Seadrill Partners' (SDLP) CEO Mark Morris on Q3 2016 Results - Earnings Call Transcript

| About: Seadrill Partners, (SDLP)

Seadrill Partners (NYSE:SDLP)

Q3 2016 Earnings Conference Call

November 22, 2016 01:15 PM ET

Executives

Mark Morris - Chief Executive Officer

John Roche - Chief Financial Officer

David Sneddon - Chief Accounting Officer

Analysts

Hillary Cacanando - Wells Fargo

Jacob Ng - Morgan Stanley

Miles Barnett - HITE

Andrew Mees - Barings

Operator

Good afternoon, and welcome to the Seadrill Partners Third Quarter 2016 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 of Seadrill Partners. Please go ahead.

Mark Morris

Thank you. Good afternoon and welcome to Seadrill Partners third quarter 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 consist 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, operational performance was strong during the quarter at 95% economic utilization although slightly lower than the record quarter two performance at 99%. Our cost reduction programs continue to yield benefits and are proving to be sustainable. Operating costs for rigs in operations, including overhead on our floater fleet have reduced from approximately 200k per day in 2014 to 150k per day currently, a 26% reduction, and we expect to remain at these levels for 2017.

Otherwise, this has been relatively quiet quarter news wise with only the West Vencedor completing its contract with Petronas. Since the quarter end, the West Vencedor has been awarded a three wells contract with additional well based options providing incremental backlog of 16 million for the firm portion. As you aware on October 3rd, we received notice of Force Majeure from Tullow for the West Leo drilling contract. We dispute Tullow’s claim for Force Majeure. We believe, we have a very strong case based on the evidence provided and we’ve initiated litigation proceedings. And finally, we have maintained our quarterly distribution at $0.10 per share.

Now turning to backlog and utilization, our order backlog stands at 2.9 billion with an average contract duration of two years. The West Leo contract is assumed at full operating rate and represents approximately 355 million of backlog with duration of 1.6 years. Utilization is down slightly reflecting 16 days of unplanned downtime on the West Vela and 10 days on the West Polaris, both BOP related. Both units are now up and operating again.

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

John Roche

Thanks, Mark. Before I jump into our third quarter results, I’d like to make some brief comments about the market and the outlook for our available units. Our long-term view of the market for high specification drilling rigs is positive; however, in the near-term the business remains subdued. It is expected that upstream spending will again decline in 2017 same stage we had another challenging year with utilization likely getting worse before improving. However, we do see a pickup in activity.

Although it’s from a low base and a quiet competitive day rate, we are seeing a pick up nonetheless. The timing of the small improvement is opportune for us as we’ve managed to avoid much of the softness in the market due to our long-term contracts, and we now have two units available currently and two more becoming available next year. If you look at the chart on Page 7, you’ll see our contract profile and I’ll just move from top to bottom here to give some flavor on what we’re seeing.

Starting with the West Capella, this is one of our available units today, she is currently having an MPD unit installed and is being marketed for a number of opportunities. With this upgrade, we think she is one of the most competitive rigs in the market today. As Mark just referenced, we’ve signed a new contract for the West Vencedor. As mentioned on our last quarterly call, the market in Southeast Asia is quite active for tender [rates] [ph] and we see potential for follow-on work here, which is reflected in the options associated with this contract.

In terms of the West Aquarius which is becoming available in April of next year. We’re currently engaged in positive discussions around follow-on work in the region. This is certainly an improvement over what we could say in prior periods. On the other hand, the West Sirius, which is currently cold-stacked may be idle for some time. Generally, first rig stacked are the last back into service due to the reactivation costs and the day rate required to make the economics work. In hindsight, we believe we made the right decision to cold stack this unit based on the cost savings achieved thus far and the lack of work that has been offered over the last 18 months since she was terminated.

Looking into 2018, we also see some potential for direct continuation on the West Polaris. Now of course, this is a bit further out, but there are active discussions. The West Leo was of course a special situation given the ongoing litigation with Tullow and we’ll keep the market up-to-date on any material developments here.

Looking at the West Capricorn, we continue to expect her return to work in September, and we’ll know the outcomes of this in the coming months. Looking at the remainder of the fleet is on long-term contracts and operating well further enhancing our ability to withstand this downturn. So, as I hope you can gather, this market is seeing some activity which is stepped in the right direction. Taking into consideration, the degree of scraping we expect to see a small increase in demand could meaningfully tighten the market, and we believe this is matter of when rather than if.

Now, moving on to some of the main movements for the quarter, third quarter revenue was 385 million down about 8% from the second quarter. Adjusted or cash EBITDA was $313 million, a 10% increase over the second quarter. The main movements were related to the following. First, in terms of day rate changes, the West Capricorn has been on standby for a full quarter, resulting in a $7 million decline in both revenue and EBITDA. In terms of utilization as mentioned in our guidance last quarter, we have some operational challenges on the West Vela related to a BOP pull. We have estimated this to be about 20 days in our guidance however managed to limit it to 16 days of downtime.

We also had a few days of unplanned downtime on the West Polaris again related to BOP pull and this was related to 10 days. These were partially offset by improved performance across the fleet and by bonuses received for a net effect of $10 million decline in both revenue and EBITDA. In terms of idle use for the third quarter, the decrease in revenue is related to the recognition of the West Capella at early termination rate as this revenue is recognized over the remaining contract term.

Idle time on the West Vencedor is also picked up here for a total impact of $14 million decline in revenue due to idle units in the quarter. The positive impact to adjusted EBITDA reflects the receipt of the first installment of West Capella termination payment. The net effect of this payment reversing out the revenue recognized through the P&L and idle time in West Vencedor was a $35 million increase in adjusted EBITDA.

On the cost side, improvements in OpEx on the West Capricorn well on standby and on the West Capella and West Vencedor well idle contributed to about $12 million improvement in adjusted EBITDA. Additionally, we also had a small improvement on G&A for the quarter.

Now, looking at some of the main movements below the operating income line, the only real items of note here relate to our interest rate hedge book and tax. We have interest rate hedges in place against 94% of our debt outstanding which are mark-to-market quarterly. During the quarter, there was a gain on this mark-to-market valuation of $5.7 million compared to a loss of 28.3 million in the prior period. The cash element was an expense of 12 million for the period. Income tax expense for the period increased to 13.9 million versus 43.6 million in the prior period primarily due to provision taken during the prior period.

Now, moving to some of the main movements on the balance sheet, the significant items to note here is the increase in cash by about $295 million. This reflects cash generated in the quarter, receipt of $62 million West Capella termination payment and about $100 million in favorable working capital movements which we expect a good portion of to reverse during the fourth quarter. Other movements on the asset side of the ledger primarily relate to the normal depreciation of drilling units and amortization of intangible assets. On the liability and equity side, there were small movements related to normal quarterly amortization of debt, payment of deferred consideration and net income for the period.

Now moving out on to outlook for the fourth quarter, adjusted EBITDA is expected to be lower at around $230 million. This reflects the receipt of the West Capella termination payment in the third quarter while no payment is due in the fourth quarter. The West Vencedor is expected to have a full quarter of idle time prior to its expected contract commencement in the first quarter of 2017. We expect to have around 26 days of downtime on the West Auriga and West Vela during the quarter again related to BOP pulls. And finally something keep in mind, this guidance is based on the West Leo operating at full day rate for the fourth quarter. And as I referenced earlier, we will update the market as when material developments occur.

And with that, I’d like to turn over to the operator to open up for some Q&A.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Hillary Cacanando with Wells Fargo. Please go ahead.

Hillary Cacanando

My question, first question is regarding West Vencedor. It sounds like there are multiple options extending until September 2018. I was wondering, if you could provide more details as to how many options there are and timeframe or length of each option?

Mark Morris

Yes. So, these are well based options so typically wells in region take about 40 days to complete. So with nine options, we estimated this to be about a year of follow-on work after the firm period.

Hillary Cacanando

Okay. Got you. Okay, that makes sense. And then the other is on outlook in the press release you mentioned that you expect upstream spending to decline again in 2017. I was wondering, if you can provide a little more details as to detail any like a number, like a percentage decline or something, a little more color?

Mark Morris

Yes. Look, Hillary, I think we’re probably all reading the same EIA, IEA reports and this is probably something in the high-teens. But I think, look, we’re in the drilling business, we’re not prognosticators on oil price, but we are probably all reading the same thing.

Operator

The next question comes from Jacob Ng with Morgan Stanley. Please go ahead.

Jacob Ng

Hi, thank you. Just on West Leo's early termination, I guess firstly, were you able to reduce OpEx immediately after the notice from Tullow? And secondly, would it be possible to have you provide more color on the timeline as to how litigation could play out?

Mark Morris

Jacob, just for clarity, the unit hasn’t been terminated. We’ve received a notice of Force Majeure. We’ve disputed this Force Majeure based on the evidence that we’ve received thus far. So that’s where it stands. I think anything further commenting on ongoing litigation is probably a bit inappropriate. So, what we’ll do is leave it to market updates as material developments occur.

Jacob Ng

Okay, understood. And just on the housekeeping front, I wonder, how much incremental CapEx will be spent on the MPD upgrade for West Capella?

Mark Morris

I assume about $20 million.

Operator

[Operator Instruction] The next question comes from Miles Barnett with HITE. Please go ahead.

Miles Barnett

Hi, guys. Thanks for taking the question. I was hoping you could provide a framework on how we should think about distribution policy, be it leverage or coverage or what not moving forward, whether you’re going to grow again at some point or conversely have to cut deeper?

John Roche

Look, just as a matter of business, we review our distribution on a quarterly basis. Take into account any developments that occurred in the quarter and determine the appropriate level that we think is sustainable. In the second quarter we reduced our dividend to $0.10 a share based on the Capricorn going down to standby rate and the termination of West Capella. As it stands at the moment, I think this is a level that we are comfortable with as you saw a couple of weeks ago, we did decide to maintain that dividend level.

And I think as we gain further clarity on what our -- the work looks like for our available units and for our units becoming available next short year which I commented on our prepared remarks here, we’ll again make another determination. So, if these all get contracted I think we feel very comfortable where we are. I think in an improving market, we certainly look to grow the dividend again. But given the number of rollovers we have coming up and the number of available units, we need to see commercial discussions develop a bit more, and we’ll revisit it on a quarterly basis.

Miles Barnett

Okay, helpful. And then one final one, have you guys kicked around internally to all any sort of discussion of a simplification transaction like they did at Transocean or is that just completely off the table?

Mark Morris

Well, it's Mark talking here. Obviously, we’re aware of what Transocean is doing but we obviously we can’t commented on the specifics or the rationale as to what they are doing and only they can really provide that. But I guess as you are aware at the Seadrill level, we have our hands full in looking at the restructuring there. And SDLP, where it sits today liquidity wise and credit wise is an island that sits quite well. Also I think as we think about our returning market, the MLP vehicle provides a natural point for Seadrill to recycle its balance sheet whilst providing contracts with modern rigs and longer-term contracts as a potential upside. So, this shows also have we thought about it? Yes. Is it on the radar for something we’re going to do shortly? No. Will we think, continue to think about it over time? The answer is yes.

Miles Barnett

Okay.

John Roche

I’d just like to add to those comments. I mean a lot of this will be determined on where the market goes. Seadrill Partners is a distribution vehicle and frankly distribution growth vehicle. This is how we command a low yield and attractive cost of equity. If there is non-equity currency, I think we would need to think about the larger cost of maintain the vehicle, where it stands today looking at a yield in 11% to 12% range we’re close to having an equity currency. I think there is probably a bit of overhang from our parent's ongoing restructuring. And we need to look at the dividend level as sustainable and if the market forecast the ability to grow, you tend to see these yields becoming very tight and see an equity raising vehicle again.

Operator

The next question comes from Andrew Mees with Barings. Please go ahead.

Andrew Mees

Just on the West Capella, what’s the timeframe around the upgrade and then I think you’ve previously spoken some stronger opportunities for that one are those still playing is that 2017 type of that?

Mark Morris

Still unplanned, Andrew, the upgrades take about four to six months, I’m sorry to work over the summer so it should be completed towards the end of 2016. And yes, these opportunities are still moving along. As you can expect in this market, there is a mixture of short-term jobs. There is also a desire for summer operators to go longer at lower rates which maybe to appetizing. So, I think we try to do is really optimize what is the available work out there and what makes the most sense for this unit. But those conversations are still pointed in the right direction.

Andrew Mees

And then just take lastly or quickly. In line to the clarification you made a little bit ago and then the fact that it’s kind of built into guidance. Does that imply that you guys are still receiving payments from Tullow on the vessel?

Mark Morris

So what we’re receiving today is. First of all, the Force Majeure was declared in October. We disagreed with this, so in-voice based on what we think the rate should be operating at. We’ve not passed the payment cycle, so we don’t know what we’re going to receive. But that certainly going to form part of litigation proceedings going forward. So, it’s really just premature, it’s not reflection on what we think, it’s not an outlook, it’s more stay in the fact of where we are today.

Operator

[Operator Instructions] Showing no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to John Roche for any closing remarks.

John Roche

Thanks Gary and thanks for everyone on the line today. This concludes Seadrill Partners third quarter earnings call. Thank you.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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