PACIFIC DRILLING S.A., 20-F filed on 3/1/2016
Annual and Transition Report (foreign private issuer)
Document and Entity Information
12 Months Ended
Dec. 31, 2015
Document And Entity Information [Abstract]
 
Document Type
20-F 
Amendment Flag
false 
Document Period End Date
Dec. 31, 2015 
Document Fiscal Year Focus
2015 
Document Fiscal Period Focus
FY 
Trading Symbol
PACD 
Entity Registrant Name
PACIFIC DRILLING S.A. 
Entity Central Index Key
0001517342 
Current Fiscal Year End Date
--12-31 
Entity Well-Known Seasoned Issuer
No 
Entity Current Reporting Status
Yes 
Entity Filer Category
Accelerated Filer 
Entity Common Stock, Shares Outstanding
211,207,230 
Consolidated Statements of Income (USD $)
In Thousands, except Per Share data, unless otherwise specified
12 Months Ended
Dec. 31, 2015
Dec. 31, 2014
Dec. 31, 2013
Revenues
 
 
 
Contract drilling
$ 1,085,063 
$ 1,085,794 
$ 745,574 
Costs and expenses
 
 
 
Operating expenses
(431,261)
(459,617)
(337,277)
General and administrative expenses
(55,511)
(57,662)
(48,614)
Depreciation expense
(243,457)
(199,337)
(149,465)
Total costs and expenses
(730,229)
(716,616)
(535,356)
Loss from construction contract rescission
(40,155)
Operating income
314,679 
369,178 
210,218 
Other expense
 
 
 
Costs on interest rate swap termination
(38,184)
Interest expense
(156,361)
(130,130)
(94,027)
Total interest expense
(156,361)
(130,130)
(132,211)
Costs on extinguishment of debt
(28,428)
Other expense
(3,217)
(5,171)
(1,554)
Income before income taxes
155,101 
233,877 
48,025 
Income tax expense
(28,871)
(45,620)
(22,523)
Net income
$ 126,230 
$ 188,257 
$ 25,502 
Earnings per common share, basic (in dollars per share)
$ 0.60 
$ 0.87 
$ 0.12 
Weighted-average number of common shares, basic
211,454 
217,223 
216,964 
Earnings per common share, diluted (in dollars per share)
$ 0.60 
$ 0.87 
$ 0.12 
Weighted-average number of common shares, diluted
211,557 
217,376 
217,421 
Consolidated Statements of Comprehensive Income (USD $)
In Thousands, unless otherwise specified
12 Months Ended
Dec. 31, 2015
Dec. 31, 2014
Dec. 31, 2013
Statement of Comprehensive Income [Abstract]
 
 
 
Net income
$ 126,230 
$ 188,257 
$ 25,502 
Other comprehensive income (loss):
 
 
 
Unrecognized gain (loss) on derivative instruments
(14,889)
(19,385)
2,139 
Reclassification adjustment for loss on derivative instruments realized in net income
10,440 
7,737 
47,720 
Reclassification adjustment for loss on derivative instruments realized in property and equipment
1,164 
Total other comprehensive income (loss)
(3,285)
(11,648)
49,859 
Total comprehensive income
$ 122,945 
$ 176,609 
$ 75,361 
Consolidated Balance Sheets (USD $)
In Thousands, unless otherwise specified
Dec. 31, 2015
Dec. 31, 2014
Assets:
 
 
Cash and cash equivalents
$ 116,033 
$ 167,794 
Accounts receivable
168,050 
231,027 
Materials and supplies
98,243 
95,660 
Deferred financing costs, current
14,636 
14,665 
Deferred costs, current
10,582 
25,199 
Prepaid expenses and other current assets
12,467 
17,056 
Total current assets
420,011 
551,401 
Property and equipment, net
5,143,556 
5,431,823 
Deferred financing costs
29,583 
45,978 
Long-term receivable
202,575 
Other assets
36,753 
48,099 
Total assets
5,832,478 
6,077,301 
Liabilities and shareholders’ equity:
 
 
Accounts payable
44,167 
40,577 
Accrued expenses
44,221 
45,963 
Long-term debt, current
89,583 
369,000 
Accrued interest
16,442 
24,534 
Derivative liabilities, current
7,483 
8,648 
Deferred revenue, current
49,227 
84,104 
Total current liabilities
251,123 
572,826 
Long-term debt, net of current maturities
2,795,845 
2,781,242 
Deferred revenue
60,639 
108,812 
Other long-term liabilities
32,816 
35,549 
Total long-term liabilities
2,889,300 
2,925,603 
Commitments and contingencies
   
   
Shareholders’ equity:
 
 
Common shares, $0.01 par value per share, 5,000,000 shares authorized, 232,770 shares issued and 211,207 and 215,784 shares outstanding as of December 31, 2015 and December 31, 2014, respectively
2,185 
2,175 
Additional paid-in capital
2,381,420 
2,369,432 
Treasury shares, at cost
(30,000)
(8,240)
Accumulated other comprehensive loss
(23,490)
(20,205)
Retained earnings
361,940 
235,710 
Total shareholders’ equity
2,692,055 
2,578,872 
Total liabilities and shareholders’ equity
$ 5,832,478 
$ 6,077,301 
Consolidated Balance Sheets (Parenthetical) (USD $)
Dec. 31, 2015
Dec. 31, 2014
Statement of Financial Position [Abstract]
 
 
Common shares, par value (in dollars per share)
$ 0.01 
$ 0.01 
Common shares, shares authorized
5,000,000,000 
5,000,000,000 
Common shares, shares issued
232,770,000 
232,770,000 
Common shares, shares outstanding
211,207,000 
215,784,000 
Consolidated Statements of Shareholders' Equity (USD $)
In Thousands, unless otherwise specified
Total
Common Shares
Treasury Shares
Additional Paid-In Capital
Accumulated Other Comprehensive Loss
Retained Earnings
Beginning Balance at Dec. 31, 2012
$ 2,315,248 
$ 2,169 
$ 0 
$ 2,349,544 
$ (58,416)
$ 21,951 
Beginning Balance (in shares) at Dec. 31, 2012
 
 
7,198 
 
 
 
Beginning Balance (in shares) at Dec. 31, 2012
 
216,902 
 
 
 
 
Increase (Decrease) in Stockholders' Equity [Roll Forward]
 
 
 
 
 
 
Shares issued under share-based compensation plan (in shares)
 
133 
(133)
 
 
 
Shares issued under share-based compensation plan
 
(1)
 
 
Share-based compensation
9,315 
 
 
9,315 
 
 
Other comprehensive income (loss)
49,859 
 
 
 
49,859 
 
Net income
25,502 
 
 
 
 
25,502 
Ending Balance at Dec. 31, 2013
2,399,924 
2,170 
2,358,858 
(8,557)
47,453 
Ending Balance (in shares) at Dec. 31, 2013
 
 
7,065 
 
 
 
Ending Balance (in shares) at Dec. 31, 2013
 
217,035 
 
 
 
 
Increase (Decrease) in Stockholders' Equity [Roll Forward]
 
 
 
 
 
 
Shares issued under share-based compensation plan (in shares)
 
418 
(418)
 
 
 
Shares issued under share-based compensation plan
95 
 
90 
 
 
Issuance of common shares to treasury (in shares)
 
 
8,670 
 
 
 
Shares repurchased (in shares)
 
(1,669)
1,669 
 
 
 
Shares repurchased
(8,240)
 
(8,240)
 
 
 
Share-based compensation
10,484 
 
 
10,484 
 
 
Other comprehensive income (loss)
(11,648)
 
 
 
(11,648)
 
Net income
188,257 
 
 
 
 
188,257 
Ending Balance at Dec. 31, 2014
2,578,872 
2,175 
(8,240)
2,369,432 
(20,205)
235,710 
Ending Balance (in shares) at Dec. 31, 2014
 
 
16,986 
 
 
 
Ending Balance (in shares) at Dec. 31, 2014
 
215,784 
 
 
 
 
Increase (Decrease) in Stockholders' Equity [Roll Forward]
 
 
 
 
 
 
Shares issued under share-based compensation plan (in shares)
 
1,013 
(1,013)
 
 
 
Shares issued under share-based compensation plan
(536)
10 
 
(546)
 
 
Shares repurchased (in shares)
 
(5,590)
5,590 
 
 
 
Shares repurchased
(21,760)
 
(21,760)
 
 
 
Share-based compensation
12,534 
 
 
12,534 
 
 
Other comprehensive income (loss)
(3,285)
 
 
 
(3,285)
 
Net income
126,230 
 
 
 
 
126,230 
Ending Balance at Dec. 31, 2015
$ 2,692,055 
$ 2,185 
$ (30,000)
$ 2,381,420 
$ (23,490)
$ 361,940 
Ending Balance (in shares) at Dec. 31, 2015
 
 
21,563 
 
 
 
Ending Balance (in shares) at Dec. 31, 2015
 
211,207 
 
 
 
 
Consolidated Statements of Cash Flows (USD $)
In Thousands, unless otherwise specified
12 Months Ended
Dec. 31, 2015
Dec. 31, 2014
Dec. 31, 2013
Cash flow from operating activities:
 
 
 
Net income
$ 126,230 
$ 188,257 
$ 25,502 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation expense
243,457 
199,337 
149,465 
Amortization of deferred revenue
(86,276)
(109,208)
(72,515)
Amortization of deferred costs
25,951 
51,173 
39,479 
Amortization of deferred financing costs
11,278 
10,416 
10,106 
Amortization of debt discount
1,015 
817 
445 
Write-off of unamortized deferred financing costs
5,965 
27,644 
Costs on interest rate swap termination
38,184 
Loss from construction contract rescission
38,084 
Deferred income taxes
9,840 
18,661 
(3,119)
Share-based compensation expense
12,534 
10,484 
9,315 
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
62,977 
(24,949)
(53,779)
Materials and supplies
(2,583)
(29,951)
(16,083)
Prepaid expenses and other assets
(10,840)
(56,493)
(30,840)
Accounts payable and accrued expenses
(18,712)
20,865 
12,301 
Deferred revenue
3,226 
117,001 
94,482 
Net cash provided by operating activities
422,146 
396,410 
230,587 
Cash flow from investing activities:
 
 
 
Capital expenditures
(181,458)
(1,136,205)
(876,142)
Decrease in restricted cash
172,184 
Net cash used in investing activities
(181,458)
(1,136,205)
(703,958)
Cash flow from financing activities:
 
 
 
Net proceeds (payments) from shares issued under share-based compensation plan
(536)
95 
Proceeds from long-term debt
315,000 
760,000 
1,656,250 
Payments on long-term debt
(581,083)
(41,833)
(1,480,000)
Payments for costs on interest rate swap termination
(41,993)
Payments for financing costs
(4,070)
(7,569)
(62,684)
Purchases of treasury shares
(21,760)
(7,227)
Net cash provided by (used in) financing activities
(292,449)
703,466 
71,573 
Decrease in cash and cash equivalents
(51,761)
(36,329)
(401,798)
Cash and cash equivalents, beginning of period
167,794 
204,123 
605,921 
Cash and cash equivalents, end of period
$ 116,033 
$ 167,794 
$ 204,123 
Nature of Business
Nature of Business
Nature of Business
Pacific Drilling S.A. and its subsidiaries (“Pacific Drilling,” the “Company,” “we,” “us” or “our”) is an international offshore drilling contractor committed to being the preferred provider of offshore drilling services to the oil and natural gas industry through the use of high-specification floating rigs. Our primary business is to contract our high-specification rigs, related equipment and work crews, primarily on a dayrate basis, to drill wells for our clients. As of December 31, 2015, we had a fleet of seven drillships.
Significant Accounting Policies
Significant Accounting Policies
Significant Accounting Policies
Principles of Consolidation—The consolidated financial statements include the accounts of Pacific Drilling S.A., consolidated subsidiaries that we control by ownership of a majority voting interest and entities that meet the criteria for variable interest entities for which we are deemed to be the primary beneficiary for accounting purposes. We eliminate all intercompany transactions and balances in consolidation.
We are party to a Nigerian joint venture, Pacific International Drilling West Africa Limited (“PIDWAL”), with Derotech Offshore Services Limited (“Derotech”), a privately-held Nigerian registered limited liability company. Derotech owns 51% of PIDWAL and PIDWAL has a 50% ownership interest in two of our rig holding subsidiaries, Pacific Bora Ltd. and Pacific Scirocco Ltd. PIDWAL’s interest in the rig holding subsidiaries is held through a holding company of PIDWAL, Pacific Drillship Nigeria Limited (“PDNL”). Derotech will not accrue the economic benefits of its interest in PIDWAL unless and until it satisfies certain outstanding obligations to us and a certain pledge is cancelled by us. Likewise PIDWAL will not accrue the economic benefits of its interest in PDNL unless and until it satisfies certain outstanding obligations to us and a certain pledge is cancelled by us. PIDWAL and PDNL are variable interest entities for which we are the primary beneficiary. Accordingly, we consolidated all interests of PIDWAL and PDNL and no portion of their operating results is allocated to the noncontrolling interest. See Note 15—Variable Interest Entities.
In addition to the joint venture agreement, we are a party to marketing and logistic services agreements with Derotech and an affiliated company of Derotech. During the years ended December 31, 2015, 2014 and 2013, we incurred fees of $13.9 million, $16.6 million and $9.4 million, respectively, under such agreements.
Accounting Estimates—The preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”) requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the balance sheet date and the amounts of revenues and expenses recognized during the reporting period. On an ongoing basis, we evaluate our estimates and assumptions, including those related to allowance for doubtful accounts, financial instruments, depreciation of property and equipment, impairment of long-lived assets, long-term receivable, income taxes, share-based compensation and contingencies. We base our estimates and assumptions on historical experience and on various other factors we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from such estimates.
Revenues and Operating Expenses—Contract drilling revenues are recognized as earned, based on contractual dayrates. In connection with drilling contracts, we may receive fees for preparation and mobilization of equipment and personnel or for capital improvements to rigs. Fees and incremental costs incurred directly related to contract preparation and mobilization along with reimbursements received for capital expenditures are deferred and amortized to revenue over the primary term of the drilling contract. The cost incurred for reimbursed capital expenditures are depreciated over the estimated useful life of the asset. 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. These conditional fees and related expenses are reported in income upon completion of the drilling contract. If receipt of such fees is not conditional, they are recognized as revenue over the primary term of the drilling contract. Amortization of deferred revenue and deferred mobilization costs are recorded on a straight-line basis over the primary drilling contract term, which is consistent with the general pace of activity, level of services being provided and dayrates being earned over the life of the contract.
Cash and Cash Equivalents—Cash equivalents are highly liquid investments with original maturities of three months or less that are readily convertible to known amounts of cash.
Accounts Receivable—We record trade accounts receivable at the amount we invoice our clients. We provide an allowance for doubtful accounts, as necessary, based on a review of outstanding receivables, historical collection information and existing economic conditions. We do not generally require collateral or other security for receivables. As of December 31, 2015 and 2014, we had no allowance for doubtful accounts.
Materials and Supplies—Materials and supplies held for consumption are carried at average cost, net of allowances for excess or obsolete materials and supplies of $8.0 million and $4.0 million as of December 31, 2015 and 2014, respectively.
Property and Equipment—High-specification drillships are recorded at cost of construction, including any major capital improvements, less accumulated depreciation and if applicable, impairment. Other property and equipment is recorded at cost and consists of purchased software systems, furniture, fixtures and other equipment. Ongoing maintenance, routine repairs and minor replacements are expensed as incurred.
Interest is capitalized based on the costs of new borrowings attributable to qualifying new construction or at the weighted-average cost of debt outstanding during the period of construction. We capitalize interest costs for qualifying new construction from the point borrowing costs are incurred for the qualifying new construction and cease when substantially all the activities necessary to prepare the qualifying asset for its intended use are complete.
Property and equipment are depreciated to their salvage value on a straight-line basis over the estimated useful lives of each class of assets. Our estimated useful lives of property and equipment are as follows:
 
 
Years
Drillships and related equipment
15-35
Other property and equipment
2-7

 
We review property and equipment for impairment when events or changes in circumstances indicate that the carrying amounts of our assets held and used may not be recoverable. Potential impairment indicators include steep declines in commodity prices and related market conditions, actual or expected declines in rig utilization, increases in idle time, cancellations of contracts or credit concerns of clients. We assess impairment using estimated undiscounted cash flows for the property and equipment being evaluated by applying assumptions regarding future operations, market conditions, dayrates, utilization and idle time. An impairment loss is recorded in the period if the carrying amount of the asset is not recoverable. During 2015, 2014 and 2013, there were no long-lived asset impairments.
Deferred Financing Costs—Deferred financing costs associated with long-term debt are carried at cost and are amortized to interest expense using the effective interest rate method over the term of the applicable long-term debt.
Foreign Currency Transactions—The consolidated financial statements are stated in U.S. dollars. We have designated the U.S. dollar as the functional currency for our foreign subsidiaries in international locations because we contract with clients, purchase equipment and finance capital using the U.S. dollar. Transactions in other currencies have been translated into U.S. dollars at the rate of exchange on the transaction date. Any gain or loss arising from a change in exchange rates subsequent to the transaction date is included as an exchange gain or loss. Monetary assets and liabilities denominated in currencies other than U.S. dollars are reported at the rates of exchange prevailing at the end of the reporting period. During 2015, 2014 and 2013, foreign exchange losses were $3.6 million, $5.3 million and $2.1 million, respectively, and recorded in other expense within our consolidated statements of income.
Earnings per Share—Basic earnings per common share (“EPS”) is computed by dividing the net income by the weighted-average number of common shares outstanding for the period. Basic and diluted EPS are retrospectively adjusted for the effects of stock dividends or stock splits. Diluted EPS reflects the potential dilution from securities that could share in the earnings of the Company. Anti-dilutive securities are excluded from diluted EPS.
Fair Value Measurements—We estimate fair value at the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal market for the asset or liability. Our valuation techniques require inputs that are categorized using a three-level hierarchy as follows: (1) unadjusted quoted prices for identical assets or liabilities in active markets (“Level 1”), (2) direct or indirect observable inputs, including quoted prices or other market data, for similar assets or liabilities in active markets or identical assets or liabilities in less active markets (“Level 2”) and (3) unobservable inputs that require significant judgment for which there is little or no market data (“Level 3”). When multiple input levels are required for a valuation, we categorize the entire fair value measurement according to the lowest level input that is significant to the measurement even though we may have also utilized significant inputs that are more readily observable.
Share-Based Compensation—The grant date fair value of share-based awards granted to employees is recognized as an employee compensation expense over the requisite service period on a straight-line basis. The amount of compensation expense recognized is adjusted to reflect the number of awards for which the related vesting conditions are expected to be met. The amount of compensation expense ultimately recognized is based on the number of awards that do meet the vesting conditions at the vesting date.
 
Derivatives—We apply cash flow hedge accounting to interest rate swaps that are designated as hedges of the variability of future cash flows. The derivative financial instruments are recorded in our consolidated balance sheet at fair value as either assets or liabilities. Changes in the fair value of derivatives designated as cash flow hedges, to the extent the hedge is effective, are recognized in accumulated other comprehensive income until the hedged item is recognized in earnings.
Hedge effectiveness is measured on an ongoing basis to ensure the validity of the hedges based on the relative cumulative changes in fair value between the derivative contract and the hedged item over time. Any change in fair value resulting from ineffectiveness is recognized immediately in earnings. Hedge accounting is discontinued prospectively if it is determined that the derivative is no longer effective in offsetting changes in the cash flows of the hedged item.
For interest rate hedges related to interest capitalized in the construction of fixed assets, other comprehensive income is released to earnings as the asset is depreciated over its useful life. For all other interest rate hedges, other comprehensive income is released to earnings as interest expense is accrued on the underlying debt.
Contingencies—We record liabilities for estimated loss contingencies when we believe a loss is probable and the amount of the probable loss can be reasonably estimated. Once established, we adjust the estimated contingency loss accrual for changes in facts and circumstances that alter our previous assumptions with respect to the likelihood or amount of loss.
Income Taxes—Income taxes are provided based upon the tax laws and rates in the countries in which our subsidiaries are registered and where their operations are conducted and income and expenses are earned and incurred, respectively. We recognize deferred tax assets and liabilities for the anticipated future tax effects of temporary differences between the financial statement basis and the tax basis of our assets and liabilities using the applicable enacted tax rates in effect the year in which the asset is realized or the liability is settled. A valuation allowance for deferred tax assets is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized.
We recognize tax benefits from an uncertain tax position only if it is more likely than not that the position will be sustained upon examination by taxing authorities based on the technical merits of the position. The amount recognized is the largest benefit that we believe has greater than a 50% likelihood of being realized upon settlement. Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations and the final audit of tax returns by taxing authorities. We recognize interest and penalties related to uncertain tax positions in income tax expense.
Recently Issued Accounting Standards
Revenue Recognition — On May 28, 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This standard will replace most existing revenue recognition guidance under GAAP when it becomes effective. The standard will be effective for annual periods and interim periods beginning after December 15, 2017. We plan to adopt the new standard on January 1, 2018. The standard permits the use of either the retrospective or cumulative effect transition method. We have not yet selected a transition method, nor have we determined the effect the standard may have on our consolidated financial statements and related disclosures.
Debt Issuance Costs — On April 7, 2015, FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30) - Simplifying the Presentation of Debt Issuance Costs, which requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the debt liability rather than as an asset. Early adoption is permitted. Upon adoption, an entity must apply the new guidance retrospectively to all prior periods presented in the financial statements. We plan to adopt the standard on a retrospective basis effective January 1, 2016 and expect that it will result in the netting of our deferred financing costs against long-term debt balances on the consolidated balance sheets for the periods presented and related disclosure. There will be no impact to the manner in which deferred financing costs are amortized in our consolidated financial statements.
Deferred Taxes — On November 20, 2015, FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes, which requires all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. The new guidance does not change the existing requirement that only permits offsetting within a tax jurisdiction. The standard will be effective for annual and interim periods beginning after December 15, 2016, and may be applied prospectively or retrospectively. Early adoption is permitted. We have not yet adopted nor selected a transition method and are currently evaluating the impact it may have on our consolidated financial statements.
Leases — On February 25, 2016, FASB issued ASU 2016-02, Leases, which requires the balance sheet recognition of lease assets and lease liabilities by lessees for virtually all of their leases. Lessees and lessors will be required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. These practical expedients relate to the identification and classification of leases that commenced before the effective date, initial direct costs for leases that commenced before the effective date, and the ability to use hindsight in evaluating lessee options to extend or terminate a lease or to purchase the underlying asset. The standard will be effective for our annual and interim periods beginning January 1, 2019. Early adoption is permitted. We have not yet evaluated the standard nor determined our implementation method upon adoption or what impact it will have on our consolidated financial statements.
Property and Equipment
Property and Equipment
Property and Equipment
Property and equipment consists of the following:
 
 
December 31,
 
2015
 
2014
 
(in thousands)
Drillships and related equipment
$
5,856,564

 
$
5,907,226

Other property and equipment
14,938

 
10,353

Property and equipment, cost
5,871,502

 
5,917,579

Accumulated depreciation
(727,946
)
 
(485,756
)
Property and equipment, net
$
5,143,556

 
$
5,431,823


During the years ended December 31, 2015, 2014 and 2013, we capitalized interest costs of $37.1 million, $62.1 million and $78.5 million, respectively.
Loss from Construction Contract Recission
Loss from Construction Contract Recission
Loss from Construction Contract Rescission
On January 25, 2013, we entered into a contract with Samsung Heavy Industries Co., Ltd. (“SHI”) for the construction of an eighth drillship, the Pacific Zonda, which provided for a purchase price of approximately $517.5 million and an original delivery date of March 31, 2015 (the “Construction Contract”). On October 29, 2015, we exercised our right to rescind the Construction Contract due to SHI’s failure to timely deliver the drillship in accordance with the contractual specifications. The carrying value of the newbuild at the date of rescission was $315.7 million, consisting of (i) advance payments in the aggregate of $181.1 million paid by us to SHI, (ii) purchased equipment, (iii) internally capitalized construction costs and (iv) capitalized interest.
On November 25, 2015, SHI formally commenced arbitration proceedings against us in accordance with the Construction Contract. On November 30, 2015, we made demand under the third party refund guarantee accompanying the Construction Contract for the amount of our advance payments made under the Construction Contract, plus interest. Any payment under the refund guarantee is suspended until an award under the arbitration is obtained. We do not expect a resolution of this matter within the next 12 months.
Based on our assessment of the facts and circumstances of the rescission, we believe the recovery of the advance payments and accrued interest is probable. As such, we have reclassified $181.1 million from property and equipment, plus accrued interest of $21.4 million, to a receivable from SHI, which is presented as a long-term receivable on our consolidated balance sheets. As of December 31, 2015, we owned $75.0 million in purchased equipment for the Pacific Zonda recorded in property and equipment. Of this amount, a majority of the purchased equipment remains onboard the Pacific Zonda subject to return to us by SHI.
Subsequent to our rescission of the Construction Contract, we incurred $2.0 million in crew costs directly associated with the Pacific Zonda. The resulting net loss recognized was $40.2 million, which is included in “loss from construction contract rescission” in our consolidated statements of income.
Debt
Debt
Debt
Debt consists of the following:
 
December 31,
 
2015
 
2014
 
(in thousands)
Due within one year:
 
 
 
2015 Senior Unsecured Bonds
$

 
$
286,500

2018 Senior Secured Term Loan B
7,500

 
7,500

Senior Secured Credit Facility
82,083

 
75,000

Total current debt
89,583

 
369,000

Long-term debt:
 
 
 
2017 Senior Secured Bonds
498,887

 
498,369

2018 Senior Secured Term Loan B
721,958

 
728,706

2013 Revolving Credit Facility
50,000

 

Senior Secured Credit Facility
775,000

 
804,167

2020 Senior Secured Notes
750,000

 
750,000

Total long-term debt
2,795,845

 
2,781,242

Total debt
$
2,885,428

 
$
3,150,242


2015 Senior Unsecured Bonds
On February 23, 2015, we repaid in full the $286.5 million outstanding principal and accrued interest on our 8.25% senior unsecured U.S. dollar denominated bonds due 2015.
2017 Senior Secured Notes
In November 2012, Pacific Drilling V Limited (“PDV”), an indirect, wholly-owned subsidiary of the Company, and the Company, as guarantor, completed a private placement of $500.0 million in aggregate principal amount of 7.25% senior secured notes due 2017 (the “2017 Senior Secured Notes”). The 2017 Senior Secured Notes bear interest at 7.25% per annum, payable semiannually on June 1 and December 1, and mature on December 1, 2017.
The 2017 Senior Secured Notes are secured by a first-priority security interest (subject to certain exceptions) in the Pacific Khamsin, and substantially all of the other assets of PDV, including an assignment of earnings and insurance proceeds related to the Pacific Khamsin.

On or after December 1, 2015, PDV may redeem the 2017 Senior Secured Notes at the redemption prices plus accrued and unpaid interests specified in the indenture for the Notes.

The 2017 Senior Secured Notes contain provisions that limit, with certain exceptions, the ability of PDV, the Company and the Company’s other restricted subsidiaries to (i) pay dividends, make distributions, purchase or redeem the Company’s capital stock or subordinated indebtedness of PDV or any guarantor or make other restricted payments (subject to certain exceptions), (ii) incur or guarantee additional indebtedness or issue preferred stock, (iii) create or incur liens, (iv) create unrestricted subsidiaries, (v) enter into transactions with affiliates, (vi) enter into new lines of business, (vii) transfer or sell the Pacific Khamsin and other related assets and (viii) merge or demerge. These covenants are subject to exceptions and qualifications set forth in the indenture for the Notes.
As of December 31, 2015, we were in compliance with all 2017 Senior Secured Notes covenants.
Senior Secured Credit Facility Agreement
In February 2013, Pacific Sharav S.à r.l. and Pacific Drilling VII Limited (collectively, the “SSCF Borrowers”) and the Company, as guarantor, entered into a senior secured credit facility agreement, as amended and restated (the “SSCF”), to finance the construction, operation and other costs associated with the Pacific Sharav and the Pacific Meltem (the “SSCF Vessels”). The SSCF is primarily secured on a first priority basis by liens on the SSCF Vessels, and by an assignment of earnings and insurance proceeds relating thereto.
In the second quarter of 2015, we completed the final drawdown under this facility, bringing the outstanding balance to $985.0 million. We do not have any undrawn capacity on this facility as of December 31, 2015.
Following the final drawdown, the SSCF consisted of two principal tranches: (i) a Commercial Tranche of $492.5 million provided by a syndicate of commercial banks and (ii) a Garanti — Instituttet for Eksportkreditt (“GIEK”) Tranche of $492.5 million guaranteed by GIEK, comprised of two sub-tranches: (x) an Eksportkreditt Norge AS (“EKN”) sub-tranche of $246.3 million and (y) a bank sub-tranche of $246.3 million.
In November 2015, we entered into Amendment No. 5 to the SSCF to, among other items, amend certain of the financial covenants. Subsequent to Amendment No.5, borrowings under (A) the Commercial Tranche bear interest at LIBOR plus a margin of 3.75%, (B) the EKN sub-tranche bear interest, at our option, at (i) LIBOR plus a margin of 1.5% (which margin may be reset on May 31, 2019) or (ii) at a Commercial Interest Reference Rate of 2.37% and (C) the bank sub-tranche bear interest at LIBOR plus a margin of 1.5%. Borrowings under both sub-tranches are also subject to a guarantee fee of 2% per annum. Interest is payable quarterly.
The Commercial Tranche matures on May 31, 2019. Loans made with respect to each vessel under the GIEK Tranche mature 12 years following the delivery of the applicable vessel. The GIEK Tranche contains a put option exercisable if the Commercial Tranche is not refinanced or renewed on or before February 28, 2019. If the GIEK Tranche put option is exercised, each SSCF Borrower must prepay, in full, the portion of all outstanding loans that relate to the GIEK Tranche, on or before May 31, 2019, without any premium, penalty or fees of any kind. Amortization payments under the SSCF are calculated on a 12 year repayment schedule and must be made every six months following the delivery of the relevant vessel.
The SSCF requires compliance with certain affirmative and negative covenants that are customary for such financings. These include the following financial covenants:
Consolidated Tangible Net Worth: maintain at least $1.0 billion consolidated tangible net worth.
Maximum Leverage Ratio: maintain a net debt to EBITDA ratio no greater than 4.75 to 1.00 as of December 31, 2015 and increasing incrementally to 6.00 to 1.00 during the period from July 1, 2016 through December 31, 2017, and 4.00 to 1.00, thereafter.
Total Debt to Capitalization Ratio: maintain a ratio of not greater than 3.0 to 5.0 of total debt to total capitalization.
Total Debt: maintain less than $3.0 billion in total debt.
Minimum Liquidity: maintain no less than $50.0 million in cash and cash equivalents.
Net Debt to Applicable Rigs ratio: maintain a net debt per rig ratio of not greater than $425.0 million through June 30, 2016 and decreasing incrementally to $360.0 million during the period from October 1, 2017 through December 31, 2017.
In addition, the SSCF contains restrictions on the ability of the Company to pay dividends or make distributions to its shareholders or transact with business affiliates. The SSCF also limits the ability of the SSCF Borrowers to incur additional indebtedness or liens, sell assets, make certain investments or transact with affiliates, among others.
Borrowings under the SSCF may be prepaid in whole or in part at any time, without any premium or penalty other than customary interest rate breakage payments, as applicable. The SSCF contains events of default that are usual and customary for a financing of this type, size and purpose. Upon the occurrence of an event of default, borrowings under the SSCF are subject to acceleration.
As of December 31, 2015, we were in compliance with all SSCF covenants.
2020 Senior Secured Notes
On June 3, 2013, we completed a $750.0 million private placement of 5.375% senior secured notes due 2020 (the “2020 Senior Secured Notes”).
The 2020 Senior Secured Notes bear interest at 5.375% per annum, payable semiannually on June 1 and December 1, and mature on June 1, 2020.
The 2020 Senior Secured Notes are guaranteed by each of our subsidiaries that own the Pacific Bora, the Pacific Mistral, the Pacific Scirocco and the Pacific Santa Ana (the “Shared Collateral Vessels”), each of our subsidiaries that owns or previously owned equity or similar interests in a Shared Collateral Vessel-owning subsidiary, and certain other of our subsidiaries that are parties to charters in respect of the Shared Collateral Vessels, and will be guaranteed by certain other future subsidiaries. The indenture for the 2020 Senior Secured Notes allows for the issuance of up to $100.0 million of additional notes provided no default is continuing and we are otherwise in compliance with all applicable covenants.
The 2020 Senior Secured Notes are secured, on an equal and ratable, first priority basis, with the obligations under the Senior Secured Term Loan B, the 2013 Revolving Credit Facility and certain future obligations (together with the 2020 Senior Secured Notes, the “Pari Passu Obligations”), subject to payment priorities in favor of lenders under the 2013 Revolving Credit Facility pursuant to the terms of an intercreditor agreement (the “Intercreditor Agreement”), by liens on the Shared Collateral Vessels, a pledge of the equity of the entities that own the Shared Collateral Vessels, assignments of earnings and insurance proceeds with respect to the Shared Collateral Vessels, and certain other assets of the subsidiary guarantors (collectively, the “Shared Collateral”).
Beginning on June 1, 2016 the Company may redeem the 2020 Senior Secured Notes at a redemption price of 104.031% of the principal amount, and at declining redemption prices thereafter as specified in the indenture. Prior to June 1, 2016, the Company may redeem all or any portion of the notes at a redemption price equal to 100% of the principal amount of the outstanding notes plus accrued and unpaid interest, plus a “make-whole” premium.
In addition, prior to June 1, 2016, the Company may redeem up to 35% of the aggregate original principal amount of the notes with the net cash proceeds from certain equity offerings at a redemption price of 105.375% of the principal amount of the outstanding notes plus accrued and unpaid interest.
The Company may also, prior to June 1, 2016, redeem up to 10% of the original aggregate principal amount of the notes in any 12-month period at a redemption price equal to 103% of the aggregate principal amount thereof plus accrued and unpaid interest.
The indenture for the 2020 Senior Secured Notes contains covenants that, among other things, limits the Company’s and its restricted subsidiaries’ ability to (i) pay dividends, make distributions, purchase or redeem the Company’s capital stock or its or its subsidiary guarantors’ subordinated indebtedness or make other restricted payments, (ii) incur or guarantee additional indebtedness or issue preferred stock, (iii) create or incur liens, (iv) create unrestricted subsidiaries, (v) enter into transactions with affiliates, (vi) enter into new lines of business and (vii) transfer or sell assets or enter into mergers.
The indenture for the 2020 Senior Secured Notes contains events of default that are usual and customary for a financing of this type, size and purpose. Upon the occurrence of an event of default, the 2020 Senior Secured Notes are subject to acceleration.
As of December 31, 2015, we were in compliance with all 2020 Senior Secured Notes covenants.
2018 Senior Secured Institutional Term Loan – Term Loan B
On June 3, 2013, we entered into a $750.0 million senior secured institutional term loan maturing 2018 (the “Senior Secured Term Loan B”). The Senior Secured Term Loan B bears interest, at our election, at either (1) LIBOR, which will not be less than a floor of 1% plus a margin of 3.5% per annum, or (2) a rate of interest per annum equal to (i) the prime rate for such day, (ii) the sum of the federal funds rate plus 0.5% or (iii) 1% per annum above the one-month LIBOR, whichever is the highest rate in each case plus a margin of 2.5% per annum. Interest is payable quarterly. The Senior Secured Term Loan B requires quarterly amortization payments of $1.9 million and matures on June 3, 2018.
The Senior Secured Term Loan B has an accordion feature that would permit additional loans to be extended so long as our total outstanding obligations in connection with the Senior Secured Term Loan B and the 2020 Senior Secured Notes do not exceed $1.7 billion.
The Senior Secured Term Loan B is secured by the Shared Collateral and subject to the terms and provisions of the Intercreditor Agreement.
The Senior Secured Term Loan B requires compliance with certain affirmative and negative covenants that are customary for such financings. These include restrictions on the Company’s and its restricted subsidiaries’ ability to (i) pay dividends, make distributions, purchase or redeem the Company’s capital stock or its or its subsidiary guarantors’ subordinated indebtedness or make other restricted payments, (ii) incur or guarantee additional indebtedness or issue preferred stock, (iii) create or incur liens, (iv) create unrestricted subsidiaries, (v) enter into transactions with affiliates, (vi) enter into new lines of business and (vii) transfer or sell assets or enter into mergers. These covenants are subject to important exceptions and qualifications set forth in the Senior Secured Term Loan B, including the ability to incur certain amounts of secured indebtedness to finance the construction of additional drillships.
The Senior Secured Term Loan B contains events of default that are usual and customary for a financing of this type, size and purpose. Upon the occurrence of an event of default, borrowings under the Senior Secured Term Loan B are subject to acceleration.
As of December 31, 2015, we were in compliance with all Senior Secured Term Loan B covenants.
2013 Revolving Credit Facility
On June 3, 2013, we entered into a $500.0 million senior secured revolving credit facility maturing 2018, as amended (the “2013 Revolving Credit Facility”). The 2013 Revolving Credit Facility is secured by the Shared Collateral and subject to the provisions of the Intercreditor Agreement.
In November 2015, we entered into the Fifth Amendment to the 2013 Revolving Credit Facility to, among other items, amend certain financial covenants and increase the cash sublimit.
Subsequent to the Fifth Amendment, borrowings under the 2013 Revolving Credit Facility bear interest, at our option, at either (1) LIBOR plus a margin ranging from 3.25% to 3.75% based on our leverage ratio, or (2) a rate of interest per annum equal to (i) the prime rate for such day, (ii) the sum of the federal funds rate plus 0.5% or (iii) 1% per annum above the one-month LIBOR, whichever is the highest rate in each case plus a margin ranging from 2.25% to 2.75% per annum based on our leverage ratio. Undrawn commitments accrued a fee ranging from 1.3% to 1.5% per annum based on our leverage ratio. Interest is payable quarterly.
The 2013 Revolving Credit Facility, as amended, permits loans to be extended up to a maximum sublimit of $500.0 million and permits letters of credit to be issued up to a maximum sublimit of $300.0 million, subject to a $500.0 million overall facility limit. Outstanding but undrawn letters of credit accrue a fee at a rate equal to the margin on LIBOR loans minus 1%. The 2013 Revolving Credit Facility matures on June 3, 2018.
Borrowings under the 2013 Revolving Credit Facility may be prepaid, and commitments under the 2013 Revolving Credit Facility may be reduced, in whole or in part at any time, without any premium or penalty other than LIBOR breakage payments.

The 2013 Revolving Credit Facility requires compliance with certain affirmative and negative covenants that are customary for such financings. These include the following financial covenants:
Maximum Leverage Ratio: maintain a net debt to EBITDA ratio no greater than 4.75 to 1.00 as of December 31, 2015 and increasing incrementally to 6.00 to 1.00 during the period from July 1, 2016 through December 31, 2017, and 4.25 to 1.00, thereafter.
Minimum Liquidity: maintain no less than $100.0 million in cash and cash equivalents (including undrawn capacity for borrowings under the 2013 Revolving Credit Facility).
Net Debt to Applicable Rigs ratio: maintain a net debt per rig ratio of not greater than $425.0 million through June 30, 2016 and decreasing incrementally to $360.0 million during the period from October 1, 2017 through December 31, 2017.
In addition, the 2013 Revolving Credit Facility contains restrictions on the ability of the Company to pay dividends or make distributions to its shareholders and restrictions on the Company’s and its subsidiaries’ ability to incur additional indebtedness or liens, sell assets, make investments or engage in transactions with affiliates, among others.
The 2013 Revolving Credit Facility contains events of default that are usual and customary for a financing of this type, size and purpose. Upon the occurrence of an event of default, (i) commitments and letters of credit under the 2013 Revolving Credit Facility could be subject to termination, (ii) borrowings under the 2013 Revolving Credit Facility could be subject to acceleration, and (iii) outstanding letters of credit could be subject to cash collateralization.
As of December 31, 2015, we were in compliance with all 2013 Revolving Credit Facility covenants.
2014 Revolving Credit Facility
In October 2014, we entered into a $500.0 million revolving credit facility for pre-delivery, delivery and post-delivery financing of the Pacific Zonda and for other general corporate purposes (the “2014 Revolving Credit Facility”).
On October 26, 2015, we repaid all amounts outstanding under the 2014 Revolving Credit Facility, and in connection with our rescission of the Construction Contract for the Pacific Zonda, the 2014 Revolving Credit Facility was terminated as of October 30, 2015.
Maturities of Long-Term Debt
As of December 31, 2015, the aggregate maturities of our debt, including net unamortized discounts of $2.9 million, was as follows:
 
(in thousands)
Years ending December 31,
2016
$
89,583

2017
589,584

2018
848,333

2019
610,833

2020
750,000

Thereafter

Total
$
2,888,333

Income Taxes
Income Taxes
Income Taxes
Pacific Drilling S.A., a holding company and Luxembourg resident, is subject to Luxembourg corporate income tax and municipal business tax at a combined rate of 29.2%. Qualifying dividend income and capital gains on the sale of qualifying investments in subsidiaries are exempt from Luxembourg corporate income tax and municipal business tax. Consequently, Pacific Drilling S.A. expects dividends from its subsidiaries and capital gains from sales of investments in its subsidiaries to be exempt from Luxembourg corporate income tax and municipal business tax.
Income taxes have been provided based on the laws and rates in effect in the countries in which our operations are conducted or in which our subsidiaries are considered residents for income tax purposes. Our income tax expense or benefit arises from our mix of pretax earnings or losses, respectively, in the international tax jurisdictions in which we operate. Because the countries in which we operate have different statutory tax rates and tax regimes with respect to one another, there is no expected relationship between the provision for income taxes and our income or loss before income taxes.
Income before income taxes consists of the following:
 
 
Years ended December 31,
 
2015
 
2014
 
2013
 
(in thousands)
Luxembourg
$
94,558

 
$
36,783

 
$
55,904

United States
4,812

 
3,631

 
206

Other Jurisdictions
55,731

 
193,463

 
(8,085
)
Total
$
155,101

 
$
233,877

 
$
48,025


 
The components of income tax (provision) / benefit consists of the following:
 
 
Years ended December 31,
 
2015
 
2014
 
2013
 
(in thousands)
Current income tax expense:
 
 
 
 
 
Luxembourg
$
(1,107
)
 
$
(979
)
 
$
(816
)
United States
(2,347
)
 
(6,030
)
 
(1,885
)
Other Foreign
(15,577
)
 
(19,950
)
 
(22,941
)
Total current
$
(19,031
)
 
$
(26,959
)
 
$
(25,642
)
Deferred tax benefit (expense):
 
 
 
 
 
Luxembourg
$
(2,908
)
 
$
(1
)
 
$
(32
)
United States
(1,071
)
 
4,281

 
2,053

Other Foreign
(5,861
)
 
(22,941
)
 
1,098

Total deferred
$
(9,840
)
 
$
(18,661
)
 
$
3,119

Income tax expense
$
(28,871
)
 
$
(45,620
)
 
$
(22,523
)

A reconciliation between the Luxembourg statutory rate of 29.2% for the years ended December 31, 2015, 2014 and 2013 and our effective tax rate is as follows:
 
 
Years ended December 31,
 
2015
 
2014
 
2013
Statutory rate
29.2
 %
 
29.2
 %
 
29.2
 %
Effect of tax rates different than the Luxembourg statutory tax rate
(22.5
)%
 
(27.6
)%
 
25.2
 %
Change in valuation allowance
10.6
 %
 
10.2
 %
 
(9.0
)%
Changes in unrecognized tax benefits
1.9
 %
 
10.1
 %
 
1.9
 %
Equity based compensation shortfall
1.4
 %
 
 %
 
 %
Adjustments related to prior years
(2.0
)%
 
(2.4
)%
 
(0.4
)%
Effective tax rate
18.6
 %
 
19.5
 %
 
46.9
 %

The components of deferred tax assets and liabilities consists of the following:
 
 
December 31,
 
2015
 
2014
 
(in thousands)
Deferred tax assets:
 
 
 
Net operating loss carryforwards
$
40,422

 
$
33,537

Depreciation and amortization
62,702

 
54,815

Accrued payroll expenses
7,662

 
9,086

Deferred revenue
8,851

 
19,107

Other
2,025

 
1,187

Deferred tax assets
121,662

 
117,732

Less: valuation allowance
(94,422
)
 
(78,328
)
Total deferred tax assets
$
27,240

 
$
39,404

Deferred tax liabilities:
 
 
 
Depreciation and amortization
$
(3,642
)
 
$

Deferred expenses
(12,483
)
 
(21,937
)
Other
(1,817
)
 
(1,220
)
Total deferred tax liabilities
$
(17,942
)
 
$
(23,157
)
Net deferred tax assets
$
9,298

 
$
16,247


 
As of December 31, 2015 and 2014, the Company had gross deferred tax assets of $40.4 million and $33.5 million, respectively, related to loss carry forwards in various worldwide tax jurisdictions. The majority of the loss carry forwards have no expiration.
A valuation allowance for deferred tax assets is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of December 31, 2015 and 2014, the valuation allowance for deferred tax assets was $94.4 million and $78.3 million, respectively. The increase in our valuation allowance partially resulted from losses incurred in Brazil and Luxembourg, for which we believe it is more likely than not that a tax benefit will not be realized. Additionally, we believe it is more likely than not that a tax benefit will not be realized from the excess of tax basis over book basis for certain of our drillships.
We consider the earnings of certain of our subsidiaries to be indefinitely reinvested. Accordingly, we have not provided for taxes on these unremitted earnings. Should we make distributions from the unremitted earnings of these subsidiaries, we would be subject to taxes payable to various jurisdictions. At December 31, 2015, the amount of indefinitely reinvested earnings was approximately $63.0 million. If all of these indefinitely reinvested earnings were distributed, we would be subject to estimated taxes of approximately $3.2 million as of December 31, 2015.
We recognize tax benefits from an uncertain tax position only if it is more likely than not that the position will be sustained upon examination by taxing authorities based on the technical merits of the position. The amount recognized is the largest benefit that we believe has greater than a 50% likelihood of being realized upon settlement. As of December 31, 2015, we had $24.9 million of unrecognized tax benefits which was included in other long-term liabilities on our consolidated balance sheet, of which $24.9 million would impact our consolidated effective tax rate if realized. A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2015 and 2014 is as follows:

 
December 31,
 
2015
 
2014
 
(in thousands)
Balance, beginning of year
$
23,248

 
$
736

Increases in unrecognized tax benefits as a result of tax positions taken during prior years
1,327

 
3,473

Decreases in unrecognized tax benefits as a result of tax positions taken during prior years
(9,592
)
 

Increases in unrecognized tax benefits as a result of tax positions taken during current year
9,931

 
19,039

Balance, end of year
$
24,914

 
$
23,248


Accrued interest and penalties totaled $2.5 million and $1.2 million as of December 31, 2015 and 2014, respectively, and were included in other long-term liabilities on our consolidated balance sheets. We recognized expense of $1.2 million, $1.0 million, and $0.2 million associated with interest and penalties during the years ended December 31, 2015, 2014 and 2013, respectively. Interest and penalties are included in income tax expense in our consolidated statements of income.
The Company is subject to taxation in various U.S., foreign, and state jurisdictions in which it conducts business. Tax years as early as 2011 remain subject to examination. As of December 31, 2015, the Company has ongoing tax audits in Nigeria, the United States, and Brazil.
Shareholders' Equity
Shareholders' Equity
Shareholders’ Equity
On November 24, 2014, the Company’s shareholders approved a share repurchase program for the repurchase of up to 8.0 million shares through May 20, 2016. Based on this authorization, the Board of Directors authorized the commencement of the program on December 1, 2014 and repurchases of up to $30.0 million under the program.
Shares under our share repurchase program are repurchased at market price on the trade date. Repurchased shares of our common stock are held as treasury shares until they are reissued or retired. Amounts paid to reacquire these shares are shown separately as a deduction from equity on the balance sheet.
During the year ended December 31, 2015, we repurchased 5.6 million shares under our share repurchase program at an aggregate cost of $21.8 million. During the year ended December 31, 2014, we repurchased 1.7 million shares under our share repurchase program at an aggregate cost of $8.2 million.
As of December 31, 2015, the Company’s share capital consists of 5.0 billion common shares authorized, $0.01 par value per share, 232.8 million common shares issued and 211.2 million common shares outstanding of which approximately 71.0% is held by Quantum Pacific (Gibraltar) Limited.
Share-Based Compensation
Share-Based Compensation
Share-Based Compensation
We recorded share-based compensation expense and related tax benefit within our consolidated statements of income as follows:
 
 
Years Ended December 31,
 
2015
 
2014
 
2013
 
(in thousands)
Operating expenses
$
4,650

 
$
3,131

 
$
2,087

General and administrative expenses
7,884

 
7,353

 
7,228

Share-based compensation expense
12,534

 
10,484

 
9,315

Tax benefit (a)
(2,690
)
 
(2,154
)
 
(2,113
)
Total
$
9,844

 
$
8,330

 
$
7,202

 
(a)
The effects of tax benefits from share-based compensation expense are included within income tax expense in our consolidated statements of income.
Stock Options
On March 31, 2011, the Board approved the creation of the Pacific Drilling S.A. 2011 Omnibus Stock Incentive Plan (the “2011 Stock Plan”), which provides for issuance of common stock options, as well as share appreciation rights, restricted shares, restricted share units and other equity based or equity related awards to directors, officers, employees and consultants. The Board also resolved that 7.2 million common shares of Pacific Drilling S.A. be reserved and authorized for issuance pursuant to the terms of the 2011 Stock Plan. On March 4, 2014, the Board approved an amendment to the 2011 Stock Plan increasing the number of common shares reserved and available for issuance from 7.2 million to 15.9 million.
The fair value of each option award is estimated on the date of grant using the Black-Scholes option valuation model utilizing the assumptions noted in the table below. Given the insufficient historical data available regarding the volatility of the Company’s traded share price, expected volatility of the Company’s share price does not solely provide a reasonable basis for estimating volatility. Instead, the expected volatility utilized in our Black-Scholes valuation model is based on the volatility of the Company’s traded share price for the period available following the initial public offering of our shares and the implied volatilities from the expected volatility of a representative group of our publicly listed industry peer group for prior periods. Additionally, given the lack of historical data available, the expected terms of the options is calculated using the simplified method because the historical option exercise experience of the Company does not provide a reasonable basis for estimating expected term. Options granted generally vest 25% annually over four years, have a 10-year contractual term and will be settled in shares of our stock. The risk free interest rates are determined using the implied yield currently available for zero-coupon U.S. government issues with a remaining term equal to the expected life of the options.
During the years ended December 31, 2015, 2014 and 2013, the fair value of the options granted was calculated using the following weighted-average assumptions:
 
 
2015
Stock Options
 
2014
Stock Options
 
2013
Stock Options
Expected volatility
40.9
%
 
46.3
%
 
47.3
%
Expected term (in years)
6.25

 
6.25

 
6.25

Expected dividends

 

 

Risk-free interest rate
1.7
%
 
1.9
%
 
1.2
%

A summary of option activity under the 2011 Stock Plan as of and for the year ended December 31, 2015 is as follows:
 
 
Number of Shares
Under Option
 
Weighted-Average
Exercise Price
 
Weighted-Average
Remaining
Contractual Term
 
Aggregate
Intrinsic
Value
 
(in thousands)
 
(per share)
 
(in years)
 
(in thousands)
Outstanding — January 1, 2015
5,029

 
$
10.00

 
 
 
 
Granted
2,729

 
3.51

 
 
 
 
Exercised

 

 
 
 
 
Cancelled or forfeited
(1,356
)
 
9.21

 
 
 
 
Outstanding — December 31, 2015
6,402

 
$
7.40

 
7.7
 
$

Exercisable — December 31, 2015
2,824

 
$
9.98

 
5.7
 
$


 The weighted-average grant date fair value of options granted during the years ended December 31, 2015, 2014 and 2013 was $1.49, $5.10 and $4.46, respectively.
During the years ended December 31, 2015, 2014 and 2013, there were 0, 0.1 million and 0 options exercised respectively. As of December 31, 2015, total compensation costs related to nonvested option awards not yet recognized was $5.3 million and was expected to be recognized over 2.5 years.
Restricted Stock Units
Pursuant to the 2011 Stock Plan, the Company has granted restricted stock units to certain members of our Board of Directors, executives and employees. Restricted stock units granted by the Company will be settled in shares of our stock and generally vest over a period of two to four years. The fair value of restricted stock units is determined using the market value of our shares on the date of grant.
A summary of restricted stock units activity under the 2011 Stock Plan as of and for the year ended December 31, 2015 was as follows:
 
 
Number of
Restricted Stock
Units
 
Weighted-Average
Grant-Date Fair
Value
 
(in thousands)
 
(per share)
Nonvested—January 1, 2015
1,767

 
$
9.99

Granted
2,393

 
3.64

Vested
(1,199
)
 
8.09

Cancelled or forfeited
(469
)
 
6.95

Nonvested—December 31, 2015
2,492

 
$
5.39


The weighted-average grant-date fair value of restricted stock units granted was $10.06 and $9.93 per share for the years
ended December 31, 2014 and 2013, respectively. The total grant-date fair value of the restricted stock units vested was $9.7 million, $4.1 million and $1.7 million for the years ended December 31, 2015, 2014 and 2013, respectively.
As of December 31, 2015, total compensation costs related to nonvested restricted stock units not yet recognized was $8.2 million and is expected to be recognized over a weighted-average period of 2.6 years.
Earnings per Share
Earnings per Share
Earnings per Share
The following reflects the income and the share data used in the basic and diluted EPS computations:
 
 
Years Ended December 31,
 
2015
 
2014
 
2013
 
(in thousands, except per share amounts)
Numerator:
 
 
 
 
 
Net income, basic and diluted
$
126,230

 
$
188,257

 
$
25,502

Denominator:
 
 
 
 
 
Weighted-average number of common shares outstanding, basic
211,454

 
217,223

 
216,964

Effect of share-based compensation awards
103

 
153

 
457

Weighted-average number of common shares outstanding, diluted
211,557

 
217,376

 
217,421

Earnings per share:
 
 
 
 
 
Basic
$
0.60

 
$
0.87

 
$
0.12

Diluted
$
0.60

 
$
0.87

 
$
0.12


 
The following table presents the share effects of share-based compensation awards excluded from our computations of diluted EPS as their effect would have been anti-dilutive for the periods presented:
 
 
Years Ended December 31,
 
2015
 
2014
 
2013
 
(in thousands)
Share-based compensation awards
8,891

 
6,196

 
5,817

Derivatives
Derivatives
Derivatives
We are currently exposed to market risk from changes in interest rates and foreign exchange rates. From time to time, we may enter into a variety of derivative financial instruments in connection with the management of our exposure to fluctuations in interest rates and foreign exchange rates. We do not enter into derivative transactions for speculative purposes; however, for accounting purposes, certain transactions may not meet the criteria for hedge accounting.
On May 30, 2013, we entered into an interest rate swap as a cash flow hedge against future fluctuations in LIBOR rates with an effective date of June 3, 2013. The interest rate swap has a notional value of $712.5 million, does not amortize and matures on December 3, 2017. On a quarterly basis, we pay a fixed rate of 1.56% and receive the maximum of 1% or three-month LIBOR.
On June 10, 2013, we entered into an interest rate swap as a cash flow hedge against future fluctuations in LIBOR rates with an effective date of July 1, 2014. The interest rate swap has a notional value of $400.0 million, does not amortize and matures on July 1, 2018. On a quarterly basis, we pay a fixed rate of 1.66% and receive three-month LIBOR.
On December 17, 2014, we entered into a series of foreign currency forward contracts as a cash flow hedge against future exchange rate fluctuations between the Euro and U.S. Dollar. We are using the forward contracts to hedge Euro payments for forecasted capital expenditures. As of December 31, 2015, the remaining forward contracts have a notional value of €3.8 million and will be settled in 2016. Upon settlement, we pay U.S. Dollars and receive Euros at forward rates ranging from $1.25 to $1.27. As a result of partially settling the effective hedge for the year ended 2015, we incurred a net cash outflow of $1.2 million based on the prevailing Euro exchange rate and reclassified the amount from accumulated other comprehensive income to property and equipment.
The following table provides data about the fair values of derivatives that are designated as hedge instruments:
 
Derivatives Designated as
Hedging Instruments
 
 
 
December 31,
 
Balance Sheet Location
 
2015
 
2014
 
 
 
 
(in thousands)
Long-term—Interest rate swaps
 
Other assets
 
$

 
$
5,601

Short-term—Interest rate swaps
 
Derivative liabilities, current
 
(5,899
)
 
(8,381
)
Long-term—Interest rate swaps
 
Other long-term liabilities
 
(238
)
 

Short-term—Foreign currency forward contracts
 
Derivative liabilities, current
 
(1,584
)
 
(267
)
Long-term—Foreign currency forward contracts
 
Other long-term liabilities
 

 
(296
)
Total
 
 
 
$
(7,721
)
 
$
(3,343
)

We have elected not to offset the fair value of derivatives subject to master netting agreements, but to report them on a gross basis on our consolidated balance sheets.
The following table summarizes the cash flow hedge gains and losses: 
Derivatives in Cash Flow
Hedging Relationships
 
Gain (Loss) Recognized
in Other Comprehensive Income (“OCI”) for the Years Ended
December 31,
 
Loss Reclassified
from Accumulated OCI into
Income for the Years Ended
December 31,
 
Gain (Loss) Recognized in Income
(Ineffective Portion and Amount
Excluded from Effectiveness
Testing) for the Years ended
December 31,
 
2015
 
2014
 
2013
 
2015
 
2014
 
2013
 
2015
 
2014
 
2013
 
 
(in thousands)
Interest rate swaps
 
$
(1,701
)
 
$
(11,085
)
 
$
49,859

 
$
10,440

 
$
7,737

 
$
47,720

 
$

 
$

 
$

Foreign currency forward contracts
 
$
(1,584
)
 
$
(563
)
 
$

 
$

 
$

 
$

 
$
(296
)
 
$

 
$


As of December 31, 2015, the estimated amount of net losses associated with derivative instruments that would be reclassified from accumulated comprehensive loss to earnings during the next twelve months was $6.7 million. During the years ended December 31, 2015, 2014 and 2013, we reclassified $9.6 million, $7.0 million and $47.1 million to interest expense and $0.8 million, $0.8 million and $0.6 million to depreciation from accumulated other comprehensive income, respectively.
Fair Value Measurements
Fair Value Measurements
Fair Value Measurements
We estimated fair value by using appropriate valuation methodologies and information available to management as of December 31, 2015 and 2014. Considerable judgment is required in developing these estimates, and accordingly, estimated values may differ from actual results.
The estimated fair value of accounts receivable, accounts payable and accrued expenses approximated their carrying value due to their short-term nature. It is not practicable to estimate the fair value of our receivable from SHI. The estimated fair value of our SSCF debt and 2013 Revolving Credit Facility approximated carrying value because the variable rates approximate current market rates. The following table presents the carrying value and estimated fair value of our other long-term debt instruments:
 
 
December 31,
 
2015
 
2014
 
Carrying
Value
 
Estimated
Fair Value
 
Carrying
Value
 
Estimated
Fair Value
 
(in thousands)
2015 Senior Unsecured Bonds
$

 
$

 
$
286,500

 
$
284,351

2017 Senior Secured Bonds
498,887

 
250,000

 
498,369

 
447,500

2018 Senior Secured Term Loan B
729,458

 
307,125

 
736,206

 
614,551

2020 Senior Secured Notes
750,000

 
322,500

 
750,000

 
600,000


 
We estimate the fair values of our variable-rate and fixed-rate debt using quoted market prices to the extent available and significant other observable inputs, which represent Level 2 fair value measurements.
The following table presents the carrying value and estimated fair value of our financial instruments recognized at fair value on a recurring basis:
 
 
December 31, 2015
 
 
 
Fair Value Measurements Using
 
Carrying Value
 
Level 1
 
Level 2
 
Level 3
 
(in thousands)
Liabilities:
 
 
 
 
 
 
 
Interest rate swaps
$
(6,137
)
 

 
$
(6,137
)
 

Foreign currency forward contracts
$
(1,584
)
 

 
$
(1,584
)
 

 
 
 
 
 
 
 
 
 
December 31, 2014
 
 
 
Fair Value Measurements Using
 
Carrying Value
 
Level 1
 
Level 2
 
Level 3
 
(in thousands)
Assets:
 
 
 
 
 
 
 
Interest rate swaps
$
5,601

 

 
$
5,601

 

Liabilities:
 
 
 
 
 
 
 
Interest rate swaps
$
(8,381
)
 

 
$
(8,381
)
 

Foreign currency forward contracts
$
(563
)
 

 
$
(563
)
 


We use an income approach to value assets and liabilities for outstanding interest rate swaps and foreign currency forward contracts. These contracts are valued using a discounted cash flow model that calculates the present value of future cash flows under the terms of the contracts using market information as of the reporting date, such as prevailing interest rates and forward rates. The determination of the fair values above incorporated various factors, including the impact of the counterparty’s non-performance risk with respect to our financial assets and our non-performance risk with respect to our financial liabilities.
See Note 10 for further discussion of our use of derivative instruments and their fair values.
Commitments and Contingencies
Commitments and Contingencies
Commitments and Contingencies
Operating Leases—We lease office space in countries in which we operate. As of December 31, 2015, the future minimum lease payments under the non-cancelable operating leases with lease terms in excess of one year was as follows:
 
 
 
 
(In thousands)
Years Ending December 31,
 
2016
$
2,327

2017
2,259

2018
2,183

2019
2,083

2020
2,121

Thereafter
8,102

Total future minimum lease payments
$
19,075


During the years ended December 31, 2015, 2014 and 2013, rent expense was $3.0 million, $4.5 million and $2.0 million, respectively. 
Commitments—As of December 31, 2015, following our rescission of the Construction Contract for the Pacific Zonda, we had no material commitments for capital expenditures related to the construction of a newbuild drillship.
Our liquidity fluctuates depending on a number of factors, including, among others, our revenue efficiency and the timing of accounts receivable collection as well as payments for operating costs and debt repayments. Primary sources of funds for our short-term liquidity needs are expected to be our cash balances and cash flow generated from operating and financing activities, which includes availability under the 2013 Revolving Credit Facility. We believe that these sources will provide sufficient liquidity over the next twelve months to fund our working capital needs and scheduled payments on our long-term debt.
Customs Bonds—As of December 31, 2015, we were contingently liable under certain customs bonds totaling approximately $227.9 million issued as security in the normal course of our business.
Contingencies—It is to be expected that we and our subsidiaries will routinely be involved in litigation and disputes arising in the ordinary course of our business.
On April 16, 2013, Transocean Offshore Deepwater Drilling, Inc. (“Transocean”) filed a complaint against us in the United States District Court for the Southern District of Texas alleging infringement of their dual activity patents, supplemented by an Amended Complaint filed on May 13, 2013. In its Amended Complaint, Transocean seeks relief in the form of a permanent injunction, compensatory damages, enhanced damages, court costs and fees. On May 31, 2013, we filed our Answer to the Amended Complaint and our Counterclaims seeking Declaratory Judgments that we do not infringe the asserted Transocean patents and that such patents are invalid and unenforceable. The Court issued its claim construction order on May 27, 2015, and the trial is currently scheduled for August 8, 2016. We do not believe that the ultimate liability, if any, resulting from this litigation will have a material adverse effect on our financial position, results of operations or cash flows.
On October 29, 2015, we exercised our right to rescind the Construction Contract for the drillship the Pacific Zonda due to SHI’s failure to timely deliver the drillship in accordance with the contractual specifications. SHI rejected our rescission, and on November 25, 2015, formally commenced arbitration proceedings against us in London (as specified in the Construction Contract) and notified us of its appointed arbitrator. SHI claims that we wrongfully rejected their tendered delivery of the drillship and seeks the final installment of the purchase price under the Construction Contract. We responded on November 27, 2015 with notice of our appointed arbitrator. The two arbitrators have selected a third arbitrator, thus completing the tribunal. On November 30, 2015, we made demand under the third party refund guarantee accompanying the Construction Contract for the amount of our advance payments made under the Construction Contract, plus interest. Any payment under the refund guarantee is suspended until an award under the arbitration is obtained. Pursuant to a mutually agreed scheduling order, SHI filed its claims submission on January 29, 2016. We responded with our defense and counterclaim on February 26, 2016 and, in addition to seeking repayment of our advance payments made under the Construction Contract, our counterclaim also seeks the return of our purchased equipment, or the value of such equipment, and damages for our wasted expenditures. We do not expect a resolution on this matter within the next 12 months, and we do not believe that the ultimate liability, if any, resulting from this arbitration will have a material adverse effect on our financial position, results of operations or cash flows.
Concentrations of Credit and Market Risk
Concentrations of Credit and Market Risk
Concentrations of Credit and Market Risk
Financial instruments that potentially subject the Company to credit risk are primarily cash equivalents and accounts receivable. At times, cash equivalents may be in excess of FDIC insurance limits. With regards to accounts receivable, we have an exposure from our concentration of clients within the oil and natural gas industry. This industry concentration has the potential to impact our exposure to credit and market risks as our clients could be affected by similar changes in economic, industry or other conditions. However, we believe that the credit risk posed by this industry concentration is largely offset by the creditworthiness of our client base. During the years ended December 31, 2015, 2014 and 2013, the percentage of revenues earned from our clients was as follows:
 
 
Years Ended December 31,
 
2015
 
2014
 
2013
Chevron
81.2
%
 
67.4
%
 
55.6
%
Total
17.2
%
 
17.3
%
 
22.6
%
Petrobras
1.6
%
 
15.3
%
 
21.8
%

Some of our employees in Nigeria are represented by unions. As of December 31, 2015, approximately 20% of our labor force was covered by collective bargaining agreements, all of which are subject to annual salary negotiation.
Segments and Geographic Areas
Segments and Geographic Areas
Segments and Geographic Areas
Our drillships are part of a single, global market for contract drilling services and can be redeployed globally due to changing demands. We consider the operations of each of our drillships to be an operating segment. We evaluate the financial performance of each of our drillships and our overall fleet based on several factors, including revenues from clients and operating profit. The consolidation of our operating segments into one reportable segment is attributable to how we manage our fleet, including the nature of our services provided, type of clients we serve and the ability of our drillships to operate in a single, global market. The accounting policies of our operating segments are the same as those described in the summary of significant accounting policies. See Note 2.
As of December 31, 2015, the Pacific Bora and the Pacific Scirocco were located offshore Nigeria, the Pacific Santa Ana and the Pacific Sharav were located offshore the United States. As of December 31, 2015, the Pacific Mistral and the Pacific Meltem were anchored at Aruba, and the Pacific Khamsin was demobilizing after recently completing its drilling contract offshore Nigeria.
During the years ended December 31, 2015, 2014 and 2013, the percentage of revenues earned by geographic area, based on drilling location, is as follows:
 
 
Years Ended December 31,
 
2015
 
2014
 
2013
Nigeria
60.3
%
 
60.2
%
 
52.1
%
Gulf of Mexico
38.1
%
 
24.5
%
 
26.1
%
Brazil
1.6
%
 
15.3
%
 
21.8
%
Variable Interest Entities
Variable Interest Entities
Variable Interest Entities

The carrying amounts associated with our consolidated variable interest entities, after eliminating the effect of intercompany transactions, were as follows:

 
December 31,
 
2015
 
2014
 
(in thousands)
Assets
$
17,612

 
$
18,349

Liabilities
(19,250
)
 
(10,559
)
Net carrying amount
$
(1,638
)
 
$
7,790



PIDWAL is a joint venture formed to provide ultra-deepwater drilling services in Nigeria and to hold equity investment in PDNL. PDNL is a company owned by us and PIDWAL, formed to hold the equity investments in certain of our rig-owning entities operating in Nigeria. We determined that each of these companies met the criteria of a variable interest entity for accounting purposes because its equity at risk was insufficient to permit it to carry on its activities without additional subordinated financial support from us. We also determined that we were the primary beneficiary for accounting purposes since (a) for PIDWAL, we had the power to direct the day-to-day management and operations of the entity, and for PDNL we had the power to secure and direct its equity investment, which are the activities that most significantly impact each entity’s economic performance, and (b) we had the obligation to absorb losses or the right to receive a majority of the benefits that could be potentially significant to the variable interest entities. As a result, we consolidate PIDWAL and PDNL in our consolidated financial statements.

During the years ended December 31, 2015 and 2014, we provided financial support to PIDWAL to enable it to operate as a going concern by funding its working capital via intercompany loans and payables. We also issued corporate guarantees in the amount of $227.9 million in customs bonds issued as credit support for temporary import bonds issued in favor of PIDWAL as of December 31, 2015.

During the years ended December 31, 2015 and 2014, we provided financial support to PDNL to fund its equity investment in our rig-owning entities operating in Nigeria via intercompany loans. Both the equity investment and intercompany loans of PDNL are eliminated upon consolidation.
Retirement Plans
Retirement Plans
Retirement Plans
Pacific Drilling sponsors a defined contribution retirement plan covering substantially all U.S. employees and an international savings plan. During the years ended December 31, 2015, 2014 and 2013, our total employer contributions to both plans amounted to $7.0 million, $6.9 million and $4.5 million, respectively.
Supplemental Cash Flow Information
Supplemental Cash Flow Information
Supplemental Cash Flow Information
During the years ended December 31, 2015, 2014 and 2013, we paid $164.5 million, $135.4 million and $87.7 million of interest, net of amounts capitalized, respectively. During the years ended December 31, 2015, 2014 and 2013, we paid income taxes of $27.2 million, $31.7 million, and $22.0 million, respectively.
Within our consolidated statements of cash flows, capital expenditures represent expenditures for which cash payments were made during the period. These amounts exclude accrued capital expenditures, which are capital expenditures that were accrued but unpaid. During the years ended December 31, 2015, 2014 and 2013, changes in accrued capital expenditures were $9.9 million, $(23.9) million and $17.3 million, respectively.
During the years ended December 31, 2015, 2014 and 2013, non-cash amortization of deferred financing costs and accretion of debt discount totaling $3.5 million, $5.1 million and $7.1 million were capitalized to property and equipment, respectively. Accordingly, these amounts are excluded from capital expenditures in our consolidated statements of cash flows for the years ended December 31, 2015, 2014 and 2013.
Significant Accounting Policies (Policies)
Principles of Consolidation—The consolidated financial statements include the accounts of Pacific Drilling S.A., consolidated subsidiaries that we control by ownership of a majority voting interest and entities that meet the criteria for variable interest entities for which we are deemed to be the primary beneficiary for accounting purposes. We eliminate all intercompany transactions and balances in consolidation.
We are party to a Nigerian joint venture, Pacific International Drilling West Africa Limited (“PIDWAL”), with Derotech Offshore Services Limited (“Derotech”), a privately-held Nigerian registered limited liability company. Derotech owns 51% of PIDWAL and PIDWAL has a 50% ownership interest in two of our rig holding subsidiaries, Pacific Bora Ltd. and Pacific Scirocco Ltd. PIDWAL’s interest in the rig holding subsidiaries is held through a holding company of PIDWAL, Pacific Drillship Nigeria Limited (“PDNL”). Derotech will not accrue the economic benefits of its interest in PIDWAL unless and until it satisfies certain outstanding obligations to us and a certain pledge is cancelled by us. Likewise PIDWAL will not accrue the economic benefits of its interest in PDNL unless and until it satisfies certain outstanding obligations to us and a certain pledge is cancelled by us. PIDWAL and PDNL are variable interest entities for which we are the primary beneficiary. Accordingly, we consolidated all interests of PIDWAL and PDNL and no portion of their operating results is allocated to the noncontrolling interest. See Note 15—Variable Interest Entities.
In addition to the joint venture agreement, we are a party to marketing and logistic services agreements with Derotech and an affiliated company of Derotech.
Accounting Estimates—The preparation of consolidated financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”) requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the balance sheet date and the amounts of revenues and expenses recognized during the reporting period. On an ongoing basis, we evaluate our estimates and assumptions, including those related to allowance for doubtful accounts, financial instruments, depreciation of property and equipment, impairment of long-lived assets, long-term receivable, income taxes, share-based compensation and contingencies. We base our estimates and assumptions on historical experience and on various other factors we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from such estimates.
Revenues and Operating Expenses—Contract drilling revenues are recognized as earned, based on contractual dayrates. In connection with drilling contracts, we may receive fees for preparation and mobilization of equipment and personnel or for capital improvements to rigs. Fees and incremental costs incurred directly related to contract preparation and mobilization along with reimbursements received for capital expenditures are deferred and amortized to revenue over the primary term of the drilling contract. The cost incurred for reimbursed capital expenditures are depreciated over the estimated useful life of the asset. 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. These conditional fees and related expenses are reported in income upon completion of the drilling contract. If receipt of such fees is not conditional, they are recognized as revenue over the primary term of the drilling contract. Amortization of deferred revenue and deferred mobilization costs are recorded on a straight-line basis over the primary drilling contract term, which is consistent with the general pace of activity, level of services being provided and dayrates being earned over the life of the contract.
Cash and Cash Equivalents—Cash equivalents are highly liquid investments with original maturities of three months or less that are readily convertible to known amounts of cash.
Accounts Receivable—We record trade accounts receivable at the amount we invoice our clients. We provide an allowance for doubtful accounts, as necessary, based on a review of outstanding receivables, historical collection information and existing economic conditions. We do not generally require collateral or other security for receivables.
Materials and Supplies—Materials and supplies held for consumption are carried at average cost, net of allowances for excess or obsolete materials and supplies
Property and Equipment—High-specification drillships are recorded at cost of construction, including any major capital improvements, less accumulated depreciation and if applicable, impairment. Other property and equipment is recorded at cost and consists of purchased software systems, furniture, fixtures and other equipment. Ongoing maintenance, routine repairs and minor replacements are expensed as incurred.
Interest is capitalized based on the costs of new borrowings attributable to qualifying new construction or at the weighted-average cost of debt outstanding during the period of construction. We capitalize interest costs for qualifying new construction from the point borrowing costs are incurred for the qualifying new construction and cease when substantially all the activities necessary to prepare the qualifying asset for its intended use are complete.
Property and equipment are depreciated to their salvage value on a straight-line basis over the estimated useful lives of each class of assets. Our estimated useful lives of property and equipment are as follows:
 
 
Years
Drillships and related equipment
15-35
Other property and equipment
2-7

 
We review property and equipment for impairment when events or changes in circumstances indicate that the carrying amounts of our assets held and used may not be recoverable. Potential impairment indicators include steep declines in commodity prices and related market conditions, actual or expected declines in rig utilization, increases in idle time, cancellations of contracts or credit concerns of clients. We assess impairment using estimated undiscounted cash flows for the property and equipment being evaluated by applying assumptions regarding future operations, market conditions, dayrates, utilization and idle time. An impairment loss is recorded in the period if the carrying amount of the asset is not recoverable.
Deferred Financing Costs—Deferred financing costs associated with long-term debt are carried at cost and are amortized to interest expense using the effective interest rate method over the term of the applicable long-term debt.
Foreign Currency Transactions—The consolidated financial statements are stated in U.S. dollars. We have designated the U.S. dollar as the functional currency for our foreign subsidiaries in international locations because we contract with clients, purchase equipment and finance capital using the U.S. dollar. Transactions in other currencies have been translated into U.S. dollars at the rate of exchange on the transaction date. Any gain or loss arising from a change in exchange rates subsequent to the transaction date is included as an exchange gain or loss. Monetary assets and liabilities denominated in currencies other than U.S. dollars are reported at the rates of exchange prevailing at the end of the reporting period.
Earnings per Share—Basic earnings per common share (“EPS”) is computed by dividing the net income by the weighted-average number of common shares outstanding for the period. Basic and diluted EPS are retrospectively adjusted for the effects of stock dividends or stock splits. Diluted EPS reflects the potential dilution from securities that could share in the earnings of the Company. Anti-dilutive securities are excluded from diluted EPS.
Fair Value Measurements—We estimate fair value at the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal market for the asset or liability. Our valuation techniques require inputs that are categorized using a three-level hierarchy as follows: (1) unadjusted quoted prices for identical assets or liabilities in active markets (“Level 1”), (2) direct or indirect observable inputs, including quoted prices or other market data, for similar assets or liabilities in active markets or identical assets or liabilities in less active markets (“Level 2”) and (3) unobservable inputs that require significant judgment for which there is little or no market data (“Level 3”). When multiple input levels are required for a valuation, we categorize the entire fair value measurement according to the lowest level input that is significant to the measurement even though we may have also utilized significant inputs that are more readily observable.
Share-Based Compensation—The grant date fair value of share-based awards granted to employees is recognized as an employee compensation expense over the requisite service period on a straight-line basis. The amount of compensation expense recognized is adjusted to reflect the number of awards for which the related vesting conditions are expected to be met. The amount of compensation expense ultimately recognized is based on the number of awards that do meet the vesting conditions at the vesting date.
Derivatives—We apply cash flow hedge accounting to interest rate swaps that are designated as hedges of the variability of future cash flows. The derivative financial instruments are recorded in our consolidated balance sheet at fair value as either assets or liabilities. Changes in the fair value of derivatives designated as cash flow hedges, to the extent the hedge is effective, are recognized in accumulated other comprehensive income until the hedged item is recognized in earnings.
Hedge effectiveness is measured on an ongoing basis to ensure the validity of the hedges based on the relative cumulative changes in fair value between the derivative contract and the hedged item over time. Any change in fair value resulting from ineffectiveness is recognized immediately in earnings. Hedge accounting is discontinued prospectively if it is determined that the derivative is no longer effective in offsetting changes in the cash flows of the hedged item.
For interest rate hedges related to interest capitalized in the construction of fixed assets, other comprehensive income is released to earnings as the asset is depreciated over its useful life. For all other interest rate hedges, other comprehensive income is released to earnings as interest expense is accrued on the underlying debt.
Contingencies—We record liabilities for estimated loss contingencies when we believe a loss is probable and the amount of the probable loss can be reasonably estimated. Once established, we adjust the estimated contingency loss accrual for changes in facts and circumstances that alter our previous assumptions with respect to the likelihood or amount of loss.
Income Taxes—Income taxes are provided based upon the tax laws and rates in the countries in which our subsidiaries are registered and where their operations are conducted and income and expenses are earned and incurred, respectively. We recognize deferred tax assets and liabilities for the anticipated future tax effects of temporary differences between the financial statement basis and the tax basis of our assets and liabilities using the applicable enacted tax rates in effect the year in which the asset is realized or the liability is settled. A valuation allowance for deferred tax assets is established when it is more likely than not that some portion or all of the deferred tax assets will not be realized.
We recognize tax benefits from an uncertain tax position only if it is more likely than not that the position will be sustained upon examination by taxing authorities based on the technical merits of the position. The amount recognized is the largest benefit that we believe has greater than a 50% likelihood of being realized upon settlement. Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations and the final audit of tax returns by taxing authorities. We recognize interest and penalties related to uncertain tax positions in income tax expense.
Recently Issued Accounting Standards
Revenue Recognition — On May 28, 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This standard will replace most existing revenue recognition guidance under GAAP when it becomes effective. The standard will be effective for annual periods and interim periods beginning after December 15, 2017. We plan to adopt the new standard on January 1, 2018. The standard permits the use of either the retrospective or cumulative effect transition method. We have not yet selected a transition method, nor have we determined the effect the standard may have on our consolidated financial statements and related disclosures.
Debt Issuance Costs — On April 7, 2015, FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30) - Simplifying the Presentation of Debt Issuance Costs, which requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the debt liability rather than as an asset. Early adoption is permitted. Upon adoption, an entity must apply the new guidance retrospectively to all prior periods presented in the financial statements. We plan to adopt the standard on a retrospective basis effective January 1, 2016 and expect that it will result in the netting of our deferred financing costs against long-term debt balances on the consolidated balance sheets for the periods presented and related disclosure. There will be no impact to the manner in which deferred financing costs are amortized in our consolidated financial statements.
Deferred Taxes — On November 20, 2015, FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes, which requires all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. The new guidance does not change the existing requirement that only permits offsetting within a tax jurisdiction. The standard will be effective for annual and interim periods beginning after December 15, 2016, and may be applied prospectively or retrospectively. Early adoption is permitted. We have not yet adopted nor selected a transition method and are currently evaluating the impact it may have on our consolidated financial statements.
Leases — On February 25, 2016, FASB issued ASU 2016-02, Leases, which requires the balance sheet recognition of lease assets and lease liabilities by lessees for virtually all of their leases. Lessees and lessors will be required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. These practical expedients relate to the identification and classification of leases that commenced before the effective date, initial direct costs for leases that commenced before the effective date, and the ability to use hindsight in evaluating lessee options to extend or terminate a lease or to purchase the underlying asset. The standard will be effective for our annual and interim periods beginning January 1, 2019. Early adoption is permitted. We have not yet evaluated the standard nor determined our implementation method upon adoption or what impact it will have on our consolidated financial statements.
Significant Accounting Policies (Tables)
Estimated useful lives of property and equipment
Our estimated useful lives of property and equipment are as follows:
 
 
Years
Drillships and related equipment
15-35
Other property and equipment
2-7
Property and equipment consists of the following:
 
 
December 31,
 
2015
 
2014
 
(in thousands)
Drillships and related equipment
$
5,856,564

 
$
5,907,226

Other property and equipment
14,938

 
10,353

Property and equipment, cost
5,871,502

 
5,917,579

Accumulated depreciation
(727,946
)
 
(485,756
)
Property and equipment, net
$
5,143,556

 
$
5,431,823

Property and Equipment (Tables)
Summary of property and equipment
Our estimated useful lives of property and equipment are as follows:
 
 
Years
Drillships and related equipment
15-35
Other property and equipment
2-7
Property and equipment consists of the following:
 
 
December 31,
 
2015
 
2014
 
(in thousands)
Drillships and related equipment
$
5,856,564

 
$
5,907,226

Other property and equipment
14,938

 
10,353

Property and equipment, cost
5,871,502

 
5,917,579

Accumulated depreciation
(727,946
)
 
(485,756
)
Property and equipment, net
$
5,143,556

 
$
5,431,823

Debt (Tables)
Debt consists of the following:
 
December 31,
 
2015
 
2014
 
(in thousands)
Due within one year:
 
 
 
2015 Senior Unsecured Bonds
$

 
$
286,500

2018 Senior Secured Term Loan B
7,500

 
7,500

Senior Secured Credit Facility
82,083

 
75,000

Total current debt
89,583

 
369,000

Long-term debt:
 
 
 
2017 Senior Secured Bonds
498,887

 
498,369

2018 Senior Secured Term Loan B
721,958

 
728,706

2013 Revolving Credit Facility
50,000

 

Senior Secured Credit Facility
775,000

 
804,167

2020 Senior Secured Notes
750,000

 
750,000

Total long-term debt
2,795,845

 
2,781,242

Total debt
$
2,885,428

 
$
3,150,242

As of December 31, 2015, the aggregate maturities of our debt, including net unamortized discounts of $2.9 million, was as follows:
 
(in thousands)
Years ending December 31,
2016
$
89,583

2017
589,584

2018
848,333

2019
610,833

2020
750,000

Thereafter

Total
$
2,888,333

Income Taxes (Tables)
Income before income taxes consists of the following:
 
 
Years ended December 31,
 
2015
 
2014
 
2013
 
(in thousands)
Luxembourg
$
94,558

 
$
36,783

 
$
55,904

United States
4,812

 
3,631

 
206

Other Jurisdictions
55,731

 
193,463

 
(8,085
)
Total
$
155,101

 
$
233,877

 
$
48,025

The components of income tax (provision) / benefit consists of the following:
 
 
Years ended December 31,
 
2015
 
2014
 
2013
 
(in thousands)
Current income tax expense:
 
 
 
 
 
Luxembourg
$
(1,107
)
 
$
(979
)
 
$
(816
)
United States
(2,347
)
 
(6,030
)
 
(1,885
)
Other Foreign
(15,577
)
 
(19,950
)
 
(22,941
)
Total current
$
(19,031
)
 
$
(26,959
)
 
$
(25,642
)
Deferred tax benefit (expense):
 
 
 
 
 
Luxembourg
$
(2,908
)
 
$
(1
)
 
$
(32
)
United States
(1,071
)
 
4,281

 
2,053

Other Foreign
(5,861
)
 
(22,941
)
 
1,098

Total deferred
$
(9,840
)
 
$
(18,661
)
 
$
3,119

Income tax expense
$
(28,871
)
 
$
(45,620
)
 
$
(22,523
)
A reconciliation between the Luxembourg statutory rate of 29.2% for the years ended December 31, 2015, 2014 and 2013 and our effective tax rate is as follows:
 
 
Years ended December 31,
 
2015
 
2014
 
2013
Statutory rate
29.2
 %
 
29.2
 %
 
29.2
 %
Effect of tax rates different than the Luxembourg statutory tax rate
(22.5
)%
 
(27.6
)%
 
25.2
 %
Change in valuation allowance
10.6
 %
 
10.2
 %
 
(9.0
)%
Changes in unrecognized tax benefits
1.9
 %
 
10.1
 %
 
1.9
 %
Equity based compensation shortfall
1.4
 %
 
 %
 
 %
Adjustments related to prior years
(2.0
)%
 
(2.4
)%
 
(0.4
)%
Effective tax rate
18.6
 %
 
19.5
 %
 
46.9
 %
The components of deferred tax assets and liabilities consists of the following:
 
 
December 31,
 
2015
 
2014
 
(in thousands)
Deferred tax assets:
 
 
 
Net operating loss carryforwards
$
40,422

 
$
33,537

Depreciation and amortization
62,702

 
54,815

Accrued payroll expenses
7,662

 
9,086

Deferred revenue
8,851

 
19,107

Other
2,025

 
1,187

Deferred tax assets
121,662

 
117,732

Less: valuation allowance
(94,422
)
 
(78,328
)
Total deferred tax assets
$
27,240

 
$
39,404

Deferred tax liabilities:
 
 
 
Depreciation and amortization
$
(3,642
)
 
$

Deferred expenses
(12,483
)
 
(21,937
)
Other
(1,817
)
 
(1,220
)
Total deferred tax liabilities
$
(17,942
)
 
$
(23,157
)
Net deferred tax assets
$
9,298

 
$
16,247

A reconciliation of the beginning and ending amount of unrecognized tax benefits for the years ended December 31, 2015 and 2014 is as follows:

 
December 31,
 
2015
 
2014
 
(in thousands)
Balance, beginning of year
$
23,248

 
$
736

Increases in unrecognized tax benefits as a result of tax positions taken during prior years
1,327

 
3,473

Decreases in unrecognized tax benefits as a result of tax positions taken during prior years
(9,592
)
 

Increases in unrecognized tax benefits as a result of tax positions taken during current year
9,931

 
19,039

Balance, end of year
$
24,914

 
$
23,248

Share-Based Compensation (Tables)
We recorded share-based compensation expense and related tax benefit within our consolidated statements of income as follows:
 
 
Years Ended December 31,
 
2015
 
2014
 
2013
 
(in thousands)
Operating expenses
$
4,650

 
$
3,131

 
$
2,087

General and administrative expenses
7,884

 
7,353

 
7,228

Share-based compensation expense
12,534

 
10,484

 
9,315

Tax benefit (a)
(2,690
)
 
(2,154
)
 
(2,113
)
Total
$
9,844

 
$
8,330

 
$
7,202

 
(a)
The effects of tax benefits from share-based compensation expense are included within income tax expense in our consolidated statements of income.
During the years ended December 31, 2015, 2014 and 2013, the fair value of the options granted was calculated using the following weighted-average assumptions:
 
 
2015
Stock Options
 
2014
Stock Options
 
2013
Stock Options
Expected volatility
40.9
%
 
46.3
%
 
47.3
%
Expected term (in years)
6.25

 
6.25

 
6.25

Expected dividends

 

 

Risk-free interest rate
1.7
%
 
1.9
%
 
1.2
%
A summary of option activity under the 2011 Stock Plan as of and for the year ended December 31, 2015 is as follows:
 
 
Number of Shares
Under Option
 
Weighted-Average
Exercise Price
 
Weighted-Average
Remaining
Contractual Term
 
Aggregate
Intrinsic
Value
 
(in thousands)
 
(per share)
 
(in years)
 
(in thousands)
Outstanding — January 1, 2015
5,029

 
$
10.00

 
 
 
 
Granted
2,729

 
3.51

 
 
 
 
Exercised

 

 
 
 
 
Cancelled or forfeited
(1,356
)
 
9.21

 
 
 
 
Outstanding — December 31, 2015
6,402

 
$
7.40

 
7.7
 
$

Exercisable — December 31, 2015
2,824

 
$
9.98

 
5.7
 
$

A summary of restricted stock units activity under the 2011 Stock Plan as of and for the year ended December 31, 2015 was as follows:
 
 
Number of
Restricted Stock
Units
 
Weighted-Average
Grant-Date Fair
Value
 
(in thousands)
 
(per share)
Nonvested—January 1, 2015
1,767

 
$
9.99

Granted
2,393

 
3.64

Vested
(1,199
)
 
8.09

Cancelled or forfeited
(469
)
 
6.95

Nonvested—December 31, 2015
2,492

 
$
5.39

Earnings per Share (Tables)
The following reflects the income and the share data used in the basic and diluted EPS computations:
 
 
Years Ended December 31,
 
2015
 
2014
 
2013
 
(in thousands, except per share amounts)
Numerator:
 
 
 
 
 
Net income, basic and diluted
$
126,230

 
$
188,257

 
$
25,502

Denominator:
 
 
 
 
 
Weighted-average number of common shares outstanding, basic
211,454

 
217,223

 
216,964

Effect of share-based compensation awards
103

 
153

 
457

Weighted-average number of common shares outstanding, diluted
211,557

 
217,376

 
217,421

Earnings per share:
 
 
 
 
 
Basic
$
0.60

 
$
0.87

 
$
0.12

Diluted
$
0.60

 
$
0.87

 
$
0.12

The following table presents the share effects of share-based compensation awards excluded from our computations of diluted EPS as their effect would have been anti-dilutive for the periods presented:
 
 
Years Ended December 31,
 
2015
 
2014
 
2013
 
(in thousands)
Share-based compensation awards
8,891

 
6,196

 
5,817

Derivatives (Tables)
The following table provides data about the fair values of derivatives that are designated as hedge instruments:
 
Derivatives Designated as
Hedging Instruments