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Executives

Robert Saltiel – President, Chief Executive Officer

James Holland – Chief Financial Officer

Analysts

Collin Gerry – Raymond James

Scott Burk – Oppenheimer

Brian Uhlmer – Pritchard Capital

Judson Bailey – Jefferies & Co.

Atwood Oceanics, Inc. (ATW) Q1 2010 Earnings Call May 5, 2010 11:00 AM ET

Operator

(Operator Instructions) It is now my pleasure to turn the conference over to Mr. Jim Holland.

James Holland

Good morning and welcome to Atwood Oceanics conference call and webcast to review the company’s operating results for the quarter ended March 31. With us today will be Rob Saltier, President and CEO, and myself, CFO.

Before we commence our financial and operational review, let me as usual, remind everyone that during the course of this conference call, we may make forward-looking statements based upon management’s current plans, expectations, estimates and assumptions and beliefs concerning future events impacting us, and therefore involving a number of risks and uncertainties. We caution that forward-looking statements are not guarantees and that actual results could differ materially from those expressed or implied in the forward-looking statements.

The words belief, estimate, impact, intend, anticipate or predict convey the uncertainty of future events or outcomes. Undue reliance should not be placed on these forward-looking statements which are applicable only the day hereof.

I will now turn the conference call over to Rob.

Robert Saltiel

Thank you, Jim. Good morning and welcome to all of you joining today’s call. We appreciate your interest in Atwood Oceanics.

Before turning to my prepared comments, I want to express our concerns and sympathy for those involved in the loss of the deep water Horizon two weeks ago. As an industry, the offshore oil field has made great strides to make our business safer, yet this event reminds us that we are in a hazardous business with inherent risks. The memory of this incident will be with us for a very long time, and our industry can expect changes as a result.

In concert with the entire offshore industry, we at Atwood extend our thoughts and prayers to the families of those who lost loved ones and to those who were injured and are recuperating, as well as those who continue to work tirelessly to arrest the oil spill that is impacting the Gulf Coast.

I want to briefly talk about the response to the Horizon incident here at Atwood. The NNS and the U.S. Coast Guard released a safety alert dated April 30 that included seven safety recommendations for operators and drilling contractors in the Gulf of Mexico. These recommendations relate to maintenance of well-controlled equipment, the review of drilling and completion practices and the knowledge and use of emergency equipment.

We are adopting these recommendations for our one rig in the Gulf of Mexico, and the rest of our rigs in our international fleet.

Separately, we have commenced an operations integrity assessment across our worldwide fleet that will closely examine our people, processes and systems to ensure that they are robust in preventing a similar incident. The leader of this initiative will report directly to me in this capacity.

Turning now to our financial performance, you will have seen from our press release that we had a solid fiscal second quarter with earnings of $1.03 per share on revenues of $159 million. Jim will take us through the details in a few moments, but our revenues were down from our first quarter revenue of $164 million, largely due to lower revenue utilization on the Atwood Falcon, the Atwood Eagle and the Vicksburg.

For each of these, a single one off operational incident accounted for the bulk of the lost revenue. Needless to say, this performance is not in keeping with our usual high standards of reliability, so we have undertaken a series of actions to prevent such a recurrence.

Despite these operational issues, our drilling costs for the second quarter came in consistent with the guidance we provided on the last call. In addition, our tax and G&A costs were lower in the second quarter versus the first quarter resulting in a total cost reduction of $5 million quarter to quarter.

Even as we build our organizational capability to support our deep-water new builds, we are working on ways to reduce our cost structure in our onshore organization.

Turning to the markets, my comments will largely echo those that have been voiced by the other drilling contractors. At the big picture level, we are in a somewhat paradoxical situation of having a very healthy oil price that has fluctuated most between $80.00 and $85.00 a barrel and yet we have seen relatively quiet contracting environment for rigs in all three segments; shallow, mid water and deep water.

The reason for this is primarily due to ample rig supplies from new builds, from existing rigs rolling off contracts and from already contracted rigs that are available on the secondary market as farm outs, but also due to some delays in the sanctioning of new programs.

The supply overhang has allowed operators to delay their contracting closer to the point of actual need and to target their tenders around very well defined drilling programs leading to shorter term contracts.

With multiple rigs bidding on most jobs, operators can afford to be more particular on equipment specifications. In the aggregate, this over supply has led to significant day rate declines from peak levels in all segments and suggests that the remainder of 2010 may continue to be challenging even with the strong commodity price outlook.

Despite this fairly bearish viewpoint, there are three positives to highlight. First, the jack up market seems to be largely stabilizing in terms of day rates, and we are seeing an increase in the number of potential jobs that could be suitable for Atwood jack ups as they come up for renewal, although many of these are shorter term in nature.

Second, the absorption of deep-water new builds continues and the rates that have been publicized have held up reasonably well considering the tough prospects some contractors have faced of potentially delivering new builds out of the yards without customers. We will continue to monitor this situation as it does impact the timing and outlook for our marketing of our uncontracted DP semi-submersible that is under construction at Jerome.

And third, we continue to see signs that the world economy is recovering from the recession. This will give greater confidence to oil demand projections holding up and give support to a sustainable higher oil price scenario. We continue to believe that oil prices north of $80.00 per barrel will drive incremental rig demand for our industry

With this backdrop, it is no surprise since our last conference call; we’ve experienced a very slow period in contracting in Atwood. Other than the extension of the Vicksburg in Thailand for three months at its current rate, everything else on the contracting front is a work in progress and despite the lack of visibility, we are working aggressively to secure work on all of our rigs that have near term availability, and we hope to have better news to report in upcoming updates.

We did release a fleet status report on Monday, and our revenue backlog stands at $1.4 billion as of May 1. I won’t go through the entire fleet status report, but I will say just a few words about certain rigs in our fleet before turning it back to Jim.

Our new build program continues to make good progress. Starting with the Atwood Osprey, this rigs construction is moving forward very nicely. We completed the important operation of joining the top sides with the pontoons ahead of schedule and we’ve commenced the commissioning process of certain equipment earlier this week.

We’ve also benefited from additional shipyard resources being assigned to the Osprey as rigs are delivered ahead of us in the queue. We still expect the Osprey’s delivery to occur in the first quarter of 2011, and for the total construction cost to be approximately $625 million, consistent with our prior guidance.

Our second new build, a dynamically positioned 10,000 foot water depth semi-sub is making good progress as well. It is still scheduled for delivery in mid 2012 and our previous estimate of a $750 million construction cost remains valid.

The Atwood Southern Cross continues its preparation to return to service for audits resources in Tunisia next month, and we continue to seek longer-term work for this rig in the Mediterranean area.

The Atwood Beacon and Seahawk continue to drill for Hess Corp in Equatorial Guinea. We now understand that Hess will likely take a break in their EG drilling programs after these current contracts expire. Therefore, we are looking at new jobs for each rig in West Africa and in other regions.

The Vicksburg may have an opportunity to stay with New Coastal beyond the current extension period, but we continue to target other work in the event that this does not materialize.

And finally, the Richmond has a single well program, which will follow the current well that should keep the rig busy until the end of June. We are working to keep the rig occupied through the hurricane season that begins June 1.

This concludes my prepared comments. Now I’ll turn it back to Jim to provide the details on our financial performance and outlook.

James Holland

Before I address certain items that will have an impact on our operating results for the third quarter and the remainder of fiscal year 2010, as Rob indicated, I will make a few comments concerning our second quarter results.

Our effective tax rate for the quarter was 13% compared to our guidance of 18%. This decline in tax rate was part of the impact to earnings by approximately $0.05 per share, resulting from a reduction in Malaysia income tax expense due to the decline in the Atwood Falcon’s revenue from its unplanned downtime, and to a $2 million Malaysian tax refund relating to prior years. We now expect our effective tax rate for the remainder of fiscal year 2010 will be around 17%.

The total drilling costs for the second quarter was approximately $63 million. Despite incurring higher than expected operating costs in the quarter, on the Atwood Falcon and the Vicksburg due to repairs resulting from the unplanned equipment downtime, lower than expected operating expense were incurred during the quarter on the Atwood Hunter, Atwood Eagle and the Atwood Southern Cross which resulted as Rob stated, in drilling costs being in line with guidance.

I will now comment on certain items that could impact results for the remainder of fiscal 2010. Currently, the only planned zero rate downtime on our rigs for the remainder of fiscal year 2010 relates to required regulatory inspections on the Vicksburg and the Richmond.

The Vicksburg inspection is expected to occur later third or early fourth quarter of fiscal 2010 while the Richmond inspection is planned to occur during the fourth quarter of the year 2010 or first quarter of fiscal year 2011 depending upon its drilling contract commitments. Both inspection periods are expected to take ten days to complete.

We currently expect drilling costs for the third quarter of fiscal year 2010 to be around $67 million. The primary reason for the increase over the drilling costs incurred in the second quarter is due to the Atwood Southern Cross expected return to service next month. And of course, with previous guidance, there will be a one-time expense of approximately $3.5 million for additional equipment costs required to have the Southern Cross to commence drilling operations.

With this one time expense coupled with one month of full operating costs, we expect that the rigs average operating cost for the third quarter will be around $85,000 per day compared to its idle cost of around $35,000 per day incurred in the last two quarters.

Expected per day operating on our rigs by rig bases for the third quarter are as follows; Atwood Hunter, $105,000 per day. Atwood Eagle, $145,000, Atwood Falcon, $85,000, Atwood Southern Cross, $85,000 as previously stated, Atwood Aurora, $60,000, Atwood Beacon, $90,000. This includes approximately $25,000 amortized expense, and this amortized expense will terminate at the end of the third quarter, Vicksburg, $40,000, Seahawk, $70,000, Richmond, $35,000 and other costs of $20,000 for a total expected cost of $76 million.

We currently expect that our general and administrative expenses for the third and fourth quarter will remain at the same level incurred in the second quarter of around $9 million. Depreciation expenses is expected to remain around $10 million for the third quarter and fourth quarters and around $39 million to $40 million for the year.

I will now comment on expected total capital expenditures for the remainder of the fiscal year 2010. Through March 31, we expended in total for the both rigs approximately $67 million toward the construction of the Atwood Osprey and our to be named semi submersible, with approximately $700 million remaining to be expended on construction of these two rigs.

Our current projection of total capital expenditures for the second half of fiscal 2010 is around $200 million for a total capital cost for the year around $270 million. Assuming no additional growth, or any significant upgrades to our existing fleet, we currently expect capital expenditures for fiscal year 2011 and 2012 to be around $400 million and $350 million respectively.

With our current backlog expected to provide approximately $800 million in future after tax, we foresee no covenant issues with our credit facilities. With expected cash flows from our current contract, available bond capacity with a current interest cost of less than 3%, we believe we can complete the funding of the construction of our two deep-water semi submersibles and maintain a strong balance sheet without requiring any additional sources of capital.

I will now turn the call back to Rob.

Robert Saltiel

With that, we can open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Collin Gerry – Raymond James.

Collin Gerry – Raymond James

Interesting comments with the MMS put out on the new safety advice I guess you could call it. Would you give us some more specifics in terms of what their recommendations were and kind of what’s being adopted?

Robert Saltiel

I won’t go through the entire alert, but let me touch on some of the basic issues. It includes examination of all well controlled equipment, making sure that its properly maintained and capable of shutting the well in during emergency operations, reviewing drilling and completion practices so that well control contingencies are not compromised, reviewing emergency shutdown procedures, inspecting life saving and firefighting equipment and emergency power equipment to make sure that its properly operable, and then making sure that all personnel are properly trained and capable of performing their tasks during normal drilling operations as well as emergency well control operations.

So it’s really getting to these three areas of people, process and systems that I was referring to in our own internal operations integrity assessment.

Collin Gerry – Raymond James

As we look out going forward, could you envision a scenario where the equipment and maybe the redundancy in terms of actual capital equipment on the rig itself is increased. I know your Gulf of Mexico exposure is limited, but I would think just for the industry, maybe there’s some more redundancy coming down the pipe.

Robert Saltiel

I think it’s too early to be definitive, but I would say that just about everything is on the table in terms of what we may see in response to the Horizon incident. Clearly, we had a catastrophic well control incident that led to the loss of lives and loss of the rig, and we have to address that as an industry and make sure that we put together again, procedures and systems to prevent that from ever occurring.

So when you talk about modifications to equipment that would prevent such a recurrence, I think absolutely that may be part of what ultimately comes out of the recommendations as a result of this investigation.

Collin Gerry – Raymond James

One thing that strikes me as kind of interesting, I don’t think I’ve ever actually asked about this rig, is the Seahawk. Tell us about the market and what we’re possibly seeing in terms of, I believe it has a renewal coming up in the later part of this year, early next year.

Robert Saltiel

The Seahawk is our lone stand to assist rig. It’s been working for the last number of years for Hess in equatorial Guinea, has been working for a couple of tension leg platforms where it hooks up, provides the drilling platform and the personnel and then helps to drill additional wells. That program is coming to an end later this summer.

As I mentioned in my prepared comments, Hess is going to take a break to evaluate the geology there in equatorial Guinea so that’s going to create an end to the program for the Seahawk at least for Hess there, and we’re currently bidding the rig on other opportunities.

I think it’s fair to say that the market is a less liquid market. It’s more of a niche market and so you really need to find the right job that fits the rig in terms of both the timing of course, but also the configuration on the rig and the configuration of the derrick set that we put on our customer’s platforms.

So we’re in the process now of looking for future work. We have identified potential work that we think is suitable for the Seahawk and we’re pursuing that work, but at this point in time, we don’t have anything we can announce.

Operator

You're next question comes from Scott Burk – Oppenheimer.

Scott Burk – Oppenheimer

I wanted to follow on the Coast Guard question. If you’re examining the processes and procedures, is there any kind of implied incremental liability that would be incurred by rig owners as opposed to the operator and owner of the oil if you’re supposed to be doing the processes?

Robert Saltiel

I don’t think that those two are directly linked. Contractually, our industry as drilling contractors, takes responsibility for certain liabilities, but those typically exclude let’s say pollution liabilities which is the big issue I think that most people are concerned about in terms of liability, and the results of the current Horizon incident and cleanup process.

So the reviewing of the practices is really to make sure that we’re doing everything we can as drilling contractors to ensure that well control is preserved. Clearly in the case of the Horizon incident, the well was lost in terms of control and that led to the issues that we’re fighting today.

So we as an industry always want to make sure that our practices are as robust as possible and as we go through the investigation process on the Horizon, we may discover that our procedures as an industry need to be adjusted.

But in the meantime, we want to make sure that we’re doing everything we can with existing equipment and existing knowledge to ensure that we have the right policies and procedures in place and that we’re following those rigorously. So that’s really what that’s about.

Scott Burk – Oppenheimer

And just to be clear, that was an alert sent to all operators or is that specifically to rig owners, to everybody in the Gulf or just to owners.

Robert Saltiel

The reference in the safety alert, and I think you can get this on the internet, but the reference is a joint issue from the MMS and the Coast Guard that they’re issuing the safety recommendations to both operators and drilling contractors. So in tandem, the two groups should work to address these safety recommendations.

Scott Burk – Oppenheimer

I wanted to ask about the Falcon. It had been off hire for, if I remember correctly, there was a problem with mobilizing two wells back in February. It appears it wasn’t as off hire as long as we anticipated. Can you give details on how long the Falcon was off hire and did the Eagle have a similar mobilization problem that caused its revenue to be down for the quarter?

Robert Saltiel

When we issued the 8-K on the Falcon, we indicated it was an issue relating to our mooring equipment. We indicated that it could lead to two to five weeks out of service. Frankly, we didn’t know, but it was at the time a significant event. I’m happy to report that our operations team working in close concert with our client were able to develop a solution to the mooring issues, which was implemented within about two weeks of time.

So we were on the very low end of the projected out of service time. But again, for prudency, we issued the 8-K. So that actually worked out to be less of an issue for us, both operationally and financially for the quarter than we would have anticipated when we issued the 8-K. It certainly could have been a lot worse.

The comment about the Eagle is a totally unrelated event to that and didn’t have anything to do really with operational capability. We just had to take some down service time for some maintenance and we took that.

Scott Burk – Oppenheimer

On the Seahawk, can it do – talk about its capabilities. Can it actually go out and drill wells on its own or is it just an assist for other active rigs?

Robert Saltiel

Just an assist. It doesn’t drill on its own.

Scott Burk – Oppenheimer

You have several rigs that are going to have some availability later on this year, particularly looking at the Southern Cross and then your jack up fleet as well. Specifically on the semi submersible fleet, we just the Venezuela get a rate of it looks like $195,000 a day in Brazil. Does that kind of represent the opportunities that you’re looking at with the Southern Cross or how does that market look to you right now?

Robert Saltiel

In terms of opportunity, as I said on the last call, we reactivated the Southern Cross with an expectation that we would be able to put together a consistent work string and we continue to work to deliver on that. We have one well that’s firm and we had a number of prospects.

And I will tell you, it’s a growing number of prospects for that rig in the Mediterranean area and outside. So our focus is really on keeping that rig utilize and making sure that the reactivation is a positive value-creating step for Atwood. We’ve got a bit of work to flange up contracts for the rig to keep it busy through 2010 and into next year, but that’s where our efforts are focused.

In terms of rates, the initial rate we’re going to go to work for is north of $150,000 a day. I think we’ve given guidance before up to and slightly beyond the $200,000 range, so that compares closely with the Venezuela number, but I don’t want to be any more specific than that because we do have discussions under way with clients.

Operator

You're next question comes from Brian Uhlmer – Pritchard Capital.

Brian Uhlmer – Pritchard Capital

I sounded like you said your CapEx was expected to be X dollars assuming no growth. I just wondered if you could talk a little bit about what the potential growth may be and what you’re looking at our there. I know there are some older rigs for sale in the market, if you would consider that or are you considering only new builds and what are you looking at out there right now?

Robert Saltiel

The opportunities for enhancing our fleet are things that is something that we look at on a regular basis and there really isn’t anything too specific to report on that. I think you’ve seen some of our competitors report that there’s still a reasonable bid ask spread that’s getting in the way of deals closing around acquisition of assets both backups and maybe floaters.

So I think we would echo those comments that you’re not seeing a lot of deals not because there aren’t sellers, but the prices being asked are still probably inconsistent with some of the contracting challenges we’re seeing in the current market, which I’ve already talked about and which are manifested in our own fleet status.

So those opportunities are things we look at. We are not interested in buying older; let’s say discarded assets from other players. I wouldn’t say that everything we would look at has to be a new build, but it would certainly need to be a recent build, and our focus is going to be on high spec assets with a bias toward deep water but not necessarily exclusive to deep water.

So hopefully that gives you enough color on how we think about growth.

Brian Uhlmer – Pritchard Capital

With six to eight months for delivery for some of these spec builds, they don’t seem to be flinching, or it seems they may be close to having to do something, but you haven’t seen that yet in what their ask is?

Robert Saltiel

Again, these guys have got creditors who they need to repay and I think some of that drives prices may be higher than the market would bear or could bear, and until they get in a real distressed situation, you may not see the bid asked spread close. Again, we continue to monitor the situation and look for opportunities that make sense for Atwood.

Operator

You're next question comes from Judson Bailey – Jefferies & Co.

Judson Bailey – Jefferies & Co.

I wanted to circle back on the Beacon. I think you suggested that Hess is going to stop their program there may be temporarily. Could you talk a little more about the opportunities for that rig and if you could handicap the odds of it staying in West Africa or perhaps moving to another market.

Robert Saltiel

The Beacon is a very capable rig for us. It was constructed within the last decade. It’s a 400-foot jack up. So we feel good about the prospects of keeping the rig active. We’re going to do everything we can to avoid any kind of idle time, but again, as we get close to end of contracts that’s always a possibility.

There are certainly some opportunities that we’re looking at in West Africa but we are also looking at opportunities outside of West Africa and sometimes we have to look at a balance between what’s close and what’s longer term. So we’re currently doing that calculus now to figure out where it makes most sense to place the Beacon and as I said, we hope to be able to announce some follow on work for the Beacon in the coming weeks.

Judson Bailey – Jefferies & Co.

At least to the extent that you can comment, it seems like the market for 350 plus IC’s is tightening a bit. Would you agree with that? Is the leading edge rate for that type of rig, would you say that it’s over 120 now generally speaking?

Robert Saltiel

I would agree that the premium jack ups are certainly seeing higher utilization than the standard jack ups so 350 plus versus the 300 footers, your assessment of the market there is correct.

In terms of the rates, I think we’ve seen rates really move around in terms of that range, but I would say that $120,000 is probably not a number that’s too far off, but it’s probably a range around that number.

Operator

There are no further questions at this time.

Robert Saltiel

We thank everyone for your interest in Atwood Oceanics and we’ll talk to you three months from now on our next conference call.

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Source: Atwood Oceanics, Inc. Q1 2010 Earnings Call Transcript
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