Diamond Offshore Drilling Inc. (NYSE:DO) Q2 2022 Earnings Conference Call August 10, 2022 9:00 AM ET
Company Participants
Kevin Bordosky – Senior Director of Investor Relations
Bernie Wolford – President & Chief Executive Officer
Dominic Savarino – Senior Vice President & Chief Financial Officer
Conference Call Participants
Operator
Good day and thank you for standing by. Welcome to the Q2 2022 Diamond Offshore Drilling Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference call is being recorded.
I would now like to turn the conference over to Kevin Bordosky. Please go ahead.
Kevin Bordosky
Thank you, Lisa. Good morning, everyone and thank you for joining us. My name is Kevin Bordosky, Senior Director of Investor Relations. 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 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 morning or afternoon to everyone and thank you for your interest in Diamond Offshore.
I’d like to start the call by saying how excited we are to be relisted on the New York Stock Exchange. Since relisting, we have seen significant liquidity with approximately 180 million shares traded to date and average daily volumes exceeding to 2 million shares. Now that we have completed the full quarter as a listed company, we plan to have regular quarterly earnings calls to provide updates on the market and the good work we are doing at Diamond.
In recent months, the broader markets have been — have seen unusually high levels of volatility particularly in the commodity markets. Since February of 2022, prices for hydrocarbons have increased dramatically with spot Brent averaging over $100 per barrel and natural gas hitting high as not seen in more than a decade. These increases have led to significant improvement in the cash flow profile of our global client base. We expect that significant portions of this improved cash flow will make its way into offshore drilling capital expenditures in 2023 and beyond and are already seeing related demand materialize. Not only do we expect a supportive commodity environment to drive offshore drilling demand but the underinvestment of past years is finally coming to bear.
Rystad estimates that offshore project sanctioning was approximately $55 billion in 2020 compared to a projected $100 billion in 2023. The historic underinvestment, coupled with energy security concerns have been the catalyst for increased demand for our services. Given the lag between investment and energy delivery, we anticipate that our customers will commit significant CapEx over the coming years and therefore, view the offshore drilling market as poised for a meaningful demand-driven recovery.
Turning to the second quarter of 2022. Diamond Offshore had a net loss per share of $0.22. This compares to a net loss per share of $0.34 in the first quarter of 2022. The improvement quarter-over-quarter was primarily driven by 4 rigs, the Ocean Apex, the Auriga, the Ocean Endeavor and the Ocean Patriot. 3 of the 4 rigs were fully operational throughout the second quarter and the Ocean Patriot resumed operations mid-quarter. Despite this higher level of activity, our costs were relatively flat quarter-over-quarter.
Turning to our operating highlights. I’m pleased to report that in the second quarter of ’22, Diamond had revenue efficiency of 96.3% across our fleet. More importantly, our crews delivered these outstanding results while maintaining the highest safety standards, all while dealing with the challenges posed by another wave of COVID infections. I’m pleased to report that our safety performance has improved materially this quarter and want to recognize the Ocean BlackHornet, the Ocean Courage and the Ocean Endeavor for each completing 3 years of operations without a single recordable injury. Hats off to these great achievements and to all who deliver safe work every day.
In May of ’22, the Ocean BlackHawk completed its inaugural contract which began 8 years earlier. Over the course of this contract, the rig drilled 124 miles of wellbore comprised of 39 new wells and worked over or completed an additional 31 wells. The rig is since mobilized to Senegal and commenced its contract for Woodside with an anticipated duration of 1 year. Diamond remains focused on making our rigs more fuel efficient and reducing our environmental impact.
In the second quarter, we were able to reduce fuel consumption by over 15% on the Ocean Endeavor. This was accomplished by providing the drilling crew with actionable real-time information to support efficient use of our power plants. We continue to explore both hardware and software-based solutions to further reduce our CO2 emissions. Additionally, we recently appointed a Sustainability Officer whose sole focus is to facilitate continuous improvement in our ESG performance.
Turning to our outlook. The second half of ’22 promises to be a busy period for the company. We had the Vela prepping to start work late in the third quarter for a previously announced contract. This work includes BOP upgrades and recertification. The Ocean Endeavor will be going into the shipyard in the fourth quarter to replace 8 diagonal braces and conduct a 5-year special haul survey to assure high rig availability for the future.
Finally, the Ocean GreatWhite is commencing reactivation and ramp up for its new contract which commences in the first quarter of 2023. This leads me to a high-level summary of the new backlog announced with this quarter’s earnings release. Our focus on delivering superior performance for our customers, while not compromising safety has facilitated this success. Yesterday, we announced the award of some $610 million of additional backlog all recently secured.
Starting with the Ocean GreatWhite. We have secured work with BP for this previously warm stacked unit. The rig was awarded a 5-well contract with an estimated duration of 300 days to start in the first quarter of 2023. Total contract value, including a modest mobilization is expected to be approximately $80 million.
With this award, Diamond will have 3 harsh environment semisubmersibles working in the U.K. North Sea, all with contracts that run through 2023. These contracts should position us well for the increase in demand anticipated in the coming years. For reference, Rystad estimates that North Sea floater demand will grow by 19% through 2026. A material portion of this demand is likely driven by Europe’s push for energy security.
Diamond also had contracting success in Australia with the Ocean Apex securing 3 new contracts with a combined backlog of approximately $90 million. The first being 2 additional wells for Woodside with a combined estimated duration of 75 days, then a new award from Chevron commencing in mid-23 for an estimated 75 days. Finally, a third contract award from Santos beginning in mid-’24 with an estimated duration of 150 days. An astute listener may pick up that we could have white space between the Chevron and Santos work. For information, we are in the late stages of negotiations to secure an additional contract to fill this gap. If successful, the Ocean Apex will be committed through late 2024.
Turning closer to home. Diamond secured 3 years of additional drillship work from BP across 2 rigs. Firstly, the Ocean BlackHornet had its contract extended by 2 years with an estimated backlog add of $290 million. This extension secures a leading edge rate for 1 of our premier offshore assets through the first quarter of 2025. Secondly, the Diamond managed Auriga secured a 1-year extension with BP which will keep the rig contracted through March of 2024, with an estimated backlog add of $150 million. Clearly, these backlog additions reflect meaningful improvement in offshore drilling demand across multiple regions. More importantly, with improved day rates and high utilization, we have an opportunity to earn considerably higher margins in 2023 and beyond.
I’d like to thank everyone involved in securing this backlog as these awards are a testament to the class-leading Diamond Offshore brand, our unwavering commitment to HSE and the hard-working people who contribute to the Diamond Difference. I cannot be prouder of this team.
And with that, I will turn the call over to Dominic. Over to you, Dominic.
Dominic Savarino
Thanks, Bernie and good morning or afternoon to everyone. As Bernie indicated, it is great to once again be able to share the Diamond story now that we have a full quarter under our belt as a New York Stock Exchange listed company. In my prepared remarks this morning, I’ll be providing an overview of our results from this past quarter. I’ll also touch on our marketing and management services agreement with Aquadrill LLC, provide a brief overview of the reactivation and contract preparation work beginning for the Ocean GreatWhite, provide some insight into our projected results for the full year 2022 and offer some commentary on the new contracts we announced yesterday.
For the second quarter, we reported a net loss of $22 million or $0.22 per diluted share. This compares favorably to our reported net loss in the first quarter of $34 million or $0.34 per diluted share. The results for the second quarter included a reported adjusted EBITDA of just over $15 million, a $26 million improvement from the prior quarter. The improvement in our results was driven by an 18% increase in contract drilling revenue as a result of increased activity in the quarter for which I would like to provide a little more detail.
Our contract drilling revenue for the second quarter, excluding reimbursable revenue, grew to $177 million as compared to $150 million in the prior quarter. The Ocean Apex, one of our more semisubmersible rigs working in Australia commenced a contract early in the second quarter following a period of idle time in the prior quarter. Both the Ocean Endeavor and Ocean Patriot, 2 of our moored semisubmersible rigs working in the U.K. sector of the North Sea return to operations in the second quarter after spending much of the first quarter in the shipyard undergoing repairs and a special hull survey for the Ocean Patriot.
In addition, the seventh-generation drillship, the Auriga which we manage on behalf of the rigs owner, had a full quarter of operations under its initial contract secured by Diamond in the Gulf of Mexico after spending the prior quarter being reactivated and readied for deployment. These increases in activity and revenue were partially offset by the Ocean Monarch completing its contract and subsequently being cold stacked and the Ocean BlackHawk completing its contract in the Gulf of Mexico and spending a portion of the quarter undergoing contract preparation and mobilization prior to joining the Ocean BlackRhino in Senegal to begin a new contract in early July.
Contract drilling expense remained relatively flat at $142 million as compared to $145 million in the prior quarter. The activity related increase in contract drilling expense for the quarter was more than offset by the conclusion of repair-related and special hull survey costs associated with the Ocean Endeavor and Ocean Patriot in the prior quarter. G&A expense for the second quarter totalled $20 million compared to $17 million in the prior quarter. The second quarter G&A expense included a noncash charge of $4 million for compensation expense associated with a long-term incentive award.
Net interest expense for the second quarter was $10 million as compared to $8 million in the prior quarter due to a higher drawn balance on our revolving credit facility and an increase in the applicable LIBOR borrowing rate.
I will now provide some additional color on our managed rig arrangement. In May of 2021, we agreed to market and manage three drilling rigs including two seventh generation drillships, the Auriga and the Vela and the semisubmersible rig, the Capricorn. The financial terms of this arrangement consists of four primary components: reimbursement of costs incurred to manage and operate the rigs, a fixed daily fee based on the status of the rig that is a different rate based on whether a rig is cold stacked, warm stacked, undergoing reactivation or operating and variable fees equal to 1.5% of revenue and 13% of margins earned on the contract.
As mentioned previously, the Auriga is currently operating under its initial contract under Diamond Management. In addition, the Vela is currently undergoing contract preparation activities for commencement of a contract in late third quarter.
And finally, we received notification in early July that the rigs owner intended to cancel the specific agreements in place for the Capricorn as a result of the sale of that rig to a third party. We helped facilitate the handover of the Capricorn to the buyer and no longer have any additional responsibilities with regard to that rig.
The contract drilling revenue and contract drilling expenses associated with the operation of these managed rigs when they are on contract are reflected in our contract drilling revenue and contract drilling expense results just as we do for our owned rigs. In the second quarter, we recorded $20 million in contract drilling revenue and $2 million in EBITDA associated with the managed rigs.
Turning now to the reactivation and contract preparation activities of the Ocean GreatWhite. We expect the total cost to be incurred in advance of contract commencement to be in the range of $35 million to $40 million, consisting of $18 million to $20 million associated with reactivation scopes with the remaining $17 million to $20 million being allocated to operating expenses until contract commencement, emissions reduction equipment, mobilization costs and customer specified equipment.
In order to meet an accelerated commencement window, a significant portion of the preparation activities will be brought forward from 2023 as originally expected and be undertaken in the second half of 2022. This acceleration will negatively impact prior capital expenditure and EBITDA guidance for 2022 but ultimately benefit the company longer term via revenue recognition earlier in 2023 than previously planned.
I would now like to provide some insight into our anticipated full year 2022 results and provide some updates to previously issued guidance. Through the end of 2022 and into 2023, we will continue to work off backlog booked at lower day rates than our recent contract awards and the current spot market reflect.
Consequently, our contract drilling revenue for the full year 2022 is anticipated to remain in line with our prior guidance of $700 million to $730 million, exclusive of reimbursable revenue. EBITDA for the full year 2022 is expected to be between $25 million and $35 million lower than our prior guidance of $55 million to $63 million as a result of 2 major activities. First, the previously mentioned acceleration in reactivation and contract preparation activities associated with the GreatWhite. And second, the Ocean Endeavor’s planned return to the shipyard for 60 days in the fourth quarter to replace certain diagonal haul braces, coupled with the acceleration of the rig’s special whole survey.
2022 costs will be higher as a result of this acceleration, ultimately benefiting our 2023 and 2024 results. The total cost of this project is estimated to be approximately $20 million. For these same reasons, we are also increasing our full 2022 capital expenditure guidance from a range of $54 million to $60 million to a range of $75 million to $80 million and decreasing our free cash flow guidance from a negative $73 million to $78 million to a negative $105 million to $115 million. This increase in negative cash flow is largely a timing issue as the Ocean GreatWhite reactivation cost had originally been anticipated to be incurred in early 2023.
Our cash flow and EBITDA over the course of 2023 should improve as a result of this acceleration of reactivation costs into 2022, along with the recent contract awards at leading edge rates. Our liquidity at the end of the second quarter stood at $339 million, including $43 million of unrestricted cash and $296 million of undrawn capacity on the revolving credit facility and delayed draw first lien notes. As our legacy contracts wind down and our new awards at significantly increased day rates begin to be executed, our liquidity profile should improve significantly.
Although we are not prepared to provide guidance for 2023 at this point, I would like to provide some additional details regarding the new contracts we announced yesterday evening. The $610 million in contract awards we signed since the close of the quarter, combined with our previously existing contracts, secures revenue for approximately 75% of our available 2023 capacity, excluding planned shipyard stays and cold stacked rigs, giving us greater visibility and confidence in our 2023 results.
In addition, the estimated average EBITDA as a percentage of revenue in these new contracts in the aggregate is approximately 10 percentage points higher than our legacy contracts, representing an approximate 25% increase in margin as compared to our current contracts.
For Diamond-owned rigs only, the new contract’s EBITDA is approximately 20 percentage points higher than our legacy contracts, representing an almost 50% increase in margin as compared to our current contracts. As a consequence, our EBITDA and cash flow results should begin to improve considerably as these new contracts commence in 2023.
I will now turn the call back over to Bernie for some additional remarks.
Bernie Wolford
Thank you, Dominic. At Diamond, we’ve been incredibly busy over the last 6 months, delivering performance for our customers, relisting on the New York Stock Exchange and adding significant backlog to both our semisubmersible and drillship fleets. We foresee continued improvement in each of our operating regions as demand increases, while supply remains relatively constrained. From our vantage point, the outlook for offshore drilling is robust and we expect to continue to benefit from the recovery currently unfolding.
We very much appreciate your interest in Diamond Offshore and we’ll now open the call for questions.
Question-and-Answer Session
Operator
[Operator Instructions] First question is going to come from Frederik [ph]. Please go ahead.
Unidentified Analyst
So congratulations on a nice quarter and maybe even more so on the new contract awards. And I think my question kind of relates to get some more color on what’s happening here. I think we can maybe start with — start with U.S. Gulf of Mexico since that’s been a hot area for many other players as well. We’ve seen rates coming up and crossing the $400,000 mark recently. And based on the numbers that you are disclosing in your report, I see that that’s probably where we are as well. But it seems like the BlackHornet is just below 400 and then we have the Auriga just above 400s. So I was wondering if you could give any color as to maybe why the rates are a bit different. Are there any special extra services, et cetera? And what is the best estimate for a clean underlying rate here?
Bernie Wolford
Thanks for the question, Frederik. With regard to the Ocean BlackHornet and Auriga, I think you should think of those rates as both being clean in the very high 300s. Both rigs are equipped with NPD. In the case of the Black Hornet, the purchase and operation of the NPD is provided by the client. Whereas in the case of Auriga, it is an owner-provided piece of equipment. So I think from a clean rate perspective, just think of it as very high 300s for both rigs. I would also point out, given the relatively long term associated with those contracts, those rates are clean with 100% utilization which would compare perhaps with 90% utilization well into the 400s.
Unidentified Analyst
That’s actually very helpful. And I agree that it’s strong to see those rates on that kind of term. So maybe with that, I have 2 regions I want to this other region I want to visit as well. So we can start with the — I think the Australian market here. The Apex looks to be mostly booked out now for 2023 and 2024, some white space, average rate, given your total additional backlog, there seems to be around $300,000. But then in that region, you also have some rigs that are not working right now. So wondering if you maybe you could comment more generally on the Australian market and what you see of opportunities for working and nonworking rigs there in addition to the dairy developments?
Bernie Wolford
Sure. We’ll do. Let’s start with the Monarch that cold stacked in Malaysia currently. That rig is do a special hole survey. And given the current state of the market and the expenses associated with reactivating that unit, that would be driven only by demand and term in rates sufficient to justify the investment in that special whole survey and upgrades. The Onyx is currently in route to a stack location on the Northwest shelf, completing the contract with Beach. We’re actively working on 1 near term opportunity for that rig and we see up to 15 opportunities emerging in the region starting mid ’23 and beyond. So although we don’t have a clean line of sight on work for that rig today, given the very tightly constrained market in Australia today and with rates trending now above 300 a day in the region, we’re reasonably optimistic that we’ll find additional work for that rig in the not-too-distant future.
Unidentified Analyst
Yes. No, I would kick off for some reason. So I’ll just go back to the transcript for color that I lost. But I have one more for me before I’ll leave it to the rest of the guys. On the GreatWhite, if possible. And you gave good color on the reactivation cost. That was one part of it but you are mentioning the report that you have some price options on that one. I think on the contract value on the firm days, you’re coming to like 267, including what you described as a moderate obligation fee. I was wondering if you’re able to kind of give some color or at least some color on the direction of where those price options are going since it could, I think, 60 days per well, assuming that, keep the rig working into 2025?
Bernie Wolford
Sure. I’m going to pass that one to Dominic. Dominic?
Dominic Savarino
Thanks, Bernie. Yes, the priced options are at a higher day rate than the firm scope. The contract is — was designed to cover all of our reactivation costs with the firm scope and then provide positive EBITDA for the optional wells at the end. So you will see a higher day rate for those options once we — once they’re executed. And we successfully execute the firm scope of that contract.
Bernie Wolford
And Frederik, just a little more color. If I recall correctly, those options will be exercised one well by one well, if at all and they will start to be exercised as we complete each well in the firm program.
Unidentified Analyst
Okay. So if you complete 1 well the first well, then you could potentially see a fixed well being added to the full scope. Is that the way to understand it?
Bernie Wolford
Correct. That’s how I understand it.
Operator
The next question will come from David Smith [ph].
Unidentified Analyst
Wanted to touch on the tax fleet real quick and just wanted to make sure I understood correctly that the Onyx is being warm stacked. And if so, should we think about any extraordinary costs to put it back to work if you find something for it next year?
Bernie Wolford
The Onyx will be warm stacked. No extraordinary work expected at all. That special hull survey runs for an additional 2 years, if I recall correctly. And we don’t have any major work anticipated for the rig to put it back to work in 2023.
Unidentified Analyst
All right. Great. And if I could circle back on the Monarch. You mentioned cost that it would need for the SBS and upgrades. Just wondering if you could provide a range of total expected costs you would anticipate if you were to put the Monarch back to work?
Bernie Wolford
Yes. I think I could offer some order of magnitude. There’s 2 pieces of work associated with the Monarch. The one is the special hull survey which would also include a ballast water treatment system. And the second would be BOP upgrade to meet, what I would call the standards, most likely required an acceptable offshore Australia. So those works would be on the order of $45 million to $50 million to bring them on or back to work.
Unidentified Analyst
I appreciate that color. I couldn’t tell from the fleet status report but I wanted to ask if there are any priced options on any of your rigs other than the GreatWhite? And if so, could you please share which rigs and maybe the option durations?
Bernie Wolford
Sure. So we have priced options on the Ocean BlackHawk and BlackRhino. I’m running through the rest of the list here just to double check I believe that’s it. Yes. That’s it.
Unidentified Analyst
Do you have approximate duration of those options for the BlackHawk in the BlackRhino now?
Bernie Wolford
It’s a combined set of options that apply to both the Hawk and Rhino on a well-by-well basis at the discretion of our client. And so we would expect some of those to be exercised. We don’t have any visibility into what would be exercised at this stage. It depends on how we progress with their development program which to date is running very well, high performance and completing a number of wells ahead of schedule. But at this stage, just don’t have much visibility into their longer-term plans with regard to exercising those options.
Unidentified Analyst
I appreciate that. And if I could be greedy and to sneak one more in with — Yes, it sure seems like there has been a premium for seventh gen capacity in the U.S. Gulf versus other regions. I’ll refer to you in your marketing team but how do you think about the rate spread for seventh gen rigs in the U.S. Gulf versus other parts of the world?
Bernie Wolford
If you were to ask me that question 3 months ago, I would have said there’s a fairly significant spread. More recently, looking at some of the fixtures we’ve seen in Brazil and expect to see closed in West Africa. We think the rates are really closing to 0 at this stage. There’s demand in excess of the capacity available in the Gulf of Mexico for seventh gen rigs. Obviously, Petrobras is a big part of that, so is West Africa in that region. And I think you’ll see rates for seventh gens across the world go to 400 or in that vicinity. And for good, high-capacity dual activity sixth gens approaching those kind of numbers. So definitely, from my perspective, the Gulf of Mexico was the one distinct bright spot, some 3 to 4 months ago. But with the demand we see materializing today, I think the gap is close.
Unidentified Analyst
Really appreciate the color. And I want to echo the earlier congratulations on the quarter and the solid backlog addition.
Bernie Wolford
Thanks, David. Appreciate your interest in the company.
Operator
I would now like to turn the call back over to management for closing remarks.
Bernie Wolford
Thanks all for participating in today’s call. We look forward to speaking with you again next quarter or any follow-up calls after this one. Thank you very much.
Operator
This concludes today’s conference. Thank you for participating. You may all disconnect and have a great day.
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