Diamond Offshore Drilling Inc (DO) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen. My name is Pam and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Diamond Offshore Drilling second quarter 2006 results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period.

[OPERATOR INSTRUCTIONS]. It is now my pleasure to turn the floor over to your host, Mr. Les Van Dyke, Director of Investor Relations. Sir, you may begin your conference.

Good morning and thank you for joining us. With me on the call today are Larry Dickerson, President and Chief Operating Officer; John Gabriel, Senior Vice President of Marketing; and Gary Krenek, Vice President and Chief Financial Officer.

Before Larry begins his remarks I should remind you that statements made during this conference call may constitute forward-looking statements and are inherently subject to a variety of risks and uncertainties that could cause actual results to differ materially from those projected. Forward-looking statements include but are not limited to discussions about future revenues and earnings, capital expenditures, industry conditions and competition, base of drilling rigs will enter service, as well as management's plans and objectives for the future.

The discussion of the risk factors that could impact these areas and the Company's overall business and financial performance can be found in the Company's reports filed with the Securities and Exchange Commission. Given these concerns, investors and analysts should not place undue reliance on forward-looking statements. The Company expressly disclaimed any obligation to release publicly any updates to any forward-looking statements to reflect any change in the Company's expectation or any changes in events, conditions, or circumstances, on which any forward-looking statement is based. And with, that I will turn the meeting over to Larry.

Thank you very much. And welcome, again, everyone to our second quarter conference call. We are pleased with the results that we announced today. I think they showed continued sequential growth and there were some numbers that were slightly ahead of First Call's projections. However, I think in the drilling space you find that because all the participants disclose their forward day rates and I think provide some excellent guidance, it's very difficult to have much variance from the results that the analysts have, but we're pleased to be on the right side of that.

The key drivers in our sector though remain to be future day rates and we released at the close of the market yesterday our latest fleet status report, which contained three new day rates, which I think are worthy of some comment. First of all, is the Ocean Worker, which is currently in Mexico at a rate in the mid-70s announced that upon the conclusion of that work, we will take some international work at $450,000 a day. I'm told that we received several phone calls yesterday on that, one wanting to know if that was a misprint and someone else asking if that was in U.S. dollars. We are very impressed with the rate as well. That is our high rate within the fleet and exceeds $425,000 a day, which we have on the Ocean America.

Additionally, we announced for some short-term Gulf of Mexico work, a $300,000 a day day rate on the Ocean Voyager. The Ocean Voyager is a 3,000 foot rig, so it probably commands a slight premium to the base second gen rigs that we have in the U.S. Gulf of Mexico. But, again, I think this indicates some continued strength and continued demand and limited supply in that particular market. I'll be coming back and talk a little bit about hurricane preparedness in a minute which touches on the Ocean Voyager located in the U.S. Gulf of Mexico.

And then we finally, we announced a $295,000ish rate for international work on the Ocean Whittington. The Ocean Whittington had been in Mexico. We received early termination of that contract about 90 days prior to the scheduled conclusion of that contract and all that's caused us to do from last-minute hustling around that's actually good news because it indicates that we will be able to step-up from a day rate that had been in the high 50s up to this higher rate much quicker and the term of that job is a little bit less than 600 days. So out of our four rigs in Mexico, we now have conditional letters of intent covering two of those, the Ocean Worker and the Ocean Whittington; the Ocean Yorktown and the Ocean Ambassador remain in Mexico. The Ocean Ambassador until the '07 is its current schedule and the Yorktown is about mid '07.

Let's talk about hurricane preparedness in the U.S. Gulf of Mexico. We are in the midst of installing 12-point mooring system on our 10 semis in the U.S. Gulf. We have two rigs that are complete and are deployed currently with 12-point mooring lines; those are the Concord and Victory. Both of those rigs we took into the shipyard and encouraged some downtime which were scheduled anyway for wire changeout, but we were able to efficiently jump on that particular work and get that done in time.

We have -- I would say three other rigs that will be complete by the beginning of first week of August, that's the Valiant America and Baroness. And then the Ocean Saratoga we're taking into the shipyard, so it will not be active during the hurricane season. And we'll do that work in the shipyard. The remainder of our U.S. fleet, which covers about four rigs, including the Voyager, we're looking now towards a mid-August deployment date. And the factors in place there have been that we're not able -- since we're continuing to work at day rate, get out the number of people and make sure that we can get the work done.

We're trying to make that up, but if need be, we may have to incur some moderate amount of downtime in the three to five day range on several of the rigs and for one of the rigs maybe as much as two weeks. But I think it's good news that we've been able to make this significant improvement in our fleet that meets or exceeds the current calculations of what is possible out there and significantly strengthen our holding position and we were able to do this with very little downtime. And, again, we'll have it done this hurricane season. Which I think puts us ahead of the curve.

And then finally, let me talk just for a minute on cost and as is our tradition, Gary Krenek will take over and expand upon cost to give you more commentary on that and give you some guidance as to where we see costs going forward in our fleet. Our costs quarter-over-quarter over the first quarter were up about $26 million. I would characterize about between 6.5 and $7 million of that as items that were unique to this particular quarter, such as can repairs that we had on the Ocean Nugget, and then the cost of mobilizing the Victory and Concord into the shipyard.

And then we had some higher costs that are coming in for offices we set up in Indonesia and some other international locations. And while those costs will continue forward they represent new contracts that we have internationally and so are more or less are offset by revenues. We had about $8 million of labor increases, that's primarily rate increases that we're paying. I think we've warned everybody that's something we see coming. But there is a component of that is -- of quantity because we're putting additional staff out there to ensure that we have backup and are able to weather a competitive market where we know that we're going to lose some people. We also have additional folks out there currently on some of the hurricane preparation.

And then about $11 million of that cost increase relate to increases in operating expense, S&R supplies. While I think we've previously predicted that Q1 was low in that area and then we expected Q2 going forward would be higher. And then -- but the bulk of it is probably inflationary costs from some of the oil field service companies that you guys track where they're raising prices as they deal with us.

But in general, out of the entire cost increase, I would say there's at least some portion of it, not the majority by any means, which is offset by additional revenue, either costs we're spending to prep for new contracts or specific items that we took on that also have a revenue component that are reflected there. So that's a general commentary on cost and we talked about the new day rates. Certainly I'll take a question -- we'll take questions on a variety of areas, but perhaps on Mexico so we can expand our commentary on that. But with that, I'm going to let Gary Krenek now give you a more in-depth commentary on cost.

Thanks, Larry. I would like to point out to reiterate our earnings release that we again set another quarterly earnings record with our net income of $176 million or $1.27 per share. This was a 21% increase over the first quarter earnings and a 325% increase over Q2 2005 earnings of 41 million. As Larry said, that was driven by the increase in revenues. Larry went over the cost for the quarter in pretty good detail. The only thing I might add on there is we -- part of the increase in the cost was related to the Ocean Spur, which relocated from the Gulf of Mexico to Tunisia during the quarter. Part of the cost are a result of international cost being more than the Gulf of Mexico, and also we had to amortize the mobe during this period of time and that increased costs. That total increase was about $2 million.

As Larry said, we saw our maintenance and repair costs increase from Q1 to Q2, which was what we expect due to our budgets being approved at the end of the prior year and a natural lag in being able to order and deliver equipment and so those costs went up from Q1 to Q2. Looking forward to Q3, we expect to see this repair and maintenance cost level out or at least see the rate of inquiry slow down to the rate of inflation effect in all of us in the offshore industry.

We do have some non-reoccurring costs that we expect to incur in the next quarter. And I'd like to point those out to you. During the quarter, we expect to perform special surveys on the Sovereign and intermediate surveys and various repair jobs on the semi Yatzy and Princess. These costs should be somewhere in the 2 to $3 million range each on these three rigs in addition to the normal costs they'll incur -- they normally incur during the quarter.

In addition, as Larry said, the Whittington will be coming back from Mexico. We will expense the mobe to bring it back into the Gulf of Mexico in Q3 and that will be about $2 million. And the Saratoga is going into the shipyard for its steel renewal project and -- which will last through most of the year. We'll probably increase cost by about $1 million in Q3 because of that. Larry talked about the mooring upgrades. We will have a -- two boats on hire in order to put out these additional mooring lines. Some of these costs will be picked up by operators in accordance with contracts and depending on the facts and circumstances of individual situations. However, we will incur a portion of these costs ourselves and we estimate this will run us into about 2 to $3 million in Q3. Upon the end of hurricane season, these costs will then cease.

As far as unusual items and the financial statements during the quarter, we did record a loss on the removal and sale of production equipment from the Ocean Monarch prior to its leaving the Gulf for Singapore for its fifth gen upgrade. In accordance with GAAP, we recorded a $2.7 million loss in the line -- gain or loss on sale of equipment. This is a one-time occurrence and we have now accounted for all those costs. Looking forward for other items in Q3 and the rest of the year, as far as the depreciation expense, we expect to see a slight increase in the last two quarters of the year. Perhaps $2 million or so to account for our continued capital expenditure program. Interest expense, we believe, will decrease as we continue to increase our capitalized interest with our upgrades and new builds and the numbers will -- interest expense will be somewhere between 5 to $5.5 million in Q3 and Q4. And finally, we believe the effective tax rate will stay somewhere between the 27 to 30% range.

With respect to expected downtime expected during the quarter, I'm not going to go through that on a rig-by-rig basis but rather remind you that this information is detailed out in our rig status report that we filed yesterday. As always, we've had a shift in timing for a few of our surveys, most noticeably the Whittington that we've spoken about being moved up to the third quarter this year. And a couple of other rigs that had surveys scheduled in Q2 that have -- that did not occur and have been moved back to Q3.

And finally capital expenditure projections, previously we reported that capital expenditures for the year would be approximately $555 million consisting of 320 million for our new build jack-up Scepter and Shield. And the fifth generation upgrades of the Endeavor and the Monarch. The remaining CapEx was for our Gulf of Mexico semi mooring upgrades, storm-related equipment or replacements and then normal maintenance capital. As part of our stated goal of maintaining our rigs and increasing our international presence, we now plan to spend approximately an additional $60 million of CapEx in addition to these numbers in the second half of this year. These additional moneys will be spent in order to prepare the Lexington for its three-year contract in Egypt, the Nugget's 2.5 year contract down in Mexico, and upgrade to the America's waterdepth from 5,000 feet to 6800 feet.

And finally, the increase is also due to the moving up of the Whittington, which was scheduled for steel renewal project in 2007. As Larry said, we'll bring that back, begin that project very soon here and also we'll have spent some money on the Whittington preparing it for international work. With that, Larry, do you have any other comments?

No, I think we're ready for questions.

Thank you. [OPERATOR INSTRUCTIONS]. Your first question is from Doug Becker of Banc of America Securities. Please go ahead.

Good morning.

Good morning, Doug.

Larry, are you now willing to say that day rates for the midwater fleet and the 250s is a little conservative?

Well, I think it varies --.

That was meant to be a little bit of a joke.

Yes. Well, I mean there's a wide variety of capabilities for rigs. So some rigs will have trouble hitting 250 and other rigs will certainly go above 250 and it depends on markets. Certainly we're above that in the north sea. David Williams is here. David, do you have anything else to say on that?

No, I mean the Voyager opportunities are a function of the fact that that rig has outfitted and has worked in over 3,000 feet of water. We've seen the New Era at around 250, so I mean that seems to be a short-term benchmark. I agree with Larry, it depends on the term and the market and what our opportunities are. I wouldn't say that's conservative, but certainly it's a benchmark that we'd like to push through.

Well, within the context for the worker contract, and I understand you don't want to give too many details as it's an LOI, but is there anything specific with that contract that we should be taking into account an extenuated mobe, where I know you compensated for, but there's an opportunity cost there, higher operating cost. Just trying to think about that contract in context for the second gen and third gen market. [multiple speakers].

I think it's very straight forward. The mobe is separately outside the 450 and including some substantial reimbursement, almost the full day rate of our lost opportunity cost during that time frame. It's internationally so you get a slightly higher costs. I'm not aware of anything else. There's no real up-front capital. You're wise to ask all those questions so that you know you've got apples and apple, but this is pretty much a straight forward international fully-priced contract. And I think it's just -- I think if anything, it reflects just tightness in supply and what operators are willing to pay to guarantee that they get a rig.

I guess I'm still having a little difficulty reconciling a 250 rate for some of the lower, granted lower end second gen semis then, it would seem like there would still be some upside there.

Well, we certainly think so. I mean to the extent there's more demand than there are rigs, then we think rates will continue to push forward and that's really where we are.

I think if everybody looks at the U.S. Gulf of Mexico with the hurricane preps that have gone on board, I don't think you're going to see, at least in the short-term -- obviously people will respond to market incentives -- but you're not going to see a lot of new rigs coming in and then there's still going to be rigs exiting this market. So I think, if anything, the U.S. Gulf of Mexico, just tightness of supply in the midwater area should have an impact on the rates we're able to earn.

Okay, fair enough. And then just touching base on the cost a little bit. I know you detailed a lot of the special costs that would be taking place in the third quarter. Doesn't sound like there's any major changes to the daily operating costs we should be using, maybe inflate those just like we've been seeing across the industry. Could you maybe detail the one-time costs in the second quarter, or is that really just all captured by that 6.5 to 7 million that was mentioned?

I think Larry did a pretty good job of that. Most of it was the Nugget can repair. We spent some $2 million there and then had another $2.5 million worth of mobe costs to get the Concord and the Victory into the shipyard to do their mooring upgrades.

Okay, so in terms of looking into the third quarter, it's reasonable to kind of subtract out that 7 million, add in the cost that you mentioned for the third quarter, and maybe even inflate that modestly, is kind of what we should be looking at?

That would -- yeah, you'd get there. The question is, what type of continued inflation will we see in the industry? We're subject to that just like everybody else.

Okay, thank you very much.

Thank you. Your next question is from Waqar Syed of Petrie Parkman. Please go ahead.

Just one clarification, first. On the DD&A you said an increase of $2 million. Is that a $2 million per quarter increase?

Yes.

Okay. Secondly, could you shed some light on the Mexican floater market? I understand they have four tenders out for four semis, but then still they've released one -- the Ocean Whittington. What do you see happening in the Mexican market and where do you think they're going to get the rigs and what does your plan for the Mexican market?

We have enjoyed drilling for PEMEX and we think that's a big growth market and we would like to be a part of it. But when you're faced with a short-term cancellation on a longer term contract, that's just not -- you don't have to take that in any other market and in most circumstances, we don't take that anywhere in the world. So on their renewals that they have -- and I think it was a three-rig package -- right David?

It was three, yes.

That they went out there they were bidding renewals against two of our rigs including the Worker and then a Pride rig as I understand it. For our two rigs, we did not submit a bid and it's a public opening process and we understand that no one else bid on that as well. So we are at a point in time where it's unclear because PEMEX is bound by certain laws how they're going to resolve their contractual problem.

Now, the issue with Whittington was at something, rig-specific, or they didn't have any program for that or for the performance, they were not happy with the performance of the rig or what happened?

I think the issue with the Whittington was that over the course of the defined program, the Whittington drilled itself out of a job. We had drilled all the wells that were in the defined program and they ran out of budget money and they didn't have any budget money approved for a continuing operation.

So they had a new program for some other work so they bid that work and that's the tender that we just had. So, no it wasn't anything with the performance. It wasn't anything with -- anything -- it wasn't anything sinister or anything weird. It was just -- they had a defined protocol, a defined program. They wanted the rig to drill, we drilled it. And you might look at the political climate in Mexico and wonder whether or not that had something to do with it or not, but at the end of the day they didn't have any more approved work, so they elected to let the rig go. So I think at the end of the day, it's good for us.

Okay, good. Are you still bidding additional jack-ups into the international markets, and how many of those that are being bid?

We are still pursuing international opportunities to the extent they fit our fleet. Of the rigs that we've got in the U.S. Gulf of Mexico, probably the best candidate to go abroad right now, the Nugget is certainly slated to go to Mexico, but the next rig that we would be interested in bidding actively, that we are bidding actively, is the Spartan. Which is a 300-foot independent-leg cantilever. It's a sister to the Spur that we recently took to Tunisia and the same class of rig as the Heritage and Sovereign, which both work abroad and have since we've know them.

So those would be the two primary -- the Spartan would be the next primary rig that we would try to get out. We've actually had conversations about three or four of the other rigs to the extent they meet the spec, we might pursue others. But I think it's fair to say the Spartan is a pretty good bet. The others are a little less likely right now. But we'll just have to see how it goes.

And for Spartan, what is the most likely market? Is it going to be North Africa, West Africa, or Middle East or?

Well, all of the above. We're pursuing numerous opportunities for the rig in each of those markets.

Okay, and then just one final question. How is the construction program for the two jack-ups going in for the major upgrades as well?

We think we're on budget. The Endeavor, David was just on board two weeks ago and tells me things are looking great. It's a very impressive unit.

It's huge. It's on target. It's going to be a tremendous upgrade. We can't wait to get it out.

Devon is very excited about receiving it here in the U.S. Gulf of Mexico in the four-year program. So that's terrific. We don't have any problems yet. Obviously, we're liaisoning with the shipyard. We've got people there. We're going back and forth constantly because there are so many rigs in the queue and our concern is that if one of them falls you'll have a domino impact. But I can't think of a better shipyard anywhere on the planet then Keppel Fels on staying on top of those kind of things both in Singapore and in the Brownsville yard. So we're very comfortable with that.

Thank you very much.

Thank you. And your next question is from Ian Macpherson of Simmons & Company. Please go ahead.

Good morning. I'm interested in a couple of your deepwater contract rollovers in the relatively near-term. You've got the Quest coming available in April and the Star in October and I'm just interested to hear how advanced you are in contract negotiations for those rigs and what we might expect out of sort of leading-edge bid rates for your fourth gen fleet?

And I like the way you characterized those as near-term. That's a departure from where we've been in the last 10 years. But both of those rigs are due, as you said, April of '07 for the Quest and October for the Star. We're in discussions for both those rigs as we speak. I don't want to get too much into details of where we are, but we're in discussion for extensions of both those rigs right now, so I really don't want to say much.

But I can tell you, basically every rig in the fleet that's available in '07 is either underbid or under discussion with somebody. That's how far out in advance we're working. So both those rigs are high on our radar screen and hopefully we'll have something in the not too distant future to report that's a little more definitive. Certainly there is no -- there's increasing demand, so we would expect the rates to improve. I guess the degree of improvement will sort of be dependent on how much term we get out of them.

Does the 450 on the Worker for a third gen put an upward bias to the repricing on the four gen rate?

Well, we certainly hope so. But the 450 on the Worker is a little bit of a function of the operator needing a rig at a specific time the Worker fitting and he wanted to go a little shorter term than what we were interested in. We would have liked to have a little more term out of that job. So we bid it at a tiered rate, this being the shortest term rate and then decreasing rates for longer term. So it's not quite apples and apples, plus it's an international location. But certainly, I would think we would see some upward pressure on the four gens and the Quest on its renewal as well.

All right, just as my follow-up, a little more high level on market dynamics and pricing. When you look across the fleet, you've got everything from low-end floaters to fifth gen floaters, low-end jack-ups to high-end jack-ups. Can you identify one or two areas within that spectrum where you see the most upside in rates over the next year?

I think just from the sheer size of our fleet, it's got to be in the second and third generation midwater fleet because -- although we've representatives in the other areas there are many of them already committed, the Endeavor is committed for a long-term. We got the Monarch to be able to price in the fifth generation area and then we've got the Confidence coming up. But those are nice but when you're looking at jumps on second and third generation rigs that are equal to the jumps that you've got on fourth and fifths and your number of population of rigs that are ready to roll over the next couple of years is 10 or 11, that's just going to have a much bigger impact.

Got you. Thank you.

Thank you. And your next question is from Robert McKenzie of Friedman Billings. Please go ahead.

Thanks, guys can you hear me?

Yes, we can.

I'm just walking back to my office. I wanted to try and get some more color on your domestic jack-ups. You talked about moving one of them overseas. By my look of your place status report you could perhaps move as many as half of your current domestic jack-up fleet overseas. Is that a possibility, something we should be thinking about given both the relative economics in some foreign markets for drilling with jack-up rigs given weakness we've seen in the Gulf of Mexico recently and the impact that has on the stock's multiple versus some of your comps?

Well, let me just take the fleet at large. I mean I'm not quite sure where you get half. We've taken the Spur out. We're taking the Nugget out and the Spartan out. That will be three of the 11, I guess, that we report here. We had a couple of others that could go, I mean there are issues with some of the rigs in terms of their capability to work abroad, in terms of quarter sizes, outfitting how they're -- when they were built, what kind of international safety standards and stuff that they might need depending on how they're constructed. So just because you have a 300 footer in the Gulf of Mexico doesn't necessarily mean it could work in the Middle East. So that's one point.

The other point that I would make is that the Gulf of Mexico where we're working today I think is about 72 jack-ups in the Gulf of Mexico. And we've worked as many as -- well over 100 rigs in the Gulf of Mexico. With our rigs leaving, the other rigs in the market that are leaving, this market is going to continue to be tighter and I don't see that the economics for jack-ups in the Gulf of Mexico are going to get a lot worse. So I'm not sure we really want to take them all out of here. This is -- it's a very dynamic market. We made a lot of money here. The fact that we can work the Ocean Drake, which is a 200 foot mat-cantilever at a rate between 150 and $120,000 a day on a shallow water rig, that's not a place you necessarily want to dive out of.

So we think there's still opportunities in the Gulf of Mexico. We like the idea of spreading strategically our fleet and this isn't something that we've looked at recently, it's something we've been working on for a couple of years. It's just easier in a market like this. So I don't -- we don't think the Gulf of Mexico is dead. We don't want to just bail out of here. We like the opportunities here and so I think we'll continue to have some rigs here.

I think on a long-term basis with the extra cost of hurricane insurance and the extra risk that you've got here, your rates in the Gulf of Mexico need to rise to compensate, rise over and above international markets to compensate you for taking that risk. And the fact that we're already here, I think it's very unlikely that some of these new rigs that are being constructed by companies with a limited number of fleet, the new Norwegian companies, are going to walk into this market given now the hurricane issues and the hurricane insurance, which is a high-marginal cost for them. So, again, we -- on a long-term basis, I'm very comfortable with the U.S. Gulf of Mexico.

Okay, fair enough. The final part of my question was, when I look at the group I see a dramatic multiple difference between some of the names, depending how much of their jack-up fleet, or their fleet is shallow water jack-ups in the Gulf of Mexico. Recognizing that's an issue, is there -- do you have more of an impetus to move more rigs out -- I guess you've already answered that question? But it seems to me that the market is not willing to pay for Gulf of Mexico jack-ups today. Is there any -- what do you see that might turn that around in terms of incremental demand, long-term contracts and the like?

Well, if you can guarantee me that today's multiples are going to be the permanent differentiation, then we might take advantage of it. But a year ago, multiples might have been higher for Gulf of Mexico fleet. I mean ultimately, we're judging it based upon earnings and only if there was a serious long-term impairment of our valuation that we thought was based upon location would we look to what you're talking about.

Okay, thank you.

Thank you. And your next question is from Pierre Conner of Capital One. Please go ahead.

Good morning, everyone.

Good morning.

Hey, Larry, let's talk about Mexico some more. Let's see, first, I wanted to ask you a bit on the Worker, then we can go into international costs could be above where they were in Mexico, but without disclosing more, is this going to a high-cost international market? There are a couple I think of that are particular higher cost than others or is it more a standard international?

I would say standard international. I don't know that it's going to be that much higher cost then -- which has a higher cost than the U.S., but when you have your own crews.

Right. And then on -- again you may have talked a little bit about it, but I was kind of looking for, now with Mexico and the other floaters, what would be your timing that you think or are you in discussions now on the remaining, on the Ambassador or the Yorktown you've talked about having discussions about equipment that has availability in '07 currently. I mean is there something that we would hear about within the next quarter or before the end of the year, obviously?

Well, it's going to depend on what happens in Mexico. But those are in Mexico and the Ambassador is not available until the end of '07, so that's pretty far out there.

The Yorktown is not either. We've had discussions about both those rigs. We've had a little more detailed discussion about the Yorktown, and I guess the reason why is because, again, the Yorktown has been -- at one point it's like been upgraded to about just under 3,000 feet of water. So it has had some appeal.

But, again, we've had discussions about both those rigs. The fact that they're still a year and a half out -- or almost a year and a half out doesn't give us "A" a lot of concern, or "B" a lot of short-term prospects. In particularly the case of the Ambassador, historically, that would have been one of the short-term rigs. So it's not something you're going to hear about I don't think in the short-term, in the near future. Although, in case of the Yorktown, you might.

Yes, okay. No, that's fine. And for Gary, just I think we got a lot of good information on the cost and the sequential differences on sort of the unique items. But what was the component of insurance cost, sequentially, or is that notable?

Notable in that ours was flat. I guess our renewal date was May 1st.

May 1st.

I'm wrong, our insurance costs have gone down because we upped our deductible and we took more risk rather than pay the higher rates. It's interesting, if you look at the various contractors, everybody had different fleets and everybody had different rates, but it would seem to me that there were two companies.

We're one of them that more or less substantially increased their risk in return for a flat or decreased premium. And then there were other companies that -- and the differentiation is mainly you have to have a significant Gulf of Mexico jack-up presence. The other company seems to have paid the rate to have the limited insurance.

At the same time, we've retained our liability insurance rates for that went up somewhat. So offsetting part of the whole insurance that we had and we had a slight decrease in total premiums, but that was effective as of May 1st, so you've got most of that already built into the Q2 numbers.

Got it. Okay, thanks. Then Larry, last one, is let you maybe talk a little more time a little bit on free cash flow uses. In the context of, is there one thing that you often feel good about, is if there are any available piece of equipment out there for upgrade that's? It's been quiet on that front in a while, is there anything else out there, and then beyond that relative to contract building against contracts on deepwater or dividend? And then that's it.

I think we made pretty clear special dividends and not just saying what we're going to do, which you can look at our track record of what we did last year. And we've said that we will look at a special dividend and set that in January of this year. And part of the determinate will be what other options we have to appropriately spend the money in the meantime.

I would say, in general, picking up equipment that's upgradeable is very limited. And there's other competition out there if you find something and that you're really down there into the just junk area buying really marginal rigs and spending a great amount of money. And we like upgrades, but we want to deliver a quality product and not something like that. So I wouldn't say that would be a possibility. I doubt that there would be anything this year, but as we go down, we would be prepared to potentially buy some of the new construction equipment if market conditions were right.

And then new builds, we talk to customers from time to time, but cost on that front are really escalating and there is so much competition that that squeezes the margin. So I don't -- we don't -- although we would certainly participate in that, we don't look at that as great, huge returns, and I don't think that's going to be a key driver of what happens in this fleet.

Okay, great. That's helpful guys. Thank you and I'll turn it back.

Thank you. Your next question is from Alan Laws of Merrill Lynch. Please go ahead.

Good morning.

Good morning.

I wonder if you can answer it -- you tend to have more near-term available capacity in your floating rig fleet than your peers. Has this been a conscious strategy to be more spot exposed, in kind of a rising market or have you just not seen the contracts that you wanted at this time? Or up until now? I know you said you're under contract -- or you're under discussions now, maybe talk a little bit about the type of contracts that you see in the market today?

Well, I don't know exactly what you're talking about. I guess our near-term availability in the floaters is probably because we've got more in the Gulf of Mexico than other people do and the Gulf of Mexico tends to be a little shorter term market.

So I wouldn't say it's a conscious strategy. It's a function, at least in this case, of where we are. We booked some of these rigs out a year, two years in advance and we'll continue to do that. Our international rigs are a little further out. So I wouldn't call it a conscious strategy. It's a strategy that's worked well for us because it's kept the market moving and [Blimp,] which is something that we've enjoyed.

Certainly, we've -- I think we've participated in the second generation, the third generation rise of markets just like we did in the fourth generation rise. So I think it's worked well for us. Certainly, we'd like to have a good mix of term and short-term and I think we actually -- at least from my perspective, I think we've got a pretty good mix now.

So is your preference then to stay with one to two-year deals or is there opportunity out there to build some pretty significant backlog in some equipment now?

In the Gulf of Mexico -- well, those two things are not mutually exclusive. You can have one to two-year deals and still build backlog by virtue of the fact you can put one on top of the another.

So the Gulf of Mexico is not necessarily driven by the larger companies that participant in the deepwater markets around the world, the elephant hunters. It's driven by largely large independence, medium size independence and small independence. And they don't have the portfolio to take the Ocean New Era for three years. So consequently, the New Era as worked for one operator, another operator and in some cases we put together -- or the operators put together a rig club to be able to come in and take a rig for a year and get a little bit better pricing power to do that.

So just by virtue of the fact you have got rigs -- this many rigs in the Gulf of Mexico keeps your fleet a little shorter term. But, again, we've been able to build a good bit of backlog on a number of these rigs well into '07 and we're talking about extensions well beyond that. So we've been able to put some term work on top of some short-term work and kind of mix and match and carry it out, but you're not going to see some of the customers in the Gulf of Mexico jump up and take some of these second generation rigs for three years by themselves.

Are there opportunities though out there for the equipment to take it outside the gulf? I know it probably makes your customers a little bit more nervous when they start to see things.

Sure, and we bid -- of the rigs in the Gulf of Mexico, we bid of our -- call our second jars -- our shallow-water fleets -- second and third generation fleet, we've bid every one of them abroad in the last six months.

You can look at the Lexington which is scheduled to leave to go for a significant term in Egypt.

I mean right now, we've got the Lexington leaving. That leaves the Saratoga, Concord, Voyager and New Era. The Whittington, which isn't actually shown in the Gulf of Mexico now, is leaving. Those four rigs have all been bid abroad. We're actually in some discussions with somebody about one of those rigs now to take it abroad and we've got some bids outstanding on a couple of others.

So yes we like the term, but the one thing about the Gulf of Mexico is the market has moved up quickly and had we tied them up on long-term a year ago we'd be working a lot less rate than we are now and we would be seeing a lot less potential than we do in the next six months. So I think it's -- I'd rather be lucky than good, but I think it has served us very well and I think it will continue to serve us well. We're not afraid of the term, but we're not afraid of the Gulf of Mexico short-term market either right now.

All right. What kind of -- if I look at your release here, you're two-thirds booked into next year. When you look at what kind of backlog in the contracts you're looking at right now, could this be five months from now, two-thirds booked through 2008?

I think what's going to hold you back is the short-term jack-up market in the Gulf of Mexico. I think we're certainly building term on the floaters and there's certainly more demand out there for term on the floaters. And if we -- I talked about some of these -- we're bidding all these term jobs, bidding all the rigs in the Gulf of Mexico on term. If lightning strikes and we land three or four of those, then that could certainly change the backlog picture that we've got. But the jack-ups that are in the Gulf of Mexico are going to remain fairly short, I would guess.

All right. Sounds good. Thanks, guys.

Thank you. Your next question is from Arun Jayaram of Credit Suisse. Please go ahead.

Good morning. David, you've pretty much contracted through the heart of the hurricane season, but you do have a couple of rigs with some time in the middle part. What's your near-term prognosis for the Gulf of Mexico jack-up market? Do you see enough demand out there to keep the industry jack-ups working through the hurricane season?

Yes, we don't -- I don't have a lot of concern about the jack-ups in hurricane season. I mean certainly if we start having some -- if we have a Katrina/Rita event that may scare some people and change the complexion, but that creates a whole other -- another other set of opportunities for rigs.

But I mean with as many rigs as there are here and as many operators that are trying to compete here, I don't have a lot of concerns about the overall market dynamics of the Gulf of Mexico. I mean its -- there's certainly been a lot made of gas prices, but I mean the wells we're drilling now weren't conceived in the last 30 days, they were thought of and generated a while back. So I don't see a major shift and I don't think we as a company have a concern about -- I don't certainly have a concern about the future of the Gulf of Mexico jack-up market as we sit today.

Okay. In that same vein, how does a carrier capacity look, David? I know that there's a number of units, 10 or 11 units which are scheduled to leave the gulf in the six months or so. How tight of carrier capacity --?

Are you talking heavy lifts?

Yes.

It would be a good business to be in if you could -- I mean it's very tight. Occasionally we'll go out and we try to monitor the availability and by virtue of the fact that we're always asking questions, we're pretty close to market. Occasionally you can stumble on a slot that is somebody has either slipped or delayed or canceled or whatever. And you might stumble on a slot and so we've looked at those and we try to monitor those.

There are a number of vessels that can carry the jack-ups. You're talking about the Monarch or the Rover or the Baroness, one of these big floaters, you're very limited in the number of carriers. So that's very tight. You have got to plan that well in advance. And certainly in the case of the Endeavor and the Monarch those are things that we're on top of and trying to stay on top of. But the heavy lift business is tight.

Okay, and just a follow-up, outside of a wet tow, does that limit because capacity is tight there the number of jack-ups that could possibly leave the gulf over the next six or eight months?

I don't see that as a limiting factor, certainly it's a complication, but I mean if an operator has got the program and they -- as part of your bid process, you'll go out and look at what your mobilization opportunities are going to be. And if an operator has got a program for a rig and then they enter negotiations with a contractor, I think that problem is solvable. I think you're well in advance, you need to plan your business well in advance, but I don't see heavy lift availability as a -- it's certainly a choke point. It's not going to be a limitation to the number of rigs we can take out of here.

Okay. Last question, guys, is I get some questions from investors, looking at what Diamond Offshore is doing with the mooring upgrades, relative to Noble who's taken their rigs in for 90 days and a little bit longer time, how do you answer that question?

I think everybody is taking a different approach. They're doing something different in let's say Santa Fe. Everybody's got competent engineers, so I'm sure everybody has got different ways. Our -- I can tell you what our drivers were -- we wanted something that was achievable this year, the Noble approach for equipment deliveries to last it takes a little bit longer and faces the potential of downtime.

Although, they've got a mooring system that is more versatile, because ours just kicks in in the event of a hurricane, but we think that's all we need. So that was kind of our drivers on our issues and we'll just have to see. As we get forward, it's our hope that each one of them works because we don't want floaters moving about in the Gulf of Mexico and bringing down any type of regulation in that market.

Okay, great job on those fixtures. Thanks.

Thank you.

Thank you. And your next question is from Stacy Nieuwoudt of Pickering Energy Partners. Please go ahead.

Hi, it's actually Dan Pickering here with Stacy. Guys, I was wondering if you could talk to us a little bit about kind of following on to the hurricane issues, the mooring, do you see any issues or risk with potentially as we move into '07 there being some differential type of market in hurricane season for the floaters like we've seen for the jack-ups? I mean, we're contracted this year, what about next?

I think this year the market impact is due to uncertainty because we don't know what the situations are. We don't know which companies are going to make what improvements and there's so substantive improvement yet that's been designed for the jack-ups. So I think in '07, again, we don't know what the actual weather we'll see this year. Many -- all of us are hoping for no hurricanes, but we understand that actually the best result would be either normal hurricanes or a powerful hurricane and we show that the fleet can withstand it. So I don't think going forward that '07 will be a different market based upon us having more information.

Okay, all right. And then Larry, I want to make sure I understood correctly when you were talking about thinking about new builds versus maybe some of the rigs that are being built by other companies and potentially purchasing some of those. Can you talk about the build versus buy trade-off on price right now?

Well, I think right now, I believe all of the Norwegian companies have a fairly high price in mind. Although, if you look at the stocks, and this is two weeks ago when I looked at them, they're actually cheaper right now reflected in the Norwegian stock market than the new build prices are right now coming out of the shipyard and for the equipment that's coming there.

Right. What would your -- if you were going to build your jack-ups again, what would they cost?

I think on the jack-up side, I mean the large scale are 190 to $200 million right now.

Yes, somewhere in that neighborhood.

And where is your cost estimate at this point?

155 per unit.

1-5-5?

Yes.

Okay. And then following on just sort of the fleet mix issues, you've got a couple of smaller jack-ups in the gulf, you've talked about being interested in staying in the Gulf of Mexico, no interest in moving assets out. But in a market that's paying a lot for assets, would you consider divesting or some of the smaller or older assets?

We will always take offers if we look forward. But on the retention side, those rigs earn great returns right now. We're getting, even in a market that has declined a bit, we're over $100,000 a day on these rigs. So I'm not -- you'd have to look and see what your offer is versus your cash flow and how long you feel comfortable in the market.

Okay. So it sounds like it's better to own them than sell them right now?

I would think so, but bring forward an offer. [Laughter].

I don't think I have got enough pocket change to buy a rig right now. Gary, on the operating cost side, you talked about some one-time issues in the second quarter. You talked about some incremental costs in the third. It seems to me like net/net were going to be higher in the third quarter by 3, 4, $5 million. Is that a rough eyeball estimate?

I do not agree with you, Dan. We'll be -- we should be a little bit higher.

Okay. All right. And then, in Mexico, you did see one early termination. The other two rigs that are down there right now, I was going to call it early termination risk, I guess it's early termination opportunity. Are there any inklings that there might be -- those rigs might come off contract early?

No. We've seen no indication to date from PEMEX that they have any interest in getting rid of any of the other rigs.

You would think if someone would retain rigs when they've got them at a quarter of the market rate.

Yes, you certainly would. But it sounds like just listening to your discussion of Mexico and their bidding process, that when those rigs come off in Mexico, unless something changes, you would probably be looking for other international opportunities?

That's correct. Again, and what those opportunities are -- clearly, we're not giving up on Mexico. We have got a jack-up headed down there on a three-year contract with a short-term cancellation, but I think that's a different market than the floaters. So again, we would look at that. I would think that no one is going to cancel, but what this has shown you is that when you finish a well or a program, then perhaps in the Mexican system you have some as you say early cancellation opportunity.

Right. Okay. That's all I had, thanks, guys.