusted EBITDA of $18.4 million reported in the third quarter.

The decrease in EBITDA was primarily a result of the reactivation expenses associated with the Ocean GreatWhite. Excluding reimbursable revenue, revenue for the fourth quarter was $208 million in line with our guidance for the quarter and up from $190 million in the prior quarter. As a result of a full quarter of operations in Senegal for the Ocean BlackHawk, the Ocean BlackLion operating for a full quarter at its higher day rate, and one of our managed rigs, the Vela, commencing its maiden contract under Diamond management during the quarter. The increase in revenue was partially offset by reduced revenue from the Ocean Onyx, which completed its contract in the third quarter and was subsequently cold stacked during the quarter, and the Ocean Endeavor which was in the shipyard for 2 months in the quarter for repairs, regulatory surveys and steel renewals.

Contract drilling expense increased to $178 million for the quarter compared to $156 million for the prior quarter as a result of the Vela going on contract and expenses related to the reactivation of the Ocean GreatWhite and the Ocean Endeavor shipyard projects. Operating cash flow for the fourth quarter was $36 million, with free cash flow of $15 million as compared to negative free cash flow of $30 million in the third quarter. The improvement in free cash flow was primarily a result of working capital released during the quarter. For the full year 2022, we reported revenue, excluding reimbursable revenue of $725 million and adjusted EBITDA of $35 million, both at the upper end of our most recent guidance for the year. CapEx for the full year of $60 million came in well under our prior guidance of $75 million to $80 million, in large part due to the Ocean Endeavor and Ocean GreatWhite projects straddling year-end with some items pushing into 2023.

We exited 2022 with a strong balance sheet, including total liquidity of $306 million. Turning now to our full year 2023 guidance. Our $1.8 billion in backlog as of January 1, 2023, positions us extremely well in terms of contract coverage for 2023, yet with some key opportunities for operational leverage in 2023 and 2024 as legacy contracts roll off and recontracting opportunities arise. As preliminarily guided last quarter, 2023 revenue, excluding reimbursable revenue, is expected to be between $950 million and $990 million, which represents a more than 30% increase over 2022 revenue as a result of higher average day rates and the Ocean GreatWhite being on contract after its reactivation. Also consistent with our preliminary guidance last quarter, EBITDA for 2023 is expected to be between $160 million and $180 million, a more than fourfold increase over 2022 EBITDA.

Embedded in these results for 2023, contract drilling expense is expected to be between $730 million and $740 million, and G&A expense is expected to be between $65 million and $75 million. Interest expense is expected to be approximately $45 million to $50 million and cash taxes approximately $15 million to $20 million. CapEx for 2023 is expected to be between $95 million and $110 million excluding any CapEx associated with the potential reactivation of the Ocean Onyx or an MPD kit for one of the black ships should it be required. Our estimated CapEx spend for 2023 does take into consideration the completion of the Ocean Endeavor repairs and Ocean GreatWhite reactivation as well as the maintenance, upgrades and special whole survey for the Ocean Apex occurring over much of the second quarter when it is off contract for approximately 110 days and the special whole survey and customer-required upgrades for the Ocean Courage occurring in the fourth quarter in advance of its new 4-year Petrobras contract.

Breaking down 2023 a bit further, beginning with guidance for the first quarter. We expect revenue, excluding reimbursables, to be between $200 million and $210 million and EBITDA to be between $15 million and $20 million. More broadly, the year can be categorized as a tale of two halves. The first half of 2023 characterized by the runoff of some lower day rate contracts, shipyard stays and reactivation resulting in modest EBITDA improvements from our current quarterly run rate, but still negative free cash flow. In contrast, the second half of 2023 benefits from full quarters operating on higher day rates for the Ocean BlackHornet and Ocean Apex and the Ocean GreatWhite being on contract for the full period, more than doubling our EBITDA potential compared to the first half of 2023, including returning to free cash flow breakeven or slightly positive for the second half.

That said, we do expect the combination of the two halves to leave us free cash flow negative for the full year. Despite this, the upward trajectory of our free cash flow beginning in the third quarter should accelerate quarter-over-quarter as the calendar turns to 2024. Our perspective on the second half of 2023 and the full year 2024 is bolstered by the continued demand we are seeing across all asset classes and regions in which we operate, as Bernie alluded to. We remain confident that we will be able to secure meaningful day rate increases for our rigs as they roll off their current contracts and combined with our current backlog are well positioned to be able to capitalize on this upcycle and deliver meaningful EBITDA and free cash flow in 2024.

That concludes my prepared remarks, and I will now hand it back to Bernie for some closing comments.

Bernie Wolford: Thank you, Dominic. At Diamond Offshore, we have remained productive over the last 6 months, securing significant backlog, executing an important shipyard project and delivering a value-enhancing rig reactivation, all while providing significant value to our customers through productivity and safe execution of work. I appreciate the talent, focus and enthusiasm the Diamond Offshore team brings to bear in order to achieve these results. Prospects for the deepwater offshore drilling market are compelling as we enter 2023, and we remain poised to capture further upside in what is shaping up to be a sustainable up cycle. We appreciate your interest in Diamond Offshore, and we will now open the call for questions.

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Q&A Session

Operator: Our first question comes from Eddie Kim with Barclays. Your line is now open.

Eddie Kim: Hi, good morning. So just wanted to touch on the contracting strategy for the BlackHawk and BlackRhino is a come-up contract here in the next 12 months. I mean everything you just described on the outlook, especially for drillships, suggest pay rates are a little bit higher from here. So I mean, would you be willing at this stage to take for 40 a day over 3 years? Or would you be more inclined to take maybe a 1-year contract to secure a longer-term contract with a five handle down the line?

Bernie Wolford: Thanks, Eddie. Good question. Not necessarily when I’m going to answer in some detail. But I will tell you, Obviously, term has value and the fact that you can secure 100% utilization without gaps between contracts. And there is certainly a modifier we use when we consider whether to go longer term or shorter term. Your question though is more direct to that, what rates would we expect in the out years, let’s say, of a 3-year contract? And would we prefer to go shorter? And quite frankly, there are a couple of fairly obvious alternatives out there today, and they differ pretty materially in terms of the duration. And we’re going to just take each one kind of case by case. We would we would be unlikely to pass on a contract in the mid-400s with long-term at this stage in the market, not wanting to be waiting on a 500 handle that may not appear in the market until late €˜24 or 2025.

Eddie Kim: Got it. That makes sense. I guess we can’t be too greedy. Just shifting over to actually just a question on your fleet status, which you did put out yesterday, I noticed there is no price options mentioned in your report. So, is it fair to assume you don’t have any price options for any of your rigs, which would obviously be a great thing in this current environment?

Bernie Wolford: So, let me kind of run through the rigs where we do actually have price options today. I know that the Ocean GreatWhite has one-well priced options, which are €“ which we reported, I think when we announced that contract. The Vela, one of the rigs that we manage also has priced options with the current client. I believe that’s all we have right now in terms of price options.

Eddie Kim: Okay. Understood. Great. Thanks for all that color. I will turn it back.

Bernie Wolford: Thank you.

Operator: Please standby for our next question. Our next question comes from David Smith with Pickering Energy. Your line is now open. David, your line is now open.

David Smith: Hey. Good morning and thank you for taking my questions.

Bernie Wolford: Hi David.

David Smith: I will start by saying congratulations on maintaining preliminary guidance. I think there was some investor concern about that after the past week, but that was good to see. Wanted to ask real quick, good to hear about your prospects for the Ocean Patriot to pick up new work in the second half of this year. I was hoping to get a little more color on the prospects. Is the opportunities that you are focused on relate more to P&A work and whether you are seeing much, if any, competitions from higher spec rigs that might be looking to fill out their own second half €˜23 availability?

Bernie Wolford: Yes. Thanks David. We have been somewhat pleasantly surprised by the interest in the Patriot since we announced the expected termination. The work offshore in the UK, that the rig is most likely to participate in is about 50% P&A opportunity and 50% drilling and appraisal work. Most of the terms are relatively short anywhere from 40 days out to 180 days right now for the works that we are actually looking at. And we are in very constructive discussions at this stage with two parties for the potential use of the rig. So, I don’t want to get too crazy optimistic on it, but we feel pretty good about the Patriot right now where it sits.

David Smith: It seems like it might actually come out ahead. I also wanted to focus on your two higher spec semis in the UK, the Ocean GreatWhite and the Ocean Endeavor. I did notice that the Endeavor on the fleet status report looks like it got pushed forward a quarter, but I am going to ask anyways, if you can tell us anything about what those contract termination provisions might look like?

Bernie Wolford: Sure, David. Both the GreatWhite and the Endeavor have contract termination provisions that allow our customers to terminate for convenience, but in the event they would choose to do that. In effect, the payments that they would owe us, allow us to recover the full economic benefit for the firm terms of the contract. So, we would not be out any EBITDA as a result of those cancellations, and we would obviously have the opportunity to market those units to other clients.

David Smith: That’s great. And if I could throw one more follow-up on Eric, those both look like deepwater rigs. If the UK stayed €“ it went softer for longer, is there any reason those rigs couldn’t be marketed for deepwater work and is the Eastern Med or maybe West Africa?

Bernie Wolford: Yes. We could consider marketing both of those rigs outside of the North Sea. I mean both have capabilities through to further regions, whether it’s a large deck space for remote operations or in the case of the GreatWhite operating in high current environments. And we obviously continue to access opportunities both in the North Sea and outside. But I have to tell you, our base case right now is to keep those rigs in the North Sea area. The GreatWhite is really ideally suited for west of Shetland’s work, and there are a number of programs coming up late €˜24 or €˜25, where that rig could potentially secure a further term. And the Endeavor is a workhorse rig with a huge deck space that allows it to load up on completions and related equipment onboard the rig and provide a relatively low-cost platform for our customers to drill and complete wells offshore.

David Smith: Great. Appreciate all that color. Thank you.

Bernie Wolford: Thank you.

Operator: Please standby for our next question. Our next question comes from Fred Bookstein with Clarkson Securities. Your line is now open.

Unidentified Analyst: Hey Bernie and Dominic. I hope you are well. I have two, I think broader questions. First, I wanted to touch a bit on the M&A discussion. There has been a few M&A transactions after the kind of bunch of drillers emerged from Chapter 11 and Diamond has been a name that has been mentioned as a potential in €“ candidate to be part of that for some time. So, I was wondering if you are thinking around kind of where you fit in this offshore drilling sphere has changed? Do you have to be where you are today, or are you actively looking for something to do either being acquired or acquiring something else?

Bernie Wolford: Yes. Thanks for the question, Fredrik. I will start by noting we are ultimately pursuing the interest of our shareholders. And as our stock currently trades today, in terms of multiples on 2024 EBITDA, we are relatively low compared to the majority, if not all of our peers. And so primarily, we are seeking value for our shareholders. I will say Diamond is in a unique position where we can continue as a standalone driller with optionality to consolidate smaller peers or, obviously, we have the option to consolidate with a larger peer. As you know, we previously disclosed we explored consolidation, and I can tell you that we continue to evaluate opportunities today.

Unidentified Analyst: Thank you. And I think a good follow-up, exactly what’s my next question that you are saying that you are keeping your shareholders’ interest in mind. So, separate to the M&A part, are you actively having discussions around capital structure, shareholder returns? And I know how you can optimize that on a standalone basis. I guess you said that the RCF for €˜23 might be net negative for the full year, but any color you can share or thoughts you have had around that would be helpful as well.

Dominic Savarino: Yes. Fredrik, this is Dominic. With regard to our view on that from a debt stack perspective as well as returning money to shareholders, it’s a €“ it’s really as we have said in the past, it’s really a 2024 issue as we get €“ as we progress through 2023 and early €˜24 and pay down our RCF. At that time, we would have the opportunity to investigate opportunities to convert our current debt stack to something that is more regular way that enables us to relieve ourselves of some of the constraints we have from the covenants that are related to the emergence from bankruptcy. So, once we go through that process and have the cash flow generation to optimize our current outstanding debt and then consider opportunities at that point, it’s really an end of 2024 story before we are able to really take advantage of that opportunity.

Unidentified Analyst: Thank you very much. And just two quick one on there, Ocean GreatWhite, you mentioned a few €“ that you had some opportunities in sites for that. Have you any color on whether or not you think BP will exercise those options? And have that changed after the EPL? I am just thinking on this in kind of relation to your activation costs and the payback of that, which I think kind of is covered by the firm period, but the options would give you economics above that.

Dominic Savarino: Fredrik, our understanding is that the and BP project will qualify for investment credits that apply against the most recent energy profits levy. So, from that perspective, I believe, BP in that project are shielded from the excess tax costs associated with that. The rig has eight priced options with BP estimated at roughly 60 days each. And we would anticipate that BP will ultimately exercise most, if not all of those options. That timeframe, should they proceed in that manner would have us well placed for the future opportunities that are present, west of Shetland starting in late €˜24 or early 2025.

Unidentified Analyst: Great. Thank you so much. That’s all for me.

Dominic Savarino: Thank you, Fredrik.

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

Bernie Wolford: Thanks all for your participation in today’s call. We look forward to speaking to you again in the next quarter. And I will note that we recently updated our investor deck on our website. So, the latest and greatest information is available there. Thank you very much. Have a good day.

Operator: This concludes today’s conference call. Thank you for participating. You may now disconnect.