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Diamond Offshore Drilling (NYSE:DO)

Q1 2013 Earnings Call

April 25, 2013 10:00 am ET

Executives

Darren Daugherty

Lawrence R. Dickerson - Chief Executive Officer, President, Director and Member of Executive Committee

Michael D. Acuff - Senior Vice President of Contracts and Marketing

Gary T. Krenek - Chief Financial Officer and Senior Vice President

Analysts

Ian Macpherson - Simmons & Company International, Research Division

Gregory Lewis - Crédit Suisse AG, Research Division

David Wilson - Howard Weil Incorporated, Research Division

John Booth Lowe - Cowen Securities LLC, Research Division

Collin Gerry - Raymond James & Associates, Inc., Research Division

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Diamond Offshore First Quarter 2013 Earnings Conference Call. [Operator Instructions]

I would now like to turn the call over to Darren Daugherty, Director of Investor Relations, to begin. Please go ahead, sir.

Darren Daugherty

Thank you, operator. Good morning, everyone, and thank you for joining us. With me on the call today are Larry Dickerson, President And Chief Executive Officer; John Vecchio, Executive Vice President; Gary Krenek, Senior Vice President and Chief Financial Officer; and Michael Acuff, Senior Vice President of Marketing.

Following our prepared remarks this morning, we'll have a question-and-answer session. Before we begin our remarks, I should remind you that statements made during this conference call may constitute forward-looking statements, which are inherently subject to a variety of risks and uncertainties. Actual results achieved by the company may differ materially from projections made in any forward-looking statements. Forward-looking statements may include, but are not limited to, discussions about future revenues and earnings, capital expenditures, industry conditions and competition, dates the drilling rigs will enter service, as well as management's plans and objectives for the future.

A discussion of the risk factors that could impact these areas of the company's overall business and financial performance can be found in the company's 10-K and 10-Q filings with the SEC.

Given these factors, investors and analysts should not place undue reliance on forward-looking statements. Forward-looking statements reflect circumstances at the time they are made, and the company expressly disclaims any obligation to update or revise any forward-looking statements.

And now, I'll turn the call over to Larry.

Lawrence R. Dickerson

Thank you, Darren, and welcome, everyone, to the Diamond Offshore First Quarter Conference Call. I wanted to have a brief opening statement, and then I'll let Michael give you some color on the market and then Gary Krenek will go through more detail on the financials.

I think the key drivers that we look at and apply to all drilling contractors are the revenue and the day rates that we're earning in this quarter were booked quite a bit before. So really, the key variable that's why investors interested in, clearly are the future day rates and where we're signing those. The market remains strong, we believe, across all the categories that we operate in. Seeing renewal rates increasing in those categories. We chose to highlight here in our press release some activity in the mid-water market, which we think doesn't necessarily get a lot of press out there because not everybody has a big presence in that market. But, again, we found that market to be very strong. Our North Sea rigs, which we've highlighted are among the most profitable in our fleet and probably within the industry, when you look at the low operating costs that occur in that environment and the future day rates that we've got booked going forward. We have one of those rigs scheduled, as we indicated to go to Latvia and in an increased day rate, which will be a new country for us. And then, as well, we highlighted the fact that we just, this week, signed a contract to take a mid-water rig, the Ocean Saratoga, out of the Gulf of Mexico and work it in Nicaragua. And so I think that the key thing that we emphasize is that there's a lot of countries that haven't had a lot of exploration activity in them. And so initial wells can very often be in the 500- to 2,000-, 3,000-foot water depths, which are where mid-water rigs operate and when you look at the deepwater and ultra-deepwater demand taking those rigs in deeper water, this is really the tools that are available sometimes.

On the cost side. Our drivers are both cost and days of uptime. Our cost in general came in, our drilling costs at $375 million per quarter, which is flat, more or less with where we were in Q4. We are down when we're running almost $400 million at the beginning of Q2 and Q1 of last year. And we've got a lot of activities going on there, watching what we're being able to do, drawdown some of our pre-existing stock and utilizing that in lieu of that, making sure that our crews are deployed at the appropriate level and just a lot of effort going on across the board, and I think we've been doing this now for 5 or 6 quarters. So not saying that from time to time, we might not have a blip and go above that but I'm very confident that we've got methods and systems in place to try to achieve the maximum efficiency in that group, even in a world where labor costs are going up and we're seeing some price rises on goods and services that we have.

The bigger impact, though, is the amount of days that we spend off contract in a particular quarter. And for this quarter, the unanticipated equipment downtime ran 157 days, which is up slightly from 130 days that we had in the quarter before, well within what we would ordinarily expect to run this fleet at.

We have had some quarters, looking back 3 or 4, we went down as low as 90 days a quarter. So we were capable of achieving better but there's so many variables that deal with that. We had some subsea equipment. We had time down while we we're changing out these bolts that everybody's been focused on. All that impacted us to some degree.

Then we had 375 days of rigs, either mobing or in the shipyard, for the quarter and that's down, actually, from what we had given guidance on, where we were in the 400-day range. So we were -- we did fairly well on that and there's these all kind of variables but the biggest thing is that some of the time where we have to have rigs in shipyards was not completed this quarter and slipped into the future quarters. We had some time that are ran over. I'm going to talk about our construction program but even within this group, of the 375 days that we have down. We have 2 rigs, the Ocean Quest and the Ocean Rover. They were both having substantial upgrades to their quarters to increase their capacity. All of which will be related to higher day rates in the future. So there's some investment as it goes on in that group.

On the construction front, we've got 7 projects underway in various stages, 4 drillships in Korea, we've got the Ocean Onyx in Brownsville and the Ocean Apex in Singapore, which is recently in Singapore and Korea and those programs are progressing very nicely. The Ocean Onyx, we did adjust delivery date on that. We found that we had more upfront steel that we had to put in the unit that we'd anticipated and that gave us some cost and some time so we've now adjusted that to a late September delivery date in this year. The Onyx, as you recall, is contracted for a 1 year program here in the Gulf of Mexico at a very nice day rate and we're looking forward to that. That will be a first of our project. It's out and working. The Ocean BlackHawk is moving along very nicely for delivery out of the shipyard later in the summer and then the mobilization in various other projects that we've got to do before we deliver that unit here.

The seventh project that we've got is the Ocean Patriot where we will be spending approximately $120 million to prepare it for a 3-year North Sea program. We're able to take best the out of the Pacific market, which our announcement, I think, we've seen some response from customers there with our remaining units and they were there now. Realized that there's not unlimited availability. So it's helped us out there, as well as having the project going in the North Sea. And we have not begun that project yet except for some planning and some ordering of equipment as the Patriot continues to work in that market and so that takes through the construction, the cost, the day rates.

And so now, Michael Acuff, give you some more detail behind where day rates are.

Michael D. Acuff

Thank you, Larry. Good morning, everyone. As we enter the second quarter of 2013, the offshore drilling industry continues to be robust across most markets with our expectations that this market strength will continue for the foreseeable future given steady commodity price.

Looking at the various floating market segments. The ultra-deepwater market continues to lead the charge, highlighted by significant numbers, new fixtures in the industry in the past few weeks, taking several new build rigs and other available rigs off the market for 2013 and 2014. This trend should continue into the second quarter of the year as we believe several of the industry contracts are currently under discussion with deal announcements expected soon. Upon completion of these deals, we estimate that there will be a total of 4 new builds available in late 2013 or early 2014 with 3 of those having delivery in Q2 of 2014, which is simultaneous with our Ocean BlackRhino.

With respect to contractual status of our available ultra-deepwater drillships, we are currently in discussions with a couple of potential operators on the Ocean BlackRhino for utilization, either in the Gulf of Mexico or West Africa. Additionally, we're already seeing interest in the Ocean BlackLion, the fourth of our 4 drillships, which will be delivered at the end of 2014, for drilling programs starting in early 2015. As we develop these discussions going forward, they will keep you updated on those discussions.

Turning to deepwater. We continue to see steady demand for rigs in this segment with pricing continuing to remain solid. The primary areas driving this segment are West Africa and the Gulf of Mexico. For example, the Ocean Victory has secured 1 well job with Stone Energy in the Gulf of Mexico at $480,000 per day from a previous long-term rate of $420,000 taking that rig's availability out into December 2013.

Additionally, the Ocean Valiant, which is currently working for Hess in Equatorial Guinea is receiving a strong interest from a number of customers who have wells or programs in the first half of 2014 in West Africa, as well as we've seen 1 or 2 longer-term follow-on opportunities that we're discussing starting in mid-2014.

Turning to the mid-water segment. We're very encouraged, as Larry said, by the continued demand for our rigs in the various international markets. As we discussed in our press release, we just yesterday signed a 1 well plus 1 well option for the Ocean Saratoga in Nicaragua with Noble Energy and that will take the rig into November if not further in -- the key, avoiding any downtime related to the hurricane season in the Gulf of Mexico.

We believe this positions us well as the only mid-water rig in the Gulf of Mexico and Central America regions for work into late 2013 and into 2014. In the North Sea, the Ocean Princess is well-positioned to take advantage of the very strong market there, as it is the first rig available, with the current contract ending in November 2013. We're currently having discussions with several customers on this rig who would like access to the rig and believe we will have a contract to them here in the near future.

Finally, in Asia, we believe that even though rates have not moved significantly in that market, there's a steady stream of exploration wells and development project opportunities that will keep the Ocean General busy in the early 2014 and beyond. We anticipate that this additional backlog will potentially translate into better day rates as the market tightens in 2014.

So in summary, we continue to see a strong ultra-deepwater market in 2013 and into 2014 and are encouraged by the continued demand for our deepwater and mid-water units at attractive day rates.

With that, I'll turn it over to Gary.

Gary T. Krenek

Thanks, Michael. As in the past, I'll make a few comments on the past quarter that just ended and what we expect to see going into the second quarter and the rest of 2013.

For the first quarter of 2013, we reported net income of $176 million or $1.27 a share earnings. On contract drilling revenues of some $700 million; that compares to $1.12 we made last quarter on $741 million worth of revenues. Overall, for at least, financially speaking, it was a fairly quiet quarter. The biggest item, I believe, was in our tax line where we booked a tax benefit of some $28 million for some tax legislation that was passed in January of this year. It was applicable to the year 2012 but because of accounting rules, we were not allowed to book that back in the '12, but rather booked it here in the first quarter. That $28 million benefit drove our tax rate to just under 15% for the quarter. This shouldn't come as a surprise. Anyone, everyone should've anticipated this as we discussed this on our last conference call and the benefit came in almost exactly as we had expected to be.

Other things that -- from the last conference call that we did and some of the guidance, some difference is, we had expected the Ocean Patriot to do their survey, which would have caused 37 down days in Q1 and the Nuggets has some can repairs that needed to be done, which would have taken the rig out of service for about 30 days. Both of those 2 projects did not occur in the first quarter. Just -- timing of wells, and they've been pushed back into Q2. So we'll see those down days in Q2 and the associated cost with them.

Looking at contract drilling expense. Our cost, Larry spoke about that sum in his opening remarks. Those costs came in at $375 million for the first quarter. We had guided to a $390 million to $410 million figure. So we came in below that. Some $7 million to $10 million of those savings were due to the Patriot surveys. So those are costs that will just be pushed back. We also have the Quest down, virtually the entire quarter in Q1, which was expected and put out in our rig status report. The cost for the Quest and that survey continues into the second quarter, those costs came in about $7 million under what we expected and at this point we're not sure whether that's timing. I believe some of that is timing, obviously, pushed back into Q2. Some of that maybe cost savings and maybe bringing that project in below some of our expectations. But if you take some of the Quest cost in the Patriot and factor that in to our actual cost, we actually came in right at the bottom edge of the guidance of $390 million or so. So the guidance was good. At the same time, a reflection of continuing the whole cost down, we did come in at the bottom of that guidance. So we're very happy with that.

The other line items and income statement. Appreciation went $97 million, that's slightly higher than our guidance of $94 million to $96 million and we'll be adjusting our go-forward guidance to reflect that, although with a slight increase. G&A came in as expected. Interest expense came in at $8 million. That's above the $6 million to $7 million guidance. That's all a factor of capitalized interest, which becomes -- it's fairly difficult for us to pinpoint exactly, so not very far off. And the tax rate, we had expected to come in at 11% to 13% and that's what I have talked and said at the last conference call, came in slightly above that at 14.6 and that's due to some of the mix in the income and also in the increase were a little bit higher than expected. Pretax income, which was booked at 28% and when you factor that in with our $28 million credit, the ratio came out to the 14.6%.

Looking forward into the next quarter. Some of the things that are going to drive the quarter, again, the Patriot survey and the Nugget can repair is being pushed into Q2. That'll affect the second quarter. We're going to finish up the Quest but we also have the Vanguard beginning at survey. Those things will affect the quarter. Couple of other minor modes in the contract prep downtime and I'll refer you to the rig status report for the exact details on that, that we released last night. I would point out one thing though, that the total expected downtime for the year did go up slightly above what was being reported last quarter. And something that Michael had said in his talk, a large portion of that is downtime on the Saratoga. Some 60 days related to contract prep and mode time to go down to Nicaragua. So while that did increase our downtime by 60 days, what that does avoid is having the rig in the U.S. Gulf of Mexico during hurricane season where very possible, the rig would have been stuck for some 120 days last we waited out the hurricane season. So that additional downtime actually a net good to us.

Looking at contract drilling expense in Q2 and some guidance there, but before, as always, I want to remind everyone that I'll be talking about the line contract drilling expense on our income statement only. The numbers will not include cost incurred in the line reimbursable expenses. So with just contract drilling expenses, we believe those will come in somewhere between $375 million to $395 million in Q2. As comprised of our normal operating costs, survey cost for the Patriot, Vanguard and completion of the Quest and also some mobe costs of approximately $11 million to $13 million that we're expecting in the quarter.

Larry, in his opening remarks, talked about some of the past contract drilling expense and what we've averaged. Actually, over the last 8 quarters, we've averaged to $387 million, and so that's right in the middle, or my guidance of $375 million, $395 million is right in the middle there. And again, just to reiterate our efforts on cost containment in the efforts we put in on that for the past 2 years, we continue to hold those costs steady and we're very proud of that.

Some of the other line items. Looking forward in the next quarter. G&A will continue to be $17 million to $18 million. Depreciation, we believe will be between $97 million and $100 million. That's, again, based on what actual Q1 was and the fact that we got a couple of extra days in Q2. We'll drive the cost a little bit above what the Q1 cost was. Interest expense we believe for Q2 will be approximately $6 million or $7 million; again, that's a net interest expense after capitalized interest and our effective tax rate, we believe for the rest of the year will be somewhere between 28% and 30%.

And finally, on our capital expenditures. Same guidance as last quarter. Maintenance capital remains steady at $325 million. Our expectations in the new builds including the Onyx, the Apex, the drillships and the Patriot, a little over $1.4 billion for a total CapEx of $1.75 billion or approximately around that number. And just a little bit of heads up for Q3, if you refer to our rig status report, you'll see. We have a number of rigs coming in to the shipyard or expected to come in, in Q3 for their 5-year survey. This is a heavy year for us. And at this point, we're anticipating 7 rigs in the shipyard for Q3. So that will, of course, have an effect on revenues and costs in that quarter.

With that, I believe we'll turn it over for questions.

Lawrence R. Dickerson

Operator, at this time we'll take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Ian Macpherson of Simmons.

Ian Macpherson - Simmons & Company International, Research Division

Just a couple of questions, please. First, I wanted to ask about the outlook for the Quest and whether you perceive any indications from OGX as to whether they might be inclined to renew that rig or if you envision keeping it in Brazil or moving it towards end of this year? Secondly, Gary, I don't -- I might have missed, I don't know if you addressed or did not address whether you're maintaining your full-year operating expenses that you've guided previously?

Gary T. Krenek

I'll answer that and let Michael talk about the Quest. Yes, the full year remains consistent, somewhere between $1.6 billion to $1.7 billion.

Michael D. Acuff

On the Quest end, in the past quarter we have had discussions with OGX about possible extension on the Quest. We had no reason to believe that's not still the case but obviously, their situation could change depending on what strategy they take. So -- but right now we firmly believe the Quest will stay with OGX.

Ian Macpherson - Simmons & Company International, Research Division

We would presume the market rate is higher than where it's working now. Would you have any commentary on where you think the market rates are?

Michael D. Acuff

I wouldn't talk because -- I'm sorry, go ahead.

Ian Macpherson - Simmons & Company International, Research Division

Well it seems to be kind of an in betweener in that mid deepwater range so but I would think that the rate is market will be higher than 2 65 now.

Gary T. Krenek

No, I agree. I think that's a good assumption. I mean obviously I'm not going to rebuild the rate but it will be an uptick from where we are today.

Operator

Our next question comes from the line of Gregory Lewis of Crédit Suisse.

Gregory Lewis - Crédit Suisse AG, Research Division

Michael, really, could you just provide a little update, I mean, clearly the Patriot's moving to the U.K. you mentioned that maybe the mid-water market in Asia-Pacific is tightening up. Could you talk a little bit on what that means for the general? I believe there it has -- I believe that rig has a couple of options that are on price. Have you seen any discussion, have discussions arisen yet for that, for those options on that rig?

Michael D. Acuff

We're just now starting to really enter the discussion phase of those options. That consortium has had several exploration wells that they've been drilling, and so a lot of it's dictated on the results they have from those initial wells. But I would say, in general, no pun intended, we're starting to see more exploration in the Indonesia area, in the Vietnam market, even up in the Myanmar now. So that whole market is just starting to pick up in activity and we believe that bodes well for the general. Additionally, as I mentioned in my notes, there are a couple of longer-term development programs or an even longer-term exploration program that we believe could add some significant backlog or allow the opportunity to add significant backlog to the rigs. So I'm actually very positive on that market right now and of course, bringing the Patriot out of there and into the North Sea, that reduces the units by 1, but a lot of times I believe we were sharing work between the Patriot in general, at times. So it should push more work towards the general.

Gregory Lewis - Crédit Suisse AG, Research Division

Okay, great, And then just one follow-up for Gary. I mean, as we look at taking delivery over the rigs that are coming out of the shipyards over the next -- call it 2 years, beyond the existing revolver, is there a thought process about potentially coming back to either to the bond market or to the banks to sort of bring in more financing into the company?

Gary T. Krenek

We certainly have the potential to do that. Right now, our -- we have a 0 net debt. We have $1.5 billion of that -- $1.5 billion of that cash, but we do have a lot of payments. We have the 70% flat payments on all 4 of the drillships and so, I think if you run the numbers out, obviously, we'll need some type of help to complete paying this new build program that we're in right now. We do have the $750 million revolver that we can draw upon that we put into effect approximately 6 months or so ago. So we'll look at that, we'll look at the debt market. Interest rates are extremely low as everybody knows, we'll certainly take advantage of that. So we'll keep our options open. We're not adverse to taking on some additional debt in the company because simply -- because we're so under levered at this point. So we'll continue to monitor the situation and to do what we think is best.

Operator

Our next question comes from the line of Dave Wilson of Howard Weil.

David Wilson - Howard Weil Incorporated, Research Division

Larry, I just wanted to confirm that there's really no more opportunities for you guys to bring another water rig into the U.K. as you pretty much exhausted the upgrades, paybacks and there's an opportunity cost for that market versus the other Global Markets?

Lawrence R. Dickerson

I would not say that. There is capability within our mid-water fleet. It just depends on the economics and what the alternatives are. I mean, if a rig is working, one, you've got to have availability, but if a rig has pretty solid prospects somewhere else and we've got to spend north of $120 million -- let's just say you're spending $150 million or something, you need to make sure that the marginal improvement in your rate is enough to pay for that. Sure, we're not going to take the entire fleet over there, but under the right circumstances we might be able to come up with an additional rig to go into that market. There is a quite stiff barrier to get into the North Sea, especially for some older equipment. Patriot had been there before so that facilitated our ability to bring it in. It's not being a game changer, but there could be something else.

David Wilson - Howard Weil Incorporated, Research Division

So basically, it's just opportunity cost right now. And then I guess as unrelated follow-on regarding the BlackRhino, Michael, you'd mentioned prospects in the Gulf of Mexico or West Africa. Collectively, as a company, any preference there in the Gulf of Mexico versus West Africa in placing that rig?

Michael D. Acuff

You got a couple of things to consider. One is concentration. We already have 2 in the Gulf. That's the concentration. However, when you look at it from a cost structure obviously, the Gulf of Mexico is a bit more attractive than West Africa. So it will depend on term rate, those types of things. All things equal, I think we're open to either one, it's just a matter of the opportunity and what's more attractive when we put all the variables on the table.

Operator

[Operator Instructions] Our next question comes from the line of JB Lowe of Cowen Securities.

John Booth Lowe - Cowen Securities LLC, Research Division

Just had a question on your propensity for a new builds to be ordered once you sign up the BlackLion and the BlackRhino.

Lawrence R. Dickerson

Yes, we would certainly consider them. I think that's the standard position of a number of a companies. But I mean, that doesn't just mean we're going to go order. We've got to study the market and figure out, can the market sustain that, which can draw scenarios where, yes, the market can take a number of other rigs and we can draw some scenarios where you begin to have a little too much supply. So I can't give you a blanket answer that will impact it. You know that at Diamond Offshore, we are -- we always watch what we spend and we are very conservative on making sure that we've got a forward plan to be able to put that rig to work. And so I don't know, at what point in time it will be that we'll calculate those things but we certainly look at it. Gary pointed out, we've got the ability to borrow to if we need some money and we're the only A-rated company in the space and I think it's nice to have that stamp but it's also nice to be able to actually use it and realize lower interest rates.

John Booth Lowe - Cowen Securities LLC, Research Division

Do you think you would order a similar drillship the one you guys are building now or could you get a little creative with some of your something like that?

Lawrence R. Dickerson

Well, we like to have the diversified fleet so I think, I can't say which one would necessarily be there. Depends on what kind of rates we get on the next to the Lion and the Rhino. But looking to diversification, I think it could well be in the semi-space.

John Booth Lowe - Cowen Securities LLC, Research Division

And switching gears, just a question on the Ambassador. It's available right now. If you couldn't find work for it soon, would there be chance you just bring the 5-year survey forward from the third quarter?

Lawrence R. Dickerson

Yes, to the degree that we can play around with these surveys and there's a window, we try to do it at the most opportune time. The limitation on the Ambassador is just the water depth and trying to find a market that will take the rig that is really limited to 1,100 feet. So it could be that we assess and we've decide that we're not going to order for another 3 or 4 years and we may let the certificate lapse and not do the survey at all. But I can't tell you yet. Let me take one more question, operator.

Operator

Our final question comes from the line of Collin Gerry from Raymond James.

Collin Gerry - Raymond James & Associates, Inc., Research Division

Just -- you covered most of the questions but we've obviously seen in the market, in the financial markets, Brent has pulled back, which I usually associated with the biggest driver of your customer spending. I mean to the extent that you've seen any sort of change in behavior or change in attitude in your customers whether it be in the North Sea or in the formal [ph]...

Lawrence R. Dickerson

I think you may have been cut off but I understood your question was about Brent. Higher is better, we think but we haven't seen anything in particular in relationship but to this number. And I would say, on the -- for good amount of the time, everybody acted as if $100-plus Brent and that Brent premium was not really real. We would talk to customers and they would say well we're evaluating on 80 or whatever the -- some significantly lower numbers. So I think there's certainly some cushion on Brent and its impact. The biggest thing you can see is the North Sea, where there's been huge demand and huge demand for our rigs to go long on the commitments, as long as 3 years, and at nice day rates. So we're still comfortable that we're well within the range that most projects around the world are economical. But again, you need to ultimately direct those questions to the customers.

Collin Gerry - Raymond James & Associates, Inc., Research Division

And just a follow-up on that, what would be your sense in terms of a Brent price where you just start to see a little bit of -- take the foot off the accelerator?

Lawrence R. Dickerson

Well, there's so many factors. The speed which it goes and obvious factors that makes them think that it's going to stay down at that level. But -- I can't pick where it is, but it's significantly below where it is today.

Well, thank you very much, operator. And listeners, we will talk to you at, subsequently. Thank you.

Operator

This concludes today's first quarter 2013 earnings conference call. You may now disconnect.

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