UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark one)

☑  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2019

OR

☐  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____ to _____

Commission file number 001-35345

PACIFIC DRILLING S.A.

(Exact name of registrant as specified in its charter)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes ☐   No ☑   

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.   Yes ☐   No ☑

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes ☑   No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S‑T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes ☑   No ◻

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non‑accelerated filer, smaller reporting company or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b‑2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b‑2 of the Exchange Act).   Yes ☐   No ☑

The aggregate market value of the Company’s Common Shares held by non-affiliates as of June 28, 2019 was $460,738,643.  

As of March 6, 2020, there were 75,198,547 shares outstanding.

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS.)

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.  Yes ☑   No ☐

DOCUMENTS INCORPORATED BY REFERENCE

None

TABLE OF CONTENTS

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements and information contained in this annual report constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, and are generally identifiable by their use of words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “forecast,” “intend,” “our ability to,” “may,” “plan,” “potential,” “predict,” “project,” “projected,” “should,” “will,” “would,” or other similar words which are not generally historical in nature. The forward-looking statements speak only as of the date of this annual report, and we undertake no obligation to publicly update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events or otherwise.

Our forward-looking statements express our current expectations or forecasts of possible future results or events, including future financial and operational performance and cash balances; revenue efficiency levels; market outlook; forecasts of trends; future client contract opportunities; future contract dayrates; our business strategies and plans or objectives of management; estimated duration of client contracts; backlog; expected capital expenditures; projected costs and savings,  expectations regarding our application to appeal the arbitration award against our two subsidiaries related to the drillship known as the Pacific Zonda in favor of Samsung Heavy Industries Co. Ltd. (“SHI”), the outcome of such subsidiaries’ ongoing bankruptcy proceedings and the potential impact of the arbitration Tribunal’s decision on our future operations, financial position, results of operations and liquidity.  

Although we believe that the assumptions and expectations reflected in our forward-looking statements are reasonable and made in good faith, these statements are not guarantees, and actual future results may differ materially due to a variety of factors. These statements are subject to a number of risks and uncertainties and are based on a number of judgments and assumptions as of the date such statements are made about future events, many of which are beyond our control. Actual events and results may differ materially from those anticipated, estimated, projected or implied by us in such statements due to a variety of factors, including if one or more of these risks or uncertainties materialize, or if our underlying assumptions prove incorrect.

Important factors that could cause actual results to differ materially from our expectations include:

All forward-looking statements in this annual report are expressly qualified in their entirety by the cautionary statements in this section and the “Risk Factors” section herein. Additional factors or risks that we currently deem immaterial, that are not presently known to us, that arise in the future or that are not specific to us could also cause our actual results to differ materially from our expected results. Given these uncertainties, you are cautioned not to unduly rely on our forward-looking statements, which speak only as of the date made. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or developments, changed circumstances or otherwise. Further, we may make changes to our business strategies and plans at any time and without notice, based on any changes in the above-listed factors, our assumptions or otherwise, any of which could materially affect our results.

PART I

As used in this annual report, 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.

ITEM 1.   BUSINESS

Overview

We are an international offshore drilling contractor committed to exceeding client expectations by delivering the safest, most efficient and reliable deepwater drilling services in the industry. We believe we own and operate the only deepwater fleet comprised solely of sixth and seventh generation high-specification drillships, and that our current fleet of seven drillships offers premium technical capabilities to our clients. 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 non-harsh environment drillships delivered in or after 2005 and capable of drilling in water depths of 10,000 feet or more.

Pacific Drilling S.A. was formed on March 11, 2011, as a Luxembourg public limited liability company (société anonyme) under the Luxembourg law of 10 August 1915 on commercial companies, as amended. Our principal executive offices are located at 8-10, Avenue de la Gare, L-1610 Luxembourg and our telephone number is +352 27 85 81 35. Our registered agent in Luxembourg is Centralis S.A, which is located at 8-10, Avenue de la Gare, L-1610 Luxembourg.  The operational headquarters of our Company is located at 11700 Katy Freeway, Suite 175, Houston Texas 77079.  Our telephone number at this address is 713-334-6662.

Our common shares were listed on the Norwegian OTC List from April 2011 to October 2016 and on the NYSE from November 11, 2011 to September 12, 2017. From September 13, 2017 to December 17, 2018, our common shares were traded on the over-the-counter market under the ticker symbols “PACDQ” and “PACDD,” respectively. Our common shares were relisted on the NYSE on December 18, 2018 and currently trade under the symbol “PACD.”

Emergence from Bankruptcy Proceedings

By order entered on November 2, 2018 (the “Confirmation Order”), the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”) confirmed the Company’s Modified Fourth Amended Joint Plan of  Reorganization, dated October 31, 2018 (the “Plan of Reorganization”) that had been filed with the Bankruptcy Court in connection with the filing by the Company and certain of its subsidiaries (the “Initial Debtors”) of petitions (the “Bankruptcy Petitions”) on November 12, 2017 (the “Petition Date”) with the Bankruptcy Court seeking relief under Chapter 11 of Title 11 of the United States Code (the “Bankruptcy Code”). During the course of the bankruptcy proceedings, the Initial Debtors continued to operate their businesses as debtors-in-possession.  On November 19, 2018 (the “Plan Effective Date”), the Company and the Initial Debtors other than the Zonda Debtors (defined below) (the “Debtors”) emerged from bankruptcy after successfully completing their reorganization pursuant to the Plan of Reorganization.

Prior to our emergence from bankruptcy on November 19, 2018, we had approximately $3.0 billion principal amount of pre-petition indebtedness consisting of amounts outstanding under a 2013 senior secured revolving credit facility (the “2013 Revolving Credit Facility”), a senior secured credit facility (the “SSCF”), a 2018 senior secured institutional term loan facility (the “Term Loan B,”), 2017 senior secured notes (the “2017 Notes”) and 2020 senior secured notes (the “2020 Notes”), plus an additional $50 million in post-petition debtor-in-possession financing.  One shareholder, Quantum Pacific Gibraltar Ltd (“QP”), owned approximately 70.3% of our outstanding common shares.

Reorganization Transactions Relating to Capital Structure

Pursuant to the Plan of Reorganization, we raised approximately $1.5 billion in new capital, before expenses, consisting of approximately $1.0 billion raised through issuance of our 8.375% First Lien Notes due 2023 (the “First Lien Notes”) and 11.0%/12.0% Second Lien PIK Notes due 2024 (the “Second Lien PIK Notes” and, together with the First Lien Notes, the “Notes”), and $500.0 million raised through the issuance of new common shares pursuant to a private placement to QP and a separate equity rights offering. We used a portion of the net proceeds to repay all of our pre-petition indebtedness that was not equitized pursuant to the Plan of Reorganization, to repay the post-petition debtor-in-possession financing, and to pay certain fees and expenses.

More specifically, upon emergence of the Company from bankruptcy on November 19, 2018 in accordance with the Plan of Reorganization:

Prior to the issuance of the shares described above, the Company effected a 1-for-10,000 reverse stock split (the “Reverse Stock Split”). As a result of the Reverse Stock Split and the issuances of common shares described above, the Company had issued and outstanding on the Plan Effective Date approximately 75.0 million common shares, and approximately 7.5 million shares were reserved for issuance pursuant to the 2018 Stock Plan.

Our emergence from bankruptcy resulted in a change of control of the Company.

In addition, pursuant to the Plan of Reorganization, on September 26, 2018 bankruptcy-remote subsidiaries of the Company issued, and on November 19, 2018 such subsidiaries merged with the Company and the Company assumed (the “Notes Assumption”):

Concurrent with the Notes Assumption, all of the Company’s subsidiaries other than the Zonda Debtors (defined below), certain immaterial subsidiaries and Pacific International Drilling West Africa Limited (“PIDWAL,” a Nigerian limited liability company indirectly 49% owned by the Company) guaranteed on a senior secured basis the First Lien Notes and Second Lien PIK Notes. If the Zonda Debtors are successful in their appeal of the Tribunal’s decision in the arbitration discussed below, it is expected that the Zonda Debtors will guarantee the First Lien Notes and Second Lien PIK Notes upon their emergence from bankruptcy pursuant to the Zonda Plan (defined below). If the Zonda Debtors are unsuccessful in the appeal, the Company expects that the Zonda Debtors will be liquidated in accordance with the terms of the Zonda Plan and the Zonda Debtors would not guarantee the First Lien Notes and Second Lien PIK Notes.

Other Reorganization Transactions

Pursuant to the Plan of Reorganization, the following additional principal transactions and events occurred on the Plan Effective Date:

Zonda Arbitration

The Company’s two subsidiaries involved in the arbitration with Samsung Heavy Industries Co. Ltd. (“SHI”) related to the drillship known as the Pacific Zonda – Pacific Drilling VIII Limited (“PDVIII”) and Pacific Drilling Services, Inc. (“PDSI” and, together with PDVIII, the “Zonda Debtors”) – are not Debtors under the Plan of Reorganization and filed a separate plan of reorganization that was confirmed by order of the Bankruptcy Court on January 30, 2019 (the “Zonda Plan”). On the date the Zonda Plan was confirmed, the Zonda Debtors had $4.6 million in cash and no other material assets after accounting for post-petition administrative expenses (other than the value of their claims against SHI) for SHI to recover against on account of its claims. On January 15, 2020, an arbitration tribunal in London, England (the “Tribunal”) awarded SHI approximately $320 million with respect to its claims against the Zonda Debtors. The award does not include approximately $100 million in interest and costs sought by SHI, on which the Tribunal reserved making a decision to a later date. As a result of the Tribunal’s decision, the Company recognized a loss of $220.2 million within loss from unconsolidated subsidiaries during the year ended December 31, 2019 primarily related to the elimination of a receivable related to the Zonda Debtors’ claim on the balance sheet. 

On February 11, 2020, the Zonda Debtors filed an application with the High Court in London seeking permission to appeal the Tribunal’s award. There can be no assurance that the Zonda Debtors will receive permission to appeal, or that if such permission is granted, that any such appeal will be successful. If the Zonda Debtors are successful in reversing the Tribunal’s decision, they will emerge from their separate bankruptcy proceedings. If the Zonda Debtors are unsuccessful in the appeal, the Company expects that the Zonda Debtors will be liquidated in accordance with the terms of the Zonda Plan. For additional information, see Item 3. “Legal Proceedings.”

Our Business Strategies

Our principal business objective is to exceed client expectations by delivering the safest, most efficient and reliable deepwater drilling services in the industry. Our operating strategy is designed to enable us to provide high quality, safe and cost-competitive services and to maintain and deploy our assets to position us to benefit from an expected increase in demand for deepwater offshore drilling and increase our cash flow and profits. Specifically, we expect to achieve our business objectives through the following strategies:

Clients

For information regarding the percentage of revenue earned from certain of our major clients, see Note 17 to our consolidated financial statements.

Contract Backlog

Our contract backlog includes firm commitments only, which are represented by signed drilling contracts. As of March  6, 2020, our contract backlog was approximately $189.2 million and was attributable to revenues we expect to generate on (i) the Pacific Sharav under the drilling contract with a subsidiary of Chevron Corporation (“Chevron”) and under the drilling contract with a subsidiary of Murphy Oil Corporation (“Murphy”), (ii) the Pacific Santa Ana under the drilling contract with PC Mauritania 1 Pty Ltd. (“Petronas”), (iii) the Pacific Bora under the drilling contract with Eni Oman B.V., a subsidiary of Eni S.p.A. (“Eni”) and (iv) the Pacific Khamsin under the drilling contract with a subsidiary of Equinor ASA (“Equinor”). We calculate our contract backlog by multiplying the contractual dayrate by the number of days committed under the contracts (excluding options to extend), assuming full utilization, and also including mobilization fees, upgrade reimbursements and other revenue sources, such as the standby rate during upgrades, as stipulated in the applicable contracts. For a well-by-well contract, we calculate the contract backlog by estimating the expected number of remaining days to drill the firm wells committed.

The actual amounts of revenues earned and the actual periods during which revenues are earned may differ from our contract backlog and periods shown in the table below due to various factors, including unplanned downtime and maintenance projects and other factors. Our contracts generally provide for termination at the election of the client with an “early termination payment” to be paid to us if a contract is terminated prior to the expiration of the fixed term. However, under certain limited circumstances, such as destruction of a drilling rig or sustained unacceptable performance by us, an early termination payment is not required to be paid. Accordingly, the actual amount of revenues earned may be substantially lower than the backlog reported.

The following table sets forth certain contracting information regarding our fleet as of March 6, 2020.

Drilling Contracts

We typically provide drilling services on a “dayrate” contract basis. Under dayrate contracts, the drilling contractor provides a drilling rig and rig crews and charges the client a fixed amount per day regardless of the number of days needed to drill the well. In certain contracts, we may also provide additional third-party services integrated into the standard drilling rig contract, which results in additional revenue, costs and associated downtime risk. The client bears substantially all of the ancillary costs of constructing the well and supporting drilling operations, as well as the economic risk relative to the success of the well. In addition, dayrate contracts sometimes provide for a lump sum amount for mobilizing the rig to the well location and a reduced dayrate when drilling operations are interrupted or restricted by

equipment breakdowns, adverse weather conditions or other conditions beyond the contractor’s control. A dayrate drilling contract generally covers either the drilling of a single well or group of wells or has a stated term. These contracts may generally be terminated by the client in the event the drilling unit is damaged, destroyed or lost or if drilling operations are suspended for an extended period of time as a result of a breakdown of equipment, “force majeure” events beyond the control of either party or upon the occurrence of other specified conditions. In addition, drilling contracts with certain clients may be cancelable, without cause, with little or no prior notice. Some longer-term contracts are subject to early termination payments. In some instances, the dayrate contract term may be extended by the client exercising options for the drilling of additional wells or for an additional length of time at fixed or mutually agreed terms, including dayrates.

Competition

The contract drilling industry is highly competitive. Our competition ranges from large international companies offering a wide range of drilling and other oilfield services to smaller, locally owned companies.

Drilling contracts are generally awarded on a competitive bid or negotiated basis. Pricing is often the primary factor in determining which qualified contractor is awarded a job; however, rig availability, capabilities, age and each contractor’s safety performance record and reputation for quality also can be key factors in the determination. Operators also may consider crew experience, technical and engineering support, rig location and efficiency, as well as long-term relationships with major international oil companies and national oil companies.

We believe that the market for drilling contracts will continue to be highly competitive in the near and intermediate term. We believe that our fleet of high-specification drillships provides us with a competitive advantage over many competitors with older fleets, as high-specification drilling units are generally better suited to meet the requirements of clients for drilling in deepwater, complex geological formations with challenging well profiles. However, certain competitors may have greater financial resources than we do, which may enable them to better withstand periods of low utilization and compete more effectively on the basis of price.

Seasonality

In general, seasonal factors do not have a significant direct effect on our business.

Insurance

The contract drilling industry is subject to hazards inherent in the drilling of oil and natural gas wells, including blowouts and well fires, which could cause personal injury, suspend drilling operations, or seriously damage or destroy the equipment involved. Offshore drilling operations are also subject to hazards particular to marine operations including capsizing, grounding, collision and loss or damage from severe weather. While we maintain insurance to protect our drillships in the areas in which we operate, certain political risks and other environmental risks are not fully insurable. We maintain insurance coverage that includes coverage for hull and machinery, marine liabilities, third party liability, workers’ compensation and employer’s liability, general liability, vessel pollution and other coverages.

Our insurance is subject to exclusions and limitations, and our insurance coverage may not adequately protect us against liability from all potential consequences and damages. We believe that our insurance coverage is customary for the industry and adequate for our business. However, there are risks that such insurance will not adequately protect us against and insurance may not be available to cover all of the liability from all of the consequences and hazards we may encounter in our operations.

Governmental Regulation/Environmental Issues

Our operations are subject to stringent and comprehensive federal, state, local and foreign or international laws and regulations, including those governing the discharge of oil and other contaminants into the environment or otherwise relating to environmental protection.

United States

In the United States, we must comply with the Oil Pollution Act of 1990, the Outer Continental Shelf Lands Act, the Comprehensive Environmental Response, Compensation, and Liability Act, the Federal Water Pollution Control Act (commonly referred to as the Clean Water Act) and the International Convention for the Prevention of Pollution from Ships, as each has been amended from time to time. Numerous governmental agencies, which in the United States include, among others, the U.S. Department of the Interior, Bureau of Ocean Energy Management, Bureau of Safety and Environmental Enforcement, U.S. Coast Guard and U.S. Environmental Protection Agency, issue regulations to implement and enforce environmental laws, which often require difficult and costly compliance measures. We could be subject to substantial administrative, civil and criminal penalties, cleanup obligations, legal damages for pollution or personal injury or injunctive relief for violations of or liabilities under these laws. Moreover, it is possible that changes in these environmental laws and regulations or any enforcement policies that impose additional or more restrictive requirements or claims for damages to persons, property, natural resources or the environment could result in substantial costs and liabilities to us. We believe that we are in substantial compliance with currently applicable environmental laws and regulations.

Nigeria

As an independent drilling contractor operating in Nigeria, we are subject to Petroleum (Drilling and Production) Amendment Regulations 1988 (the “Regulations”) which require us to be accredited with the Department of Petroleum Resources (the “DPR”). The Guidelines and Application Form for Oil & Gas Industry Service Permit issued by the DPR (the “DPR Guidelines”) require that we are accredited and issued with a permit by the DPR (the “DPR Permit”) in order to carry out the services in the industry. We have received and must annually renew the DPR Permit in accordance with the DPR Guidelines. In addition to the DPR Permit, under the Local Content Act (as defined below), we are required to be registered with the Joint Qualification System (“JQS”). The Nigerian Petroleum Exchange (“NIPEX”) administers the JQS. NIPEX is required to pre-qualify companies and categorize them into its database as a prerequisite for any company intending to offer services in the industry and forms the basis for an invitation to tender for contracts. Under the Regulations we are also required to obtain a valid license prior to operating a drilling rig (a “Drilling Rig Permit”). A Drilling Rig Permit is granted by the Minister of Petroleum Resources (“Minister”) or any other public officer in the Ministry authorized by the Minister in writing in that regard.

Our operations are also subject to the provisions of the Environmental Guidelines and Standards for the Petroleum Industry of Nigeria which establish a uniform monitoring and control program in relation to discharges arising from oil exploration and development in Nigeria.

The Nigerian Oil and Gas Industry Content Development Act, 2010 (the “Local Content Act”) was enacted to provide for the development, implementation and monitoring of Nigerian content in the oil and gas industry and places emphasis on the promotion of Nigerian content among companies bidding for contracts in the oil and gas industry. It also provides for majority Nigerian equity distribution of the relevant companies. The Local Content Act requires contractors within the oil and gas industry to comply with the minimum Nigerian Content (as defined in the Local Content Act) specified for each particular project item, service or product specification as set out in Schedule A of the Local Content Act (the “Schedule”). The Schedule provides the parameters and minimum level/percentages to be utilized in determining and measuring Nigerian Content in the composite human, material resources and services applied by operators and contractors in any project in the industry. The most relevant categories under the Schedule for us fall under the headings of “Well and Drilling Services/Petroleum Technology” and “Exploration, Subsurface, Petroleum Engineering and Seismic.” The activities listed therein include: “Producing Drilling Services” and “Drilling Rigs Semi-submersibles/Jack ups/others” which both apply to us. For offshore drilling services within the above referenced categories, the minimum required Nigerian Content for the provision of such services provided in the Schedule is stated in terms of “Manhours” (i.e., human resources) and is 85% and 55%, respectively. In the event there is insufficient Nigerian capacity to satisfy the minimum percentages prescribed in the Schedule, the Minister may authorize the continued importation of the relevant item or personnel for a maximum period of three years from the commencement of the Local Content Act. This implies that the Minister may grant a waiver for up to a maximum of three years from the commencement of the Local Content Act (i.e., by 2013). Subject to any amendments to the Local Content Act, and/or guidelines issued by the Nigerian Content Monitoring Board clarifying certain provisions of the Local Content Act, all entities must comply with the provisions of the Local Content Act.

We are required to submit a proposed Nigerian Content Execution Plan and will provide a Monthly Nigerian Content Report, a document that details the amount of Nigerian Content utilized in the performance of the contract.

In addition to the above Nigerian Content requirements, Nigerian subsidiaries of international companies are required to demonstrate that a minimum of 50% of the equipment deployed for execution of works is owned by the Nigerian subsidiary.

The Local Content Act also requires that our Nigerian subsidiary place 100% of its insurance policies with local Nigerian insurers and that local capacity must have been exhausted before any insurance risk is placed with foreign insurers and any offshore placement of insurance must be with prior approval of the National Insurance Commission.

Ghana

We have formed a joint venture company in Ghana for the purpose of bidding on projects in Ghana. As an independent drilling contractor operating in the upstream petroleum sector in Ghana, we must comply with, among others, the Petroleum (Exploration & Production) Act, 2016 (Act 919)(“the Act”); Petroleum Exploration and Production – HSE Regulations 2017 (L.I 2258); Petroleum Exploration And Production - Data Management Regulations, 2017 (L.I 2257); Petroleum Exploration And Production (General) Regulations, 2018 (L.I 2359); Petroleum (Local Content and Local Participation) Regulations, 2013 (L.I 2204); Petroleum Commission: Guidelines for the Formation of Joint Venture Companies in the Upstream Petroleum Industry of Ghana (March 2016) (“JV Guidelines”); Environmental Protection Agency Act, 1994 (Act 490); and the Environmental Assessment Regulations, 1999 (L.I 1652), as each has been amended from time to time.

The Petroleum (Exploration & Production) Act, 2016 (Act 919), L.I 2204 and the JV Guidelines require us to incorporate in Ghana and to form a joint venture with an Indigenous Ghanaian Company (IGC), in which the IGC must have at least 10% shareholding, in order to provide services in Ghana. Both our incorporated company and the joint venture company must obtain permits to operate from the Petroleum Commission.

The Petroleum (Exploration and Production) (Health and Safety and Environment) Regulations, 2017(L.I 2258), prescribes different health and safety precautions that we must comply with.  Furthermore, the Petroleum (Exploration and Production) (Data Management) Regulations, 2017(L.I 2257) provide that we are required to report and manage all petroleum data obtained from our activities.

The Petroleum (Local Content and Local Participation) Regulations, 2013 (L.I 2204) was enacted to promote the maximization of value addition and job creation using local expertise, goods and services, businesses and financing in the petroleum industry value chain and their retention in country.  The law requires minimum thresholds for the procurement of local goods and services where first consideration must be given to qualified Ghanaians.

Before engaging in petroleum activities, we are required to submit a Local Content Plan for approval by the Commission. The Local Content plan must include: (i) an Employment and Training Sub-Plan; (ii) a Research and Development Sub-Plan; (iii) a Technology Transfer Sub-Plan; (iv) a Legal Services Sub-Plan; and (v) a Financial Services Sub-Plan.  It is an offence under L.I 2204 to submit a false plan.

L.I2204 also requires that insurable risks relating to petroleum activity in the country shall be insured through an indigenous brokerage firm or where applicable, a reinsurance broker, and that we retain the services of a Ghanaian legal practitioner or a firm of Ghanaian legal practitioners whose principal office is located in Ghana.  We are further required to retain the services of a Ghanaian financial institution or organization and maintain a bank account with an indigenous Ghanaian bank.

Environment, Health, Safety and Quality

Pacific Drilling recognizes that, as a leading offshore drilling contractor, we must be a responsible corporate steward with a strong commitment to sustainability. This commitment is fundamental to the way that we conduct business and is critical to our future success.

Our business requires us to operate in remote and sensitive marine environments. On our drillships, our employees conduct their work in challenging and complex industrial conditions. Our corporate Health, Safety and Environment (HSE) Policy highlights the importance of HSE to our overall success and sets expectations for all personnel to take personal responsibility for the safety of themselves, others and the environment. Pacific Drilling is committed to creating an incident free work place for all our employees, contractors, suppliers and clients. All personnel working for, or on behalf of, Pacific Drilling are empowered to stop their own work, or the work performed by co-workers, client representatives, contractors or management, if it causes concern related to health, safety, security or environmental pollution. We provide comprehensive training programs to ensure our people understand our safety policies and processes and are prepared to perform their work functions safely, including focused programs for short service personnel as they develop their familiarity with our work environment. All personnel are expected to plan work in a manner that encourages active involvement in hazard identification and risk assessment, including the implementation of appropriate risk reduction measures. We implement programs to involve all personnel in the monitoring of our work activities and proactively report and address at-risk behaviors and substandard conditions. If any HSE events do occur, we are prepared to respond in case of emergency, and we investigate all incidents with an aim to correct errors and share learnings. We track our HSE performance and include HSE-focused metrics in our annual company goals to drive ongoing improvement.

Just as we are committed to sustainability in our current operations, we are also committed to longer-term efforts to minimize our environmental impact. In 2019, we initiated an accredited third-party study to analyze the current carbon footprint of our drilling operations worldwide.  From this study we will establish a baseline to evaluate areas for improvement and set goals for future initiatives to increase our carbon efficiency and minimize our environmental impact.

At Pacific Drilling, we believe that the methods we employ to achieve our results are as important as the results themselves. We believe that our aim to exceed client expectations by delivering the safest, most efficient and reliable deepwater drilling services in the industry is best accomplished through stringent ethical requirements and the highest standards of corporate governance. Our Global Code of Conduct is designed to support the Company's core values and allow each of us to live up to those values as we work. We deliberately set high expectations for our corporate and personal behavior that apply to all employees—regardless of rank—and any independent contractors, agents, or consultants who are working for or on behalf of the Company, no matter where in the world they may be located.

Organizational Structure and Joint Venture

We have 40 subsidiaries organized under the laws of various jurisdictions.  For a full listing of our subsidiaries, including their jurisdictions of organization, see Exhibit 21.1 to this annual report. All subsidiaries are, indirectly or directly, wholly-owned by Pacific Drilling, S.A., except for Pacific International Drilling West Africa Limited (“PIDWAL”), Pacific Drillship Nigeria Limited (“PDNL”), Pacific Bora Ltd. (“PBL”), Pacific Scirocco Ltd. (“PSL”) and Pacific Menergy Ghana Limited (“PMGL”).

PSL and PBL, which own the Pacific Scirocco and Pacific Bora, respectively, are owned 49.9% by our wholly-owned subsidiary Pacific Drilling Limited (“PDL”) and 50.1% by PDNL.  PDNL is owned 0.1% by PDL and 99.9% by PIDWAL, which is our Nigerian joint venture with Derotech Offshore Services Limited (“Derotech”). Derotech owns 51% of PIDWAL and PDL, indirectly through another wholly-owned subsidiary, owns 49% of PIDWAL. 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 in our consolidated financial statements.

Employees

As of December 31, 2019, we had a total of 763 employees and three subcontractor, consisting of:

As of December 31, 2019, approximately 501 members of our workforce were located in the United States and four were located in Nigeria. The remainder were in various other locations around the world.

We believe that our relations with employees are good.

Research and Development

We do not undertake any significant expenditure on research and development. Additionally, we have no significant interests in patents or licenses.

Available Information

We file annual, quarterly and current reports and other information with the SEC.  The SEC maintains a website at www.sec.gov, which contains reports, proxy and information statements and other information regarding registrants that file electronically with the SEC.  In addition, the Company maintains a website at www.pacificdrilling.com on which our latest annual report on Form 10-K, recent quarterly reports on Form 10-Q, recent current reports on Form 8-K, any amendments to those filings, and other filings are available as soon as reasonably practicable after we file them with, or furnish them to, the SEC, and may be accessed free of charge.

ITEM 1A.    RISK FACTORS

An investment in our common shares involves a high degree of risk. You should consider carefully the following risk factors, as well as the other information contained in this annual report, before making an investment in our common shares. Any of the risk factors described below could significantly and negatively affect our business, financial position, results of operations or cash flows. In addition, these risks represent important factors that can cause our actual results to differ materially from those anticipated in our forward-looking statements.

Risks Related to Our Business

The demand for our services depends on the level of activity in the offshore oil and gas industry, which is significantly affected by, among other things, volatile oil and natural gas prices. Our business has been and may continue to be materially and adversely affected by the significant decline in the oil and gas industry. Since January 2020, the Coronavirus outbreak and fear of further spread of the Coronavirus have caused significant disruptions in international economies and international financial and oil markets, including a substantial decline in the price of oil. Lack of an improvement in the market for our offshore contract drilling services would materially and adversely affect our liquidity and ability to repay or refinance our indebtedness.

The offshore contract drilling industry has been cyclical and volatile, and the substantial drop in oil prices beginning mid-2014 resulted in a significant decline in drilling activity. Since January 2020, the Coronavirus outbreak and fear of further spread of the Coronavirus have caused significant disruptions in international economies and international financial and oil markets, including a substantial decline in the price of oil, with such disruptions intensifying, and Brent crude oil prices closing at $36.7 on March 10, 2020.  In addition, during 2020, major stock market indices have experienced substantial declines, with such declines intensifying.  As of March 10, 2020 the S&P 500 Index had fallen by 11.2% since the start of 2020.  The Coronavirus outbreak has weakened demand for oil, and after the Organization of the Petroleum Exporting Countries (“OPEC”) and a group of oil producing nations led by Russia failed on March 6, 2020 to agree on oil production cuts, Saudi Arabia announced that it would cut oil prices and increase production, leading to a sharp further decline in oil trading prices.  The Coronavirus and responses of oil producers to the lower demand for oil and lower oil prices are rapidly evolving situations.  Sustained low or worsening oil prices are likely to have a material adverse effect on our financial condition, results of operations and cash flow.

The demand for our services depends on the level of activity in oil and natural gas exploration, development and production in offshore areas worldwide. Oil and natural gas prices and market expectations of potential changes in these prices also significantly affect the level of offshore activity and demand for drilling units.

Oil and gas prices are extremely volatile and are affected by numerous factors beyond our control, including:

Declines in oil and gas prices for an extended period of time, and market expectations of continued lower oil prices, have negatively affected and could continue to negatively affect our business, including due to the Coronavirus. Sustained periods of low oil prices have resulted in and could continue to result in reduced exploration and drilling. These commodity price declines have an effect on rig demand, and periods of low demand can cause excess rig supply and intensify competition in the industry, which often results in drilling units of all generations and technical specifications being idle for periods of time. As a result of the low commodity prices, exploration and production companies have significantly reduced capital spending over the last few years, leading to a current oversupply of drilling rigs and negative pricing pressure on our market. Recently, we have seen increased capital spending by exploration and production companies and subsequent demand for drilling rigs, which resulted in higher utilization and improving dayrates in certain regions of the world; however, these developments may be stopped or reversed by the evolving Coronavirus outbreak and reactions to it.

We cannot accurately predict the future level of demand for our services or future conditions in the oil and gas industry and we cannot assure you that the market will improve. If the market for our offshore contract drilling services does not improve as a result of oil prices, demand for contract drilling services and/or levels of exploration, development or production expenditures by oil and gas companies, our revenues could be impacted and our business, results of operations, liquidity and ability to repay or refinance our indebtedness would be materially and adversely affected.

Failure to secure new drilling contracts for our drillships could have a material adverse effect on our financial position, results of operations or cash flows.

As of March 6, 2020, we did not have signed drilling contracts for three of our seven drillships, the Pacific Meltem, the Pacific Scirocco or the Pacific Mistral. Our ability to obtain drilling contracts for our drillships will depend on market conditions and our clients’ drilling programs. Our recent new contracts are short to medium term in length and there is uncertainty as to whether new contracts we may enter into in the future will continue to have comparatively shorter durations or require us to work at lower dayrates. We may not be able to secure contracts for our drillships on favorable terms, or at all. Our failure to secure drilling contracts for our uncontracted drillships or currently operating drillships after the expiration of existing contracts, or to successfully negotiate and execute definitive contracts and satisfy other conditions precedent to finalizing any letters of intent and letters of award, could have a material adverse effect on our financial position, results of operations or cash flows.

An oversupply of rigs competing with our rigs could continue to impact the utilization and contract prices for our rigs and could adversely affect our financial position, results of operations or cash flows.

There are several high-specification floating rigs currently available for drilling services in the industry worldwide. The oversupply of high-specification floating rigs has led to a significant reduction in dayrates and lower utilization over the past few years. Recently, we have seen improvement in the utilization and associated dayrates for our service, however there is no guarantee that this trend will continue going forward, particularly given recent developments related to Coronavirus. Should this improvement in utilization and dayrates not continue, it could require us to enter into lower dayrate contracts or to idle or stack more of our drillships, which could have a material adverse effect on our business prospects, financial condition, liquidity and results of operations.

We have a small fleet and rely on a limited number of clients. The loss of any client or significant downtime on any drillship attributable to maintenance, repairs or other factors could adversely affect our financial position, results of operations or cash flows.

As a result of our relatively small fleet of seven drillships, we anticipate that revenues will depend on contracts with a limited number of clients. The loss of any one of our clients or any potential clients could have a material adverse effect on our financial position, results of operations or cash flows. In addition, our limited number of drillships makes us more susceptible to incremental loss in the event of downtime on any one operating unit. If any one of our drillships becomes inactive for a substantial period of time and is not otherwise earning contractual revenues, it could have a material adverse impact on our financial position, results of operations or cash flows.

Our backlog of contract drilling revenue may not be fully realized.

Our contract backlog includes firm commitments only, which are represented by signed drilling contracts. We calculate our contract backlog by multiplying the contractual dayrate by the number of days committed under the contracts (excluding options to extend), assuming full utilization, and also including mobilization fees, upgrade reimbursements and other revenue sources, such as the standby rate during upgrades, as stipulated in the applicable contracts. For a well-by-well contract, we calculate the contract backlog by estimating the expected number of remaining days to drill the firm wells committed. The actual amounts of revenues earned and the actual periods during which revenues are earned may differ from the amounts and periods shown in the contract backlog amounts we present, due to various factors, including unplanned downtime and maintenance projects and other factors. We may not be able to realize the full amount of our contract backlog due to events beyond our control, and accordingly the actual amount of revenues earned may be substantially lower than the backlog reported. In addition, some of our clients may experience liquidity issues, which could worsen if commodity prices remain low or decrease further for an extended period of time. Liquidity issues could lead our clients to seek to repudiate, cancel or renegotiate contracts for various reasons, as described below under “—Our drilling contracts may be terminated early in certain circumstances.” Our inability to realize the full amount of our contract backlog could have a material adverse effect on our financial position, results of operations or cash flows.

We may enter into drilling contracts with less favorable terms that expose us to greater risks than we would assume under stronger market conditions.

The current market conditions and oversupply of drilling rigs have impacted and could continue to impact our existing drilling contracts. We may not be able to extend contracts with our clients on favorable terms, or at all.  

We may enter into drilling contracts or amendments to drilling contracts that expose us to greater risks than we would assume under stronger market conditions, such as greater exposure to environmental or other liabilities and more onerous termination provisions giving the client a right to terminate without cause or upon little or no notice. Upon termination, these contracts may not result in a payment to us or, if a termination payment is required, it may not fully compensate us for the loss of a contract. In addition, the early termination of a contract may result in a rig being idle for an extended period of time, which could adversely affect our financial position, results of operations or cash flows. In certain contracts, we may also provide additional third-party services integrated into the standard drilling rig contract. While these additional third-party services generate incremental revenue, they also lead to related costs and associated downtime risk. We can provide no assurance that any such increased risk exposure will not have a material negative impact on our future operations and financial results.

We may not continue to realize the cost-savings we have recently achieved on our idle rigs and reactivation of idle rigs may take longer or be more costly than we anticipate.

Our operating expenses and maintenance costs depend on a variety of factors including crew costs, provisions, equipment, insurance and maintenance and repairs, many of which are beyond our control. During periods in which a rig is idle, we may decide to “smart-stack” the rig, which means the rig is maintained with a reduced level of crew to be ready to ramp up to operational status for redeployment.  During periods in which multiple rigs are idle, we may decide to maintain the rigs in “modified smart-stack” status, which means the idle rigs are maintained as a group with one rig providing the power source for the other rigs, which have no crew onboard.

We believe our results for the year ended December 31, 2019 reflect the cost savings we expected to achieve from our smart-stacking and modified smart-stacking approaches. We may not continue to realize those cost-savings, and, if we are required to idle additional rigs, we may not achieve similar cost savings.

Reactivation of idle rigs may take longer and be more costly than anticipated and there is limited history of reactivating idle rigs after smart-stacking. Reactivation costs can be higher than expected due to a longer ramp up time than expected, and increased capital expenditures required to bring the rig back to operational status. Contract preparation expenses vary based on the client requirements, the scope and length of contract preparation required and the duration of the firm contractual period.

Our drilling contracts may be terminated early in certain circumstances.

Our contracts with clients generally may be terminated at the option of the client upon payment of an early termination fee, which is typically a significant percentage of the dayrate or the standby rate under the drilling contract for a specified period of time. During periods of depressed market conditions, we are subject to an increased risk that our clients may seek to terminate our contracts. Early termination payments may not fully compensate us for the loss of the contract. Accordingly, the actual amount of revenues earned may be substantially lower than the backlog reported. Our contracts also generally provide for termination by the client without the payment of any termination fee under various circumstances, such as sustained unacceptable performance by us, as a result of impaired performance caused by equipment or operational issues, destruction of a drilling rig, or sustained periods of downtime due to force majeure events (which could include downtime related to the Coronavirus) or otherwise. Many of these events are beyond our control. If our clients terminate some of our contracts, and we are unable to secure new contracts on a timely basis and on substantially similar terms, or if payments due under our contracts are suspended for an extended period of time or if a number of our contracts are renegotiated, our financial position, results of operations or cash flows could be materially adversely affected.

The market value of our drillships may decrease, which could cause us to take accounting charges or to incur losses if we decide to sell them following a decline in their values.

If the offshore contract drilling industry does not continue to improve, the fair market values of our drillships may decline further. The fair market values of the drillships we currently own or may acquire in the future may increase or decrease depending on a number of factors, many of which are beyond our control, including the general economic and market conditions affecting the oil and gas industry and the possible corresponding adverse effect on the level of offshore drilling activity.

Any such deterioration in the market values of our drillships could require us to record an impairment charge in our financial statements, which could adversely affect our results of operations. We may not be able to sell our drillships at prices we deem acceptable or at all.  If we sell any of our drillships when prices for such drillships have fallen, the sale may be at less than such drillship’s carrying amount on our financial statements, resulting in a loss.

Any such reduction in the fair market value of our fleet could also adversely affect our flexibility under our new $50.0 million revolving credit facility (defined below under “Risks Related to our Indebtedness”), due to additional limitations that may be imposed under the credit agreement if our aggregate fleet value were to decrease below $500 million.

Our business and the industry in which we operate involve numerous operating hazards which, if they occur, may have a material adverse effect on our business.

Our operations are subject to the usual hazards inherent in the drilling and operation of oil and natural gas wells, such as blowouts, reservoir damage, loss of production, loss of well control, cratering, fires, explosions, spills of hazardous materials and pollution. The occurrence of any of these events could result in the suspension of our drilling or production operations, claims by the operator, severe damage to or destruction of the property and equipment involved, injury or death to drilling unit personnel and environmental and natural resources damages. Our operations could be suspended as a result of these hazards, whether the fault is ours or that of a third party. In certain circumstances, governmental authorities may suspend drilling operations as a result of these hazards, and our clients may cancel or terminate their contracts. We may also be subject to personal injury and other claims by drilling unit personnel as a result of our drilling operations.

We may experience downtime as a result of repairs or maintenance, human error, defective or failed equipment or delays waiting for replacement parts.

Our operations may be suspended because of machinery breakdowns, human error, abnormal operating conditions, failure of subcontractors to perform or supply goods or services, delays on replacement parts or personnel shortages, which may cause us to experience operational downtime and could have an adverse effect on our results of operations.

In addition, we rely on certain third parties to provide supplies and services necessary for our offshore drilling operations, including, but not limited to, suppliers of drilling equipment and catering and machinery suppliers. Mergers in our industry have reduced the number of available suppliers, resulting in fewer alternatives for sourcing key supplies. Such consolidation may result in a shortage of supplies and services, potentially inhibiting the ability of suppliers to deliver on time, or at all. These delays may have a material adverse effect on our results of operations and result in downtime, and delays in the repair and maintenance of our drillships.

Our business is subject to numerous governmental laws and regulations, including environmental requirements, that may impose significant costs and liabilities on us.

Our operations are subject to federal, state, local, foreign and international laws and regulations that may, among other things, require us to obtain and maintain specific permits or other governmental approvals to control or limit the discharge of oil and other contaminants into the environment or otherwise relate to environmental protection, and which impose stringent standards on our activities that are protective of the environment. For example, any operations and activities that we conduct in the United States and its territorial waters are subject to numerous environmental laws, including the Oil Pollution Act of 1990, the Outer Continental Shelf Lands Act, the Comprehensive Environmental Response, Compensation, and Liability Act and the International Convention for the Prevention of Pollution from Ships (each, as amended from time to time), and analogous state laws. Failure to comply with these laws, regulations and treaties may result in the assessment of administrative, civil and criminal penalties, the imposition of remedial obligations, the denial or revocation of permits or other authorizations and the issuance of injunctions that may limit or prohibit some or all of our operations. Laws and regulations protecting the environment have become more stringent in recent years and may in certain circumstances impose strict liability, rendering us liable for environmental and natural resource damages caused by others or for acts that were in compliance with all applicable laws at the time the acts were performed. The application of these laws and regulations, the modification of existing laws or regulations or the adoption of new laws or regulations that curtail exploratory or developmental drilling for oil and natural gas could materially limit future contract drilling opportunities or materially increase our costs, including our capital expenditures.

The imposition of stringent restrictions or prohibitions on offshore drilling by a governing body may have a material adverse effect on our business.

Prior catastrophic events that resulted in the release of oil or other contaminants offshore have heightened environmental and regulatory concerns about the oil and gas industry. In the past, the U.S. federal government, acting through the U.S. Department of the Interior and its implementing agencies that have since evolved into the present day Bureau of Ocean Energy Management and Bureau of Safety and Environmental Enforcement, have issued various rules, Notices to Lessees and Operators and temporary drilling moratoria that interrupted operations and resulted in additional stringent environmental and safety regulations or requirements applicable to oil and gas exploration, development and production operators in the U.S. Gulf of Mexico, some of whom are our clients. Any such regulatory initiatives may

serve to effectively slow down the pace of drilling and production operations in the U.S. Gulf of Mexico due to adjustments in operating procedures and certification requirements as well as increased lead times to obtain exploration and production plan reviews. Also, our clients may require changes to our operations or procedures in order for our clients to meet their own additional compliance requirements, which may increase our costs.

Our global operations may be adversely affected by political and economic circumstances in the countries in which we operate, including as a result of violations of the U.S. Foreign Corrupt Practices Act and similar foreign anti-bribery laws. A significant portion of our business has been, and may in the future be, conducted in West Africa, which exposes us to risks of war, local economic instabilities, corruption, political disruption and civil disturbance in that region.

We operate in oil and natural gas producing areas worldwide. We are subject to a number of risks inherent in any business that operates globally, including: political, social and economic instability; war; piracy and acts of terrorism; corruption; potential seizure, expropriation or nationalization of assets; increased operating costs; wage and price controls; imposition or changes in interpretation and enforcement of local content laws; and other forms of government regulation and economic conditions that are beyond our control.

The United States Foreign Corrupt Practices Act (the “FCPA”), the UK Bribery Act 2010, the Nigerian Corrupt Practices and Other Related Offenses Act of 2000, Brazil’s Anti-Corruption Law of 2014 and similar worldwide anti-bribery laws generally prohibit companies and their intermediaries from making, offering or authorizing improper payments to government officials for the purpose of obtaining or retaining business. We may operate in countries where strict compliance with anti-bribery laws conflicts with local customs and practices. Violations of, or any non-compliance with, current and future anti-bribery laws (either due to acts or inadvertence by us or our agents) may result in criminal and civil sanctions and could subject us to other liabilities in the U.S. and elsewhere.

In order to effectively compete in some foreign jurisdictions, we utilize local agents and/or establish joint ventures with local operators or strategic partners. Our agents often interact with government officials on our behalf. Even though some of our agents and partners may not themselves be subject to the FCPA or other anti-bribery laws to which we may be subject, if our agents or partners make improper payments to government officials in connection with engagements or partnerships with us, we could be investigated and potentially found liable for violation of such anti-bribery laws and could incur civil and criminal penalties and other sanctions, which could have a material adverse effect on our financial position, results of operations or cash flows.

These risks may be higher in developing countries such as Nigeria, Ghana and Mauritania. Countries in West Africa have experienced political and economic instability in the past and such instability may continue in the future. Disruptions in our operations may occur in the future, and losses caused by these disruptions may not be covered by insurance.

We may be required to make significant capital expenditures to maintain our competitiveness and to comply with applicable laws, regulations and standards of governmental authorities and organizations.

Changes in offshore drilling technology, client requirements for new or upgraded equipment and competition within our industry may require us to make significant capital expenditures in order to maintain our competitiveness. Our competitors may have greater financial and other resources than we have, which may enable them to make technological improvements to existing equipment or replace equipment that becomes obsolete. In addition, changes in governmental regulations, safety or other equipment standards may require us to make additional unforeseen capital expenditures.

If we are unable to fund these capital expenditures with cash flow from operations, we may either incur additional borrowings or raise capital through the sale of debt or equity securities. Our ability to access the capital markets may be limited by our financial position at the time, changes in laws and regulations and by adverse market conditions. In addition, our ability to raise additional capital is limited by the terms of our debt agreements. Our failure to obtain the funds for necessary future capital expenditures could limit our ability to continue to operate some of our vessels and could have a material adverse effect on our business and on our financial position, results of operations or cash flows.

There may be limits on our ability to mobilize drillships between geographical areas and the time spent on and costs of such mobilizations may materially and adversely affect our business.

The offshore contract drilling market is generally a global market, as drilling units may be mobilized from one area to another. However, the ability to mobilize drilling units can be impacted by several factors including governmental regulation and customs practices, the significant costs to move a drilling unit, weather, political instability, civil unrest, military actions and the technical capability of the drilling units to operate in various environments. Additionally, while a drillship is being mobilized from one geographic market to another, we may not be paid by the client for the time that the drillship is out of service. Also, we may mobilize a drillship to another geographic market without a client contract, which may result in costs that are not reimbursed by future clients.

The loss of key personnel could negatively impact our business.

Our future operational performance depends to a significant degree upon the continued service of key members of our management as well as marketing, sales and operations personnel. The loss of one or more of our key personnel could have a material adverse effect on our business. We believe our future success will also depend in large part upon our ability to attract, retain and further motivate highly skilled management, marketing, sales and operations personnel. We may experience intense competition for personnel, and we may not be able to retain key employees or be successful in attracting, assimilating and retaining personnel in the future. In addition, our ability to attract, recruit and retain key personnel may be negatively impacted by our emergence from bankruptcy and the uncertainties currently facing the industry in which we operate.

Any significant cyber-attack or interruption in network security could materially and adversely disrupt and affect our operations and business.

We have become increasingly dependent upon digital technologies to conduct and support our offshore operations, and we rely on our operational and financial computer systems to conduct almost all aspects of our business. Threats to our information technology systems associated with cybersecurity risks and incidents or attacks continue to grow. Any failure of our computer systems, or those of our clients, vendors or others with whom we do business, could materially disrupt our operations and could result in the corruption of data or unauthorized release of proprietary or confidential data concerning the Company, its business operations and activities, clients or employees. Computers and other digital technologies could become impaired or unavailable due to a variety of causes, including, among others, theft, cyber-attack, design defects, terrorist attacks, utility outages, human error or complications encountered as existing systems are maintained, repaired, replaced or upgraded. Any cyber-attack or interruption could have a material adverse effect on our financial position, results of operations or cash flows, and our reputation.

Our insurance may not be adequate in the event of a catastrophic loss.

Damage to the environment could result from our operations, particularly through oil spillage or extensive uncontrolled fires. We may be subject to property, environmental, natural resource and other damage claims by oil and gas companies, other businesses operating offshore and in coastal areas, environmental conservation groups, governmental entities and other third parties. Insurance policies and contractual rights to indemnity may not adequately cover losses, and we may not have insurance coverage or rights to indemnity for all risks. In particular, pollution and environmental risks generally are not fully insurable.

Losses caused by the occurrence of a significant event against which we are not fully insured or caused by a number of lesser events against which we are insured but are subject to substantial deductibles, aggregate limits and/or self-insured amounts, could materially increase our costs and impair our profitability and financial position. Our policy limits for property, casualty, liability and business interruption insurance, including coverage for severe weather, terrorist acts, war, civil disturbances, pollution or environmental damage, may not be adequate should a catastrophic event occur related to our property, plant or equipment, or our insurers may not have adequate financial resources to sufficiently or fully pay related claims or damages. When any of our coverage expires, adequate replacement coverage may not be available, offered at reasonable prices or offered by insurers with sufficient financial resources.

Our clients may be unable or unwilling to indemnify us.

Consistent with standard industry practice, our clients generally assume, and indemnify us against, well control and subsurface risks pursuant to our dayrate contracts. These risks are associated with the loss of control of a well, such as blowout or cratering, the cost to regain control or re-drill the well and associated pollution. However, the indemnification provisions in our contracts may not cover all damages, claims or losses to us or third parties, and our clients may not have sufficient resources to cover their indemnification obligations or may contest their obligation to indemnify us. The indemnification provisions of our contracts may be subject to differing interpretations and the laws or courts of certain jurisdictions may enforce such provisions while other laws or courts may find them unenforceable, void or limited by public policy considerations, including when the cause of the underlying loss or damage is our gross negligence or willful misconduct, when punitive damages are attributable to us or when fines or penalties are imposed directly against us. Also, in the interest of maintaining good relations with our key clients, we may choose not to assert certain indemnification claims. In addition, in certain market conditions, we may be unable to negotiate contracts containing indemnity provisions that obligate our clients to indemnify us for such damages and risks.

We may suffer losses as a result of foreign currency fluctuations.

A significant portion of the contract revenues of our foreign operations will be paid in U.S. dollars; however, some payments are made in foreign currencies. As a result, we are exposed to currency fluctuations and exchange rate risks as a result of our foreign operations. To minimize the financial impact of these risks when we are paid in foreign currency, we attempt to match the currency of operating costs with the currency of contract revenue. If we are unable to substantially match the timing and amounts of these payments, any increase in the value of the U.S. dollar in relation to the value of applicable foreign currencies could adversely affect our operating results.

Public health threats, including the evolving risks presented by the Coronavirus, could have a material adverse effect on our financial position, results of operations or cash flows.

Public health threats, such as Ebola, the H1N1 flu virus, the Zika virus, Severe Acute Respiratory Syndrome, and more recently Coronavirus and other highly communicable diseases, outbreaks of which have occurred in various parts of the world in which we operate, could adversely impact our operations, the operations of our clients and the global economy, including the worldwide demand for oil and natural gas and the level of demand for our services. Since January 2020, the Coronavirus outbreak and fear of further spread of the Coronavirus have caused significant disruption in international economies and international financial and oil markets.  For additional information, see the first Risk Factor under “Risks Related to our Business” above.

The Coronavirus outbreak has led to quarantines, cancellation of events and travel, business and school shutdowns, supply chain interruptions and overall economic and financial market instability.  Further spread of the Coronavirus could cause additional quarantines, reduction in business activity, labor shortages and other operational disruptions. Any quarantine of personnel or inability to access our offices or rigs could adversely affect our operations. Travel restrictions or operational problems in any part of the world in which we operate, or any reduction in the demand for drilling services caused by public health threats, may adversely affect our financial position, results of operations or cash flows.

We may be adversely affected by national, state and foreign or international laws or regulatory initiatives focusing on greenhouse gas (“GHG”) reduction.

Due to concern over the risk of climate change, there has been a broad range of proposed or promulgated initiatives regarding GHG reduction. Regulatory frameworks adopted, or being considered for adoption, to reduce GHG emissions include cap and trade regimes, carbon taxes, restrictive permitting, increased efficiency standards, and incentives or mandates for renewable energy. Although it is not possible at this time to predict how new legislation or regulations that may be adopted to address GHG emissions in the United States would impact our business, any such future laws and regulations that require reporting of GHGs or otherwise limit emissions of GHGs from oil and gas exploration and production operators, some of whom are our clients, could require such operators to incur increased costs, lengthen project implementation times, and adversely affect demand for the oil and natural gas that they produce, which could decrease demand for our services. In addition, some experts believe climate change could increase the frequency and severity of extreme weather conditions. We are currently unable to predict the manner or extent of any such potential GHG reduction or climate change effects.

We are engaged in legal proceedings relating to a construction contract for the drillship known as the Pacific Zonda. We may be involved in other litigation, arbitration or other legal proceedings from time to time, the outcomes of which may be unpredictable and may have an adverse impact on our business and financial condition, which may be material.

Two of our subsidiaries, the Zonda Debtors, are involved in arbitration proceedings relating to the drillship known as the Pacific Zonda, as described elsewhere in this report (the “Zonda Arbitration”).  On January 15, 2020, the arbitration Tribunal awarded SHI approximately $320 million with respect to its claims against the Zonda Debtors.  On February 11, 2020, the Zonda Debtors filed an application with the High Court in London seeking permission to appeal the Tribunal’s award.  There can be no assurance that the Zonda Debtors will be granted permission to appeal, or if such permission is granted, that the appeal will be successful. If the Zonda Debtors are unsuccessful in the appeal, we expect the Zonda Debtors will be liquidated in accordance with the terms of the Zonda Plan.

 As a result of the Tribunal’s decision, we recognized a loss of $220.2 million during the year ended December 31, 2019  primarily related to the elimination of the receivable on our balance sheet related to the arbitration. For additional information, see Item 3 – Legal Proceedings, and Note 16 to our consolidated financial statements.

On December 20, 2018, after the Company and its subsidiaries other than the Zonda Debtors had completed the Plan of Reorganization and emerged from bankruptcy, SHI filed with the Bankruptcy Court an untimely secured contingency claim against Pacific Drilling S.A., our parent company, in the amount of approximately $387.4 million.  We have filed an objection to the claim on the basis that the claim should be disallowed due to its being filed long after the May 1, 2018 claims bar date established by order of the Bankruptcy Court. In addition, we believe SHI has no basis for a claim against Pacific Drilling S.A. because, among other things, Pacific Drilling S.A. was not a party to the Construction Contract nor the guaranty.

Our business involves numerous operating hazards and risks, and we operate in many different international jurisdictions. In the normal course of our business we may become involved in disputes and legal or arbitration proceedings, which may have unpredictable outcomes and which may be material.

Risks Related to Our Emergence from Bankruptcy

We experienced a change of control in connection with our emergence from bankruptcy and our new board of directors may change our business strategy and has changed and may continue to change key personnel.

As a result of the issuances of common shares, change in the composition of our board of directors, amendments to our Articles and execution and delivery of the Governance Agreement discussed elsewhere in this annual report, a change in control of the Company occurred on the Plan Effective Date in connection with the Company’s emergence from the Chapter 11 bankruptcy proceedings. Pursuant to the Governance Agreement, until the “Nomination Termination Time” (as defined therein), certain of our shareholders have the right to appoint our Class B directors, constituting three of our seven directors. As of the Plan Effective Date and March 6, 2020, only a few of our shareholders, if they were to act in concert, could control the election of our remaining four Class A directors.

Pursuant to our Articles and the Governance Agreement, prior to the Nomination Termination Time, any two Class B directors acting in their capacities as such (a “Class B Majority”) have broad authority to act on the Company’s behalf in connection with any Acquisition Proposal or Acquisition (as such terms are defined in the Articles), including but not limited to the authority to solicit prospective Acquisition Proposals, to retain, at the Company’s expense such consultants, legal counsel and other advisors as a Class B Majority may from time to time deem appropriate to assist the Class B directors in the performance of their duties with respect to Acquisition Proposals, and subject to specified conditions, to execute and deliver on behalf of the Company definitive documentation providing for the consummation of an Acquisition. For additional information, see Item 13 – “Certain Relationships and Related Transactions, and Director Independence.”

Our post-emergence board of directors may change our business strategy, including but not limited to changing our operating strategy or soliciting Acquisition Proposals. On the Plan Effective Date, our new board of directors appointed a new chief executive officer and has made and may make other changes in key personnel. These or potential future changes may not be successful and may be disruptive to our business and relationships with clients, vendors, suppliers, service providers, other third parties and employees.

We remain subject to risks and uncertainties associated with our emergence from bankruptcy.

Notwithstanding our emergence from bankruptcy on November 19, 2018, our operations and liquidity remain subject to a number of risks and uncertainties related to the fact that we operated under Bankruptcy Court protection for approximately one year. These risks and uncertainties include the following:

Our operating results may be adversely affected by the possible reluctance of third parties to do business with a company that recently emerged from Chapter 11 bankruptcy proceedings. For example, third parties could require that we provide additional financial assurances, which could be costly. In addition, failure to retain or attract and maintain key personnel or erosion of employee morale could have a material adverse effect on our ability to meet client expectations, obtain new contracts and effectively operate our business, thereby adversely affecting our results of operations and financial condition. We cannot accurately predict or quantify the ultimate impact that our emergence from bankruptcy may have on our business, results of operations and financial condition.

The Plan of Reorganization was based in large part upon assumptions and analyses developed by us. If these assumptions and analyses prove to be incorrect, our results of operations, liquidity and financial condition may be materially and adversely affected.

As a part of the Plan of Reorganization process, we were required to prepare projected financial information to demonstrate to the Bankruptcy Court the feasibility of the Plan of Reorganization and our ability to continue operations upon emergence from bankruptcy. The Plan of Reorganization, and these projections, were reflective of assumptions and analyses based on our experience and perception of historical trends, prevailing conditions and expected future developments, as well as other factors that we considered at the time to be appropriate under the circumstances. Whether actual future results and developments will be consistent with our expectations and assumptions reflected in the Plan of Reorganization depends on a number of factors, including but not limited to: (i) our ability to maintain our clients’ confidence in our viability as a continuing entity and to attract and retain sufficient business from them, (ii) our ability to retain or attract and retain key employees, (iii) the overall strength and stability of general economic conditions of the financial and oil and gas industries, both in the U.S. and in global markets and (iv) our ability to make required interest payments on and ultimately pay or refinance our debt. Any of these factors could materially adversely affect the success of our reorganized business.

In addition, the Plan of Reorganization was developed in reliance upon financial projections, and these projections are not part of this annual report, have not been and are not expected to be updated and should not be relied upon in connection with the purchase of our common shares. Financial forecasts are necessarily speculative, and it is likely that one or more of the assumptions and estimates that are the basis of these financial forecasts will not be accurate.

In connection with our emergence from bankruptcy, our historical financial information may not be indicative of our future financial performance.

In connection with our emergence from bankruptcy, we have adopted Fresh Start Accounting in accordance with provisions of ASC 852, Reorganizations, which resulted in the Company becoming a new entity for financial reporting purposes on November 19, 2018, the effective date of emergence. Fresh Start Accounting results in the Company’s assets and liabilities being recorded at fair value as of the Plan Effective Date. As a result of the adoption of Fresh Start Accounting, the Company’s consolidated financial statements subsequent to November 19, 2018 will not be comparable to its consolidated financial statements on and prior to that date. The lack of comparable historical information may discourage investors from purchasing our common shares.

Our pre-emergence net operating losses may be significantly reduced and/or limited under Luxembourg income tax law.

From a Luxembourg Generally Accepted Accounting Principles (the “Lux GAAP”) standpoint, debt forgiveness resulting from the Chapter 11 bankruptcy proceedings would lead to an increase of the net asset value of the Luxembourg debtor benefitting from the forgiveness. Such an increase would correspond to the amount of the debt that is forgiven for no consideration. The increase of the net asset value would also be reflected in the Lux GAAP profit and loss through recognition of cancellation of debt income (“COD Income”) corresponding to the amount of the debt forgiven for no consideration. Based on the principle of “accrochement du bilan fiscal au bilan commercial” (translated as “tax follows book”) provided in article 40 of the Luxembourg Income Tax Law (the “Luxembourg ITL”) (which is considered as the general rule), any COD Income realized upon the cancellation of a debt from a Lux GAAP standpoint should also increase the net asset value of the debtor for Luxembourg tax purposes.

Article 52 of the Luxembourg ITL relates specifically to gains derived by a Luxembourg corporate debtor upon total or partial debt forgiveness occurring in the context of a financial reorganization aimed at the financial recovery of the debtor (i.e., “gain d’assainissement” or “reorganization profit”). This article provides that the increase in the net asset value of a Luxembourg corporate debtor resulting from a gain d’assainissement / reorganization profit is eliminated from the positive taxable result of the Luxembourg debtor only to the extent of that result. In other words, the tax exemption applies only to the portion of net gain d’assainissement / reorganization profit exceeding existing tax losses available during the year of the debt forgiveness.

Considering the above, we may benefit from an exemption of COD Income pursuant to article 52 of the Luxembourg ITL upon cancellation of our debts. Based on article 52 of the Luxembourg ITL and article 114(2)1 of the Luxembourg ITL, COD Income derived by us upon cancellation of our debts should first be offset with existing tax losses carry forwards and be exempt based on article 52 of the Luxembourg ITL for the remainder.

Luxembourg tax law allows tax losses to offset taxable profits unless it is determined that a change of shareholders results in tax abuse. Luxembourg jurisprudence uses a “facts and circumstances” analysis that indicates an abuse of law could be found where the loss-generating activity is discontinued following a change in ownership and a new profitable business is begun. However, a finding of valid commercial reasons reflecting the economic reality should be sufficient to avoid the perception of abuse of law. Also, after a corporate restructuring, utilizing accumulated tax losses within the same group should not be suspect if there are economic reasons beyond using the losses. Finally, the mere conversion of our legal form may, in certain situations, not prevent our use of the losses to offset future profits. Similarly, a mere change in shareholders should not result in loss of the deductibility of the tax losses. However, a change in shareholders together with a change of activity (such as disposition of the loss generating assets and the beginning of a completely new activity by the loss company) would significantly increase the risk of characterization of the transaction as tax abusive and jeopardize the deductibility of the tax losses.

There is uncertainty regarding whether courts outside the United States will recognize the Confirmation Order.

Our parent company, Pacific Drilling S.A., is incorporated pursuant to, and the rights attaching to its shares are governed by, the laws of Luxembourg. Additionally, many of our subsidiaries which were Debtors under the Plan of Reorganization are incorporated under, and their interests are governed by, the laws of foreign jurisdictions other than the United States. Although we intend to make commercially reasonable efforts to ensure that the Confirmation Order and the steps we took to implement the restructuring thereunder are effective in all applicable jurisdictions, it is possible that if a creditor or stakeholder were to challenge the restructuring, a foreign court may refuse to recognize the effect of the Confirmation Order.

Risks Related to Our Indebtedness

We have substantial indebtedness and may incur additional debt.

As of December 31, 2019, we had total long-term debt of $1.1 billion. In February 2020, we entered into a $50.0 million first lien superpriority revolving credit facility (the “Revolving Credit Facility”), on which no amounts were drawn as of March 6, 2020. Our substantial debt could have important consequences to our debt and equity holders, including, but not limited to:

Our ability to service our debt obligations and fund any working capital needs and capital expenditures will depend, among other things, on our future operating results, which could be affected by market, economic, financial, competitive and other factors beyond our control. We may not be able to generate sufficient cash flows or obtain other capital resources to service our debt obligations. If our cash flows and capital resources are insufficient to fund our debt service obligations and other cash requirements, we may be forced to reduce or eliminate our share repurchase program, sell assets, seek additional capital or seek to restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our debt service obligations and fund other cash requirements.

The indentures governing our First Lien Notes and Second Lien PIK Notes, and the terms of our Revolving Credit Facility, contain restrictive covenants that may limit our ability to pursue business opportunities, change our capital structure or respond to changes in market conditions.

The indentures governing our First Lien Notes and Second Lien PIK Notes, and the terms of our Revolving Credit Facility, contain restrictive covenants that may limit our ability to pursue business opportunities, change our capital structure or respond to changes in market conditions. For example, the indentures and the Revolving Credit Facility contain covenants that limit our ability, and the ability of our subsidiaries, to:

These limitations may adversely affect our ability to take actions that we would choose to take in the absence of such restrictions, such as pursue certain business opportunities, obtain certain financing, pay dividends, redeem shares, sell assets or fund capital expenditures, and may adversely affect our ability to react to changes in market or competitive conditions or withstand a downturn in our business.

We and our subsidiaries may incur additional debt.

In February 2020, we entered into the $50.0 million first lien superpriority Revolving Credit Facility.  We and our subsidiaries may incur additional debt in the future, subject to the limitations in the indentures governing our First Lien Notes and Second Lien PIK Notes and the terms of our Revolving Credit Facility.  Our other permitted indebtedness capacity includes the ability to incur up to $50.0 million with respect to a capital lease facility or to incur up to $50.0 

million through the use of our general indebtedness basket, which may be secured. If we incur additional debt, the risks related to our capital structure and outstanding indebtedness could be exacerbated, and we may not be able to meet all of our debt obligations. 

We cannot assure you that we will ever pay cash interest on the Second Lien PIK Notes, and the payment of PIK interest will increase our indebtedness and the risks associated therewith.

The indenture governing the Second Lien PIK Notes provides that we are permitted to pay all or a portion of the interest on such notes in cash in lieu of payment in-kind (“PIK”) interest. However, our ability to pay cash interest on the Second Lien PIK Notes will depend on available restricted payment capacity under the indenture governing the First Lien Notes and the terms of the Revolving Credit Facility. We cannot assure you that we will have available capacity or, if we do have available capacity, that we will use that capacity to pay cash interest on the Second Lien PIK Notes. As a result, holders of the Second Lien PIK Notes could potentially receive no cash interest on such notes. In addition, the payment of PIK interest will increase our indebtedness, related interest obligations, and the risks associated therewith. The original principal amount of the Second Lien PIK Notes was $273.6 million, and we project that if no cash interest is paid on the Second Lien PIK Notes throughout their term, the total amount we would owe the holders of such notes upon maturity on the notes on April 1, 2024 is approximately $520.2 million. For additional information regarding our Second Lien PIK Notes, see Note 7 to our consolidated financial statements.

Default under the terms of the indentures governing our First Lien Notes and Second Lien PIK Notes or the Revolving Credit Facility could result in an acceleration of our indebtedness.

If we are unable to make required payments of principal and interest on our debt or to comply with the other covenants and restrictions in the indentures governing our First Lien Notes and Second Lien PIK Notes, the Revolving Credit Facility,  or other debt agreements we may enter into in the future, there could be a default under the terms of these debt instruments. Our ability to make such payments and to comply with other covenants and restrictions may be affected by events beyond our control. As a result, we cannot assure you that we will be able to make such payments and to comply with the other covenants and restrictions.

If an event of default under the indentures governing our Notes or our Revolving Credit Facility occurs, the holders of the Notes and the lenders under the Revolving Credit Facility may accelerate the Notes and loan and declare all amounts outstanding due and payable. Borrowings under other future debt instruments that contain cross-acceleration or cross-default provisions may also be accelerated and become due and payable. If any of these events occurs, our assets might not be sufficient to repay in full all of our outstanding indebtedness and we may be unable to find alternative financing. Even if we could obtain alternative financing, it might not be on terms that are favorable or acceptable to us.

We are a holding company and will depend on cash flow from our operating subsidiaries to meet required payments on our debt.

We conduct our operations through, and many of our assets are owned by, our subsidiaries. Our operating income and cash flow are generated by our subsidiaries. As a result, the principal source of funds necessary to meet our obligations in respect of our indebtedness will be cash we obtain from our subsidiaries. Contractual provisions or laws, as well as our subsidiaries’ financial condition, operating requirements and debt requirements, may limit our ability to obtain cash from our subsidiaries to meet our debt service obligations. Our inability to obtain cash from our subsidiaries may mean that, even though we may have sufficient resources on a consolidated basis to meet our obligations, we may not be able to pay our debts or meet our other obligations. In addition, applicable tax laws may subject such subsidiaries’ distributions to us to further taxation.

We may not be able to satisfy our obligations to holders of our First Lien Notes and Second Lien PIK Notes and the lenders under our Revolving Credit Facility upon a change of control.

The indentures governing the Notes contain provisions relating to certain events constituting a “change of control” (as defined therein). Upon a change of control, holders of the Notes will have the right to require us to repurchase the Notes at 101% of their principal amount, plus accrued and unpaid interest. Our ability to repurchase Notes upon a change of control would be limited by our access to funds at the time of the repurchase and the terms of our then-outstanding debt agreements, which could restrict or prohibit such a repurchase. A change of control results in a

default under our Revolving Credit Facility, giving the lenders the ability to accelerate payment of any amounts borrowed under the facility. A change of control may also result in a default under other future debt instruments, giving the holders of such obligations the right to accelerate payment thereunder. We cannot assure you that we will have sufficient funds available upon a change of control to make any required repurchases of Notes, pay amounts borrowed at the time under our Revolving Credit Facility or to make any other required repayments of debt.

Risks Related to Our Common Shares

Our common shares were relisted and began trading on the New York Stock Exchange (the “NYSE”) on December 18, 2018. We may not be able to continue to meet the NYSE’s continued listing criteria. Investors may be unable to sell common shares at or above the price they bought them for.

Our common shares were relisted and began trading on the NYSE on December 18, 2018. We believe that as of March 6, 2020, approximately 90.3% of our outstanding common shares were controlled by eight principal shareholders. There can be no assurance that any of our existing shareholders will sell any or all of their common shares. There may be a lack of supply of, or demand for, our common shares on the NYSE, and in such case, the trading prices of our common shares may be particularly volatile, and a holder of common shares may not be able to sell the number of shares such holder wants to sell at the desired price.

The closing price of our common shares fell below $1.00 per share in recent trading.  The continued listing standards of the NYSE require us, at a minimum, to maintain an average closing price per share of our common shares of at least $1.00 per share over a period of 30 consecutive trading days.  Generally speaking, the NYSE provides a six-month cure period for this standard.  In addition, we must maintain an average global market capitalization of not less than $15.0 million over a consecutive 30 trading-day period, and failure to do so would result in immediate delisting.  The NYSE also imposes immediate delisting for shares that trade at an “abnormally low share price,” typically considered $0.15 per share or less. 

The delisting of our common shares could result in a less liquid market available for existing and potential shareholders to trade the common shares and could further depress the trading price of the common shares.  The delisting of our common shares from the NYSE could also result in other adverse consequences, including lower demand for our shares, adverse publicity and a reduced interest in our Company from investors, analysts and other market participants.  In addition, the delisting could impair our ability to raise additional capital through equity or debt financing and our ability to attract and retain employees by means of equity compensation.  We cannot assure you that we will meet the NYSE’s continued listing standards in the future

Sales of our common shares by existing shareholders, or the perception that these sales may occur, may depress the trading price of our common shares or cause the trading price of our common shares to decline.

Pursuant to our obligations under the Registration Rights Agreement that we entered into as of the Plan Effective Date with certain of our shareholders, we filed a registration statement with the Securities and Exchange Commission (the “SEC”) to register for resale certain of the shares held by those shareholders, and are generally required to maintain the registration statement for use by those shareholders, subject to exceptions and limitations in the Registration Rights Agreement. Up to approximately 54.8 million of our common shares may be sold pursuant to the registration statement by the selling shareholders, which represents approximately 73% of our issued and outstanding common shares as of March 6, 2020. We cannot predict the timing or amount of future sales of our common shares by selling shareholders, but such sales, or the perception that such sales could occur, may adversely affect prevailing trading prices for our common shares. In connection with the Company no longer qualifying to report under the U.S. federal securities laws as a foreign private issuer effective January 1, 2020, promptly after filing this annual report on Form 10-K, the Company intends to file a post-effective amendment to the Form F-3 on Form S-3.

We may pay little or no dividends on our common shares.

We do not expect to pay dividends on our common shares for the foreseeable future. The payment of any future dividends to our shareholders will depend on decisions that will be made by our board of directors and will depend on then-existing conditions, including our operating results, financial condition, business prospects, Luxembourg corporate law restrictions, and restrictions under the indentures governing our Notes, our Revolving Credit Facility and under any future debt agreements or contracts.

We cannot guarantee that our share repurchase program will be fully implemented or that it will enhance long-term shareholder value.  Repurchases of our common shares could also increase the volatility of the trading price of our common shares and will diminish our cash reserves.

On February 22, 2019, our shareholders approved a share repurchase program for a total expenditure of up to $15.0 million for a two-year period. The share repurchase program does not obligate the Company to repurchase a specific number or dollar value of our common shares and may be suspended or discontinued at any time, which could result in a decrease in the trading price of our common shares. We cannot guarantee that the program will be fully consummated or that it will enhance long-term shareholder value. The share repurchase program will diminish our cash reserves. In addition, repurchases of our common shares through the program could affect the trading price of our common shares and increase volatility. The existence of a share repurchase program could cause the price of our common shares to be higher than it would be absent such a program and could potentially reduce the market liquidity for our common shares.  As of March 6, 2020, we had $14.3 million remaining available under the program.

Certain shareholders have the right to appoint directors to our board of directors, and have the ability to influence other corporate matters, and their interests may not coincide with yours.

Our Articles establish a board of directors of seven directors, with three Class B directors and four Class A directors. Pursuant to the Governance Agreement, until the “Nomination Termination Time” (as defined therein), certain funds affiliated with Avenue Capital Management II, L.P. (collectively, the “Avenue Parties”) have the right to nominate one Class B director, certain affiliates of Strategic Value Partners, LLC (collectively, the “SVP Parties”) have the right to nominate one Class B director and the other parties to the Governance Agreement (defined therein collectively as the “Other Lenders”) have the right to nominate one Class B director. From and after the Nomination Termination Time, the board of directors will cease to be classified.

Pursuant to our Articles and the Governance Agreement, prior to the Nomination Termination Time, any two Class B directors acting in their capacities as such (a “Class B Majority”) have broad authority to act on the Company’s behalf in connection with any Acquisition Proposal or Acquisition (as such terms are defined in the Articles), including but not limited to the authority to solicit prospective Acquisition Proposals, to retain, at the Company’s expense such consultants, legal counsel and other advisors as a Class B Majority may from time to time deem appropriate to assist the Class B directors in the performance of their duties with respect to Acquisition Proposals, and subject to specified conditions, to execute and deliver on behalf of the Company definitive documentation providing for the consummation of an Acquisition. For additional information, see Item 13 – “Certain Relationships and Related Transactions, and Director Independence.”

In addition, as of March 6, 2020, only a few of our shareholders, if they were to act in concert, could control the election of our four Class A directors. As a result of the nomination rights in the Governance Agreement and the concentration of ownership of our common shares, a relatively few number of shareholders are able to influence the composition of our board of directors and thereby our management and business strategy. Further, as of the Plan Effective Date, only a few of our shareholders, if they were to act in concert, could determine the outcome of a shareholder vote on significant corporate matters. The interests of these shareholders may not coincide with your interests.

The rights of our shareholders and responsibilities of our directors and officers are governed by Luxembourg law and differ in some respects from the rights and responsibilities of shareholders under other jurisdictions, including jurisdictions in the United States.

Our corporate affairs are governed by our Articles, and by the laws governing companies incorporated in Luxembourg, including the Luxembourg Company Law ( loi du 10 août 1915 concernant les sociétés commerciales-). The rights of our shareholders and the responsibilities of our directors and officers under Luxembourg law differ in some respects from those of a company incorporated under other jurisdictions, including jurisdictions in the United States. Corporate laws governing Luxembourg companies may not be as extensive as those in effect in U.S. jurisdictions and the Luxembourg Company Law (as defined above) in respect of corporate governance matters might not be as protective of shareholders as the corporate law and court decisions interpreting the corporate law in Delaware, where the majority of U.S. public companies are incorporated. In addition, we anticipate that all of our shareholder meetings will take place in Luxembourg. Our shareholders may have more difficulty in protecting their interests in connection with actions taken by our directors and officers or our principal shareholders than they would as shareholders of a corporation incorporated in a jurisdiction in the United States.

Because we are incorporated under the laws of Luxembourg, shareholders may face difficulty protecting their interests, and their ability to obtain and enforce judgments through other international courts, including courts in the United States, may be limited.

We are a public limited liability company incorporated under the laws of Luxembourg, and as a result, it may be difficult for investors to effect service of process within the United States upon us or to enforce judgments against us obtained in U.S. courts based on the civil liability provisions of the federal securities laws of the United States. In addition, a substantial portion of our assets may be located outside the United States. There is uncertainty as to whether the courts of Luxembourg would enforce final judgments of United States courts obtained against us predicated upon the civil liability provisions of the federal securities laws of the United States.

Tax Risks

Changes in tax laws, treaties or regulations or adverse outcomes resulting from examination of our tax returns could adversely affect our financial results.

Our future effective tax rates could be adversely affected by changes in tax laws, treaties and regulations, both in the United States and internationally. Tax laws, treaties and regulations are highly complex and subject to interpretation. Consequently, we are subject to changing tax laws, treaties and regulations in and between countries in which we operate or are resident. Our income tax expense is based upon the interpretation of the tax laws in effect in various countries at the time that the expense was incurred. A change in these tax laws, treaties or regulations, or in the interpretation thereof, could result in a materially higher tax expense or a higher effective tax rate on our worldwide earnings. If any country successfully challenges our income tax filings based on our structure, or if we otherwise lose a material tax dispute, our effective tax rate on worldwide earnings could increase substantially and our financial results could be materially adversely affected.

We may not be able to make distributions without subjecting our shareholders to Luxembourg withholding tax.

If we are not successful in our efforts to make distributions, if any, through a withholding tax-free reduction of share capital or share premium (the absence of withholding on such distributions is subject to certain requirements), then any dividends paid by us generally will be subject to a Luxembourg withholding tax at a rate of 15% (17.65% if the dividend tax is not withheld from the shareholder). The withholding tax must be withheld by the Company from the gross distribution and paid to the Luxembourg tax authorities. Under current Luxembourg tax law, a reduction of share capital or share premium is not subject to Luxembourg withholding tax provided that certain conditions are met, including, for example, the condition that we do not have distributable reserves or profits. However, there can be no assurance that our shareholders will approve such a reduction in share capital or share premium, that we will be able to meet the other legal requirements for a reduction in share capital or share premium, or that Luxembourg tax withholding rules will not be changed in the future. In addition, over the long term, the amount of share capital and share premium available for us to use for capital reductions will be limited. If we are unable to make a distribution through a withholding tax-free reduction in share capital or share premium, we may not be able to make distributions without subjecting our shareholders to Luxembourg withholding taxes.

U.S. tax authorities could treat us as a “passive foreign investment company,” which could have adverse U.S. federal income tax consequences to U.S. holders of our common shares.

A foreign corporation will be treated as a “passive foreign investment company,” or “PFIC”, for U.S. federal income tax purposes if, after the application of certain look-through rules, either: (i) at least 75% of its gross income for any taxable year consists of certain types of “passive income” or (ii) at least 50% of the value (determined on the basis of a quarterly average) of the corporation’s assets for any taxable year produce or are held for the production of those types of “passive income.” For purposes of these tests, “passive income” includes dividends, interest and gains from the sale or exchange of investment property and rents and royalties other than certain rents and royalties that are received from unrelated parties in connection with the active conduct of a trade or business but does not include income derived from the performance of services. For purposes of the above tests, if a non-U.S. corporation owns, directly or indirectly, 25% or more of the total value of another corporation, it will be treated as if it (a) held a proportionate share of such other corporation and (b) received directly a proportionate share of the income of such other corporation. U.S. shareholders of a PFIC are subject to a disadvantageous U.S. federal income tax regime with respect to the income derived by the PFIC, the distributions they receive from the PFIC, and the gain, if any, they derive from the sale or other disposition of their interests in the PFIC. These adverse consequences to U.S. shareholders include (i) the treatment of all

or a portion of any gain on disposition of their interests in the PFIC as ordinary income, (ii) the application of a deferred interest charge on such gain and the receipt of certain dividends and (iii) the obligation to comply with certain reporting requirements.

Based on our operations as of the date of this annual report, we believe that we will not be a PFIC in the current taxable year and that we will not become a PFIC in any future taxable year. However, this involves a facts and circumstances analysis and it is possible that the IRS would not agree with this conclusion. Further, the determination of whether a corporation is a PFIC is made annually and thus may be subject to change. Therefore, we can give investors no assurance as to our PFIC status. Investors are encouraged to consult their own independent tax advisors about the PFIC rules, including the availability of certain elections and reporting requirements.

We may become a controlled foreign corporation in the future.

While we do not believe that we are currently a controlled foreign corporation (“CFC”), we will become a CFC if U.S. persons, who own (or are considered to own, as a result of the attribution rules) 10% or more of the voting power of our stock (each a “10% U.S. shareholder”), collectively own more than 50% of either the total combined voting power of all classes of our voting stock or the total value of our stock.

If we become a CFC, each U.S. Holder that is a 10% U.S. shareholder may be required to include in income its allocable share of our “Subpart F” income reported. Subpart F income generally includes dividends, interest, net gain from the sale or disposition of securities, non-actively managed rents and certain other generally passive types of income. The aggregate Subpart F income inclusions in any taxable year relating to a particular CFC are limited to such entity’s current earnings and profits (as determined for U.S. federal income tax purposes). These inclusions are treated as ordinary income (whether or not such inclusions are attributable to net capital gains). Thus, if we become a CFC, a 10% U.S. shareholder may be required to report as ordinary income its allocable share of our Subpart F income without corresponding receipts of cash.

Further, if we become a CFC, the tax basis of a 10% U.S. shareholder shares will be increased to reflect any required Subpart F income inclusions. Such income may be treated as income from sources within the United States, for certain foreign tax credit purposes, to the extent derived by us from U.S. sources. Such income will not be eligible for the reduced rate of tax applicable to “qualified dividend income” for individual U.S. persons.

Regardless of whether we have any Subpart F income, if we become a CFC, any gain recognized by a 10% U.S. shareholder from the disposition of our stock will be treated as ordinary income to the extent of such holder’s allocable share of our current and/or accumulated earnings and profits. In this regard, earnings would not include any amounts previously taxed pursuant to the CFC rules.

If we are classified as both a CFC and a PFIC, a 10% U.S. shareholder will be required to include amounts in income as described this subheading, and the consequences described under the above risk factor entitled “U.S. tax authorities could treat us as a ‘passive foreign investment company,’ which could have adverse U.S. federal income tax consequences to U.S. holders of our common shares” above will not apply. The interaction of these rules is complex. U.S. Holders should consult their own advisers as to the consequences of the CFC and PFIC rules in their individual circumstances.

Changes in our U.S. federal income tax classification, or that of our subsidiaries, could result in adverse tax consequences to our 10% or greater U.S. shareholders.

The Tax Cuts and Jobs Act (the “2017 Act”) signed on December 22, 2017 may have changed the consequences to U.S. shareholders that own, or are considered to own, as a result of the attribution rules, 10% or more of the voting power or value of the stock of a non-U.S. corporation (a “10% U.S. shareholder”) under the U.S. federal income tax laws applicable to owners of U.S. controlled foreign corporations (“CFCs”).

The 2017 Act repealed Section 958(b)(4) of the Internal Revenue Code of 1986, as amended (the “Code”), which may result in classification of certain of the Company’s foreign subsidiaries as CFCs with respect to any single 10% U.S. shareholder. This may be the result without regard to whether 10% U.S. shareholders together own, directly or indirectly, more than 50% of the voting power or value of the Company as was the case under prior rules. In late 2019, the IRS issued guidance in the form of a safe harbor that provides relief to certain U.S. shareholders from this change.

Additional tax consequences to 10% U.S. shareholders of a CFC may result from other provisions of the 2017 Act. For example, the 2017 Act added Section 951A of the Code which requires a 10% U.S. shareholder of a CFC to include in income its pro-rata share of the global intangible low-taxed income (GILTI) of the CFC. The 2017 Act also eliminated the requirement in Section 951(a) of the Code necessitating that a foreign corporation be considered a CFC for an uninterrupted period of at least 30 days in order for a 10% U.S. shareholder to have a current income inclusion.

From time to time, the Company may elect to employ measures such as the share repurchase program approved by the Company’s shareholders on February 22, 2019 that could inadvertently create additional 10% U.S. shareholders or result in the Company itself becoming a CFC, and thus trigger adverse tax consequences for those shareholders as described above.

We urge shareholders to consult their individual tax advisers for advice regarding the 2017 Act revisions to the U.S. Federal income tax laws applicable to owners of CFCs.

If a U.S. Person is treated as owning at least 10% of our common shares, such holder may be subject to adverse U.S. federal income tax consequences.

If a U.S. person is treated as owning (directly, indirectly, or constructively) at least 10% of the value or voting power of our common shares, such person may be treated as a “U.S. shareholder” with respect to each “controlled foreign corporation” in our group (if any). If our group includes one or more U.S. subsidiaries, certain of our non-U.S. subsidiaries could be treated as controlled foreign corporations, regardless of whether or not we are treated as a controlled foreign corporation. A U.S. shareholder of a controlled foreign corporation may be required to report annually and include in its U.S. taxable income its pro rata share of “Subpart F income,” “global intangible low-taxed income,” and investments in U.S. property by controlled foreign corporations, regardless of whether we make any distributions. Failure to comply with these reporting obligations may subject a U.S. shareholder to significant monetary penalties and may prevent the statute of limitations with respect to such shareholder’s U.S. federal income tax return for the year for which reporting was due from starting. An individual who is a U.S. shareholder with respect to a controlled foreign corporation generally would not be allowed certain tax deductions or foreign tax credits that would be allowed to a U.S. shareholder that is a U.S. corporation. We cannot provide any assurances that we will assist investors in determining whether any of our non-U.S. subsidiaries is treated as a controlled foreign corporation or whether any investor is treated as a U.S. shareholder with respect to any such controlled foreign corporation or furnish to any U.S. shareholders information that may be necessary to comply with the aforementioned reporting and tax paying obligations. A U.S. investor should consult its advisors regarding the potential application of these rules to an investment in our common shares.

ITEM 1B.  UNRESOLVED STAFF COMMENTS

Not Applicable.

ITEM 2.    PROPERTIES

Our Fleet

The following table sets forth certain information regarding our fleet as of March 6, 2020:

Our Revolving Credit Facility and the First Lien Notes are secured by first-priority liens (with a superpriority right to repayment in favor of the Revolving Credit Facility), and the Second Lien PIK Notes are secured by second-priority liens, on substantially all assets of the Company including all of our drillships.

Properties

We lease our registered office in Luxembourg and our principal executive and operational headquarters in Houston, Texas. We also provide technical, operational and administrative support from leased offices  in Nigeria and Dubai.

ITEM 3.    LEGAL PROCEEDINGS

Zonda Arbitration

In January 2013, our subsidiary PDVIII entered into, and our subsidiary PDSI guaranteed, a contract with SHI for the construction of the Pacific Zonda, with a purchase price of approximately $517.5 million and original delivery date of March 31, 2015 (the “Construction Contract”). On October 29, 2015, PDVIII and PDSI exercised their right to rescind the Construction Contract due to SHI’s failure to timely deliver the drillship in accordance with the contractual specifications. SHI rejected the rescission, and on November 25, 2015, formally commenced an arbitration proceeding against the Zonda Debtors in London under the Arbitration Act 1996 before a tribunal of three arbitrators (as specified in the Construction Contract) (the “Tribunal”). SHI claims that the Zonda Debtors 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, the Zonda Debtors made demand under the third-party refund guarantee accompanying the Construction Contract for the amount of the advance payments made under the Construction Contract of approximately $181.1 million, plus interest. Any payment under the refund guarantee is suspended until an award in the Zonda Debtors’ favor under the arbitration is obtained. In addition to seeking repayment of the advance payments made under the Construction Contract, the Zonda Debtors made a counterclaim for the return of their purchased equipment, or the value of such equipment, and damages for wasted expenditures. The Zonda Debtors owned $75.0 million in purchased equipment for the Pacific Zonda, a majority of which remains on board the Pacific Zonda. An evidentiary hearing was held in London before the Tribunal from February 5 through March 2, 2018. Written closing submissions and short

replies to such submissions were filed with the Tribunal in May 2018. Oral closing submissions were heard by the Tribunal in August 2018.   

As part of our “first day” relief sought in the Chapter 11 bankruptcy proceedings, the Bankruptcy Court granted us a modification of the automatic stay provisions of the Bankruptcy Code to allow the arbitration to proceed. In our bankruptcy proceedings, SHI asserted claims against the Zonda Debtors, secured by the Pacific Zonda, for approximately $387.4 million, for the remaining unpaid purchase price, interest and costs. Subsequent to the initial plan of reorganization filed by the Debtors and the Zonda Debtors with the Bankruptcy Court, the Company filed an amended plan of reorganization that removed the Zonda Debtors from the Plan of Reorganization. The Zonda Debtors are not Debtors under the Plan of Reorganization and filed a separate plan of reorganization that was confirmed by order of the Bankruptcy Court on January 30, 2019 (the “Zonda Plan”).  On the date the Zonda Plan was confirmed, PDVIII and PDSI had $4.6 million in cash and no other material assets after accounting for post-petition administrative expenses (other than the value of their claims against SHI) for SHI to recover against on account of its claims.

On January 15, 2020, the Tribunal awarded SHI approximately $320 million with respect to its claims against the Zonda Debtors.  The award does not include approximately $100 million in interest and costs sought by SHI, on which the Tribunal reserved making a decision to a later date.  On February 11, 2020, the Zonda Debtors filed an application with the High Court in London seeking permission to appeal the Tribunal’s award.  There can be no assurance that the Zonda Debtors will receive permission to appeal, or that if such permission is granted, that any such appeal will be successful in reversing the Tribunal’s award.

If the Zonda Debtors are successful in the appeal and reverse the Tribunal’s award, the Zonda Debtors will emerge from their separate plan of reorganization, and will guarantee the First Lien Notes, Second Lien PIK Notes,  and the Revolving Credit Facility. In addition, the Company will be required to offer to purchase First Lien Notes at 100.0% of the principal amount thereof, plus accrued and unpaid interest, with any cash proceeds from a settlement or award in connection with the arbitration, with such offer to be for an aggregate principal amount of First Lien Notes equal to the lesser of (x) 50.0% of such cash proceeds and (y) $75.0 million. The Company will also be required to offer to purchase Second Lien PIK Notes at 100.0% of the principal amount thereof, plus accrued and unpaid interest, with the portion of such cash proceeds, if any, that has been declined by the holders of First Lien Notes. If the Zonda Debtors are unsuccessful in the appeal, the Company expects the Zonda Debtors will be liquidated in accordance with the terms of the Zonda Plan.

As a result of the Tribunal’s decision, the Company recognized a loss of $220.2 million during the year ended December 31, 2019 primarily related to the elimination of a receivable related to the Zonda Debtors’ claim on the balance sheet.  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, although given the unpredictable nature of arbitration, litigation and bankruptcy proceedings, we cannot provide you with any assurances.

On December 20, 2018, after the Company and its subsidiaries other than the Zonda Debtors had completed the Plan of Reorganization and emerged from bankruptcy, SHI filed with the Bankruptcy Court an untimely secured contingency claim against Pacific Drilling S.A., our parent company, in the amount of approximately $387.4 million.  We have filed an objection to the claim on the basis that the claim should be disallowed due to its being filed long after the May 1, 2018 claims bar date established by order of the Bankruptcy Court. In addition, we believe SHI has no basis for a claim against Pacific Drilling S.A. because, among other things, Pacific Drilling S.A. was not a party to the Construction Contract nor the guaranty.

ITEM 4.   MINE SAFETY DISCLOSURE

Not Applicable.

PART II

ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market for Shares of our Common Equity

Our common shares were listed on the Norwegian OTC List from April 2011 to October 2016 and on the NYSE from November 11, 2011 to September 12, 2017. From September 13, 2017 to December 17, 2018, our common shares were traded on the over-the-counter market under the ticker symbol “PACDQ” and “PACDD,” respectively. Our common shares are currently listed on the NYSE, and trade under the symbol “PACD.” As of March 6, 2020, there were 15 record holders of our common shares. This does not include the number of shareholders that hold shares in “street name” through banks or broker dealers.

Distribution Policy

We do not expect to pay dividends on our common shares for the foreseeable future. The payment of any future dividends to our shareholders will depend on decisions that will be made by our board of directors and will depend on then-existing conditions, including our operating results, financial condition, business prospects, Luxembourg corporate law restrictions, and restrictions under our Revolving Credit Facility,  the indentures governing our Notes and under any future debt agreements or contracts.

Exchange Controls

There are no legislative or other legal provisions currently in force in Luxembourg or arising under our Articles that restrict the payment of dividends or distributions to holders of our common shares not resident in Luxembourg, except for regulations restricting the remittance of dividends, distributions and other payments in compliance with United Nations and European Union sanctions. There are no limitations, either under the laws of Luxembourg or in our Articles, on the right of non-Luxembourg nationals to hold or vote our common shares.

Certain Luxembourg and U.S. Tax Considerations

For a discussion of Material Luxembourg Tax Considerations for U.S. Holders of Common Shares and a discussion of Material U.S. Federal Income Tax Considerations for Holders of Common Shares, see the information under those headings in Exhibit 4.10 to this Annual Report, which information is incorporated herein by reference.

Share Repurchase Program

On February 22, 2019, our shareholders approved a share repurchase program for a total expenditure of up to $15.0 million for a two-year period.  We may purchase shares in one or several transactions on the open market or otherwise; however, we are not obligated to repurchase any dollar amount or specific number of common shares under the program.  We anticipate that repurchases will be funded with cash on hand.  As of March 6, 2020, we have repurchased a total of 44,710 of our common shares on the open market and had approximately $14.3 million remaining available under the program.

ISSUER REPURCHASES OF EQUITY SECURITIES

For information regarding our securities authorized for issuance under our equity compensation plans, see Item 12. “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

The graph below matches the cumulative one-year total return of holders of Pacific Drilling S.A.'s common stock with the cumulative total returns of the Russell 2000 index, the PHLX Oil Service Sector index and a customized peer group of five companies that includes: Diamond Offshore Drilling Inc, Noble Corporation Plc, Seadrill Ltd, Transocean Ltd and Valaris Plc. The graph assumes that the value of the investment in our common stock, in each index, and in the peer group (including reinvestment of dividends) was $100 on December 18,  2018, the day our common shares were relisted on the NYSE and tracks it through December 31, 2019.

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

ITEM 6.    SELECTED FINANCIAL DATA

On the Plan Effective Date, we adopted and applied the relevant guidance with respect to the accounting and financial reporting for entities that have emerged from bankruptcy proceedings, or “Fresh Start Accounting.”  Under

Fresh Start Accounting, our balance sheet on the Plan Effective Date reflects all of our assets and liabilities at fair value.  Our emergence from bankruptcy and the adoption of Fresh Start Accounting resulted in a new reporting entity, referred to herein as the “Successor”, for financial reporting purposes.  To facilitate discussion and analysis of our financial condition and results of operations herein, we refer to the reorganized Debtors as the Successor for periods subsequent to November 19, 2018 and as the “Predecessor” for periods on or prior to November 19, 2018.  As a result of the adoption of Fresh Start Accounting and the effects of the implementation of the Plan, our consolidated financial statements subsequent to November 19, 2018 may not be comparable to our consolidated financial statements prior to November 19, 2018, and as such, “black-line” financial statements are presented to distinguish between the Predecessor and Successor companies.

You should read the following selected consolidated financial data in conjunction with Item 7. “Management’s Discussion and Analysis of Financial Condition and Result of Operations” and our historical consolidated financial statements and related notes thereto included elsewhere in this annual report. The financial information included in this annual report may not be indicative of our future financial position, results of operations or cash flows.

ITEM 7.    MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with Item 1A. “Risk Factors,”  Item 6. “Selected Financial Data” and the financial statements in Item 8, “Financial Statements.”

Predecessor and Successor Reporting

On November 2, 2018, the Bankruptcy Court issued the Confirmation Order approving the Plan of Reorganization and on November 19, 2018, the Plan of Reorganization became effective pursuant to its terms and we emerged from our Chapter 11 bankruptcy proceedings. We had filed the Plan of Reorganization with the Bankruptcy Court in connection with our voluntary petitions for relief under Chapter 11 of Title 11 of the United States Code, initially filed on November 12, 2017, which were jointly administered under the caption In re Pacific Drilling S.A., et al., Case No. 17-13193 (MEW).

On the Plan Effective Date, we adopted and applied the relevant guidance with respect to the accounting and financial reporting for entities that have emerged from bankruptcy proceedings, or “Fresh Start Accounting.”  Under Fresh Start Accounting, our balance sheet on the Plan Effective Date reflects all of our assets and liabilities at fair value. Our emergence from bankruptcy and the adoption of Fresh Start Accounting resulted in a new reporting entity, referred to herein as the “Successor,” for financial reporting purposes.  To facilitate discussion and analysis of our financial condition and results of operations herein, we refer to the reorganized Debtors as the Successor for periods subsequent to November 19, 2018 and as the “Predecessor” for periods on or prior to November 19, 2018.  As a result of the adoption of Fresh Start Accounting and the effects of the implementation of the Plan, our consolidated financial statements subsequent to November 19, 2018 may not be comparable to our consolidated financial statements on or prior to November 19, 2018, and as such, “black-line” financial statements are presented to distinguish between the Predecessor and Successor companies.

Market Outlook

Historically, operating results in the offshore contract drilling industry have been cyclical and directly related to the demand for and the available supply of capable drilling rigs, which are influenced by various factors. Although dayrates and utilization for high-specification drillships have in the past been less sensitive to short-term oil price movements than those of older or less capable drilling rigs, the sustained decline in oil prices from 2014 levels rendered many deepwater projects less attractive to our clients. This decline, coupled with investor pressure on our clients to be free cash flow positive, has significantly impacted the number of projects available for high-specification drillships.  However, over the period from 2015 to today, our clients have managed to reduce their total well construction costs thereby allowing them economic success at lower oil prices and making deepwater projects more attractive.

Drilling Rig Supply

We estimate that there are currently 107 high-specification drillships across the industry. There has been one order placed since April 2014 to build an additional high-specification drillship, and within the last year, there have been several delays in delivery dates for new drillships. We estimate that there are approximately 12 high-specification drillships in late stages of construction still to be delivered with only one having a firm contract announced.

However, as a result of significantly reduced contracting activity, a significant number of floating rigs have been removed from the actively marketed fleet through cold stacking or scrapping since early 2014. Despite this reduction in supply, the excess supply of high-specification drillships is expected to continue in 2020. Although we have visibility into the maximum number of high-specification drillships that could be available, we cannot accurately predict how many of those rigs will be actively marketed or how many of those rigs may be temporarily or permanently removed from the market.

Drilling Rig Demand

Demand for our drillships is a function of the worldwide levels of deepwater exploration and development spending by oil and gas companies, which has decreased or been delayed significantly as a result of the sustained weakness in oil prices. The type of projects that modern drillships undertake are generally located in deeper water, in more remote locations, and can be more capital intensive or require more time to first oil than competing alternatives. The drilling programs of oil and gas companies are also affected by the global economic and political climate, access to quality drilling prospects, exploration success, perceived future availability and lead time requirements for drilling equipment, advances in drilling technology, and emphasis on deepwater and high-specification exploration and production versus other areas.

We have recently seen some increases in the capital expenditure budgets for many exploration and production companies from the lows of the market downturn. Overall, 2019 saw an improving pace for high-specification drillship contracting activity with about 40 rig years contracted, compared to 32 rig years in 2018. There is currently a total demand for 70 high-specification drillships. We expect contracting activity to continue to improve; however, no assurances can be given as to the scope, pace or duration of any recovery.

Supply and Demand Balance

Since 2014, the imbalance of supply and demand has resulted in significantly lower dayrates. While recent scrapping and cold stacking of floating assets have lowered the total rig supply, supply of deepwater drilling rigs continues to exceed demand. However, we believe that, if oil prices at March 6, 2020 levels are sustained, reduction in rig supply continues and breakeven costs for deepwater projects remain competitive, utilization of high-specification floating rigs should improve in 2020 and over the next few years.

Fleet Status

The status of our fleet as of March 6, 2020 and certain historical fleet information for the periods covered by the financial statements included in this annual report follows:

From time to time, we are awarded letters of intent or receive letters of award for our drillships. Certain of those letters remain subject to negotiation and execution of definitive contracts and other customary conditions. No assurance can be given as to the terms of any such arrangement, such as the applicable duration or dayrate, until a definitive contract is entered into by the parties, if we are able to finalize a contract at all.

Factors Affecting our Results of Operations

The primary factors that have affected our historical operating results and are expected to impact our future operating results include:

Our revenues are derived primarily from the operation of our drillships at fixed daily rates, which depend principally upon the number and availability of our drillships, the dayrates received and the number of days utilized. We recognize revenues from drilling contracts as services are performed upon and after contract commencement.

Additionally, we may receive revenues for preparation and mobilization of equipment and personnel or for capital improvements to rigs. Revenues earned directly related to contract preparation and mobilization are deferred and recognized over the primary term of the drilling contract. We may also receive fees upon completion of a drilling contract that are conditional based on the occurrence of an event, such as demobilization of a rig.

Our expenses consist primarily of operating expenses, depreciation, administrative expenses, interest and other financial expenses and tax expenses.

Operating expenses include the remuneration of offshore crews, repairs and maintenance, as well as expenses for shore-based support offices and onshore operations support staff.

Depreciation expense is based on the historical cost or, upon the adoption of Fresh Start Accounting, fair value of our drillships and other property and equipment and recorded on a straight-line basis over the estimated useful lives of each class of assets. Upon the adoption of Fresh Start Accounting, the estimated useful lives of our drillships and their related equipment generally range from 8 to 33 years.

General and administrative expenses include the costs of management and administration of our Company, such as the labor costs of our corporate employees, remuneration of our directors and legal and advisory expenses.

Interest expense primarily depends on our overall level of indebtedness and interest rates.

Tax expenses reflect current and deferred tax expenses. Our income tax expense generally results from the taxable income on our drillship operations. We also incur withholding taxes on cross border intercompany payments, such as services or bareboat charter fees, and we sometimes operate in jurisdictions that levy income taxes on a deemed profit or gross income basis.

Results of Operations

References to the year ended December 31, 2018 relate to the combined Successor and Predecessor periods for the year ended December 31, 2018.

Year ended December 31, 2019 compared to Year ended December 31, 2018

The following table provides a comparison of our consolidated results of operations for the years ended December 31, 2019 and 2018:

Revenues. The decrease in revenues of $35.1 million for the year ended December 31, 2019, as compared to the revenues of $264.9 million for the year ended December 31, 2018 resulted primarily from lower operating revenues from the Pacific Sharav completing its legacy Chevron five-year contract in late August 2019 and rolling over to continue working for Chevron at a lower current market dayrate, and lower amortization of deferred revenue. This decrease in revenue was partially offset by increased fleet utilization. During the year ended December 31, 2019, we achieved fleet utilization of 30.0% compared to 21.6% during the year ended December 31, 2018. Fleet utilization is defined as the total number of contracted operating days divided by the total number of rig calendar days in the measurement period.

Revenue for the years ended December 31, 2019 and 2018 included amortization of deferred revenue of $1.9 million and $20.2 million, respectively, and reimbursable revenues of $12.0 million and $6.5 million, respectively. The decrease in the amortization of deferred revenue was due to elimination of deferred revenue upon the adoption of Fresh Start Accounting in November 2018.

During the year ended December 31, 2019, we achieved an average revenue efficiency of 97.4%, compared to 97.8% during the year ended December 31, 2018. Revenue efficiency is defined as actual contractual dayrate revenue (excluding mobilization fees, upgrade reimbursements and other revenue sources) divided by the maximum amount of contractual dayrate revenue that could have been earned during such period.

Operating expenses. The following table summarizes operating expenses:

The increase in direct rig related operating expenses for the year ended December 31, 2019, as compared to the year ended December 31, 2018, resulted primarily from the Pacific Khamsin incurring ramp-up costs for its contract with Equinor. The increase was also due to the Pacific Santa Ana operating at a higher level of costs while performing drilling service for Total in 2019, compared to the costs incurred under the contract with Petronas to perform integrated services under Phase I of the plug and abandonment project in 2018. The increase was partially offset by lower costs of maintaining our idle rigs together in Las Palmas.

Integrated services for the year ended December 31, 2019 represent costs incurred by the Pacific Khamsin and the Pacific Santa Ana for subcontractors to perform integrated services as part of the contract with Equinor and Phase II of the plug and abandonment project with Petronas, respectively, both of which commenced in December 2019. Integrated services for the year ended December 31, 2018 represent costs incurred by the Pacific Santa Ana for Phase I of the plug and abandonment project with Petronas that was completed in May 2018.

Reimbursable costs are not included under the scope of the drilling contract’s initial dayrate but are subject to reimbursement from our clients. Reimbursable costs can be highly variable between quarters. Because the reimbursement of these costs by our clients is recorded as additional revenue, the expense does not negatively affect our profit in general.

The increase in shore-based and other support costs for the year ended December 31, 2019, as compared to the year ended December 31, 2018, was primarily due to the classification of health and safety and supply chain costs within operating support costs upon the adoption of Fresh Start Accounting in November 2018,  compared to being classified within general and administrative expenses in the Predecessor period in 2018. The increase was partially offset by the impact of cost control and process optimization initiatives implemented during the first quarter of 2019.  

The decrease in amortization of deferred costs for the year ended December 31, 2019, as compared to the year ended December 31, 2018, was primarily due to the elimination of deferred costs upon the adoption of Fresh Start Accounting in November 2018.

General and administrative expenses. The decrease in general and administrative expenses for the year ended December 31, 2019, as compared to the year ended December 31, 2018, was primarily due to the classification of health and safety and supply chain costs in shore-based and other support costs as discussed above, lower legal costs associated with the arbitration proceeding related to the Pacific Zonda and the impact of cost control and process optimization initiatives implemented during the first quarter of 2019.  

Depreciation and amortization expense. The decrease in depreciation and amortization expense for the year ended December 31, 2019, as compared to the year ended December 31, 2018, resulted from the fair value adjustment of our property and equipment upon the adoption of Fresh Start Accounting in November 2018, partially offset by the amortization expense of our client-related intangible asset.

Loss from unconsolidated subsidiaries. For the year ended December 31, 2019, we recognized a loss of $216.7 million, recorded in loss from unconsolidated subsidiaries, due to the write-off of the $204.7 million receivable related to the Zonda Arbitration and other asset balances associated with the Zonda Debtors. See Note 16 to our consolidated financial statements.

Interest expense. The decrease in interest expense for the year ended December 31, 2019, as compared to the year ended December 31, 2018, was primarily due to less interest expense incurred on lower outstanding debt balances. The decrease was also due to default interest incurred on the 2013 Revolving Credit Facility and SSCF in accordance with the Plan of Reorganization in 2018.

Reorganization items.  We classified all income, expenses, gains or losses that were incurred or realized subsequent to the Petition Date and as a result of the Chapter 11 proceedings as reorganization items, which primarily consisted of professional fees. See Note 3 to our consolidated financial statements.

Income taxes. During the year ended December 31, 2019, income tax expense was $12.4 million, compared to an income tax benefit of $9.1 million for the year ended December 31, 2018.  The income tax benefit for the year ended December 31, 2018 was primarily the result of internal restructuring in 2018 allowing recognition of the tax benefits of net operating losses.  Tax expense from ongoing operations for the year ended December 31, 2019 increased primarily from profitable operations in certain jurisdictions.

The relationship between our provision for or benefit from income taxes and our pre-tax book income can vary significantly from period to period considering, among other factors, (a) the overall level of pre-tax book income, (b) changes in the blend of income that is taxed based on gross revenues or at high effective tax rates versus pre-tax book income or at low effective tax rates and (c) our rig operating structures. Consequently, our income tax expense does not necessarily change proportionally with our pre-tax book income. Significant decreases in our pre-tax book income typically result in higher effective tax rates, while significant increases in pre-tax book income can lead to lower effective tax rates, subject to the other factors impacting income tax expense noted above. Additionally, pre-tax book losses typically result in negative effective tax rates due to withholding taxes, local taxation on profitable operations, and deemed profit tax based on revenue even while reporting operational losses. During the years ended December 31, 2019 and 2018, our effective tax rate was (2.3)% and 0.4%, respectively.

Year ended December 31, 2018 compared to Year ended December 31, 2017 

The following table provides a comparison of our consolidated results of operations for the years ended December 31, 2018 and 2017: