Valaris Limited (VAL) Q1 2012 Earnings Report, Transcript and Summary

Good day, and welcome to Ensco Plc's First Quarter 2012 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mr. Sean O'Neill, Vice President of Investor Relations. Please go ahead.

Thank you, operator, and welcome, everyone, to Ensco's first quarter 2012 conference call. With me today are Dan Rabun, CEO; Bill Chadwick, our Chief Operating Officer; Jay Swent, our CFO; as well as other members of our management team. We issued our earnings release, which is available on our website at enscoplc.com. As usual, we will keep our call to one hour. Any comments we make about expectations are forward-looking statements and are subject to risks and uncertainties. Many factors could cause actual results to differ materially. Please refer to our earnings release and SEC filings on our website that define forward-looking statements and list risk factors and other events that could impact future results and disclose important additional information regarding our acquisition. Also, please note that the company undertakes no duty to update its forward-looking statements. As a reminder, our most recent Fleet Status Report was issued on April 18. Before we begin our discussion of first quarter results, we would like to thank everyone who joined us in Corpus Christi, Texas, in April for our Investor Day, as well as everyone who watched our video webcast. We enjoyed meeting with you, and we hope you found the event to be helpful in terms of expanding your knowledge of Ensco. Now let me turn the call over to Dan Rabun, Chairman and CEO.

Thanks, Sean, and good morning, everyone. Before Jay takes us through the financial results, I will discuss first quarter highlights and the state of our markets. Before I do, though, let me also extend our thanks to everyone who participated in our Investors Day. I mentioned last quarter that we were realizing the benefits of our acquisition, and I'm sure, following our Investor Day, the benefits of the acquisition are even more clear. We have a deep pool of talent within our company, ranging from engineering and capital projects, as evidenced by our drillship and high-spec jackup presentations; to operational expertise, as noted in our 8500 Series discussion and tour of ENSCO 8505; to safety management and training and market intelligence. Our talented rig crews and onshore professionals are leveraging the advantages we have in terms of our large customer base, geographic presence, newer fleet and standardization across our rigs. And I'm sure it was evident from our Investor Day that our teams from the various departments have joined together extremely well and are very passionate about their work. I can say this because it was extremely gratifying for us once again to earn the #1 customer satisfaction rating in EnergyPoint's independent survey. In fact, we earned the #1 score in 13 of 17 categories. This is a big achievement in any year but particularly this year given the integration of our 2 companies. Sometimes, employees lose their focus when 2 companies come together. Our employees did not. They remained focused on safety, operational excellence and addressing customer needs, and I'm very proud of their performance during this transition period. Turning now to other highlights during the quarter. ENSCO 8506, the final rig in the 8500 Series, was contracted to Anadarko at $530,000 per day for 2.5 years and will commence its term contract in the fourth quarter in the U.S. Gulf of Mexico. This is yet another positive sign that customers are confident in their ability to manage the permitting process. We are also very gratified that ENSCO 8506 is the third 8500 Series rig that Anadarko has contracted with us. During the quarter, we also contracted our newest drillship, ENSCO DS-6, to BP, another repeat customer, for an initial 5-year term. Given our contracting success and positive outlook for future demand, we ordered a new ultra-deepwater drillship, ENSCO DS-8, with options for 2 additional drillships. In total, we now have 6 rigs under construction that will drive earnings and cash flow growth well into the future. Given our positive outlook, our Board of Directors increased our regular cash dividend by 7% during the first quarter. We believe Ensco is now solidly both an income and a growth investment. The key is execution. I mentioned last quarter that some of our new-build drillships experienced downtime on their initial wells mostly due to OEM equipment issues. We are working through these issues and other causes of downtime, such as human error, that added to unacceptable levels of downtime in the first quarter, including some for seasoned rigs that should not be experiencing extended downtime. We are systematically sharing lessons learned to prevent repeat occurrences. And, given the measures we have taken and the benefits of standardization and a newer fleet, we anticipate higher utilization for our deepwater segment in 2012. As I noted on prior calls, all of Ensco's active rigs, including their BOPs, are certified to work in the markets where they are currently working, and none of the current or upcoming shipyard stays noted on our Fleet Status Report involve any recertification work related to new requirements since Macondo. While we did have unacceptable levels of downtime in the first quarter, I believe Ensco has effective systems to both minimize unplanned downtime and effectively recover from an unplanned downtime when it occurs. One example of the latter is a recent contract we have signed with Noble Energy since our last Fleet Status Report. Following the acquisition last year, we had some downtime challenges with ENSCO 5006 working in the Mediterranean. We acted quickly to resolve the problems with an integrated team approach to regain our customer's confidence, and in the first quarter, ENSCO 5006 had 97% utilization. Given this positive performance, last week, Noble Energy not only exercised 6 months of remaining options, they added a new 1-year term at a day rate of $415,000, up significantly from the current rate of $285,000. This is the type of performance that I believe distinguishes Ensco from other drillers. As noted in our fleet status reports, we've also added several jackup contracts around the globe at higher day rates and for longer terms. Finally, our shipyard personnel successfully delivered DS-6 and ENSCO 8505, and they have already begun the work on ENSCO DS-8, our next-generation drillship that we recently ordered. To crew these rigs, we will promote and recruit hundreds of employees around the world, and I truly believe ENSCO will continue to offer fantastic career opportunities to our employees as we grow our company. Now let me discuss the markets. I'll begin with deepwater in the U.S. Gulf of Mexico. The permitting process continues to improve. The clarity of regulations and requirements is increasing each month. The level of inquiries continues to increase, and operators are planning to expand their drilling programs. For example, we understand BP is looking to increase from 8 deepwater rigs in 2012 to 12 by 2014. In Brazil, several units arrived during the first quarter to commence contracts, and Petrobras awarded contracts for 21 units to be built in Brazil with delivery dates between 2015 and 2010. Petrobras has outstanding tenders, 2 rigs for 3- to 6-year term contracts, and other operators have requirements as well. The African deepwater market continues to be very active, and given the short supply of ultra-deepwater assets globally, several lucrative contracts were recently awarded. Given the tightness of supply, we feel that operators will exercise whatever options they can in 2012 and early 2013. On a longer-term basis, deepwater floater demand in the West Africa is projected to rise considerably in coming years. Of significant interest was the award of 11 Pre-Salt blocks offshore Angola. Sustained activity is expected offshore Nigeria and Angola and will be complemented by increase in activity in Ghana, Cote D'Ivoire and Sierra Leone and potentially offshore Namibia. East Africa is a newly emerging deepwater frontier with several world-class gas discoveries, which should lead to developments linked to LNG. The Asian deepwater market is still in its infancy, but with its recent reports indicating the potential for large oil and gas reserves, this market is expected to grow significantly. Current demand for deepwater rigs has picked up with interest coming from clients to drill 1 or 2 exploration wells. As a result, mid- and deepwater floater market remains very tight with no surplus capacity of rigs in 2012. Operators with short-term programs in Asia are trying to form consortiums to attract suitable rigs into the market. Almost a dozen operators are actively looking for rigs for exploration programs. Floater activity in the Mediterranean is set to increase, driven by opportunities in the Egyptian, Libyan and Israeli markets. Total and Gaz de France have outstanding requirements in Egypt but have been unsuccessful in securing rig time. Now moving to midwater. The market remains challenging for lower-spec assets that can only drill in water depths below 2,000 feet. However, there are pockets of activity, and, as mentioned, there is no rig availability this year in the Asia Pacific region. ENSCO 5004 recently drilled a new discovery for OGX in Brazil. The well, which is named OGX-79, reached a depth of 2,030 meters and confirms our customer's expectations for the unexplored potential, the Campos Basin. Now turning to the jackup markets. In the U.S. Gulf of Mexico, marketed utilization is effectively 100% for premium jackups. Two competitive jackups were recently contracted outside the region, so we anticipate that the U.S. Gulf of Mexico market will continue to be tight, especially given that PEMEX has reaffirmed its intention to increase its jackup fleet to 40 units before the end of the year. PEMEX, listed several rigs in the U.S. Gulf and is evaluating its options. In the North Sea, jackup utilization and day rates continue to trend upward, and 2013 appears to be promising as well with the current demand outlook exceeding supply. Standard-duty jackup availability in the U.K., Dutch and Danish sectors is now at a premium as demonstrated by the new fixtures set over the last quarter. Availability is even tighter in the 12-strong, non-Norwegian, heavy-duty fleet with one rig being reactivated. We continue to receive new inquiries for work starting in 2013 and 2014, with the majority of the demand being for work in the Central North Sea. Mediterranean jackup market is expected to remain a challenge, and contractors continue to reposition jackups to other regions. In the African markets, the demand for high-specification units continues to grow. Over the next few months, there will be 4 new arrivals, and day rates are increasing for higher-end rigs. By contrast, the market for standard-duty rigs is less active. There has been very little tendering activity this quarter with only 2 fixtures compared to 14 at the end of 2011. The most notable inquiry in the recent weeks was from Eni, which is planning to drill its first exploration well off Togo in the third quarter of 2012. Only a handful of wells have ever been drilled offshore Togo, none since 2005. So this campaign, along with the deepwater program that Eni is planning for later this year, will be monitored with great interest. In the Middle East, high commodity prices continue to support strong tender activity in the region, and operators are struggling to secure rigs for their programs. Rigs are entering the market from all corners of the globe in order to meet demand, and subsequently, day rates continue to trend higher. In the first quarter, Saudi Aramco contracted another 6 jackups. And in Qatar, Maersk has issued a tender for up to 5 jackups. Opportunities also exist in the surrounding vicinity. We expect overall utilization in the region to be close to 100% for the remainder of the year, with only a handful of lower-specification jackups becoming available. In the Asia Pacific market, there is a shortage of rigs with programs that had been planned for second, third quarters of 2012 now being deferred until late into the year or into 2013. In order to fill long-term work projects, operators contracted several rigs from outside the region. Most of the demand is being driven by governments who are taking an aggressive approach to increase production. To summarize, customer demand is growing, and there is limited near-term supply of new rigs, which is driving up deepwater and jackup utilization and day rates. Exploration and appraisal success through deepwater basins, improved permit activity in the U.S. Gulf, healthy commodity prices, these are all positive indications for long-term growth. In addition to these factors, clients are placing a greater value on newer high-specification equipment and on rigs that are part of a series that have performed well due in part to standardization, as seen with Anadarko contracting 3 8500 Series rigs and BP contracting another drillship, ENSCO DS-6. Clients are also focused on hiring companies with proven operational experience, competent crews and successful safety and environmental track records. All of these factors bode well for Ensco and put us in a great position to meet incremental customer demand. Now I'll turn it over to Jay.

Thanks, Dan. My comments today will cover highlights of our first quarter results and our financial position. We provided information on our earnings release that we issued yesterday after the market closed that should assist you in making certain year-to-year comparisons related to our acquisition. Therefore, my comments today will focus mainly on factors, such as the growth of our fleet and rising utilization and day rates, that influence the comparisons between periods. Now let's start with first quarter results versus prior year. Earnings were $1.15 per share, up from $0.45 a year ago. Total revenue for the quarter was $1.03 billion compared to $362 million a year ago. Approximately $461 million of the increase was related to our acquisition. Deepwater revenues increased from $98 million to $549 million, driven primarily by the acquisition as well as the addition of ENSCO 8503 and ENSCO 8504 to the fleet and the commencement of ENSCO 7500, which began its new contract in Brazil in late December following upgrades completing during 2011. Midwater revenues were $91 million, all related to the acquisition. The average day rate was $227,000, and utilization was 68%. Jackup segment revenues increased by approximately 39% primarily due to higher utilization and higher average day rates. Utilization for the entire jackup fleet in the first quarter was 84%, up from 72% a year ago. The average day rate increased $2,000 year-over-year to $99,000 as shown in our earnings release. For our marketed jackup fleet that excludes cold-stacked rigs, utilization was 94%. Total contract drilling expense for all segments was $520 million, up from $192 million in the first quarter of 2011. Excluding $269 million from the effect of our most recent acquisition, contract drilling expense increased $59 million or 31% year-to-year, mostly related to significantly improved utilization in the jackup segment, the commencement of ENSCO 7500 contract and the addition of ENSCO 8503 and ENSCO 8504 to the fleet. Unit labor costs increased year-to-year, in line with our expectations, but contract drilling expense overall came in below our prior outlook, mostly due to lower repair and maintenance costs related to timing. As I'll discuss in a moment, we expect to see an increase in contract drilling expense in the second quarter. For full year 2012, our outlook for contract drilling expense is in line with our prior outlook on our last earnings call. Now let's discuss quarterly trends by comparing first quarter 2012 sequentially to fourth quarter 2011. First quarter revenue increased 3%, mostly attributable to a $35 million or 7% increase in deepwater segment revenues, driven by a 7-percentage-point increase in deepwater utilization to 87%, combined with an $11,000 increase in the average day rate. In addition, we had a $16 million or 5% increase in jackup segment revenues, driven by a 2-percentage-point increase in utilization to 84%, combined with a $3,000 increase in the average day rate. These increases were partially offset by a decline in midwater segment revenue due mostly to ENSCO 5003 being stacked and shipyard work for ENSCO 5002. Total contract drilling expense increased $5 million sequentially from the fourth quarter primarily due to higher personnel costs as projected last quarter, as well as an increase in mobilization expense, offset in part by lower repair and maintenance costs. Looking at other expenses, depreciation was essentially flat compared to the fourth quarter, and G&A expense decreased $2 million. The effective tax rate in the first quarter was 11.6%, slightly lower than our guidance for the full year, due to a discrete tax item in the quarter. Now let's discuss the second quarter outlook. Based on our current projections, revenues are expected to increase approximately 6% from the first quarter. Deepwater segment revenue is projected to increase by approximately 10% primarily due to further improvement in utilization and day rates. For midwater, our smallest segment, we expect higher utilization in the second quarter due to the completion of planned shipyard work for ENSCO 5002, as noted in our Fleet Status Report. For jackups, the average reported day rate will increase further based on contracts already in place. However, utilization will decline somewhat to about 80% for the entire jackup fleet due mostly to planned shipyard stays. As noted in our most recent Fleet Status Report, 8 rigs will be in the shipyard for upgrades or regular inspections during the second quarter. For example, we have a few rigs in Saudi Arabia undergoing upgrades funded mostly by our customer under long-term contracts. And in Mexico, ENSCO 83 as well as ENSCO 98, which recently received an extension with PEMEX through November, are undergoing regular inspections. For full year 2012, we expect utilization to be approximately 80% for the entire jackup fleet, including cold-stacked rigs. Marketed jackup utilization, which includes cold-stacked rigs, is anticipated to be in the high 80% range. This outlook includes planned shipyard upgrades or regular inspections for approximately 15 of our 40 active marketed jackup rigs. We anticipate second quarter 2012 total contract drilling expense will be up approximately 4% from the first quarter, mostly due to higher repair and maintenance expense. Depreciation expense should increase approximately $3 million primarily due to the commencement of ENSCO 8505 drilling operations. We anticipate G&A expense will decline further to about $34 million in the second quarter, which in part reflects the synergies that we have described from the acquisition. Other expense is anticipated to be approximately $25 million, comprised of $31 million of interest expense, partially offset by $6 million of interest income. Overall, we feel very good about our synergy targets for 2012 and beyond. Full year 2012 capital spending is forecasted to be about $1.9 billion. The anticipated breakdown is as follows: $1.3 billion is for new-build rigs, $380 million for rig enhancement projects and $250 million for sustaining projects. In terms of our financial performance, we ended the first quarter with a 32% leverage ratio and more than $10 billion of revenue backlog. As we noted in our earnings release, we have recently extended our 364-day credit facility at improved terms. This facility, plus our remaining 4-year credit facility, totals $1.9 billion of undrawn revolver capacity, giving us ample liquidity. The strong financial position, coupled with our positive outlook for customer demand and future cash flows, prompted the board's decision to increase our regular cash dividend by 7% during the first quarter, as Dan noted earlier. As we discussed during our Investor Day in Corpus Christi, we have the newest fleet of ultra-deepwater rigs and the largest fleet of active premium jackups, which we expect will lead to industry-leading utilization and day rates, especially given the advantages of scale and our enhanced diversification across geographies, rig types and customers. Customers have ranked us #1 for overall customer satisfaction, and we are realizing the benefit of our competitive advantages, including those gained through the acquisition. We will continue to capitalize on these advantages for our shareholders, and we expect to see significant growth opportunities as market-wide utilization and day rates increase, as well as from our new-build rigs as they are delivered and commence their initial contracts. Now I will turn the call back to Sean.

Okay, operator, if you could please open it up for questions?

[Operator Instructions] And our first question comes from Dave Wilson of Howard Weil.

Jay, I know we've spoken about this in the past, about a Class A share listing. But that was at a time when it was unclear as to whether Aon [ph] insurance enrollment would benefit from such a structure. Now that it seems to work for them, do you think ENSCO is going to follow along a similar path? I know you got to weigh the merits of the costs involved with the class -- creating a Class A and the benefits of getting back in the S&P possibly, but I just want to check again if something like that was still under contemplation by you guys.

But -- and the short answer is of course. The longer answer is there were some problems when we did our re-domestication between HMRC and DTC that were very difficult to solve at that point in time and would have been very expensive to try to solve. HMRC has really changed their position on stamp tax, which is what's allowed all of this to happen. So as we look at making the change now, it's not a particularly expensive thing to do, and it doesn't require undue regulatory approval. So I think it'd be safe to assume we're looking at it and we'll move us quickly as we think makes sense.

Okay. Great. And then just as a follow-up on, in your recent Analyst Day, you guys went into some specifics on the 120 Series, the jackups, and introduced some of the designs for the 130 Series. And Dan, I wanted to get an update on the 130 Series and see if you were seeing more customer interest in that type of rig, especially in light of some of your commentary you made on the North Sea.

This is Kevin, Dave. On the 130 Series and the 120 Series, those rigs have a wide operating envelope in the North Sea. So as that market demands that kind of equipment, we are seeing interest. It's also giving some clients alternatives versus some of the semis in that market which are, of course, in tight supply. So yes, we are seeing interest.

And the next question comes from Robin Shoemaker of Citigroup.

I wanted to just ask about the situation with Petrobras, and you mentioned a couple of rigs that they may have tenders open currently. But just looking a little beyond that and given what we've been reading about the challenges of building rigs in Brazil in those first stages, what could you anticipate as coming tenders or requirements in the next year or 2 and in comparison to the total opportunities you see around the world from other operators and how that -- sorry, how that relates to the overall supply of rigs coming out that are currently uncommitted?

Robin, this is Kevin Robert. Regarding Brazil right now, all the questions you asked are currently under study by Petrobras with the recent announcements down there about different shipyards and different projects and different players in those shipyards, along with kind of how the worldwide market has tightened up considerably. Petrobras has stepped back and they're running a study to try to determine what their go-forward position is going to be. But in all scenarios they're looking at, they're looking at increased demand. So where the rigs come from, I think, is a question mark, but the demand is there. And with the recent discoveries they've had, as they move to book those reserves and commit to development programs, our expectation is that we see demand in Brazil increasing. Now, in a worldwide market where the rest of the world is already practically 100% utilized for deepwater rigs in 2012 and it appears that most of '13 is, if not spoken for, close to being spoken for, this -- whether the incremental demand actually adds rigs in Brazil or creates a vacuum where rigs are in short supply in other markets I don't think matters because it's a global market. But we are seeing now a significant requirement being talked about into 2014. So I think that's the takeaway here, is operators are realizing they need to get out in front of this or they're not going to have a rig.

Right. Just following on, Kevin, to that issue about Brazil, you have quite a few rigs that are coming up for contract renewal, not really this year but starting fairly early in '13. And some of them are, especially, well, midwater rigs and some of the deepwater as well, would appear to be pretty low compared to what we've seen as recent fixtures and leading-edge rates for mid and kind of conventional deepwater rigs. So how do think that -- how far in advance of those expirations would you expect to be talking to Petrobras about pricing for or -- on the renewals of those rigs assuming they stay in Brazil?

Yes. One thing to make sure that you're clear on, Robin, is the difference in specifications. The 10,000-foot ultra-deepwater equipment that we see coming out of yards today is very different than the deepwater equipment currently in Brazil. Also, Petrobras still has plenty of work in the existing basins as well as pre-salt. So we are always in dialogue with Petrobras about our rigs down there because we are in their top 2 in terms of size of contractors. So we're always looking for solutions and always in discussion with them about extending rigs and bringing new rigs in.

[Operator Instructions] The next question comes from Waqar Syed of Goldman Sachs

My question relates to the -- can you hear me?

Yes.

Oh, sorry. Okay. So question relates to the 5003. That rig is cold stacked. Is there any future for that rig? Or do you think it just stays cold stacked?

We could put that rig to work on short-term programs. We've made a decision, given the -- what's best for the earnings potential for that rig, not to bring it back out into the market unless we can secure term work, which we feel is the best thing for that rig. So whether or not it has a future or not, certainly, it could be working and it does have a future. It's something that we're being selective about putting back to work.

And the next question comes from Ian Macpherson of Simmons. Ian Macpherson - Simmons & Company International, Research Division: I didn't catch the Noble extension for the 5006, I believe. Is that effective from June? Or is that effective after some price options at the end of this year or early '13?

What they did, Ian, is they termed up the remaining options at the current rate through the end of 2012 and then added a 12-month extension for the calendar year 2013 at $415,000 a day. Ian Macpherson - Simmons & Company International, Research Division: Got it. It seems like everything we're hearing from you and your peers suggest that you're -- you have all this open ultra-deepwater capacity next year. That could start to move pretty quickly in terms of contracting momentum. Is that your expectation, that we could see a lot of your open capacity in your fleet for next year taking off over the next couple of quarters?

I think it's an expectation that you should have for the entire market. But in particular, for our fleet, we are in discussions essentially on all of our 13 availability right now with various clients. Ian Macpherson - Simmons & Company International, Research Division: Good. And can I squeeze in one more follow-up? Jay, there was one -- I'm sorry to be small minded with this question. There was one thing on the P&L that eluded me a little bit, which was below minority interest, another adjustment of a few million dollars to get to your earnings per share. I think it's about $2.5 million, $3 million?

Can I get back to you on that one, Ian? I'll call... Ian Macpherson - Simmons & Company International, Research Division: Yes, yes. No, yes, of course.

[Operator Instructions] The next question comes from John Lawrence of Tudor, Pickering, Holt. John D. Lawrence - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division: Just a question on the cold-stacked jackups. Anything in terms of reactivations or potential sales we're talking about?

John, there are -- we're talking to a number of people about potential sales, and I think we're probably close to some resolution there. At the current time, we are not looking at reactivating any of the cold-stacked jackups. John D. Lawrence - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division: And then just another jackup question on the Gulf of Mexico. Do you think the market is strong enough there where rates can continue to move higher?

John, I hate to speculate on rates. But what I can tell you is that operators are talking about longer terms. There's a real concern amongst the operators in the Gulf of Mexico that if they don't term up some rigs, they may not be able to get the rigs.

This concludes our question-and-answer session. I would like to turn the conference back over to Sean O'Neill for any closing remarks.

Thanks very much, operator. And we appreciate all of your interest in ENSCO, and we'll talk to you on our next call. Thanks very much.