Shelf Drilling, Ltd. (OTCPK:SHLLF) Q1 2023 Earnings Conference Call May 16, 2023 10:00 AM ET
Company Participants
David Mullen – Chief Executive Officer
Greg O’Brien – Chief Financial Officer
Conference Call Participants
Fredrik Stene – Clarksons Securities AS
Robert Ellenbogen – MUFG Securities
Operator
Good day, and thank you for standing by. Welcome to the Shelf Drilling Quarter One 2023 Earnings Call. [Operator Instructions] Please be advised that today’s conference is being recorded.
I would now like to hand the conference over to your speaker today, David Mullen. Please go ahead.
David Mullen
Thank you, operator, and welcome, everyone, to Shelf Drilling quarter one 2023 earnings call. Joining me on the call today is Greg O’Brien, the Shelf Drilling CFO. Yesterday, we published the Q1 2023 financial statements for Shelf Drilling, Ltd. and Shelf Drilling North Sea, Ltd. as well as our latest fleet status report on the Investor Relations page of our company website. In addition to our press release and financial statements, we also published a presentation with highlights from the quarter.
A recording of this call will be made available on our website within the next few days.
Before we begin, let me remind everybody that on our call, we will contain forward-looking statements. Except for statements of historical facts, all statements that address our outlook for the full year 2023 and beyond, activities, events or developments that we expect, estimate, project, believe or anticipate may or will occur in the future are forward-looking statements. Forward-looking statements involve substantial risks and uncertainties that could significantly affect expected results. Actual future results could differ materially from those described in such statements. Also note that we may use non-GAAP financial measures in the call today. If we do, you will find supplemental disclosures for these measures and an associated reconciliation in our financial reports.
I will provide an overview of the company’s performance for Q1 2023 before sharing my latest views on the jack-up market. I will then hand over to Greg to walk you through our first quarter financial results before opening the floor to Q&A.
As always, I would like to start my commentary on our earnings call with our safety performance. The year-to-date total recorded incident rate as of the 31st of March 2023 was 0.07, an excellent safety performance, especially considering the backdrop of supply chain constraints and employee retention challenges. We had single low-severity recordable incident in the first quarter across the fleet of 36 rigs. The excellent safety performance was a result of rigorous planning and seamless execution in all aspects of our operating business.
In quarter one 2023, we achieved a fleet-wide uptime of 99.3%, an excellent operating performance despite the quarter being the busiest period of contract preparation activity in the company’s history. In April, we successfully completed the transition of 4 recently acquired jack-ups in the UK, Denmark, Qatar, to Shelf Drilling operating system. This was in line with our fastest time line for the transitional service agreement and represents an enormous team effort across the various functions at HQ and shore-based offices, and of course, the offshore crews involved. The formal handover for the Shelf Drilling Barsk will occur at the end of the current contract, which is currently estimated to be in late November, late quarter four of 2023.
In the first quarter, there were 9 out of service projects, which represented the highest number of ongoing concurrent projects in the company’s history. Despite a backdrop of industry-wide challenges such as the shortage of manpower, supply chain bottlenecks and shipyard congestion, only 2 of the 7 projects originally scheduled to be completed in Q1 shifted into Q2. The Shelf Drilling Victory commenced its contract in the Middle East in late April, and the Harvey Ward will follow suit in the coming days. We avoided an out-of-service project for the Shelf Drilling Achiever by completing the scope of work while the rig was in service. This is the first time this has been done in Saudi Arabia and delivered significant value to both Shelf Drilling and our customer.
The Compact Driller and the C.E. Thornton commenced their respective 3-year contracts with ONGC in May.
The revenue recorded for quarter one 2023 was $180 million with an adjusted EBITDA of $36 million, representing a margin of 20%. All of the above results are recorded on a consolidated basis with Shelf Drilling North Sea. Both revenue and EBITDA were substantially in line with what we had guided on our last earnings call, and as guided, the financial results for the quarter were impacted by the high concentration of planned out-of-service projects. Greg will provide you more details on our Q1 2023 results and the financial outlook for the rest of 2023.
Brent crude oil prices, the key driver in demand for shallow water drilling activity, averaged $82 per barrel year-to-date 2023. In March, concerns surrounding challenges in the banking sector led to a decline in oil prices. The market pivoted to a positive momentum in early April when the OPEC+ announced further supply cuts. And more recently, Brent crude oil prices declined to the mid-70s due to concerns over contagion risk associated with the large U.S. regional banks combined with higher-than-expected oil supply due to an increase in Russian oil exports.
In summary, the Brent crude oil benchmark has been range bound from the low 70s to the mid-80s since the beginning of the year. And while I expect oil demand to grow in the second half of 2023, current prices support additional investment in shallow water projects and a positive outlook for offshore shallow water spending and activity. We, therefore, maintain an optimistic and constructive multiyear outlook for the industry.
Within our geographies of operations, the Middle East continues to drive the lion’s share of jack-up rig demand. We have tracked approximately 50 jack-up rigs that have or will mobilize from elsewhere in the world to the Middle East since the beginning of 2022. With the vast majority contract to Saudi Aramco and the balance either purchased by ADNOC are contracted into Qatar.
Although contracted rig counts in Southeast Asia and West Africa are lagging and have not yet recovered to pre-pandemic levels, the marketing activity is pointing to an improving market in 2024. The offshore India market is building strong momentum, with ONGC looking for more incremental supply. Cairn Energy and Oil India have recently issued tenders and market inquiries for multiple rigs, and both seem likely to have sustained offshore activity into the future.
The UK North Sea market has slowed in 2023 as a result of the UK government imposing an energy profit levy on the oil and gas producers. A number of development projects scheduled for 2023 have pushed into 2024 and beyond. I expect there will be a rebalancing of supply in the UK market through 2023 as rigs leave the market for more compelling opportunities in alternative geographies, and I expect to see an improving market into 2024 and beyond.
The Norwegian CJ70 market fundamentals are strong. And while there has been a temporary slowdown in activity owing to timing of projects, I expect to see a very strong market in Norway in 2025 and beyond.
The global number of contracted jack-up rigs further increased from 390 in January 2023 to 394 in May 2023. Market utilization is holding steady above 90% and approaching highs we have not seen since 2014, as the excess supply and the overhang of newbuilds have substantially disappeared. I expect the global jack-up market to be resilient despite macroeconomic volatility, and I expect positive day rate momentum will continue to build through 2023 and into 2024.
The Shelf Drilling Barsk was awarded an important contract with Equinor in Norway commencing in May 2024. This contract includes 2 firm wells with an expected duration of approximately 270 days and an estimated value of $61 million, excluding other contracted services. Additionally, there are 2 option wells which are expected to occur in direct continuation. The Shelf Drilling Barsk was a transformational acquisition for Shelf Drilling as it expanded our capabilities into ultra-harsh jack-up market segment. The opportunity to establish and grow the relationship with Equinor is key to growing into this market, and we are grateful for the trust placed in us by Equinor.
The Adriatic I secured a 90-day contract in Nigeria for approximate value of $11 million and is expected to commence the program in the coming days. The Shelf Drilling Mentor, also in Nigeria, secured a 1-well extension for approximately 120 days with a $16 million in contract value.
As of the 31st of March 2023, our contracted backlog was $2.8 billion across 36 rigs, of which 34 are contracted, representing 94% marketed utilization. The Adriatic I was contracted subsequent to quarter end, making the Shelf Drilling Fortress in the North Sea the only rig available, and it is currently being marketed for opportunities inside and outside the North Sea.
In late March, we have published our latest sustainability report, showcasing our ongoing commitment to sustainability and our progress in various areas. One of our key accomplishments during this period has been the significant improvements we have made in the quality and consistency of our Scope 1 and Scope 3 emissions reporting. We are pleased to report that we have achieved a reduction of 5.5% in our per rig per day Scope 1 emissions on an annual basis. Regarding Scope 3 emissions, we performed a detailed analysis in line with the greenhouse gas protocol to identify further areas for inclusion in reported Scope 3 data. By expanding the scope of our emissions reporting, we aim to provide a more comprehensive and accurate representation of our environmental impact.
Furthermore, we have invested in initiatives to support our employees, local communities and stakeholders across our value chain. We performed a comprehensive assessment of the salient human rights issue for our business and established action plans and metrics that will be further refined this year to ensure our compliance with the relevant requirements. We are proud of the strides we have taken to advance our sustainability agenda, and we invite all of our stakeholders to review the detailed actions and performance outlined in our 2022 Sustainability Report.
Despite recent oil volatility, the demand remains very strong for jack-up in all regions with the exception of the UK sector of the North Sea. Global demand looks set to outstrip the available supply, and we expect that this will bring further day rate momentum and any excess supply from the North Sea will be quickly and easily absorbed into other regions of the world. The rapidly-improving market will bring some challenges as it pertains to supply chain and employee retention. I believe we have a differentiating strategy as it pertains to people and supply chain. We were also quick to reposition our fleet in light of this improving market, and I feel that this high concentration of out-of-service projects is now behind us. We remain focused on delivering safe and efficient operations to our customer, and I believe that Shelf Drilling is in a very strong position to reap the benefits of an improving jack-up market.
I will now hand over to Greg to walk you through the financials.
Greg O’Brien
Thanks, David. As mentioned earlier, we published our Q1 2023 results yesterday, including standalone financial reports for Shelf Drilling North Sea. We’d encourage you all to review the results presentation on our website as this includes additional detail and schedules for both companies.
Reported revenue for Q1 2023 of $183 million included $3 million for amortization of intangible liability associated with the contracts we assumed at closing of the SDNS acquisition. As discussed on our last call, we’ll focus on and refer to adjusted revenue, which excludes the impact of this noncash item.
Adjusted revenue for Q1 of $180 million included $161 million of day rate revenue, $4 million of mobilization and bonus revenue and $15 million of recharges and other revenue. Adjusted revenue for Q1 decreased by $35 million or 16% relative to Q4 2022. This compares favorably to the sequential decline guidance of approximately 20% that we provided on our last call in March. The decline was primarily driven by lower revenue on 4 rigs preparing for new contracts, expected to commence in Q2 and Q3 2023, the Shelf Drilling Resourceful and 3 rigs in India, the C.E. Thornton, Key Singapore and Compact Driller.
In addition, revenue at Shelf Drilling North Sea declined by $8 million following the contract completion for the Shelf Drilling Fortress in the UK in January. This was partially offset by higher revenue from 2 rigs in West Africa, the Baltic and the Shelf Drilling Mentor operating at higher day rates as well as 2 rigs in India, the Ron Tappmeyer and FG McClintock, which commenced new 3-year contracts during Q1.
As a reminder, other revenue includes the contribution associated with the Shelf Drilling Barsk, representing the net margin generated by this rig under its current bareboat charter agreement. As a result of the increase in planned out-of-service time, effective utilization decreased to 75% in Q1 from 86% in Q4. As 35 of our 36 jack-ups are now under contract, we expect this figure to increase in both Q2 and Q3 as rigs return to service and commence new contracts.
Average day rate was $70,000 per day in Q1, up from $67,000 in Q4. This increase resulted from higher day rates on a total of 9 rigs across Saudi Arabia, West Africa and Egypt. We also expect sequential improvements in average day rate in both Q2 and Q3 as additional new contracts commence.
Operating and maintenance expenses of $129 million in Q1 increased from $122 million in Q4. We incurred a significantly higher-than-normal level of cost in Q1 on 2 rigs preparing for long-term contracts, the Compact Driller in India and the Harvey Ward in the Arabian Gulf. Operating expenses were also higher on the Shelf Drilling Scepter as this rig was preparing for a new contract in West Africa following a period of idle time in the prior quarter. At the SDNS level, operating expenses increased sequentially due to demobilization costs for the Shelf Drilling Fortress and higher personnel expenses with the strengthening of the British pound versus the dollar in Q1.
G&A expenses were $15 million in Q1, down from $17 million in Q4, mainly due to lower compensation expenses as compared to the prior period. Adjusted EBITDA was $36 million in Q1, representing a margin of 20% compared to $76 million and a margin of 35% in the previous quarter. The adjusted EBITDA contribution was $7 million from SDNS in Q1 2023 and $29 million from the rest of the business.
Income tax expense was $9 million in Q1, similar to the previous quarter or 5% of revenues. Net interest expense of $33 million for the quarter was in line with Q4. Noncash depreciation and amortization expenses totaled $31 million in Q1, down from $36 million in Q4, and the net loss for Q1 was $34 million.
Capital expenditures and deferred costs totaled $83 million in Q1, down from $471 million in Q4. The sequential decrease related to the $418 million recorded in Q4 for the acquisition of the 5 jack-ups by SDNS. Spending in Q1 included an additional $23 million for the rig readiness for the Shelf Drilling Victory, which commenced its new 5-year contract in the Middle East in late April. Spending across the rest of the fleet increased by $30 million from Q4, mainly due to the out-of-service projects for 4 other rigs being prepared for new contracts, all expected to start in Q2 and Q3 of 2023. Total spending for these 4 rigs, the Harvey Ward, Compact Driller, Shelf Drilling Scepter and Shelf Drilling Resourceful was $40 million in Q1, CapEx at SDNS was $3 million, and spending across the rest of the business was $17 million in Q1.
Our consolidated cash balance as of March 31 was $144 million or $3 million higher than the balance at the end of December. This increase was mainly due to the $44 million of net proceeds from the issuance of common shares in Q1, which offset the sequential decrease in EBITDA and high level of capital spending during the quarter. The end of March cash balance included $63 million at Shelf Drilling North Sea and $81 million at the parent company.
In our release yesterday, we also maintained our financial guidance for full year 2023. Fully consolidated adjusted EBITDA is estimated between $310 million and $345 million, with a significant concentration in the second half of 2023 due to the commencement of new long-term contracts in the Middle East, India, Italy and West Africa, all at attractive day rate levels. Our total capital spending guidance for full year 2023 is also maintained between $220 million and $245 million, including $20 million to $25 million at the SDNS level. The higher than normal level of spending across the rest of the business is largely concentrated on 4 rigs: the Shelf Drilling Victory, Harvey Ward, Resourceful and Scepter. Mobilization fees of approximately $100 million included in these contracts will serve as a material offset to the spending requirements for these 4 rigs.
We, therefore, expect our 2023 spending net of mobilization fees to be close to the $100 million range for our 31 rig fleet at the parent company, which is consistent with the directional annual guidance we provided in recent periods.
Our results in Q1 were in line with expectations and consistent with the guidance we provided for 2023. As David mentioned, we’re nearing the end of one of the busiest periods in our history of rig upgrades and fleet repositioning. Following commencement of the Shelf Drilling Victory contract in late April and as 5 additional rigs returned to work during May, we expect to be significantly cash generative starting in Q3. We believe our recent capital investments position us well to deliver meaningful growth in run rate earnings for the rest of the year as we work towards a refinancing of our debt in late 2023 or the first half of 2024.
We’d now like to open the call for any questions.
Question-and-Answer Session
Operator
[Operator Instructions] We will take our first question. The question comes from the line of Fredrik Stene from Clarksons Securities AS.
Fredrik Stene
Hey, David and Greg. Hope you’re well. And nice performance this quarter. I wanted to touch a bit upon your contracting strategy going forward. David, I think in your commentary, you definitely see the momentum, the positive momentum continuing through this year and also into next year. But on your fleet status report, you have a relatively large share of your fleet locked up in the near to medium term. So on the assets that are not locked up in the same manner, are you wanting — or do you want to chase, call it, short-term contracts and opportunity to reprice the fleet faster on those? Or are you still wanting to lock in capacity for longer?
David Mullen
No, look, I mean, I don’t think it’s that simple. We see a lot of benefits in positioning in a single geography for a long period of time rather than moving rigs around. Every time we move a rig around, there’s a cost associated with it. And when you change operators, you’ve typically got gaps. So I’m still very much of the mindset that you take the opportunities as they come, and you go long.
We have quite a few rigs that are coming off in the near term, and I think they’re well positioned to get good day rate contracts. But I would be more inclined to take a longer-term job than a shorter-term job and keep changing operators. So I think that kind of has always underpinned our marketing strategy rather than moving things around. One market I particularly like right now is India. India is showing a lot of strength. And we have potentially 2 new players. Cairn, we’re currently working for and we’ve had 2 rigs with them, the Compact Driller and Key Singapore in the past. We see them building a sustainable level of activity and that’s in a geography that we like very much. So that is something that’s really attractive to us. We want to build a long-term relationship with Equinor. We incurred a nice contract with the Barsk, and I think it serves us better to stay with the same operator and build a long-term relationship. You will always have — when you have a fleet of 36 rigs, we’re always going to have rigs that are rolling off contract to capture the upside on the day rate.
I hope that kind of answers the question, Fredrik. Good to hear from you.
Greg O’Brien
Fredrik, one comment for me that I think is helpful. And I think one big positive is we have a relatively small number of rigs with near-term availability. We’ve built quite a bit of visibility across the business through the second half of this year, into 2024. I mean it’s concentrated on a couple of rigs in West Africa. We have 3 rigs that are all contracted but all have relatively short-dated contracts.
We have been able to move pricing on those rigs reasonably higher over the last few months. I think the key across those units is keeping them working through the end of the year and into 2024 where obviously, we’ve talked a lot about trying to start building cash second half of this year through the course of 2024. So I think on those units, it’s trying to build as much visibility at leading-edge rates as possible. And then we have a lot of exposure that starts to roll towards the end of 2024 into 2025. And with our outlook for the market, we think those are going to present opportunities to reprice higher. So it’s a relatively small number of rigs. I think the key is trying to keep those rigs working at current rate levels for the next 12 to 18 months.
Fredrik Stene
This is super helpful. I think to say, Greg, also on — for example, the Adriatic I has been — and that was a very nice data point. Just before I go back or leave you for the next one in the queue. The Tenacious, I think the fleet status report said that you had got a 15-month option on that. Is that option priced? And if so, how have you been kind of going about rate thinking on that particular rig?
David Mullen
Yes. The option is priced. It’s priced at a very good day rate. And look, this is — again, it’s another example of building an anchor. We like our presence in Angola, where we moved in there quite recently. It’s been an extremely interesting project. And we imagine that that rig will stay there for 10, 15 years more, so that’s what it’s really all about. And we — all probability, we’ll get the opportunity to add a second rig there, which we would really like to do. We’ve had a great performance. That rig has done an extraordinarily good job with Chevron there in Angola. And it’s — the day rate we have at the 15 months that commences in — I think it’s late 2024, keeps the rig there at a very, very good day rate. So we’re happy with that.
Operator
We will take our next question. Your next question comes from the line of [Marianna Kushner] from Nomura.
Unidentified Analyst
I was curious, what is the timing of you guys receiving the mobilization fees? And also given the coupons, I guess maybe you already paid the coupon on the unsecureds, right, because that was May 15. Then what is — when do you expect the low point in the cash balance? Is this basically second quarter where the cash balances are going to dip or stay flat? Just if you could give me an idea?
Greg O’Brien
Yes, sure. I mean we talked about the first 4 or 5 months of this year being the likely the trough full in cash. With the equity raise we did in January or February, we effectively derisked that period altogether. I think it’s fair to assume that the cash balance at the parent company probably dips a bit in Q2 and then starts to build from there. And we’ve mentioned this $100 million total estimated amount of mobilization fees. It’s probably sort of a rough split half-half between Q2 and the second half of the year, if that’s helpful context.
So probably, it’s a small drop in Q2. We had a relatively large build in payables at the end of Q1, just a working capital release that probably corrects this quarter and then we start to build from there.
Operator
We will take our next question. Your next question comes from the line of Robert Ellenbogen from MUFG Securities.
Robert Ellenbogen
Just in terms of the refi, you contemplated structure at this stage. Just what combo secured and unsecured might look like?
Greg O’Brien
Yes. We haven’t talked so specifically about that. I think we mentioned on our last call that we think we have a few different pools of capital available to us. We’re looking into options in the bank market in the Middle East. We think that is an option that is uniquely available to us, given how much backlog and presence we have here. I think it’s fair to assume that secured debt would make up the lion’s share of anything we do in a refi. But in terms of exact split, now we haven’t talked too specifically about that. At this point, we’ve also been pretty clear. We think the timing is the tail end of this year or potentially into the early part of 2024, so then we’ll have more context and detail on that as that window gets closer.
I think we’re hopeful the total quantum of that comes down relative to what we have on balance sheet today. As we’ve mentioned, we think we’ll start to build cash in the second half of the year and into early 2024, so that helps. I think we’ll also look to put a revolver in place in some quantum that would allow us to keep less cash on balance sheet for liquidity purposes. So I think we do hope that, at a minimum, that $1.2 billion number comes down a little bit. But in terms of exact split, I think we’ll share more detail around plans later in the year.
Operator
[Operator Instructions] There seems to be no further questions at this time, so we’ll hand back to David Mullen for closing remarks.
David Mullen
Thank you, operator, and thank you, everybody, for joining the call. We look forward to our next earnings call. Thank you. Bye.
Operator
This concludes today’s conference call. Thank you for participating. You may now disconnect.
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