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Ensco International Inc. (NYSE:ESV)

Q2 FY08 Earnings Call

July 24, 2008, 11:00 AM ET

Executives

Richard A. LeBlanc - VP of IR

Jay W. Swent - Sr. VP and CFO

Daniel W. Rabun - Chairman, President and CE

Analysts

Collin Gerry - Raymond James

Arun Jayaram - Credit Suisse

Pierre Conner - Capital One Southcoast

Thomas Curran - Wachovia

Jeff Spittel - Natixis Bleichroeder

Byron Pope - Tudor Pickering

Ian Macpherson - Simmons and Company

Michael Drickamer - Morgan Keegan

Daniel Boyd - Goldman Sachs

Sonny Randhawa - Banc of America Securities

Judson Bailey - Jefferies and Company

Operator

Good day everyone and welcome to the ENSCO International Second Quarter of 2008 Earnings Conference call. As a reminder, this call is being recorded and your participation constitutes consent to its taping.

I will now turn this conference over to Mr. Richard LeBlanc, Vice President of Investor Relations, who will moderate this call. Please go ahead sir.

Richard A. LeBlanc - Vice President of Investor Relations

Thank you, Chad. I'd like to welcome everyone to our conference call today. With me in Dallas are Dan Rabun, our Chief Executive Officer and Jay Swent, our Chief Financial Officer, as well as other members of our Executive Management team.

This morning we released our earnings announcement and we filed our 8-K with the SEC. We also expect to file our 10-Q a little later today. The earnings release is available on our website at www.enscous.com, where you'll also find a reconciliation of any non-GAAP financial measures that may be used on the call. As usual, we'll keep the call to about an hour. Jay will provide a financial overview. Dan will then discuss our markets and operations.

I'd like to remind everyone that any comments we make today about our expectations of future events are forward-looking statements pursuant to the Private Securities Litigation Reform Act of 1995. All such statements are subject to risk and uncertainties and many factors could cause actual results to differ materially. We refer you to our earnings release and SEC filings available on our website, which define such forward-looking statements, state that the Company undertakes no duty to update any such statement and risk factors that could cause actual results to differ materially from our expectations.

I'd also like to remind everyone, that with regard to our rig status, a detailed listing is provided on our website and it's updated the middle of each month, when we file our K with the SEC. The last update was as of July 15th. At the end of our prepared remarks we'll have some time for questions.

With that let me turn it over to Jay.

Jay W. Swent - Senior Vice President and Chief Financial Officer

Thank you, Richard. Good morning and thank you all for joining us today. We're pleased to report another record quarter with net income up 17% from prior year levels to $297 million and earnings per share up 20% to $2.07. Our year-over-year improvement reflects higher day rates for our international jackup fleet, improved utilization of our Gulf of Mexico jackup fleet, and significant day rate improvement on ENSCO 7500, our deepwater semi.

We repurchased 1.5 million shares during the quarter to a total cost of $108 million or an average price of $72.43 per share. From inception of the share repurchase program in March 2006 through second quarter 2008, we have repurchased 14.3 million shares at a cost of $790 million or an average of $55.06 per share.

As of yesterday, we have completed an additional $50 million of repurchases during July, which brings us or leaves us a $160 million remaining under our $1 billion share repurchase authorization. We continue to balance share repurchases with our growing deepwater investment.

The six deepwater semis that we have under construction will represent an investment of over $2.5 billion when completed in 2012. We believe that continued investment in our core business combined with share repurchases, will generate excellent long-term returns for our shareholders.

Let's look more closely at second quarter specifics. Here we will compare second quarter 2008 sequentially to first quarter...second quarter 2008 sequentially to first quarter 2008. Second quarter revenue increased by approximately 10% from first quarter levels, I'll review the details of the quarter-over-quarter improvement in just a moment when we discuss regional results.

Contract drilling expense increased to $214 million in the second quarter compared to $191 million last quarter, generally in line with the guidance given last quarter. As expected, labor costs represented over one third of this increase and the balance came from growth in repair and maintenance and mobilization expenses. As we explained last quarter, labor costs are up largely as a result of wage increases that were implemented late in the first quarter for many of our offshore personnel.

In addition, the weakening US dollar is negatively impacting certain payroll costs, as well as the cost of local purchases in a number of the countries in which we operate. Most of the repair and maintenance cost increases were incurred in our Asia Pacific jackup fleet, and this also resulted in reduced utilization in this region versus first quarter levels.

G&A expense and depreciation were generally in line with expectations with both slightly below our guidance for the quarter. Our second quarter effective tax-rate was approximately 19% slightly higher than the 18% guidance given last quarter, primarily due to stronger profits in our U.S. Gulf of Mexico operations that are taxed at a higher effective rate than our international Operations.

Now let's look more specifically at second quarter results in each of our major geographic markets. The average day rate for our Asia Pacific jackups was $152, 900 a 7% increase compared to the first quarter as we realize day rate increases from contract rollovers or cost escalation reimbursements on nearly three quarters of the Asia Pacific jackup rig fleet.

Asia Pacific jackup rig utilization was 91% down from the 97 % last quarter as we completed under water inspections on two rigs and we brought three rigs into a shipyard for scheduled repairs. The average day rate for our Europe/Africa fleet was $217, 700, an increase from the $213,100 average rate in the first quarter, as three rigs rolled to higher rates with existing customers.

Utilization in our Europe/Africa fleet was 97% this quarter down slightly from 99% in the first quarter and primarily due to a slight increase in repair activity. Day rates for our North and South America jackup rigs increased by 9% to an average of $97,800 in the second quarter compared to $89,400 in the first quarter.

North, South America jackup rig utilization improved significantly to 100% from 92% in the first quarter reflecting a market that has tightened considerably over the last several months. ENSCO 7500 work during the second quarter 2008 at an average day rate of $365,000 per day a 31% increase from the first quarter average. This rig commenced the year-to-day rate in the low 200's and reset to its current rate during February.

Let's now look or turn to the outlook for the third quarter 2008. We expect third quarter revenue to increase by approximately 5% from second quarter levels primarily due to higher day rates for our Gulf of Mexico jackups and higher rates on two of our Asia Pacific jackups and one of our North Sea jackups.

We anticipate third quarter contract drilling expense and G&A expense will be generally in line with second quarter actual results. I'll provide more detail on our outlook for contract drilling expense in a moment. Depreciation expense is expected to increase slightly to $50 million in the third quarter and we expect our effective tax rate to remain at approximately 19% consistent with the second quarter rate.

Now, a few comments on full year 2008, we expect continued earnings growth over the last two quarters of the year given the strength of our international backlog and the favorable outlook for the Gulf of Mexico jackup market. We indicated on last quarter's call that we expected a downward trend in contract drilling expense in the second half of 2008 as much of our inspection and repair work was front end loaded. We still anticipate a reduction in quarterly contract drilling expense versus second quarter levels but it will not be as dramatic as originally anticipated.

We now expect the full year increase in contract drilling expense versus 2007 to be in the range of 18% 20%, an increase from the 15% guidance given last quarter. More than one third of this guidance increase relates to higher mobilization and reimbursable costs that are directly recoverable from customers.

Another third of the increase is due to higher than anticipated repair costs. The balance of the increase is split between labor increases and a variety of other cost categories. We expect depreciation expense to be approximately $196 million for the full year and G&A expense to be approximately $53 million both slightly lower than prior guidance.

Our full year effective tax rate is expected to be approximately 18% 19%, a little change from our guidance last quarter. 2008 capital spending should be approximately $725 million. $590 million of this amount represents interim payments on our six new deepwater rigs now under construction. We also expect to spend about $25 million for rig enhancement projects and $110 million for sustaining projects.

Our 2008 outlook is currently based on the assumption that there are no major rig relocations during the remainder of the year. Dan will brief you on some recent developments that could affect this assumption. And with that lead in, I'll now turn the call over to Dan.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Thanks, Jay, and good morning, everyone. We're very pleased with our second quarter results and we expect our performance will continue to improve for the remainder of the year. First, I will discuss recent developments regarding our deepwater initiatives and then provide some insight into our current markets and operations. I'll refer you to our monthly contract status report filed nine days ago for specific rig details.

ENSCO currently is undertaking one of the largest ultra-deepwater rig fleet expansion programs in the industry. Since our last Conference Call in April, we placed orders for the construction of two deepwater semi-submersibles, ENSCO 8504 and ENSCO 8505. This is in addition to our four ENSCO 8500 series rigs currently under construction. Due to the unprecedented demand for deepwater drilling equipment, we continue to evaluate additional opportunities to expand our deepwater fleet.

We are pleased to report that we're making good progress on our ENSCO 8500 series currently under construction. The naming ceremony for ENSCO 8500 was recently held in a shipyard in Singapore, and we are on schedule for the anticipated delivery and departure from Singapore during the fourth quarter or during the fourth week of September. It will take an estimated 90 days to let tow the rig to the Gulf of Mexico where we will commence operations in mid-first quarter of 2009.

ENSCO 8501 also is on schedule and progressing well. The next key milestone in the project will be the main engine startup which is scheduled for August 1st. We look forward to the anticipated rig delivery in the early part of second quarter 2009. We continue on schedule with ENSCO 8502 and ENSCO 8503 as well.

With regard to our most recently announced rig construction projects, we plan to strike still in February 2009 for ENSCO 8504 and in August 2009 for ENSCO 8505. We currently estimate that when all six rigs are delivered, approximately 30% of our total revenue will be derived from deepwater assets. And with a total of seven rigs, we will have one of the largest ultra-deepwater dynamically positioned semi fleets in the world.

I am pleased to advise that we are on schedule with accruing of ENSCO 8500 series rigs. The staggered delivery of the rigs stays approximately nine months apart, allows us to efficiently recruit training personnel for each of the new rig additions. During the second quarter we filled all of our remaining key management and marketing positions for our newly formed deepwater business unit.

Now let's move to market report, starting with the Eastern Hemisphere. In Southeast Asia, Pacific Rim area, numerous contracts have been awarded and multiple requirements are outstanding. With the exception of ENSCO 56, the ENSCO jackup fleet is fully contracted through 2008.

Following its current commitment in November, and demobilization from New Zealand to Singapore, ENSCO 56 is scheduled for approximately three weeks of shipyard work. We are discussing several opportunities for this rig and expect to have our contract upon completion of shipyard work. We believe there is sufficient incremental demand in the region to keep the industry jackup fleet utilized through 2008 and well into 2009.

In the Middle East there continues to be a great deal of activity. Saudi Arabia hopes to further boost oil production capacity by March 2009 and has recently tendered for four incremental rigs, three for oil and one for gas development. There are also several outstanding or likely requirements between the UAE and the Kuwait neutral zone. Iran remains the most under-supplied market, having requirements for approximately nine additional rigs.

With the recently executed LNG export agreement between Qatar and China, we expect that additional rig requirements in Qatar will be announced for 2009 and beyond. We anticipate that our Middle East jackup market or jackup fleet will be fully committed to at least the third quarter of 2009, as options were recently exercised on two of the four ENSCO rigs working for Saudi Aramco, and we expect that the other two rigs will be extended soon as well.

In India, several outstanding tenders are yet to be awarded and we expect demand to continue increasing. India currently imports a majority of its hydrocarbon requirements and will likely continue to increase drilling activity as a matter of national priority. ENSCO 50 and 53 have been working for BG India for several years. And we are optimistic that this will continue.

The North Sea standard jackup market remains tight, with several imparities in a tender still outstanding. Recent fixtures for standard work in late 2008 and 2009 are at higher rates and suggest an extremely tight market. All ENSCO rigs in this region are fully committed through 2008.

We are encouraged by the level of additional inquiries for work in the Mediterranean. The market is under supplied by at least one rig. We currently have two jackups committed to this market with good prospects for continued work, and there are opportunities for further expansion.

Now turning to the Western Hemisphere, the US Gulf of Mexico jackup market has seen a substantial improvement since our second quarter earnings call. The improvement in the market is being driven by several factors. A balance between demand and supply of drilling rigs, due to the substantial decrease in the size of the jackup fleet in recent years, the property divestitures that have impacted activity in 2007, are now being drilled following completion of evaluations from the new owners, and favorable commodity pricing.

ENSCO owns the entire 250 foot independent leg premium jackup fleet currently in this market. The 250 to 300 foot jackup market continues to gain momentum and demand in day rates for these rigs have increased. We are adding backlog which is significant when considering the historic short-term nature of this market. We have also received inquiries from customers for possible term work in the Gulf of Mexico which is a further indication of possible changes in the market.

With a limited supply of larger jackups in the area, currently only 11 and with the likelihood of additional rig departures, we expect the high-end rig market will tighten further. One industry rig is scheduled to mobilize to Canada in 2009 and it's highly likely that more rigs in this class potentially ENSCO rigs will mobilize in the near-term to Mexico and Venezuela.

We get questions from the financial community about customers limiting drilling activity during the hurricane season, which impacted our results in 2007. During the third quarter of 2007, our utilization for jackups in the Gulf of Mexico was 78%. We are currently out looking utilization for our Gulf of Mexico jackups at 97% during the third quarter 2008. This increase and expected utilization is a further indication of the strengthening in this market.

Recently there's much discussion about opening up more of the U.S. outer Continental shelf to offshore drilling. It is difficult to predict whether this will occur but given the limited supply of premium equipment remaining on the Gulf and with the expected additional departures, rig availability to address any new offshore areas would likely be an issue. We are seeing a considerable increase in activity in Mexico.

PMEX has outstanding tenders for one, 250 foot rig and one, 350 foot independent cantilever jackup. The results of those tenders were opened yesterday in Mexico and we were the low bidder on both of these jobs. These jobs were approximately two year contracts and we bid 185,000 per day and $155,000 per day for the 350 foot and 250 foot independently, respectively plus lump sum demobilization.

PEMEX has until August 12 to accept our tender, so it will be a few weeks before we know definitively whether these two rigs will be going to Mexico. In addition, PEMEX indicates that it now will be seeking six incremental rigs for work beginning in late 2008 and early 2009. There's also a requirement for jackup work in Venezuela for which we are in the midst of negotiating with operators. These requirements will likely pull rigs out of the U.S. Gulf of Mexico adding additional pressure to the demand supply balance.

Now let's turn to the deepwater market where recent contract fixtures clearly demonstrate market strength. The Gulf of Mexico, Brazil and West Africa continue to be the most active deepwater areas. We believe Asia will become an important deepwater market with exploration activity increasing in Australia, Malaysia, and India. We are very encouraged by the level of dialogue with customers on our two available new build rigs.

We believe ENSCO is uniquely positioned to take advantage of this market with our recently announced new build rigs as existing shipyard and supplier capacities are constrained and there are few rigs under construction without long term contracts. Our growing backlog and earnings potential, we believe demonstrates that we're on the right path and we have every reason to be optimistic about our future.

Before opening the conference call to questions, I want to acknowledge a change in our in our Senior Management. Mark Burns joined us in June and became President of our International Business following Paul Mar's retirement. Mark has over 25 years of experience in the industry and most recently Vice President and Division Manager for Nobel Drilling.

We welcome Mark and are delighted with his enthusiasm about joining the ENSCO team. We look forward to his contribution over the coming years. Mark would have been a participant in today's call but he and Bill Chadwick, our Chief Operating Officer are traveling on business this week. Jay and I are available to answer your questions and additionally several other members of our management team are here. And can address questions regarding the respective areas.

Richard, I'll now hand the call back to you.

Richard A. LeBlanc - Vice President of Investor Relations

Okay, Chad. At this time we'll be happy to take some questions. Thank you.

QUESTION AND ANSWER

Operator

[Operator Instructions]. And we'll go first to Collin Gerry with Raymond James.

Collin Gerry - Raymond James

Good morning, guys.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Good morning.

Collin Gerry - Raymond James

Appreciate the commentary on the jackup market. I guess my first question seems a little bit more relevant these days. We're watching natural gas pull back rather substantially, the merits or longevity of which can be debated all day long but what's your sense of the Gulf of Mexico's response to natural gas prices? Is there a floor price where you see demand tail off and what price are you assuming in your commentary about the strength of the market?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Yeah, you know, the commodity prices clearly have backed off here recently. We're basing our outlook based upon what we currently have booked for 2008.

Jay W. Swent - Senior Vice President and Chief Financial Officer

And Jay here. I don't think the operators are really focused on the spot market so much as they are some anticipated supply demand forecasts that they have in place and that's the basis for their activity level.

Collin Gerry - Raymond James

Okay. Which certainly helps with the major kind of coming back to the jackup market a little bit more, I would imagine?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Yeah. You know, the three factors we list which is the demand- supply equation and then people drilling on these areas they've recently acquired and then commodity pricing, I think those are the orders of priority. I think the biggest driver for demand right now is supply equation in the Gulf of Mexico.

Collin Gerry - Raymond James

Okay, and then I guess to follow-up, offsetting that, Mexico certainly seems like an incremental bullish kind of data point here. The incremental tenders are certainly positive news and I guess the rates that you all are bidding are a little bit higher than what I would have guessed. One of your competitors recently spoke about on top of that, PEMEX seeking to replace its current MAC fleet with independent cantilevers. Is that something you've heard as well?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

We've seen a trend as those rigs are rolling off contracts that they are not renewing those contracts, but PEMEX has not stated that that is their position but it seems to be what's happening.

Collin Gerry - Raymond James

Okay. Well that wraps it up for me. I'll turn it back over. Thanks, guys.

Operator

Next we'll go to Arun Jayaram with Credit Suisse.

Arun Jayaram - Credit Suisse

Good morning, gentlemen. I was thinking or trying to get a good gauge of where you think the daily operating costs are for the deepwater fleet today on the 7500, what your expectations are for the 8500 class rigs, as those come into fold?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Arun, are you talking about operating cost?

Arun Jayaram - Credit Suisse

Yes, sir. Yes, sir.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Yes, just bear in mind one thing on the 7500 and all of our 8500 series contracts, we have full cost reimbursement from the day we sign the contract. So costs are definitely going up but they're dollar-for-dollar recoverable.

Arun Jayaram - Credit Suisse

Just wondered if you could help me what the daily costs are?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Probably about 75, maybe a little above that Arun 75,000 a day.

Arun Jayaram - Credit Suisse

Okay, that's very helpful. And then on the two rigs in Mexico, ENSCO 87 and 93, would you have to do any contract specific upgrades for those two rigs, if you're awarded the commitments on those two rigs?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

The answer is yes. I mean, any time you take rigs into Mexico or most international Markets are contract specific modifications that you need to make to your equipment. So the answer is yes.

Jay W. Swent - Senior Vice President and Chief Financial Officer

And that's why I made the point in our outlook. Right now, we haven't outlooked any impact of that move since it's not a done deal at this point. Obviously, to the extent we have to go in the shipyard, there would be some revenue impact in the fourth quarter of this year, but we don't think it will be dramatic.

Arun Jayaram - Credit Suisse

And follow-up on that, what would be the timing of these two awards, understanding that you haven't been awarded those, but if you were awarded, wonder when these contracts start?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Do you remember, Jay.

Jay W. Swent - Senior Vice President and Chief Financial Officer

Yes, one of them will start in mid-November for the first one, which is the 116 and the 250 would begin in the first part of February.

Arun Jayaram - Credit Suisse

Okay. That's all I got, guys. Thanks.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Arun?

Arun Jayaram - Credit Suisse

Yes.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Back on your OpEx question, just remember that the classification of the 7500 and the 8500 are dynamically positioned non-self-propelled. So those are the only rigs that are classified in that manner. So we do not have to have marine crews on both the rigs. So on a comparative basis we're going to have lower OpEx than most competitors.

Arun Jayaram - Credit Suisse

Right, because you don't have the marine crews, it makes sense. Thanks.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

You're welcome.

Operator

Next we'll go to Pierre Conner from Capital One Southcoast.

Pierre Conner - Capital One Southcoast

Morning, gentlemen.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Hi, Pierre.

Pierre Conner - Capital One Southcoast

Congratulations on Mexico, assuming that it progress. My question to you on those contracts, the last one I think that was awarded to a competitor you had an index in it. Are these fixed rates or will they be indexed?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

They're indexed to global rates.

Pierre Conner - Capital One Southcoast

Okay, so global as opposed to just Gulf of Mexico?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Absolutely.

Pierre Conner - Capital One Southcoast

And the other potential one you mentioned that's Saudi Arabia and it seems to be, they were out, and then maybe it was delayed. Could you give us an update on what you think the timing of those potential tenders might be?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Saudi Arabia tenders?

Pierre Conner - Capital One Southcoast

Yes.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

They're outstanding currently.

Pierre Conner - Capital One Southcoast

And in terms of when they could be awarded?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Bids are due in mid-August.

Jay W. Swent - Senior Vice President and Chief Financial Officer

That's right.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Yes, I think mid-August, so some time shortly thereafter.

Pierre Conner - Capital One Southcoast

Dan, you're pretty comfortable with those, you mentioned coming out of the Gulf of Mexico, obviously for you all. But that would be where this that where they would pull from?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

For Saudi?

Pierre Conner - Capital One Southcoast

Yes.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

No, I think you'll get a lot of rigs over in that market competing for those jobs as well.

Pierre Conner - Capital One Southcoast

Okay. When you sum up these incrementals as well, and you mentioned that obviously you're fully contracted for 08 and you see the markets balance. How far do you see out now, the balance with the new supply coming on? And what you know about for incremental demand in the jackup market worldwide?

Jay W. Swent - Senior Vice President and Chief Financial Officer

I think the last time we looked at this, Pierre it's been a little while. But we could see based on the ODS petro data information that everything through '09 was pretty well accounted for in demand. As, you know, as you get out past that timeframe, the demand forecasts are a little less precise. But certainly all of '08 and '09 looks like every rig that comes out will have a job.

Pierre Conner - Capital One Southcoast

Okay. So I think the big issue there has been of course the international jackup markets and we've seen some good numbers, and you mentioned some potential increases even in North Sea. I just wanted to see if your sense of talking to customers has been just in the last 90 days or the last two quarters as there been an increase in demand or these rates kind of always been there and we're just now seeing them visible with new contracting?

Jay W. Swent - Senior Vice President and Chief Financial Officer

I think you are just seeing that we've been pretty bullish about the jackup market for a long time and a lot of people haven't been. So our customer engagement what we're seeing today is what we're seeing six months ago from customer engagement. It's a fairly robust market out there.

Pierre Conner - Capital One Southcoast

Okay. That's it on the jackup side, and that's the perspective. But quickly on the other, on your 8504 and 8505, and those kind of early and you've just early discussions contract levels are high potentially. But what do you think about, do you see a trend towards increasing term? You've been typically in the two-year timeframe would you look for longer-term here or is it the shorter-term potentially getting you better rates?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

You know, Pierre, that's a hard question to answer.

Pierre Conner - Capital One Southcoast

Yes.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

The customer I will say just based on the customers that have inquired today, it's been much longer term work than shorter term work, but clearly, the marketing activity is in the initial stages.

Pierre Conner - Capital One Southcoast

Okay. We'll watch it with interest. All right, thanks, gentlemen.

Jay W. Swent - Senior Vice President and Chief Financial Officer

Pierre, this is Jay. From what we've seen here lately, I think that the likelihood for the term on the 8504 and 5 will be of a longer duration than a two year period. Even there seems to be some interest developing here not even four years but even longer than the four year term, so

Daniel W. Rabun - Chairman, President and Chief Executive Officer

And I think one of the dynamics and one of the reasons we placed orders for two rigs, the shipyards are really going to be fully tied up with all of these rigs being built for Brazil, for an extended period of time. I think our customers are starting to realize that there's not going to be a lot of new deepwater equipment that's going to be available for the marketplace, so we see customers at least trend right now is that they're looking for longer terms that have gone through this period.

Pierre Conner - Capital One Southcoast

So we had seen them move towards longer. That's what I was trying to verify. All right thanks, gentlemen.

Operator

Moving on we'll go to Tom Curran from Wachovia.

Thomas Curran - Wachovia

Good morning, guys.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Hi, Tom.

Thomas Curran - Wachovia

Jeff, with regards to those first two PEMEX bids you have pending, when you say they're indexed to global rates, when would the indexing kick in and then how long are the terms for each? Sorry if I missed that.

Jay W. Swent - Senior Vice President and Chief Financial Officer

I don't think that was mentioned. It resets every six months and it would initially, it begin, we actually, it's not indexed against the regional bid but it resets every six months.

Thomas Curran - Wachovia

Okay, so the first six months would be fixed at the day rates you shared and then from that point forward for however long each of the respective terms are, it would reset to this index every six months?

Jay W. Swent - Senior Vice President and Chief Financial Officer

That's correct.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

It's so the high fixtures during that period for 250 or 350 foot rigs on a global basis, in the various global markets.

Thomas Curran - Wachovia

Okay. Great. Thank you. And then for the six incremental tenders you mentioned, are any of those for or open to Mat supported jackup and then are your marketing guys aware of any potential forthcoming tenders that would be eligible formats supporting jackups?

Jay W. Swent - Senior Vice President and Chief Financial Officer

Tom at this time, we haven't seen any interest in the additional mats or what Mat they have, they seem to be releasing those and replacing them when they can.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Of course we haven't made that inquiry. What they're looking for is five 250 foot rig and one 300 foot rig.

Thomas Curran - Wachovia

Okay. All independently independent leg.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

But those are independent legs. And so anyway, I don't think, my own personal opinion, I don't think they're going to be asking for additional mats. I can't guarantee you that.

Thomas Curran - Wachovia

Okay. That's helpful. Thank you for that color. And then as you look out internationally it, which foreign markets look most promising in terms of emerging growth? We know what the major drivers of growth of incremental demand in far markets has been up cycle to date but looking ahead which market you think do you think might have the potential to surprise?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Are you talking about jackup market there?

Thomas Curran - Wachovia

Jackups, sorry, guys, yes, still speaking to jackups here.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Southeast Asia.

Jay W. Swent - Senior Vice President and Chief Financial Officer

Yeah, Southeast Asia. And no specific country, just all across Southeast Asia.

Thomas Curran - Wachovia

Okay. All right, thanks, guys, I'll turn it back.

Operator

We'll move on and go to Mike Drickamer with Morgan Keegan. And Mr. Drickamer, please go ahead with your question. Hearing no response we'll move on and go to Jeff Spittel with Natixis.

Jeff Spittel - Natixis Bleichroeder

Good morning, guys, first question was with regard you talked about an escalation in mobilization expenses. Can you talk a little bit about the timing of recapturing some of that?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

It will get matched up quarter for quarter. Most of the mobilization is in the fourth quarter as we move ENSCO could 56 from New Zealand and Singapore.

Jeff Spittel - Natixis Bleichroeder

And then on the labor cost front, could you characterize I guess your ability to recapture some of the escalation and labor costs on a regional basis? Is it a little bit easier right now to recapture that in term of day rate in Asia Pacific versus say the Gulf of Mexico?

Jay W. Swent - Senior Vice President and Chief Financial Officer

Yeah, I mean, most of our Gulf of Mexico contracts are short-term in nature and don't have any cost escalation provision in them with the exception of our deepwater contracts there. So in the case of the 7500 or any of the newer rigs that will come into the Gulf, we'll have dollar for dollar cost recovery pretty much on those. As you look out into the international jackup market, we have varying forms across recovery and each contract's unique probably in its own right.

Labor is generally the one that we have the best cost recovery provisions against, so it's pretty good and in some cases, it's dollar for dollar, in most cases it's dollar-for-dollar there's sometimes a wag there .And I would say that if you looked across the entire universe of our international jackups, we're probably going to be recovering 30% of those labor increases in the current period.

Jeff Spittel - Natixis Bleichroeder

Okay. Thanks very much.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

That's a very rough estimate.

Jeff Spittel - Natixis Bleichroeder

Sure. Thanks.

Operator

[Operator Instructions]. Next we'll go to Byron Pope with Tudor Pickering.

Byron Pope - Tudor Pickering

Good morning, guys.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Good morning.

Byron Pope - Tudor Pickering

Just in terms on the R&M side of the equation. In an environment where rigs are pretty full utilized across-the-board, there's areas that tend to surprise to the up side. Could you give us a little more color on kind of what some of those drivers might be in terms of repair and maintenance costs for you, were they in instances where they come in a little bit higher than what you would expect?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Well I think its a couple things, one as you rightfully point out, Byron. These rigs are working flat out, full time and under more pressure than they've been under for a long, long time. So to the extent that, you work them hard, you're going to have more repair maintenance costs. There's a tendency when business is as brisk as it is to try to delay that as much as you can, ultimately it catches up with you.

But in terms of what's driving the cost there's an awful lot of third party costs involved. At the end of the day, everything is driven off of oil prices and steel prices in our industry and all of that is translating in through third party costs for work on the rig s. So it's really, I'd say it's not a simple answer. It's a combination of more activity and higher inflation for the people that are providing at the helm.

Byron Pope - Tudor Pickering

Okay, thank you.

Operator

Next we'll go to Ian Macpherson with Simmons and Company.

Ian Macpherson - Simmons and Company

I wanted to see if I could dig into the two jackups that might be moving in Mexico in Q4 and Q1. Do you, can you give us a ballpark of what the shipyard time looks like in terms of days and dollars, a broad range around it?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Yeah, I don't know that we have a dollar amount yet to share with you. I'd say in terms of timetable, it's probably something on the order of 60 days for each one of those rigs.

Ian Macpherson - Simmons and Company

60 days door to door?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

There's probably a little bit of time for MOB on top of that but it's in that range.

Ian Macpherson - Simmons and Company

Okay. Would the costs be capitalized or would that hit OpEx?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Most of that would be capitalized. Some would be recovered probably through the MOB cost.

Ian Macpherson - Simmons and Company

Okay. If I can get a follow-up on the deepwater side, is there, what is the strategy for the 8504 and 05 with respect to timing? Are you disposed to contract those sooner than later or do you prefer to see how day rates develop over the next year? And I guess as a follow-up to that, I assume you want to keep building these, building more of these as long as the demand is there and would we need to see backlog materialize on one or both of those before an 8506 comes into the fold?

Jay W. Swent - Senior Vice President and Chief Financial Officer

The way we've always explained the strategy is every day that we go uncommitted, there's more risk that we've taken and we want to be paid for it. So we look at all the opportunities as they come in the door and we've already received some inquiries. And as you might expect, the operators would like a better price if they sign-up today because they know they're taking a risk.

So it's a balance, the longer we go uncontracted, the higher those great expectations we have, so there's a balance there. On 8506, we continue to evaluate the opportunities. We still think we have a real cost advantage over our competitors, and it's a competitive advantage. And we plan to be very aggressive and have been in terms of expanding our fleet.

Ian Macpherson - Simmons and Company

If you ordered today, would that be a second half of 2012 delivery?

Jay W. Swent - Senior Vice President and Chief Financial Officer

Yes, what we're trying to do is stage these things out six to nine months apart so approximately that time period after 8505.

Ian Macpherson - Simmons and Company

Okay. Could you, if you were so disposed, could you pay the shipyard more and get an earlier delivery slot or not?

Jay W. Swent - Senior Vice President and Chief Financial Officer

No.

Ian Macpherson - Simmons and Company

No, okay. All right, that's all I have. Thank you.

Jay W. Swent - Senior Vice President and Chief Financial Officer

It just depends on how much more.

Operator

And then we'll go back to Mike Drickamer from Morgan Keegan.

Michael Drickamer - Morgan Keegan

Sorry, guys, can you hear me this time?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Yes, we can.

Michael Drickamer - Morgan Keegan

All right, you talk earlier about inquiries about returned contracts for jackups in Gulf of Mexico. But on your side strategically what are your thoughts on accepting guide term contracts at this time?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

You're talking about on the jackups or on the?

Michael Drickamer - Morgan Keegan

Right. No, sorry, the jackups. Are you willing to accept term at this point in the cycle for jackups in the Gulf of Mexico?

Jay W. Swent - Senior Vice President and Chief Financial Officer

Well that would be a new twist to have term, but we would, and we certainly would, maybe not for the entire fleet, we want to maintain some leverage. But with the rates where they are and where the levels they're approaching, we would certainly accept term in the Gulf of Mexico and I mean by term, I think term in the Gulf of Mexico may be referencing approximately one year as opposed to three or four. So we would expect some term in that neighborhood.

Michael Drickamer - Morgan Keegan

Right.

Jay W. Swent - Senior Vice President and Chief Financial Officer

At these prices.

Michael Drickamer - Morgan Keegan

Okay, that was my question. Thanks, guys.

Operator

Next we'll go to Dan Boyd with Goldman Sachs.

Daniel Boyd - Goldman Sachs

Hi, just a quick clarification on the PEMEX tenders. How many of those do you expect to be incremental as opposed to just bidding against the existing rigs in the region?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Thus we know they're all incremental.

Daniel Boyd - Goldman Sachs

And then more of a strategy question. Even with your new builds your generating quite a bit of free cash flow in the next couple years. Lead times are getting pretty far out there for new builds and you seem to be getting more comfortable with the longer term outlook for deepwater so with that in mind, are you interested at all in adding leverage to the balance sheet to acquire deepwater assets to speed up this expansion or would you say that an 8506 is more likely?

Jay W. Swent - Senior Vice President and Chief Financial Officer

I think we're certainly open to both. I mean unfortunately, there's a limited number of opportunities on both fronts, as we said earlier, you can throw the money in the world you want it and you can't speed up shipyard deliveries, at this point, so there's a finite amount of capacity that can be added there, and quite frankly can be managed there.

I think we've always said we're open to M&A opportunities if they present themselves. At the moment we don't see a lot that on the horizon that makes sense but we continue to look at situations and we will continue to look at situations going forward.

Daniel Boyd - Goldman Sachs

So if nothing arises should we expect to see maybe increased share buybacks then?

Jay W. Swent - Senior Vice President and Chief Financial Officer

Yeah, I think what we've always said is that to the extent we have cash, that can't be productively put to work in the near-term, that we would return that to shareholders and that we would always be willing to lever up to do a deal that made sense. So we don't view ourselves as needing to stockpile a strategic pile of cash for an M&A activity that we can't describe to you.

We feel like to the extent there is cash available that can't be put to work immediately, we should return as much of that as we can efficiently to shareholders, but as I said, we are more than willing to tap the balance sheet for the right transaction.

Daniel Boyd - Goldman Sachs

All right, thanks.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Just one additional follow-up, because there's been a couple of questions about shipyard deliveries. One thing everyone needs to remember even if you can find a shipyard that can deliver or you couldn't find the equipment to get there early, so the whole Supply Chain, shipyards, supplier s, everything is fairly constrained at the moment.

Operator

[Operator Instructions]. We'll take our next question from Sonny Randhawa of Banc of America Securities.

Sonny Randhawa - Banc of America Securities

Good morning, guys. Quick question on you're seeing PEMEX or indications are that they're going to be high grading their jackup fleet. In other Markets, you really don't have the Mat supported rigs out there but there are older jackups within those Markets or less capable jackups. Are you seeing move in any other Markets for the same sort of high grading of the fleet?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

You know, I think you see around the world some of the customers prefer some of the newer equipment, and so I think as these new builds come into the marketplace, they get some opportunities presented to them that may have displace some older equipment.

Sonny Randhawa - Banc of America Securities

So there's not I guess a strategic shift by any other market into just newer rigs?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Not that we're seeing.

Jay W. Swent - Senior Vice President and Chief Financial Officer

I think one of the things that trend we'll see in future is the balance between the older equipment and the brand new equipment, and that's kind of in the middle of the market where we have upgraded equipment that are already stacked crude and up and running that can produce the efficient results that these Operators are looking for. When you get on each end of the spectrum, you know, there's other challenges around the equipment and the people.

Sonny Randhawa - Banc of America Securities

Okay, I guess on the upgrading side then, you guys have actually done a pretty good job of sustaining your fleet or upgrading your jackup fleet. Right now, I have a pretty good handle on what the new build costs are, we get or at least we can see how they're escalating every time another new build is announced, on the shorter term lead time items like shipyards R&M, I'm assuming that those costs are going to be even higher in terms of just escalation; right?

Jay W. Swent - Senior Vice President and Chief Financial Officer

Yes.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Yes, absolutely.

Sonny Randhawa - Banc of America Securities

Okay. So I guess from a, could you see looking out a year or two since we've actually been drilling pretty much non-stop for an extended period down, operator or contractors that didn't do the types of sustaining on their jackup fleets, could you actually see an increase in attrition, just due to the return requirements for doing upgrades?

Jay W. Swent - Senior Vice President and Chief Financial Officer

Well, I think you're going to see a number of things. One is that as people have really older pieces of equipment that they didn't invest in several years ago and that they've worked really hard for a few years as they're trying to pass inspections and things like that, they're going to find it very expensive to upgrade those rigs and I think you'll possibly see the rigs leave the fleet as people make decisions about does it make sense to invest that kind of money in the rig. It actually set us up for a pretty good commercial about ENSCO which as you know, we've invested heavily in our fleet, we got all that worked on right before the big up swing here.

But we've also invested in lots of new jackups overtime through the Childs [ph] acquisition and new builds that we did with KFELS, so we feel like we have a great balance between new rigs that are the most capable rigs in the market and very cost effectively upgraded rigs and well maintained rigs, that may be older, but as Jeff said can still efficiently do the work that the operators want done and then generate good returns for us.

So we feel like the direction that the markets moving and I think the point everybody has been kind of getting at is that the market is going to move to newer more capable assets and I think that plays very well to the rig fleet that we have.

Sonny Randhawa - Banc of America Securities

If you could just for the last follow-up, if you could get to a number on the shipyard escalation cost for short lead time items, what will we put that on an annual run-rate at?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Huge. I don't think I could give you a number but it's large.

Sonny Randhawa - Banc of America Securities

Great. Thanks a lot.

Operator

And moving on, we'll go to Jud Bailey from Jefferies and Company.

Judson Bailey - Jefferies and Company

Thank you, good morning.

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Hi, Jud.

Judson Bailey - Jefferies and Company

Dan, a follow-up to your comment regarding Venezuela. You already have the 69 down there and it is up for renewal later this year. Are you looking at another opportunity to move another one of your Gulf rigs into that region, did I understand that correctly?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

That's correct.

Judson Bailey - Jefferies and Company

Okay. When we look at the rate on the 69 and a rollover second half of the year, is it reasonable to expect that to be at a similar rate that it's working today?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Yes.

Judson Bailey - Jefferies and Company

Okay. And the incremental requirement is that for long legged of jackup or a 250 foot unit?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Long legged.

Judson Bailey - Jefferies and Company

Okay. So a rate probably in line with the 69 and something that we could potentially see?

Daniel W. Rabun - Chairman, President and Chief Executive Officer

Potentially.

Judson Bailey - Jefferies and Company

Okay. That's all I've got. Thank you.

Operator

It appears there are no more questions at this time. Mr. Le Blanc, I'll now turn the call back over to you for additional or closing remarks.

Richard A. LeBlanc - Vice President of Investor Relations

Yes. We certainly like to thank everyone for joining us today. Look forward to talking with you again on Thursday, October 23rd for our third quarter 2008 earnings conference call.

With that, Chad I'll turn it back to you to close it out.

Operator

And ladies and gentlemen, that will conclude today's presentation. Thank you again for joining us and have a great rest of your day

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Source: ENSCO International, Inc. Q2 2008 Earnings Call Transcript
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