Seadrill Limited (SDRL) Q3 2016 Earnings Report, Transcript and Summary

Good afternoon and good morning. Welcome to the Seadrill Limited Third Quarter Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please also note that today's event is being recorded. At this time, I would like to turn the conference call over to Mr. John Roche, Director of Investor Relations. Sir, please go ahead.

Thank you. Good afternoon and welcome to Seadrill Limited's third quarter earnings call. With us today we have Per Wullf, our Chief Executive Officer; Mark Morris, our CFO; and Anton Dibowitz, our Chief Commercial Officer. Before we get started, I'd like to remind everyone that much of the discussion today will not be based on historical fact, but rather consist of forward-looking statements and are subject to uncertainty. We articulate some of the key items on Page 2 of the presentation, and for additional information and to view our SEC filings, please visit our Web-site at seadrill.com. To begin the discussion today, Per will take us through the third quarter highlights and updates on our progress on key action items thus far as we work through this market, Mark will then address our financial highlights and outlook, and lastly, Anton will offer some colour on the overall market. And with that, I'd like to turn over the call to our CEO, Per Wullf. Per?

Thank you, John, and good day and evening everyone. Moving to our third quarter summary highlights, on the operations side, we achieved 95% economic utilization for the quarter, another solid result achieved by all our offshore and onshore employees. On the commercial side, although most of the new work is for short-term contracts at or near breakeven levels, we are seeing an improvement in the level of bidding activity. However, we still continue to see a number of contract cancellations and blend and extents [ph] in the market as customers remain focused on preserving cash. 2017 is expected to remain challenging, but we do expect the market to start showing sign of life in 2018 and 2019. This year, we have reduced our operating cost further, and we have lowered our cost base approximately 28% since the beginning of the downturn and we believe we are now at a sustainable cost level operating our [indiscernible] rigs, proven by our quarter-over-quarter cost levels. This is an impressive resetting of our Group-wide operating costs, both onshore and offshore, as we work our way through the downturn. Mark will present the reduction in numbers in more detail in a moment. Now, on to the third quarter operational highlights for Seadrill Limited, utilization decreased from the record level achieved in the second quarter. For Seadrill Limited, we achieved 94% economic utilization on our floaters and 97% for the jack-ups, a fair result considering the fact that we took technical downtime on a couple of our floaters due to crown block repairs. Our backlog currently stands at $3 billion, down from $3.6 billion during the last quarter. Seadrill Group’s backlog stands at $7 billion. Next, we will look at our newbuild deferrals. As you are all aware, we currently have eight units scheduled for delivery in 2017, five jack-ups, two drill ships, and a semi-submersible. We continue progress in discussions with the yards to further defer deliveries as we do not intend to take delivery of any unit without a bankable contract. This decision of course leads to intensive discussions with the shipyards. On Dalian, we are now – where we build our jack-ups, we are ongoing positive discussions to defer all eight non-recourse jack-ups an additional six months with no cash outlay until delivery. The two drillships with Samsung are under deferral discussions as well. The units are not technically ready for delivery and likely won't be prior to the current delivery dates. However, as you will recall, we gave our right of termination with the first deferral agreement of these units. And lastly, we are due to receive our final yard refund installment on the Sevan Developer, our Cosco semi-submersible, in the first quarter of 2017, after which there will be no equity tied up in that non-recourse unit. Now I'll turn things over to Mark who will cover our financial performance. Mark?

Thank you, Per. Good afternoon and good evening to all of you. I will briefly pull out the highlights for the third quarter, then provide an update on where we are with our restructuring plans, and then finally provide our guidance for Q4 2016. So, turning to the quarter highlights, lower revenues for the quarter reflect five additional units coming off contract, lower dayrates coming into effect on four units, and slightly lower economic utilization at 95% compared to a record 98% for the previous quarter. This was partially offset by the West Eclipse having a full quarter of operations, the West Vigilant starting work during the quarter, and additional de-winterization revenues related to West Alpha coming off contract. On the cost front, actions taken last year, and ones we continue to take, are yielding benefits as both our OpEx and G&A continue to fall. Rig operating costs reduced from $248 million to $243 million over the quarter, a 2% reduction. Operating costs for rigs in operation, including overhead on our floater fleet, have been reduced from $200,000 per day in 2014 to $145,000 per day currently, a 28% reduction. Operating costs for rigs in operation, including overhead on our jack-up fleet, have been reduced from $90,000 per day in 2014 to $63,000 per day today, a 29% reduction. And we expect 2017 to continue at similar levels. G&A costs for the full year 2016 are projected to be approximately $220 million, down from $315 million in 2014. Finally, we performed better than our guidance for the quarter, primarily due to better economic utilization than forecast and slightly lower stacking costs on our idle units. On impairments, during the quarter we have taken a number of non-cash impairment charges, reflecting continued uncertainty in the market and sustained lower share prices of certain of our investments. We have impaired our investments in Seadrill Partners by $806 million and SeaMex by $76 million. In total, we have taken non-cash impairments of $882 million. More details on this can be found in our press release and in the notes to the accounts. Moving on to the balance sheet, as always there are various movements on the balance sheet and I'm just going to draw out the main ones as identified here. In relation to current marketable securities, the $48 million reduction reflects the decrease in Seadrill Partners' share price from $5.37 to $3.53 over the period. The decrease in accounts receivable primarily reflects the lower number of units operating during the quarter, partially offset by the West Hercules early termination fee, which is subsequently being received. Investments in associated companies have decreased by $642 million, primarily due to the impairments we have taken. On the liability side, the main movement between long-term debts and the current portion of long-term debt is the reclassification of $789 million of debt maturing in September 2017 from non-current to current. Additionally, long-term debt decreased due to usual quarterly amortization. And finally, other current liabilities, these decreased by $141 million, mainly reflecting gains on derivatives of $92 million and a reduction in accrued interest expense of $29 million. So, turning to our restructuring plans, you are aware that we have recently extended the West Eminence facility from the 31st of December to the 30th of April 2017. While we have made good progress with our banks and met the milestones as they have become due, it has taken us a little longer than envisaged to get to a stage where we are now ready to engage with bondholders and prospective providers of new capital. This reflects the relative complexity of our corporate structure and how we legislate for the various consolidated and nonconsolidated interests we have, along with other contingent liabilities. The devil is in the detail, you might say. We are in advanced stage with our banks on the overall terms and structure of an agreement that will help us put through a recovery by extending our secured credit facilities out to the 2020 and 2023 timeframe, reduce fixed amortization and cash debt service costs, amend our financial covenants and ensure we can operate effectively and benefit from our scale. Importantly, it must also create a structure that will attract new capital and facilitate an agreement with our bondholders. We have initiated dialog with an ad hoc group of large bondholders through their advisors and also with potential providers of new capital. These discussions are ongoing and we will keep you updated as and when we have something to announce. Our objective is and remains to have a comprehensive package that will provide a long-term solution to address our capital structure needs while positioning us for a recovery in the industry. We should not forget that the market we operate in is experiencing the worst downturn in its history, so things won't be normal. This is all about managing through a period of lower revenues through a combination of reducing costs, managing our newbuilds, resetting our debt service levels and improving liquidity through the provision of some new capital. We have a strong preference for a consensual solution, but given the number of parties involved, we have also developed contingency plans should the need arise. We are confident about our business and our recovery for this sector. We have the youngest and most modern fleet of all the major drillers, a proven track record of operation, the benefit of scale and we are well-positioned asset-wise to compete effectively. Finally, turning to guidance for the fourth quarter, EBITDA for the fourth quarter is expected to be lower at around $340 million, mainly reflecting increased idle time on a number of units detailed in our press release. With that, I will hand it over to Anton for some comments on the state of the offshore drilling market.

Thanks Mark. Good day and evening to all. In the near term, the offshore drilling sector remains extremely challenging. Oil prices remain at a level that is insufficient to reverse the prior two years of upstream spending declines and we can expect that spending will further decline into 2017 as oil companies continue to focus primarily on preserving cash. The longer that underinvestment continues, the more drilling will ultimately be required to offset the increased decline curves in existing fields and meet increased future demand. In the floater market, the tender activity level has increased, albeit from a low base. Many of the near-term opportunities are of short duration with term contracts having later start dates. All are being bid at extremely competitive dayrates. Older floater units that are off contract will face high barriers to re-entry due to their lowest specifications and the significant capital expenditure needed to return to the working fleet. Based on the expected levels of cold stacking and scrapping activity, a relatively small increase in spending could meaningfully tighten the floater market. In the jack-up market, utilization continues to decline as more units are rolling off contract than are being contracted for new work. However, there continues to be an active spot market centered primarily in Southeast Asia and the Middle East. However, with an order book of over 100 units and muted scrapping activity, it may take more time for the jack-up market to return to a healthy utilization level. We continue to face contract renegotiations and terminations, as we have detailed in our quarterly release. Included in that category was a disclosure we made about the agreement with Total to reduce the remaining contract value on the West Jupiter in return for amended contract terms. This deal provides us assurance that the remaining backlog on that rig will remain fully intact. This deal should also be viewed in the context of the Nigeria market, which a year ago had six ultra-deepwater rigs operating. Today, there are two ultra-deepwater rigs operating in Nigeria, one of which is the West Jupiter. As far as new contracts are concerned, during the period since the start of the third quarter, we have secured the following new contracts. The jack-ups AOD I and AOD II each received three year contract extensions from Saudi Aramco, taking those rigs to June 2019 and July 2019 respectively. The short-term extension on jack-up AOD III, also working for Saudi Aramco, should be viewed in the context of a similar short-term extension awarded to AOD I prior to concluding the term deal that I just mentioned. We continue to enjoy an excellent relationship and operational track record with Saudi Aramco and remain confident that there is future work scope for that rig. The West Castor secured a new one-year contract with ENI in Mexico which will commence shortly, in December. The West Vigilant secured a three-month contract with Repsol in Malaysia. The West Phoenix was awarded a 90-day contract with Total in the U.K., West of Shetland. We are already in serious discussion for a follow-on opportunity and this rig is well-placed to take advantage of the strengthening in demand that we are seeing in the North Sea. The West Saturn was awarded a one well contract with ExxonMobil in Liberia. We are already in discussion for a number of opportunities for the units in 2017 and are optimistic given the rig's specification and operating track record. In total, these new awards have added more than $300 million in new contract backlog. On a relative basis, these new awards are a marked improvement from what we were experiencing a year ago. Whilst we forecast 2017 to be another tough year, we are cautiously optimistic that we are beginning to see the conditions necessary for a longer-term recovery to materialize. Today, we are tracking or engaged in discussions on approximately 40 opportunities worldwide. As I mentioned earlier, many of these are spot market and all are contested, but we are, it's fair to say, much busier than we were a year ago, and for us it's an early positive sign. Our strategy will continue to be to ensure we are optimally placed by keeping rigs working or warm stacked in key operating regions in order to take advantage of the upswing when it comes.

Thank you, Anton. Safe and efficient operation continues to be our bread and butter. Without 100% committed employees, we would be even more challenged in this downturn. This quarter, just as in previous quarters, they have proven their commitment to help Seadrill weather the storm. We have reduced operating costs substantially this year excluding stacked units and have reset our daily cost on both our floaters and jack-ups. This has only been possible by adjusting salaries, reducing headcount as well as improving vendor agreements. I mentioned before, we are continuing discussions for further deferrals from the interim deliveries, and let me repeat, we do not intend to take any delivery without a bankable contract. Mark and team, together with our advisors, are progressing well on the overall restructuring plan and we see a willingness to come to a consensual solution for all stakeholders, and we expect to conclude our plans by April 2017. Throughout this upturn, we have learned that scale matters. We have cold stacked units when strategically justified and we keep some warm stacked units ready for into the market when needed. We have also reset our operating costs and retained our best people both offshore and onshore. This combined with the new fleet, second to none, prepares us to take advantage when the market recovers. With that, we will now open up for Q&A.

[Operator Instructions] Our first question comes from Jacob from Morgan Stanley. Please go ahead with your question.

We saw an announcement from one of your peers yesterday on a JV with Saudi Aramco to own, operate, and build jack-ups in Saudi Arabia. So I was just wondering if you could first comment on how your competitive position in Saudi Arabia changes in light of this, but more broadly, I'm curious to know if you see this partnership as the start of a new trend for owners to team up more closely with operators and even shipyards to work through the downturn, and if so, would you be inclined in pursuing a similar model?

This is Anton. Yes, we have seen the announcement. Obviously we are not going to speculate too much on what others have done and I think there's still a lot of details that have to come out about how exactly that JV is going to work. But for a little bit of context, Saudi Aramco over the last few years currently generally operates between 45 and 50 jack-ups, and Rowan has about 9 or 10 rigs operating there. So there will be plenty of opportunity for other contractors to continue to work with Saudi Aramco. We have a great relationship with them, we recently had extensions and we see a good future for us there. Is it an opportunity or does it set a trend? Being local, we have done it in some places. We have a JV in Mexico and it is an opportunity to enter a market and keep a presence in the market, and I guess that's all I can say about that. In the grand scale of things, in the context of building a few additional rigs, a market that has jack-up market which is around 550 rigs and more than half of those, about 275 are more than 30 years old, I don't think that building 10 or 15 rigs is going to move the needle in that regard.

Okay, great. Thank you. Just one follow-up, I wonder if you can remind us if any of your remaining contracts allow for early termination without a make-whole sort of provision, and if so, do you have a rough percentage of backlog that those contracts account for?

Our contracts are generally bound by confidentiality. So I'm not going to get into the specifics of any particular contract. In general, I think it's fair to say in the market that floater contracts and deepwater contracts generally provide for some form of termination payment or a significant termination payment in the event of termination for convenience. I think that's been characteristic of the industry to date and continues.

Great. Thank you.

Our next question comes from Gregory Lewis from Credit Suisse. Please go ahead with your question.

Anton, I just want to follow up on Jacob's question about the joint venture with Saudi Aramco. Clearly, Seadrill has four rigs in country currently. Was that something that Seadrill was invited to participate in, did you guys actually look at potentially doing the JV?

Yes, this has been a long-standing or a long process. I think three, maybe more years ago Saudi Aramco, as some of the NOCs always had an aspiration to build their own rigs and obviously having yards in country and support the shipbuilding industry there. So this is a long-standing process. I believe they spoke to a number of drilling contractors, including us.

Okay, great. And then just one other question for me around the jack-up market, I mean clearly it sounds like based on your prepared remarks, you're a little bit more positive on the opportunity set in the jack-up market. Is that just a function of the shorter cycle nature of the business or are you actually seeing real opportunities to get rigs back to work? I mean just sort of looking at Southeast Asia where you have a handful of idle rigs, could we see any of these rigs getting to work maybe sooner rather than later?

I think you have it right there. It is a shorter cycle market. It is more focused on development work. So, as oil prices pick up, there are a lot of small programs that people look for putting rigs back to work. On the flip side of it, there are 100 odd newbuilds sitting at the yard that have to come to market in some way, shape or form, probably in the hands of more established contractors, not speculators. So I think that's going to dampen the overall recovery in that market. So, it ticks along a little better at the bottom of the market but it's going to be maybe more muted in the recovery. That hasn't stopped us and there is an active market and there continues to be an active bidding market for jack-ups around the world. As you can see, we signed the contract with ENI with Castor going to Mexico on the back of our established operations there, and there are pockets of opportunities around the world for us to take advantage of.

Okay, perfect. Thank you very much for the time gentlemen.

[Operator Instructions] Our next question comes from Lukas Daul from ABG. Please go ahead with your question.

I was wondering on the Samsung drillships, I understand you want to have a contract before you take delivery, but is there a way how you can avoid taking delivery?

There is not a way to avoid to take these rigs, and we will go and do that one day. If you recall, we gave up our right of termination of these units when we made the deferral a year and a half ago. And also we have been dealing along here with no outlay [cash right] [ph] for us for a year and a half now, and that continues until we actually take technically delivery of the units, and that has not happened till date because the units are not complete, and I doubt they will be ready to take delivery off in 2017 April when we are supposed to take them over. And that's why we are into intensive talks with Samsung about the two units in question. And I'm sure and I'm confident that we will get this one here pushed out to a level which satisfies both Samsung and Seadrill. And I also think, in this context, you shouldn't underestimate the fact that we are part of the Fredriksen Group, and just for your information, in the Fredriksen Group more than 60 new buildings are currently ongoing in the Far East and that of course is a pretty nice [indiscernible] when you negotiate with the shipyards.

Okay, great. Thanks. And Mark, just in a very general sense regarding the restructuring, could you sort of elaborate on the pros and cons of taking the path of Chapter 11?

I'm not sure I want to elaborate on the paths. I mean, look, clearly from our side, and we think really from every party side, there is a vested interest in arriving at a consensual solution. I mean, clearly, any decision to use some form of implementation tool, whether it's a scheme or whether it's a Chapter 11 is really a function on whether all the players are playing the way that we want them to and whether it's a requirement to bind certain parties to bring them to the table. But look, there is definitely a value preserving interest in reaching at a consensual solution. We think we have a very good and sensible proposal. Like I said, we're at an advanced stage with the banks and I think it's appropriate for us to have discussions first with the bondholders and the new capital providers before we conclude anything in relation to whether we can do something consensually or whether we may need to use some implementation tools.

All right. Thank you.

[Operator Instructions] Our next question comes from Nikhil from Citi. Please go ahead with your question.

This is Mukhtar from Citi. Two questions if I may, gentlemen. So first of all, how are you thinking about recovery demand levels given the drilling efficiency that is being highlighted by IOCs, do you see us ever getting back to sort of 170-200 levels that was previously flagged? My second question is, could you help me reconcile, there is a lot of contracted capacity out there that is currently being idled and not working, could you reconcile that with your commentary around sort of more active activity for [indiscernible] et cetera? Is it mismatch between who has the rigs and who wants to work or is it people trying to renew the fleet at a lower rate, could you please comment on that?

I can take them, and I guess Per, if you want to add, on the drilling efficiency, there are two sides to it. I mean much is made of that drilling efficiency allows wells to be drilled faster and what is that effect on demand. I mean conversely, I think you can look at it that in order for the offshore drilling business to be healthy, we need to have a competitive, be drilling on a competitive supply and offshore barrels need to be competitive with onshore and other sources of supply. So, have better drilling efficiency along with all the other steps that the whole value chain is taken makes the average cost of developing offshore field cheaper and overall makes it more competitive with other sources, which in the end actually helps offshore relative to other sources. On the comments, we do see 2017 being a tough year and there is still more rigs available in the market than there are jobs for, to be absolutely clear about that. What I did say in my comments, on a relative basis from where we were a year ago, you could say the phone wasn't ringing at all or the only time it was ringing we were talking about renegotiations. What we have seen is a qualitative difference in the conversations we are having with our customers. There are more tenders out. There are more conversations about them needing to get back to work, recognizing that taking rigs off developments is increasing the decline curves and in order to meet expectations for where demand is going to be a few years down the road, more drilling is going to be needed. So, I think that's the context you should look at those comments in on a more relative basis for where we see early signs for people talking about getting back to work and increased activity versus that there is a bounce in the market in 2017. 2017 will be tough, we know that.

Right. And if I may ask a quick follow-up, in terms of the tenders that you are seeing, could you give a rough split of how much of that is development, how much is exploration?

We don't really get into that much detail. I mean, the spot market work is obviously more focused on some exploration work, but there is a split, probably along the lines of the general market which is slightly more focused on the development side than on the exploration side. I think the long-term tenders that you see that are further out in the future are more development focused and the spot market and short term stuff would be more exploration focused.

That's very helpful. Thank you for your answers.

[Operator Instructions] At this time, I'm showing no additional questions. We will conclude today's conference call. I'd like to turn the conference call over to management for any closing remarks.

No closing remarks, just like to thank everyone for joining us today and enjoy the rest of your day.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your lines.