Seadrill Partners' (SDLP) CEO Mark Morris on Q1 2016 Results - Earnings Call Transcript

| About: Seadrill Partners, (SDLP)

Seadrill Partners LLC (NYSE:SDLP)

Q1 2016 Earnings Conference Call

May 26, 2016 01:15 PM ET

Executives

Mark Morris - CEO

John Roche - CFO

David Sneddon - CAO

Analysts

Lucas Dahl - ABG

Heath Christensen - Eaton Vance

Operator

Good afternoon, and welcome to the Seadrill Partners First Quarter Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there'll be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Mark Morris, CEO. Please go ahead.

Mark Morris

Thank you. And good afternoon, good evening to you all. Welcome to Seadrill Partners quarter one earnings call. With me today, I have John Roche, our CFO, and David Sneddon, our Chief Accounting Officer.

Before we get started, I'd like to remind everyone that much of the discussion today will not be based on historical facts, but rather consists of forward-looking statements that are subject to uncertainty. Included on Page 2 of the presentation is a comprehensive list covering forward-looking statements. For additional information, and to view our SEC filings, please visit our website at www.seadrillpartners.com.

Moving onto the agenda, I will cover the main financial and commercial highlights and then hand over to John, who will provide some market commentary and cover this quarter's financial performance in more detail. And then we'll open up for Q&A.

So, summarizing the quarter, operating performance was strong, achieving 99% economic utilization. Our cost production programs are yielding benefits quicker than expected which combines with a good operating performance has led to better than expected earnings for the period. We had a full quarter of operations on the West Vencedor and a day rate reduction on the West Polaris. Subsequent to the quarter end, we've received an early termination notice, the West Capella and will receive a $125 million in termination fees.

Additionally, the West Capricorn was placed on a 30-day extended standby rate at 60% of day rate, as we discuss long term options with the operator. You'll recall we announced amendments to three of our secured credit facilities that have both Seadrill Limited and Seadrill Partners as guarantors. This forms part of a broader package of measures being undertaken by Seadrill Limited, our largest shareholder, and its banking group. We have consented to the amendments on the grounds that they are beneficial to Seadrill Partners. Seadrill Partners involvement in Seadrill Limited's financing plan will be limited to the three facilities where there is crossover.

Now turning to backlog and utilization, our order backlog stands at 3.6 billion, with an average contract duration of 2.2 years and record matching economic utilization.

With that I will hand over to John who will take you through our financial performance.

John Roche

Thanks Mark. Before I cover our first quarter financials, I would like to make some brief comments about the overall market. The offshore drilling market remains challenging. The focus for many of our customers continues to be balancing the books with respect to revenue and planned capital expenditures. Lack of near term planned activity from oil companies, a significant overhang of contracted rigs for which no scope -- no work scope currently exists and continued efforts to reduce current spending continue to several affect demand and encourage renegotiations and in some cases terminations.

While the market is expected to remain challenging for some time to come, there are a few indicators that leave us optimistic on the longer term. First, there's growing evidence that oil markets are becoming more balanced and may move inter-balanced as the year progresses and into 2017. This view is supported by the effect that short term supply disruptions are having on oil prices and by narrowing of OpEx spare capacity. Additionally, the significant and sustained reduction in drilling activity during this downturn it's having a production effect both in terms of increased decline rates on existing fields and delays in new productions being brought online. Ultimately these will need to be overcome through increased drilling in the future.

Finally, the sustained downturn continues to encourage the cold stacking and scrapping activity that is needed to rebalance the drilling market, although there's a significant overhang of available units, this trend is encouraging. At this point of the cycle it's difficult to predict the ultimate timing of a balanced oil market or drilling market. What we do know is that with a premium fleet, long term contracts and continued demonstrations of excellent operations Seadrill Partners as well placed for the future.

Now I would like to move on to some of the main movements for the quarter. In terms of volume, we had no acquisitions of drilling units during the period, however the West Vencedor was operating for a full quarter resulting in an increase in both revenue and EBITDA. Looking at day rates, the decline in revenue seen in the chart above relates to the daily rate reduction on the West Polaris, you’ll recall that we acquired this rig from Seadrill based on the day rate $450,000 per day and any day rate above this level is paid to Seadrill in the form of deferred consideration therefore has no EBITDA impact.

In terms of utilization, utilization was broadly in line with last quarter, however we achieved lower bonuses. Often times bonuses are not only linked to utilization and can be driven by other performance metrics relating to maintenance or time spent between wells. As we guided in our last call the bonus was achieved in the fourth quarter were rather unique and were not expected to be repeated this quarter.

Moving to costs, our cost basis improved quarter over quarter that resulted in a $12 million improvement in our EBITDA this is primarily driven by reduction in operating expenses and overhead as we realize the benefits of our cost savings programs. We recently expected to see the benefits of these cost savings initiatives in the second quarter and beyond and we’re pleased that they have been realized earlier than expected, this was a big driver of our better than expected results for this quarter.

Moving to net income, looking at some of the main movements in net income the key items were in our interest rate hedge book and tax. In terms of our hedge book we use interest rate swaps to fix the rate of our floating rate debt and manage our interest rate risk. As a result of falling interest rates in the period we incurred a loss of 69.7 million compared to a gain of 19.2 million in the prior period. The realized cash portion of this quarter’s loss was 12.2 million and a non-cash element was 57.5 million.

Looking at taxes. You will see that the overall effective tax rate is 34% because this is calculated on profit before tax which is influenced by financial items, this rate is significantly higher than rate based on operating profit which is 21% for the period. The sequential increase reflects there being a higher proportion of profits to earned jurisdictions with a higher tax rate as well as provisions taken for uncertain tax positions in certain regions. Therefore net income for the quarter was 73.2 million and after adjusting for income to non-controlling interest was 36.1 million. Looking now at our balance sheet for the period. The only material changes relate to increase in our cash balance and normal working capital movements.

I will move on to our guidance for the second quarter. Second quarter adjusted EBITDA is expected to be in excess of 320 million. We expect the West Capella termination payment to be partly offset by reduction in the West Capricorn day rate. And just a point of clarity in exactly what we’re guiding here. This is adjusted for cash EBITDA and we therefore include the lump sum termination payment on the West Capella in this figure. From a reported earnings perspective, this payment will be recognized as having been earned over the remaining contract term and the lump sum is therefore excluded.

As far as our plans for the West Capella, we expect it will spent some time Tenerife while being marketed for new work. We expect operating costs to be in the region of $60,000 to $70,000 a day in the very near term as we evaluate these opportunities. Beyond that costs will be determined by the rigs operating or idle status. As far as the Capricorn is concerned following being put on extended stand by rate the OpEx for the West Capricorn will be at a similar level for the West Capella roughly $60,000 to $70,000 a day as the operator evaluates its future drilling needs. We will update you all as and when we have reached the commercial agreement with the operator.

And with that I would like to turn over to our operator to open up for Q&A.

Question-and-Answer Session

Operator

We will now begin the question answer session. [Operator Instructions] The first question comes from Hillary [indiscernible] of Wells Fargo Please go ahead.

Unidentified Analyst

So first just on the West Capricorn, would you be entitled to an early termination fee, should this charterer decide that there is no need for the rig?

John Roche

Yes we would, I think what you can read into this extended stand by rate if you will, just a little bit of background there, in February we began -- the operator began looking at its current work program for the rig and there wasn’t too much in there in their current budget, so it went down to 98% of day rate. As we entered into a negotiation period since it was on an extended rate and based on the contract terms it dropped down to 60%. I am not going to get into exactly what the terminated rate is as we are in the middle of commercial discussions, but you can expect there to be a termination payment if it is in fact terminated. I stress, we’re not there yet though.

Unidentified Analyst

Okay, great. That’s good to know. And then just on the -- there is -- you guys had a $109.5 million vendor financing loan which I think is due this quarter, was that paid down or was that extended?

John Roche

No, it was due at the beginning of this month and it has been paid.

Unidentified Analyst

It has been paid down, okay. And then just quickly on the amended covenants, I noticed the language refers to Seadrill Ltd. not Seadrill Partners, so the new -- like the new ratios and everything just applies to Seadrill, not Seadrill Partners? You don’t have to comply with any of the new ratios, it doesn’t apply to you?

John Roche

That’s correct. These are Seadrill covenants and as you know there is 3 of our credit facilities where both Seadrill Limited and Seadrill Partners are guarantors, this is why we are asked to agree to this amendment. In our opinion, it absolutely makes sense for procedural, it actually benefits both parties as Seadrill Limited advances its more broad financing plans and in terms of milestones and any other restrictions, those do not apply to Seadrill Partners, just o Seadrill.

Unidentified Analyst

Okay, great got it. Thanks for taking my questions John thank you.

Operator

The next question comes from the Andrew [indiscernible]. Please go ahead.

Unidentified Analyst

Alright, thanks for taking my questions. Appreciate the comments around the West Capricorn. Can you offer any color as to when you think the negotiations maybe complete, is that something we should look for on the next call or do you think it will be concluded prior to that?

Mark Morris

Andrew, it’s always tough to put a timeframe around commercial discussions. I think both us and the operator are incentivized to reach a conclusion at some point. From our standpoint we want to understand what type of cost we should be incurring on the rig and I’m not talking about investments, I’m talking about CapEx and I think -- pardon me I’m talking about OpEx and I think the operator is simply incentivized because they need to put something in their budget. But again very hard to put a timeframe around that.

Unidentified Analyst

Okay, alright. And then just on the cost side obviously nice cost improvement here over the quarter. Any color as to should we expect similar type improvement in the next quarter here or how should we think about the cost going forward?

Mark Morris

Well I think you’ve seen a big step down Q4 to Q1. There will be incremental improvements through the year I am not sure if you listened in on Seadrill Limited’s conference call, but Seadrill Limited who operates our rig is our largest shareholder indicated that for the group they were looking at about 30 million in additional cost savings. As a rough estimate, if you portion that roughly pro rata based on percentage of revenue between the 3 companies, you’re going to get about the answer.

So there is some room for improvement but I wouldn’t expect a big step down that you saw recently. Going into year-end we really had a big -- for that matter throughout 2015 really had a big efficiency drive and the first step of those programs generally gets a lot of the low hanging fruit and subsequent steps are going to be -- are probably going to be slightly lesser.

Operator

The next question comes from Lucas Dahl of ABG. Please go ahead.

Lucas Dahl

First question is again on Capricorn, but just to understand, you went from the standby of 98% to an extended standby of 60% of day rate. Is that feature included in other contract that you have or is that the result of the Capricorn contract being renegotiated just a few years back?

Mark Morris

So Lucas, as you know every contract is unique. It was not a feature of the contract swap with a serious or any renegotiation, but there was an amendment in the contract to negotiate a new term which is extended standby. So it’s really not a usual feature. I think really how we look at it, by giving a customer 30 days in a negotiation period, it’s not effecting us in terms of the slope from operating to stacking, whether it’s warm or cold it doesn’t matter because in the first step what we can do is we can de-man the rig, take OpEx from let’s just say that the mid-100s down to roughly 60 or 70, but there is a point where we need to say okay, if things are going too long then we'll occur additional cost and that's when we say that it doesn't make commercial sense for us. So, it's not going to impact our margins dropping down to 60% for 30 days and frankly it gives us more time to reach a conclusion. And discussions are ongoing, we wouldn’t have done this if they weren't ongoing, it's a good customer and we would like to see this rig continue with its employment.

Lucas Dahl

Okay. So, am I understanding it correctly that you have a 30 day period and after that you are going to have a decision, either going back or striking some kind of deal, it's not going -- they are not able to put you on an extended standby rate for a year.

John Roche

No, no, this was 30 day period after 30 day period the contract, the rig goes back up to the old contracted rate.

Lucas Dahl

Okay, thanks. And then on Capella, you said that’s going to be in Spain for a while, but are inclined towards longer term contracts, when it comes to new work or would you sort of pickup anything along the way, just to have in working, what are your thoughts on that?

John Roche

Yes, I think any job that we're evaluating has to make commercial sense and look I think our preference at the moment is not to lock in to a long-term rates at these levels. I don't think that makes a lot of sense and to be frank there is not a whole lot of long-term work being offered at the moment, but that -- don't read into that, there is work to be had, it just happens to be short-term.

And so I think, this is a 2008 field drill ship, one of the better available rigs on the market, we think it's well positioned to potentially win some short-term work, to the extend we can successfully conclude that work and we can evaluate the terms and if it make sense at the rate and to the extent that we don’t than we need to consider what level of warmer or lukewarm cold stack to go towards.

Lucas Dahl

Okay and just finally on the overall cost savings within the Seadrill Group, I mean Seadrill Partners is about a third of the group's revenue, is that sort of a way how to look at the OpEx reductions going forward as well?

Mark Morris

Lucas, you have to be a little bit careful about because some of the cost savings are going to be driven on idle rigs, the cost of cold stocking going down at Seadrill. If you look at the change in operating cost, percentage change that is at Seadrill versus the percentage change of Partners, you will see that Partners' OpEx went down by roughly half and you will see in Seadrill report half of that cost savings -- the operating cost saving was due to idle units, or cost savings on idle units. So I think, a third is probably a little bit too reach to a portion to Partners.

Operator

[Operator Instructions] Next question comes from Stan Genter [ph] of HSBC. Please go ahead.

Unidentified Analyst

I have three questions, so my first question is, could you please let us know how much of distributions both to common units and non-controlling interest, would you expect to come out of Seadrill Partners this year?

John Roche

I think you can look at the silhouettes [ph] that have been over the last couple of quarters and assume that consistent.

Unidentified Analyst

Okay, thanks and then just a follow up to that, would you consider decreasing distributions if any of the fleet which is coming potentially off contract or is going to be canceled, is not being re-contracted?

Mark Morris

I think, we'll have to take into account every quarter when we look at it, and as we sit here today, we weigh up a number of options and thoughts, where we see prospects and above all making sure that we have sufficient cash within the Seadrill Partners too, services needs as it goes forward. So I don't think we have any current plans to change it, but like all these things if more rigs were to come off contract then we would have to look at it. And of course for two that are coming off or in the case of Capella and we will be looking for work for it and depending on how some of those commercial negotiations go that will be factored into the thought process as well.

Unidentified Analyst

Okay, thank you. My other question is, you mentioned that there is going to be three facilities which are effectively guarantors under Limited are going to be the only ones involved in the refinancing exercise, I guess currently ongoing at Limited. Do you mean that they are the only facilities which could potentially consider -- be considered for extension or for some sort of like a restructuring, which is what obviously people are expecting at Limited and the rest of the facilities at Partners are not expected to be impacted. Is that what you mean when you talk about only these three facilities that are going to be subject to the refinancing?

Mark Morris

Yes. That’s correct. Let me just -- let’s go back a little bits. What you’ve got with those three facilities are an effect as rigs were sold from Seadrill Limited to Seadrill Partners. A number of them were in existing facilities and affected that element of the facility sort of when with the rig and the rig earning entities. So when at a Seadrill Limited level, they’re looking at refinancing. Obviously rigs that sit within the same facility will be impacted in the same way. So those facilities, the three facility we talk about specific bank based facilities, primarily in relation to the Vela, the Polaris for ’15 and ’16 and they will, from our perspective, from Seadrill Partners perspective and to the extent there are extensions and amended terms, they will benefits from that. But in relation to TLB or any other parts of Seadrill Partners, no.

What is in the scope from Seadrill Limited and of course, let’s not forget Seadrill Limited is our largest shareholder at SDLP. But also importantly it provides various services to Seadrill Partners. In looking to provide, as I call it a recovery, runway to the recovery, what it does in terms of adjusting its bank facilities will obviously benefit Seadrill Partners in relation to those three facilities. And obviously we will take this decision within Seadrill Partners as to whether we think they are appropriate for us to consent to.

Unidentified Analyst

Okay, thank you. And my final question is on West Vencedor. Would you given that its -- looks like it’s coming up for -- contracts coming to expiry toward sort of the second half of this year. Have you had any discussions or duration from potential extension?

Mark Morris

Yes. Look this is, in Southeast Asia, there is a lot of spot work, these tender rigs are primarily used for development projects. I know, I think this morning we put on our fleet status as July. I think there are a couple of wells beyond the current scopes, or maybe you see this going to August and of course we continue to actively market it for post any identifiable work that it’s on now.

Operator

Next question comes from Heath Christensen of Eaton Vance. Please go ahead.

Heath Christensen

If you could provide some color on the West Aquarius, I realize that’s ways out. But are you in renegotiation talks with the operator there?

Mark Morris

Look Heath, I think generally speaking we’re not going to comments on whether we’re in renegotiation conversations on any of our rigs. I think what you can assume is since the West Aquarius, this is one of our more near-term rig rollovers, we are absolutely trying to find extensions for it or market it for new work.

Heath Christensen

Got it. And any thoughts on that area that it’s in, that part of Canada?

Mark Morris

Look, there is some activity there. Obviously, you saw the West Hercules just on the Seadrill side, just get cancelled. They were quite close to each other. I think our initial instincts following the termination of that unit is that was probably a single operator events and less of a comment on the region. So I think it’s really hard to say at this point and in some of my prepared remarks I talked about operators really trying to solve for balancing the books rather than making pure economic decisions. And so it’s really tough to rank that ahead or behind any other regions, but certainly trying to do our best to keep that rig working.

Heath Christensen

Got it, that’s helpful. And then on the West Sirius, so what’s the status there? Is that being currently marketed, if you re-contract that rig at a rate less than 297, does the 297 go away, how are the prospects of that?

Mark Morris

So, first point is no, it is not being marketed. This rig was one of the earlier rigs to be terminated and we made the decision to get it down into a state of cold stack as quick as possible to preserve costs seeing that it was covered by a termination payment going out to mid ’17. Right now OpEx on that unit is below 10 a day and I think when looking at the current market it wouldn't make sense to incur the reactivation cost to get her back to work, but when it does make sense to bring her back, we will.

Heath Christensen

And sorry, to be clear on the 297, is that just the accounting treatment of the cancellation payment that you received or are you actually going to pay [indiscernible]?

Mark Morris

That's actually cash, yes. And I failed to answer the second part of your question. There's a feature in that contract, if you do get a rate above 297, then those payments we would seize, and you get something below and that is received overtime, both in cash and obviously according to the accounting treatment.

Heath Christensen

So, sorry to be clear, even though you could -- so, if you would have re-contract it today, let's say at 200, you would combine the receiving 500 a day on it, do you still think that's not economic, you'd rather keep it cold stacked?

John Roche

There's not really whole lot of 200 a day contracts at the moment, and don't forget the reactivation costs to put in there, which would be -- these are tough budgets at the moment to put a number on. But I suspect it will probably be in the neighborhood of $30 million to $40 million. Also remember once you do take a decision to put a rig cold, we'll also -- we'll be looking at some of our warm rigs for example, in 2017, for example the Aquarius which you just mentioned and the Capella as well to market in front of it.

Mark Morris

So, just to be clear, I think the question you said, would we get 200, plus 300? The answer is no we wouldn't. We would get the difference that got us to 300, just to be clear.

Heath Christensen

Okay got it.

John Roche

[Multiple Speakers] anything obviously above 300 and as long as the contracts are longer than the period it underwent, it would be terminated, we would obviously get the higher rate and it would fall away, and anything below, we get the difference to get it to 297.

Operator

This concludes our question-and-answer session. I would now like to turn the conference back over to John Roche for any closing remarks.

John Roche

Thanks everyone for joining us. And this concludes our first quarter earnings call. Thank you.

Operator

The conference has now concluded. Thank you all for attending today's presentation. You may now disconnect.

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