Shelf Drilling Ltd

OSE:SHLF

Earnings Call Transcript

[Operator]

Hello, and welcome to the Shelf Drilling Q3 2023 Earnings Call. [Operator Instructions] Please be advised that today's call is being recorded.

I would now like to hand over to David Mullen, the CEO. Please go ahead.

[David Mullen, executive]

Thank you, operator, and welcome, everyone, to Shelf Drilling's Quarter 3 2023 Earnings Call. Joining me on the call today is Greg O'Brien, Shelf Drilling's CFO.

Earlier today, we published the quarter 3 2023 financial statements for Shelf Drilling, Ltd. and Shelf Drilling North Sea, Ltd. 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 financial statements, we also published a presentation with highlights from the quarter. 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 facts, all statements that address our outlook for the full year 2023 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 measures in the call today. If we do, you will find supplemental disclosure for these measures and an associated reconciliation in your financial reports.

I will provide an overview of the company's performance for quarter 3 2023 before sharing my latest views on the jack-up rig market. I will then hand over to Greg to walk you through our third quarter results before opening the floor for Q&A.

As always, I would like to start my commentary on our earnings call with our safety and operational performance. The year-to-date total recordable incident rate as of 30th of September was 0.16, in line with our industry-leading performance of recent years. In quarter 3 2023, we achieved a fleet-wide uptime of 98.7%, and our year-to-date uptime as of the end of September is 98.9%. This strong operating performance was against a challenging backdrop of a deteriorating industry trend with both safety and uptime performance.

During the quarter, Shelf Drilling Fortress commenced its contract with CNOOC in the U.K. sector of the North Sea. In October, subsequent to quarter end, the Key Singapore completed its contract preparation project in India and commenced a 3-year contract with ONGC.

In addition, we commenced planned shipyard projects on the Trident II in UAE and the Main Pass IV in Saudi Arabia. Both rigs are expected to recommence operations by the first quarter of 2024 and the Trident II heading back to India for a new 3-year contract with ONGC and the Main Pass IV returning to Saudi Aramco with its -- under its current contract. As mentioned on our last earnings call, the high concentration of contract preparation activity is now behind us, and our project schedule is returning to a more normalized pace.

Adjusted revenue for quarter 3 2023 was $264 million, an increase of 25% on the prior quarter. Adjusted EBITDA for the quarter was $115 million, a sequential increase of $42 million, a significant improvement in the EBITDA margin to 43%. The very strong financial results was due to a combination of high utilization and commencement of new contracts at improving day rates.

In September and October, we successfully completed a multifaceted refinancing transaction, which included the launch on pricing of approximately $1.1 billion principal amount of new 9.625% senior secured notes due in 2029. These notes were complemented by a $60 million private equity placement and a $50 million term loan due in 2024, all strategically designed to refinance the company's existing debt. The proceeds of this transaction were used to redeem all outstanding notes due in late 2024 and early 2025.

As part of this transaction, we also put in place a $125 million revolving credit facility. This transformational transaction represents a significant milestone achievement for Shelf Drilling as it substantially derisks our capital structure. Notably, it extends the maturity date of our notes by 5.5 years while also facilitating meaningful deleveraging through the partial amortization of the debt principal in the interim, while providing a liquidity cushion through the revolving credit facility.

I'm extremely proud of our team's exceptional efforts in orchestrating this complex transaction within a very compressed time frame. Greg will provide more details on our quarter 3 2023 results and financial outlook for the rest of 2023.

Brent crude oil prices, the key driver of demand for shallow-water drilling activity, averaged $83 a barrel year-to-date. OPEC's decision to extend production cuts through year-end had kept oil prices in positive trajectory for much of the quarter 3, surpassing $95 a barrel in September. However, concerns on oil demand led to Brent prices returning to the mid-80s by the end of September.

Subsequently, the conflict in the Middle East has resulted in greater volatility, initially resulting in a price strike above $90 a barrel before dropping back to the low 80s, as concerns on slowing demand outweighing supply concerns related to the conflict. The geopolitical situation in the Middle East is tense, and I expect the commodity prices to remain volatile over the near term. I believe that prevailing oil prices and concerns around security of oil supply will continue to support increasing demand for shallow-water drilling services through 2024 and beyond.

The global number of contracted jack-up rigs increased from 352 in December 2021 to 403 in November 2023. The market utilization improved 85% to 94% over the same period. The Middle East region was the primary driver in this growth in demand through 2022. Subsequently, we have seen demand growth in most other regions through 2023.

Following this recent surge in demand and years of rig retirements, the jack-up supply overhang from the last decade has been effectively eliminated. Day rates and new jack-up fixtures have accelerated across the region and asset classes, and we expect this trend to continue in the quarters ahead.

In the Middle East, Saudi Aramco and ADNOC been focused on their respective expansion -- expansive rig intake program following the unprecedented awards of incremental rigs. We're not expecting to see further incremental demand in the Middle East in the near term.

Demand in West Africa is poised to grow where the incremental demand is being driven by Nigerian indigenous operators looking to shore up production following an extended period of low activity. We see Oriental Energy and the FIRST E&P all in the market for near-term field development programs and work-over operations on some existing infrastructure as well as opportunities in the longer term with both Total and Chevron. For 2024 and beyond, there appears to be more demand than existing supply in the region.

In India, the demand is outstripping the available supply. ONGC's 5-rig tender launched in July has resulted in 3 awards with rates now exceeding $90,000 per day. ONGC is currently evaluating a 3-rig HPHT tender. Cairn Energy are also expected to come to the market with a 2-rig requirement before the year-end. And Oil India will look for a rig in early 2025. In addition, we have a number of Indian independents looking for rigs for short-term programs. All told, there is a shortage of available supply in the region.

The markets in Southeast Asia are tightening, driven primarily by incremental demand in Thailand and Vietnam. While there remains some near-term capacity, it is likely that all the available capacity in the region will be absorbed by the second half of 2024. The North Sea market is also tightening with several contract awards in recent months and another expected to be concluded in the near term.

The Adriatic I and the Shelf Drilling Mentor have been awarded contracts in Nigeria for 16- and 18-months term, respectively. And both rigs have already commenced these new contracts. In the U.K. sectors in North Sea, CNOOC has awarded 2 of the 4 optional wells, extending the contract end date from January to June of 2024.

The Baltic in Nigeria completed its contract with Total in late September and has been actively marketed into multiple new opportunities in the region. The Shelf Drilling Perseverance is being marketed for opportunities both inside and outside the North Sea. As of the 30th of September 2023, our contracted backlog was $2.5 billion across 34 rigs with a weighted average day rate of $83,000 per day and a market utilization of 94%.

In the third quarter, we continued to advance our sustainability efforts. We successfully completed a pilot testing of a new system to record real-time engine and fuel data to assist our rig crews in driving down our Scope 1 emissions. We'll begin to roll out this system to our premium rigs in 2024, and a similar system is currently being tested for our standard rigs to ensure consistent data capture across our entire fleet.

We made significant progress in the third quarter on actions needed to ensure compliance with the EU's Corporate Sustainability Reporting Directive. We completed a double materiality assessment and identified those areas we consider material for environment, society and the company. In the fourth quarter, we will finalize the gap analysis to the European Sustainability Reporting Standards to ensure we have systems and process in place to monitor, track and report on these material issues.

In closing, the third quarter financial operating results were very strong, following an intense period of contract preparation work. The market continues to improve with positive day rate momentum, and this bodes well for strong cash flow generation in '24 and beyond.

I would like to thank all our investors for their keen interest and support in our debt and equity offerings. As always, Shelf Drilling, we are committed to delivering safe and best-in-class operations to our valued customers. With our current capital structure, following a very successful refinancing transaction, we are well prepared for an improving market in the years ahead.

I will now hand over to Greg to walk through the financials.

[Gregory Brien, executive]

Thanks, David. As a reminder, our earnings release this morning also included stand-alone financial reports for Shelf Drilling North Sea. We'd encourage everyone to review the results presentation on our website, and this includes additional metrics and schedules for both Shelf Drilling and SDNS.

Reported revenue for Q3 2023 of $268 million included $4 million for amortization of intangible liability. We'll continue to focus on and refer to adjusted revenue, which excludes the impact of this noncash item.

Adjusted revenue for Q3 2023 of $264 million included $235 million in day rate revenue, $11 million of mobilization and bonus revenue and $18 million of recharges and other revenue. Adjusted revenue for Q3 increased by $53 million or 25% relative to Q2 2023. The 31-rig fleet at the parent company drove substantially all of this growth.

Revenue of $232 million increased sequentially by $51 million as 7 rigs started new contracts, 4 contract extensions between late April and early August: the Shelf Drilling Victory and Harvey Ward in Saudi Arabia, the C.E. Thornton and Compact Driller in India, the Shelf Drilling Resourceful in Italy and the Adriatic I and Shelf Drilling Scepter in West Africa.

Three additional rigs in West Africa, the Shelf Drilling Mentor and the Baltic and Trident VIII, also contributed to the Q3 revenue improvement as they were operating at higher day rates for the full quarter. This was partially offset by lower revenue from Key Singapore in India, which was preparing for a new 3-year contract that started in October.

Revenue at Shelf Drilling North Sea of $32 million represented a sequential increase of $2 million following the contract commencement of the Shelf Drilling Fortress in the U.K. in August and additional contribution from the Shelf Drilling Barsk in Norway. As a reminder, other revenue included the contribution associated with the Shelf Drilling Barsk, which is the net margin generated by this rig under its current bareboat charter agreement that is expected to finish later this month.

The revenue increase was partially offset by lower revenue for the Shelf Drilling Perseverance, which completed its contract in July in the U.K. With rigs returning to operations, effective utilization increased to 90% in Q3 from 82% in Q2. Average day rate was $81,000 per day in Q3, up from $75,000 in Q2, mainly driven by higher day rates in West Africa and Saudi Arabia following the commencement of new contracts and extensions mentioned earlier.

Operating and maintenance expenses of $129 million in Q3 increased from $120 million, primarily due to higher operating costs on the Shelf Drilling Victory in Saudi and the Shelf Drilling Scepter in West Africa as both rigs started their new long-term contracts during Q2, as well as on the Trident II, which began a planned out-of-service shipyard ahead of its next long-term contract in India expected to start in 2024.

At the SDNS level, operating expenses increased sequentially to $24 million in Q3 from $21 million in Q2, primarily due to higher operating costs on the Shelf Drilling Fortress, resulting from its new contract start-up in the U.K. in August and higher maintenance costs on the Shelf Drilling Winner in Denmark.

G&A expenses of $20 million in Q3 increased from $15 million in Q2, mainly due to a $6 million provision for credit losses recorded in Q3, the majority of which was reflected at the SDNS level.

Adjusted EBITDA improved by 58% to $115 million in Q3 for a margin of 43% compared to $73 million and a margin of 34% in the previous quarter. Adjusted EBITDA for SDNS was $1 million in Q3 versus $5 million in Q2, with the sequential reduction mostly due to the bad debt provision recorded in Q3.

Income tax expense was $7 million in Q3, down from $8 million in Q2. Year-to-date tax expense of $23 million represents 4% of revenues. Net interest expense of $34 million for the quarter was in line with Q2. Other net expense fell to 0 in Q3 from $4 million in Q2 from foreign currency exchange losses reflected in the prior quarter.

Noncash depreciation and amortization expenses totaled $40 million in Q3, up from $34 million in Q2, due to the higher amortization of deferred costs for contracts that started in late Q2 and Q3. The net income attributable to controlling interest was $41 million in the third quarter.

Capital expenditures and deferred costs totaled $35 million in Q3, down from $61 million in Q2. This sequential decrease is primarily related to lower spending for the Trident VIII, Adriatic I, Shelf Drilling Scepter in West Africa, the Shelf Drilling Resourceful in Italy and the Shelf Drilling Victory and Harvey Ward in the Middle East, following their new contract commencements. This was partially offset by higher investment in fleet spares and contract costs on the Key Singapore, which commenced its new contract with ONGC in October.

CapEx at Shelf Drilling North Sea was $3 million in Q3, primarily for transition-related spending and investment in fleet spares, bringing year-to-date spend at SDNS to $8 million.

Our consolidated cash balance as of September 30 was $145 million, relatively unchanged from the balance of $142 million at the end of June. Cash at Shelf Drilling North Sea declined from $53 million in June to $47 million at the end of September. Cash at the parent company increased from $89 million in Q2 to $98 million at the end of Q3 due to the strong EBITDA generation, but partially offset by an increase in net working capital during the quarter.

The closing of our refinancing transaction occurred in October. As covered on Page 8 of our presentation, we used approximately $70 million of cash on hand as a partial funding source to facilitate the closing and settlement. This included $23 million of restricted cash, which was previously used to collateralize bank guarantees that are now supported by our new revolver, and $47 million of unrestricted cash. As a result, our pro forma cash position following the refinancing was closer to $50 million versus the reported balance of $98 million at the parent company at the end of September.

In our release this morning, we also maintained our financial guidance for 2023. Fully consolidated adjusted EBITDA is estimated between $310 million and $345 million. The sequential growth in earnings in Q3 brought year-to-date adjusted EBITDA to $224 million. However, with the planned out-of-service projects on 2 of our rigs in Saudi Arabia and some idle time across 3 jack-ups in Nigeria in Q4, we expect our EBITDA in Q4 to decline sequentially relative to Q3 due to a temporary reduction in effective utilization.

Our total capital spending guidance for full year 2023 is also maintained between $220 million and $245 million, with year-to-date spending of $178 million through Q3. We're well on track to meet this guidance.

Our performance in Q3 further demonstrates the unique execution capabilities of our team. A large number of our rigs successfully commenced new contracts following major capital projects and out-of-service periods. Our financial results significantly improved again on a sequential basis and illustrate the operating leverage and potential earnings growth capacity of the business.

We're very pleased with the outcome of our refinancing and the strong support we received to facilitate these transactions. We've made great progress on delevering our balance sheet in 2023 and expect this trend to continue in the coming quarters. With our strong contract backlog, favorable jack-up market outlook and improved financial position, we're focused on generating free cash flow and creating value for our shareholders in the years ahead.

With that, we'd like to open the call for questions.

[Operator]

Apologies, there are currently no questions in the queue. [Operator Instructions] The first question comes from Patrick Fitzgerald at Baird.

[Patrick John Fitzgerald, analyst]

Congratulations on the refinancing. What happens with your free cash flow priorities as you are generating pretty solid free cash flow on a run rate basis going forward and you got this refinancing behind you? So what are your thoughts there now?

[David Mullen, executive]

Yes. Look, I'll start with that. Yes, I mean, as we generate the positive cash flow beyond the commitments that we signed up for with our refinancing, we'll look to return capital to shareholders. I don't imagine we'll be doing that before the back end of '24, early '25, but that would be certainly the priority for the CapEx.

Greg, do you want to add anything to that? Operator, are you on the line?

[Operator]

Yes. Greg is still connected. I'm not sure...

[Gregory Brien, executive]

Yes, I'm here. Sorry about that. Yes, no, what I just wanted to add, I think that was a good summary. But I think we've been pretty clear over the last 6 to 12 months that our near-term priority is on deleveraging. We've made very good progress on that front over the last couple of quarters. We do have higher fixed amortization payments through the first 12 months. So with the $50 million term loan that we put in place and as the amortization schedule on the new bond kicks in, there's more scheduled repayment in this first 12 months. So that will be the clear focus between now and the second half of 2024.

We do think there's a large portion of the fleet that has significant upside repricing potential as contracts start to expire in the 2025 time frame. So as and when that happens, we think there is going to be a lot more free cash flow potential in the business. And as David mentioned, I think looking to use a portion of that cash flow to capital return will very much be a priority. That's something we plan to communicate in more detail as 2024 [ approaches ].

[Patrick John Fitzgerald, analyst]

And obviously, a higher CapEx year this year. Could you just kind of remind us what it looks like on maybe '24 or on a normalized basis?

[Gregory Brien, executive]

Yes. Yes, so we've been using $100 million to $110 million as the right annual level to think about going forward. The first half of this year was obviously a lot higher than that on a run rate or annualized basis. Q3 starts to look a little bit more normal. We still have one of these bigger projects, the Key Singapore that prepared for a maiden ONGC contract in Q3. But we think the kind of -- the heavier figures are behind us with the majority of the program for 2023 weighted to the first half of the year.

So I think we've given guidance for this year. We think we're on track to hit the lower end of our CapEx guidance for full year 2023. I think for next year, at the parent company, $110 million should be a reasonable sort of place to think about for next year.

SDNS is a little bit different. I know we have spent very little on the rigs in Shelf Drilling North Sea this year. Just given the operation, we haven't had large capital projects. The program for next year will partially depend on what we do with the Perseverance. As David mentioned, we're bidding that rig into multiple contract opportunities. There could be a cost associated with a new contract for that rig. So a little more variability on CapEx and investments next year.

[Patrick John Fitzgerald, analyst]

All right. What -- could you just give kind of an outlook on what needs to happen in the U.K. North Sea to get that back to participating in kind of the upward trend in day rates with the rest of the market? And any thoughts on moving rigs out of that jurisdiction?

[David Mullen, executive]

Yes, I mentioned that in my commentary. We are looking at opportunities outside the North Sea. We're also looking at opportunities in the North Sea. And we have seen a pickup in marketing activity, market inquiries and tenders, most of them with start dates in the -- after the winter period in the second quarter of 2024.

And look, I think the government is trying to stimulate a bit of activity in the U.K. sector in the North Sea. So I do imagine that there will be a pretty good pickup in activity in general in the North Sea. I think there, you may see 1 or 2 rigs leave the North Sea, which would tighten it even more, and I think that will create a balanced market. If 1 or 2 rigs were to leave and the activity we see on the horizon, I think you will see a balanced market and you'll see good momentum on day rates.

Based on some of the market information we have seen, activity with forward start dates are certainly coming at a higher day rate than activity with nearer start dates, which implies to the market that people are seeing more activity as you look into '24 and beyond.

[Operator]

Your next question comes from Nikhil Bhat at JPMorgan.

[Nikhil Bhat, analyst]

Relatively simple ones, just a couple. First one, how should we think about working capital going into the fourth quarter and maybe early next year, given that you have a few rigs that are going to be in out-of-service sort of projects?

And the second question is on your term loan. I remember it had to be paid in installments -- quarterly installments. Could you remind us if those were going to be equal installments? Or do they follow a certain schedule?

[Gregory Brien, executive]

Sure. Yes, the $50 million term loan that matures in June 2024, that's 3 equal repayments. So the first $17 million, we'll repay at the end of this year, and the balance is splitting 2 payments in March and June of 2024.

On working capital, I mean we had a pretty significant build in Q3. So the fall-through of EBITDA to cash conversion, it doesn't look great at first glance in Q3, but that's what you would expect when you build up revenue and earnings quite quickly. So we had a fair amount of that in Q3 with the payable balance coming down following the completion of a number of big projects and then revenue and receivables ramping up. So that was more of a Q3 dynamic, to be honest. I think we expect working capital flows to be more normalized from here in Q4 and into Q1.

I think the only other point is that we did pay accrued interest at closing and settlement of the refi as well. So it's about $25 million of interest that we paid in October, which is more or less in line with where we'd expect to be on a quarterly basis going forward. And then in the first quarter next year, we would not add an interest payment just based on the way timing works with the new bond.

But I think in terms of the business operation, we had a big working capital build in Q3. We used quite a bit of cash in October to affect the refi. But from there, things should be relatively normalized through year-end and into the first quarter of '24.

[Operator]

There are no further questions. Thank you.

[David Mullen, executive]

Okay. If there are no further questions, I'd like to take the opportunity to thank everybody for joining the call and look forward to talking to you on -- in early part of the new year when we release year-end results. Thank you very much, and goodbye.

[Operator]

This concludes today's conference. Thank you for participating. You may now disconnect. Speakers, please stand by.