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Vantage Drilling (NYSEMKT:VTG)

Q2 2014 Earnings Call

August 05, 2014 11:00 am ET

Executives

Mark Howell -

Paul A. Bragg - Chairman and Chief Executive Officer

Douglas G. Smith - Chief Financial Officer and Treasurer

Analysts

Robert J. MacKenzie - Iberia Capital Partners, Research Division

Anders Bergland - RS Platou Markets AS, Research Division

Roland Morris - Cowen and Company, LLC, Research Division

Edward Okine - Basso Capital Management, L.P.

Operator

Good morning, ladies and gentlemen, and welcome to the Vantage Drilling Company Scheduled Second Quarter 2014 Earnings Conference Call. Today's conference is being recorded. And at this time, I will turn the conference over to Mr. Mark Howell, General Counsel. Please go ahead, sir.

Mark Howell

Thank you. Good morning, everyone, and welcome to the Vantage Drilling Company Second Quarter 2014 Conference Call. We appreciate you joining us. I'm Mark Howell, General Counsel for Vantage. With us today on the call, we have Paul Bragg, our Chairman and Chief Executive Officer; and Douglas Smith, our Chief Financial Officer. I'll open with a few brief remarks.

This morning, we released our earnings announcement for the period ended June 30, 2014. This afternoon, we intend to file our 10-Q. The earnings release is available on our website at www.vantagedrilling.com.

Please note that any comments we make today about our expectations of future events and projections are forward-looking statements pursuant to the Private Securities Litigation Reform Act. Forward-looking statements made in today's call are subject to a number of risks and uncertainties, many of which are beyond our control and could cause actual results to differ materially from the projections made in today's conference call.

We refer you to our earnings release and SEC filings available on our website. Vantage does not undertake the updating of any such statement or risk factor that could cause actual results to differ materially from our expectations.

At the end of our prepared remarks, we will entertain some questions.

With that, I would like to turn things over to Mr. Paul Bragg.

Paul A. Bragg

Good morning, everyone. Well, debt reduction gained momentum in Q2 with the repayment of about $57 million of debt, which was about 14% above our target for the quarter. We believe we remain on track to reduce debt by more or less $50 million per quarter throughout the rest of 2014 and 2015.

In Q2 we continued with generally high productivity and strong cash generation from our 7 assets that are in service. While cash flow was strong, net earnings were negatively impacted, particularly by the tax provision, which was revised upward based on our customer changing their forward drilling plans to a different country of operations. Doug Smith will give you some further insight into that.

Second quarter revenues were $220 million and net income was $10 million. Diluted earnings per share was $0.03, about $0.05 excluding the tax and other items. EBITDA was $113 million during the quarter.

Now Q2 was another excellent operational quarter for Vantage. Our jackups once again worked at high revenue efficiency, exceeding 99% during the quarter. Our deepwater efficiency was about 83% in Q2. That's a little misleading on the negative side, I would say, so I'll explain. Platinum Explorer efficiency was 100%; Titanium Explorer was about 92%; and Tungsten Explorer was 57%. Now Tungsten actually achieved about 100% efficiency while drilling. However, we had out of service time related to transit time to West Africa.

As we've mentioned on previous calls, the transit time has been fully compensated but will be paid in a lump sum and recognized over the 2-year initial contract period of our long-term contract in Congo, which is not the one that we're starting now but the next one. So I'll just provide a little recap around that.

Tungsten commenced operations in Q3 of 2013 and drilled 7 wells in Myanmar, Brunei and Malaysia. And that finished up around May 23, 22, and Tungsten began its voyage to Africa for 2 projects there. She stopped off in Singapore and Port Elizabeth, South Africa, for our customer-specific equipment to be installed on Board, and she has since moved on to West Africa and commenced a 60-day contract in Gabon this week on August 1.

Next, after finishing that contract, Tungsten will commence the long-term contract for Moho Nord development in Congo in Q3 of 2014, or early Q4. At that time the revenue recognition for the mobilization period will begin, and so that will be recognized over the 2-year period following.

With that, I'll turn it over to Doug Smith to go through the highlights of the financial results.

Douglas G. Smith

Thanks, Paul. For the second quarter, we achieved revenues of approximately $219.7 million as compared to $232.5 million in the prior quarter and $170.6 million in the second quarter of 2013. The sequential decrease was primarily due to the timing of the mobilization of the Tungsten Explorer to West Africa, which we commenced on May 22. A year-over-year increase was due to the addition of the Tungsten Explorer in the prior year, and improved revenue efficiency and productive time on the Titanium Explorer.

Income from operations for the second quarter was $81.7 million. This compares to $91 million in the prior quarter and $61.5 million in the second quarter of 2013. The jackup operations for the second quarter had revenue of $61.8 million, which is consistent with the $61.6 million in the prior quarter. Utilization for the quarter was approximately 99.2% as compared to utilization of 100% during the prior quarter.

The average contract revenue per day, excluding reimbursable revenues for our jackup rigs, was approximately $162,100 per day as compared to $161,400 in the prior quarter. The operating costs, again less reimbursables, for the jackup operations was approximately $22.4 million for the second quarter as compared to $23.8 million in the prior quarter.

For the quarter, the direct operating costs on a per day basis for the fleet, net of reimbursable expenses, was approximately $61,500 per day as compared to $66,000 per day in the prior quarter. As I discussed on prior conference calls, before jackups and service, the daily operating costs can fluctuate significantly based on the timing of maintenance and other rig period costs. This quarter's $61,500 per day is in our benchmark range of $61,000 to $65,000 per day.

Deepwater operations for the second quarter had revenue of $145.3 million as compared to $159.2 million in the prior quarter. Direct operating expenses, excluding reimbursables, were $51.2 million for the second quarter as compared to $55.8 million in the first quarter.

Deepwater utilization for the second quarter was 83.1% as compared to 96.5% in the prior quarter. The revenue from operations, cost and utilization were all down, primarily due to the Tungsten Explorer's mobilization to West Africa. Additionally, we had about 7 days of downtime on the Titanium Explorer to make repairs to the slip joint and other minor repairs.

Our management business had revenue for the quarter of approximately $12.6 million, consisting of $3.2 million of management fees, $2.8 million of termination fees associated with the contract in Mexico, and $6.6 million of revenue per reimbursable cost.

The second quarter revenue in comparison of the revenue in the prior quarter of $11.7 million, consisting of $4.6 million of management fees and reimbursable revenue of $7.2 million.

The cost of our operations for it was approximately $10.3 million during the quarter, compared to $10.8 million in the prior quarter.

Corporate G&A was $8.4 million and depreciation for the quarter was $31.6 million. These numbers are consistent with the prior quarter totals of $8.1 million and $31.6 million, respectively. EBITDA for the quarter was $113.4 million as compared to $122.6 million in the prior quarter and $86.5 million in the second quarter of 2013.

We had interest expense of $54.3 million, a loss in the early retirement of debt of approximately $1.4 million, and tax expense of $15.3 million for the quarter, which resulted in net income of approximately $10.2 million, or $0.03 per diluted share. This compares to interest expense of $54.5 million and tax expense of $12.4 million in the prior quarter, which resulted in net income of approximately $24.8 million, or $0.07 per diluted share.

When analyzing the second quarter, it is important to note that the $1.4 million charge associated with the early retirement of debt is due to our previously announced strategy of paying down debt during the year. These charges were not included in our previous guidance.

Also not included in our guidance, but included in our tax provision, is approximately $3.5 million of tax due to a catch up adjustment for effective tax rate, which must be calculated on an annual basis.

During the quarter, our customer for the Titanium Explorer informed us that they were changing their drilling locations for the remainder of the year. Instead of moving the Titanium to a low-tax country following the completion of its work in Equatorial Guinea, the rig will be mobilizing back to the U.S. Gulf of Mexico. Adjusting for these 2 items, comparable results to the guidance would've been net income of $15.1 million, or $0.05 per share, which was in our guidance range.

Looking to the balance sheet. As of June 30, we had approximately $89 million of cash on hand, as compared to $56.8 million of cash on hand at December 31, 2013. We have outstanding borrowings of approximately $2.8 billion.

During the quarter, we had debt paydown of approximately $56.9 million, bringing the year-to-date total to $86.3 million. The $56.9 million exceeded our previously announced goal for the quarter of $50 million.

Debt paydown for the quarter consisted of $55.4 million of our debt paydown on our term loan and $1.5 million of open-market purchases on our 7 1/8% [ph] senior notes. We continue to pay down the term loans with our excess cash flow and look for opportunities to buy higher-cost debt in the open market.

CapEx for the second quarter consisted of $7.4 million for the operating fleet, primarily fleet spares, and $700,000 for software upgrades. Our growth capital for the quarter was for the Cobalt Explorer of $4 million, including a approximately $1.2 million of capitalized interest. This brings the year-to-date CapEx to a total $12.2 million for the operating fleet and $3.3 million for software upgrades.

Our growth capital year-to-date is $7.1 million, including capitalized interest of $2.4 million.

Looking to the future guidance for the company. The guidance for the third quarter, unfortunately, will be negatively impacted by the Titanium Explorer having downtime associated with an LMRP connector. This has currently anticipated a result of approximately 22 days off contract in the third quarter.

Additionally, the forecast is impacted by the timing and duration of rig mobilizations for the Tungsten Explorer and the Titanium Explorer. The Tungsten Explorer has commenced operations in Gabon, and is scheduled to mobilize to the Congo later this year.

Additionally, we are currently revising our estimates for the Titanium Explorer as we are now on schedule to return to the U.S. Gulf of Mexico.

For the third quarter, we are currently projecting EBITDA of $90 million to $105 million. Depreciation for the third quarter will be approximately $32 million. Interest expense is estimated to be $54 million, including approximately $5 million of noncash interest, net of capitalized interest. We expect income taxes of approximately $2 million to $9 million. Taking all this into account results in a profit range of approximately breakeven to $10 million, or $0.00 to $0.03 per share. We are on track for our debt paydown target of $50 million for the third quarter, and on target for $175 million for 2014.

With that, I'll turn it back to Paul.

Paul A. Bragg

Okay, thanks, Doug. Next we'll just bring everyone up to date on construction. Construction efforts continue to be focused on the fourth DSME drillship, Cobalt Explorer. We've mentioned before, but this is a very high-spec unit, dual activity 2.5 million-pound load path and equipped with 2 onboard 7-ram BOPs. Steel cutting on the unit occurred January 15, and the keel lining occurred on July 28. Delivery and mobilization is scheduled for Q3, Q4 2015.

During the first quarter, our Sigma joint venture received approximately $65 million under a refund guarantee as a result of STX's termination of the Palladium drillship project. Substantially all of the monies received under the refund guarantee were since distributed to the partners at the beginning of Q3 2014. At this time, Vantage expects to add such to our existing investment in the Cobalt Explorer.

Also of note, Sigma has invoked its arbitration rights and is seeking additional compensation from STX due to the cancellation.

Work is also progressing as planned under the construction management contracts with Senegal for the construction of 2 other ultra-deepwater drillships.

Next I'd like to review our outlook on the market. Starting with jackups. As we've said in the past, the modern high-spec jackups continue to be fully or nearly fully utilized with high demand. All 4 of the Vantage jackups are with repeat customers and are nearly fully committed for 2014. We are in discussion currently for possible jackup extensions and we're also reviewing new opportunities.

Current bids for modern jackups in Asia are generally in the range of $145,000 to $165,000. You can generally increase that by $10,000 to $20,000 a day for projects in West Africa. It is our view that this market remains solid with strong customer demand. But the question hanging before us is whether a large number of jackup newbuilds coming into the market over the next few years will be disruptive to rates and utilization. We continue to believe that the customer preference is strongly in favor of the new modern jackups and that utilization of these newer modern rigs will continue to be near 100%. We do see the possibility of some regional weakness in jackup day rates as a result of incremental rig supply. But at this time, we do not anticipate significant rate deterioration.

With regard to ultra-deepwater units, it's a market that's in transition, due mostly to the new supply. Once again, as in previous quarter, we've seen few fixtures, so it's impossible to be conclusive about the state of play in the market. New high-specification ultra-deepwater rigs are clearly the rig of choice, and the higher efficiency of these rigs has become and continues to be a significant factor in rig selection by customers.

The new modern rigs are very likely to continue to be nearly fully utilized looking forward. My belief is essentially unchanged from that, that we expressed in the Q1 call, that day rates for the rest of the year and for the first half of next year for these type of rigs would generally be in the $500,000, although some will be less.

The additional supply resulting from newbuild deliveries has begun to significantly impact utilization of older and less capable rigs in the marketplace, as well as the pricing for all floaters.

However, with regard to demand, we see very little change in exploration development plans and overall customer sentiment. We continue to believe there will be a strong market and strong demand for our ultra-deepwater drilling for some years to come, despite any softening of rates that is triggered by near-term supply imbalance.

We are discussing our late 2015 newbuild delivery Cobalt Explorer with a number of customers and we see strong interest in the rig. We expect strong competition for all job opportunities in the near term, and we probably will not contract the rig until later this year or into next year. There is a possibility, of course, that, that could change or we could contract it sooner.

In conclusion, the company is performing very well and we're positioned extremely good for the future. Debt reduction is our primary priority for this year and next. And in accordance with our guidance, we repaid about $30 million in Q1 and $57 million in Q2. We're still targeting $50 million per quarter over the remainder of 2014 and '15.

I'd like to point out that our Q2 debt reduction represents about 10% of our market capitalization. While our shares have performed well relatively to our peers over the last 2 years, we have directionally traded with the peer group. The significant deleveraging that is now ongoing at Vantage clearly sets us apart from a valuation perspective. We believe that we are uniquely positioned to drive share growth through debt reduction.

We continue to have exceptional operating and safety performance, which is our trademark. We expect to maintain predictable cash flows, as our backlog is among the best in the industry relative to the size of the asset base. And our fleet is essentially fully contracted this year, and the ultra-deepwater fleet through next year as well. We do have some manageable and attractive growth in the Q, which is the 2015 -- late 2015 delivery of Cobalt Explorer. So I believe we are uniquely positioned to drive value near term, and we are well positioned for longer-term value creation as well.

With that, we're prepared to take some questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Rob MacKenzie with Iberia Capital.

Robert J. MacKenzie - Iberia Capital Partners, Research Division

A question for you, I guess, Paul. Thanks for the operational update, obviously, for the third quarter. Any planed downtime that we should roll into our models for the fourth quarter or into next year, as well as we update our numbers here?

Paul A. Bragg

The planned downtime, the timing of it is what's still a bit in question. We know that we're going to have Titanium moving back to the Gulf of Mexico, just whether that represents something that starts mid-quarter, fourth quarter or sooner or later than that is yet to be determined, at this point. I think it will be a while before we can be accurate on that.

Douglas G. Smith

Rob, on the Titanium move, because it's in the middle of a contract, that one will be just recognized at the standby rate, so we'll have a -- we don't have to defer the revenue during that particular move.

Robert J. MacKenzie - Iberia Capital Partners, Research Division

And can you remind me what that standby rate is?

Douglas G. Smith

We're not actually supposed to disclose it, but it's a healthy percentage of the total.

Robert J. MacKenzie - Iberia Capital Partners, Research Division

Okay. How should we...

Paul A. Bragg

Especially with our historical contracts.

Robert J. MacKenzie - Iberia Capital Partners, Research Division

Okay, that's helpful. How should we think about the tax rate going forward? Obviously, you've had an adjustment with the Titanium moving to the Gulf, what should we think about in terms of tax rate in 4Q and into next year?

Douglas G. Smith

A lot of that's going to be impacted, and unfortunately, those estimates are, maybe it will get better on this based on this rate move. And so what we have on that is we did a rough calculation -- I say a rough calculation -- the calculation itself ties to the plan that was put forward between us and our customers on the actual date. It will move a bit, so the -- for the third and fourth quarter, it can be hard for me to give you a more accurate description than we still think that it's going to trend back to that 5% of revenue. And as far as for 2015, we also are generally guiding to the 5% of revenue. The difficulty with these contracts and the effective tax rate calculation is most of our taxes are generated on revenue calculations and not on the actual obtained margin. But the tax rules require you to evaluate the taxes relative to the actual margins. So that's why we've had such a significant fluctuation. But I think, generally, long-term and over any cycle, you're going to end up with about 5% of revenue.

Robert J. MacKenzie - Iberia Capital Partners, Research Division

Got it. Any help on that front, Doug? Vis-à-vis how much of the taxes that you're reporting on the book for the remainder of this year, our cash taxes versus how much of that being noncash?

Douglas G. Smith

The cash tax -- obviously, there's a period you accrue the taxes that are paid in subsequent quarters and then some of them have different timeframes when you actually pay them. But what we consider cash taxes versus what you're thinking of in terms of the typical deferred tax scenario, we have very little deferred taxes. There's only a couple of jurisdictions where we have any recognition of deferred taxes, and so I would say that the cash tax portion of it is going to be anywhere from like 98% to 102%, depending upon the timing.

Operator

We'll take our next question from Anders Bergland with Platou Markets.

Anders Bergland - RS Platou Markets AS, Research Division

I had 2 questions. One on the market outlook, can you give us some kind of indication whether the activity level concerning potential work in '15 or '16 is higher these -- around these days and also last quarter? And secondly, could you give us some kind of color on the legal actions between Vantage and your largest shareholder, Nobu Su?

Paul A. Bragg

Certainly. Regarding activity, we see in the marketplace, I can't say that it's significantly changed from previous quarter or really anytime this year. There have obviously been a lot fewer fixtures. I think one of the factors there is that historically, when the supply was sort of imbalanced, customers were out looking for rigs, ultra-deepwater rigs significantly before they were required to startup on the projects. With them seeing both available supply today and additional coming supply, the concern to contract earlier is not there. So if you picked a time duration, say it was previously 18 months before requirement, then today, it's probably 12 months before requirement or some change in that factor. So we see as a sort of additional or less -- incrementally less activity in tendering now then -- but as you go out and visit with the customers and discuss their actual projects and requirements for this year, next year, the following year, we don't see much difference in terms of needs than what we previously saw. We're certainly not seeing big reductions. In terms of the litigation that you mentioned, the shareholder litigation, we continue to push forward to a scheduled trial date in October. I think we reported before that the company had been successful in obtaining some restraining orders respecting the vast majority of the shareholdings that they couldn't be sold or pledged. That was challenged, and again, ruled in our favor just recently. So I would say our position continues to strengthen, and we're marching toward the upcoming trial later in the year.

Anders Bergland - RS Platou Markets AS, Research Division

Okay. So can I have just one follow-up on the market outlook. Do you see that the -- is there a chance for market recovery, if you could put it that way, late '15 or early '16? Or has anything changed during the past quarter that suggests that, that is pushed to the right?

Paul A. Bragg

I don't see anything that's definitive around that. It's hard for me to say. I don't see people making significant cuts to their programs, nor do we see significant additions. But in terms of demand for hydrocarbon, it still continues to increase. I've noticed with a lot of the quarterly reports that are come out with the E&P companies, a number of them are reporting sequential and year-over-year declines in production. All those things tend to be positive in terms of indicating more drilling is going to occur. Whether it will increase at a rate that absorbs a sufficient number of newbuilds, no one really knows the answer to that. But the flip side is we also don't know how many of the older units will cease to be marketed, whether that's permanently or for temporary stacking. But the market will self-correct itself to the amount of demand. History kind of tells us that, that takes a while for their 12, 18, 24 months. But I think we can expect weakness persisting, at least through the middle of next year and probably through the end of next year. That's more gut feel than data telling me that.

Operator

[Operator Instructions] We will take our next question from Roland Morris with Cowen and Company.

Roland Morris - Cowen and Company, LLC, Research Division

I just wanted to ask what your thoughts are now on as it stands today, the Cobalt Explorer, in terms of trading term for rates. I mean, are you guys looking to when do you sign that rig operator, are you looking for a multi-year contract and willing to go a little lower on rate in order to do that? Are you -- where are you thinking there in terms of term versus blank or term versus rate?

Paul A. Bragg

Well, I think the rate that's available will be a significant factor, that if we think we are significantly off what a go-forward rate is, then we'd rather have a shorter term than longer. On an overall basis, we generally prefer longer term and I think the fact that we have significant financial leverage, even though we're reducing it, we would err on the side of longer than shorter. But any kind of rules of thumb that previously existed, I'd say still apply with respect to once you get a duration of a contract that's more than 2 or 3 years, you're generally prepared to give up $5,000 or $10,000 a day per incremental year that you add onto the contract. So I think the customer would expect that and that's sort of the rules of engagement. So the amount of discount is one that you subject to determination, but that's the way we would approach it.

Roland Morris - Cowen and Company, LLC, Research Division

Okay. And then just as a quick follow-up. Are you guys, in terms of the Emerald Driller, the Aquamarine Driller and the Topaz Driller, are you guys -- what -- sorry not the Sapphire, the Aquamarine -- in terms of the market in Southeast Asia right now, when those rigs come up for contract renewals and you're looking to sign them up, have you guys looked at what other rigs in the region you think you're competitive with and what jobs are out there right now? I mean are there any rigs directly you could speak to that might be comparable to those rigs?

Paul A. Bragg

There obviously are some rigs in the market, there's some new deliveries that will occur over the rest of this year and into next year. We are currently in the discussion phase, in advanced discussions in some case with customers, regarding the Aquamarine and Topaz. We feel quite good with not only the opportunities for renewal with existing customers, but also some alternative projects that exist where the operators have pretty strong interest in moving forward. So I would say that in the case of at least one of the 2 rigs, something's likely to happen sooner rather than later. And there seems to be sufficient demand, particularly for rigs that have a good operating history, such as those in the area. We're not expecting any issue in terms of follow-on work nor are we expecting any significant change in the rates on either the positive or negative side.

Roland Morris - Cowen and Company, LLC, Research Division

Okay. But we shouldn't be really considering the idea of significant gap in contracts between the Aquamarine towards the end of 2014 or '15 or start of '15, right?

Paul A. Bragg

No.

Operator

We will take our next question from Edward Okine with you Basso Capital.

Edward Okine - Basso Capital Management, L.P.

Just with regards to your long-term contracts, particularly on the drill ships [ph] side, are they open to renegotiations of any of the market risk change?

Paul A. Bragg

No.

Edward Okine - Basso Capital Management, L.P.

No. And so contractually, I mean, there are no issues like that?

Paul A. Bragg

No.

Operator

[Operator Instructions] And I'd like to turn it back to today's speakers for any additional or closing remarks.

Paul A. Bragg

Okay. We don't really have any other follow-up that I'm aware. I appreciate everyone's interest in joining us for the call this morning. We look forward to speaking to you again at the end of Q3.

Operator

And this does conclude today's conference. Thank you for your participation.

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