Hercules Offshore Q4 Earnings Conference Call: Full Transcript

Operator: Good day, ladies and gentlemen and welcome to the Hercules Offshore Inc. Q4 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. If anyone should require assistance during the conference please press star, then zero on your touchtone telephone. As a reminder, today's conference call is being recorded. I would now like to turn the call over to Son Vann, Vice President and Treasurer of Hercules Offshore. Please go ahead. Son Vann: Vice President and Treasurer: Thank you, Candice and good morning everyone to our fourth quarter 2015 earnings call. With me today are John Rynd, President and CEO; Troy Carson, Senior Vice President and CFO, and Beau Thompson, Senior Vice-President and General Counsel. Yesterday after market close we issued our fourth quarter results. We also filed our 8-K and our 10-K with the SEC. John will begin today's call with some broad remarks on our overall restructuring process, current market conditions, and quarterly performance. Troy will follow with a detailed financial review and provide initial 2016 guidance for various costs and capital expenditure items. As we have previously disclosed, the Company has formed a special committee to review our strategic alternatives. During this review process, we are limited in what we can discuss and as a result we will not have a Q&A session following our remarks. Before I hand the call over to John let me remind everyone that our call will contain forward-looking statements. Except for historical facts, all statements that address our outlook for 2016 and beyond, as well as activities, events or developments that we expect, estimate, believe or anticipate, may, or will occur in the future, are forward-looking statements. Forward-looking statements involve substantial risks and uncertainties and that actual future results could differ materially from those described in such statements. More information about these risks, uncertainties and other factors can be obtained in our SEC filings. With that, it's my pleasure to turn over the call over to John. John T. Rynd: President & Chief Executive Officer: Thank you, Son and good morning everyone and thanks for joining us today to discuss our latest quarterly results. This is our first quarter of operations since exiting Chapter 11. We are excited to move pass through restructuring process and began a new chapter for the Company. We concluded our restructuring process on November 6, 2015 after meeting all the conditions to exit from Chapter 11. Upon emergence, all of our prior unsecured bonds were converted to new common equity and we closed on a new $450 million term loan. Proceeds from the term loan along with our existing cash position gives us a much better liquidity position today than we had prior to our restructuring. As of yesterday, we had just under $510 million of cash of which $200 million is escrowed for the final shipyard payment for the Hercules Highlander. Throughout our time under Chapter 11 and after our exit, we continue to operate the business without interruption and received great support from our customers, vendors, and employees. I want to thank them all for their commitment through the Chapter 11 process. System restructuring agreement was first agreed to last summer, the business environment has further deteriorated. The price of oil was at $60 when we signed on the RSA and it's traded down below $30 earlier this year. This has led many old companies to announce massive reductions in capital spending for 2016 which we expect will have significant impact on rig demand. To offset some of the pressures on our business, we have taken additional permanent cost reduction measures across the company and we'll continue to evaluate our cost structure and capital spending projects to align ourselves to the realities of the environment. The uncertainty around the depth and duration of this downturn also prompted our Board of Directors to form a special committee earlier this year consisting of our Independent Directors to explore our strategic options. We have not disclosed anything on this matter since that announcement and we are limited in what we can discuss. What I can't opine on is that consolidation of the offshore drilling industry is badly needed to rationalize and rebalance the offshore drilling business. Turning to our outlook for shallow water activity, there has been no improvement in the jack-up drilling markets since our last earnings call. The retrenchment in oil prices over the past six months comes at a particularly bad time when many E&P companies determine their capital spending plans for 2016. With no certainty over commodity prices and their own cash flows, our customers are hard pressed to move forward with any drilling programs. As such many of the opportunities that we have been pursuing or either being deferred to late 2016 or 2017, are cancelled all together. Excess capacity in our industry is the other challenge. Today there are approximately 350 jack-ups worldwide under contract which represents a 74% utilization rate. Over 60 of these rigs are scheduled to conclude their existing contracts by mid-year 2016. If there is no incremental work during this period, the market utilization rates could fall through approximately 60% by the third quarter approaching the industry lows during the mid-1980s. These numbers do not include the interest in new builds. There are still some 122 new build jack-ups in the order book of which around 80 are scheduled for delivery in 2016. We suspect however, that a good portion of new deliveries will be deferred or remain stacked at the yards. At this point the industry was scheduled to deliver close to 70 jack-up rigs in 2015. Only 15 actually made it out of the yard last year. The majority of the approximately 122 rigs still under construction have been deferred both by seasoned contractors and speculators, with speculators making up nearly 6% of the jack-ups on order. While the deference might help in the near term but it still pose a long term challenge to recovery in the jack-up market. As you can imagine, we are in an extremely competitive pricing environment. We believe that day rates across regions for all new tenders will have very thin margins, if not already at breakeven, at the rig level. Speaking more specific to our asset base, current activity in US Gulf of Mexico is the lowest levels since beginning of the offshore drilling industry. This morning there are five rigs working in the US Gulf of which we have two rigs and are preparing for a third rig to start working over the next few weeks. There are 16 total jack-ups being marketed in Gulf of Mexico. The number of shallow water well permits have been falling for two years and is dropped by almost 90% from its cyclical peak in 2014. Discussions with our customers in the region suggests some incremental demand might develop as the year progresses. Depending on economics and funding, there could be some property transactions that occurred during the year which might start a bit of activity. As only one of three contractors in the region has any scale, relationships, and liquidity, we're well positioned to win new work that comes through the market. Moving on to the international drilling segment. The construction project for the Hercules Highlander remains on track for delivery in the second quarter. Jack in trials was scheduled to occur on April 5. We are reviewing a learning window with the heavy lift which is currently step between late May to early June. Trended found notes need approximately 50 days. Once we arrive in the North Sea, the rig is scheduled to go dock side for short periods to finalize the load out and installation of merged third party equipment and undergo round of inspections. Once that is completed we will mobilize to location. Assuming that this schedule holds we will be on standby rig for a portion of the time once we offload from heavy lift and well dock side. We will go on full day rate when the rigs gets on the drilling location. If the time line slips and we arrive in the North Sea after August 31, than our day rate won't begin until we get on location. While we don't expect such a delay, if in the event we arrive after August 31, we see to go directly to location once the rig's offloaded and perform the inspections and equipment installations while on site. We have developed a great relationship with Maersk over the past two years and they've been very supportive our efforts with regards to Highlander. We continue to have an open and constant dialogue with Maersk at all levels. Everyone is focused on successfully executing this program given its importance to both organizations. In the Middle East, Saudi Aramco once again saw our pricing concessions from drilling contractors earlier this year. As we disclosed in our last fleet status report, we agreed to a 5% reduction in day rates. The rate reduction will be effective from January 1 through December 31, 2016 for the Hercules 261 and 262 and from January 1 through the contract expiration on the Hercules 266. We did this in order to protect our relationship with largest global consumer jackups, maintain the time in our existing contracts and position ourselves for an extension on the Hercules 266. The contract on the 266 is scheduled to end once we conclude the current well in progress which could be in late April early May. While the contracts with Hercules 261 and 260 remain in effect through late 2019. We are in discussions with Aramco for an extension on the Hercules 266. Duration of such extension is uncertain but if successful, the new day rate is likely to be similar to the current level. In the North Sea, the Hercules Triumph is idle in Rotterdam. Over the past several months we have been pursuing and were shortlisted for a competitive program in the region. However we see what early this year that the customer decided to further program to 2017. We will aggressively pursue opportunities for the rig and there are a few prospects in the region. However, it is possible that Triumph to remain idle through a good portion of 2016 if there is no improvement in the current market conditions. We have already implemented measures to reduce operating expense for the rig while maintaining the quality of the equipment. In West Africa, the Hercules 260 which is contracted to Eni through 2020 continues to perform well. The Hercules Resilience and Hercules 267 remains stacked in Gabon. A few opportunities in West Africa are by and large single well a very short term programs. Aside from the poor economics, these jobs have various operational local content risks that make them difficult to accept. We will continue to be diligent in our effort to secure work although based on our current prospect outlook it is possible for the Resilience to remain off-hire for a good portion of 2016. We have already taken steps to lower the rig's operating cost while maintaining its condition to respond to any contracting opportunity that may arise. Moving on to international liftboat business, while activity levels in West Africa remain weak we have been able to keep a core group of vessels employed with Chevron. Recently we've also been able to secure some short term work for our largest vessel the Bull Ray and are pursuing follow on opportunities for the vessel. Day rates across all the vessel classes have come under pressure. Given our outlook for a soft environment through much of 2016, we have implemented plans to reduce headcount and other costs in the region. In the Middle East we only had one or three vessels work during the fourth quarter. Currently all three liftboats are at the shipyard either ready stacked or undergoing shipyard work. Although all three vessels will be idle in the first quarter we are in the running from a multi-year contract as one of our vessels that could commence in the second quarter. We're also in discussions for work on two other vessels during the second half of 2016. Pricing and all opportunities are below historical levels, but would generate some margins if we're successful in our biz. Overall Middle-East activity in the near term appears to have stalled with projects being deferred part of 2016 and in to 2017. However, the scale and construction programs planned for the regions keeps us positive on the long term prospects for liftboat use in the region. That global overview is pretty clear that 2016 will be an extremely challenging year for the industry. Liquidity in this market is paramount which is one of the key reasons that led us to our decision to restructure. I think we are fortunate to have gone through the process early when new capital was still accessible. We are aggressively bidding our assets and have taken significant steps to reduce cost. All this tough environment they will be with us for some time I am confident the industry conditions will eventually improve. We need to remain focused on our responsibilities, maintain our liquidity, and better position ourselves as a viable drilling contractor. If we are successful in doing this, I think we stand a good chance to capitalize on the recovery. With that, let me turn the call over to Troy. Troy Carson: Senior Vice President and Chief Financial Officer: Thank you, John and good morning everyone. Typically my comments focused on sequential quarterly comparisons. Well I will do the same for today, these comparisons are complicated by our mid quarter exit from Chapter 11. As described in our release, upon emergence from Chapter 11 and the adoption of fresh start accounting, the company became a new entity for financial reporting purposes as of November 6. All results from November 6 through December 31 are accounted for in the successor entity while results prior to November 6, are presented under the predecessor entity. From our commentary today, references to our fourth quarter 2015 results relate to a combination of both predecessor and successor results for the periods of October 1 to November 6, and November 6 to December 31 were applicable, for items such as revenues, expenses and average daily performance. Importantly, as a result of the application of fresh start accounting and the effects of the implementation of the plan of reorganization, the financial statements on or after November 6, are not comparable with the financial statements prior to that date as they're prepared on a different basis of accounting. In addition, our per share data will be significantly different as our share count declined from over 161 million shares to 20 million shares after our reorganization. I should stress that while this combined presentation is a non GAAP presentation for which there is no comparable GAAP measure, we believe that providing this financial information is the most relevant and useful method for making comparisons to the fourth quarter. Finally in addition to the quarterly comparison, I will also provide guidance on our operating cost and capital spending. On a consolidated basis for the fourth quarter, we reported a net loss of $385 million which included total adjustments of $347 million primarily related to reorganization items and costs associated with financing and restructuring activities. This compares to a third quarter net loss of $95 million which included a total of $23 million of adjustments primarily related to reorganization items as well as financing and restructuring activities. Moving on to our segment results beginning with domestic offshore. The segment reported a fourth quarter operating loss of $600,000 compared to a third quarter operating loss of $13.7 million. Segment revenues fell by 26% on an 18% decline in average day rates to $62,600 and an 11% decline in operating days versus the third quarter. Domestic offshore operating expenses declined 48% to $14.4 million for the fourth quarter which included a $1.9 million gain on asset sales compared to third quarter operating expenses of $27.5 million which included a $3.7 million sales in US tax accrual. Operating expenses were below prior guidance as we took more aggressive steps to reduce warm stacking and shore based cost. With respect to what we expect, domestic offshore operating costs during the next few quarters to approximate $15 million per quarter assuming similar operating activity levels. Moving on to our international offshore segment. We reported an operating loss of $12 million in the current quarter compared to a loss of $23.4 million in the third quarter. Segment results declined by 7% on lower day rates which dropped by approximately $6500 per day to average $81,000 per day in the fourth quarter. Utilization was flat at 50%. Operating expenses declined 15% to $27.6 million from $32.4 million in the third quarter and was below prior guidance on more aggressive steps to reduce cost particularly on rigs that remained idle throughout the quarter. We expect international offshore operating cost to remain in the mid to high $20 million range per quarter during the first half of 2016. Operating cost will increase during the second half as we commence operations on the Highlander. Our international liftboat segment reported an operating loss of $4.7 million for the fourth quarter. This compares to a loss of $12.2 million in the third quarter which included a $7.6 million bad debt expense that was reported in segment's general and administrative expenses. Segment revenue fell by 30% to $10.1 million due to a 9% decline in average day's rates and a 23% decline in operating days. Partially offsetting lower revenue with a 23% decline in operating expenses. Fourth quarter operating expenses came in at $10.1 million below our previous guidance and down from $13.1 million in the third quarter driven primarily by lower activity levels and cost cutting measures for the segment. We expect quarterly operating cost to be in the $10 million to $12 million range assuming similar operating activity levels. Now moving on to other income statement and cash flow items. General and administrative expenses for the fourth quarter were in line with guidance at $14.4 million in compared to $31.8 million in the third quarter which includes the previously mentioned bad debt expense of $7.6 million in international liftboats as well as approximately $8 million of pre-petition restructuring and financing related activities additional cost reduction measures and a full quarter's benefit of prior measures are expected to slightly lower general and administrative expenses to the $12 million range per quarter for 2016. Moving on to reorganization items. We recorded a net charge of $344.1 million during the fourth quarter. This consisted of a $1 billion non-cash charge from the valuation adjustments of our assets due to the application of fresh start accounting, a $700 million non-cash gain on the cancellation of prior debt, and $11 million in other reorganization items principally professional fees. Excluding the non-cash adjustments, we have incurred approximately $33 million of restructuring fees since beginning the restructuring process early last year through year end. Depreciation and amortization expense for the fourth quarter was $19.3 million down from $37.5 million in the third quarter reflecting lower asset values due to fresh start accounting adjustments as we emerged from Chapter 11. As we have just recently completed the fresh start evaluation of our assets, our preliminary estimate of depreciation and amortization expense is in the $7 million to $9 million range per quarter for the first half of 2016 increasing by just under $2 million per quarter once to Highlander goes into operations during the third quarter. Interest expense was $7.9 million for the fourth quarter. This represents interest charged on our term loan from November 6 to December 31. We expect a full quota of interest expense to approximate $13 million. Income taxes for 2015 was significantly impacted by the restructuring. Rather than go through the numerous items that impacted our 2015 tax provisions I think it is more beneficial to discuss our current position and expectation of future tax exposure. After adjustments for such items as the cancellation of our prior notes and the basis of various assets and liabilities, we ended 2015 with approximately $150 million of net operating loss carry forwards or NOLs. However, the application of these NOLs to offset future taxable income will be significantly limited by IRS Code 382. We currently estimate that the NOL usage will be limited to approximately $7.5 million per year. It should be noted that this limitation applies only to our legacy NOLs and any NOLs that we generate post emergence are not subject to this limitation. Application of NOLs is also limited to taxable income from entities exposed to US taxation jurisdictions. We will still have tax exposure for certain operations where tax liabilities are in foreign deemed profit restrictions. As a result we still expect some cash taxes to be paid during 2016. Based on our current outlook, we expect this cash tax amount to be in the $6 million to $8 million range. This figure could fluctuate high or low depending on actual results. Capital and drydocking expenditures were approximately $8 million during the fourth quarter. For the full year 2015, total CapEx and drydock expenditures were $83 million, almost half of which was related to the Highlander. Our budget for 2016 is estimated to be in the $220 million to $250 million range, the majority of which will be spent on the Highlander. There is the approximate $190 million final amount owed to the shipyard which is expected to be paid in the second quarter with another $25 million or so of additional expenditures for equipments, spares, commissioning, and mobilization cost. With respect to our balance sheet and liquidity, we ended the fourth quarter with $331 million of unrestricted cash and equivalents and $200 million of restricted cash shown on escrow per for the final shipyard payment on the Highlander. As John is stated earlier, our unrestricted cash balance is currently just under $310 million after making several large payments related to the restructuring process. Our current cash level should be more than adequate for us to meet our minimum liquidity covenant which requires us to maintain at least $100 million of unrestricted cash in the second quarter of 2016 dropping to $75 million for the third and fourth quarters of 2016. There is also a maximum secured debt to EBITDA coverage test that does not apply into the first quarter of 2017. As we review our strategic alternatives, we understand that our high level cash is a great asset of the company and we will continue to work diligently to realign our cost structure to minimize the downward pressure on revenues as a result of the weak contracting environment. I would like to close out my comments by echoing John's remarks, thanking everyone who has supported the company throughout this restructuring process. I ask for their continued support as we continue through this cycle and seek opportunities to best position the new company to be successful through the many cycles that our industry will face over the coming years. As Son mentioned at the beginning of the call, due to our ongoing review of strategic alternatives, we will not be holding Q&A at this time. Son Vann: Thank you Candice and thanks everyone for joining us today. A replay of this call will be available on our website within the next few hours and we look forward to visiting again with your next quarter. Operator: Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Have a great day everyone.