Valaris Limited (VAL) Q3 2019 Earnings Report, Transcript and Summary

Good day everyone and welcome to Valaris plc's Third Quarter 2019 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I will now turn the call over to Mr. Nick Georgas, Senior Director of Investor Relations who will moderate the call. Please go ahead sir.

Welcome everyone to the Valaris third quarter 2019 conference call. With me today are President and CEO, Tom Burke; Executive Vice President and CFO, Jon Baksht; and other members of our executive management team. We issued our press release which is available on our website at valaris.com. Any comments we make today about expectations are forward-looking statements and are subject to risks and uncertainties. Many factors could cause actual results to differ materially from our expectations. Please refer to our press release and SEC filings on our website that define forward-looking statements and list risk factors and other events that could impact future results. Also please note that the company undertakes no duty to update forward-looking statements. During this call we will refer to GAAP and non-GAAP financial measures. Please see the press release on our website for additional information and required reconciliations. As a reminder, we issued our most recent Fleet Status Report which provides details on contracts across our rig fleet on October 25th. An updated investor presentation is also available on our website. Now, let me turn the call over to Tom Burke, President and CEO.

Thanks Nick and good morning everyone. Welcome to the call and thank you for your interest in Valaris. I'm going to speak to three main topics in my prepared remarks today. I will briefly comment on the company's third quarter results and provide an update on the company's four main priorities before discussing the broader market for offshore rigs and specific contract wins. I will then hand the call over to Jon for his comments. In terms of our financial results for the third quarter, we reported adjusted EBITDA of $35 million, approximately $26 million better than the outlook we provided on our second quarter conference call. These results reflect robust execution on our ongoing focus on operational excellence and disciplined cost management including aggressively realizing merger synergies. While we have a lot going on with integration, we remain focused on delivering safe and reliable operations to our customers. On our last conference call, I highlighted four priorities for the company following the combination in April. These are integration and synergy capture; delivering value from ARO Drilling; proactively managing our balance sheet; and fleet management, which encompasses our contracting strategy. With respect to our integration and synergy capture priority, we reached the six-month mark as a combined company in mid-October. During this time, we've made significant headway on our integration plan which is now approximately 65% complete. This plan includes a standardization of operational policies and procedures across our fleet which will drive a consistent approach to rig operations plus ongoing consolidation of IT infrastructure and performance management systems. As of the end of September, we reached a run rate synergies of approximately $115 million, which is ahead of schedule as we worked towards our previously announced merger synergy target. By completing the merger earlier this year, Valaris became the leading offshore driller in terms of scale and scope of operations. However, I am intent on Valaris also being an industry cost leader. On our August earnings conference call, I noted that we are looking for opportunities to deliver additional value from the combination and so with six months of operations behind us, we now have better insight into areas where we can further increase efficiencies. To this end, I'm committing that the company will deliver significant incremental merger synergies beyond the previously announced $165 million target. Most synergies targeted announced today have come from onshore G&A and operations support. We are now expanding our focus to optimizing all areas of costs within the business. While we will leverage our scale to create additional value by providing efficiencies across our operations, we will not increase our risk profile unless our operational performance slip in order to do so. We intend to provide more details on our revised target and expected timing for the end of the year. Our second priority is ARO Drilling, our 50-50 joint venture with Saudi Aramco which owns and operates offshore drilling rigs for the largest customer for jackups in the world. ARO Drilling's operating fleet continues to deliver steady results with the leased rig fleet expanding to eight rigs with the addition of a Valaris jackup last month and another Valaris jackup expected to commence operation under its lease to ARO Drilling imminently. With respect to the newbuild construction program, International Maritime Industries or IMI and GustoMSC recently announced an agreement whereby IMI would license GustoMSC technology for jackups that are built in Saudi Arabia, with the expectation that construction of the first newbuild jackups in the King Salman Global Maritime Industries Complex, at Ras Al-Khair will commence in 2021. In the meantime, ARO Drilling continues to consider various options, for the period before IMI is ready to start construction in Saudi Arabia. Additionally, as the time line and plans for newbuild construction firm up, ARO Drilling, Valaris and Saudi Aramco, will cooperatively develop the next steps, in ARO Drilling's financial strategy. Jon will comment on our balance sheet priority in his prepared remarks. As you will expect, with respect to balance sheet management, Valaris' Board of Directors and management are highly engaged on this priority. We recognize that our shareholders and other stakeholders are focused on how we plan to address our balance sheet and capital structure. We intend to take action that is in the best long-term interest of the company, so that we maximize value for our shareholders. To help us achieve this, the Valaris Board of Directors, has formed a finance committee, to assist in its oversight of the company's capital structure and financial strategies. Now moving on to our broader, fleet management priority, our focus remains on taking a disciplined portfolio approach to contracting, reactivations, and the retirement of assets. In terms of our floater fleet, as is reflected in our investor presentation, we think about our floaters as a portfolio of three main groups of assets. Those modern floaters we are working or intend on working, those modern floaters that we're holding off marketing for now, and a smaller group of much older floaters. We have 15 floaters in the first group of rigs that are working or we intend on working, including 10 drillships and five semisubs, including the VALARIS MS-1 and DPS-1. These assets were focused on winning new contracts that generate cash for the company, and actively managing costs for these rigs during uncontracted periods particularly between now and mid-2020. We anticipate that, as we secure higher levels of utilization for this group of rigs, we will see a higher pricing on the subsequent contracts. Within the second group of floaters, we have 10 rigs. This includes, two warm-stacked drillships, two newbuilds in Korea, two preservation-stacked drillships and four preservation-stacked 8500 Series semisubs. These assets fall well behind the first group of rigs I mentioned, in the contracting queue. We are holding these rigs at a lower state of readiness, which reduces our cost. Given the queue, I just mentioned, we are marketing these rigs on a very limited basis and would need to be compensated, for putting a rig from the second group to work. And for the contract to be cash accretive for us to do so. The third group contains our three much older rigs. We will continue to evaluate whether these rigs have a place in our ongoing fleet. One of these rigs VALARIS 5006 recently completed a contract. And we now have the rig classified as held for sale. I would note that since the beginning of 2015, Valaris and its predecessor companies have retired 14 floaters including two drillships and 12 semisubs. Excluding this third group, which is composed of three late semisubs, the remaining 25 floaters in the Valaris fleet are more than sixth-or seventh-generation assets, all of which were delivered in 2008 or later. With respect to our jackup fleet, we take a similar approach to fleet management and contracting. While we may consider reactivating jackups under the right economic terms, our focus remains on securing accretive backlog, for our actively-marketed assets before doing so. We continue to take appropriate action when it comes to removing jackups from the global drilling supply. To this end, we recently sold one jackup to Valaris California, for salvage value, and are now holding VALARIS JU-68 for sale. Since the beginning of 2015, we retired 19 jackups from the fleet. And we expect the VALARIS JU-68 joins these rigs soon. We continue to evaluate our legacy jackups, and may retire more rigs in the quarters to come. Our fleet strategy is also influenced by broader industry dynamics. And I will briefly touch on this before delving into the specifics of the offshore market. As it relates to macro factors impacting the demand for hydrocarbons, concerns over a potential global economic slowdown, have led market forecasters to adjust their growth expectations lower in the near-term. On the supply side, growth from non- OpEx sources has been partially offset by continued reductions from OPEC. Supply growth from U.S. shale has tapered-off more recently and there is potential that it slows further as financing conditions tighten and declines in production accelerate. These factors collectively have led to a more volatile commodity price environment that in turn impacts market expectations for future demand for offshore drilling services. Meanwhile, many integrated energy companies continue to discuss the relative attractiveness of offshore projects given improved economics. With respect to the offshore markets total utilization for the global floater fleet continues to gradually increase and currently stand at 67% versus 58% a year ago. This improvement is a result of both increased contracting activity with a 23% year-on-year increase in the number of rig years awarded through the first nine months of the year and a decline in total supply as the number of floating rigs retired from the global fleet continues to outpace newbuild deliveries. Despite the macro backdrop, I just described new floater contracting opportunities increased meaningfully during the third quarter. For example during the third quarter we recorded 19 customer inquiries for firm projects that will require a drillship compared to 21 inquiries for the entire first half this year. We also observed a similar trend in pre-inquiries which indicates a good number of additional tenders will be released in the coming months. In addition floater contract durations have increased slightly over the past three months and our expectation is that contract durations will start to lengthen as we move into 2020. Focusing on the drillship market excluding 19 assets that are yet to be delivered there are currently 105 drillships on the water today. Of these, we classify 39 as highest specification, meaning they were delivered in 2013 or later have two blowout preventers and dual derricks with at least £2.5 million hookload capacity. Utilization for these highest specification drillships currently stands at 85% versus just 59% for the remaining 66 drillships in the global fleet. Of the open drillship opportunities at tender or pretender stages, approximately 50% are for work offshore Africa and Brazil and we expect these two regions to be a significant driver of incremental drillship activity over the next few years. Our drillship fleet includes 11 of the highest specification assets including newbuilds Valaris DS-13 and DS-14 and is well positioned to benefit from the recent increase in customer activity to deepwater projects. Since our second quarter conference call, we've been awarded new contracts or extensions of 5 of our drillships: Valaris DS-15 and DS-16 in the U.S. Gulf, Valaris DS-7 offshore Egypt and Valaris DS-12 and DS-4 offshore Angola and Ghana respectively. Moving now to the benign environment semisub market, there are approximately 75 assets on the water today that fit within this category with approximately 2/3 of these rigs capable of working in moored mode and 1/3 capable of operating in dynamically positioned mode. Certain projects in regions will require quite difficult specifications and our fleet of versatile semisubmersibles provides us with the technical capabilities to meet such unique demands. Our recent contracting wins underscore these abilities. We won work for dynamically positioned semi-Valaris DPS-1 offshore Australia that is expected to run from the first quarter of next year through the end of the third quarter 2021. The Australian market continues to be an important region for semisubmersibles and we expect several opportunities to emerge for semis in this region in 2020. Meanwhile Valaris 8505 had its current contract offshore Mexico extended through the end of the third quarter 2020. The versatility of the 8505 and its sister rig the 8503 which are capable of operating in either dynamically positioned or moored modes, places these rigs well for future opportunities in the Gulf of Mexico. Moving to the jackup market, we continue to see an improvement in global jackup utilization which currently stands at approximately 73% compared to 66% a year ago. This improvement in utilization is almost exclusively driven by higher customer demand with a number of contracted rigs increasing to 380 from approximately 340 this time last year and more than 50% year-on-year increase in the number of rig years awarded for new jackup fixtures through the first nine months of 2019. The overall improvement in the jackup market is also highlighted by an increase in the average contract durations. New jackup contracts signed during the first nine months of 2019 had an average term of 16 months versus 11 months for the same period in 2018, and this number increased to 18 months when looking at contracts signed during the third quarter. These dynamics are helping to drive a broad-based improvement in pricing for jackup rigs, although the strength of the improvement varies by asset type and region. The stronger segment of the jackup market is the modern ultra-harsh and harsh environment rigs, which are mostly located in the North Sea. Utilizations of these rigs stand at 98% reflecting a highly contracted nature of this asset class. As a result of these high utilization levels, we've seen day rates for these rigs steadily increased since the beginning of 2018 with leading-edge day rates of approximately $200,000 per day for our N-Class rigs operating in Norway and above a $100,000 per day for assets operating in other sectors of the North Sea. Valaris has the largest fleet of modern ultra-harsh and harsh environment rigs with 13 of these assets, all of which are either under contract or have a contract for future work. In the past three months, we've been awarded new contracts or extensions for these assets totaling roughly $135 million in contract backlog as disclosed in our Fleet Status Report at the end of last week. Since this Fleet Status Report, we've been awarded at least nine months of additional work split between the VALARIS JU-249 with Chrysaor and the VALARIS JU-122 with Shell both in the U.K. sector of the North Sea. We will provide additional details in our November contracting update. Benign environment jackups were also seeing customers demonstrate a strong preference for modern rigs. Total utilization for modern benign environment jackups is currently 77%, 10 percentage points higher than utilization for older jackups. Despite new rig entering the market over the past year, utilization from modern benign environment rigs has increased by approximately eight percentage points during this period. Once again, Valaris is the market leader in the modern benign environment jackup space with 25 of these rigs, including five that are leased to ARO Drilling on long-term contracts. The Middle East and Southeast Asia are the primary markets to these types of assets and there are several opportunities including multi-year jobs that we are currently bidding on. In addition, we are pleased to start a program in Guyana with our JU-144 expanding our footprint in Central America where we'll see additional activity in 2020. Additionally, we received a number of recent inquiries for development and exploration work in shallow water offshore Mexico from both Pemex and the international players. Overall, our marketing efforts are benefiting from our enhanced scale. And as the largest offshore driller with exposure to shallow and deepwater markets we are much more relevant to customers with offshore projects. With customer demand increasing over the past three months, we will leverage these advantages to add approximately $415 million to our contract revenue backlog replacing nearly 90% of the backlog consumed during the third quarter. This is an excellent result considering some of the higher dollar legacy contracts that were within our backlog, and we're focused on signing additional contracts that benefit our backlog position provided they are consistent with the marketing strategy I laid out earlier. Before I hand the call over to John, I want to emphasize that while the offshore drilling market continues its recovery we remain focused on our four priorities namely proactive balance sheet management, continuing to support ARO Drilling's development, delivering on our cost reduction commitments from the merger and winning new work for our rigs that benefit cash flow and position our fleet to meet increasing levels of customer demand. By pursuing these priorities, we will enable the company to weather the cyclical nature of our industry, participate in the unfolding offshore market recovery and maximize value for our shareholders. I'll now turn the call over to Jon.

Thanks, Tom, and good morning everyone. My prepared remarks today will focus primarily on discussing our financial position and balance sheet management, given the heightened interest in our ability to manage our liabilities. As I've noted previously, we continue to focus on managing our liabilities in a manner that provides the company with a financial runway and adequate liquidity to best navigate the sector recovery. But before going into this topic in more detail, I'll first cover our third quarter's 2019 financial results and our outlook for fourth quarter 2019. Starting with our third quarter 2019 results. Adjusted EBITDA was $35 million for the quarter approximately $26 million better than the guidance we provided on our last conference call. These better than expected results were primarily driven by disciplined expense management, including efficiently reducing costs for rigs that recently completed contracts and a faster realization of merger synergies. When comparing to our third quarter 2019 results to the prior sequential quarter, as we have done in our press release, note that the third quarter was our first full quarter as a combined company following merger closing earlier this year, and that second quarter results reflected 10 fewer days of legacy Rowan operations since we completed the merger on April 11. Revenue for the third quarter was $551 million compared to $584 million in the prior quarter. In the floater segment, revenue declined to $270 million from $296 million from the prior quarter primarily due to VALARIS 8504, DS-4 and DPS-1 having fewer operating days on a sequential basis after completing projects during the third quarter. This is partially offset by increased revenue for drillships VALARIS DS-7, DS-9 and DS-15 which had more operating days in the third quarter after beginning new contracts in the prior quarter. In the jack-up segment revenue declined to $218 million from $229 million primarily due to a four percentage point decline in utilization. This decline in utilization resulted from several rigs that were in transit or experienced other idle periods between contracts, which is partially offset by VALARIS jackup 123 commencing its maiden contract during the third quarter as well as contracts startups for VALARIS JU-100 and JU-117. Moving out to costs. Excluding transaction costs contract drilling expense was $488 million, which was in line with the prior quarter, and $17 million lower than our prior conference call guidance primarily due to more efficiently reducing costs to rigs that completed contracts and the deferral of certain repair projects. Within third quarter contract drilling expense of $488 million was $13 million for rig mobilizations during the period as we repositioned assets for new contracts or in anticipation in future contracting opportunities, which was $11 million higher than those costs in the prior quarter. This is offset by lower contract preparation costs as compared to the second quarter, which included costs to prepare two rigs for lease contracts with ARO Drilling along with large JU-100, which commenced a new contract in June. Third quarter results included a non-cash asset impairment charge of $88 million related to semisubmersible VALARIS 5006, which has been classified as held for sale and is expected to be retired from the global drilling fleet. After carefully considering the opportunities for this asset and the costs required to keep the rig competitive we do not foresee an adequate return on invested capital and therefore we are moving to quickly divest the rig to minimize future holding costs. Depreciation expense increased to $163 million in third quarter 2019 from $158 million in the second quarter, due to a full quarter of depreciation for legacy Rowan rigs and the addition of VALARIS JU-123 to the active fleet during the third quarter. Excluding transaction costs general and administrative expense declined to $29 million from $33 million in the prior quarter primarily due to lower personnel costs resulting from merger synergies. During the third quarter, we incurred approximately $16 million of merger-related transaction costs which are excluded from adjusted EBITDA and the adjusted loss per share amounts presented in the press release. Other income was $40 million for the third quarter driven by $194 million gain resulting from the July repurchase of $952 million of debt due in near and medium term and partially offset by $114 million in net interest expense and a $53 million bargain purchase gain adjustment. Tax expense declined to $2 million from $33 million mostly due to $18 million of discrete tax benefit in third quarter 2019 compared to $1 million of discrete tax benefit in the prior quarter. The discrete tax benefit in the third quarter was primarily due to the impairment charge for VALARIS 5006. Cash outflows from changes in working capital were $43 million for the third quarter, due primarily to interest payments and I would note that each year the third quarter is the quarter where we pay the most interest. In addition to interest, we made a $29 million prepayment related to a tax matter in Australia that we are in the process of litigating and a $23 million payment to a shipyard as part of a previously disclosed agreement to delay the delivery of VALARIS DS-13 and DS-14, which I'll expand upon in a moment. These payments were partially offset by an approximately $60 million reduction in accounts receivable in the third quarter and we expect to see accounts receivable decline further in the fourth quarter. Now we'll move to third quarter results for our joint venture ARO Drilling. Operating income was $22 million compared to $27 million reported by Valaris in the second quarter. When accounting for the 10 operating days before the merger closed on April 11 ARO Drilling's second quarter operating income was $30 million. As compared to the prior quarter, higher revenues for an additional 10 days of ARO Drilling financial results were more than offset by higher repair and maintenance costs to survey work on two rigs additional operating costs for VALARIS JU-147 and 148 following their delivery from the shipyard and certain nonrecurring and other minor ramp-up costs as ARO Drilling continues to transition its processes and personnel from Valaris. As a reminder ARO Drilling is a 50-50 nonconsolidated joint venture between Valaris and Saudi Aramco and Valaris is entitled to 50% of ARO's net earnings. Valaris' 50% interest in ARO Drilling's net income was $5 million through the third quarter as compared to $8 million in the prior quarter driven by the items I just discussed. Because of the nonconsolidated status of the joint venture Valaris' 50% interest in ARO Drilling is accounted for using the equity method of accounting and we only recognize our portion of ARO Drilling's net income which is included in equity earnings of ARO Drilling and the condensed consolidated statement of operations. The equity earnings of ARO is also impacted by noncash amortization of the basis difference generated from the fair value write-up of our investment in ARO reflected on our balance sheet through acquisition accounting. This upward adjustment through our investment in ARO resulted from the estimated fair value of ARO, exceeding its U.S. GAAP book value at the time of the merger. The amortization of this basis difference is $9 million through the third quarter, resulting in a net loss of $4 million recognized in our income statement through equity earnings in ARO. While this trend of noncash amortization will continue for a period of time, it does not impact our overall equity interest in the joint venture or our access to our share of cash flow that ARO Drilling is expected to generate. Please reference our Form 10-Q filed with the SEC this morning for more information on this concept. Looking forward, we expect ARO Drilling 2019 EBITDA will be approximately $170 million towards the low end of our prior guidance, due to VALARIS JU-147 and 148 commencing contracts to Saudi Aramco later than previously anticipated. Now moving to the Valaris fourth quarter 2019 outlook. We expect total revenues to be approximately $505 million with fleet utilization declining to approximately 60% from 64% in the third quarter, due to fewer operating days for floaters VALARIS 5006, DPS-1, DS-15 and DS-4 that will be partially offset by higher revenue for the jackup fleet as harsh environment rigs begin new contracts in the North Sea. Our fourth quarter revenue outlook breaks down as follows, $205 million to $210 million from our floater segment; approximately $230 million from our jackup segment; and approximately $67 million of other revenues, including $23 million of reimbursable revenue from ARO Drilling, $22 million of ARO Drilling lease revenue and $22 million related to two managed rigs in the U.S. Gulf. Note that this revenue outlook includes day rate revenue from the approximately $440 million of contracted backlog disclosed in our most recent Fleet Status Report, plus additional revenue from expected contracting and reimbursables and amortized revenues that are excluded from contracted backlog. Including transaction costs, we anticipate that fourth quarter contract drilling expense will be approximately $450 million. Sequential quarter decline is mostly due to reduced operating costs for rigs that completed contracts during the third quarter or expected to complete contracts during the fourth quarter, lower mobilization costs compared to the prior quarter and for the realization synergies. We expect depreciation expense will be approximately $165 million. And G&A expense excluding transaction costs is anticipated to be approximately $29 million in line with the prior quarter. We estimate the fourth quarter tax provision will be approximately $33 million and fourth quarter EBITDA is expected to be approximately $25 million. Fourth quarter capital expenditures are expected to total approximately $65 million. This includes $50 million of costs from minor rig enhancements and upgrades, including residual spend for Schedule G upgrade on VALARIS JU-147 and 148, which are partially reimbursed by the customer in advance of their commencement in multi-year contracts in the Middle East and the addition of the fully automated drill floor on VALARIS JU-291 before beginning a new contract in the North Sea. We also anticipate $15 million of newbuild CapEx, primarily related to the startup and mobilization of VALARIS JU-123, which commenced its maiden contract in the North Sea during the third quarter. Turning now to our financial position. As of September 30, our available liquidity was $1.6 billion of which $130 million was cash and $1.5 billion was undrawn capacity on our revolving credit facility. Pro forma for the debt repurchase completed in July, our cash balance declined by $224 million on a sequential quarter basis, primarily due to the repayment of $202 million of debt that matured during the quarter and $124 million of cash interest payments. In addition, we made a $29 million tax prepayment and a $23 million payment to delay the delivery of two newbuild drillships as I mentioned earlier. The impact of these payments on our cash position was partially offset by borrowings on our revolving credit facility, which had an outstanding balance of $141 million at the end of the third quarter. We anticipate using our revolving credit facility to meet our interim funding need as borrowings on this facility are at LIBOR plus 4.25% which is more cost effective financing than if we were to raise additional capital today. However, we recognize that using our revolving credit facility to meet funding gaps is not sustainable in the long run since this facility is scheduled to expire at the end of the third quarter of 2022. We have several tools at our disposal to help us address our funding needs and as we have done throughout the cycle we will not sit idle while we wait for the industry recovery. Our financial strategy will focus on two key tenets, extending runway and bolstering liquidity. Our capital structure permits us a great deal of flexibility, since it is composed largely of unsecured debt. And because of this, we have the ability to layer our capital structure by adding guaranteed debt and secured debt. Since our last earnings call, market sentiment towards energy and offshore drilling has continued to weaken, including increased market concern regarding a broader global economic slowdown and a corresponding impact on hydrocarbon demand that would negatively impact customer activity. Our credit spreads have widened meaningfully in the last quarter, which could limit our ability to raise new funding on an unsecured basis on reasonable terms in the current market. However, given our high-quality asset base, which third-party analysts have estimated has between $9 billion and $12 billion of gross asset value, we believe that the secured debt market is currently accessible to us. In addition to raising new debt, our capital structure also gives us the ability to monetize assets. While this provides further funding flexibility, there are limited cash buyers for offshore drilling rigs at the moment. That said, the market for asset sales is dynamic and there's potential that we see increased interest from buyers if day rates continue their gradual improvement. Our ownership interest in ARO Drilling also provides us with a potential source of liquidity. And as Tom noted earlier, we are in discussions with ARO and Saudi Aramco to better develop ARO's financial strategy. ARO Drilling has no external debt, which presents a future financing opportunity, given that the company's rig fleet is fully contracted and has meaningful revenue backlog. Furthermore, Valaris holds $453 million of shareholder notes from ARO Drilling with 2027 and 2028 maturities that bear interest at LIBOR plus 2%, and will receive this compensation for assets that were contributed to the joint venture. As of September 30, ARO Drilling's current assets including cash and accounts receivables were $453 million. Due to the sizable liquidity position at ARO today, as Tom mentioned earlier, we expect the Board of managers to support a cash interest payment of $23 million in the fourth quarter for our portion of the shareholder notes. Valaris has also received an arbitration award for $180 million for damages resulting from a pending legal matter with Samsung Heavy Industries. And we are seeking interesting in related costs that would increase the amount due to Valaris. Samsung has filed to leave to appeal this ruling, and we expect the English High Court to issue its ruling on the matter during the fourth quarter. We would move to enforce this judgment if the high court were to rule in our favor, although, I'd note the timing of collection of the award in full or in part is uncertain at this time. In addition, to help reduce our funding requirements, we are focused on actively managing our liabilities and cost base. As I mentioned earlier, we reached an agreement with DSME shipyard in the third quarter to delay the deliveries of newbuild drillships Valaris DS-13 and DS-14 by up to two years each. As part of this agreement, we made a payment of approximately $23 million representing all holding costs and related accrued interest through the first quarter 2019. As a result, the scheduled delivery dates for these rigs are now September 2021 and June 2022 respectively. Most importantly, the final milestone payments and interest thereon for the rigs are due at these revised delivery dates. If these payments were to be made upon delivery, they would total approximately $313 million in aggregate. However, we continue to have the option of finance the milestone payments and accrued interest through a promissory note, which will bear interest at 9% per year with maturity at year-end 2022. The management of cash requires tight scrutiny of our cost base and adjustment to these costs in light of market conditions. Beyond direct costs to run and manage our fleet of 79 rigs, we currently require approximately $950 million of cash to cover interest, capital expenditures, taxes and support costs on an annualized basis. Of this amount, roughly $400 million is cash interest on our debt and another $150 million are for cash taxes and other costs like pension obligations that are more difficult to reduce. However, the remaining $400 million for capital expenditures and support costs can be managed to reduce annual cash spend going forward. One way that we are able to reduce capital expenditures and ongoing holding or stacking costs is by disposing of non-core rigs from our fleet, and we will continue to do this as older and less capable rigs complete contracts. Further, project spend on core rigs will continue to be closely scrutinized. And unless these projects result in relatively short paybacks, they will not be funded. Support costs are also expected to decline. After giving effect to merger synergies realized to-date, our annual run rate for G&A expense stood at approximately $115 million at the end of the third quarter. As we continue to realize synergies from the merger over the next year, this run rate is expected to decline to $100 million per year. Similarly, the annual run rate for operation support expense is currently $100 million and is expected to decline to $90 million per year as visible merger synergies are captured. As a result of these efforts, we expect the capital expenditures and support costs for 2020 are reduced from $400 million to $350 million lowering next year's expected cash uses. We will continue to evaluate our cost base, as we complete our annual budget process and look for additional ways to further reduce costs, so that we lower our near-term funding requirements. Another aspect of the capital structure that we continue to work on is the previously announced internal reorganization to make the unsecured senior notes issued by Rowan Companies Inc. pari passu with our other unsecured senior notes. By completing this reorganization, we will simplify the capital structure and gain additional flexibility as we plan our next financial actions. While we have yet to effect his reorganization we have made significant strides towards facilitating it. In addition to managing our liquidity and liabilities, I also want to reiterate our focus on winning new contracts for our rigs as a means to generate better operating cash flow. Our marketing teams are committed to contracting rigs on sensible terms to generate cash for the company and recent contracting success has helped to derisk our outlook for next year with the addition of approximately $300 million to our 2020 contracted revenue backlog. While we anticipate some gaps for rigs between contracts during the first half of 2020, particularly for floaters, we expect to add more revenue backlog that will result in better utilization in the second half of the year. We will remain highly focused on disciplined cost management for rigs with uncontracted time during the year to minimize cash outflows during these periods. As a result of our contract backlog, anticipated contracting success and cost management efforts, we expect next year's EBITDA will improve as compared to this year, the first year-over-year improvement this cycle. While the gaps in utilization, I just mentioned, our anticipated to cause EBITDA to move slightly lower in the near term. Fleet utilization is expected to gradually increase during 2020 as a result of new contracts and coupled with further improvements in our cost structure from fleet rationalization and other efforts leading to a noticeable improvement in EBITDA as we move into the back half of 2020. In closing, we will continue to focus our efforts on addressing our capital structure, proactively managing our liquidity and liabilities, and winning new contracts that are accretive to cash flow. By doing this, we can most effectively execute our strategic priorities and maximize value for shareholders. Now, I'll turn the call back over to Nick.

Thanks, Jon. Operator, at this time please open the line for questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from James West with Evercore ISI. Please go ahead.

Hey. Good morning, Tom. Good morning, Jon.

Hey. James, good morning.

Good morning, James.

Tom, you seem a bit -- I guess, a bit more optimistic about the floater market than you maybe were previously specifically citing more tenders in the third quarter than almost all that first half from the high end. And you suggested that the rates would start to move up here on the higher end group of floaters that you have. Could you elaborate a bit more on kind of how you're seeing the conversations change, how you're seeing the interest from your clients change? And if there's a bit of urgency now in the market to lock in rigs for next year.

Yeah. Thanks, James. It's a good question. It's an important question, and we certainly still project from what we -- what I talked about last quarter, which is we see the second half of next year considerably a larger amount of work. So, I think overall the theme is the back half of next year is looking pretty good, which is what we said last quarter. I would say that in this last quarter or the third quarter of this year, we did book more than $250 million of backlog which included five contract extensions and -- across our drillship fleets. And so as I sort of look forward to what is going on and the tempo, it has certainly moved up quite a bit from last -- from where we were at the last earnings call. As I highlighted in my comments, the first half of this year, we had 21 firm orders, which is 21 projects, which we -- 31 -- 21 firm tenders that we're responding to. And in the third quarter it was 19. So, it's quite a significant increase in the tempo. With respect to the customers, I do spend a lot of time with customers talking to them about their plans. And certainly, the tempo on deepwater, particularly for work starting Q2, Q3, Q4 of next year is increasing. And we do have -- there is limited availability in certain markets such as the drillship market in the Gulf of Mexico. And so, I would say, yes, it is improving obviously. We want to see contract lengths improve. Contract lengths for floaters have increased. If we look at year-to-date 2018 versus year-to-date 2019, we have seen a modest improvement, as I said in my comments, but we're also seeing that improvement starting to actually quicken as we -- at least in the tenders that we are being asked to respond to. Because, those haven't actually been pinned yet haven't actually been won yet by anybody. But we do see that the contract length is increasing, which along with utilization is important. I would say in the short-term, as other drillers have said, we have turned down work for early 2021, which we basically just didn't have a rig available. And we've also turned down work where we weren't willing to mobilize a rig or put a warm rig back to hot or back onto contract without being contracted forward.

Okay. Okay. It makes sense. Thanks. Thanks, Tom. And then, Jon maybe a quick question for you on the liquidity side. You went through a lot of stuff in your prepared remarks. But I guess the big question for me is to prove this liquidity is available what's stopping you or what's impeding you from going ahead and hitting the secured debt markets today? Is it just you don't like the price? I mean is that the issue? Or is it it's not open?

Yes. Sure James. I recognize that my prepared remarks are a bit normal -- a little bit longer than the normal. So, just kind of going through it a little bit just to reiterate. But you're -- the word you used is kind of to prove that we have access. It's an interesting choice of words. I would tell you that we have liquidity today of $1.5 billion if you look at between the cash on hand and the available revolver today. So the revolver we have is $1.5 billion available on that and another $130 million of cash. So, I'm sorry $1.6 billion of total liquidity. And so that's available to us effectively on demand and we have drawn on the revolver as you know starting a few months back. And so there is certainly -- we certainly recognize as I said in the prepared remarks that it's not a long-term funding strategy to rely on the liquidity from the revolver in the short-term -- I'm sorry in the long-term but it is something that is available to us and that we can continue to utilize. We have the asset base that based on your gross asset value and those of some of your peers is in the magnitude of $10 billion. And so since we have no unsecured -- there's no secured debt in the capital structure today that is certainly a level that we feel very strongly that we could utilize and access that market should we choose to do so with the appropriate terms and timing. But again we don't -- there's -- we're certainly focused on it. We're -- certainly something that we can spend a lot of time thinking about having conversations about with here internally. But it's also something that we don't feel like we need to go out there and rush off to do something just to kind of use your words prove to the market that we could do it.

Okay, makes sense. Thanks Jon. Thanks Tom.

Thanks James.

The next question is from Greg Lewis with BTIG.

Yes, thank you and good morning and I guess good afternoon. hiJust looking at the floater fleet specifically the drillships you have nine here I guess what you deem to be premium high-end drillships contracted. It's interesting as you look at those nine drillships each one of them has varying levels of options attached to them. I guess just looking at the initial four that roll off through Q1 of 2020 they all have options. Any thoughts around when you expect or sort of thoughts around do we think some of these options get exercised? Really I'm just trying to understand. And I don't think you were talking about these rigs but when you mentioned not necessarily being able to bid into some work for availability of rigs how should we think about the availability of kind of what you guys deem to be your high-end drillships in 2020?

So, Greg, yes, good morning. So, as we look at the fleets and we look at the options that we have, obviously, it varies by customer-to customer-and the strike dates on options fairly. But I would say that we think that based on public commentary from our customers, we expect those options to be exercised right or a number of them. And there's really options that -- aren't exercised. We do see opportunities in the so-called Golden Triangle in the Mediterranean for which those rigs are pretty well suited for work beginning in mid-2020 and beyond. There may be some gaps. But certainly as I articulated in my comments we have 25 floating rigs which were delivered in 2008 or later of which 15 we are actively marketing. And the other 10 we're holding back to reduce our costs. So, we are focused on that on those 15 rigs and we do feel that we will be able to contract them.

Okay, great. And then just one more for me. I mean clearly you guys highlighted in your prepared remarks that the jackup market is improving. You mentioned about the potential for rig disposals. I guess as we look at the jackup fleet -- and I'm really just curious around I guess the specific class rigs because they look to be two of your better stacked jackup rigs. As we look at 2020 are there thoughts about maybe reactivating? Or maybe I'm looking at -- maybe I'm thinking about it differently. Are there any -- I mean the jackup market is good. Are there opportunities to maybe put some of these sideline jackups to work/or is it more a function of hey we have kind of our core fleet of jackups working and it's really just about keeping those on higher rigs working?

So, with respect to those two specific rigs they are very good rigs and so they are something which customers visit have looked at a lot. Certainly, we want to keep our -- the rigs that we have working -- that are hot are working. So we certainly are very focused on that. We would reactivate those rigs if as I said in my remarks if the economics were right. So we do think those rigs are in very good shape and -- but we would want to make sure that we were comfortable that we would get a good return on capital for reactivating them.

Okay. Hey, perfect. Thank you everyone for the time.

Thanks very much.

Thanks, Greg.

The next question is from Connor Lynagh with Morgan Stanley. Please go ahead.

Hi, Connor.

Yeah, thank you. Hey, there. Just wanted to address some of the information that's out there in the market perhaps suggested by some of your competitors that you guys are being undisciplined in some regions. I just wanted to, sort of, you give the mic and give you a chance to address what some have been saying out there.

Yes. Certainly -- we're certainly in competition for work across the world. And I'm not really going to dignify some of the comments perhaps directly. But what I would say is as I articulated in my comments we have -- we're holding 40% of our excellent modern floater fleet off the market today to help us reduce our costs. And so the rigs that we do have and we are marketing we certainly want to keep working. And so I think that there has been -- there have been opportunities or there have been instances where we have a rig coming off a contract and there was a short gap and we've been aggressive on filling that gap. But we certainly are focused on driving value and expanding on margin on all of our floating assets. So -- and I can't -- I'm not going to give you specifics about where we're bidding because that isn't appropriate, but we certainly feel like we have a very good understanding of the market and every drillship tender that we make is very thoughtful about how to maximize value for our shareholders.

Got it. I appreciate the color. Just switching gears here you were alluding to some potential upside to synergies. I appreciate you don't want to give a number yet. But could you preview maybe where the conversation for you has shifted? Is this more cost savings? Is it more balance sheet efficiency like reducing spares or things like that? How do you think about what the next leg is here?

Yes. I can try to give a little bit more color. So we are six months into the merger. And certainly as you know when two companies are going to combine there's a lot of information that cannot be shared and was not shared around a lot about -- lot of the two companies' cost structure. So now with six months into it or actually just over six months into it we have spent a lot of time thinking about the cost structure and what we can do. And we are very focused on driving better cash flow margins. And so I would say as far as specifically where and how much we will -- we'll have to hold off on that for the moment. But it will be significantly higher than the $165 million and we're looking across all of our cost base. I'm excluding from -- when I'm thinking about synergies, I'm excluding from that any improvement or any reduction in interest. I'm more focused on operating costs support costs. The $165 million of synergies which is still our current target for the end of 2020 until we announce something higher -- a large portion of it is coming from the G&A and the support costs or the contract drilling expense portion which is onshore support. And we're broadening out to look at all of our costs specifically our procurement costs and other costs. So we're going to -- so we're looking wider and it's hard -- it's very hard to give before you close a merger to give synergies on some of the costs that you don't actually -- are unable to look at before the merger closes. And so now we've had six months we're able to go back and say there's more opportunity here and we'll be giving an announcement on it before the end of the year.

One thing, I would just add just briefly is the fact that we're already $115 million in effectively two quarters into the combination -- and really that's not even two full quarters because we closed on April 11. That also gives us a lot of confidence one in the synergy target and two the ability to increase that target based on the factors Tom just discussed.

Makes sense. Thanks, guys.

The next question is from Cole Sullivan with Wells Fargo. Please go ahead.

Hi. Thanks for taking the question. On the 3Q OpEx you guys beat from both the synergies and kind of some deferred R&M. In the quarter, the 4Q guidance is obviously lower than I think the $480 million that was kind of implied on the last call. How do we think about the kind of moving parts? So is it mostly synergies that's kind of coming in, in the fourth quarter? Or is there some -- potentially some other deferrals or something that's going in there as well?

Sure, Cole. I'll address that. I think the biggest piece is really, there's just fewer operating days. Particularly for floaters, we have several floaters that are coming down. I mentioned the 5006 the DPS-1 the DS-15 the DS-4. And really we are going to be able to just reduce the cost on those rigs and other rigs as we move between contracts. But it is, as Tom highlighted, I don't know if you're picking up the theme between the two of us, I mean, we are very focused on just managing cost aggressively when we're between contracts in any way that we've been able to continue to look for opportunities to reduce cost over the last three months since the last earnings call. And I think, what you're seeing there is a reflection of that. I think, the activity is largely in line with where we were seeing things last quarter. It's probably a touch better, but it's really just a fact -- a matter of really focusing in on costs and where we can be more efficient.

And as we think about -- as we kind of enter into 2020, with where we kind of exit on the cost side and 4Q, I know, there's a lot of moving parts with rigs. Some rigs may be going back to work in 1Q. Is there any kind of base cost level that we can kind of think about before we start to include utilization changes and that sort of thing?

Yes. Cole, we're not going to guide any further into 2020 yet. We're actually going through our budgeting process now, real time, and I would look to more guidance on Q1 and full year, any other expectations we've said afterwards we're done with our budgeting process that we're right in the middle of.

All right. Thanks. I'll turn it back.

The next question is from Sean Meakim with JPMorgan. Please go ahead.

Thank you. Hey, guys.

Hey, Sean.

Good morning, Sean.

So on your floater fleet, does your current balance sheet position restrict you from any opportunities in terms of capital upgrades that could be necessary for certain jobs? How do you think about that for portions of your fleet where that could be applicable?

No. I don't think it does.

No. There's no restrictions as it relates to capital upgrades.

Okay. Fair enough. And I was hoping to touch on ARO as well. Good to see the progress in the near-term results. But as we think longer term, how would you frame the probability distribution of your first newbuild deliveries and some of the key milestones that you're focused on between here and there to stay on track?

Yes. No. Thanks for the question, Sean. And as you know it's one of our big priorities for the company. So I feel very good about the newbuild program at ARO. Obviously, we set up ARO before the IMI joint venture was set up. And we've -- and so IMI is now fully set up. It has -- it's been set up for sometime. We're working very closely with them. And the announcements which I highlighted which -- between Gusto MSC and IMI on rig design is a really good one. So, obviously, the shipyard in Ras Al-Khair in Saudi Arabia is still under construction. Actually, a group went up there recently and I'll probably visit it in December. But they'd given some realistic time lines for that rig -- that yard to start to be ready to cut steel. And we, IMI, Gusto MSC and ARO are working hard on the newbuild design. So I feel good about it. And not only is it important to us, but it's also very important -- it's a part of the vision 2030 plan for Saudi Arabia. So I feel good about it. And, overall, the fleet in Saudi Arabia, there are some good new assets in the fleet in Saudi, but they're all older assets that will need to be replaced. In the meantime, as I mentioned in my comments, there is a possibility of other construction, other -- accessing other opportunities for rigs, but nothing has been decided on that. But I feel very good about the newbuild program for ARO along the time lines that I highlighted in my comments.

All right. Thanks a lot Tom.

Sean. Thank you very much.

The next question is from Kurt Hallead with RBC. Please go ahead.

Hey, good morning.

Kurt, good morning.

Good morning, Kurt.

A lot of great color. I appreciate all that info. Tom, you did offer up perspective here on -- perspective looking at the ARO dynamic and trying to figure out ways to kind of I guess maximize the financial leverage kind of back to Valaris, right? Beyond just the dynamics around the note payable, what other things could be possible in terms of potentially accelerating some cash or getting some cash out of that JV and into your hands?

Well as I mentioned to Sean, it's an important subject. What I would say, Kurt is that we are obviously pinning down the newbuild program and having more understanding of when that's going to start. And the rig cost is being key. And there have been some delays because of the shipyard has been a little bit of delay -- I wouldn't say delayed. It's just the projections that we had at the front end before they start construction have basically clarified. So when I think about ARO, it is obviously as Jon highlighted and you'll see in our Q the -- current assets are increasing. So there is as we move forward more flexibility over time. We just need to pin down a little bit more our newbuild program and our -- the newbuild program and the newbuild price. Right now as Jon highlighted, ARO doesn't have any external debt and we're working on the steps that you would do with any company such as putting a new credit facility and potentially putting in more permanent -- changing out permanent debt. But there's no -- not basically -- when we know more Kurt we will certainly alert you and give more color to it.

Thanks. Appreciate that. And just out of curiosity and Jon you kind of referenced that EBITDA in 2020 will be higher than what it was in 2019. So I appreciate that directional dynamic. I just wanted to make sure we're calibrating off the right starting point on 2019. So given that you've already provided fourth quarter guidance, what is the baseline of EBITDA that we should be looking off to build on on 2019 on a full year basis? Just I know -- is it merger dynamics? Just kind of making sure, we're all on the same page on that EBITDA number?

Sure. Sure, Kurt. Well we guided to Q4 of $25 million of EBITDA was the guidance. And to date, we've accrued here -- I would say that puts us roughly around $155 million of EBITDA for the full year basis on that $25 million guidance for Q4.

Okay. All right. Thanks for that clarity. Appreciate it.

The next question is from Taylor Zurcher with Tudor, Pickering & Holt. Please go ahead.

Hey, thank you. Wanted to circle back on the capital structure. Clearly, the opportunity is there to raise additional secured debt and -- certainly on any metric on gross asset value. But on the other hand at least on the floater side there really isn't any long-term contract backlog. And so Jon, curious if you could give us your thoughts on what the market is today for raising secured debt against a rig by itself versus a rig with a long-term contract on the other side of it.

Sure, Taylor. Yes. We've -- the characteristics you call out are generally true, right? Most secured debt if you have some cash-flowing assets across of them or some backlog typically easier to secure against on a like-for-like basis. Again, I would just point to the fact that today we have 79 rigs of which none of them are secured. And with the gross asset value of $10 billion, if we wanted to -- and I'm just using -- I'm rounding for simplicity. The range I quoted before was -- is the range that we see in analyst estimates. But on that basis, ultimately then if you don't have cash-flowing assets people will look at asset value and underlying kind of steel, which is why I referenced the gross asset value. And then, if you kind of subsegment our asset class, there are certain asset classes that are cash-flowing assets, certain asset classes that have longer backlog and duration than others. The drillship part of our business is probably one of the -- probably stronger asset class valuation on an asset basis certainly on replacement cost. But then you look at some of the other parts of the business and Tom highlighted some of the strengths in -- particularly around -- look at the North Sea jackup business. So those businesses have probably higher cash flowing on a margin basis and probably more duration to the contract. But we have a mix in the fleet and so we would -- across all of these characteristics, we have plenty of assets and cash flow profiles that would suit a variety of different secured investors.

Okay, understood. And I wanted to follow-up on the topic that I don't think I heard in the prepared remarks which is the 20,000 psi opportunity set moving forward. Obviously, there's only one rig in the market with that type -- or soon to be in the market with that type of capability. But there's more than one opportunity -- incremental opportunity on the horizon. And those are likely to go to upgraded rigs that are still newbuilds in the shipyard of which you have two. Is that -- is the 20,000-psi opportunities something that you're thinking about or pursuing moving forward?

Yeah. We see a reasonable level of customer interest in 20k-psi work in the U.S. Gulf of Mexico. I mean, it's always going to be a niche market in this game of -- or at least in the short-term it'll be a niche market. Short and medium-term, it'll be a niche market, in the scheme of the overall floater market. But we would consider an upgrading one of our assets perhaps the DS-13 or DS-14, to be capable of 20k work. If we felt that it would achieve a good return on any capital invested in it. So, yeah, in general, any capital investment if there were good return we would certainly consider. And as far as drilling wells with 20k BOPs to this point, I believe Valaris is the only company who's done although it's been on the jackup side. So we have drilled 20k before on the jackup side. And we would certainly be interested in doing it on the floating side, if it was a good return on capital.

Awesome, thanks for the responses.

Thank you.

The next question is from Mike Sabella with Bank of America. Please go ahead.

Hi. Good morning, everyone.

Good morning.

I'm wondering if maybe we could circle back to ARO. And I know in the past you guys have said, the Valaris jackups that operate outside of the JV, we should just assume they continue to operate independently. Kind of given the update on the manufacturing facilities, is there any room for that strategy to change at all? And can you kind of walk us through how both you and the JV partner view that sort of transaction?

Yeah. Sure. I think that obviously we have some jackups working in -- we have jackups in -- there are jackups from Saudi Arabia, which we are in half of because we are a 50% owner in ARO Drilling. There are jackups in Saudi, which we own 100% of and they are leased to ARO Drilling. And there are jackups which we're operating outside of ARO Drilling in Saudi. And we'll have to see how things pan out over time. But the Valaris jackups in Saudi will -- operating outside of our ARO Drilling will certainly finish their current contracts. What happens to them after that we will tell you, when we sign new contracts. But they will -- the rigs that are on contract there will certainly finish their current contracts as part of Valaris. Does that help?

Great, that's helpful. Yeah, that's helpful. And then, just real quick you kind of touched on technology. I know that in the past you've discussed some of the advancements you guys have made on the rigs. Can you comment a little on the success you've had getting paid for those investments? And are you still making incremental investments in technology? Or has that mainly stopped?

I -- that's quite a -- I mean, it's a -- excuse me, I think the question which we could probably talk about for some time. I would say that, generally we are very focused on driving value in everything we do. And I'll give you an example of some technologies where we think that we are being paid for, and that is certainly our focus. So, Valaris has some very what we believe advanced technology to help us move drilling rigs where we instrument the jackup. It's patented. And it allows us to move jackups in -- to be very precise about what conditions we are able to move our jackups. We've use that technology in certain markets in the world and we believe that we have been able to get outsized -- or better day rates, because we have that technology, because the customers believe we'll be able to move our rigs when -- or at least we believe we'll be able to move our rigs when others won't. So that will be a good example of a technology we've invested in where we are able to gain an advantage in contracting -- or at least we believe we have an advantage in contracting. So certainly there are opportunities. Another one would be what we've done with -- on maintenance system. We have an advanced maintenance system, which helps us manage our costs and drive down our costs and be efficient in our maintenance. Certainly not doing too little though, but certainly not doing too much. And so, the customer is not paying us for that, but we do believe it's an example of something where we reduce our costs. So, we would certainly be looking at that. Are we -- our appetite at this point of the cycle to do heavy capital investments in new projects is limited unless we get paid for it.

That’s really helpful. Thanks a lot, guys.

Thanks Mike.

Thank you, Mike.

There are no further questions. I would like to turn the conference back over to Nick Georgas for any closing remarks.

Thanks, Gary, and thank you to everyone on the call for your interest in Valaris. We look forward to speaking with you again when we report full year and fourth quarter 2019 results. Have a great rest of your day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.