Diamond Offshore Drilling Inc (DO) 2008 Q1 法說會逐字稿

Good morning, my name is Natasha and I will be your conference operator today. At this time I would like to welcome everyone to the Diamond Offshore Drilling first quarter 2008 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, Les Van Dyke, Director of Investor Relations. Sir, you may begin.

Good morning and thank you for joining us. With me on the call today are Larry Dickerson, President and Chief Operating Officer, Gary Krenek, Senior Vice President and Chief Financial Officer, and John Gabriel, Senior Vice President Contracts and Marketing. 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, dates that drilling rigs will enter service, as well as management's plans and objectives for the future.

A 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 disclaims any obligation to release publicly any updates to any forward-looking statements to reflect any change in the Company's expectations or any changes in events, conditions or circumstances on which forward-looking statement is based. With that I will turn the meeting over to Larry.

Thank you, Les. Let me open with a statement that last night at midnight we took delivery of the Ocean Shield, our 350-foot new-build jack-up under construction at Keppel FELS in Singapore. That rig was delivered, depending upon how you measure it, probably six to eight weeks later than when we first believed we would get the rig when we placed the order for a variety of reasons, but substantial performance on our commitment date. Because the rig was turnkey, there was very little increase in cost except for some time-related costs, such as capitalized interest and certain shore-based costs. So our expected final delivery cost will be within a 5% overrun of our initial commitment amounts, so we're very pleased with that. We also announced in our fleet status report that we have accepted a five-month approximate commitment for the rig for an initial job in Indonesia. We had announced sometime ago that our initial job would be a one-year commitment in Australia at a very nice rate.

However, to facilitate certain operator preferences between the two customers, we agreed to go ahead and begin with this lower rate job as a fill-in job in Indonesia. We think that will be good for all the parties involved. However, it will slide some of the higher day rate earnings term out of 2008 and 2009. But again, we're pleased with that. But we're scheduled to have tugs show up in Singapore and depart about the 15th of May to go on contract. So we're pleased with that. We'll continue to commission the rig. We're pleased with the state and happy with that particular upgrade. The Ocean Scepter, which is a sister unit being built at the Keppel FELS' Brownsville, Texas facility, is about five weeks away from a similar delivery. We have not announced a job on that, but I can tell everyone that we are in advanced stages of negotiation for an international term job.

We are just not at liberty, for a variety of reasons, to disclose who that is, where the location will be, or what that rate is as well. But again, we're very comfortable with the prospects for that new-build jack-up as well. Additionally, we announced in the fleet status report that we've signed a two-year extension on the Ocean Guardian with its existing customer in the North Sea. The existing job ran through July, 2009, so this will now take it out through July 2011. We announced the rate in the mid 380s, which I think there had been a similar posting of a similar rig in the North Sea at about that rate. Certainly a step-up from our present rate and we're pleased with that as well. Finally, I will just remark in the quarter we saw continued improvement in the Gulf of Mexico jack-up rates, certainly moving back towards high utilization of the ready fleet, and we've seen renewals continue to be at modest rises from well to well.

But because it's a very short-term market, the cumulative effect of that is to reprice the fleet at much higher rates than what we thought the prospects were, based upon rates in effect in the end of the fourth quarter when we had a number of stacked rigs. So again, we're pleased with that. Other than that, that will conclude my opening remarks. Obviously, John Gabriel and the rest of us can comment further on various other markets to your questions. I'm sure we'll get some dividend questions. But I'm going to turn it over right now to Gary Krenek, Chief Financial Officer, to give some additional guidance on financial numbers.

Thanks, Larry. I have just a couple items that I'd like to mention to you this morning before we move on to the Q&A portion of the call. As before, I'm not going to reiterate all the numbers from our press release, but suffice to say that our first quarter results for contract drilling revenues, which were $770 million, net income, which was $291 million, and earnings per share that were $2.09, again set all-time quarterly highs for Diamond Offshore. Looking at the specifics behind those numbers, we gave out some pretty detailed guidance as to what to expect for contract drilling expenses in the first quarter in our last conference call and those numbers came in pretty close to what we expected. The Ocean Patriot survey cost did come in about $3 million above expectations and overall costs for our various international rigs were up another $3 million due to the further decline in the U.S. dollar.

We do hedge much of our foreign currency requirements and our quarterly results include a $2 million gain on those foreign currency contracts. But due to accounting rules we're not allowed to net those gains and losses. As such, contract drilling expenses include the extra $3 million of costs associated with the currency and the $2 million gain is included below the line, below operating results down in the other income and expense line. Depreciation expense ended up a little more than we had anticipated for the quarter at $69 million and we expect it to be around the same amount again in Q2. Depreciation expense will then increase to $72 million to $73 million in the third and fourth quarters of this year as a result of the new-build jack-up, Scepter and Shield, coming on line at that point. With respect to contract drilling expenses in the upcoming quarter, the per day cost that we gave by rig class in our last conference call still applies.

In addition to those normal daily operating costs, we expect to incur a combined total of $17 million to $20 million in additional survey and related costs for the Guardian, Drake, Ambassador, General, and Clipper surveys, which will all be performed either totally or partially in Q2. Unless the U.S. dollar strengthens, we will again expect to incur $3 million to $5 million additional costs in our international operations. And we will also incur an additional $2 million related to completing the mobe of the Ambassador back to the United States from Mexico. One final note with respect to drilling expenses. We will incur approximately $5 million in the second quarter for amortized mobe expenses that had been previously deferred. As always, this expense will be offset by amortized mobe revenues that had also been deferred. If you do the math on all this correctly it should result in expected contract drilling expenses of $300 million to $310 million for the second quarter.

Having said that, this estimation will change if there's a change in our rig survey timing. I'd like to take this opportunity to remind everyone that we file an updated rig status report on our website every two weeks. Changes in survey, down time dates, contract rollover dates, et cetera can be found in that report. The guidance we gave on our last conference call with respect to G&A, interest expense, our tax rate still stands. For those that may have missed it, G&A should continue to run at $14 million to $16 million per quarter, interest expense net of capitalized interest at about $2 million a quarter, and the tax rate should remain somewhere between 28% and 29%. Finally, our guidance for capital expenditures for 2008 also remains consistent with our last quarter's conference call.

Just to break that down one more time, the Monarch and completion of the new-build jack-ups we expect to spend $180 million and the Monarch, of course, is our 10,000-foot upgrade that we're doing in Singapore. We are going to spend about $130 million on required contract upgrades for our Brazil contracts. CapEx associated with the 12 rigs that are undergoing their surveys this year is expected to be around $160 million. We'll spend an additional $50 million for additional spare equipment, which is part of our revenue preservation plan. And finally, just general maintenance capital will be about $160 million. All total, that comes up, again, to $680 million per year. And with that, I'll turn it back over to Larry.

Okay. So let's begin the questions, Les.

Operator, we're ready to begin the questions.

(OPERATOR INSTRUCTIONS) Your first question comes from Ian MacPherson of Simmons & Company.

Good morning. Larry, I guess my first question, starting on the deep water side, seemed a lot of very attractive fixtures with the fourth generation and up fleet, so I guess looking at your fleet, I think the Star is the next rig you have rolling off contract. Have you seen the bidding environment improve over the past quarter for fourth generation rigs or pretty steady state from where you have been, and if you can characterize in any way the work possibilities for that rig in terms of what you envision in terms of renewing the rig in the Gulf of Mexico or putting it somewhere else and what type of term possibilities are out there for that rig.

You are correct, the Star is our first higher specification unit in the fourth quarter that will be available for rollover, and I would -- we haven't fixed it, so there's not a data point that we can look at, but we have bid this in international locations and in the Gulf of Mexico, and we do follow, obviously, the market in establishing our rates. It all depends upon the competition that's in there. John, you have anything else to add on?

We're looking, obviously, at Gulf of Mexico opportunities and I think the most recent lease sales bode very well for keeping these rigs gainfully employed here. The interesting part is there are a lot of competing opportunities outside the Gulf of Mexico. There is some unsatisfied demand for that class of rig in Brazil. We're looking at about three different opportunities in West Africa. There's been some conversation about a need for one or two rigs of this caliber in the Australasia area and there is also at least one opportunity in the Mediterranean. And all of them involve some level of term anywhere from I'd say a year to 18 months on the low end to as long as three years or better on the high end.

In general, there's more term in international markets than in the Gulf of Mexico, but if we renew it in the Gulf of Mexico, we don't have to deal with mobilization issues and the accounting rules are such that during that mobe period, even if you're compensated for that mobe time, you go to a zero rate and you spread that all into the future. So we're cognizant of that as well, although ultimately we do look at cash rather than book income.

Sure. And then if I could just ask you a quick follow-up on the jack-up side, if you could talk about the status of the Heritage that's hot-stacked in the Middle East, is there some sloppiness with the windows of supply/demand there or when do you think that rig gets back to work?

I think -- I don't think it's a function as much of market sloppiness as it is the process, the bidding process that we've got to deal with in that area. And unfortunately, in some late stages of negotiations while we were still working, we had an LOI withdrawn and that basically threw us out of sequence on the rig. What we are looking at right now is a couple of promising opportunities that start in the next month or two and there is obviously significant incremental demand throughout that area in the second half of the year. So we just got caught, in my mind, in a process-driven situation as opposed to a market-driven situation.

Okay. Got it. Thank you.

Thank you. Your next question comes from Jeff Tillery of Tudor Pickering Holt

Just wanted to ask a little bit following up on the previous question on some of your fourth gen rigs in the Gulf. We've seem terms stretch out longer and longer for the fifth gen and up class rigs. What's the longest term you guys are looking at? I know you mentioned some specific opportunities on the Stark of 18 months to three years but what's the longest term you guys at looking at for kind of the 5500-foot class rig?

Clearly Brazil offers a fairly substantial term seen around the world. John, anything.

I think that's the right answer, Larry. Outside of Brazil, the terms are probably, again, 18 months to three years. We have not seen anything formal in Brazil as yet, but if you go based on what we've seen the other rigs being committed to term-wise down there it could be anywhere from four to six years, if we were to pursue that.

Okay. So maybe five-year-type opportunities if something manifests in Brazil, otherwise it's kind of three years or less is the typical opportunity?

I think that's fair, yes.

In terms of an operating preference, would you prefer to operate these class rigs outside of the Gulf where you avoid any sort of hurricane risk or hurricane related down time, or is there, is there any preference internally?

I think hurricanes are a factor that we weigh in making those decisions. As John mentioned before, the strength of the lease sale and the fact that there are so few midwater units left in the Gulf of Mexico also opens up quite a bit of area for these fourth generations to dip down and do some of that drilling. So I think there's great opportunities here and we're not set to abandon the Gulf of Mexico by any means.

And the last question on the Shield, the five-month LOI, is that with the same customer?

No.

And the rate on that would you view that as indicative of the market or just a view of the type of rate you could get on a short window?

I think it's indicative of the market.

Okay. Thank you very much.

Your next question comes from Tom Curran of Wachovia.

Moving to the earlier generation and to the midwater market. In both the Gulf of Mexico and the North Sea a major driver of this renaissance in demand we've seen has been abandoned prospects or marginal prospects that have become economic because of the step change in oil prices. I was wondering, for each of those markets if you could give us a sense of just how large an inventory roughly is remaining of those type of abandoned/marginal prospects in the Gulf and in the North Sea.

I think that's really a question for the operator. Not that I'm hesitant to give you an estimate. It's just that I think we lack the tools to put it in context. It's clearly -- it is a factor. What we've seen probably in the Gulf of Mexico is the limiting factor is just companies dedicated to that sector. There are some, but there's so many people moving into deeper waters, but there's certainly ripe opportunity there. I think we've seen it be a bigger factor in the North Sea, because that was really on the standpoint of maybe being abandoned and now you've got lots of companies being active there. And there's actually less midwater units in the Gulf because we all moved out for hurricanes for term and for the fact that the Gulf of Mexico was a short-term market.

And I guess then in turning to the North Sea, are you seeing any signs whatsoever yet that inventory of those types of prospects may be starting to shrink at a pace or to a number that would cause you concern relative to the supply of midwater rigs there?

I think the only real indicator we have is what our rigs are able to accomplish on a go-forward basis from a term and a rate basis and the extension on the Guardian, I think, bodes well for that. We are quite a ways away from having conversations about any of the other three rigs there, but every indication we have is that there's -- there's nothing on the horizon that would cause us concern about that market and that class of rig.

That's helpful. Thank you. Turning to some rig specific questions, starting with the next two early generation midwater semis set to come off contract in the Gulf, the Saratoga and Ambassador, John, could you share your current expectations for each of those rigs?

The Gulf of Mexico market is going to be characterized by a little bit shorter term, either well to well or multiple wells as opposed to term commitments, but we do have significant interest from a lot of different people and we have -- we've been able to string that -- basically we've had that rig working for one customer for a long time, but we have a lot of interest in it and expect to be able to keep it busy, let's say, in the 250 to 300 range, just on a short-term commitment basis. With respect to the Ambassador, a little bit less water depth capability, but we've got the rig busy now and are looking at putting another well hopefully in front of it before it goes into the yard. I guess we've got about 90 days worth of shipyard time planned on that rig and we are already in conversation with people about the commitment on the rig post its shipyard stay. Again, it's a short-term market, but it's a healthy market.

and the day rate range that you expect for the Ambassador at this point?

Maybe 10% either side of 250 would be my guess right now, just depending on the specific application.

That's some helpful color. Thanks, John. Then lastly, the Baroness, that is set to roll off in November of 2009, and I would think you're in a position to command, if not something close to current leading edge, maybe even push for something higher given the dwindling amount of availables for deepwater capacity at this point in late '09. Could you speak to that?

No. (LAUGHTER) We'll talk about the general market, but I hate to talk about a specific rig where we have an existing customer who has that and we have yet to enter into negotiations. You understand.

Okay. Thanks, guys, I'll turn it back.

Thank you. Your next question comes from [Doug Garber] of FBR.

Cash building on your balance sheet, currently over $620 million and growing. If the special dividend is flat at 125 per quarter, I estimate there could be about $800 million to $900 million in cash on the balance sheet by the end of the year. Is there another way you guys are thinking about returning the cash to shareholders other than through a special dividend?

We remain committed to the special dividend as our primary means of returning cash and enhancing -- there's a number of ways to enhance shareholder value, but we think that that does it in addition to our earnings capability. And the board will analyze that at each particular quarter. And although we're not giving future guidance on that, that is our primary method of dealing with that. And if you look -- even if we had acquisition opportunities to come into the future and you look at the fact that we have a low level of debt on the balance sheet, I don't necessarily think that it's an either/or on the use of our cash, whether or not we can maintain or increase or let the board determine what size dividend we want to pay or divert it to other opportunities. They're not in all cases an either/or situation.

And could you give me a little bit of color into the decision the board made of maybe why they didn't increase the dividend this time? I estimate another quarter of the special dividend would have cost about $35 million and there's well over $600 million on the balance sheet. Is there any reason to keep $600 million on the balance sheet versus $500 million?

We have declined to give a formula and so I'm going to stick with that as to if you look over a several year period you will see that the amounts that we have paid have grown, but no future color that I could give you as to how that would happen.

One final question. What's the maximum amount of cash you guys would leave on the balance sheet? Would it go up to $800 million, $900 million ultimately, or is there a cut-off that you want to have there?

I think that would be getting into a formula. We will look at all the factors involved, including cash needs and cash requirements, which would change over time, in setting our special dividend.

All right. Great, thank you. I'll turn it back.

Thank you. Your next question comes from Waqar Syed of Tristone Capital.

I understand that Transocean is in the process of marketing or selling some of its semi-submersible rigs in the North Sea. Do you guys have any interest in those rigs or otherwise you think that maybe on the cycle it doesn't make sense to buy rigs at this time?

That's something that you would need to ask Transocean, I would think. They're handling that sale and I don't want to get into their business.

No, I'm asking you, would you be interested in this part of the cycle to make acquisitions? The last time you bought semi-submersibles you paid like $60 million, $70 million. It's unlikely you can pay that much for a rig now. Would you have any interest in buying at this time?

I can agree that we're not going to see in the foreseeable future those kind of rig prices, but beyond that, if things are up for sale or not up for sales, you'll hear a comment from us. And I don't mean to be less than clear, but I think anybody that's in the business, as we have been, in buying rig purchases, cannot make comments as to -- that we're interested in this one or that one, or any particular opportunities that may be out there.

Great. Gary, you gave some guidance for 2008 costs last quarter. Could you repeat that again for us, please?

For the year?

For the year, yes.

We're still looking at -- we had said 18% to 20% over last year. We're still expecting somewhere around that with the weakening of the U.S. dollar, as talked about, probably toward the upper part of that 20%. But not substantially outside that range.

Okay, great. Thank you very much.

Thank you. Your next question comes from David Smith of JPMorgan.

Wondering if you can talk about the labor situation, what you're seeing on turnover and maybe where wage inflation is running now and if that's changed over the last 12 to 18 months.

I would think we've continued to see demand for people, but I would say our wage escalation is not running away from us. I haven't seen that to be the case. Certainly we're pleased to be able to return and make sure that our employees enjoy this up cycle as well, and so we've been making steady increases, but they're not beyond what I think is reasonable given the business environment.

Is there a maybe a numeric range around that?

I guess we've said that overall, if you strip out of our cost the fact of new rigs and rigs going overseas, both of which drive up costs on a year-to-year basis, that we've been looking in the 10% range, 10% to 12% range for overall inflation. Wages are a component of that.

About half, probably?

Half might be a reasonable guess as to broadly define what are all the components, but there's also components on prices we pay for goods as well. And those two things split back and forth. But those are in the ranges of what we're looking at.

Is that 10% to 12% across all of the OpEx fairly evenly distributed, so we would be looking at a similar range for labor?

No, if I said if our costs go up 10% to 12%, half our costs are labor, then our labor is not necessarily driving up at that rate.

Okay. And any thoughts on turnover, how that's been tracking?

We're pleased with our turnover. We have retention programs in place. We offer lots of promotional opportunities in addition to that and we are comfortable that for the foreseeable future we're able to maintain adequately trained crews and we're committed to continuing to do that.

Okay. Well, thank you.

Thank you. Your next question comes from Arun Jayaram of Credit Suisse.

Gary or Larry, I was wondering if you could comment a little bit. You have a lot of rigs that you have done survey work over the last couple of years. Just wondering if you could comment on some of the challenges of getting these surveys done in a timely manner and is it getting easier as your experience grows or does the tightness make it more challenging?

It's a constant challenge, I think, for us and for everybody that's in the industry to get anything done on a timely basis because there's a huge demand in shipyards. Many of the shipyards are involved in new construction projects. And so being able to get space to perform your surveys is an issue. Getting labor and welders, because when you go in you're doing any kind of upgrade that you've got, being able to take equipment off, service it, and get it returned by the time you're ready to set sail is a huge challenge. I would guess in -- on looking at this year versus last year, most of our surveys last year were domestic and this year most of our surveys are international. So the international ones are always more challenging because they're further away and each individual market is unique. So far I'm pleased with our ability to manage. We've had some rigs go over. We've had some rigs go under and so I'm pleased with that. But you'll have things like weather that are really not related to this market that can be a huge variability.

Okay. During these SPSs, particularly on the floating rig fleet, are there common things that you're seeing in terms of things that are addressed during the SPS and any surprises you're seeing, given the age of the fleet?

Well, sometimes we'll see a rig that will be in -- have some deterioration over and above what we might have expected, but we try to do a lot of presurvey of -- where we can before we get in there and adequate planning is the best tool that anybody has to be able to manage these type of projects. So by and large, I think we're seeing what we expect and then occasionally we'll see a rig that's in much better shape than our fears or our initial survey may have indicated that it would be. So all those balancing out, we're comfortable that they're staying more or less as we expect.

Last question, in the fleet status you did update and it looks like there's no changes to the 2009 survey schedule. Do you have a read on 2010? Is it going to be similar to '09 or it could be a heavier load in 2010?

2010 will be less, just from the number of rigs that we've got scheduled for survey. We have our 45 or so rigs that we've got are scheduled primarily to be in every five years, and they have a two-year cluster, which is occurring in 2008 and 2007. So when we get to 2010, I don't know the number, but it would probably be four or five rigs.

Just to clarify, it will be definitely less than this year, probably similar to 2009, give or take -- .

That's on the scheduled shipyards. But we also, if we have a job and we have elected to take rigs off-line to do upgrades for jobs. For instance, going into Brazil can take some period of time to do that, which we'll characterize that as shipyard, and then there will be an acceptance testing on the other end that we'll face in Brazil, Mexico, and some of the other locales. So those are almost voluntary. We look at the cash flow impacts of it before we make those overall decisions, so those kind of things could be variable. But we are expecting, as we clear through 2008, that we will see declines in 2009 and 2010.

All right, that's very helpful, gentlemen. Thanks a lot.

Your next question comes from Dan Boyd of Goldman Sachs.

You mentioned earlier that the market rate on the Shield was 175 for the five months. Is it safe to assume that on a two or even a one-year contract that the market rate would be lower than that?

It depends on the area. I think what we're seeing with respect to the new-build commitments in particular that have come out and been contracted recently have run in a range anywhere from somewhere in the low 160s to 190, maybe a little bit better. There are certainly exceptions to that rule, or exceptions to that characterization, if you will. Northwest Europe, the North Sea and Norway are substantially higher based on higher cost of entry and limited supply. On the low side you will see some things in the mid one teens, like the Gulf of Suez. And for some short-term and either every difficult or opportunistic commitments, we're still seeing a commitment now and then above $200,000 a day. But generally I think those rigs are going to be, at this stage, somewhere in the 165, 170, to 190 range.

Okay. I know you don't want to comment specifically on the Scepter, but that is pretty much the same rig as the Shield and I know the Scepter received 175 for five months. It's likely that if the Scepter was on a longer term contract it would be lower though. Is that the correct way to read that?

No, I don't think so.

Part of it is area-specific in Malaysia. That is part of it.

Okay. And then, Larry, if you can comment more, you mentioned acquisitions. Can you talk about what you are seeing out there in terms of opportunities. If you would be willing to acquire a new-build as part of your acquisition strategy. And then also you mentioned the clean balance sheet and the balance sheet optionality you have, what levels of debt would you be comfortable with?

We are committed to enhancing shareholder value and so we look at opportunities all the time. I think it's going to be really dependent upon pricing that's out there. And I think in general new-build pricing is still at a premium and we would look for that rare situation. And we're no different than anybody else. So I understand that there's not going to be any great steals out there, because everybody would be dancing around that same thing. So we would look at that. We always look at used equipment across a wide variety of areas, because we think that there can be some really good values there at a point in time when other costs are escalating. So far as debt on the balance sheet, I can't really tell you. But when you start with our low level and with the market cap of the overall Company, obviously as -- when you look at what rigs or a couple of rigs would cost, there's clearly room to take on -- to contemplate debt in that range without being over levered.

Given that new-builds are likely to be priced at a significant premium, I guess it's safe to assume then that you're unlikely to do a new-build, or better said, more likely to purchase used equipment or an existing rigs on the market.

I wouldn't rule that out, because it all depends on the specifics of the rig and the contract opportunity. So you will have to -- as you indicated, you may believe in our history has been more towards used equipment, but I think we surprised the market when we ordered two new jack-ups. Thanks. Which worked out -- has worked out very well for us.

Your next question comes from Bill Sanchez of Howard Weil.

Morning. Just one question following up on the Scepter. I guess on previous conference calls there was some thought that that rig might actually start off in the Gulf of Mexico and given the comments this morning, is it just likely we go straight from the shipyard internationally, or could this thing still go in the Gulf of Mexico for a brief period of time before starting a term contract internationally?

I said at the beginning that we are in advanced stages on an international contract. So unless the wheels fall off that for some unforeseen reason, that would be our initial job.

That's it for me. Thank you.

Thanks. Let's take a couple more questions.

Thank you. Your next question comes from Geoff Kieburtz of Citi.

Geoff?

Can you hear me?

Now I can, Geoff. How are you doing?

Okay, how are you doing?

How was your trip?

Made it back okay.

Made it back from Mexico?

Yes. A short-term question. Looking at the high spec, the midwater and the jack-up categories, all three categories had increased utilization, but the high spec and jack-up operating expenses went down, where as the midwater operating expenses went up on a sequential basis. What is going on there?

I'll let Gary comment on that because we don't have a -- I'm sure it's related to survey costs and things that we're spending on the rigs in total.

Well, for the jack-ups, you're right, that went down and that was due in the fourth quarter we had survey costs on the Crusader and the Tower which we incurred. Also in the fourth quarter we had some 210 days worth of warm-stack time and when you are warm-stacked without a job, you have additional costs, such as fuel and helicopter, travel, et cetera. And we worked the vast bulk of the time in the first quarter, we put up those rigs back to work. So we had no surveys and no stacking type costs, so that's what drove those costs down in Q1.

Gary, sorry, just to clarify, though, your costs when you're warm-stacked are higher than when you're operating?

Yes, because while we're operating, there's fuel getting the crews back and forth to the rig, that is part of operating cost.

There are certain costs that the operator will pay for.

Got you.

And they then switch to us. And then in addition, in this market, if we're down for a short period of time, then we will do catch-up maintenance, so you will actually see more money go out the door during those times. We would only cut back on our operating expenses if we thought there was a long-term stacking thing in front of us. But I think with, as Gary indicated, any of the swings that you've seen in the individual components from Q4 to Q1 are situational specific and there's no indication of long-term trends that jack-up costs are out of whack or that age of the midwater fleet is catching up, and, therefore, it costs -- any of those type conclusions I don't think are valid. I think the rigs are pretty much operating within budget as we had designed it.

For the midwater fleet or the semi-submersible easily answered by the Patriot, that was in for survey in the first quarter of this year, and as we had indicated, that was one of our higher cost surveys that we anticipated. And those costs still went a little bit over than what we actually anticipated.

Just to come back on the questions that have already been asked on the Shield. Just so I make sure I understand it, you have a prior commitment at 265, but you would say that the current market is 175 for that rig?

Well, they're different areas. Australia is going to be a much higher cost area and it's a timing issue. There were very few competing jack-ups at the time that we entered into that original commitment. And now the market has gotten a little more competitive and in Malaysia that is probably a pretty good number for Malaysia. We've seen commitments in that area for new rigs as low as the low 150's.

Right. Okay. I guess -- I don't know if this is an answerable question, but at the time you signed the contract for the rig in Australia, what would you say the rates would have been in Malaysia?

Originally, I believe there were -- or early on I believe there were some commitments in Malaysia in the low 200's.

So we have seen a, in your mind, a decline in the day rate environment in Malaysia on the order of maybe $50,000 or $60,000?

Yes, I mean this is a single data point and you can't totally draw on that. It is reflective of the market that there's new delivered rigs that took short-term jobs and there's more bidding activities and Malaysia has -- the approval process of contacts can be drawn out and we wanted to fill it in on a short-term basis. A number of factors all brought it to bear, but we don't feel like we underpriced it in the market and I don't necessarily -- the market certainly has come down from an earlier point in time. Internationally, broadly speaking, when you go out for bid for new rigs, many of the bids now will be certainly under 200 and they were above 200 at one point in time. And I don't think that's a surprise or that you had to wait necessarily for this posting to be able to see that.

Sure. And my last question is somewhat strategic in nature. Has the recent sort of dialogue or lack of dialogue, I'm not sure, going on between SeaDrill and Pride prompted any renewed strategic dialogue or discussions within Diamond? Is this a factor or is this really not very important to you?

Well, we monitor everything that goes on around the world, but we're comfortable with where we are. We believe that we can continue to compete with anybody, that we're a sufficient size and we're comfortable with that. Certainly we've seen merger activity up to this point in time and that we'll see some more, but it's not causing us to change our goals.

Thank you.

We'll take one last question.

Thank you. Your final question comes from Ole Slorer of Morgan Stanley.

Thank you very much. Just back to what you said on new buildings, I can understand acquisition of second-hand units, opportunistically that makes sense, But just to clarify on new building floaters, there was another announcement today about a Company that bought two or there is three sales for $800 million. What's your view in terms of recommending something like that to your board at that type of a level? What type of a return do you think you can get on that relative to investing in your own asset base?

Well, I think we've deployed a lot of cash into our own asset base and that's why we've elected to return cash via the dividend mechanism. Certainly when there's been some movement in rates on fifth generation rates, but I'm not sure that they're enough to compensate for the $800 million plus of valuations of new-builds. That the math is no great secret there, that if you just run that existing day rates that you have today on out 20 years, that you'll be in the 12%, 13% pretax rate of return on $800 million plus drill ships. And that's okay, but it's certainly not the high rates return that I think you would want to put that much money -- that we would want to put that much money out there.

So how likely do you think it will be that you would recommend to your board to make an investment into a new rig, a new construction project at this point?

I think we've given you enough guidance as to -- with the kind of rates of return that we've done. You can look at it historically what we've done, but I wouldn't want to specifically say that we would not do a new-build because there might be a situation with some special factors where we could make that pay. But certainly your plain vanilla commit for $800 million and take a day rate below 500, and we've seen some of those, that's not attractive to us.

So in order to do that, would you need a contract locked up beforehand that could guarantee you -- would that be a hurdle that would you require?

Contracts are good, but again, I think rates are -- the rate of the contract is very important.

Thank you very much.

Thank you. I appreciate everybody joining us today and we will talk to you in approximately 90 days.

Thank you. This concludes today's conference call. You may now disconnect.