Archer Ltd

OSE:ARCH

Earnings Call Transcript

[Operator]

Good day, and welcome to the Archer First Quarter 2018 Earnings Release Conference Call.Today's conference is being recorded.At this time, I would like to turn the conference over to John Lechner, CEO. Please go ahead.

[John Lechner, Chief Executive Officer]

Thank you, Paul. Good morning or good afternoon, ladies and gentlemen, and thank you for joining us for Archer's First Quarter 2018 Earnings Conference Call.The call is being hosted jointly from Houston and Oslo. And I'm on the call together with Dag Skindlo, our Chief Financial Officer.As always, please note that the information provided in today's call includes forward-looking statements as well as non-GAAP financial measures.I will summarize Archer's operational highlights from the first quarter before handing over the call to Dag, who will review the financials and comment on our market outlook. Before ending the call, we will open the line for questions.Operating revenue in the first quarter amounted to $218.3 million, up 8% from the same quarter last year. And EBITDA before exceptional items ended at $18.1 million.On the 2nd of April, Statoil announced that Archer was awarded 12 of the 18 drilling platforms tendered on the Norwegian continental shelf. Platform Drilling currently holds contracts for 8 of these 12 and we will thus increase our portfolio by 4 additional platforms. We will start operating the additional 4 active platforms for Statoil in October, which will further add to our operating base and revenue beginning Q3 of this year.Wireline and Oiltools experienced increased activity levels in March this year and completed a historically high number of runs in Norway and target markets globally. As previously announced, Quintana Energy Services or QES IPO-ed on the New York Stock Exchange in early February at a market cap of $330 million. Archer's share of QES is approximately 28.7%. AWC continues to grow in line with the increase in rig count onshore U.S. and is experiencing strong demand for new valves from multiple customers. Archer mobilized yet another rig in Bolivia in the first quarter. And performance in the Northern Vaca Muerta shale play continues to be strong, where we are well positioned. The financial performance for our Land Drilling division is again negatively impacted by poor profitability in the South. We are addressing this challenge and working to improve our organizational efficiency.As mentioned, Statoil awarded a 4-year firm contract to Archer for the provision of drilling services for fixed platforms for 12 platforms located on the NCS. Archer currently provides drilling provision for 8 of these platforms; and we'll add crews for the Gullfaks A, B and C and Grane platforms. These additional 4 platforms are currently in drilling mode and will have material impact on our NCS Platform Drilling revenue. We also continue to hold a life-of-field contract for Statoil's Veslefrikk platform. I am very pleased with this award and the trust Statoil puts in our employees and crews. We strive every day to deliver as per our core safety, integrity and performance values. And I believe this award is recognition of the positive impact of this effort.Note that a contract award includes 3 contract extension options of 2 years each. The contract is effective from October 1, 2018, following a transition period to prepare for operations. The firm contract award has a value of more than NOK 6 billion, based on the current drilling schedule, and ensures Archer's continued operations for Statoil on the Norwegian continental shelf until at least October 1, 2022. This valuation excludes additional work scope such as modifications and upgrades for the platforms in the portfolio [ which was ] most efficiently delivered by our Engineering division. The total contract award of approximately NOK 15 billion [ should ] Statoil to -- elect to exercise all options.With the new contract with Statoil, Archer will slightly increase its market share in the North Sea despite 3 other contractual platforms scheduled to be permanently abandoned towards the end of the year. These include 2 in the U.K. and 1 in Norway. Our Platform Drilling business holds a significant firm order backlog of more than $1 billion and a total backlog close to $2.5 billion. This gives Archer a good foundation to further enhance our offering.Wireline had a slow start to the year in January, but as the quarter progressed, we experienced a significant increase in activity with sustained momentum within our mechanical Wireline and our logging business. Logging activity is strong, not only in Norway but also in Asia. Activity is also starting to pick up in the Middle East, although from the low base. In the first quarter, we retained our logging contract with PETRONAS for the provision of ultrasound well downhole leak detection. The contract is for an initial period of 3 years, plus 1 optional year. The total contract value is estimated at $20 million should PETRONAS decide to exercise the 1-year option.In Q1, we launched VIVID, our next-generation leak detection tool. The full-spectrum ultrasound acoustic sensors deployed in this tool have industry-leading sensitivity; and can accurately locate even the lowest-energy leaks, verifying cement barrier seals and characterizing downhole events with unparalleled precision. We are experiencing significant client interest in the technology, and we are ramping up our operations in order to deliver on the market interest.Within our Engineering division, we expect positive synergies in conjunction with the Statoil award for Platform Drilling. General market activity is slowly picking up in Norway, where we're launching an inspection business in 2018. In the U.K., we continue to experience delays in project sanction.Oiltools experienced the second highest all-time number of runs in March. Activity is high in Norway and in the U.S. Despite the high number of runs, revenue per plug has gone down since the peak in 2013 and 2014, partly due to greater competition and partly due to clients deciding to run lower-specification plugs. We're countering this trend by offering unique tools to allow our customers to save rig time by deploying multiple tools in one run. The Middle East is another target market for Oiltools. We have good traction in Saudi Arabia, where sales of certain existing Archer tools as well as tailor-made products such as the annulus packer which is said to be [ VISO ] tested in May this year.The ComTrac deployment system continues to attract significant commercial interest on the back of successfully completed client jobs. Most recently, we showcased the versatility of the deployment system with respect to its ability to carry heavy loads. The strength and lift capacity are beyond conventional Wireline capabilities, thus allowing for longer tools and perforation guns to be deployed. The low friction, stiffness and almost nonexistent stretch of the carbon composite rod alleviates the problem of stick-and-slip downhole tool motion experienced with standard Wireline cables. This contributes to exceptional data quality, particularly for high-resolution logging services such as fluid saturation logs. The resulting superior, repeatable data quality leads to significant rig time savings for clients. Early commercial jobs are in the pipeline for Wireline.As for tractor development, our C6 JV, one of the first unique tractor tools, ready for testing within the first half of 2018. This will showcase the capabilities of the new tractor relative to existing technologies on the marketAWC, our U.S. onshore-based Frac Valve business, experienced a slow start to the year in January and February, but as of March, the market improved. New valve sales, repair revenue and parts revenue all contributed positively. The strong demand for new valves is forecast to continue into the second quarter. In addition, we're adding new customers to our client base. The first quarter of 2018 marks the first quarter where we have sold spare parts sourced internationally. Demand for these products was higher than expected, outstripping our supply.Archer's rig count in Argentina and Bolivia was 52 active rigs in the quarter, up 3 from the end of 2017. We continued to deliver strong performance in the Vaca Muerta region in Argentina. The market is tightening as there are limited unconventional rigs available. Archer and [ H&P ] are the 2 clear market leaders in this unconventional play. We also mobilized and now operate 2 deep gas rigs in Bolivia, up from 0 for most of last year.We are spending significant time and energy in improving the overall operational performance in the South of Argentina. Following a reduction in activity over the last 3 years, we're in discussions to reduce the employee base by [ 7% to 9% ] this year, dependent upon anticipated rig activity. And in the first quarter, we released 34 individuals, with related restructuring costs. The majority of the employees expected to be terminated this year are in support and overhead functions. Our average payback on redundancy costs is approximately 12 months, so margins will increase as we reduce head count. Addressing the revenue side, we are also running a project to improve our processes as well as our maintenance systems to ensure we provide best-in-class contract drilling, workover and pulling services. We've had lengthy discussions with our largest clients in order to improve contract sustainability. Nothing has been agreed, but the dialogue suggests a positive outcome. Furthermore, we released 30 out of a planned 48 employees from our drilling fluids service. This business previously delivered good performance but then experienced intense pricing pressure over the last 2 years, resulting in several tenders being lost. The latest tendering round resulted in several contract losses in January, leading to financial losses and excess people. Combined, the above efforts should result in improved performance, contributing to the bottom line going forward. I will now hand the call over to Dag.

[Dag Skindlo]

Thank you, John.Our first quarter revenue ended at $218.3 million, up 8% relative to first quarter 2017. All divisions in Eastern Hemisphere showed growth from same quarter last year. We have total revenue improvement of 19.3%. The Eastern Hemisphere revenue was down 3% from the same period last year, as we saw reduced revenue in fluids and in Bolivia.EBITDA before exceptional items was $18.1 million in the quarter, an increase of $1.5 million compared to Q4. CapEx amounted to $2.9 million in the quarter, a decrease of $3.6 million compared to previous quarter. As per previous guidance, we expect slightly higher CapEx in the quarter to come due to rig mobilization and general maintenance CapEx.Net debt increased by approximately $15 million in the quarter. Majority of this increase was due to our $10 million investment in QES shares during the IPO. Our moderate increase in working capital in the quarter was largely driven by March revenue being $6 million higher than in December.Turning to the profit and loss statement. Revenue was $218 million in the first quarter, up 8%, as already mentioned. Compared to fourth quarter revenue of $223.7 million, we are down $5.4 million or 2.4%. Note that first quarter revenues are subject to winter conditions in the North Sea and less operating days in Argentina compared to fourth quarter. Eastern Hemisphere revenue was up 1.2% from Q4, while Western Hemisphere revenue is down 6.5 relative to the fourth quarter. Sequential revenue reduction in Latin America stems from several factors, including 2 less operating days, loss of contracts for fluids, unfavorable exchange rates, increased number of strike days and absence of Flex rig mobilization revenue which we had in the fourth quarter.EBITDA before exceptional items was $18.1 million for the first quarter of 2018, as mentioned, an increase of $1.5 million compared to fourth quarter. The increase in EBITDA is mainly due to high EBITDA in Land Drilling on strong financial performance in Vaca Muerta and Bolivia and the impact of previous actions taken for the operations in Argentina South. Unfortunately, we continue with the restructuring program in the South and for fluids, but as mentioned, we are starting to see benefits from early downsizing.Exceptional items for the first quarter totaled $4.9 million. These exceptional items consist of severance payments and compensation for idle personnel in Argentina. We expect further restructuring costs ahead as we continue downsizing of the organization in Argentina, as outlined by John. As we have discussed earlier, timing and cost redundancies in Argentina are substantial, and our success depends upon union cooperation and client support.Archer reported a positive net income in the first quarter of $4.4 million, including a positive currency effect on internal loans of $16.9 million in the quarter.To conclude. Platform Drilling has further strengthened its position as the market leader in the North Sea. The Statoil award brings further visibility and additional revenue to Platform Drilling and to our Engineering Division. We are experiencing increased activities for Oiltools and Wireline both in Norway and internationally. Operators are slowly increasing their investments, but it is still challenging to increase unit prices. Onshore U.S. is experiencing a strong increase in rig count, which is reflected in the performance of AWC. We expect the positive trend to continue into Q2. Archer Group performance has, over prolonged periods, been negatively impacted by land drilling in the South of Argentina. We are working diligently to increase performance and reviewing all aspects of our operations.Overall, we see improved outlook for 2018 with a good base for further growth into 2019. We guided in Q4 a margin increase of 1% to 2%, and if anything, after the Statoil award and recent activity uptick, we are even more confident on achieving these improvements.With that, I will hand the call over to the operator for any questions.

[Operator]

[Operator Instructions] Our first question comes from Haakon Amundsen from ABG.

[Haakon Amundsen, Lead Analyst]

Just one question from me on the Platform Drilling unit. You're seeing some higher activity coming through here. And then you have your new platform starting up later in the year. What about the margins going forward? They have slipped a little bit below 9% here recently. What should we think about that in later '18 and into '19?

[Dag Skindlo]

John, do you want to answer, or do you want me to answer?

[John Lechner, Chief Executive Officer]

Go ahead, Dag. I'll let you look to the financial side.

[Dag Skindlo]

I think we -- in the winter, Haakon, we have the winter season, and we have more risk related to helicopter delays and weather. And we have some [ standby ]on some of the contracts in the North Sea. In the summer this year, we do not predict that. And we will have lower, let's say, downtime due to delays of the winter. So we think no -- there is no trend in Q1 to say that the margins are lower in Q1. And some of these risks is also better maintained, I will say, and contained in the new contract with Statoil, so in the next winter, we don't expect to have the same impact of weather as we have had in the past. So if anything, the margins will continue to be strong and probably better than what you have seen in Q1.

[John Lechner, Chief Executive Officer]

Yes. Haakon, I agree with Dag, the -- particularly the sort of the operational downtime. We've got 2 years of the previous contract operational experience. So the downtime, particularly to helicopter delays and weather, are -- we've got a better handle on that going forward.

[Haakon Amundsen, Lead Analyst]

All right. All right, thanks. And then maybe I didn't pick up this from your prepared remarks, but could you give some status on the AWC strategic process, please?

[Dag Skindlo]

Haakon, as we have said before, we have a process where we review all strategic options. We are still working through that process, and we will update you when we have any conclusions or final outcomes.

[Operator]

[Operator Instructions] Our next question comes from Morten Bystrøm (sic) [ Morten Nystrøm ] from Nordea.

[Morten Nystrøm]

Yes. Haakon, I believe, basically answered 2 of my questions, but 2 more. And that is, if you could guide us on working capital. And also, you mentioned South Argentina here. How difficult is it to solve that part of your business with the unions et cetera? You're talking about restructuring costs will continue, if you also could guide us somewhat on that.

[Dag Skindlo]

John, do you want to take the restructuring...

[John Lechner, Chief Executive Officer]

Yes. So yes, in the South it's simply a matter of we've built up infrastructure and overhead to support a much higher level of activity back in, say, 2013, 2014. And it's just really hard work. Contract drilling doesn't have huge -- especially on land, does not have big margins. And to work through the -- just the process, to rightsize the organization, is difficult, especially with a heavily unionized workforce. And so we've had to just -- one, is put in pretty experienced drilling personnel, operational personnel that focus on getting us -- identifying where we need to get to; and then working through the costs of redundancy in Argentina, which are quite high. So it's a long road, but we've gone through a lot of the hard steps of identifying where we need to get to. Now we're just working through that. We are targeting relatively aggressive reductions going through the year. Hopefully, we'll finish it up around in Q3. We have to be slow and steady just because of the cash flow considerations. I would say probably, through Q2, the -- we'll probably look very similar to what we had in Q1. And then Q3, we should work through, hopefully, the tail end of the requirements. That's assuming activity stays as we expect it. If there is an uptick, then we're happy because we can slow down, but we're planning for what we can see right now and working towards that.

[Morten Nystrøm]

If I can just follow up a question --

[John Lechner, Chief Executive Officer]

And, Dag, on working capital...

[Morten Nystrøm]

Yes, if I just can follow up a question on the drilling side there. What is actually your target margin, post let's say, the downsizing you're currently doing now? What kind of effects on margin are you targeting, expecting?

[Dag Skindlo]

We are not giving guidance of an individual business unit or segment from...

[Morten Nystrøm]

No, but I'm just -- is it -- would you say it's substantial? Or is it just up to 8% or something? Just to give a -- get a flavor on how much actually the South is dragging on the margins in the drilling efforts?

[Dag Skindlo]

We -- South revenues is about -- just to give you some ideas, so without going into specifics. In the South we'll probably have around $230 million of revenue this year. The rest is -- Land, Drilling Division there is in the North and in Bolivia. So the margin in the North is fairly unaffected by the South. And it's they are typically running -- at certain rigs, we have 30%. On other rigs, overall, we probably have just north of 20% EBITDA margin in the [indiscernible]. We will not achieve those margins, but if you look at the margins they are -- in the South it's probably realistically improved by 5% to 10%, depending on our success with our client discussions, our improved drilling performance and our cost cuts. So it's in the range of 5% to 10% for that business.

[Morten Nystrøm]

And if you just could guide us on the working capital there, given what you said about -- yes.

[Dag Skindlo]

So we're like -- the reason why we had a small uptick is basically 2 reasons. We had quite a lot of revenue in the March month itself. We had a big upticks actually from February to March. And March was about $6 million higher revenue than December and typically the highest -- the higher of capital -- working capital has [ created new ] revenue in the quarter -- last month of the quarter. We also had a little bit of, let's say, [indiscernible] on payments, but if you look going forward, we will -- we are very confident on having lower revenue of net working capital as a percentage of revenue compared to what we had in Q1. It's not significant and we'll have lower net working capital as a percentage of revenue compared to what we had in the end of Q1. And we're not -- we are -- of course, if we are increasing revenue, we will tie up a slightly more working capital, but we're also then generating free cash flow from the operations.

[Operator]

[Operator Instructions] It appears there are no further questions at this time.

[John Lechner, Chief Executive Officer]

Okay, well, everyone, we appreciate everyone joining us for today's call. We look forward to speaking to you next quarter. Thank you, and have a good day.

[Operator]

This concludes today's call. Thank you for your participation. You may now disconnect.