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Executives

Scott Kerr – CEO

Jon Wilmann – CFO

Analysts

Fredrik Lunde – Carnegie

Frank Harested – Pareto Securites

Sevan Drilling ASA (OTCPK:SDRNF) Q1 2013 Earnings Call May 7, 2013 7:00 AM ET

Scott Kerr

All right. Well, welcome everyone to the presentation of the Q1 2013 results, which were announced earlier this morning. A lot of the presentation will be also linked back to the investor presentation we made in April. So you will have seen some of this before. But part of that is just to reinforce the direction that the company is going and the strategy of the company going forward.

But let me first focus on the Q1 and the events during Q1. I think one of the clear highlights of the first quarter was we did sign a three-year contract for our number 3 rig called the Sevan Louisiana with contractor LLOG to be in the Gulf of Mexico to start up in early 2014. And I'll do a real quick summary of that contract later on.

The uptime in Q1 was obviously impacted by events which we clearly outlined to the market. The first was on Sevan Driller, which was the maintenance and flag state required inspection of the hull and the DP systems. Took slightly longer than we anticipated, but that's done now and the rig is back in operation. So that impacted the technical and commercial uptime.

Sevan Brasil actually had a very good quarter. We had only one downtime event, which was an event of failure in electrical circuit, which we repaired and been back on line. So Sevan Brasil has had a very good startup compared to Driller and continues to operate quite well. So we think that's important as we look forward to rig number 3 and rig number 4 and look at the expected results from those rigs.

Early in the quarter, we had an equity placement to recapitalize the company. At the same time, we changed our bank loan agreements and allowed the company to have more flexibility in using cash and in paying the banks and the bank facilities. And that's important now because as we look at the funding for rig number 3 and, ultimately, rig number 4, we have retained a straightforward balance sheet and can now look at a broader fleet financing going forward.

So it was an important step for us not just for the recapitalization, but also for the ability to set up for the next stage, which we will talk a little bit about today and are working now to implement.

The construction remains on track. In fact, a little later in the presentation we'll show you that and you'll see that we're actually slightly ahead of schedule on the construction. So it's progressing quite well. And we have a new management in place in Brazil from the 1st of February. So we're moving to strengthen the operational side of the business as well as during the fourth quarter strengthen the balance sheet quite substantially in the business.

So as we come out of that quarter and look forward now, we have a new contract, we have a stronger balance sheet, we have the rigs in operation, and we can now look forward to what's going to happen next.

And that's really, as we look at the company going forward, we're moving through a transition. And it's a transition of freeing from a purely project company in a sense of having one rig in operation and another three under construction, to moving to a much more operational company with projects that will continue. And that transition is under way now and will go for the next 12 to 18 months.

But at the end of that period of time, we will have a fleet that is twice as large as we have now, we'll have much more increased economics of scale, we'll have more attractive financing terms as we go through from a purely project-by-project financing base to a more fleet type financing, more improved risk diversification because we'll have more rigs, and we'll also have rigs in operation in more than one area. We'll have at least the Gulf of Mexico and Brazil. And we will continue to build credibility with our clients going forward.

So it's an important transition that we're going through, but it is a period of transition, and as we move through there will be challenges and opportunities at the same time. It is important during that transition that we continue to focus on the rigs we have under operation, and then building that capability in the company as we go forward.

So looking then at the first kind of major opportunity in the quarter was the contract for Sevan Louisiana. This contract had been discussed for awhile. It's the first contract with a client outside of Petrobras for us. So it's an important step for us. It's a three-year contract with LLOG Bluewater Holdings. It will start up in early 2014. So we'll accept the rig from China and mobilize to the Gulf of Mexico.

When we get to the Gulf of Mexico, we will go on standby rate, just 90%, once we have what is called the certificate of compliance from the US Coastguard. So as we mobilize the rig, we will be completing this required paperwork and certificate so that we can get that certificate of compliance as quickly as possible once we get to the US waters and get close to the location.

We then go on operational rate when we're within 1 mile of the well location. Then we also have -- but during that period of time, there will be acceptance by LLOG. The difference between this and a Petrobras contract is, rate starts after acceptance with -- a Petrobras contract with this one, it starts when we have the certificate of compliance and we're within a nautical mile of the well location. So it's a small but an important distinction.

Total value of the contracts, roughly $550 million, plus the mobilization fee of $32.5 million. So the total amount is about $580 million contract value. The day rate is $505,000 a day, as the contract of day rate.

The delivery will be in Q3, early Q4, more likely Q3 and will mobilize to the Gulf of Mexico right after that. It's capable of drilling in waters up to 10,000 feet and the operational cost is estimated to be around $150,000 a day, which is somewhere in the neighborhood of $20,000 plus less than in Brazil.

Part of that lower cost will be taken up in the overhead in an office structure in Houston, but, still, this is a rate that is at higher day rate and lower operating expenses than we found in Brazil. It really helps to confirm the premise we had along that we can deliver lower-cost rigs and get competitive day rates for them, and we think that this helps to show that. We also have a market under way for rig number 4, and we'll come back to that.

So let me turn it over to Jon and we can do a financial update. And then we'll come back and do operational and the update on the project construction itself.

Jon Wilmann

Thank you, Scott. Good afternoon. Clearly, the revenues reflect the uptime on the two units in Q1, and like as Scott said, Sevan Brazil has had a very good operational quarter, with commercial uptime of 95%. Sevan Driller has had a less good quarter with commercial uptime of 70%.

So the revenues reflected the commercial uptime during the quarter. What I want to point out to the audience is that we deduct the agent fees from the revenues. So the revenues in our P&L is net of agent fees, and we paid 3% agent fees in both of the contracts, so on Driller and Brazil. And that amounts close to $2 million for the quarter. So that's something you need to be aware going forward. So 3% agent fees deducted from revenue on both contracts.

When it comes to cost, we have operational expenses in low and mid expectations, a little bit higher on Sevan Driller, $178,000 per day. Sevan Brasil, in line with expectations, $170,000. And also included in operating expenses for the quarter, we have booked and expensed the cost related to the well, or more precise, the maintenance work and marine hull survey we did in January. That amounts to $6.7 million. It's expensed and it's contained within the operating expenses.

Depreciation, according to what we have, the amount before, we are depreciating both rigs over approximately 25 years. So we have two rigs depreciating during the quarter, Sevan Driller and Brasil. When it comes to financial expenses, it's basically the interest expenses related to both facilities, Sevan Driller and Sevan Brasil.

In addition, we have booked one-off expense related to the restructuring of the bank debt we did in January. So that's approximately between $5.5 million and $6 million for this quarter, and related to the restructuring of the bank debt.

Balance sheet. Clearly, the biggest item is over the four rigs -- Sevan Driller and Brasil, which are the biggest items, but also Sevan Louisiana and Sevan Drilling rig number 4, are booked within the drilling rigs. We have further a cash balance of $150 million by the end of the quarter and of the $150 million, approximately $90 million is free cash. And the rest is restricted cash and also it relates to debt service reserve accounts for the two bank facilities. That's $40 million.

So free cash position by the end of the quarter is $90 million, and that's in line with the forecast we predicted in connection with the equity rates in January.

Further, when it comes to liabilities, I just want to point out that in the current liabilities, we have, again, booked the $50 million deferred liability, which we described in connection with the equity rates. We have deferred $50 million related to two vendors. That also booked in current, in Q4. And these liabilities are due in Q1 2014. So it's now back as to the current liability.

Also, when it comes to the current portion of short-term debt, the current portion of the long-term debt, we have assumed an uptime of 90% going forward. As you remember, we agreed with the banks a cash sweep in 2013. So there are no fixed amortization under the bank debt in 2013. But for the purpose of short-term portion of the long-term debt, we have assumed a 90% utilization and amortization, accordingly. We have in general a good cash position and a solid balance with an equity ratio of 46%.

As you know, we are in the process of refinancing the company to fit into the company, transforming into an operational company. And we have put the basics in place. We raised new equity in January. That is in place. We got a contract for Sevan Louisiana. And also, the annual cash flow from the two rigs and getting stronger, and that will be further emphasized when we get Sevan Louisiana in operation in January 2014.

So we are now in the process of moving from project type of financing into a corporate multi-rig type of financing. And this implies that we target to amortize in a slow pace. Today, we are amortizing approximately 80% of the EBITDA and the target for a new corporate-based financing is to keep an amortization of 40% to 60% of EBITDA.

So what we are seeking is a sustainable financing structure which fits to the company going forward. And that implies that we go from the current financial structure, being a rig-based financing, project financing related to each of the two rigs, with that fixed amortization, a very aggressive amortization. We are amortizing around $60 million per rig per year, down to a balloon of $150 million at the end of the charter contract, and that's very aggressive. And we also have restrictions in the current financing arrangements for moving cash from the bank structures to use for corporate purposes.

So we want to switch over to a new corporate-based financing structure, which implies a fleet-based financing, which is also to the benefit of the lenders. They have not the only one asset to rely on. They have multiple rigs, which implies diversification of the lender's risk as well.

We are, as I mentioned, looking for a more appropriate amortization profile, meaning that we are amortizing in a slower pace. The company has evolved from being a new company without any operational experience, and also introducing a new design to become a more mature company and [technical difficulty] from operation, from the revenues to use to cover corporate expenses.

We'll utilize the debt capacity to increase the given liens on what we described during the investor day that we have amortized. We have repaid more than $200 million of debt since we started up in 2011. I will now take the opportunity to increase the leverage, somewhat, to cover the capital need going forward.

So we are now in a process of evaluating and implementing our refinancing, which we target to have in place by the latest, Q3 2013. We are basically looking into two alternatives. One implies a bond structure. And the other alternative implies a bank structure. Both are sustainable and good solutions, and we will move forward with both alternative, until we at a certain point need to make a decision where to go.

Like we said during the investor day, we have no plans for raising new equity in the company, and also financing related to rig number 4 will be put in place when we are in contract for rig number 4, and the type of debt and the size of debt will be determined by the contracts.

All right. Then I hand it back to Scott.

Scott Kerr

Okay, thanks, Jon. If we look then at the rig-by-rig operations for the first quarter, you can see that Sevan Driller had a very challenging quarter. The majority of that was due to the maintenance and flag state requirements for the whole inspection survey and sort of the thrusters, which was started in late 2012 and then went on into 2013. And that really drove the timing and the uptime in the first quarter.

Then, when we started back up, we ran the blowout preventer and we found that we had leaking seals and some of the blowout preventer, we had to pull the BOP, replace the seals and run it again, and that all occurred in that same period of time. And that really had the influence on the first quarter numbers.

In April, you saw that rig was operating very well. We have now to go in. At the end of this well we're drilling, we were just competing it, we have to go and replace a bearing, and that may take up to seven days. So we will expect some downtime in May of up to around seven days to replace that bearing.

The cost of replacement of that bearing is covered under warranty, but the time is our expense. So just a pre-warning, that is. We found that just within the last few days. The Bad Sonda rating down also this quarter, below nine, which is not where we want to be. That's really driven by the work that was made under way within the rig itself. For Driller, we're through that maintenance now. We don't have to do that survey again. So that's good and that's behind us.

We had actually a very good quarter on Sevan Brasil, 92% technical and 95% commercial uptime. So again, a good quarter. There was one incident in January where we had electrical circuit which needed to be repaired, and the repair took a very short period of time, but it took time for Petrobras to come out and inspect it, and all of that was considered downtime. But other than that, it's been running extremely well and you can see the improvement from rig 1 to rig number 2, from Driller to Brasil, frankly.

Since the startup of the operations after the blowout preventer, after we damaged the BOP, it's been above 96%. So it's done very, very well. The Bad Sonda rating, about 8.9 slightly down from where we want it to be, again due to the downtime we had from the electrical circuit, but also coming back.

So as we come out of Q1, we continue to work with Driller. We're very pleased with the performance of the Brasil and the performance going forward from that rig and the future rigs.

On the downtime events, just to show what they were. Again, the first on Driller was the marine hull survey and maintenance. It lasted a total of 25 days. That's about five days more than we had anticipated, just due to timing of getting the equipment in place and getting everything done. So it took longer than we had anticipated and the cost was around $6.7 million.

So the cost was actually not substantially out of line. It's the downtime days that impacts our revenues.

As I said, we replaced the seals from the blowout preventer as soon as it's restarted. And then, now, we need to go in and we have a main shaft bearing that needs to be replaced. We estimate that it will take about seven days. We're not exactly sure how many of those days will be actually moving the rig and how many will be off hire. But for planning purposes, seven days.

The cost of the repair, which is actually around $500,000, will be covered by the vendor, because it is under warranty. But the impact is clearly on the startup or on the uptime for Driller for this event.

On Brasil, the repair of the electrical switch board, we talked about that a little bit in January. The rig has been operating very well. In fact, both rigs are operating quite well now and generating very good strong uptime and operations. So that's important to continue.

So then, if we look at where we are in rig progress, I think the first thing to notice is we're actually ahead of plan. The rigs have been progressing extremely well, work has been going quite well. On rig number 3, the Louisiana, we're well under way with commissioning. The office space and quarters on the rig will be available for us starting in June. And then we will bring more people on site to finish the commissioning and startup work that's necessary between then and the taking over of the rig in late Q3 and moving it to the Gulf of Mexico.

We estimate that we will be having a naming ceremony for the rig in August, second of half of August will estimate of a naming ceremony for the rig. We'll get that out for everyone. It's an opportunity for anyone who wants to see actually the rig and the progress that's been made so far on that rig. So it's moving along as anticipated.

The Sevan rig 4, it actually is also slightly ahead of schedule, 62% complete. The main deck has been lifted in, the drilling is all integrated, so is the derrick now. All the main modules are in place, so we're really looking at starting the final portions of tying in everything and start commissioning in Q3 for this rig.

We are in dialog with companies now on the use of the rig, both in Brazil. We expect to have a contract on the rig in the second half of this year and then be set for delivery in Q1, early Q2 2014.

So both rigs are progressing well and the Costco [ph] has been delivering extremely good work on time and very highly quality.

So if we just look at the quarter, first of all, we've undergone a lot of expansion. We've done quite a bit of changing in the company over the last two years and we've got another 18 months to go. That means the startup of new rigs, the completion of the projects and the continuation of really building up the operational capacity within the company.

We can now say, without a doubt that the technology of this type of rig is well proven now. The construction is very well proven now and the market is out there for the rigs. And we're now really focusing in as we look at last year and this year as the operations and operational excellence.

So the focus as we move will be to continue to projects, to continue delivering what we have on the two new rigs but it's also to focus on operational excellence and increase our, basically, run rates and EBITDA through increased focus on that. Completion of the Sevan Louisiana and marketing of rig number 4, still very important steps going forward.

Marketing, we will be continuously marketing the rigs now and looking for opportunities for other places to have the rigs and an upgrade of the rig design for the future rigs as we look at what the market needs and wants going forward. So while we're focusing on operations, we're also looking at what's the market going to do going forward and where do we need to go.

We then need, and we've talked about that, a financial framework that matches that focus. And that's what we're looking at going forward for the company but it's not taking away our focus from really running the business and needing operational excellence.

So that's the story. I think in a way, it was a mix quarter. It was very good to have a new contract. It's very good to get a new operation in place but we're struggling to get the maintenance and get the work done on driller and focus on that all the time.

So I'll leave it at that and answer any questions for myself, for Jon on anything that you might want to have. Just a reminder, questions, we should use the microphone so people on the web an actually hear the question as well.

Question-and-Answer Session

Fredrik Lunde – Carnegie

Fredrik Lunde, Carnegie. Just a question on the OpEx, you have about $47 million this quarter. That's about $250 million [ph] or $150,000 per day per rig. How do you expect that number to progress in the second quarter?

Jon Wilmann

We expect to keep the guidance on OpEx or $170,000 [ph] for each units both as Sevan driller and Sevan rig.

Fredrik Lunde – Carnegie

How about SG&A because I mean the total number is higher.

Jon Wilmann

In respect to SG&A, we are on budget. We have guided on a total SG&A for 2013 over $37 million. We are on budget, so we expect to keep that number. And we also said that when we start up in the Gulf of Mexico, we will establish an onshore base in Houston. That will have an implication on the SG&A but that will be from 2014 and onwards.

Fredrik Lunde – Carnegie

Just a bit [inaudible]. Your CapEx is over $38 million this quarter but the rigs falls about $10 million [inaudible] their depreciation. Do you remember where CapEx are going.

Jon Wilmann

I hate to have a sharp analyst in the audience. No, you're referring to the cash flow statement. The $39 million is basically deferred liabilities we paid when we raised the equity. So those are liabilities or deferred liabilities from 2012 annually.

Fredrik Lunde – Carnegie

So that is all the known current liabilities?

Jon Wilmann

Sorry?

Fredrik Lunde – Carnegie

All the economic current liabilities in then balance sheet?

Jon Wilmann

That has reduced the current liabilities with approximately $40 million.

Fredrik Lunde – Carnegie

Thanks.

Jon Wilmann

Any further questions?

Frank Harested – Pareto Securites

Frank Harested from Pareto, related to the same question with your faith creditors still went up, right, I think current liabilities?

Jon Wilmann

Yes. In respect to the current liabilities, there are two things to mention. I guess you can certainly say it's pretty high right. There's two things to mention, one is the deferred liabilities, different to the $40 million we have right about now. In connection with the researching of the depth and the equity rates, we deferred $50 million liabilities related to the vendors.

Those liabilities are due in Q1 2014 and they are now back booked as current liabilities so that's $50 million. And then we do financing exercise, those $50 million will be a part of all the uses for that financing. That's one thing.

The second thing is, and that's something we have mentioned before. When we receive payments from Costco, and under the PMT and through the management and preoperational agreements related to rig 3 and 4, we are book the portion of it we have not used as a current liability. And for this quarter, it's approximately $35 million.

As we move delivery, we will basically -- the payment schedules under those agreements are frontloaded. So that will be reduced towards zero as we move towards completions of those rigs.

Frank Harested – Pareto Securites

But the deferred liabilities you were answering in terms of the CapEx, that's for example our resolution [ph]. You have paid out resolution for the first two weeks now?

Jon Wilmann

We don't go into details.

Frank Harested – Pareto Securites

That's fine.

Jon Wilmann

The only thing I can say is one, we paid $40 million in deferred liabilities in connection with the equity rates. And we agreed to defer another $50 million with two vendors until Q1 2014. We really don't go into more details.

Frank Harested – Pareto Securites

And I'm just a little bit curious about the Sevan Driller you had in terms of the downtime and the flag state require the marine hull survey. Is that related to the rigs are registered in Singapore?

Scott Kerr

Yes. I mean, every flag state will have the same requirements for the marine hull survey. Some flag states will allow to defer that and some don't. So with Singapore, it's a requirement that you do a survey and we moved it from about two and a half years to three years but then we needed to do that survey and that was completed.

At the same time, we took the opportunity to do maintenance and work on the DP system because that needed also to be maintained, required maintenance for the DP system. So those two things together were really what took the time. So yes, it is a flag state requirement. It's not just Singapore, it's other flag states as well and each one will have their own rules about how often and how much is necessary in those surveys.

Frank Harested – Pareto Securites

And then the last question, we just a struggle a little bit when we went back to the monthly statements about utilization. Again, there's differences between technical and commercial in your view and how you calculated is?

Scott Kerr

Well, the technical uptime -- and the first quarter was an anomaly in that sense. We had some disputed time, which related to the amount of time it took to actually look at and inspect the repair that was done on the electrical system on Brasil. And we had, in that case, reported that and thought we had agreed that it would be uptime. When we received the actual statements from the client, it was considered downtime.

So that is a difference, and that can happen sometimes. It's not common but it has happened to us. So that caused the difference. And on then commercial versus technical, that typically, if the technical uptime is high, then you see commercial uptime reflecting the bonus structure. If we're on standby, waiting on weather or other things then you will see it being lower. So there is a difference obviously between commercial and technical uptime.

Frank Harested – Pareto Securites

So that is bonus and the weather.

Scott Kerr

Well, it's the bonus, it's the first one, and it is waiting on weather or on standby rate. And that could be moving the rig, it could be on standby while you wait for an inspection or something and that is an agreement with the client.

Now that will be different with rig number 3, because it's a different client and a different contract, so we'll get more complex but that's frankly where we are. In the first quarter, the biggest difference really was around Brasil.

Jon Wilmann

And the third element which differentiates commercial uptime to technical uptime is penalties.

Scott Kerr

Penalties, yes.

Jon Wilmann

So bonus and 90% day rates to really do the standby maintenance and other things, and penalties in Brasil.

Scott Kerr

It's easy for us to answer now when we have one client. I'm glad it's going to get more complex.

Jon Wilmann

Any questions? All right, we're clear.

Scott Kerr

Thank you very much for your time, we do appreciate it and we'll speak next time.

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