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Diamond Offshore Drilling (NYSE:DO)

Q2 2011 Earnings Call

July 21, 2011 10:00 am ET

Executives

Gary Krenek - Chief Financial Officer and Senior Vice President

Morrison Plaisance - Vice President of Contracts & Marketing

Michael Acuff - Vice President of Contracts and Marketing

Les Van Dyke - Director of Investor Relations

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

Analysts

G. Scott Burk - Canaccord Genuity

Arun Jayaram - Crédit Suisse AG

Judson Bailey - Jefferies & Company, Inc.

Darren Gacicia - Morgan Stanley

John Lawrence - Tudor, Pickering, Holt & Co. Securities, Inc.

Geoff Kieburtz - Weeden & Co., LP

Robin Shoemaker - Citigroup Inc

Michael Urban - Deutsche Bank AG

Matthew Conlan - Wells Fargo Securities, LLC

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Diamond Offshore Drilling Second Quarter 2011 Results Conference Call. [Operator Instructions] Thank you. I would now like to turn the conference over to Mr. Les Van Dyke, Director of Investor Relations.

Les Van Dyke

Thank you. Good morning. And with me on the call today are Larry Dickerson, President and Chief Executive Officer; Gary Krenek, Senior Vice President and Chief Financial Officer; Moe Plaisance, Vice President of Marketing; and Michael Acuff, Vice President of Marketing.

Before we begin our remarks, I should remind you that statements made during this conference call may constitute forward-looking statements and are inherently subject to a variety of risks and uncertainties that could cause actual results to differ materially from those projected. Forward-looking statements include, but are not limited to, discussions about future revenues and earnings, capital expenditures, industry conditions and competition, dates that 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 and the company's overall business and financial performance can be found in the company's reports filed with the Securities and Exchange Commission. Given these concerns, investors and analysts should not place undue reliance on forward-looking statements. The company expressly disclaims any obligation to release publicly any updates to forward-looking statements to reflect any change in the company's expectations or any changes in events, conditions or circumstances on which any forward-looking statement is based. [Operator Instructions]

And with that, I'll turn the meeting over to Larry.

Lawrence Dickerson

Thank you, and good morning. We're pleased with our results today of $1.92. Point out that, that includes in it a $10 million write-off related to a deferred mobilization on the Ocean Monarch that was resolved with our customer at the point in time that we signed the commitments on 2 of our new drillships. So that was a $10 million write-off. About between $0.04 and $0.05 of earnings is included in that number.

The positives for the quarter that we would focus on was we had almost all-time low amounts of downtime within our fleet. There were only 24 days covering one rig where we had a rig in the shipyard. It's with the Ocean Yatzy in Brazil doing some thruster work, whereas in the ordinary course of business there will be multiple rigs with many more days.

In fact, in all likelihood, our schedule shows that there will be multiple rigs in Q3 down for planned maintenance. And on the other side, the thing that we do work to control, we had a near-record low unanticipated equipment downtime of only 65 days here in this quarter. It was down from 72 in the quarter before, which I'm also pleased with. So we got a nice trend going in that direction, and that obviously is something that we can control and generate more the revenue and have more of it drop to the bottom line.

Although costs were up sequentially quarter-over-quarter, I'm pleased with our efforts and where we're spending money. We did start at the beginning of the quarter an offshore rig raise, which is reflected in there. And we've also put in place a retention program for selected employees on selected rigs, the ones that are under the most demand, the highly skilled rigs covering the newer rigs.

And so those costs are in there. We would expect those to come forward back [ph], but again, we're pleased with that.

The other big thing is the amount of backlog that we were able to add, and all of that sort of came together in almost a 10-day period. So we were really excited about that. But the disclosures on the press release cover $1 billion. There were some other minor ordinary course of business adjustments that really put the number of $1.1 billion of additional backlog. We're burning. And in the quarter, we burned right under $900 million of revenue, which in effect, is backlog being burned off. So we were able to certainly replace that, and that ignores the $1.8 billion of backlog that we added through the 2 new drillships, and I'll come to that.

But in the details of the rigs that we added additional time on, I think most significantly, it was down in Brazil with our customer, Petrobras, one of our new builds, the Ocean Valor had initially signed the contract at 3 years with Petrobras at $450,000 a day. We had included at that point in time our provision that would allow them to extend that to 5 years in return for a $10,000 prospective decrease in the day rate, and they elected to exercise that, covering the Ocean Valor. We had a similar provision in the fifth generation, Ocean Baroness rig, which we located down there, where they extended that for an additional 2 years for a similar rate reduction.

And I think that's significant, and I think it points out the demand that Petrobras has in the near term. And of course, these extensions really don't kick in for 2 years or so. So it covers some years that -- '13, '14. So it's not just near team, but intermediate term. They've got lots of discoveries down there. They need these type of large rigs to develop those, so that's a net positive.

At the same time, we had an opportunity to take the Ocean Yorktown, an intermediate rig, and put it into a bid in Mexico. We really didn't have another rig in the immediate area that could fulfill that job. And because it would be to Petrobras' mutual benefit to relieve them of some near-term commitments, they elected, we negotiated to free up the Ocean Yorktown and move the Ocean Yorktown time to another mid-water rig, the Ocean Concord.

Also, in Brazil, our good customer, OGX, put one-year extensions on their larger rigs, the Ocean Star and the Ocean Quest. So significant developments in our biggest market. We continue to have 16 rigs operating in that market and with all kind of backlog. So we're pleased with that.

Also, in Mexico, we are seeing a movement off of, frankly, some low-level activity that we've seen for the past year or 2. And we have 3, in addition to the Ocean Yorktown arriving, we've got 3 jack-up jobs there. A slight extension on one of the existing rigs, a longer-term extension on the Ocean Summit. And then the Ocean Titan, which has been working in the Gulf of Mexico, and was frankly down due to permitting issues, we were able to get a 777-day job there at a little over $100,000 a day. Now we’ll have to do some modifications to the Ocean Titan to get it qualified to go down in Mexico. The Summit is now going to have been there for some period of time. But we think that will pay out very quickly.

Then on our fleet status report that we released, we also indicated smaller extensions, which we didn't include on the press release. The Ocean Nomad, extended in the North Sea, puts that rig to work through the winter. And the Ocean Valiant continued to tack on time in West Africa. West Africa is certainly an exciting market for there. One of the big events on the horizon is that our Ocean Confidence in moving on location for Cobalt for a highly anticipated well down there. So we will be, obviously, giving any updates on what's happening there. But we're there participating, and we certainly think there's a lot of upside in West Africa.

To go back to what's probably old news, what happened earlier in the quarter where we took both of our first 2 drillships that we had ordered and signed a combined 10 years worth of work, 5 years per vessel at rate that generated $1.8 billion of backlog, and I think everybody can do the math, can see that those are nice rates. And that excludes mobilization. We don't know where the rigs were -- are going. In all likelihood that mobilization will be also rolled into the dayrate contractually, and certainly from an accounting standpoint, that's the way that our rig would work.

And the final thing I would point out would be the continuation of our dividend policy. As indicated in the press release, we renewed our special dividend at the same rate that's been established now, I believe, for 4 quarters, combined with our regular dividend. The 2 dividends combined, looking back to 2006 have paid out just a hair under $29 in value to shareholders and, again, continues to reflect our belief that dividends are an important component of returning value to shareholders. And I always tell investors that we meet that you can't just look at our share price compared with the competition and how that may perform but also that you need to keep in mind, depending on how long you've held it. So at least some portion, and hopefully, for long-term shareholders, all of the portion of that dividend just under $29 of value that you receive.

So that concludes my opening remarks. And I will now turn it over to Gary Krenek to go through a little bit more of the details of our financials.

Gary Krenek

Okay. Thanks, Larry. For the second quarter, the most of the line items on the income statement came within expectations of what we expected, what we had talked about in our previous conference call. The one line item Larry already alluded to that was slightly above was our contract drilling expense. We had guided to between $360 million to $375 million, is what we said in the last conference call, and we came in at $388 million.

As Larry said, the biggest component of that overrun was the $10 million worth of deferred mobe and preparation cost on the Monarch that we took in a noncash charge for in the second quarter because of early termination of the contract on that rig.

I remind everybody that when we do -- when we mobe rigs, we defer any costs occurring when that happens and amortize it over the length of the contract. So that was a $10 million charge. We also had some weakening of the U.S. dollar, slight weakening for some of our unhedged positions and foreign denominated expenditures. That cost us somewhere between $5 million and $7 million on expected, and then slightly higher because some of the labor increased, as Larry talked about. So if you take all of those into account and adjust our actual numbers, we actually come right in the middle of the guidance that we had put out last quarter.

Other than that, that’s it. Everything came in pretty much what we had expected. Looking forward to next quarter and the rest of 2011, I think the biggest thing is, again, Larry talked about it, is the downtime on our rigs that we expect in the third and the fourth quarters. Again, you can look at our rigs status report that we released this morning to get the details of that. But just briefly, we have 4 rigs that will be undergoing a 5-year survey in the third quarter. We have 3 rigs in the fourth quarter undergoing surveys. We have 3 rigs, the Yorktown, Monarch and Titan that will be mobing from one major area of location to another during the third and fourth quarters. They will have downtime. And finally, the Ocean Clipper will be down for a few days in the third quarter and the entire fourth quarter for some contractual upgrades that we had agreed to do with Petrobras, 1.5 years, 2 years ago, when we extended the Clipper contract. We had been waiting for delivery of equipment and also for a convenient time for both us and Petrobras that will take that rig out of service, and that time is now coming up. If everything goes according to plan and we start when we're supposed to at the end of the third quarter, we will be back on contract by January 1, 2012.

So this downtime for our rigs, we had very good downtime in the first half of the year. It just so happened that most of it is going to be back-end loaded in the second half of the year with costs to some on both the revenue line and will also affect our expense lines.

Looking at contract drilling expense for the third quarter. Again, we'll incur our daily normal -- normal daily operating costs that we foretold everyone earlier in the year. To that, you need to add some $22 million worth of amortized mobe costs that we’ll record in the quarter. The 4 survey costs, each of those rigs will be somewhere between $4 million and $8 million each. We have 2 jack-ups and 2 semi-submersibles. The U.S. dollar we're expecting to remain consistent. So you need to add another $6 million to $8 million to our normal cost to that.

And finally, our major expense cost for our major projects. It will increase somewhere in the $7 million to $10 million range in Q3, and then following it also in Q4. And as we've said before, this is normal. When we do our budgets in the fall of any given year, it takes the first quarter and part of the second quarter for us to write our AFEs, order our equipment, wait on delivery. All of that stuff comes in, and we actually spend the money and record it in the second half of the year.

So if you add up those daily -- regular daily costs and the additional items that I gave you, that should come up to a third quarter contract drilling expense of somewhere between $395 million to $410 million.

Again, I caution everybody that’s the contract drilling expense only. That does not include reimbursable costs. We do not budget for reimbursable costs. If you look at that, the reimbursable costs are virtually offset, dollar-for-dollar, with reimbursable revenues. And the revenue guidance that we give on our rig status report excludes any type of reimbursable revenues.

So when you're looking at -- trying to project our earnings in the future, you really need to net those 2 lines out, which we do.

For the rest of the income statement line items, the guidance remains virtually the same as it had in the last quarter. G&A, we expect it to continue to be at $17 million to $18 million per quarter. Depreciation, $101 million to $104 million per quarter. It will be slightly up in the third quarter simply because there's 92 days the next quarter versus 91 days in Q2.

Interest expense remains at about $22 million per quarter. Our effective tax rate at 21% to 24%, which is the same as we had guided up previously. And finally, maintenance capital remains at $320 million for this year.

Additionally, we had some $475 million of down payments we'd made already in the first half of the year on the 3 new build drillships that we did. Just for accounting purposes, that $475 million is not considered capital expenditures this year, but rather are -- is recorded in the balance sheet as a long-term deposit on our new builds. That will be flipped around when we actually take delivery of the rigs and will come out of the deposit account into our fixed assets.

And with that, I'll turn it back over to Larry.

Lawrence Dickerson

Okay. So I think we're ready for questions. We'll let the marketing folks say their piece during the Q&A.

Question-and-Answer Session

Operator

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

Ian Macpherson

Larry, on the Noble call preceding yours, they were cautioning a lot about more systemic downtime for the industry because of less tolerance for BOP anomalies, et cetera. Have you seen a change on your fleet with that? And do you expect it going forward?

Lawrence Dickerson

Yes, we think that is a factor. It didn't hit us in this quarter. We are trying to take steps to minimize that. We've seen instances where we think in the past, we might not have had to take some period of downtime. We've had a little downtime here going into Q3 already on BOP stacks. It just hadn't hit us to that point yet. But certainly, in our future projections and whatnot, we're building in a little bit more downtime on bigger, deeper water rigs for BOP differences. We don't have a sense yet on what changes may happen in our mid-water fleet.

Ian Macpherson

Okay. Follow-up question. What would you say is the direction of the mid-water market right now? Because it seems to be that it's been sort of getting slightly better, but not with a lot of -- I guess the emphasis is on slightly, and we have seen some plusses and minuses, and we've seen now Petrobras putting their backlog on the fewer rigs, onto one rig with you today. So can you really call a clear direction in mid-water right now? Do you think that we're doing well to hold flat? Or do you think we're definitely improving over the next year or what?

Lawrence Dickerson

Our marketing guys will comment on that

Michael Acuff

Ian, this is Michael here. I would say you're correct. We continue to see a fairly flat to slightly improving. Again, back to your slightly comment. With Petrobras, we had an opportunity to add backlog on that mid-water fleet at similar margins. With PEMEX, it was a good opportunity. And they had some short-term drilling schedule issues that was able to benefit them also. But in general, as you look around the world, I think it's still a fairly flat market. No pricing power to say. And we're continuing to be somewhat positive on it. The North Sea, we're seeing work coming through the wintertime. We're getting that visibility now and securing that work. But to say that we're seeing a big uptick, we're just not at this moment.

Operator

The next question comes from the line of Robin Shoemaker with Citigroup.

Robin Shoemaker - Citigroup Inc

Just wanted to, along the same lines of kind of more downtime and unexpected, on your third quarter estimate of the number of days, is that kind of forecasted somewhat conservatively? Or is there a significant over/under kind of range on that number of days that you've indicated? And I guess, 5-year survey could turn up a lot of new projects that perhaps weren't anticipated. That’s kind of the gist of my question.

Gary Krenek

This is Gary, Robin. The number of days is our best estimate. We have a pretty good idea coming up this quickly on us. We’ve already had the engineers out there, looked at it. You can always run into unexpected items, no doubt. But we're fairly confident with these numbers of days. Now can they go over an additional 10 days? Sure. We can find things. We have had times when we've got caught by weather, just trying to get in and out of the shipyard. So again, it's a best guess. We're comfortable with the third and the fourth quarter. Could go over a little bit. We'll see. What becomes very difficult is when we try to give some estimates for next year and the downtime for 2012 before we do those engineering studies. Those dates can certainly shift in the future.

Robin Shoemaker - Citigroup Inc

Right. Okay. A follow-up then. I just appreciate your perspective on the North Sea market post the U.K. tax law change. And the Gulf of Mexico permitting pace, as you expected, going forward, and the rig, its impact on the deepwater rig market there.

Lawrence Dickerson

I guess, the North Sea, we haven't really seen a big move one way or the other. Offsetting that tax increase has got to be the positive spread on grant over WTI, where we get interest and people that talk about wanting to drill, they don't really always share all their thoughts and processes. But I think our sense is that the oil price balances out those taxes in some instances. Beyond that, it really gets into production and dates that they had leases and things that aren't always clear to us, and they change a little bit. Permitting in the Gulf of Mexico, I think, has picked up. We've seen more permits being issued. They primarily seem to be issued toward the deeper end of the spectrum rather than the mid-water. But the mid-water fleet is so reduced now. I mean you've got, really, our Ocean Saratoga, which are coming up to a survey. And you got our Ocean Victory, which will service that. And that's it. Everything else is a deepwater market. So it's not taking place in a world where there's still the same number of rigs so that you can measure things. Certainly, I think when we talk to customers in those markets, they seem to be very optimistic that things are picking up. I don't know. Moe, even the tone at the government regulatory agencies seems to be they're getting a little more certainty.

Morrison Plaisance

I think it seems to be getting more upbeat that they're looking at and it's being focused on the deepwater to get things back, and we’ve had a couple of customers looking out towards the future, and maybe having to move some rigs back. But there's some positive...

Lawrence Dickerson

So I guess the summary is the tone is improving, and they are more for permits going out to Noble [ph]. But we're not near where were previous to that. And ultimately, I believe that the market has to have permits stacked up in their pocket because no one knows exactly when a well’s going to end. It could be declared a no-show and they want to move off, and they need to be able to move this equipment rapidly and not go through another process. So we've got a ways to go.

Operator

Next question comes from the line of Judd Bailey with Jefferies & Company.

Judson Bailey - Jefferies & Company, Inc.

First, a follow-up. Gary, I apologize that I missed this, but did you give any fourth quarter cost guidance, or just third quarter?

Gary Krenek

Just third quarter.

Judson Bailey - Jefferies & Company, Inc.

Okay. Directionally, should we think about that as a similar level? Is there any reason it would go down or up meaningfully from that third quarter level?

Gary Krenek

Meaningfully, no. We'll have rigs filling the shipyards to survey incurring those costs and everything else. So I'm not going to make or give any type of guidance. But nothing meaningful up or down.

Judson Bailey - Jefferies & Company, Inc.

Okay, that's fair. And my follow-up is on kind of some of your deepwater rigs, like the Valiant, which picked up the contract in West Africa. Can you give a little more color on what you're seeing in that market? It seems like rates have perked up a little bit there. Are you seeing any more term contract opportunities? Or is it still predominantly kind of more well-to-well-type stuff?

Michael Acuff

Yes, Judd. On West Africa, we're really positive on that market. We're seeing, starting to extend on the term a bit. We're starting to see some 1-, 2-year terms. We're definitely seeing some 6-month opportunities out there. So we believe it's a positive market, and we continue to see that the next few years as we see it today. So we're excited about the position of the Valiant. The Confidence has had a lot of inquiries also while it's over there. So, in general, everything is positive in West Africa at the moment.

Judson Bailey - Jefferies & Company, Inc.

Okay. And is timing more of an issue now for operators? Are they willing to pay a premium to get that type of rig today because there's maybe not other rigs available? They're willing to pay up to get something more immediate now? Is that what's going on?

Michael Acuff

I think we're seeing of that. That's true. Because like you say, the availability is just not -- there’s not as much of a surplus as in other markets. So yes, that would be a true statement in certain situations.

Operator

The next question comes from the line of Geoff Kieburtz with Weeden.

Geoff Kieburtz - Weeden & Co., LP

You noted at the outset that the rapid pace at which you added backlog, do you attach significance to that? Is that indicative of a general trend in the market? Or is this just coincidence that a bunch of discussions kind of came to fruition at the same time?

Lawrence Dickerson

Well, in the subsequent 10-day period, we didn't add to this [ph]. So I don’t think you can trend it out. But it seemed to sort of come together but there was a general theme there of people looking forward and having to grab capacity. Mexico's got issues with declining production, everybody knows about that. They've been going through a couple of years of bid processes, where they've not been getting the equipment that they need. So I would say there's that common theme with down in Brazil where huge, not decline, but huge anticipated upswings in available prospects to be developed. And it means that Petrobras needs to secure continued rigs to go down there, and this was, I think, a pretty good indication of that. And with Petrobras, they're looking by extending existing 2-year contracts that we're not even one year into, in the case of new build Valor. That really -- that shows some advanced planning more so than I think we were seeing down in Mexico. And then OGX, at the same time, I think it's more of the same. OGX is a little bit looking -- dealing with stuff a little bit closer to what's going on just because of the size of their company versus Petrobras. But so I think all those common themes come together. But we didn't finish it saying, "Oh, boy, wait for the next 20 days."

Geoff Kieburtz - Weeden & Co., LP

And I understand that what you're saying. I guess my follow-up question is has this rapid pace of fixtures and extensions and so on had any noticeable effect on your conversations with other customers in other parts of the road? Or is it too early to really make any judgment on that?

Michael Acuff

Geoff, it's Michael here. I believe, what we're seeing and the pace has been in the recent quarter or the activity in the recent quarter is people are really starting to position themselves for '12 and '13. We're seeing that, more inquiries. And it seems you can -- it's a noticeable pickup to where, especially in deepwater, we're seeing everyone trying to make sure they have the capacity they need come next year and looking out in the '13. So I think in general, the theme is that though this flurry happened here in Brazil and in Mexico, there's still everyone still positioning themselves, and we're seeing an increase there.

Geoff Kieburtz - Weeden & Co., LP

Okay. And if I could shift it to the downtime, Larry. I think you mentioned you were quite pleased with the unplanned downtime performance in the first and second quarter. Is that the result of any specific program or initiatives that have been put in place prior to that? Do you have a sense that, that can be sustained kind of consistently going forward?

Lawrence Dickerson

Well, we have -- we didn’t just flip the switch and put something in place. We've got a number of preventive maintenance programs and programs designed to concentrate, replace BOP parts when we get an opportunity and those kind of things, all of which is designed to reduce downtime. So I would say it's just incremental improvements in those programs. And I'm comfortable that we've got good programs going forward. I would not bet that we could continue to sustain this. We talked earlier on the call about the issue of increased scrutiny on BOPs, and control systems around that will naturally result in a little bit more downtime there.

Geoff Kieburtz - Weeden & Co., LP

Okay. All right. So the net effect is it the greater scrutiny is almost certainly going to cost more unplanned downtime?

Lawrence Dickerson

Than you would have had without that. But we're not just sitting there taking it. We've got all kind of steps involved, upping our spares, we're putting dual stacks on the new drillships that we've got out there, which should reduce that.

Operator

The next question comes from the line of John Lawrence with Tudor, Pickering.

John Lawrence - Tudor, Pickering, Holt & Co. Securities, Inc.

Just given the backlog growth we've seen and the fact that 2 of the 3 new builds are on contract, any appetite for additional new builds?

Lawrence Dickerson

We think that continuing to add to our fleet via new builds makes a lot of sense. That is we had purchased new builds, as everybody knows, back in '09, Courage and Valor, and we shifted into the contracting with the shipyards. But I can't say that we have a plan that will yield x number within so much time. But we continue to evaluate it, evaluate the use the cash, look at our contractual situation. We were very, very pleased with being able to put 2 units on long-term contract this early. And I think that certainly improves our outlook, as you indicated in there, but we're not at a point of saying…

John Lawrence - Tudor, Pickering, Holt & Co. Securities, Inc.

Okay. And then just maybe along those same lines. As far as committing capital to Epoch now that you have the backlog there, is there any kind of commitment there also? Or should it remain stacked?

Lawrence Dickerson

The Epoch -- the Epoch, I'm sorry, the rig. We haven't made a decision on Epoch. We've got 4 floaters that are idle, 2 in the Gulf of Mexico, 2 in the Far East. But we are looking at those, and we continue to look at those on some sort of upgrade plan and return to service for those rigs. They had reached the point that there was going to be substantial amount of money put into them, and we weren't quite sure where the market was heading with everything overhanging it. For the 2 in the Gulf of Mexico, you've got the permitting problems that cover those. But those are -- that is an asset in an upside that exists within this company. As you mentioned, the Epoch or the Bounty being upgraded and coming out right because they’re next door to Singapore, where you would naturally do that. And then the Voyager and New Era in the Gulf of Mexico would also be candidates.

John Lawrence - Tudor, Pickering, Holt & Co. Securities, Inc.

Okay. And then just last question, just on the 4 Brazil extensions, any material CapEx associated with those?

Lawrence Dickerson

No.

Operator

Your next question comes from the line of Chris Wicklund with Wells Fargo Securities.

Matthew Conlan - Wells Fargo Securities, LLC

It's actually Matt Conlan here. In Brazil, the OGX extensions, you've reported $20,000 to $30,000 bump but -- to the prior disclosed rates of 2012. But the rate bumps also took place for 2012. So am I reading this right that we can sort of infer there's been a $40,000 to $50,000 dayrate increase projection for the 2013 term?

Michael Acuff

Yes, I think as you blend the rates and see the projection, Matt, that's correct.

Matthew Conlan - Wells Fargo Securities, LLC

Okay, that's pretty encouraging.

Michael Acuff

Let's clarify. Say your question one more time. Let's clarify and make sure we're speaking on the same thing.

Matthew Conlan - Wells Fargo Securities, LLC

Sure. So the Star and the Quest not only got $20,000 to $30,000 dayrate bumps for 2013, but also for 2012 versus what the contracts were previously stated out on previous fleet status reports?

Lawrence Dickerson

Okay, well, at the same time, we took a rig, the Lexington, working for OGX, which was at a previously established a market rate in the $300,000s, which is difficult above market today. So we lowered that, moved some time onto the Quest and Star. So -- and that's the way accounting works. You’ve got to average all that data, but the economics of the deal was that we did receive -- this Quest and Star. But that we did receive an increase on the Star. But other than that, everything was revenue neutral.

Matthew Conlan - Wells Fargo Securities, LLC

Okay, great. That's helpful. And just an accounting question. On the $475 million of long-term deposit on new builds, are you able to capitalize interest against that?

Gary Krenek

No.

Operator

The next question comes from the line of Arun Jayaram with Crédit Suisse.

Arun Jayaram - Crédit Suisse AG

Larry, I wanted to get your color on what you're seeing at the PEMEX. Obviously, PEMEX, at a time when the jack-up market was less robust, was attempting to try to upgrade the capabilities of their fleet. And obviously, given the improvement in the jack-up market, we haven't seen a lot of bid activity. Hence, they face a pretty large deficit in terms of demand. Do you see any opportunities -- obviously, you have 4 stacked rigs in the Gulf of Mexico for them to switch tact [ph] then and maybe go down market? And maybe look at mat rigs again? Obviously, with the accident a few years ago, I'm not sure if that's possible. I'm just trying to see if you could give us a sense of what PEMEX may do, given the fact they’re unlikely to meet their demand requirements, on the jack-up side?

Lawrence Dickerson

Well, the movement today has been from -- their initial desire was for newer rigs. And I'm not sure they’ve moved that much down market. They're now seeking older 300-, 350-foot rigs that will do their work and substitute for that. I don't think mat rigs, from a water-depth capacity, from a hook load capacity, from all the other limitations that exist from there are their preferred assets. And we're certainly not counting on the mats suddenly having a renaissance and going down to Mexico.

Arun Jayaram - Crédit Suisse AG

Fair enough. Switching gears, Larry, obviously, you have a lot of backlog earnings. In Brazil, they have a tender out, that again, will look at more rigs. What is your thoughts on assessing the potential of adding more rigs into Brazil? Or is there a saturation point where just from an overall portfolio standpoint, where you wouldn't want to get much bigger -- the old putting all your eggs into one basket? Just given your -- just want to get your color on that.

Lawrence Dickerson

Well, we got one rig coming out. Then we would certainly, I think, have room for another one. I can't rule that out, obviously. It's a big active market. We're a big participant there with 2 big customers. And we would like to -- it's a market we're comfortable with. We'd like to add rigs there, and we're not going to rule that out, but you're right, in the back of your mind. Our goal has always been to spread our rigs around the world with a number of customers just so that we're diversified from any of the risk that might come to one customer or to one region.

Operator

The next question comes from the line of Scott Burk with Canaccord.

G. Scott Burk - Canaccord Genuity

I just want to follow up on the backlog discussion that you had. Is there any kind of plans for that? Specifically, if -- are you trying to make sure you got funding for all your new builds or do you have additional plans to maybe order some other rigs or maybe increase the dividend? What are your thoughts there?

Lawrence Dickerson

I think backlog is a milepost that people should be interested in, in this business. It shows how much your earnings can go forward, and it does have a dividend component. But there's no overt signal as to what's going to happen with dividends just because we're adding the backlog.

G. Scott Burk - Canaccord Genuity

Okay. I wanted also to follow up on the rigs that you have stacked. Exactly how much capital would be needed to bring those back, or maybe if you could give a range for the 8 rigs?

Lawrence Dickerson

It varies. The Ocean Bounty, it went down, has some engine issues, so that one’s on the higher side. It all depends on what we want to come out of it with. We don't necessarily want to come out with a 3,000-foot unit. We may want to have a 5,000-foot unit at which [ph] timing brings it up. Other rigs that we stacked, the Ocean Spartan here in the Gulf of Mexico, due to permit issues, and it just really needs a special survey. So you're going to be on the low end on something like that. And everything else is in between.

G. Scott Burk - Canaccord Genuity

Okay. But nothing that would be prohibitive to actually bring these out within a few months, if needed, I guess, except maybe the Bounty?

Lawrence Dickerson

Well, again, it depends on -- if the market says, yes, I want 2,000-foot rigs and I want to pay $300,000 a day for them, then we can get those out pretty well. But I suspect many of these rigs, we would like to improve them. We're going to enhance their lives. And so we'll do more than just the minimum. And then we'd like some enhanced capabilities, which also, it's time and money.

G. Scott Burk - Canaccord Genuity

Okay. And the one kind of question a little more broad. Day rates seem to be stabilizing for most rig classes, especially for premium rigs, and rates seem to be actually trending up a bit. But if you look at overall operating margins for the space, they’re still significantly above some of the other oil services segments. Where do you see the risk of potential margin compression for the sector coming from? Either from increased supply or more of a potential for increased OpEx? Or how do you see that trending over a multiyear period?

Lawrence Dickerson

Yes.

G. Scott Burk - Canaccord Genuity

Yes?

Lawrence Dickerson

If supply outstrips demand, that's a fundamental of this business, we do see cost pressures, particularly on labor and on some equipment. I don't think it's gotten out of size. I mean, as you point out, rigs that are mid-water fleet, working in the North Sea, that we're renewing in the low to mid-200s, I mean, our operating costs are such that we're still enjoying a 50% to 60% margin. So it is a profitable business from that perspective. It's not necessarily that profitable if you have to go out and replace all the fleet at new construction costs. Then you would be for a lot of that. So we think shareholders earn money by having rigs, investing in a company that has a fleet of rig that they previously acquired.

Operator

Your next question comes from the line of Mike Urban with Deutsche Bank.

Michael Urban - Deutsche Bank AG

You'd commented earlier that it might make some good sense to continue adding new builds to the fleet, given the broader renewal of the fleet industry-wide that we’re seeing with -- in recognizing their -- or some constraints there in terms of price, your availability and so on, but would you view this investment on your part as an ongoing item, an ongoing capital item, or just continuing to be more opportunistic and subject to what you're seeing in the market and from your own backlog standpoint?

Lawrence Dickerson

We only invest when we think it makes sense. So we would not be in a program that says we're going to build 2 rigs a year for the next 20 years because I know market conditions will change. It'll be really based upon all the alternatives that we're looking at.

Michael Urban - Deutsche Bank AG

Right. And then from a capital structure standpoint, the cash flow situation looks pretty good here in the relatively near-term, certainly next, say, 12, 18 months, and you have added some backup here. But capital commitments do jump up a good bit as you get further out. Are you thinking about managing things proactively there, and in terms of either building cash, taking on some debt, or is it still too early to say and you'd have to wait to see how the market would develop from a cash flow perspective?

Lawrence Dickerson

We do plan our cash needs, and we'll look at them. I mean, right now, we're continuing to generate cash even after paying the deposits and continuing to pay our dividends, and we're in a nice cash position. And because you earn nothing on your cash, we don't really see a need for us to rush out and borrow money at this particular point in time. But we will handle that. I think, Les, we have time for one more question.

Operator

The next question comes from the line of Darren Gacicia with Vertical Research.

Darren Gacicia - Morgan Stanley

Two things. First, it seems to me that there's a lot of sort of potential demand out there for '12 and '13. And you go into the second half of 2011 and you'll get a lot of the operators starting to work through their budgets. Is that -- do you think that could be a catalyst to see maybe more projects come to the front and possibly improve the near-term outlook? Because it seems like you're optimistic, but sort of cautious at this point. And I'm just trying to see if there's a transference or a catalyst in here in the second half of the year?

Morrison Plaisance

We're optimistic but cautious. We're seeking -- we're seeing operators looking at their projects as we spoke about earlier, West Africa, we've seen increases there. We're seeing Australasia good inquiries, good projects coming up with medium-term to long-term prospects. And we're moving the Ocean Monarch to that market. So I think we're in good shape. This business is very fickle. We all know that. We’ve been around a long time. Plan for some upside, but always keep looking at the downside.

Darren Gacicia - Morgan Stanley

But do you think that there is a potential catalyst as people maybe -- because in an aggregate, as you have more people looking at their budgets and pushing more projects, like basically pushing them forward, as everybody starts to realize that happening, that may create a catalyst here. I mean, what you think the probability of that happening is?

Lawrence Dickerson

I'm not going to give projections on that. But I mean, there's a natural trend in the business that rigs return to work for a little bit more term that leads to opportunities to raise rates. And then, as you say, then there's a catalyst that will some time occur and make things really explode. Among the catalyst is probably what you're saying, the sense from the operators that there's not going to be enough rigs to cover their needs certainly until some of the new builds arrive, and maybe not even then because a lot of the deepwater activity continues to generate demand from more rigs. You've got catalyst and Mexico's begins to take, and I know they're primarily in the jack-up stage. But still, that could contribute, sucking rigs out of there. If Brazil moves, and then the Gulf of Mexico, if the permitting situation returns, that would be huge. The point I make again and again, which is not really relevant on this call, but that we, in this country, we’ve got 9% unemployment and this industry has the ability to employ lots of people here in the United States without subsidy and paying among the highest blue-collar wages that are out there in the world. Our average rate in the Gulf of Mexico back when we had a number of rigs working out there is above $80,000 a day for a job where you have 6 months off. So maybe somebody will finally decide that, that's some positive step that they can take. So lots of positive catalysts that could come about.

Darren Gacicia - Morgan Stanley

Okay. And so the secondarily, it seems like there's a lot of index options in the market and the rest, and it seems like the average cost of the marginal new builds is probably going up because some of the incentives from the shipyards have come off. Does that start to make that option less attractive? And maybe, as you look at free cash flow, make dividends more attractive going forward?

Lawrence Dickerson

I'm not sure I followed everything that you said. But you’re talking about indexed options at shipyards to build rigs?

Darren Gacicia - Morgan Stanley

Well, I'm just saying the cost of new builds seems to be rising, not falling. Right? And so if you've sort of take a counter-cyclical approach in getting things at a good price, I would imagine that the margin that makes new builds less attractive and dividends more attractive. Am I thinking about that the right way?

Lawrence Dickerson

Yes, I mean if the direction moves that the cost of new builds goes up, then it would. You’d a lower return than we would perhaps seek. But other market conditions change. So the cost of new builds has gone up, but it certainly hasn't skyrocketed. And it’s much less than it was at the peak of the market when it was over $700 million, $800 million so.

Again, thank you for all the good questions. We had a broad range of financial market-driven questions this quarter. And hopefully, we were able to answer them. We will talk to you next quarter and at a couple of conferences between now and then. Thank you.

Operator

Thank you, ladies and gentlemen, for joining today's conference call. You may now disconnect.

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