Shelf Drilling Ltd

OSE:SHLF

Earnings Call Transcript

[Operator]

Welcome to today's Q2 2018 earnings conference call. [Operator Instructions] I must advise you that this conference is being recorded today, Wednesday, 15th of August 2018. I would now like to hand the conference over to your speaker today, Mr. David Mullen. Please go ahead.

[David Mullen, executive]

Thank you, operator, and welcome, everyone, to Shelf Drilling Quarter 2 2018 Earnings Call. Joining me on the call today is Greg O'Brien, our CFO. On August 14, we published the Shelf Drilling, Ltd. financial statements for quarter 2 2018 as well as our latest fleet status report on the Investor Relations page of our company website.

In addition to our press release and the interim financial statements, we also published a short presentation, which highlights -- with highlights from the quarter. Given the level of transaction activity in 2018, we wanted to summarize our latest performance as well as the impact of the various capital raises. A recording of this call will be made available on our website within the next few days.

Before we begin, let me remind everyone that our call will contain forward-looking statements. Except for statements of historical fact, all statements that address our outlook for the rest of 2018 and beyond, activities, events or developments that we expect, estimate, project, believe or anticipate may or will occur in the future are forward-looking statements.

Forward-looking statements involve substantial risks and uncertainties that could significantly affect expected results. Actual future results could differ materially from those described in such statements. Also note that we may use non-GAAP financial measurements on the call today. If we do, you will find supplemental disclosures for these measures and an associate reconciliation in our financial reports.

I will provide an overview of the company's performance in quarter 2 2018 and share my latest views on the jackup rig market. I will then hand over to Greg to walk you through the financials before we open the floor to question and answer.

I would first like to begin with our safety performance. The key safety performance indicator, total recordable incident rate, has improved year-over-year, with year-to-date recordable incident rate of 0.21. We firmly believe that an incident-free operations can be achieved but only through more rigorous planning.

Earlier this year, we launched an initiative that further emphasized improved [indiscernible] for our drilling and marine operations. We are seeing encouraging signs of improvement from what has already been an industry-leading safety performance.

Our operational uptime, up 98.3% for the first 6 months of 2018. The uptime was impacted by some startup issues of rigs returning to active operations in India and Nigeria. However, the past 2 months, we've seen an outstanding uptime performance of 99.4% and 99.5%, respectively.

Our 6 rigs in Saudi Arabia continued to deliver a top-tier performance in all categories, as measured by Saudi Aramco, for both quarter 1 and quarter 2. Our 2 newbuilds, the Shelf Drilling Chaophraya, the Shelf Drilling Krathong, continued to deliver wells with exceptional performance for Chevron in the Gulf of Thailand. And our 4 rigs operating in UAE, working for ADNOC and Dubai Petroleum, are incident-free and continued to deliver better-than-expected results and well delivery.

We completed 2 Schedule G out-of-service projects on the Main Pass IV and the High Island II for Saudi Aramco, more than 30% ahead of the original scheduled time. In the case of the High Island II, we were able to conduct the project offshore and on location using innovative ROV technology specifically designed for carrying out a [ U-walled ] while drilling.

In summary, we remain very focused on delivering safe and efficient operations to our customers while targeting further cost savings and efficiency gains across the organization.

Since the last earnings call in May, AMNI Petroleum executed a contract on the Trident VIII for 245 days with an option for an additional 110 days. The rig with shallow draft capability is uniquely suited for our customers' development program, which is scheduled to commence in Nigeria in quarter 1 2019, upon completion of our upgrade and contract preparation project currently underway in Bahrain. With this award, all of our 6 shallow draft jackups are under contract.

Following a multiyear downturn in the offshore drilling industry, there are indications across our markets of improving jackup demand. Brent crude oil prices have significantly increased from a low point of $28 a barrel in early 2016 to north of $70 a barrel for most of 2018. We believe this price stabilization at current levels, coupled with the lack of investment and new development projects in recent years will stimulate an increase in offshore activity in 2019 and beyond.

While competition among jackup contractors continues to be intense and market day rates remain at historical low levels, the global number of contract to jackup rigs has begun to gradually increase, growing by 8% from 311 rigs in January 2017 to 335 rigs in June 2018. Further, there has been a significant rise in tendering activity in 2018 compared to 2017 and 2016, which is expected to result in increased utilization in 2019 and beyond.

In 2018, we have experienced an increase in market inquiries from our customers, particularly in Middle East and West Africa. We believe that we are particularly well positioned to benefit from any increase in demand for jackup rig services due to our excellent operating track record and competitive low-cost structure.

After securing the contract for the 3 premium jackups that we acquired from Seadrill in late 2017, we reached 100% utilization on our 8 premium jackup fleet of rigs. We continue to evaluate options to expand our premium jackup fleet and have remained very disciplined around price and rig specification.

We strongly believe there is more value in acquiring a rig with a proven track record versus a newbuild rig from a shipyard that often requires significant startup cost and typically has some teething issues during the startup phase of operation. We also believe there's a strong customer preference to have a rig design that is well suited to the area of operation with a rig with a good operating track record.

In early July, we entered into an agreement with Diamond Offshore to acquire the 2008-built Shelf Drilling Scepter for $68.5 million. The rig has a Keppel FELS Super B design with specifications complementary to our existing premium jackups and well suited for our core operating regions. The rig has enjoyed a very good track record working for large national oil companies and independent oil companies.

Specifications include 2 million pound hook load capacity and 6,000 barrels of mud storage. The rig has essentially the same operating capability as Keppel FELS jackup rigs built in the last few years, and our purchase price is 50% of the construction cost and less than 50% of some of the recent rig transactions from the shipyard. We took delivery of the rig in July 26, expanding our premium jackup fleet to 9 rigs.

As of June 30, our contracted backlog is approximately $1,050,000,000 across 28 contracted rigs, representing 78% of market utilization. We continue to see a solid pipeline of marketing opportunities, and we are in advanced discussions on several potential contracts that should be executed in the coming months.

Total revenue for the quarter increased by $5 million on a sequential basis from $147.5 million in quarter 1 2018 to $152.5 million in quarter 2 2018. The positive variance was primarily due to increased activity. The adjusted EBITDA increased $6 million on a sequential basis from $49 million to $55 million. The positive variance was due to an increase in revenue.

Last but not least, I would like to thank our investors for their participation in our recent financing transaction and initial public offering and for continuing to place their trust and confidence in Shelf Drilling. Our focus on delivering safe and reliable services to our customers exclusively in shallow water market remains a differentiating factor in Shelf Drilling delivering continued strong financial results and securing new contracts.

The series of transformational steps over the last 18 months, culminating with our initial public offering in the second quarter in Norway, has further enhanced our financial position and improved our fleet composition. The simplification of our capital structure and access to equity markets has positioned the company to pursue additional growth opportunities in the early stages of the recovery in the jackup market.

The day rate environment remains challenging, but we have seen a steady increase in utilization since the beginning of 2018. With a significantly improved commodity price backdrop, we expect further growth in the jackup demand in our core regions into 2019 and beyond.

With that, I will now hand it over to Greg to provide you additional detail on the Q2 financial results.

[Gregory Brien, executive]

Thanks, David. I'll start with operating results for the period and close with details on our capital structure.

Revenue for Q2 2018 was $152.5 million, including $144 million of dayrate revenue, $5 million of mobilization and bonus revenue and $3.5 million of recharges and other revenue. Revenue increased by 3% relative to Q1, primarily due to an increase of $8 million in Nigeria following the commencement of 2 contracts in Q1 with Chevron and Exxon and 1 contract during Q2 with AMNI and a $4 million increase for the 3 rigs that started new contracts with ONGC during Q1 2018. This was partially offset by a $7 million reduction in Saudi Arabia, the result of the 2 planned out-of-service projects we completed during the quarter. Average dayrate for Q2 was $68,000 a day, down slightly from $70,000 in Q1.

Effective utilization was 67% in Q2, up by an additional 4 percentage points versus Q1, following the net increase in activity during the quarter. As a reminder, this reporting statistic, previously referred to as market utilization, is a measure of revenue efficiency for our active jackup fleet in a given period and is impacted by 3 components: idle time for rigs awaiting contract opportunities, planned out-of-service time for rigs under contract or any downtime during operation.

Rig operating expenses fell by $3 million from $82 million in Q1 to $79 million in Q2. Following an intense period of contract preparation in late 2017 and early 2018, total rig operating costs of $79 million in Q2 should reflect a more normalized quarterly figure for our current level of activity. However, a portion of the expected relocation and reactivation costs for the Shelf Drilling Scepter will be recorded as onetime acquisition-related expenses during the second half of 2018.

Shore-based expenses of $8.4 million were down slightly from Q1, bringing total operating and maintenance expenses to $87 million versus $90 million in Q1. General and administrative expenses increased significantly from $13 million in Q1 to $27 million in Q2 but included $16 million of nonrecurring items. The primary driver of the sequential increase was an $11 million deferred noncash charge for the vesting of shares issued in prior years and already fully reflected in the current number of common shares outstanding. We also recognized $3.9 million of onetime corporate transaction costs. Finally, the $4.5 million annual sponsor fee recorded to G&A terminated at the end of Q2 following our IPO.

Adjusted EBITDA was $55 million in Q2 for a margin of 36% compared to $49 million and 33% in Q1. As anticipated, capital expenditures and deferred costs increased from $17 million in Q1 to $29 million in Q2. Spending associated with the 3 rigs we acquired in 2017 fell from $7 million in Q1 to $2 million in Q2 as all 3 rigs are now in operation.

Spending across the rest of the fleet increased by $17 million from $10 million in Q1 to $27 million in Q2, primarily due to the planned shipyard activity for 3 of our rigs in Saudi and the commencement of the upgrade and contract preparation project that David mentioned for the Trident VIII.

Excluding acquisitions, CapEx and deferred costs totaled $37.5 million for the first half of 2018 or approximately $75 million on an annualized basis. The reconciliation to our cash flow statement is covered in detail on Page 13 of the slide deck we published yesterday.

Income tax expense was $4.3 million in Q2 or 3% of revenue. Interest expense was $27 million for the quarter, which included $7 million of onetime transaction-related costs. The net loss for the quarter was $37.4 million, adjusted net loss was $15.5 million after removing the effects of transaction costs and the onetime noncash share-based compensation charge.

As David mentioned, we completed a series of capital raises in the last 2 months. In June, we announced an amendment to our revolving credit facility that extends the maturity date from 2020 to 2023 and increases the facility size from $160 million to $225 million.

We appreciate the support from our 5 lenders in helping provide improved and long-term liquidity for the business. The facility is undrawn with only $10 million of bank guarantees outstanding.

We also completed a $300 million tack-on offering to the senior unsecured notes originally issued in Q1. The proceeds were used to refinance the sale and leaseback obligations associated with our 2 newbuild rigs now operating in Thailand.

Through the listing in Norway, we raised net equity proceeds of $216 million, which were used to fully fund the redemption of our $167 million preferred equity and partially fund the acquisition of the Shelf Drilling Scepter.

Cash was $143 million as of June 30, 2018. Both the final settlement of the sale leaseback facility and the purchase of the Scepter occurred in July. Pro forma for these events, our cash balance and net debt were $58 million and $830 million, respectively.

During the first 7 months of 2018, we simplified and improved the debt side of our balance sheet, converting 5 separate facilities into 2. On a pro forma basis, we have only a single $900 million tranche of bonds with no long-term debt maturities before 2025. We reduced annual fixed charges by approximately $50 million beginning in Q3 2018 and have $275 million of liquidity. We believe that our unique geographic footprint, differentiated operating cost structure and robust financial position creates significant flexibility for us moving forward.

We'd now like to open the call for questions.

[Operator]

[Operator Instructions] And our first question comes from the line of Eirik Røhmesmo.

[Eirik Røhmesmo, analyst]

Regarding the fleet for contract roll-offs later in 2018, can you maybe provide a bit more color in terms of what you expect there and [ know if ] there's a potential extensions or new rigs?

[David Mullen, executive]

Yes, I mean, there's a -- we're pretty confident that we'll roll over the contracts coming off. So I can walk you through a few of them. We have the Baltic coming off in Nigeria. We're pretty confident that, that will roll on to another contract in Nigeria. We have Trident 16 is rolling off contract in ENI with Petrobel in Egypt. We're in discussions with them on continuing. There's a lot of noise on the line.

[Eirik Røhmesmo, analyst]

Sorry about that.

[David Mullen, executive]

And we have the Key Singapore. We're pretty confident that rolls on to a contract. We have the High Island VII coming off the end of this year. We're pretty confident that would roll on to another contract. Without -- we don't want to give specific details as to who and -- who we're actually negotiating with, but a lot of them will roll on with the existing operator.

[Eirik Røhmesmo, analyst]

Okay, that's great color. And then secondly, just on your idle fleet, again not to predict too much, but should we expect all of the idle to remain marketed? Or is there a chance that some of those go to cold stack?

[David Mullen, executive]

We've taken the Rig 124 out of warm stack, and we are putting that in the cold stack because we don't see too many opportunities for that rig. We see opportunities for quite a lot -- for the other -- the remaining warm stack rig. Whether they all go back on contract or not remains to be seen. I think that would be a best-case scenario, but we're certainly optimistic on some of them. If you take the Key Hawaii and the Galveston Key, which are warm to hot stacked here in the Middle East, we're pretty confident that those rigs go back to work.

[Eirik Røhmesmo, analyst]

Okay, great. And just my last one, one other housekeeping item. On the Trident VIII, and the upgrade and repair cost, when should we expect that would be, is that a Q3 or Q4 kind of item? And also [indiscernible] update on that.

[David Mullen, executive]

That rig will go back to work in the end of Q1, maybe beginning of Q2 in 2019. The rig would be ready to work the end of the year. So if we find that opportunity to have a gap filler, we'll look at that.

[Gregory Brien, executive]

And Eirik, around the cost, we moved -- it was -- the rig was originally in West Africa. We moved it to the Middle East in the beginning of Q2. So the round-trip mobilization and some of the upgrades we're doing on the rig, it's around $50 million of aggregate costs. Some of that hits in Q2 and the increased CapEx and deferred cost number we mentioned. The rest of that margin hits in Q3. And as David mentioned, the rig should be back in Nigeria around the end of 2018.

[Operator]

Your next question comes from the line of Martin Karlsen.

[Martin Karlsen, analyst]

David, I think you appear a bit more optimistic in your market commentary compared to earlier. And although we highlight pricing, clearly, it's challenging. I wanted to see if you have started to see any change in bidding behavior out there and if there are any specific regions that stand out at the moment.

[David Mullen, executive]

We continue to see strong activity, strong marketing activity in the Middle East, notably with Saudi Aramco but not only Saudi Aramco. We're seeing a good level of activity in Qatar and it's building. We're seeing activity in other regions in the Middle East. Nigeria continues to be a lot of marketing information. We see quite a lot of opportunities developing in Nigeria and more generally in West Africa. India, we'll see a tender come out sometime in the very near future. It's expected within the coming weeks. And it's still a little bit unclear how many rigs they're going to look for, but we understand it's going to be a minimum of 9 rigs. It's potentially more than that.

[Martin Karlsen, analyst]

Good. And second question, you acquired the Scepter for a highly attractive price. And one of your competitors also recently acquired a premium jackup at a decent price. To what extent do you see opportunities for more asset deals in the same price range as we have seen recently? And as a follow-up on this, could you share some thoughts on your long-term capital allocation between growing the company and returning cash to shareholders?

[David Mullen, executive]

Yes, we continue to see that there are more opportunities to acquire assets. We are very selective. We have -- definitely, we have a very much preferred design that really fits into our geographical regions, and we're price-sensitive. We're not going to pay a very high price for an asset that's -- we will remain very price-sensitive, but we do see more opportunities. And look, it's our ambition, as we reflected in the presentation material we sent out. Before we bought the Scepter, we have what we consider 8 premium jackups in our fleet and we have 100% utilization on those. So we have capacity to add more premium jackups to our fleet and put them under contract. So we are definitely going to continue to look at those opportunities. With this recent equity raise, we took out the preferred equity notes, so we cleaned up our capital structure and we acquired one rig. We're using a certain amount of cash on hand as well as the equity raised. But we have ambitions to continue with this strategy and continue to grow our premium jackup fleet.

[Gregory Brien, executive]

It's Greg. The only thing I would add, there was another rig transaction announced in the last week or 2. It's a similar rig, a working rig for about $85 million. And we do think there are potential acquisition opportunities in that general zip code, somewhere between $70 million and $100 million. I think that's a product of the dayrate environment still remaining pretty challenging. So we think short term, that's the most interesting way to think about allocating capital. If that starts to move materially, it's likely a product of the dayrate environment being a lot better, and we should start to see some of that fall through to us. And I think longer term, capital return would be a piece of the story. So it's not the near-term focus, that's obviously something we'll continue to monitor, but we do think there is a window here to think about trying to add some additional rigs to the fleet.

[Operator]

And your next question comes from the line of Gibson Cooper.

[J. Gibson Cooper, analyst]

Just back on the question of acquisitions, I'm just kind of curious what your preferred financing vehicles would be for any future acquisitions.

[Gregory Brien, executive]

I mean, if you look at the 2 transactions we've done in the last 1.5 years, I mean, it was the majority equity financing for the rig purchases. The 4 rigs we bought did not have contracts. And the rig -- the transaction last year, we funded the reactivation and contract preparation out of cash flow. Net-net, it was sort of 20% to 30% of the all-in costs was funded out of cash flow leverage. And given where we are in the cycle, that feels like a reasonable mix, largely the same with the Scepter that we purchased this year. So anything else we do would require some level of external capital. It'd be difficult to purchase a couple of rigs with cash and resource. I don't think that's something we'd look to do short term. So given where we are and the market hasn't materially moved, I think we'd want to be somewhat conservative with funding structure.

[J. Gibson Cooper, analyst]

Okay. And back on the Trident VIII, great to see a contract there. I was just curious as to whether that -- those terms are additive to 2019 backlog dayrate. Kind of share some thoughts on that.

[David Mullen, executive]

Not sure what you mean by additive to -- if the -- it's a good dayrate. And it's -- but not sure what you mean by additive to 2019 backlog. It's...

[J. Gibson Cooper, analyst]

Well, yes, so 2019 backlog has an implied dayrate. Just wondering if the rate on the current contract is in excess of that average. That's all.

[Gregory Brien, executive]

It's a good question. 2019 backlog is currently weighted to markets where we have slightly higher pricing, places like Thailand obviously with our newer rigs and in Saudi. Now we do think, in general, pricing in Nigeria is sort of better than the average across our jurisdictions. We're not fully sold out for 2019. So what's in the backlog today isn't a perfect proxy for what average dayrate would be next year. But as David mentioned, we think it's a good rate that'd be positive in terms of margin and cash flow and generally above the average across the rigs and the various regions we work.

[J. Gibson Cooper, analyst]

Okay. And then David, what's the confidence level around the Scepter, getting a Scepter contract near term?

[David Mullen, executive]

Yes, we're confident. I mean, we wouldn't have bought the rig if we weren't confident. We feel pretty good about that. It's -- as I said, we have, in our mind, 8 premium jackups today and they're all under contract. So we feel pretty good that we'll be able to place that rig under contract. And if we were to give a time frame, I'd say within the next 6 months. It's going to take quite a while to bring the rig into -- we're -- at the moment, we're looking at transporting the rig from where it is. It's in the U.S. Gulf of Mexico to the Middle East and we'll start the reactivation project. So don't expect that the rig will go to work in the imminent future. It's probably -- we're probably looking at something around the end of H1 2019.

[J. Gibson Cooper, analyst]

Okay, got it. And I think you were undergoing a compact driller upgrade. I'm just curious as to where that sits and any contract outlook there.

[David Mullen, executive]

That rig is warm stacked. We're looking at a few opportunities for that rig. More than that, I really can't say at this point in time.

[Gregory Brien, executive]

But that's one -- there's no active project underway. I mean, it's a quality rig, very good work history. We have bid that into a couple of different contract opportunities. We're not spending a huge amount of capital on the rig until we have a better sense of where it could go.

[Operator]

Your next question comes from the line of Lukas Daul.

[Lukas Daul, analyst]

I was wondering, the 2 rigs that you have classified as assets held for sale, do you intend to scrap them?

[David Mullen, executive]

No. One of them is being held for sale for a non-drilling application, which is mobile offshore production unit. And if the buying party who has placed a small deposit on the rig is going to execute it, he's waiting on the results of a tender process. The Trident IX has been sold. We haven't finalized the proceeds, but a very significant downpayment has been made. So we expect that to be fully executed in end of September. And that one is being sold for scrap.

[Lukas Daul, analyst]

Okay. And then David, you talked about some start-up issues on some of the rigs that went back to work. Can you just sort of maybe talk a little bit more about what these issues typically are and how are they being rectified, et cetera?

[David Mullen, executive]

Yes, there -- I think we had a few startup issues on one of the rigs that went -- that we put back into contract with ONGC. It was an electrical issue. We solved the issue. But as with any electrical issue, it took a little bit of time. And the other one were some teething problems we had with a rig going back to work in Nigeria. But again, that one has been resolved. The rig is working fine now. I would qualify that by saying we put an awful lot of rigs back to work without any issues. The Key Manhattan, which went back to work with ENI, went into operation and it's been running at 99.8% uptime since it went into service in the beginning of January of 2018. So we drew attention to it because our uptime performance year-to-date, 98.3%; last year, we were averaging 98.7%. It's not a huge delta, but I just wanted to explain that we're a little bit behind where we normally are. The last 2 months, we were averaging 99.4% and 99.5%, respectively, which is pretty close to a near perfect uptime.

[Gregory Brien, executive]

I think in general, it is fairly common to have some level of issues when you're starting in a new location with a new customer. We've always tried to get rigs in the markets we think that have a high probability of staying there and recontracting. So it's obviously not unique, that's common across the industry. I think the rigs that David talked about are doing quite a bit better after the first couple of months. So we think it was somewhat unique and onetime to the first half of 2018.

[Lukas Daul, analyst]

Okay, that's a good color. And then have you sort of changed your thoughts compared to last time where you think the utilization is heading towards the end of this year and somewhere midways through to 2019?

[David Mullen, executive]

Things may have moved to the right a little bit, but other than that, I'd say no. I'd say high level, we still see that the utilization is moving slowly. It's improving slowly, and we expect that trend to continue into 2019. I probably gave a little bit more stronger guidance on the last call that we expected the uptick before the end of the year. I think it's pushing a little bit to the right. So we expect it more in 2019 than in 2018.

[Lukas Daul, analyst]

And then one bidding for new work, have you sort of experienced tenders where the operator would come back and ask for sort of repricing, basically indicating that people have gotten a little bit more sort of aggressive on when they are bidding for new work, probably more demanding?

[David Mullen, executive]

We experienced a little bit of everything. You have situations where you can negotiate directly with the customer and that's obviously a much better situation. You have situations where you're in an open tender, and they -- customer keeps trying to cut it back a little bit more. And you have a situation where you're in a tender with select few others. So we have experienced everything. It is a highly contested market, but we -- owing to the service we're providing, maybe somewhat unique capability we have in certain areas, we're in position in certain circumstances where we're able to negotiate directly. And that obviously is a better place to be than when you're competing with a whole lot of other people. And you're in other situations where you're competing with maybe a few well-established drilling contractors, that's a better place to be. And then you have the occasional tender where you're competing against a very large number of companies. I don't know if that's really answering your question, but we've seen a little bit of a mix of everything over the past 12 months.

[Lukas Daul, analyst]

Okay. I guess, everyone is looking for that one single point in time when the inflection point occurs. But I guess, nobody has a crystal ball. So thanks for your answer.

[Operator]

And there are no further questions at this time. Please continue.

[David Mullen, executive]

Okay. If there are no further questions, I'd like to thank everybody for participating in the call and look forward to our next earnings call. Thank you very much, and goodbye.

[Operator]

And that does conclude our conference for today. Thank you all for participating. You may now disconnect.