Valaris Ltd

NYSE:VAL

Earnings Call Transcript 2021-Q3

[Operator]

Good day, everyone, and welcome to Valaris' Third Quarter 2021 Financial Results Conference Call. Please note that this event is being recorded.

I will now turn the call over to Mr. Tim Richardson, Director of Investor Relations, who will moderate the call. Please go ahead, sir.

[Tim Richardson, Director of Investor Relations]

Welcome, everyone, to the Valaris Third Quarter 2021 Conference Call. With me today are Interim President and CEO, Anton Dibowitz; Interim CFO and Vice President Investor Relations and Treasurer, Darin Gibbins; and other members of our executive management team.

We issued our press release, which is available on our website at valaris.com. Any comments we make today about expectations are forward-looking statements and are subject to risks and uncertainties.

Many factors could cause actual results to differ materially from our expectations. Please refer to our press release and SEC filings on our website that define forward-looking statements and list risk factors and other events that could impact future results.

Also, please note that the Company undertakes no duty to update forward-looking statements. During this call, we will refer to GAAP and non-GAAP financial measures. Please see the press release on our website for additional information and required reconciliations.

As a reminder, we issued our most recent Fleet Status Report, which provides details on contracts across our rig fleet on October 27. An updated investor presentation will be available on our website after the call.

Now I'll turn the call over to Anton Dibowitz, Interim President and CEO.

[Anton Dibowitz, Interim President and CEO]

Thanks, Tim, and good morning and afternoon to everyone. Welcome to the call, and thank you for your interest in Valaris. During today's call, I will start by providing a brief overview of Valaris, highlighting the key attributes that make Valaris the industry leader in offshore drilling. I'll then provide some commentary on the current state of the offshore drilling market and highlight some of our recent contract wins.

I will also provide an update on ARO Drilling, a 50-50 joint venture with Saudi Aramco. Lastly, I will discuss some of our recent developments on sustainability. After that, I'll hand the call over to Darin for a financial update, including preliminary 2022 guidance.

Valaris is the largest drilling contractor by fleet size, but more importantly, we have the highest quality fleet in the industry as ranked by an independent third party. That fleet is managed by a best-in-class team that is guided by strong values and a purpose-driven culture.

Our operations have unmatched scale and geographic reach with a presence in virtually all major offshore regions, and the most extensive customer base of any offshore driller. And those operations are delivered with an industry-leading cost structure built around the shared services model, which allows our cost structure to quickly adapt to changes in the market environment.

We focus every day on delivering safe, reliable and efficient operations to our customers. And I would like to take this opportunity to thank the Valaris team for continuing to deliver the strong performance that our customers have come to expect from us, again, during the third quarter.

This performance is evidenced by the 99% revenue efficiency, both during the third quarter and year-to-date, and our personal safety performance that has improved 25% year-to-date in 2021 as compared to our full year 2020 performance. This is particularly impressive considering the challenging working conditions faced by offshore crews and support teams during the ongoing pandemic.

Valaris is an operationally leveraged play into a recovering market, and one that is underpinned by the strongest balance sheet in the offshore drilling sector. Our balance sheet provides ample liquidity to fund operations and the flexibility to make disciplined decisions about bringing new capacity to the market when justified by the economics of new opportunities.

Turning to the market. Spot Brent crude prices have recovered strongly in 2021 from the pullback in 2020, resulting from the COVID-19 pandemic. Given the long lead times for offshore projects, particularly those in deepwater, our customers tend to be more focused on medium-term commodity prices rather than what is happening in the spot market.

Two-year forward Brent crude prices are currently around $70 per barrel, the level that is viewed as highly constructive offshore project demand. Research from Rystad indicates that floater demand is expected to increase at a compound annual growth rate of approximately 6% between 2021 and 2025, and this growth is expected to be driven by both exploration and development drilling.

This is a strong signal of our customers' conviction in the economics of deepwater projects and is positive for term demand for these rigs as new exploration activities will lead to future appraisal and development campaigns. We are already seeing tangible evidence of this improvement in the number of awarded contracts, inquiries and tenders as well as in discussions with our customers.

We've seen several multiyear awards in Brazil during 2021, and there are a number of active tenders currently in progress. Brazil is reportedly seeing double production by 2030. And with offshore resources that can deliver production at attractive economics we anticipate that Brazil will be a significant driver of offshore demand over the next several years. U.S. Gulf of Mexico operators have expedited rig selections this year in anticipation of a lack of supply which has played a key role in pushing day rates in this market higher.

We have also seen a noticeable increase in deepwater tendering in West Africa, where activity fell to an extremely low level in 2020. Growth in the jackup market is expected to be more muted than for floaters. This is not surprising given that jack-up demand was more resilient during the downturn, with a significant portion of demand driven by infill drilling and a large portion of the customer base being national oil companies, which are more likely to maintain activity during low parts of the cycle to meet state production and fiscal budget targets.

The recent rise in commodity prices has, however, driven an increase in tendering activity, particularly in Southeast Asia and the Middle East, and there are ongoing tenders that could result in a significant number of incremental rigs being contracted.

We see limited near-term opportunities in the harsh environment jack-up market on the Norwegian continental shelf through the end of 2022. Consequently, some of the rigs ending their contracts in Norway are now actively competing for work in other sectors of the North Sea, which has increased competition in those markets.

We anticipate this will be a transitory issue with the Norwegian market expected to improve in 2023. Against this market backdrop, we will continue to actively manage our fleet and contracting activities to position Valaris for success.

In response to the decline in demand for hydrocarbons and offshore drilling services during 2020, we carefully preservation stacked a large portion of our floater fleet, to help preserve cash in the near term while maintaining option value on their future cash flows in a market recovery.

The quality of these rigs are detailed rig-specific reactivation procedures, strong customer relationships and operational track record gave us confidence that Valaris rigs would be at the front of the cube when demand supported reactivating stacked assets, and we are now seeing this play out.

Over the past few months, we have secured long-term contracts with important deepwater customers for four of our seven preservation stacked drillships. We will continue to take a disciplined approach to fleet management and contracting. Now that we have improved earnings visibility with 8 of our 11 drillships currently or future contracted, we have increased the economic hurdle rate for both follow-on contracts and future reactivations.

We continually review our fleet for divestiture and retirement candidates. Since the last conference call, we sold one of our preservation stacked jackups, Valaris 142 and to an operator with specific use restrictions to ensure that it will not compete against our own rigs.

We also retired a further two legacy jackups. We have now retired 18 rigs since the beginning of last year, and more than 50% since the beginning of the downturn. We will continue to take a disciplined returns-focused approach to fleet management as we position Valaris to maximize earnings and cash flows during the market recovery.

Moving now to our recent contracting success. Our high-quality fleet, keep customer relationships and demonstrated track record of operational performance have enabled us to continue translating our operational leverage into meaningful backlog additions with approximately $330 million added in the past three months and more than $2.1 billion added year-to-date.

As a result of these new contracts, Valaris' total backlog has increased to more than $2.3 billion from just over $1 billion at the beginning of the year. These backlog additions have enhanced our earnings visibility and importantly, have been added at higher day rates, which will help delay the foundation for improved financial performance in 2022 and beyond. More than $1.7 billion of the backlog added year-to-date has been for our floater fleet, including several multiyear drillship contracts.

As a result of these contracts, the average day rate within our floater backlog has increased by 25% year-to-date to $235,000 a day. It is also worth noting that approximately 75% of the backlog added year-to-date is with majors and large international oil companies, the primary users of high-specification floaters.

Our contract wins year-to-date represent an outsized share of those awarded in the market. Valaris owns approximately 8% of the global fleet, but has won 15% of total fixtures and 13% of total rig years awarded. I'd like to take the opportunity to recognize all the Valaris team's success over the past several months.

We've been particularly successful in securing work for our drillship fleet winning several multiyear contracts over the past few months. On the prior quarter conference call, we announced contracts for Valaris DS-11, DS-16 and DS-18, all for work in the U.S. Gulf of Mexico. More recently, we have been awarded contracts for Valaris DS-4 offshore Brazil, as well as DS-9 and DS-10 offshore West Africa, enhancing our presence in each region of the Golden Triangle.

Valaris DS-4 was recently awarded a contract with Petrobras for a minimum term of 548 days. Rig was previously preservation stacked in the UK and just recently arrived in the Canary Islands, where it will be reactivated and then mobilized to Brazil. The contract is anticipated to commence by early second quarter 2022.

We are very pleased to place another rig in Brazil with the largest customer in that market. as we expect Brazil will be one of the primary drivers of incremental floater demand over the next few years. We have also recently been awarded a two-year contract for Valaris DS-9 with Exxon Offshore Angola, which is expected to commence in the second quarter of 2022. DS-9 is currently preservation stacked in the Canary Islands and will be reactivated and mobilized to Angola for this project.

DS-9 is one of the most technically capable assets in the global fleet, and we look forward to getting her back to work. We also recently won another short-term contract for semisubmersible Valaris MS-1 offshore Australia, and are in advanced discussions for a further short-term follow-on job.

Importantly, these contracts helped to bridge a gap in the rig schedule before it is due to start a longer-term campaign in the second quarter of 2022, and should keep the rig almost continuously utilized through the middle of 2023. We now have both the DPS-1 and MS-1 contracted on longer-term projects offshore Australia. This is the market that these rigs were built for and where they have a successful operating history.

Finally, we also have won several new contracts for our jackup fleet since the second quarter call. These include projects in the UK, the Netherlands, the U.S. Gulf of Mexico, Southeast Asia and Australia. We were also awarded a seven-month extension for Valaris 36, one of our rigs leased to ARO Drilling in Saudi Arabia.

As a reminder, ARO Drilling is a 50-50 joint venture with Saudi Aramco. We view ARO as an important strategic asset since it places us in a privileged position with the largest customer of offshore drilling rigs in the world, with ARO and Valaris combined holding nearly a 40% share of Saudi Aramco's offshore drilling rigs currently under contract.

Since ARO is an unconsolidated joint venture, we believe that many investors and analysts do not fully appreciate the value of ARO to Valaris. ARO owns a fleet of seven jackup rigs, operating under contracts with Saudi Aramco with a contract backlog of more than $750 million. ARO leases an additional seven jackup rigs from Valaris through larger arrangements, each also operating under contracts with Saudi Aramco.

ARO recently signed a short-term extension for one of the leased rigs, and negotiations are ongoing related to longer-term extensions for most of these assets. Substantially all operating costs for the leased rigs are incurred by ARO, meaning the lease revenue represents nearly 100% margin for Valaris.

Finally, ARO intends to build 20 jackups over the next decade, with the first two scheduled to be delivered in the second half of 2022. Each of the new builds are backed by long-term contracts with Saudi Aramco at attractive economics. Given these economics, the newbuild rigs are expected to be financed by cash from ARO operations and third-party financing.

We do not expect Valaris or Aramco will need to provide any additional financing to ARO to fund the newbuild program. Further information on ARO can be found in a separate investor presentation on the Valaris website.

I would now like to spend a few moments talking about offshore drilling and its place within the energy transition as well as specifically vector. Many of our customers have set goals to lower or eliminate net greenhouse gas emissions.

Recent WoodMac study on emissions intensity highlighted that offshore oil and gas production has amongst the lowest carbon emissions of all the types of production. As a result, we expect some operators with exposure to multiple sources of production to shift focus to lower intensity sources such as offshore to meet their emissions targets.

As a part of the value chain that delivers reliable and affordable energy, we recognize the importance of producing that energy responsibly. The emissions from our drilling rigs currently represent the largest contributor of atmospheric CO2 in our business, and therefore, decarbonizing our own operations are the initial focus in our sustainability efforts.

Recent developments on this front include harsh environment jackup Valaris 123 being upgraded with a selective catalytic reduction, or SCR, system in advance preparation of a wellbore of the Porthos CO2 transport and storage project.

Volaris now has an SCR system fitted on four drillships and one jackup. When in operation, the SCR system is designed to eliminate almost all NOx and SOx emissions from the rig. In addition, drillship Volaris DS-12 recently became the first vessel in the world to receive the ABS enhanced electrical system notation, EHS.

This system is designed to allow the vessels to optimize its power plant performance enabling operations on fewer generators and thereby reducing emissions. The system may have both environmental and financial benefits as we expect to share the financial gain of any fuel savings with our customer.

On a similar note, Valaris Viking, an ultra-harsh environment jack-up operating offshore Norway, recently achieved a fuel incentive award from its customer. This was achieved through implementation of an energy management plan that helped the rig to avoid nearly 200 metric tons of CO2 equivalent emissions over a two-month period.

We're pleased that our efforts in the ESG area are being recognized by our customers. The Volaris recently being ranked Best Performer for Drilling Rigs in ENI's 2021 HSC and sustainability awards.

I'd like to conclude by reiterating some of the key points and priorities from my prepared remarks. First, the size and quality of the Valaris fleet and demonstrated operational track record coupled with our industry-leading cost structure, provides significant earnings potential in a market recovery.

The Valaris management team and Board are laser-focused on maximizing earnings to drive meaningful free cash flow as the market recovers. To achieve these objectives, we are focused on the following: first, exercising our operational leverage in a disciplined manner with respect to contracting both our active fleet and also when further reactivations may be warranted.

Second, continuing to take a rational approach to fleet management including continually reviewing our fleet for further retirements when economics don't justify holding them.

Third, maintaining an industry-leading and adaptable cost structure and finally, highlighting the significant inherent value in ARO.

In summary, we believe that Volaris is well positioned to benefit from the opportunities we see in the market today and we will continue to focus on delivering against the priorities I just mentioned.

I'll now hand the call over to Darin to take you through the financials.

[Darin Gibbins]

Thanks, Anton, and good morning, everyone. I'm excited to be speaking to you all today on my first conference call at a time when we are seeing tangible signs of a market recovery. The volume of recent contract awards and associated backlog, particularly for the floater fleet, has provided greater visibility into future earnings.

And as a result, I will be providing preliminary 2022 guidance on today's call. In our most recent fleet status report published last week you can see an encouraging view for floater day rate progression over the next few years with average day rates increasing meaningfully each year.

In my prepared remarks today, I will provide an overview of third quarter results our outlook for the fourth quarter and full year 2021 and provide preliminary guidance for 2022. In addition, I will briefly review our financial position and capital structure. I would also like to highlight our third quarter results press release.

Beginning last quarter, we significantly enhanced the level of disclosure in our press release to provide additional transparency. You'll continue to see a trailing five-quarter analysis for the income statement, balance sheet and cash flows as well as supplemental data by asset category for revenues, contract backlog and average day rates, utilization, revenue efficiency, rig numbers and available and operating days.

You will also see offshore gross margins by asset category and onshore support costs that are incurred supporting rig operations. As a reminder, these costs are included within contract drilling expense on a consolidated basis and include non-G&A items such as our regional support basis. As Anton mentioned earlier, we have been successful in winning contracts for several of our preservation stacked assets.

As a result, we will be incurring onetime reactivation costs to put these rigs back to work. We estimate it will cost in the range of $30 million to $45 million to reactivate the preservations stacked floater and $10 million to $20 million to reactivate a preservation stacks jack-up. These estimates include all costs to reactivate the rig, but do not include mobilization costs or costs for contract or region-specific upgrades for which we would generally expect to be compensated.

These reactivation costs will have a negative impact on earnings and cash flows in the period they are incurred. However, by returning these rigs to the active fleet, we expect to benefit from increased earnings and cash flows in the future. The majority of these costs are recognized in our income statement with the remainder recognized as capital expenditures. We believe that investors should consider these like growth capital expenditures and back the income statement portion out of EBITDA.

As such, we have presented results on both an EBITDA and EBITDAR basis, which strips out these reactivation costs. We believe that Valaris has a compelling value proposition built on our four key elements: and that the best way to value Volaris is on a sum-of-the-parts basis. As a result, we have also presented analysis in the press release broken out by these four value drivers.

First, the active fleet of 31 rigs that is generating positive cash flow today; second, our leased and managed rigs comprised of seven rigs we leased to ARO Drilling under bareboat charter agreements with the Valaris 37 recently coming off contract, and two rigs that we manage on behalf of a customer in the U.S.

Gulf of Mexico; third is stacked fleet, which includes many high-specification assets, which we have already demonstrated the ability to win work for; and finally, ARO Drilling, our unconsolidated 50-50 joint venture with Saudi Aramco, which is a cash-generative business with significant growth plans.

Because we emerged from financial restructuring at the end of April, the second quarter results include one month related to the predecessor company and two months for the successor company. During my review, I will compare the third quarter with combined second quarter results, which are non-GAAP and as I believe that this comparison provides the most meaningful basis to analyze our results.

Reconciliations between non-GAAP combined numbers and GAAP numbers for the predecessor and successor periods are provided in our quarterly results press release and are more fully described in our third quarter 10-Q filings.

Moving now to the third quarter results. Adjusted EBITDA was $30 million compared to $17 million in the combined prior quarter. And adjusted EBITDAR which as a reminder added back onetime reactivation costs, was $49 million compared to $41 million in the combined prior quarter. Revenues for the third quarter were $327 million compared to $293 million in the combined prior quarter.

Excluding reimbursable items, revenues increased to $293 million from $261 million primarily due to higher utilization for the floater fleet as drillships Valaris DS-15 and DS-12 started new contracts with Total Energies in June and July, respectively.

DS-15 is currently working offshore Brazil and DS-12 is working in West Africa offshore Ivory Coast. Also semisubmersible Valaris MS-1 commenced a contract with Santos offshore Australia in May and benefited from a full quarter of revenue in the third quarter. Contract drilling expense for the third quarter was $274 million compared to $254 million in the combined prior quarter.

Excluding reimbursable items, contract drilling expense increased to $255 million and $236 million, primarily due to additional operating days for the three rigs I just mentioned. This increase was partially offset by rig reactivation costs, which declined to $19 million in the third quarter from $24 million in the combined prior quarter.

Third quarter reactivation costs primarily related to the reactivation of jackups Valaris 249 and 117 from preservation stacked and warm stacked, respectively. Valaris 249 is currently mobilizing to New Zealand from the UK for a 400-day contract with OMV, which is expected to commence early in the first quarter of 2022 and Valaris 117 recently commenced a two-year contract with ENI offshore Mexico.

General and administrative expense increased to $27 million from $19 million in the combined prior quarter, primarily due to severance costs related to the departure of certain senior executives. Onshore support costs, which are included within contract drilling expense in the income statement, declined to $27 million from $29 million.

Some of these two categories provides our total onshore support costs, which increased to $54 million in the third quarter from $48 million in the combined prior quarter. Depreciation expense declined to $24 million from $54 million in the combined prior quarter due to a full quarter impact of fresh start accounting adjustments.

We've significantly reduced the carrying value of property and equipment on the balance sheet. Other expense was $3 million in the third quarter compared to $3.5 billion in the combined prior quarter due to reorganization items and fresh start accounting adjustments in the predecessor period of the second quarter.

Please refer to our third quarter 2021 Form 10-Q filing that can be found on the Investors page with the Valaris website for further details regarding reorganization items and fresh start accounting. Tax expense of $53 million in the third quarter of 2021 compared to a tax benefit of less than $1 million in the combined prior quarter.

The third quarter tax provision included $39 million of discrete tax expense primarily related to changes in liabilities for unrecognized tax benefits associated with tax positions taken in prior years. The combined prior quarter tax provision included $13 million of discrete tax benefit primarily related to fresh start accounting adjustments. Adjusted for discrete items, tax expense of $14 million in the third quarter compared with tax expense in the combined prior quarter.

Notably, we anticipate a tax refund of $97 million related to the CARES Act, so the timing of this receipt is uncertain and may or may not occur prior to the end of this year. Now moving to our fourth quarter 2021 outlook.

We expect total revenues will be in the range of $310 million to $320 million as compared to $327 million in the third quarter. The sequential quarter decline is primarily expected to be driven for revenues from the jackup fleet, resulting from the softness we are currently seeing in the harsh environment jack-up market.

Valaris Norway has moved from a drilling contract offshore Norway to a combination work in the UK at a significantly lower day rate, and the Valaris Viking is expected to have some idle time in the fourth quarter after completion of its current contract.

We anticipate that fourth quarter contract drilling expense will be in the range of $275 million to $285 million as compared to $274 million in the third quarter, primarily due to higher reactivation costs, which are expected to increase to approximately $30 million in the fourth quarter from $19 million in the third quarter.

Reactivation costs in the fourth quarter primarily relate to floaters Valaris DS-4, DS-16 and DPS-1, which are scheduled to commence new contracts in the first and second quarters of 2022. Finally, general and administrative expense is anticipated to decline to approximately $20 million in the fourth quarter from $27 million in the third quarter, primarily due to executive severance costs incurred in the third quarter.

As a result, EBITDA for the fourth quarter is expected to decline to approximately $15 million from $30 million in the third quarter. Adjusted EBITDAR is expected to be approximately $45 million in the fourth quarter compared to $49 million in the third quarter. Adjusted EBITDA and adjusted EBITDAR for full year 2021 are anticipated to be approximately $90 million and $175 million, respectively.

In terms of our value drivers, this translated -- this translates to expected full year 2021 operating margin, exclusive of onshore support and G&A expense of $260 million to $270 million for the active fleet or $345 million to $355 million when adjusting for onetime reactivation costs of approximately $85 million.

$80 million $85 to million for our leased and managed rigs and carrying costs of $60 million to $65 million of the stacked fleet. Now, I'll move to third quarter results and fourth quarter outlook for ARO Drilling, our 50-50 joint venture with Saudi Aramco.

As a reminder, ARO is not consolidated in the financial results of Valaris. ARO EBITDA was $18 million in the third quarter compared to $28 million in the prior quarter. This was primarily due to a decline in revenues as one of ARO's owned rigs was out of service for a special periodic survey. The Valaris 22 completed its lease contract with ARO Drilling during the third quarter, after which the rig was returned to Valaris and subsequently retired.

ARO's fourth quarter EBITDA is expected to be approximately $20 million, providing full year 2021 EBITDA of approximately $100 million. Moving now to capital expenditures. Fourth quarter CapEx is anticipated to be $30 million to $35 million, approximately $10 million of which is for maintenance CapEx and the remainder for enhancements and upgrades, a portion of which is reimbursed by customers.

As a result, total capital expenditures for full year 2021 are expected to be $62 million to $67 million, which is lower than our prior guidance of $85 million to $95 million, primarily due to the deferral a certain cost to next year. Our recent contract awards have provided greater visibility into future earnings.

And as a result, I will now provide some preliminary financial guidance for 2022. This preliminary guidance assumes reactivations announced to date but does not include any potential incremental contract awards for the rest of the stacked fleet. As Anton noted, we will be highly disciplined when evaluating opportunities for future reactivations.

Based on current contract lead times, particularly for floaters, if we work to reactivate additional rigs in 2022, it would likely have a negative impact on 2022 EBITDA and CapEx, but would increase expected earnings and cash flow in future years. I would also note that our 2022 budget process is still ongoing, and I expect to further refine 2022 guidance on the fourth quarter conference call.

Revenues are expected to be $1.3 billion to $1.5 billion, up from approximately $1.24 billion in 2021. Revenues are anticipated to increase primarily due to a combination of higher utilization and higher day rates from the floater fleet. Contract drilling expense is anticipated to be $1.1 billion to $1.25 billion, inclusive of approximately $70 million to $80 million of reactivation expense.

The vast majority of these costs are expected to be incurred in the first half of the year related to the reactivation of drillships Valaris DS-4, DS-9 and DS-16 as well as semisubmersible Valaris DPS-1. Contract drilling expense also includes $35 million to $40 million of costs related to the stacked fleet, down from $60 million to $65 million in 2021 due to winning contracts for several of our high-quality stacked rigs in recent months and disposing of assets where we cannot justify the carrying cost of holding them.

G&A expense is anticipated to be $80 million to $90 million which, combined with $115 million to $125 million of support costs included within contract drilling expense, provides total onshore support costs of approximately $195 to $210 million in 2022.

The sum of these items provides adjusted EBITDA of $135 million to $175 million and adjusted EBITDAR, which adds back onetime reactivation costs, of $210 million to $250 million. Full year 2022 CapEx is expected to be in the range of $200 million to $250 million.

The year-over-year increase is primarily due to the 20-K upgrades to Valaris DS-11, which are being reimbursed by the customer, the three drillship reactivations I just mentioned, including certain customer or region-specific modifications, and higher activity levels, particularly for our floater fleet.

In total, we anticipate receiving approximately $155 million in upfront payments from customers in 2022 related to capital reimbursements and mobilization fees. It is worth noting that these and any other upfront customer payments, whether in the form of capital reimbursements or mobilization fees, are not included in our contract backlog or average day rates reported in our quarterly filings.

And for some of our recently awarded contracts, these represent a meaningful portion of the total contract value. Based on this guidance and our current market outlook, we expect to generate free cash flow in the second half of 2022 after completing several reactivations in the first half of that are expected to increase the future earnings power of our active fleet.

Of course, we will continue to look at opportunities to put the remainder of our stacked fleet back to work on attractive contracts. And depending on the time of those reactivations, it could impact cash flows in the second half of next year. We will remain disciplined in our deployment of capital as we look at these opportunities and would expect that any reactivation spend is recovered including a return on that spend over the initial contract.

Finally, I will provide a brief overview of our capital structure. Valaris has the strongest balance sheet in the offshore drilling sector. As of September 30, 2021, we had cash and cash equivalents of $621 million plus $34 million of restricted cash.

Our capital structure is simple. With only one tranche of debt in the form of a secured note due in 2028 with a principal value of $550 million. The coupon for the note is 8.25%, if paid in cash; 10.25%, if paid half cash, half debt; and 12%, if we elected to pick the entire interest payment.

Interest payments are due semiannually on May 1, November 1, and we must decide the interest payment option 30 days prior to the beginning of the interest payment period. The first interest payment of $23 million was paid in cash, and we will pay the next installment in cash in May of next year.

The note provides a pari passu debt basket of $275 million and junior secured debt capacity of the greater of $200 million or 8% of total assets. Finally, our note allows for the flexibility to contribute all of our floating rigs to an unrestricted subsidiary and release their leans subject to meeting a 2x pro forma adjusted interest coverage ratio, providing additional financial flexibility.

With the strongest balance sheet in the industry and the flexibility provided in our senior secured notes, we are well positioned to take advantage of contracting and strategic opportunities as they arise.

However, we will continue to be disciplined in our allocation of capital as we focus on driving increased earnings and cash flow as the market continues to recover. We've now reached the end of our prepared remarks.

Operator, please open the line for questions.

[Operator]

[Operator Instructions] And the first question comes from Fredrik Stene with Clarksons Platou Securities. Please go ahead.

[Fredrik Stene, Clarksons Platou Securities]

Fredrik from Clarksons here. Congratulations on the first full quarter as a restructured entity. I wanted to touch upon the recent reactivations because that's been a discussion point with several of our clients here around the -- how you have approached it with your -- or in discussions with the clients. And I'm thinking the rate levels that would justify these reactivations.

And as a side comment, I believe you're in a bit of a different position than some of your peers as several of these assets have been stacked for a shorter amount of time. So I was wondering the way you bid in these assets, the periods that you have been comfortable with, and potentially the upfront fees or mobilization fees that you received for them, have you bid in, call it, the lowest hanging fruits now?

Or has it been more about bilateral discussion with clients based on asset capabilities, et cetera? And do you expect that the rest of your stacked, floater fleet in particular, can be reactivated economically at the same levels as you've done so far?

[Tim Richardson, Director of Investor Relations]

Fredrik, thanks for the question. I think there are a couple of questions there, but let me walk through them in series. I mean, obviously, the market has developed significantly since the start of the year, but generally, the way that we look at it is that for every job that we look at, it needs to be justified, including the reactivation.

We obviously have quite an advantage over the general fleet. The average stacked period of our stacked rigs have been in preservation stack for less than two years when talking about floaters now where the average fleet stacked carried is approaching four years, around three and half. So for us, it's a relatively easier project to reactivate a rig, and I know there's been debate about numbers that various folks have pegged on reactivation costs, but we stand by our costs.

The way we look at it is that especially for our rigs, the reactivation cost needs to be reimbursed or significantly reimbursed by the customer. That obviously can take a couple of different forms upfront within the mobilization payment part of it reimbursed based on the contract value or a combination of the two.

But as I said, the market has significantly improved. The spot market and clearing day rates that we see today are significantly ahead of where they were eight months ago. And as I said in my prepared remarks, the hurdle rates that we're going to consider when we look at future reactivations need to move commensurately with that.

That would apply both to follow-on contracts, but definitely, before we take additional capacity out onto the market. Look, to be frank, we were in a position at the start of the year where 4 out of our 11 drillships were active and on the market. And we've taken a great effort and a great job has been done by the team in order to get capacity out onto the market to have some earnings visibility.

The average backlog in our floater fleet has improved from around eight months at the start of the year to around 20 months where it's a tighten now. But we still have three great assets left floaters that we can bring back to the market when it makes sense, and we'll be diligent in what opportunities we put them on. So I think that probably covers most of your questions.

[Fredrik Stene, Clarksons Platou Securities]

Yes. That's very helpful. And I'm sure you know I put those questions about in a bit of a messy way. But you definitely touch up on the key points here. Just a follow-up on the assets that you haven't reactivated at this point on the floater side, and also actually on the jackup side, are you in active discussions for work for any of those assets?

[Tim Richardson, Director of Investor Relations]

We will -- obviously, we bid where we have attractive opportunities. So where the rigs are -- the way we consider it active rigs or rigs that are moving to contract. So we bid rigs beyond the rigs that are in the active fleet and working or on the way to a contract the economics need to be justified. So there is definitely additional work available. I mean we're seeing additional work in the Gulf of Mexico.

Obviously, we talked about Brazil and what's happening there. Ongoing tenders, but we expect there to be more. And West Africa, as I mentioned, out of the lows that they were in last year as additional work scopes that are under a tender there. So we definitely see opportunities -- increasing opportunities.

[Operator]

[Operator Instructions] The next question comes from Greg Lewis with BTIG. Please go ahead.

[Greg Lewis, BTIG]

I was -- I just had a question on the ARO fleet, not for the JV owned rigs, but for the leased assets. And just trying to understand, obviously, the two new builds, the 2005, 2006, are going to be delivering in -- next year. But as we look at the existing lease in rig fleet at ARO, is there any kind of way that we should be thinking about the evolution of ARO, i.e, is the fleet going to kind of be flattish to higher from here? Or could we see it I guess, as the new build program has changed, could we actually potentially see it maybe dip down in the medium term before it then accelerates growing in the outer years?

[Tim Richardson, Director of Investor Relations]

Look, I think a step back from ARO specifically for a second and look at the Saudi market in general. Saudi Aramco has a significant drive to increase rigs and, in fact, bring rigs from out of country to ads to their drilling programs. Obviously, ARO itself has the newbuild program, seven rigs owned by ARO and seven rigs leased in.

We are in discussions for additional lease extensions on a number of the leased rigs. So I think it's fair to expect them to carry on within ARO operated by ARO. But there's also definitely capacity given Saudi Aramco's plans to increase the number of rigs that ARO is operating in the kingdom.

[Darin Gibbins]

Greg, I'll just comment. There are two legacy jackups at ARO, leased to ARO. Those, if they aren't extended, are more likely retirement candidates.

[Tim Richardson, Director of Investor Relations]

But we do other assets around the fleet. And obviously, we're actively tendering in the tenders that are going in the Kingdom with our stacked assets and working assets, and we'll just have to see how it develops.

[Greg Lewis, BTIG]

Okay. And then just as I think about maybe some of those rigs that are either in Asia or I guess we have a couple in the Atlantic Basin. Are there any limitations or upgrades that would be required on any of those rigs or pretty much as we think about the rigs that are idle that could be marketed to Saudi? Are those rigs basically plug and play here or would they need some upgrades to be able to get in country to work for ARO?

[Tim Richardson, Director of Investor Relations]

Saudi Aramco has had some very specific and very high standards on how they want their assets to operate, very specific configurations, API, monogrammed, well controlled equipment. They're continually upgrading and extending their well-controlled manual. So I think it's true to say of our rigs and of pretty much any rig in the world that's going into Saudi Arabia that there is a fairly material CapEx upgrade program required in order to operate, which is part of the reason why rigs that go in there generally work not only because of stable work streams that Saudi Aramco has, but also because of that CapEx barrier to entry in order to get into the Kingdom.

[Operator]

[Operator Instructions] And it looks like we have no further questions. So this concludes our question-and-answer session.

I'll now turn the conference back over to Tim Richardson for any closing remarks.

[Tim Richardson, Director of Investor Relations]

Thanks, Tom, and thank you to everyone on the call for your interest in Valaris. We look forward to speaking with you again when we report our fourth quarter results.

Have a good day.

[Operator]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.