UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 6-K

REPORT OF FOREIGN PRIVATE ISSUER

PURSUANT TO RULE 13a-16 OR 15d-16

UNDER THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended September 30, 2016

Commission File Number 001-35345

PACIFIC DRILLING S.A.

8-10, Avenue de la Gare

L-1610 Luxembourg

(Address of principal executive offices)

Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F.

Form 20-F  ☒            Form 40-F  ☐

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1):

Yes  ☐            No   ☒

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7):

Yes  ☐            No   ☒

Indicate by check mark whether the registrant by furnishing the information contained in this Form, is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.

Yes  ☐            No   ☒

If “Yes” is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b):

 

 

 

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PACIFIC DRILLING S.A.

TABLE OF CONTENTS

As used in this report on Form 6-K (this “Form 6-K”), unless the context otherwise requires, references to “Pacific Drilling,” the “Company,” “we,” “us,” “our” and words of similar import refer to Pacific Drilling S.A. and its subsidiaries. Unless otherwise indicated, all references to “U.S. $” and “$” in this report are to, and amounts are represented in, United States dollars.

The information and our unaudited condensed consolidated financial statements in this Form 6-K should be read in conjunction with our Annual Report on Form 20-F for the year ended December 31, 2015 (our “2015 Annual Report”) filed with the Securities and Exchange Commission (“SEC”) on March 1, 2016. We prepare our unaudited condensed consolidated financial statements in accordance with generally accepted accounting principles in the United States of America (“GAAP”).

 

 

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PART I — FINANCIAL INFORMATION

Item 1 — Financial Statements (Unaudited)

Unaudited Condensed Consolidated Financial Statements

PACIFIC DRILLING S.A. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(in thousands, except per share information) (unaudited)

		Three Months Ended September 30,						Nine Months Ended September 30,
		2016			2015			2016			2015
Revenues
Contract drilling		$	182,427		$	260,176		$	591,515		$	817,463
Costs and expenses
Operating expenses			(68,530)			(98,334)			(223,491)			(326,391)
General and administrative expenses			(15,150)			(13,208)			(44,471)			(42,902)
Depreciation expense			(69,731)			(61,472)			(206,020)			(175,778)
			(153,411)			(173,014)			(473,982)			(545,071)
Operating income			29,016			87,162			117,533			272,392
Other income (expense)
Interest expense			(45,888)			(36,361)			(137,497)			(106,297)
Gain on debt extinguishment			22,002			—			36,233			—
Other expense			(628)			(459)			(2,812)			(2,853)
Income before income taxes			4,502			50,342			13,457			163,242
Income tax expense			(4,346)			(9,344)			(7,578)			(23,420)
Net income		$	156		$	40,998		$	5,879		$	139,822
Earnings per common share, basic (Note 5)		$	0.01		$	1.95		$	0.28		$	6.61
Weighted-average number of common shares, basic (Note 5)			21,183			21,065			21,161			21,168
Earnings per common share, diluted (Note 5)		$	0.01		$	1.95		$	0.28		$	6.60
Weighted-average number of common shares, diluted (Note 5)			21,184			21,066			21,161			21,176

See accompanying notes to unaudited condensed consolidated financial statements.

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PACIFIC DRILLING S.A. AND SUBSIDIARIES

Condensed Consolidated Statements of Comprehensive Income

(in thousands) (unaudited)

		Three Months Ended September 30,						Nine Months Ended September 30,
		2016			2015			2016			2015
Net income		$	156		$	40,998		$	5,879		$	139,822
Other comprehensive income (loss):
Unrecognized gain (loss) on derivative instruments			1,030			(6,330)			(6,533)			(17,663)
Reclassification adjustment for loss on derivative instruments realized in net income (Note 7)			2,254			2,625			6,748			7,831
Reclassification adjustment for loss on derivative instruments realized in property and equipment (Note 7)			—			—			585			—
Total other comprehensive income (loss)			3,284			(3,705)			800			(9,832)
Total comprehensive income		$	3,440		$	37,293		$	6,679		$	129,990

See accompanying notes to unaudited condensed consolidated financial statements.

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PACIFIC DRILLING S.A. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(in thousands, except par value) (unaudited)

		September 30,			December 31,
		2016			2015
Assets:
Cash and cash equivalents		$	363,303		$	116,033
Restricted cash			82,015			—
Accounts receivable			114,307			168,050
Materials and supplies			97,267			98,243
Deferred costs, current			11,226			10,582
Prepaid expenses and other current assets			16,932			14,312
Total current assets			685,050			407,220
Property and equipment, net			4,969,016			5,143,556
Long-term receivable			202,575			202,575
Other assets			38,433			39,369
Total assets		$	5,895,074		$	5,792,720
Liabilities and shareholders’ equity:
Accounts payable		$	19,137		$	44,167
Accrued expenses			37,211			44,221
Long-term debt, current			74,283			76,793
Accrued interest			33,527			16,442
Derivative liabilities, current			6,219			7,483
Deferred revenue, current			35,083			49,227
Total current liabilities			205,460			238,333
Long-term debt, net of current maturities			2,911,332			2,768,877
Deferred revenue			37,143			60,639
Other long-term liabilities			37,166			32,816
Total long-term liabilities			2,985,641			2,862,332
Commitments and contingencies
Shareholders’ equity:
Common shares, $0.01 par value per share, 5,000,000 shares authorized, 22,551 and 23,277 shares issued and 21,183 and 21,121 shares outstanding as of September 30, 2016 and December 31, 2015, respectively			212			218
Additional paid-in capital			2,358,632			2,383,387
Treasury shares, at cost			—			(30,000)
Accumulated other comprehensive loss			(22,690)			(23,490)
Retained earnings			367,819			361,940
Total shareholders’ equity			2,703,973			2,692,055
Total liabilities and shareholders’ equity		$	5,895,074		$	5,792,720

See accompanying notes to unaudited condensed consolidated financial statements.

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PACIFIC DRILLING S.A. AND SUBSIDIARIES

Condensed Consolidated Statements of Shareholders’ Equity

(in thousands) (unaudited)

															Accumulated
							Additional								Other						Total
		Common Shares					Paid-In			Treasury Shares					Comprehensive			Retained			Shareholders’
		Shares		Amount			Capital			Shares		Amount			Loss			Earnings			Equity
Balance at December 31, 2015		21,121		$	218		$	2,383,387		2,156		$	(30,000)		$	(23,490)		$	361,940		$	2,692,055
Shares issued under share-based compensation plan		62			1			(90)		(62)			—			—			—			(89)
Cancellation of treasury shares		—			(7)			(29,993)		(726)			30,000			—			—			—
Share-based compensation		—			—			5,328		—			—			—			—			5,328
Other comprehensive income		—			—			—		—			—			800			—			800
Net income		—			—			—		—			—			—			5,879			5,879
Balance at September 30, 2016		21,183		$	212		$	2,358,632		1,368		$	—		$	(22,690)		$	367,819		$	2,703,973

See accompanying notes to unaudited condensed consolidated financial statements.

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PACIFIC DRILLING S.A. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(in thousands) (unaudited)

		Nine Months Ended September 30,
		2016			2015
Cash flow from operating activities:
Net income		$	5,879		$	139,822
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense			206,020			175,778
Amortization of deferred revenue			(37,640)			(65,827)
Amortization of deferred costs			9,888			20,119
Amortization of deferred financing costs			10,928			7,971
Amortization of debt discount			1,071			702
Deferred income taxes			2,801			1,306
Share-based compensation expense			5,328			8,439
Gain on debt extinguishment			(36,233)			—
Changes in operating assets and liabilities:
Accounts receivable			53,743			84,583
Materials and supplies			976			(6,322)
Prepaid expenses and other assets			(12,556)			231
Accounts payable and accrued expenses			(1,830)			(8,058)
Deferred revenue			—			3,735
Net cash provided by operating activities			208,375			362,479
Cash flow from investing activities:
Capital expenditures			(42,806)			(143,324)
Net cash used in investing activities			(42,806)			(143,324)
Cash flow from financing activities:
Net payments from shares issued under share-based compensation plan			(89)			(456)
Proceeds from long-term debt			235,000			265,000
Payments on long-term debt			(69,180)			(478,168)
Payments for financing costs			(2,015)			(500)
Purchases of treasury shares			—			(21,760)
Net cash provided by (used in) financing activities			163,716			(235,884)
Net increase (decrease) in cash and cash equivalents			329,285			(16,729)
Cash, cash equivalents and restricted cash, beginning of period			116,033			167,794
Cash, cash equivalents and restricted cash, end of period		$	445,318		$	151,065

See accompanying notes to unaudited condensed consolidated financial statements.

 

 

 

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PACIFIC DRILLING S.A. AND SUBSIDIARIES

Notes   to   Condensed   Consolidated   Financial   Statements (Unaudited)

Note 1 — Nature of Business

Pacific Drilling S.A. and its subsidiaries (“Pacific Drilling,” the “Company,” “we,” “us” or “our”) is an international offshore drilling contractor committed to being the preferred provider of offshore drilling services to the oil and natural gas industry through the use of high-specification floating rigs. Our primary business is to contract our high-specification rigs to drill wells for our clients.

Note 2 — Significant Accounting Policies

Basis of Presentation — Our accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and Article 10 of Regulation S-X of the Securities and Exchange Commission. Pursuant to such rules and regulations, these financial statements do not include all disclosures required by GAAP for complete financial statements. Our unaudited condensed consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of financial position, results of operations and cash flows for the presented interim periods. Such adjustments are considered to be of a normal recurring nature unless otherwise identified. Operating results for the three and nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016 or for any future period. The accompanying unaudited condensed consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes of the Company for the year ended December 31, 2015.

Reverse Stock Split — On May 24, 2016, shareholders at our Extraordinary General Meeting approved a 1-for-10 reverse stock split of our common shares (the “Reverse Stock Split”). The Reverse Stock Split became effective and our common shares began trading on a split-adjusted basis as of the commencement of trading on May 25, 2016. On the effective date of the Reverse Stock Split, our shareholders received one new common share for every 10 common shares they owned. No fractional shares were issued in connection with the Reverse Stock Split; instead holders of fractional shares were paid out in cash for any fractional interests, which was not material in the aggregate. All share and per share information in the accompanying financial statements has been restated retroactively to reflect the Reverse Stock Split.

Principles of Consolidation — Our unaudited condensed consolidated financial statements include the accounts of Pacific Drilling S.A. and consolidated subsidiaries that we control by ownership of a majority voting interest and entities that meet the criteria for variable interest entities for which we are deemed to be the primary beneficiary for accounting purposes. We eliminate all intercompany transactions and balances in consolidation.

We are party to a Nigerian joint venture, Pacific International Drilling West Africa Limited (“PIDWAL”), with Derotech Offshore Services Limited (“Derotech”), a privately-held Nigerian registered limited liability company. Derotech owns 51% of PIDWAL and PIDWAL has a 50% ownership interest in two of our rig holding subsidiaries, Pacific Bora Ltd. and Pacific Scirocco Ltd. PIDWAL’s interest in the rig holding subsidiaries is held through a holding company of PIDWAL, Pacific Drillship Nigeria Limited (“PDNL”). Derotech will not accrue the economic benefits of its interest in PIDWAL unless and until it satisfies certain outstanding obligations to us and a certain pledge is cancelled by us. Likewise, PIDWAL will not accrue the economic benefits of its interest in PDNL unless and until it satisfies certain outstanding obligations to us and a certain pledge is cancelled by us. PIDWAL and PDNL are variable interest entities for which we are the primary beneficiary. Accordingly, we consolidate all interests of PIDWAL and PDNL and no portion of their operating results is allocated to the noncontrolling interest.

In addition to the joint venture agreement, we are a party to marketing and logistic services agreements with Derotech and an affiliated company of Derotech. During the three and nine months ended September 30, 2016, we incurred fees of $1.9 million and $7.2 million, respectively, under such agreements. During the three and nine months ended September 30, 2015, we incurred fees of $4.1 million and $10.9 million, respectively, under such agreements.

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Recently Adopted Accounting Standards

Debt Issuance Costs — On April 7, 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-03, Interest - Imputation of Interest (Subtopic 835-30) - Simplifying the Presentation of Debt Issuance Costs , which requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the debt liability rather than as an asset. We adopted the standard effective January 1, 2016 on a retrospective basis, which resulted in the netting of our deferred financing costs against long-term debt balances on our consolidated balance sheets for the periods presented (see Note 4). Deferred financing costs related to our revolving credit facility were reclassified to prepaid expenses and other current assets, and other assets. The adoption had no impact on our operating results or cash flows for the current and prior periods.

Statement of Cash Flows — On August 26, 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230), a consensus of the FASB’s Emerging Issues Task Force , which is intended to reduce diversity in practice in how certain transactions are classified in the statements of cash flows. We adopted the standard effective in the interim period ended September 30, 2016 on a retrospective basis, which resulted in no reclassifications to prior periods. The adoption had no impact on our consolidated balance sheets or operating results.

Recently Issued Accounting Standards

Revenue Recognition — On May 28, 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers , which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This standard will replace most existing revenue recognition guidance under GAAP when it becomes effective. The standard will be effective for annual periods and interim periods beginning after December 15, 2017. We plan to adopt the new standard on January 1, 2018. The standard permits the use of either the retrospective or cumulative effect transition method. We have not yet selected a transition method, and we are currently evaluating the effect the standard may have on our consolidated financial statements and related disclosures.

Deferred Taxes — On November 20, 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes , which requires that all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. The new guidance, however, does not change the existing requirement that only permits offsetting within a tax jurisdiction. The standard will be effective for annual and interim periods beginning after December 15, 2016, and may be applied prospectively or retrospectively. We plan to adopt the standard prospectively effective January 1, 2017, and expect that it will result in the reclassification of our deferred tax balances from current to long-term on our consolidated balance sheets. As of September 30, 2016 and December 31, 2015, our current deferred tax assets and current deferred tax liabilities were $2.0 million and $2.1 million, respectively.

Leases — On February 25, 2016, the FASB issued ASU 2016-02, Leases , which requires the balance sheet recognition of lease assets and lease liabilities by lessees for virtually all of their leases. Lessees and lessors will be required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. These practical expedients relate to the identification and classification of leases that commenced before the effective date, initial direct costs for leases that commenced before the effective date, and the ability to use hindsight in evaluating lessee options to extend or terminate a lease or to purchase the underlying asset. The standard will be effective for our annual and interim periods beginning January 1, 2019, although early adoption is permitted. We have not yet determined our implementation method upon adoption, and we are currently evaluating the effect the standard may have on our consolidated financial statements and related disclosures.

Share-based Payments — On March 30, 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting , which requires recognition of the income tax effects of equity awards in the income statement when the awards vest or are settled. The standard also allows employers to withhold shares upon settlement of

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an award for an amount up to the employees’ maximum individual tax rate in the relevant jurisdiction without resulting in liability classification of the award. The standard permits entities to make an accounting policy election for the impact of forfeitures on the recognition of expense for share-based payment awards. The standard will be effective for our annual and interim periods beginning January 1, 2017, although early adoption is permitted. We do not expect the adoption of the standard to have a material effect on our consolidated financial statements and related disclosures.

Measurement of Credit Losses on Financial Instruments — On June 16, 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326) , which introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. The new model will apply to: (1) loans, accounts receivable, trade receivables, and other financial assets measured at amortized cost, (2) loan commitments and certain other off-balance sheet credit exposures, (3) debt securities and other financial assets measured at fair value through other comprehensive income, and (4) beneficial interests in securitized financial assets. This update is effective for our annual and interim periods beginning after January 1, 2020. We are currently evaluating the effect the standard may have on our consolidated financial statements and related disclosures.

Tax Accounting for Intra-Entity Asset Transfers — On October 24, 2016, the FASB issued ASU 2016-16, Accounting for Income Taxes: Intra-Entity Asset Transfers of Assets Other than Inventory ,  which requires entities to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transaction occurs as opposed to deferring tax consequences and amortizing them into future periods. This update is effective for our annual and interim periods beginning after January 1, 2018 with early adoption permitted. A modified retrospective approach with a cumulative-effect adjustment directly to retained earnings at the beginning of the period of adoption is required. We are currently evaluating the effect the standard may have on our condensed consolidated financial statements and related disclosures.

Note 3 — Property and Equipment

Property and equipment consists of the following:

		September 30,			December 31,
		2016			2015
		(in thousands)
Drillships and related equipment		$	5,885,612		$	5,856,564
Other property and equipment			16,081			14,938
Property and equipment, cost			5,901,693			5,871,502
Accumulated depreciation			(932,677)			(727,946)
Property and equipment, net		$	4,969,016		$	5,143,556

 

 

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Note 4 — Debt

Debt consists of the following:

 

2017 Senior Secured Notes

In November 2012, Pacific Drilling V Limited (“PDV”), an indirect, wholly-owned subsidiary of the Company, and the Company, as guarantor, completed a private placement of $500.0 million in aggregate principal amount of 7.25% senior secured notes due 2017 (the “2017 Senior Secured Notes”). The 2017 Senior Secured Notes bear interest at 7.25% per annum, payable semiannually on June 1 and December 1, and mature on December 1, 2017.

The 2017 Senior Secured Notes are secured by a first-priority security interest (subject to certain exceptions) in the Pacific Khamsin , and substantially all of the other assets of PDV, including an assignment of earnings and insurance proceeds related to the Pacific Khamsin .

During the three and nine months ended September 30, 2016, we repurchased $36.9 million and $60.6 million of our 2017 Senior Secured Notes for a purchase price of $14.4 million and $23.6 million plus accrued interest, respectively. We recorded the resulting gain, net of the corresponding unamortized deferred financing costs and debt discount, of $22.0 million and $36.2 million respectively, as a gain on debt extinguishment in our statements of operations.

Effective October 5, 2016, we amended the indenture governing the 2017 Senior Secured Notes (see Note 11).

Senior Secured Credit Facility Agreement

In February 2013, Pacific Sharav S.à r.l. and Pacific Drilling VII Limited (collectively, the “SSCF Borrowers”) and the Company, as guarantor, entered into a senior secured credit facility agreement, as amended and restated (the “SSCF”), to finance the construction, operation and other costs associated with the Pacific Sharav and the Pacific Meltem (the “SSCF Vessels”). The SSCF is primarily secured on a first priority basis by liens on the SSCF Vessels, and by an assignment of earnings and insurance proceeds relating thereto.

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In 2015, we completed the final drawdown under this facility, resulting in a cumulative total drawdown of $985.0 million. We do not have any undrawn capacity on this facility as of September 30, 2016.

Following the final drawdown, the SSCF consisted of two principal tranches: (i) a Commercial Tranche of $492.5 million provided by a syndicate of commercial banks and (ii) a Garanti - Instituttet for Eksportkreditt (“GIEK”) Tranche of $492.5 million guaranteed by GIEK, comprised of two sub-tranches: (x) an Eksportkreditt Norge AS (“EKN”) sub-tranche of $246.3 million and (y) a bank sub-tranche of $246.3 million.

Borrowings under (A) the Commercial Tranche bear interest at London Interbank Offered Rate (“LIBOR”) plus a margin of 3.75%, (B) the EKN sub-tranche bear interest, at our option, at (i) LIBOR plus a margin of 1.5% (which margin may be reset on May 31, 2019) or (ii) at a Commercial Interest Reference Rate of 2.37%, and (C) the bank sub-tranche bear interest at LIBOR plus a margin of 1.5%. Borrowings under both sub-tranches are also subject to a guarantee fee of 2% per annum. Interest is payable quarterly. The SSCF requires semiannual amortization payments of $39.9 million. We have entered into interest rate swaps to hedge against fluctuations in LIBOR (see Note 7).

The Commercial Tranche matures on May 31, 2019. Loans made with respect to the Pacific Sharav under the GIEK Tranche mature on May 12, 2026. Loans made with respect to the Pacific Meltem under the GIEK Tranche mature on November 24, 2026. The GIEK Tranche contains a put option exercisable if the Commercial Tranche is not refinanced or renewed on or before February 28, 2019. If the GIEK Tranche put option is exercised, each SSCF Borrower must prepay, in full, the portion of all outstanding loans that relate to the GIEK Tranche, on or before May 31, 2019, without any premium, penalty or fees of any kind.

During the quarter ended September 30, 2016, we pledged $82.0 million as collateral to the SSCF lenders to comply with the loan to value covenant, which requires semi-annual broker valuations of the vessels securing the SSCF to equal at least 125% of the outstanding SSCF balance as of the valuation date. The pledged amount was classified as restricted cash on our consolidated balance sheets.

2020 Senior Secured Notes

On June 3, 2013, we completed a $750.0 million private placement of 5.375% senior secured notes due 2020 (the “2020 Senior Secured Notes”). The 2020 Senior Secured Notes bear interest at 5.375% per annum, payable semiannually on June 1 and December 1, and mature on June 1, 2020.

The 2020 Senior Secured Notes are guaranteed by each of our subsidiaries that own the Pacific Bora , the Pacific Mistral , the Pacific Scirocco and the Pacific Santa Ana (the “Shared Collateral Vessels”), each of our subsidiaries that own or previously owned equity or similar interests in a Shared Collateral Vessel-owning subsidiary, and certain other of our subsidiaries that are parties to charters in respect of the Shared Collateral Vessels, and will be guaranteed by certain other future subsidiaries. The indenture for the 2020 Senior Secured Notes allows for the issuance of up to $100.0 million of additional notes provided no default is continuing and we are otherwise in compliance with all applicable covenants.

The 2020 Senior Secured Notes are secured, on an equal and ratable, first priority basis, with the obligations under the Senior Secured Term Loan B (as defined below), the 2013 Revolving Credit Facility (as defined below) and certain future obligations (together with the 2020 Senior Secured Notes, the “Pari Passu Obligations”), subject to payment priorities in favor of lenders under the 2013 Revolving Credit Facility pursuant to the terms of an intercreditor agreement (the “Intercreditor Agreement”), by liens on the Shared Collateral Vessels, a pledge of the equity of the entities that own the Shared Collateral Vessels, assignments of earnings and insurance proceeds with respect to the Shared Collateral Vessels, and certain other assets of the subsidiary guarantors (collectively, the “Shared Collateral”).

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2018 Senior Secured Institutional Term Loan – Term Loan B

On June 3, 2013, we entered into a $750.0 million senior secured institutional term loan maturing 2018 (the “Senior Secured Term Loan B”). The Senior Secured Term Loan B bears interest, at our election, at either (1) LIBOR, which will not be less than a floor of 1% plus a margin of 3.5% per annum, or (2) a rate of interest per annum equal to (i) the prime rate for such day, (ii) the sum of the federal funds rate plus 0.5% or (iii) 1% per annum above the one-month LIBOR, whichever is the highest rate in each case plus a margin of 2.5% per annum. Interest is payable quarterly. The Senior Secured Term Loan B requires quarterly amortization payments of $1.9 million and matures on June 3, 2018. We have entered into interest rate swaps to hedge against fluctuations in LIBOR (see Note 7).

The Senior Secured Term Loan B has an accordion feature that would permit additional loans to be extended so long as our total outstanding obligations in connection with the Senior Secured Term Loan B and the 2020 Senior Secured Notes do not exceed $1.7 billion.

The Senior Secured Term Loan B is secured by the Shared Collateral and subject to the terms and provisions of the Intercreditor Agreement.

2013 Revolving Credit Facility

On June 3, 2013, we entered into a $500.0 million senior secured revolving credit facility maturing 2018 (as amended, the “2013 Revolving Credit Facility”). The 2013 Revolving Credit Facility is secured by the Shared Collateral and subject to the provisions of the Intercreditor Agreement.

Borrowings under the 2013 Revolving Credit Facility bear interest, at our option, at either (1) LIBOR plus a margin ranging from 3.25% to 3.75% based on our leverage ratio, or (2) a rate of interest per annum equal to (i) the prime rate for such day, (ii) the sum of the federal funds rate plus 0.5% or (iii) 1% per annum above the one-month LIBOR, whichever is the highest rate in each case plus a margin ranging from 2.25% to 2.75% per annum based on our leverage ratio. Undrawn commitments accrue a fee ranging from 1.3% to 1.5% per annum based on our leverage ratio. Interest is payable quarterly.

The 2013 Revolving Credit Facility permits loans to be extended up to a maximum sublimit of $500.0 million and permits letters of credit to be issued up to a maximum sublimit of $300.0 million, subject to a $500.0 million overall facility limit. Outstanding but undrawn letters of credit accrue a fee at a rate equal to the margin on LIBOR loans minus 1%. The 2013 Revolving Credit Facility matures on June 3, 2018.

Covenants

As of September 30, 2016, we were in compliance with all of our debt covenants.  However, market conditions continue to be challenging, which will impact our financial results in the near future.  It is therefore likely we will be in violation of our leverage ratio financial covenants in our 2013 Revolving Credit Facility and our SSCF within the next twelve months. We plan to seek amendments or waivers of such covenants to avoid any violation. If we are unable to obtain such amendments or waivers, such covenant default would entitle the lenders to declare all outstanding amounts immediately due and payable, and any such acceleration would trigger the cross-default provisions of our other long-term debt.

Liquidity

Our liquidity fluctuates depending on a number of factors, including, among others, our revenue efficiency and the timing of accounts receivable collection as well as payments for operating costs and debt repayments. Primary sources of funds for our short-term liquidity needs are expected to be our cash balances and cash flow generated from operating and

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financing activities. We believe our cash balances and cash flow generated from operating activities will provide sufficient liquidity over the next twelve months to fund our working capital needs and scheduled payments on our long-term debt.

We are engaged in discussions with certain of our lenders and noteholders regarding amendments to the terms of our long-term debt. We believe we can continue to meet our existing obligations as they come due through 2017. However, absent a significant improvement in market conditions in the near term, we will likely need our lenders and noteholders to agree to modifications to the terms of our long-term debt for our capital structure to be sustainable in the longer term.

Note 5 — Earnings per Share

The following reflects the income and the share data used in the basic and diluted earnings per share computations:

		Three Months Ended September 30,						Nine Months Ended September 30,
		2016			2015			2016			2015
		(in thousands, except per share information)
Numerator:
Net income, basic and diluted		$	156		$	40,998		$	5,879		$	139,822
Denominator:
Weighted-average number of common shares outstanding, basic			21,183			21,065			21,161			21,168
Effect of share-based compensation awards			1			1			—			8
Weighted-average number of common  shares outstanding, diluted			21,184			21,066			21,161			21,176
Earnings per share:
Basic		$	0.01		$	1.95		$	0.28		$	6.61
Diluted		$	0.01		$	1.95		$	0.28		$	6.60

 

The following table presents the share effects of share-based compensation awards excluded from our computations of diluted earnings per share as their effect would have been anti-dilutive for the periods presented:

		Three Months Ended September 30,				Nine Months Ended September 30,
		2016		2015		2016		2015
		(in thousands)				(in thousands)
Share-based compensation awards		1,214		951		1,217		945

 

 

Note 6 — In c ome Taxes

We recognize tax benefits from an uncertain tax position only if it is more likely than not that the position will be sustained upon examination by taxing authorities based on the technical merits of the position. The amount recognized is the largest benefit that we believe has greater than a 50% likelihood of being realized upon settlement. As of September 30, 2016 and December 31, 2015, we had $27.1 million and $24.9 million, respectively, of unrecognized tax benefits (excluding interest and penalties) which were included in other long-term liabilities on our consolidated balance sheet. The entire balance of unrecognized tax benefits as of September 30, 2016 would favorably impact our effective tax rate if recognized. Included on our balance sheet as of September 30, 2016 and December 31, 2015 were $3.8 million and $2.5 million, respectively, of interest and penalties related to unrecognized tax benefits.

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Note 7 — Derivatives

We are currently exposed to market risk from changes in interest rates and foreign exchange rates. From time to time, we may enter into a variety of derivative financial instruments in connection with the management of our exposure to fluctuations in interest rates and foreign exchange rates. We do not enter into derivative transactions for speculative purposes; however, for accounting purposes, certain transactions may not meet the criteria for hedge accounting.

On May 30, 2013, we entered into an interest rate swap as a cash flow hedge against future fluctuations in LIBOR with an effective date of June 3, 2013. The interest rate swap has a notional value of $712.5 million, does not amortize and matures on December 3, 2017. On a quarterly basis, we pay a fixed rate of 1.56% and receive the maximum of 1% or three-month LIBOR.

On June 10, 2013, we entered into an interest rate swap as a cash flow hedge against future fluctuations in LIBOR with an effective date of July 1, 2014. The interest rate swap has a notional value of $400.0 million, does not amortize and matures on July 1, 2018. On a quarterly basis, we pay a fixed rate of 1.66% and receive three-month LIBOR.

On December 17, 2014, we entered into a series of foreign currency forward contracts as a cash flow hedge against future exchange rate fluctuations between the Euro and U.S. Dollar. We use the forward contracts to hedge Euro payments for forecasted capital expenditures. As of September 30, 2016, the remaining forward contracts have a notional value of €3.8 million and will be settled in December 2016. Upon settlement, we will pay U.S. Dollars and receive Euros at a forward rate of $1.27. As a result of partially settling the effective hedge for the nine months ended September 30, 2016, we incurred a net cash outflow of $0.6 million and reclassified the amount from accumulated other comprehensive income to property and equipment.

The following table provides data about the fair values of derivatives that are designated as hedge instruments:

				September 30,			December 31,
Derivatives Designated as Hedging Instruments		Balance Sheet Location		2016			2015
					(in thousands)
Short-term—Interest rate swaps		Derivative liabilities, current		$	(5,148)		$	(5,899)
Long-term—Interest rate swaps		Other long-term liabilities			(1,299)			(238)
Short-term—Foreign currency forward contracts		Derivative liabilities, current			(1,071)			(1,584)
Total				$	(7,518)		$	(7,721)

 

We have elected not to offset the fair value of derivatives subject to master netting agreements, but to report them on a gross basis on our condensed consolidated balance sheets.

The following table summarizes the cash flow hedge gains and losses for the three months ended September 30, 2016 and 2015:

														Gain (Loss) Recognized in
		Gain (Loss) Recognized in Other						Loss Reclassified from						Income (Ineffective Portion and
		Comprehensive Income (“OCI”)						Accumulated OCI into Income						Amount Excluded from Effectiveness
		for the Three Months Ended						for the Three Months Ended						Testing) for the Three Months Ended
		September 30,						September 30,						September 30,
Derivatives in Cash Flow Hedging Relationships		2016			2015			2016			2015			2016			2015
		(in thousands)
Interest rate swaps		$	3,315		$	(3,735)		$	2,254		$	2,625		$	—		$	—
Foreign currency forward contracts		$	(31)		$	30		$	—		$	—		$	—		$	—

 

 

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The following table summarizes the cash flow hedge gains and losses for the nine months ended September 30, 2016 and 2015:

 

 

As of September 30, 2016, the estimated amount of net losses associated with derivative instruments that would be reclassified from accumulated other comprehensive loss to earnings during the next twelve months was $5.9 million. During the three and nine months ended September 30, 2016, we reclassified losses of $2.1 million and $6.2 million to interest expense and $0.2 million and $0.6 million to depreciation from accumulated other comprehensive loss, respectively. During the three and nine months ended September 30, 2015, we reclassified losses of $2.4 million and $7.2 million to interest expense and $0.2 million and $0.6 million to depreciation from accumulated other comprehensive loss, respectively.

Note 8 — Fair Value Measurements

We estimated fair value by using appropriate valuation methodologies and information available to management as of September 30, 2016 and December 31, 2015. Considerable judgment is required in developing these estimates, and accordingly, estimated values may differ from actual results.

The estimated fair value of accounts receivable, accounts payable and accrued expenses approximated their carrying value due to their short-term nature. It is not practicable to estimate the fair value of our receivable from SHI (as defined in Note 9). It is also not practicable to estimate the fair value of our SSCF debt and 2013 Revolving Credit Facility. The following table presents the carrying value and estimated fair value of our other long-term debt instruments:

		September 30,						December 31,
		2016						2015
		Carrying			Estimated			Carrying			Estimated
		Value			Fair Value			Value			Fair Value
			(in thousands)
2017 Senior Secured Notes		$	438,761		$	169,155		$	498,887		$	250,000
2018 Senior Secured Term Loan B			724,394			203,175			729,458			307,125
2020 Senior Secured Notes			750,000			202,500			750,000			322,500

 

We estimate the fair values of our variable-rate and fixed-rate debt using quoted market prices to the extent available and significant other observable inputs, which represent Level 2 fair value measurements.

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The following table presents the carrying value and estimated fair value of our financial instruments recognized at fair value on a recurring basis:

 

		December 31, 2015
		Carrying			Fair Value Measurements Using
		Value			Level 1		Level 2			Level 3
			(in thousands)
Liabilities:
Interest rate swaps		$	(6,137)		—		$	(6,137)		—
Foreign currency forward contracts		$	(1,584)		—		$	(1,584)		—

 

We use an income approach to value assets and liabilities for outstanding interest rate swaps and foreign currency forward contracts. These contracts are valued using a discounted cash flow model that calculates the present value of future cash flows under the terms of the contracts using market information as of the reporting date, such as prevailing interest rates and forward rates. The determination of the fair values above incorporated various factors, including the impact of the counterparty’s non-performance risk with respect to our financial assets and our non-performance risk with respect to our financial liabilities.

See Note 7 for further discussion of our use of derivative instruments and their fair values.

Note 9 — Commitments and Contingencies

Commitments — As of September 30, 2016, we had no material commitments.

Customs Bonds —As of September 30, 2016, we were contingently liable under certain customs bonds totaling approximately $145.0 million issued as security in the normal course of our business.

Contingencies — It is to be expected that we and our subsidiaries will routinely be involved in litigation and disputes arising in the ordinary course of our business.

On April 16, 2013, Transocean Offshore Deepwater Drilling, Inc. (“Transocean”) filed a complaint against us in the United States District Court for the Southern District of Texas alleging infringement of their dual activity patents, which was supplemented by an Amended Complaint filed on May 13, 2013. In its Amended Complaint, Transocean seeks relief in the form of a permanent injunction, compensatory damages, enhanced damages, court costs and fees. On May 31, 2013, we filed our Answer to the Amended Complaint and our Counterclaims seeking Declaratory Judgments that we do not infringe the asserted Transocean patents and that such patents are invalid and unenforceable. The trial was set for August 8, 2016; however, the Court has granted a stay of the litigation pending the resolution of three Inter Partes Reviews (“IPRs”) instituted by the U.S. Patent and Trademark Office (“PTO”) on March 28, 2016 with respect to the same three patents that are the subject of Transocean’s litigation against us. The PTO instituted the IPRs upon the petition of Seadrill Americas, Inc., Seadrill Gulf Operations Auriga, LLC, Seadrill Gulf Operations Vela, LLC and Seadrill Gulf Operations Neptune, LLC (collectively, “Seadrill”) based on a finding by the PTO that there is a reasonable likelihood that Seadrill will succeed in proving that at least one of the asserted claims of each of the Transocean patents is invalid. Resolution of the IPRs is expected by the end of March 2017. We do not believe that the ultimate liability, if

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any, resulting from this litigation will have a material adverse effect on our financial position, results of operations or cash flows.

 

On October 29, 2015, we exercised our right to rescind the construction contract with Samsung Heavy Industries (“SHI”) for the drillship the Pacific Zonda (the “Construction Contract”) due to SHI’s failure to timely deliver the drillship in accordance with the contractual specifications. SHI rejected our rescission, and on November 25, 2015, formally commenced arbitration proceedings against us in London under the Arbitration Act 1996 before a tribunal of three arbitrators (as specified in the Construction Contract). SHI claims that we wrongfully rejected their tendered delivery of the drillship and seeks the final installment of the purchase price under the Construction Contract. On November 30, 2015, we made demand under the third party refund guarantee accompanying the Construction Contract for the amount of our advance payments made under the Construction Contract, plus interest. Any payment under the refund guarantee is suspended until an award under the arbitration is obtained. Pursuant to a mutually agreed scheduling order, SHI filed its claims submission on January 29, 2016. We responded with our defense and counterclaim on February 26, 2016 and, in addition to seeking repayment of our advance payments made under the Construction Contract, our counterclaim also seeks the return of our purchased equipment, or the value of such equipment, and damages for our wasted expenditures. SHI submitted their response to our defense and counterclaim on April 11, 2016, we filed our rejoinder on May 23, 2016 and SHI filed its sur-rejoinder on July 8, 2016.  The pleadings and the disclosure phase of the arbitration proceeding are now complete and the preparation of witness statements and expert reports is under way. A hearing for the arbitration proceeding has been set for May 30, 2017. We do not believe that the ultimate outcome resulting from this arbitration will have a material adverse effect on our financial position, results of operations or cash flows.

Note 10 — Supplemental Cash Flow Information

During the nine months ended September 30, 2016 and 2015, we paid $107.3 million and $116.7 million of interest, net of amounts capitalized, respectively.

Within our condensed consolidated statements of cash flows, capital expenditures represent expenditures for which cash payments were made during the period. These amounts exclude accrued capital expenditures, which are capital expenditures that were accrued but unpaid. During the nine months ended September 30, 2016 and 2015, changes in accrued capital expenditures were $9.8 million and $5.0 million, respectively.

During the nine months ended September 30, 2016 and 2015, non-cash amortization of deferred financing costs and accretion of debt discount totaling $0 and $3.4 million were capitalized to property and equipment, respectively. Accordingly, these amounts are excluded from capital expenditures in our condensed consolidated statements of cash flows for the nine months ended September 30, 2016 and 2015.

On May 2, 2016, shareholders at our Extraordinary General Meeting approved the cancellation of 7.3 million treasury shares (on a pre-Reverse Stock Split basis) that we repurchased under our share repurchase program.  We accounted for this non-cash transaction by netting the treasury shares at total cost of $30.0 million against the statutory share capital of the cancelled shares and additional paid-in capital. Upon cancellation, the cancelled shares were returned to authorized but unissued shares.

Note 11 — Subsequent Events

On October 5, 2016, the Company and PDV and the indenture trustee entered into an amendment to the indenture governing the 2017 Senior Secured Notes (the “Amendment”). The Amendment modified a covenant in the indenture to allow the Company or certain of its subsidiaries (other than PDV) to incur indebtedness in an amount calculated with reference to the number of vessels owned by the Company or any of its subsidiaries (including PDV), based on a formula prescribed in the indenture. This Amendment aligns this provision with the same provision in the indenture governing the

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Company’s 2020 Senior Secured Notes. Following September 30, 2016,  the Company drew the remaining $215.0 million available under its 2013 Revolving Credit Facility,  which was previously limited by the secured debt incurrence covenant in the indenture governing the 2017 Senior Secured Notes.

 

 

 

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Item 2 — Operating and Financial Review and Prospects

Overview

Our primary business is to contract our fleet of high-specification rigs to drill wells for our clients. We are focused on the high-specification segment of the floating rig market. The term “high-specification,” as used in the floating rig drilling industry to denote a particular segment of the market, can vary and continues to evolve with technological improvements. We generally consider high-specification requirements to include rigs capable of drilling in water depths of more than 7,500 feet or projects requiring advanced operating capabilities, such as high hook-loads (>1,000 tons), large accommodations (200+ beds), increased mud storage and pumping capacity, and high deck-load and space capabilities.

Our Fleet

The following table sets forth certain information regarding our fleet of high-specification drillships as of November 1, 2016:

Rig Name		Delivered		Water Depth (in feet)		Drilling Depth (in feet)		Customer
Pacific Bora (a)		2010		10,000		37,500		Available (b)
Pacific Scirocco		2011		12,000		40,000		Total
Pacific Santa Ana		2011		12,000		40,000		Chevron
Pacific Sharav		2014		12,000		40,000		Chevron
Pacific Mistral		2011		12,000		37,500		Available
Pacific Khamsin		2013		12,000		40,000		Available
Pacific Meltem		2014		12,000		40,000		Available

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Fleet Status

The status of our fleet as of November 1, 2016 is as follows: