VTDRF Vantage Drilling International Ltd (CE)

1. Organization and Recent Events

Vantage Drilling International, a Cayman Islands exempted company, together with its consolidated subsidiaries (collectively the “Company”), is an international offshore drilling company focused on operating a fleet of modern, high specification drilling units. Our principal business is to contract drilling units, related equipment and work crews, primarily on a dayrate basis to drill oil and gas wells for our customers. Through our fleet of drilling units, we are a provider of offshore contract drilling services to major, national and independent oil and gas companies, focused on international markets. Additionally, for drilling units owned by others, we provide operations and marketing services for operating and stacked rigs, construction supervision services for rigs that are under construction, and preservation management services for rigs that are stacked.

Ongoing Impact of COVID-19 and Declines in the Demand for Oil and Gas

The COVID-19 pandemic continues to spread worldwide and has exacerbated since the World Health Organization first classified the COVID-19 outbreak as a pandemic in March 2020. The global spread of COVID-19 has caused widespread illness and significant loss of life, leading governments across the world to impose severely stringent limitations on movement and human interaction, with certain countries being forced to implement multiple shelter-in-place and stay-at-home orders. While conditions have improved in certain portions of the world, other jurisdictions, including India, are experiencing record incident rates of COVID-19 as of the date of this Quarterly Report. In India, specifically, a second wave of COVID-19 began in early March 2021 and has quickly spread across the country. India has imposed a general and widespread lock-down in response to the substantial increase in cases related to COVID-19. Several states have imposed nightly curfews for all persons (with limited exceptions for essential services). Such governmental responses to the pandemic have depressed economic activity worldwide, impacting all industries, but with a significant adverse effect on the oil and gas industry. The short-term impact of these challenges has resulted in (i) lower revenue due to terminations of (or amendments to) our existing drilling contracts and (ii) increased expenses due to higher labor and related costs.  We cannot at this time determine with certainty how long these challenges will persist as well as the long-term impact that such challenges may have on our operations and growth on a go-forward basis, including in jurisdictions, such as India, where we have significant contractual backlog and derive material revenue; however, the Company is actively managing the business in an attempt to mitigate the impact of the foregoing matters.  In order to decrease the Company’s overall operating expenses, the Company has undertaken significant headcount and salary reductions, both onshore and offshore, as well as other cost reduction measures to reflect the lower operating activity.  Headcount and salary levels have not recovered to pre-pandemic levels.

The reduced global economic activity resulting from the COVID-19 outbreak in 2020 caused demand for global oil and gas to significantly decline.  The efforts to contain the COVID-19 outbreak will likely continue to depress global economic activity in the near-term, and the supply and demand imbalance of oil and gas will likely continue for the foreseeable future. 

The potential for oil prices to decline in the future continues to put pressure on oil and gas activity levels, particularly in the deepwater segment.   Notwithstanding the recovery in global oil prices in early 2021, oil and gas prices are expected to continue to be volatile as a result of the ongoing COVID-19 outbreak, changes in oil and gas inventories and industry demand, and therefore, the Company cannot predict how long oil and gas prices will remain stable or further improve, if at all, or whether they could reverse course and decline. While our management is actively monitoring the foregoing events and its associated financial impact our business, it is uncertain at this time as to the full magnitude that volatile and uncertain oil and gas prices will have on our financial condition and future results of operations.

Agreements with Seadrill Partners

On February 9, 2021, Vantage Holdings International (“VHI”), a subsidiary of VDI, entered into a Framework Agreement and related Management and Marketing Agreements, as amended on March 16, 2021 (collectively, the “Operations, Management and Marketing Agreements”) with Seadrill Partners LLC (“Seadrill Partners”) pursuant to which certain subsidiaries of VHI (the “VHI Entities”) will provide operating, management and marketing services to Seadrill Partners and its subsidiaries (the “Seadrill Partner Entities”) in respect of four deepwater floaters owned by the Seadrill Partners Entities, which include two drillships, the West Polaris and the West Capella, and two semisubmersibles, the West Leo and the West Sirius. The Operations, Management and Marketing Agreements were subject to the approval of, and were approved by, the U.S. Bankruptcy Court for the Southern District of Texas on March 18, 2021.

In connection with the entry into the Operations, Management and Marketing Agreements, VHI organized a new legal entity, Vantage Financial Management Co. (“VFMC”), based in the Cayman Islands, to provide certain cash management services to the Seadrill Partners Entities in respect of the management of the vessels subject to the Operations, Management and Marketing Agreements.  VFMC was organized as an unrestricted, indirectly owned subsidiary of the Company and is therefore not subject to the restrictions under the First Lien Indenture.

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Purchase and Sale Agreement to Sell the Titanium Explorer

On December 31, 2020, we entered into a purchase and sale agreement with Best Oasis Limited (the “Buyer”) to sell the Titanium Explorer (the “Purchase and Sale Agreement”), for an aggregate purchase price of $13.8 million and we classified the rig as held for sale on our Consolidated Balance Sheet. The transactions contemplated by the Purchase and Sale Agreement closed on March 10, 2021. Pursuant to the Purchase and Sale Agreement, the Buyer is required to recycle the rig in an environmentally sound manner.

Letter of Award for the Platinum Explorer

On February 3, 2021, our ultra-deepwater drillship, the Platinum Explorer, received a letter of award for a two-year contract from Oil and Natural Gas Company (“ONGC”). The Platinum Explorer is currently performing under an existing three-year contract with ONGC, which is expected to close in the second quarter of 2021, and it will experience some brief out-of-service time for planned maintenance after the existing contract expires. The new contract with ONGC is expected to commence shortly thereafter.

2. Basis of Presentation and Significant Accounting Policies

3. Revenue from Contracts with Customers

4. Leases

We have operating leases expiring at various dates, principally for office space, onshore storage yards and certain operating equipment. Additionally, we sublease certain office space to third parties. We determine if an arrangement is a lease at inception. Operating leases with an initial term greater than 12 months are included in “Operating lease ROU assets”, “Other current liabilities”, and “Other long-term liabilities” on our Consolidated Balance Sheet. Operating lease ROU assets and operating lease liabilities are recognized based on the present value of the future lease payments over the lease term at commencement date. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. The operating lease ROU asset also includes any lease payments made prior to or at the commencement date and is reduced by lease incentives received and initial direct costs incurred. Our lease terms may include options

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to extend or terminate the lease when it is reasonably certain that we will exercise that option. Lease expense is recognized on a straight-line basis over the lease term. We have lease agreements with lease and non-lease components, which are generally not accounted for separately. Certain of our leases include provisions for variable payments. These variable payments are not included in the calculation of lease liability and ROU assets.

As of March 31, 2021, the weighted average discount rate and the weighted average remaining lease term for operating leases was 9.25% and 2.12 years, respectively. ROU assets and lease liabilities recorded for leases commencing during the three months ended March 31, 2021 was $0.6 million.

The bareboat charter contract on the Soehanah jackup rig was accounted for as an operating lease with charter revenue included in “Reimbursables and other” in the Consolidated Statement of Operation for the three months ended March 31, 2020. In May 2019, the parties to the bareboat charter terminated the charterer’s right to acquire the rig at the end of the term of the bareboat charter, which was originally intended to end on December 31, 2019. However, under the terms of the bareboat charter, the lease term continued until the rig was redelivered to the Company, which occurred on February 3, 2020.

5. Debt

9.25% First Lien Notes. On November 30, 2018, the Company issued $350.0 million in aggregate principal amount of 9.25% First Lien Notes in a private placement. The 9.25% First Lien Notes were issued at par and are fully guaranteed on a senior secured basis by the Company’s direct and indirect subsidiaries and are secured by a first priority lien on substantially all of the assets of the Company and its subsidiaries, in each case subject to certain exceptions. The 9.25% First Lien Notes are subject to first payment priority in favor of holders of up to $50.0 million of future super-priority debt and are subject to both mandatory and optional redemption provisions.

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The 9.25% First Lien Notes mature on November 15, 2023 and bear interest from the date of their issuance at the rate of 9.25% per year. Interest is computed on the basis of a 360-day year comprised of twelve 30-day months and is payable semi-annually in arrears, commencing on May 15, 2019.

The First Lien Indenture includes customary covenants and events of default, including covenants that, among other things, restrict the granting of liens, restrict the making of investments, restrict the incurrence of indebtedness and the conveyance of vessels, limit transactions with affiliates, and require that the Company provide periodic financial reports.

The net proceeds from the issuance were used (i) to repay all obligations under the 2016 Term Loan Facility and to terminate the credit agreement governing such facility, (ii) to redeem all outstanding 10% Second Lien Notes, (iii) to fund the remaining amounts to be paid in connection with the purchase of the Soehanah jackup rig, (iv) to pay fees and expenses related to the foregoing and to the offering of the 9.25% First Lien Notes and (v) for general corporate purposes.

Concurrently with the issuance of the 9.25% First Lien Notes, we entered into a letter of credit facility to replace the letter of credit facility existing under the 2016 Term Loan Facility. The facility has a capacity of $50.0 million, with all outstanding letters of credit being cash collateralized. We have issued $11.0 million in letters of credit under this facility as of March 31, 2021.  

6. Shareholders’ Equity

Stock Issuance

VDI has 50,000,000 authorized Ordinary Shares. Upon emergence from bankruptcy on the Effective Date, VDI issued 5,000,053 Ordinary Shares in connection with the settlement of Liabilities Subject to Compromise in accordance with the Reorganization Plan and the VDC Note. On December 4, 2019, VDI issued an additional 8,114,977 Ordinary Shares to convert all of the outstanding Convertible Notes. As of March 31, 2021, 13,115,026 Ordinary Shares were issued and outstanding.

Share-based Compensation  

 On August 9, 2016, the Company adopted the 2016 Amended MIP to align the interests of participants with those of the shareholders by providing incentive compensation opportunities tied to the performance of the Company’s equity securities. Pursuant to the 2016 Amended MIP, the Compensation Committee may grant to employees, directors and consultants stock options, restricted stock, restricted stock units or other awards.

No awards were granted to employees or directors during the three months ended March 31, 2021 and 2020. During the three months ended March 31, 2021, 18,224 of previously granted TBGs vested.

Both the TBGs and PBGs are classified as equity awards. For the three months ended March 31, 2021 and 2020, we recognized share-based compensation expense related to the TBGs of approximately $0.3 million and $0.7 million, respectively. As of March 31, 2021, we concluded that it was not probable that the TEV performance condition would be met and therefore, no share based compensation expense was recognized for PBGs.

Pursuant to the 2016 Amended MIP and the terms of the applicable unit awards, participants holding restricted stock units are contractually entitled to receive all dividends or other distributions that are paid to VDI’s stockholders, provided that any such dividends will be subject to the same vesting requirements of the underlying units. Dividend payments accrue to outstanding awards (both vested and unvested) in the form of “Dividend Equivalents” equal to the dividend per share underlying the applicable award under the 2016 Amended MIP. As a result of a special cash distribution paid to shareholders of record on December 17, 2019, $8.8 million has been recorded in “Other long-term liabilities” in our Consolidated Balance Sheet at March 31, 2021 to be paid upon settlement of the TBGs.

7. Income Taxes

VDI is a Cayman Islands company operating in multiple countries through its subsidiaries. The Cayman Islands do not impose corporate income taxes. Consequently, we have calculated income taxes based on the laws and tax rates in effect in the countries in which operations are conducted, or in which we and our subsidiaries are considered resident for income tax purposes. Our income taxes are generally dependent upon the results of our operations and when we generate significant revenues in jurisdictions where the income tax liability is based on gross revenues or asset values, there is no correlation to the net operating results and the income tax expense. Furthermore, in some jurisdictions we do not pay taxes, pay taxes at lower rates or receive benefits for certain income and expense items, including interest expense, loss on extinguishment of debt, gains or losses on disposal or transfer of assets, reorganization expenses and write-off of development costs.

On January 22, 2020, VDI filed the Tax Election with the IRS to be treated as a partnership, rather than a corporation, for U.S. federal income tax purposes, with an effective date retroactive to December 9, 2019. As a result, U.S. Holders are required to take into account their allocable share of items of income, gain, loss deduction and credit of VDI for each taxable year of VDI ending with or within the U.S. Holder’s taxable year, regardless of whether any distribution has been or will be received from VDI. Each item generally will have the same character and source (either U.S. or foreign) as though the U.S. Holder had realized the item directly. VDI’s change in tax status has not had a material impact on our consolidated financial statements as of March 31, 2021.

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On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted, a sweeping stimulus bill intended to bolster the U.S. economy and provide emergency financial assistance to qualifying businesses and individuals. The CARES Act, among other things, modified the net operating losses carryovers and carrybacks rules, and included modifications to Section 163(j) of the Code to increase the allowable business interest deduction.  On December 27, 2020, the Taxpayer Certainty and Disaster Tax Relief Act of 2020 was enacted as part of the Consolidated Appropriations Act, 2021, followed by the American Rescue Plan Act on March 1, 2021. These recent laws, among other provisions, expand and extend the refundable employee retention tax credits previously made available under the CARES Act. As of March 31, 2021, our analysis of the provisions of the CARES Act revealed no material implications on the income tax provision.

Deferred income tax assets and liabilities are recorded for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. We provide for deferred taxes on temporary differences between the financial statements and tax bases of assets and liabilities using the enacted tax rates which are expected to apply to taxable income when the temporary differences are expected to reverse. Deferred tax assets are also provided for certain tax losses and tax credit carryforwards. A valuation allowance is established to reduce deferred tax assets when it is more likely than not that some portion or all of the deferred tax asset will not be realized. We do not establish deferred tax liabilities for certain of our foreign earnings that we intend to indefinitely reinvest to finance foreign activities.

In certain jurisdictions we are taxed under preferential tax regimes, which may require our compliance with specified requirements to sustain the tax benefits. We believe we are in compliance with the specified requirements and will continue to make all reasonable efforts to comply; however, our ability to meet the requirements of the preferential tax regimes may be affected by changes in laws or administrative practices, our business operations and other factors affecting the Company and industry, many of which are beyond our control.

Our periodic tax returns are subject to examination by taxing authorities in the jurisdictions in which we operate in accordance with the normal statute of limitations in the applicable jurisdiction. These examinations may result in assessments of additional taxes that are resolved with the authorities or through the courts. Resolution of these matters involves uncertainties and there are no assurances as to the outcome. Our tax years from 2010 onward remain open to examination in many of our jurisdictions and we are currently involved in several tax examinations in jurisdictions where we are operating or have previously operated. As information becomes available during the course of these examinations, we may increase or decrease our estimates of tax assessments and accruals.

8. Commitments and Contingencies

We are subject to litigation, claims and disputes in the ordinary course of business, some of which may not be covered by insurance. There is an inherent risk in any litigation or dispute and no assurance can be given as to the outcome of any claims.

Brazil Improbity Action

On April 27, 2018, the Company was added as an additional defendant in a legal proceeding (the “Improbity Action”), initiated by the Brazilian Federal Prosecutor against certain individuals, including an executive of Petrobras and two political lobbyists, in connection with the contracting of the Titanium Explorer drillship to Petrobras under the Drilling Contract, with the Brazilian Government and Petrobras as plaintiffs. Vantage is alleged to have been involved in and benefitted from the purported bribery scheme at Petrobras through Hamylton Padilha, the Brazilian agent our former parent company, VDC, used in the contracting of the Titanium Explorer drillship to Petrobras, and Mr. Hsin-Chi Su, a former member of VDC’s board of directors and a significant shareholder of VDC. We first became aware of the legal proceeding on July 19, 2018 as it was previously under seal. On March 22, 2019, we were formally served in the United States, and we filed our preliminary statement of defense with the 11th Federal court of the Judicial Branch of Curitiba, State of Parana, Brazil (the “Brazilian Federal Court”) on April 12, 2019 in response. On August 20, 2020, the Brazilian Federal Court dismissed our preliminary statement of defense. On October 5, 2020, we subsequently filed a motion to clarify with the Brazilian Federal Court requesting the reconsideration of certain aspects of the decision dismissing our preliminary statement of defense. Our motion to clarify was denied on December 14, 2020, and on February 10, 2021 we filed an appeal to the 4th Federal Court of Appeals seeking to reverse the Brazilian Federal Court’s denial of our preliminary defense.   On April 15, 2021, the Brazilian authorities served us indirectly through the U.S. Department of Justice agreeing to formally send us documents related to the Improbity Action. We will be obligated to file a statement of defense in the matter as soon as the case docket demonstrates that all of the defendants have been served again in this legal proceeding. The Company understands that the Improbity Action, is a civil action and is part of the Brazilian Federal Prosecutor’s larger “Car Wash” investigation into money laundering and corruption allegations in Brazil.

The damages claimed in the proceeding are in the amount of BRL 102.8 million (approximately $18.3 million), together with a civil fine equal to three times that amount. The Company understands that the Brazilian Federal Court previously issued an order authorizing the seizure and freezing of the assets of the Company and the other three defendants in the legal proceeding, as a precautionary measure, in the amount of approximately $73.4 million. The Company and the other three defendants are jointly and severally liable for this amount. The seizure order has not had an effect on the Company’s assets or operations, as the Company does not own any assets in Brazil, and does not currently intend to relocate any assets to Brazil. On February 13, 2019, the Company learned that the Brazilian Federal Prosecutor had previously requested mutual legal assistance from the U.S. DOJ pursuant to the United Nations Convention against Corruption of 2003 to obtain a freezing order against the Company’s U.S. assets in the approximate amount of $73.4