Transocean Ltd

NYSE:RIG

Earnings Call Transcript 2018-Q3

[Operator]

Good day, and welcome to the Third Quarter 2018 RIG Earnings Conference Call, Transocean Ltd. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Bradley Alexander. Please go ahead sir.

[Bradley Alexander, Transocean Ltd.]

Thank you, Brandon. Good morning, and welcome to Transocean's third quarter 2018 earnings conference call. A copy of our press release covering financial results, along with supporting statements and schedules, including reconciliations and disclosures regarding non-GAAP financial measures are posted on our website at deepwater.com.

Joining me on this morning's call are Jeremy Thigpen, President and Chief Executive Officer; Mark Mey, Executive Vice President and Chief Financial Officer; and Roddie Mackenzie, Senior Vice President of Marketing and Contracts.

During the course of this call, Transocean management may make certain forward-looking statements regarding various matters related to our business and company that are not historical facts. Such statements are based upon the current expectations and certain assumptions and are therefore subject to certain risks and uncertainties.

Many factors could cause actual results to differ materially. Please refer to our SEC filings for more information regarding our forward-looking statements including the risks and uncertainties that could impact our future results. Also, please note that the company undertakes no duty to update or revise forward-looking statements.

Following Jeremy and Mark's prepared comments, we will conduct a question-and-answer session. During this time, to give more participants an opportunity to speak on this call, please limit yourself to one initial question and one followup.

Thank you very much. I'll now turn the call over to Jeremy.

[Jeremy D. Thigpen, Transocean Ltd.]

Thank you, Brad, and welcome to everyone participating in today's call. As reported in yesterday's earnings release, for the third quarter of 2018, the company generated adjusted normalized EBITDA of $341 million on $816 million in total contract drilling revenues.

This industry-leading EBITDA was once again driven by the efficient conversion of our well-priced $11.5 billion backlog with strong uptime performance across our global fleet, generating revenue efficiency in excess of 95%, and the continued focus on organizational and operational efficiency resulting in adjusted normalized EBITDA margin of over 42% in the quarter.

In addition to producing solid operating results, during the third quarter, we entered into a definitive agreement to acquire Ocean Rig and its fleet of 13 floaters. When we considered all of the possible options for further high-grading our fleet of ultra-deepwater and harsh environment floaters, without compromising our liquidity position or balance sheet flexibility, Ocean Rig provided the right strategic opportunity for us.

The Ocean Rig fleet is currently comprised of nine ultra-deepwater drillships, which are seven years of age or younger, two harsh environment semisubmersibles, and two high specification ultra-deepwater drillships, the Santorini and the Crete, which are currently under construction. It's important to note that the shipyard has extended Ocean Rig attractive financing terms on the two newbuilds.

The Santorini is scheduled for delivery in 2019 with the final shipyard payment not due until 2023. And the Crete is scheduled for delivery in 2020 with the final shipyard payment not due until 2024.

According to our internal rig ranking tool, upon completion of this acquisition, we will control 31 of the top 100 ultra-deepwater and seven of the top 25 harsh environment assets in the world, strategically positioning us well ahead of the competition and better equipping us to capitalize on the market as it continues to recover.

Additionally, Ocean Rig will add approximately $743 million to our industry-leading backlog with ongoing operations with strategic customers in Norway and West Africa. The Extraordinary General Meeting, providing our shareholders the opportunity to vote on the proposed transaction, has been scheduled for November 29 and we anticipate closing the transaction in December.

Once closed, we will work quickly to fully integrate Ocean Rig into Transocean and begin realizing the $70 million in annualized synergies that we expect to generate through this combination. While we are pleased with the size, composition, and quality of our floater fleet, we may consider future opportunities that would enhance our industry-leading position. Having said that, we will remain very consistent and disciplined in our approach, exclusively targeting top-tier ultra-deepwater and harsh environment assets as part of transactions that do not materially compromise our near-term liquidity position.

As you will remember, just over a year ago, we employed that disciplined approach when we entered into an agreement to acquire Songa Offshore. With Songa, we acquired almost $4 billion in high-margin backlog and four new high-specification harsh environment semisubmersibles at a time when demand for these assets was beginning to strengthen in Norway. Since that time, the market has continued to improve, driving a 40% increase in purchase prices for similar assets.

Today, we believe that the global ultra-deepwater drilling market is on the verge of a similar recovery, which is why we made the decision to approach Ocean Rig. While the precise timing and trajectory of that recovery is still materializing, many data points clearly suggest that we are poised for an increase in demand and ultimately in day rates in the ultra-deepwater market.

In support of that thesis, we recently executed a contract for the Petrobras 10000 in Brazil at incremental day rates that are well above the spot prices seen in the market over the past three years. In addition to this contract, we have witnessed a material increase in offshore contracting activity in recent quarters. And based on our frequent and direct conversations with our customers, we know that there are a number of ultra-deepwater projects on the horizon across our customer base and in every major ultra-deepwater basin around the world.

As such, we are confident that our acquisition of Ocean Rig provides us with a unique and timely opportunity to increase the number of modern high-specification, ultra-deepwater drillships that we have in our fleet, better positioning us to capitalize on the market recovery.

Following the transaction, we will have five high-specification, ultra-deepwater drillships constructed within the past five years, which will be available for contracting in 2019, with three more available in 2020. Since these are the efficient drilling machines that our customers prefer, we expect them to be in high demand as the recovery continues to take shape.

While we're certainly excited about the prospect of adding new high-specification assets to our fleet, we recognize that we must continue to evaluate the competitiveness of some of our older rigs. To that end, during the quarter, we identified and retired two additional assets: the C.R. Luigs and the Songa Delta. These retirements were executed because we determined that these rigs were unlikely to be competitive with the newer, more efficient assets, which have been recently introduced to the market.

Overall, we have now recycled 45 floaters and when including our decision to exit the jackup market, we have divested a total of 60 rigs since the start of the downturn. Considering the addition of the Songa Offshore fleet, our acquired interest in the Transocean Norge and upon completion of the Ocean Rig transaction, we will have a fleet of 57 floaters, over twice the number of our next nearest competitor, of which almost 90% are either characterized as harsh environment or ultra-deepwater.

In short, we have completely transformed our fleet over the past three years into a much younger, higher specification fleet of floating rigs designed to operate in the industry's most challenging environments and most demanding applications.

Turning now to the market. Since our second quarter call, we have added $465 million of backlog, bringing our total contract awards over the past four quarters to approximately $1.5 billion. Over a trailing 12-month period, this is the largest quantity of backlog we've added since 2014, providing further evidence that we are in the early stages of that market recovery.

Starting with the harsh environment market, in August, we extended the Husky contract on the Henry Goodrich for 12 months through November 2019, adding $100 million in backlog, with an additional opportunity to earn a performance bonus, which would enhance our already solid margins on this rig.

You may remember that the Goodrich was the first reactivation we completed almost three years ago, and this profitable extension further justifies the strategy we have employed as a company regarding the reactivation of our assets. Needless to say, we're extremely pleased to keep this rig working in Canada where it has a very strong operational reputation and a great market position.

Additionally, in the harsh environment market of Norway, we've executed the maiden contract for the Transocean Norge. When we entered into the joint venture with Hayfin Capital to acquire the Norge, we were confident that we could quickly place her. Fortunately, we were able to contract her even prior to her expected delivery in early 2019.

In line with the current base rates for assets of this capability, she will earn a day rate of approximately $300,000 with performance bonus opportunities that provide additional upside for strong safety and drilling performance. The contract is currently expected to commence shortly after acceptance and mobilization near the middle of next year.

We've also added a three-well contract to the Transocean leader with Hurricane Energy that begins in February. This marks the third transition rig that Hurricane has contracted since 2016 and demonstrates the confidence that Hurricane has in the quality of our fleet and our crews. The estimated value of this contract is approximately $27 million.

Lastly, we begin contracted the Paul B. Loyd with BP in the UK for a two-well contract beginning in March with four one-well options. This is a very welcome reunion of BP and Transocean on the Loyd, building on our previous 24 years of activity with BP on this rig.

Turning to the ultra-deepwater market, we're pleased to have received the previously mentioned 26-month extension for the Petrobras 10000, which added approximately $185 million to our backlog. This work will commence in August of next year at the conclusion of the initial 10-year contract peered with Petrobras.

As previously noted, this contract is significant as its day rate is well above the depressed pricing of previous fixtures and represent the tangible sign of strengthening in the Brazilian market. This contract also helps us to retain our continuity in country and maintain our long-standing relationship with Petrobras, both of which are important as we position our self to respond to their upcoming round of new tenders.

It should also be noted that in addition to the headline day rate on the Petrobras 10000, we expect to receive approximately $16 million associated with the license dues of our patented dual-activity technology, which remains valid in Brazil through 2025.

We also contracted the KG2 CNOOC in China for a three-well term with two one-well options beginning in February. This rig has just recently completed a very successful campaign in the Asia-Pacific region, so we are very pleased to so quickly be putting her back to work.

It's important to note that we do not believe these fixtures with Petrobras are seen to be outliers. Our marketing and contract team is building more inbound customer request and they happen at the start of the downturn. And the number of ultra-deepwater fixtures continues to increase throughout the world. As such, we are growing increasingly encouraged about the possibilities we think are likely to emerge in the coming months for the assets in our fleet.

In preparation for what we believe to be an imminent recovery in the ultra-deepwater market, we are carefully assessing our fleet, determining the assets we believe our customers are most likely to contract first and fine tuning our detailed reactivation plans, including our crude complement for each rig.

With the assets that will be added from the Ocean Rig acquisition, we will soon have three warm-stacked ultra-deepwater drillships in our fleet. Naturally, these assets will be our top priorities as we endeavor to place rigs on contracts with our customers because the reactivation cost for such assets are comparatively low, generally less than $5 million, with the majority of that cost associated with recurring the rig.

At this point, we do not intend to reactivate our cold-stacked assets on speculation. Instead, we will closely monitor the market and reactivate our rigs to fulfill contracts in which the day rates and contract terms reach the necessary level to make the economics and the risk profiles more attractive.

Speaking of day rates, we believe that rates should begin to appreciate as we move through 2019 and into 2020. We have this belief because the improving sentiment in the energy space. The increase we are seeing in contracting activity is not surprising as Brent oil prices have remained steadily above $70 per barrel for most of the year and recently climbed above $80 per barrel.

These relatively high and sustained prices have meaningfully improved the cash flows and strengthened the balance sheet of our customers. Additionally, energy demand continues to show healthy levels of growth and a supply backdrop indicate the need for increased investment. This, combined with current offshore breakeven price per barrel economics for most projects at levels ranging from the 40s to below 20s, is increasing our customer's level of optimism around future offshore developments.

In short, the combination of relatively high and sustained oil prices, low project break evens, high free cash flows for our customers and the need to replace reserves appears to be directly impacting contracting as 40 deepwater contracts were signed in the quarter, an increase of almost 40% sequentially with tenders increasing almost 10% sequentially to 117.

Needless to say, we are encouraged by the direction of the market. 12 to 18 months ago, some analysts and investors questioned whether the offshore market would ever rebound. Today, most agree that recovery is on the horizon and are simply asking questions about the timing and shape.

As we await the answers to those critical questions, we will remain focused on safety, equipment reliability, drilling efficiency and our cost structure, while continuing to exercise discipline in contracting our existing fleet and evaluating strategic opportunities to further enhance it.

Before handing the call over to Mark, I would just like to thank the entire Transocean team for delivering another strong quarter. I sincerely appreciate your continued commitment and focus and ask that you maintain both as we close out the year. Mark?

[Mey Lovell Mark-Anthony, Transocean Ltd.]

Thank you, Jeremy, and good day to all. During today's call, I will recap our third quarter results and then provide an update to our 2018 guidance, provide some early commentary on our 2019 cost expectations and discuss our liquidity forecast. Lastly, I'll provide an update on the Ocean Rig acquisition.

For the third quarter 2018, we reported net loss attributable to controlling interest of $409 million or $0.88 per diluted share. After adjusting for unfavorable items associated with impairment charges related to the previously announced floater retirements and write-off of goodwill, we reported an adjusted net income of $30 million or $0.06 per diluted share. Further details are included in our press release.

Highlights for the third quarter include an increase of 134 operating days on the fleet relative to the prior quarter due to the commencement of a new contract for the KG1, a full quarter of operations from Discoverer India, KG2, Transocean Enabler and Transocean Arctic, an increase in revenue from the prior quarter of approximately $27 million.

Additionally, we have fleet-wide revenue efficiency of 95% that contributed to an adjusted normalized EBITDA margin of 42.7%. That continues to lead the industry and showcase the strength of both our backlog and operational performance. Operating and maintenance expense of $447 million was above our guidance, but consistent with the greater-than-expected increase in customer reimbursable costs.

General and administrative expense was $35 million for the quarter, $17 million lower sequentially and in line with expectations as the second quarter was negatively impacted by the voluntary employee retirement plan.

Turning to the balance sheet and cash flow. Cash flow from operations totaled $214 million compared with $3 million in the prior quarter. The increase was primarily due to the timing of interest and insurance payments. Additionally, we saw a decrease in the magnitude by income tax payments from the prior quarter. As we discussed on last quarter's call, we accessed the debt capital markets twice during the third quarter using the Deepwater Pontus and the Songa Enabler and Songa Encourage as collateral for two separate secured financings. The proceeds from these offerings were used to retire the Songa-related debt that we assumed as part of acquisition earlier this year.

Through the third quarter, we opportunistically repurchased $11 million of our debt due in 2022 in the open market. We ended the quarter with total liquidity of approximately $3.3 billion, including cash and cash equivalents of $2.3 billion and $1 billion of unrolled revolving credit facility capacity. This results in a reduction of our net debt position by approximately $100 million.

Last week, we again accessed the debt capital markets issuing similar to $50 million of priority guaranteed notes with a 2025 maturity, receiving net proceeds of $735 million. The net proceeds will be used to pay a portion of the cash consideration for the Ocean Rig acquisition.

We'll continue to be disciplined in our approach to maintaining our liquidity runway, evaluate opportunities to enhance our liquidity and strategically addressing our near and midterm debt maturities.

Let me now provide an update on our 2018 financial expectations. For the fourth quarter of 2018, assuming revenue efficiency of 95% our active fleet, we expect the total contract drilling revenues to be down approximately 11%. This forecast includes the impact of the recent Petrobras 10000 contract to an extent, reduction of early termination revenue on the Discoverer Clear Leader, and $50 million amortization related to the Songa contract intangible revenues.

We expect fourth quarter O&M expense to be approximately $454 million. This includes reimbursable expenses of approximately $22 million. In addition to the increased reimbursable expenses, there's a sequential increase in earnings expense related to contract preparation related to our recently announced reactivation of the ultra-deepwater floater Development Driller III.

The rig is expected to commence operations in Equatorial Guinea in the first quarter of next year. We expect G&A expense for the fourth quarter to be approximately $43 million. The sequential increase primarily relates to increased professional and other fees offset by recovery of legal fees in Norway recognized in the third quarter that should not reoccur.

Net interest expense for the fourth quarter is expected to be approximately $152 million. This forecast includes capitalized interest of approximately $9 million and interest income of $11 million. Capital expenditures including capitalized interest for the fourth quarter anticipated to be approximately $49 million in line with the third quarter. Our fourth quarter cash taxes are expected to be approximately $10 million.

Looking specifically at the Transocean Norge, the high-specification harsh environment semisubmersible in which we own a 33% interest, we will not consolidate the rig-earning energy and our interest in the rig will be reflected in investment in unconsolidated affiliates. We will however operate the Norge for the Transocean Energy and therefore include 100% of its backlog in revenue within our results.

Due to the ownership of the rig residing with the joint venture, we will recognize income at both the operating and other income lines. We'll provide further detail regarding this joint venture on our fourth quarter earnings call.

Although we will reserve providing our full 2019 cost guidance until after the closing of Ocean Rig transaction in December and the completion of the combined company budget, let me offer a few high-level comments. I previously guided you to expect annual maintenance expenditures to fluctuate by the number of special-purpose surveys we performed during each year.

For 2018, we have two SPSs; for 2019, we expect seven SPSs. We will complete routine five-year SPSs on the Deepwater Invictus and Deepwater Asgard; 10-year SPSs on the Deepwater Inspiration, Petrobras 10000 and Transocean Spitsbergen; and two 35-year SPSs on the Transocean Arctic and Sedco 712. Our estimated costs for these seven surveys in 2019 is approximately $50 million, of which 80% will be expensed and should result in 57 days out of service.

Compared to historical costs for these number of surveys, this is (20:48) lower, a direct result of earlier planning, performing portions of the work between survey dates, and the benefits we are recognizing from our OEM care agreements.

The two five-year surveys and the 10-year survey on the Deepwater Inspiration are expected to be performed without any out-of-service days and at a total cost of just over $2 million. The 10-year survey on the Petrobras 10000 is expected to result in only five out-of-service days in the third quarter.

The 10-year SPS on the Spitsbergen is expected to result in 21 out-of-service days in the third quarter where, in addition to the survey, we expect to enhance the riser tensioner system. This will enable us to work in roles with less robust volume-weight tolerances. Regarding our two 35-year SPSs, we're performing a routine survey on the Sedco 712 that we estimate will take 30 days in the first quarter.

Looking more closely at the survey on the Transocean Arctic, we expect her to be out of service for approximately 21 days, also in the first quarter. We will perform enhancements to the well control system along with certifications on the rig structure and propulsion system. We anticipate this will extend her service life by three years and permit us to capitalize the $35 million of costs, $28 million of which will be spent in 2019.

We also note that in several countries where we operate, labor unions are successfully negotiating salary increases for offshore employees. We could see modest labor cost inflation 2019 with cost escalation clauses in our longer-term contracts offsetting these costs.

Turning now to our projected liquidity at December 31, 2020. Including our new $1 billion revolving credit facility which matures in June 2023, our end of year 2020 liquidity is estimated to be between $1.2 billion and $1.4 billion. This amount includes the $240 million we expect to close the Ocean Rig transaction coming from our current cash balances, but excludes any cash from Ocean Rig operations for the period in December post closing. This liquidity forecast includes an estimated 2019 CapEx of $241 million, $86 million of which is related to the two newbuild drillships at Jurong.

2019 maintenance CapEx is expected to be approximately $155 million. This includes the implementation of a new ERP system and the buildout of our new corporate office building.

Additionally, we currently forecast 2020 CapEx to be approximately $1.1 billion. This includes the final payments of approximately $965 million on the remaining two newbuild drillships at Jurong and $115 million for maintenance CapEx. Please note that our CapEx guidance excludes any rig reactivations.

Before I conclude, I'd like to make a few brief comments regarding the pending acquisition of Ocean Rig. We received the required approvals from the Brazilian and Norwegian antitrust authorities and have filed both an S-4 Registration Statement and a joint proxy statement with Ocean Rig. These filings were reviewed by the SEC as is customary for these type of transactions.

As previously mentioned, the Extraordinary General Meeting is scheduled for November 29 at 5 PM Swiss Time at Transocean's offices in Steinhausen, Switzerland, to vote on the proposed acquisition. We expect to close the transaction by mid-December. Meanwhile, integration planning is well underway, enabling full realization of the previously discussed synergies 2019. I'd now like to turn the call back over to Brad.

[Bradley Alexander, Transocean Ltd.]

Thank you, Mark. Brandon, we're now ready to take questions. And as a reminder to the participants, please limit yourself to one initial question and one follow-up question.

[Operator]

The first question will come from Eirik Røhmesmo with Clarksons. Please go ahead with your question.

[Eirik Røhmesmo, Clarksons Platou Securities AS]

Thank you. Just thinking about day rates, you were mentioning the Petrobras 10000 that's higher than the current spot market. Could we see this as a proxy for other contracts starting in sort of the (25:19) on them or is this a one-off? How would you think about that?

[Roddie Mackenzie, Transocean Ltd.]

Yeah. Hi, Eirik, this is Roddie. Yeah, that's exactly it. We see that as a trend. Certainly, we've been very disciplined in how we're contracting the fleet for long-term opportunities. So, I would say certainly, we should see amongst the market a much better discipline about keeping rates a bit higher and certainly a lot more profitable for the longer term contracts.

[Eirik Røhmesmo, Clarksons Platou Securities AS]

All right. Thank you. The second question, you had a couple of older rigs that are rolling off contract or have recently rolled off. Do you see opportunities for these further or should we expect these to get retired in the near term?

[Jeremy D. Thigpen, Transocean Ltd.]

I think wait and see, but we've long since said that we probably still have a few more assets in our fleet. So, as they roll off contract, we don't expect them to be marketable going forward. But as long as they are in the day rate today, that's not a decision we're going to make right now.

[Eirik Røhmesmo, Clarksons Platou Securities AS]

All right. Thank you.

[Operator]

Thank you. The next question will come from Greg Lewis with BTIG. Please go ahead with your question.

[Gregory Robert Lewis, BTIG LLC]

Yes. Thank you, and good morning.

[Jeremy D. Thigpen, Transocean Ltd.]

Good morning, Greg.

[Gregory Robert Lewis, BTIG LLC]

I guess, Roddie, as we think about the North Sea, we're heading in towards the winter season. It's typically a little bit slower. Just looking at a few of the rigs that were in the North Sea, it looks like there are some gaps between when they role off current contracts and when they go on the new contracts more in the spring time. How should we be thinking about the cadence and the tenor? So, like, if I look ahead to the 2019, 2020 winter, should we continue to expect some seasonality in the North Sea or are you seeing things that maybe convince you or you're thinking that maybe we're working through the winter this time next year?

[Roddie Mackenzie, Transocean Ltd.]

Yeah, okay. Good question. So, let me tell you, from the Norwegian side, we're essentially sold out on high-spec rigs across the fleet and actually the industry. And what we've seen is that a couple of our rigs have been delivering well ahead of schedule, so they actually creating their own gaps by delivering the wells quicker. But in that market, the demand has been strong enough that so far we've been able to fill those gaps with additional wells. So, I think Norway is already looking very good for this winter and we would expect that the same would continue on for next winter.

In the U.K., it's really interesting. We always expect there'll be quite of idle rigs over the winter, but we're really seeing a rush of fixtures and awards and it's beginning to look like a sellout in the summer of 2019. So, the operators are now seriously considering winter program. So, we actually expect there will be a small amount of idle time this winter and certainly a lot of programs are going to either have to be pushed all the way to 2020 or we're going to see more activity in the winter of 2019.

So, I think you're just getting away from that ability to pick and choose the exact timing and having to consider the availability of the rigs rather than just the demand for the services. So, we're quite positive about this winter being better than last winter and certainly very positive about the winter of 2020.

[Gregory Robert Lewis, BTIG LLC]

Okay, great. And then just one for me on activity in Brazil. I guess Petrobras has some existing tenders out there. Realizing that industry sources can be wrong, it doesn't – it looks like maybe Ocean Rig is bidding into some of these like multiyear tenders, but it looked like Transocean's name was noticeably absent in a couple of those three-, four-year tenders. Just kind of wondering, is that a function of availability or like – or should we be thinking about Ocean Rig and Transocean kind of as one going forward as we look at potential bidding by Transocean?

[Roddie Mackenzie, Transocean Ltd.]

Well, certainly, at this stage, we are separate entities. So, going forward, that will only really be applicable from December onwards. But on those other tenders, you're right. Actually, this is a really exciting time because you're basically seeing Petrobras themselves going to award at least three tenders in the next six months, probably four rigs in total with two of them being for Libra.

In terms of go-forward tenders, they also have another couple of tenders that are out there. We will be participating in and we actually think that Petrobras alone could award six rigs by the middle of 2019. So, very positive sentiment for Brazil. And the one thing I would say is about the elections in Brazil with Jair in place now.

He had promised deregulization and then privatization of some of the Petrobras subsidiaries and essentially ensuring that they'll maintain the auction calendar for block beds. So, everything kind of points to paving the way for the investment and acceleration of awards in Brazil and that's even before we've discussed the IOC tenders. So, looking pretty positive there. In terms of your rumors about Ocean Rig's position, I couldn't comment on that, but if they happen to win some stuff in Brazil that's fine.

[Gregory Robert Lewis, BTIG LLC]

Okay, guys. Thanks. Thank you very much.

[Roddie Mackenzie, Transocean Ltd.]

Okay.

[Operator]

Thank you for the question. The next question will come from Ian Macpherson with Simmons. Please go ahead with your question.

[Ian Macpherson, Simmons & Company International]

Thanks. Good morning. Good quarter. Jeremy, you discussed the Ocean Rig Crete and Santorini pretty much upfront in your prepared remarks, which to me sounds like you're pretty sweet on those. But that's a lot of incremental capital to spend compared to all of the other money you're already spending on the open Ocean Rig fleet in your own available reactivation. So, would you walk us through the thought process for those two rigs in particular, as well as maybe the eventual full buy-in of the Norge at a later point in time?

[Jeremy D. Thigpen, Transocean Ltd.]

Sure. I'll start, then hand it over to Mark for additional color. I mean, these are two of the most highly capable assets in the world and so we think they're going to be in demand as this recovery starts to take shape. We also believe assets of that technical spec. There's such a shortage of them that we believe day rates could move fairly quickly. And so as we kind of look at the profile here, take delivery of one in late 2019, the other in late 2020 and don't have final payments on those until 2023, 2024. And so got a bit of time to see how this market plays out and we certainly believe by that point in time that the contract terms and the day rates will certainly support the final payment in acquiring those assets. And I'll just I'll – Mark, do you have anything to add to that?

[Mey Lovell Mark-Anthony, Transocean Ltd.]

No. That's exactly right. These are 2023 and 2024 final payments. So, that gives us a lot of breathing room with regard to seeing a real market recovery.

[Ian Macpherson, Simmons & Company International]

Okay. Well, I think that's the answer. Thanks. My followup, you've been beating – I mean, you've typically been beating analyst estimates a lot more times than not and revenue over delivery has been a fairly consistent theme. Can you discuss ballpark what you're capturing on your bonus opportunity across the contracts that apply? Because we can see your total fleet revenue efficiency that you report, but of course we never get the audit on what you're capturing on bonuses and that's one obvious explaining factor how you're doing better than we're modeling.

[Mey Lovell Mark-Anthony, Transocean Ltd.]

Great question, Ian. Let me add a few points here and then I pass it over to Roddie to explain the bonus part of that a little better. So, one thing that you know we got to do with the new revenue standard is include reimbursables in revenue. So, we have some of that every quarter. That's impossible to try and forecast. In addition, we've got 134 additional operating days in the third quarter. So, you're seeing more activity and you're seeing a pretty high level of revenue efficiency. And then, during the certain quarters you may have additional collections or you may have provisions put out for this – creating fluctuations with regard to revenue recognition. So, there's a lot of things moving around. But the biggest part, as you've identified, is bonuses.

[Roddie Mackenzie, Transocean Ltd.]

Yeah and I just add to that. So, we're relatively conservative in that regard in terms of projecting what we may or may not receive. But we have a variety of bonus schemes and some have a very large potential and some have smaller potential, but we also have corresponding likelihood of collection numbers associated with them. So, we tend not to give any guidance on that. But we have, on many occasions, picked up full bonuses and, of course, those other occasions where we have not. So, it really is a range of stuff all the way from contracts with zero bonus available to them to contracts that have 10% and 15% and sometimes 20% of revenue available.

[Ian Macpherson, Simmons & Company International]

Okay. Thank you, gentlemen, for the color there. I'll pass it on.

[Operator]

Thank you The next question will come from Sasha Sanwal with UBS. Please go ahead.

[Sasha Sanwal, UBS Securities LLC]

Thank you, guys. Good morning.

[Jeremy D. Thigpen, Transocean Ltd.]

Good morning, Sasha.

[Sasha Sanwal, UBS Securities LLC]

Yeah. And so maybe, firstly, just to kind of get to the day rate question a different way. If I could ask about option, can you talk about whether the types of options that you are negotiating on current contracts are changing and whether they're priced or non-priced options? And is there any color you can share on discussions on further options being exercised?

[Roddie Mackenzie, Transocean Ltd.]

Yeah, sure. So, as we mentioned previously, we were very cautious as we went through the downturn not to make extensive commitments at low rates. So, of the priced options that we do have, the one that extend out significantly are escalating options. They're moving up in rates.

The other ones that extend out extensively are mutually agreed options, so that basically is a return to the negotiating table to see where the market is at that time. So, the discussions I would say are really shifting towards a lot more direct negotiations and tenders previously, so that's typically a sign that the assets that the customers really want are becoming in shorter and shorter supply, so they come to us directly.

And I would say these triggering of options as we reported in the Fleet Status Report, we get quite a few of those. We've also had a couple of options that have lapsed for various different reasons, but it's – the option game is kind of playing out now and our willingness to grant fixed-priced options going forward for any length of term is obviously diminishing sharply.

[Sasha Sanwal, UBS Securities LLC]

Great. Thank you. That's helpful. And just an unrelated followup on reactivation. We're hearing some concerns about OEM capacity to deliver specifically on long lead time items for reactivations kind of given cutbacks in service departments during the downturn. If you could just share your thoughts there?

[Jeremy D. Thigpen, Transocean Ltd.]

I mean, it's certainly something that the industry faces through every cycle. And so, it's really going to depend on the pace of the recovery and how much demand is placed on the OEMs at a single point in time. From our standpoint, the healthcare agreements that we have with all of the major OEMs are proving to be very helpful as it's a very connected collaborative approach with a lot of good open dialogue around planning and needs.

And so, as I mentioned in my prepared remarks, we're going though the detailed reactivation plans on those assets we think are going to be in demand for reactivation first and working closely with the OEMs to make sure that we have schedules together where we don't have any significant delays.

[Sasha Sanwal, UBS Securities LLC]

Thank you, guys, and great to see the traction on the new award.

[Jeremy D. Thigpen, Transocean Ltd.]

Thanks.

[Operator]

Thank you for the question. The next question will come from Taylor Zurcher with Tudor, Pickering & Holt. Please go ahead.

[Taylor Zurcher, Tudor, Pickering, Holt & Co. Securities, Inc.]

Hey, thanks. Good morning.

[Jeremy D. Thigpen, Transocean Ltd.]

Good morning, Taylor.

[Taylor Zurcher, Tudor, Pickering, Holt & Co. Securities, Inc.]

Maybe one – good morning. Maybe one for you, Roddie. We've touched on Brazil, haven't talked about Mexico. You've got two rigs going to work there pretty soon here and just curious if you could give us your updated thoughts as it relates to how that market looks over the next 12 to 24 months.

[Roddie Mackenzie, Transocean Ltd.]

Yeah. So, we've been discussing Mexico for a couple of quarters now and we've always been quite excited about it. And I think we're happy to report that we've got one rig heading there right now. And with the signature for the Asgard, we are taking that rig there in the first quarter as well. So, that's pretty good. There's also the possibility that another one of our rigs will be assigned to Mexico. So, we could be bouncing between two and three rigs in Mexico next year, which is really positive.

One thing I would say is, there was a lot of question marks about the change in government and whether that was going to hold things up and we're happy to report that permitting is progressing very well. And in fact, one operator was telling me that their permitting had gone much quicker than expected and in fact they are now waiting on the rig contractors permitting. So, I think in terms of delivering what we promised, the government has stood up to that and I don't think permitting is the issue that we thought it was going to be.

And then looking forwards, there are PETRONAS, Equinor, Repsol, amongst others, are in tendering phase for Mexico and BP and Chevron are coming out soon. So, I think we're seeing that there's already plenty of activity. There's several awards made plus we see a lot more in the pipeline. So, Mexico is looking pretty positive.

[Taylor Zurcher, Tudor, Pickering, Holt & Co. Securities, Inc.]

Okay. Thanks for that. And then, specifically as it relates to the Discoverer Clear Leader, could you just give us a sense as to what the marketing strategy there is?

I suspect that rig's well-suited for some of these tenders coming out of Brazil and Mexico and probably most places in the world, but any update there as it relates to marketing strategy with your – are you looking for short-term work, more longer-term work or how are you thinking about putting that rig back to work moving forward?

[Roddie Mackenzie, Transocean Ltd.]

Yes. So, we're looking for the right opportunities to bring it back and...

[Jeremy D. Thigpen, Transocean Ltd.]

Long term work at high day rate.

[Roddie Mackenzie, Transocean Ltd.]

So, as Jeremy said. No, but really, yeah, measured approach, not just throwing it onto every opportunity that's out there. We're going to be avoiding the bottom of the market in terms of rates and we're already seeing a good shift upwards in rates in all the basins around the world. So, we'll be waiting for the right opportunity.

[Taylor Zurcher, Tudor, Pickering, Holt & Co. Securities, Inc.]

Okay. One more if I could squeeze it in for the DD3, Mark. Could you just frame for us how much of the reactivation and maintenance cost will be expensed Q3 versus Q4?

[Mey Lovell Mark-Anthony, Transocean Ltd.]

So, Q3 was about $15 million; Q4 should be about double that.

[Taylor Zurcher, Tudor, Pickering, Holt & Co. Securities, Inc.]

Okay, great. That's it for me. Thanks, guys.

[Operator]

Thank you. The next question will come from Colin Davies with Bernstein Research. Please go ahead.

[Colin Davies, Sanford C. Bernstein & Co. LLC]

Hey, good morning. Seems interesting that some of the longer-term contracts seem to be coming forward predominantly from the NOCs or international NOCs.

Can you perhaps give us some color as to the thinking going on in the major versus the independent NOCs and whether there's a difference in willingness to engage in more aggressive pricing discussions?

[Roddie Mackenzie, Transocean Ltd.]

Yeah. I think – so, the things you're probably not seeing are kind of the tenders that are not out there and a lot of the direct negotiations stuff, right. So, one of the things that we've been tracking very closely is that the mix between the majors, the NOCs and IOCs is really reaching a nice balance.

Now, previously, the majors were absent simply because they were long on rigs from the better times, but now they have returned with a vengeance. And if we think about Angola is about to kick off.

We understand that the Senegal stranded assets are close to being agreed and delivered and that's expected in the first half of 2019. And in Angola alone, you've got Exxon, Eni, Total, BP all getting ready to award work.

And as we mentioned before in Brazil and in Mexico, that's kind of dominated by the independents and the majors. So, really I think it's a balance. And I think we probably see that better than most just simply because that's the pipeline of work that's coming forward. It's not just the announced awards.

[Colin Davies, Sanford C. Bernstein & Co. LLC]

That's encouraging. Thanks. And just sort of a more strategic followup. I was surprised and interested in your prepared remarks. You made some comments around still potentially looking at further opportunities, M&A opportunities, perhaps. Perhaps just a little bit more strategic conversation around how you see the endgame of the industry. Do you see, perhaps, a window closing as the market improves around what the further potential consolidation could be?

[Jeremy D. Thigpen, Transocean Ltd.]

I don't know that the window would close necessarily. But yeah, the recovery does take shape the way we think it will and asset values will certainly increase. And so we made the comment about the timing of the acquisition of Songa Offshore since that time. The purchase prices have increased 40% and it's because of the strengthening in the market that we've seen in Norway for high specification, the harsh environment semisubmersibles.

We believe that a similar recovery could take shape in the ultra-deepwater market. Now, the exact timing and trajectory is still somewhat elusive. But, no, I think there will still be opportunities out there. For us right now, most important thing is closing the Ocean Rig transaction and then recognizing the integration synergies that we've committed to and then putting those assets to work. And so that's our primary focus at this point in time.

[Colin Davies, Sanford C. Bernstein & Co. LLC]

That's great. Thank you. I'll turn it back.

[Operator]

Thank you. The final question will come from Ian Macpherson with Simmons. Please go ahead.

[Ian Macpherson, Simmons & Company International]

Hey, thanks for letting me back in. Just quickly a bit of a little devil's advocate and on a happy note. The speculative newbuild orders for harsh environments, semis doubled this quarter from one to two. Not a big deal. But if we follow your optimism to its logical conclusion, how – with respect to the parallel cycle for ultra-deepwater drillships, how do we get comfortable with supplies staying without a newbuild cycle coming sooner than later if you guys are right on the shape of the recovery? And what are you seeing there with regard to animal spirits with some of the other players that you may see better than we do?

[Jeremy D. Thigpen, Transocean Ltd.]

Yeah. Well, I mean, if you think about speculative newbuild in the ultra-deepwater space right now, you're probably looking at, what, $600 million capital investment, maybe more. And day rates are currently sitting between, I mean, average in the Gulf of Mexico probably limited to the $160 million. I don't think that supports new investment. You'd have to see day rates run pretty fast and hard to get up to a day rate that would justify a newbuild. There are still a number of assets out there that are available to go to the market. So, I can't personally envisage a newbuild in the near term.

[Ian Macpherson, Simmons & Company International]

Right.

[Jeremy D. Thigpen, Transocean Ltd.]

But I don't know if you guys...

[Mey Lovell Mark-Anthony, Transocean Ltd.]

If you're referring to harsh environment, Ian, rates, they have improved quite dramatically and we – within half of the bonus, you can quite easily see rates there right now are round about $330 million, $340 million, $350 million area. That too doesn't support a new growth despite the fact that the ones you have seen orders have been fairly lower spec assets. It would be lower spec assets that are going to come out of this shipyard fully loaded with a price in the mid-$500 million to $600 million.

So, even though that market's recovered, you don't have day rate supporting that. And the folks that have gone out and ordered them aren't exactly household names. So, I would have a little bit of skepticism towards that, as to whether they're really here to stay or just an opportunistic approach of trying luck in the rig and perhaps flip that if the market recovers over the next few years.

[Ian Macpherson, Simmons & Company International]

Okay.

[Roddie Mackenzie, Transocean Ltd.]

Yeah, and Ian, one thing I would add on the marketing side for ultra-deepwater is we are seeing a sharp uptake and interest for the very high specification rigs. So, there are several in the yard at the moment including a couple of our own. So, those super high workload dual BOP rigs, I think you'll see them come out of the yard and go to work for improving day rates. You'll have to see that happen extensively before anyone turns their mind to newbuilds.

[Ian Macpherson, Simmons & Company International]

That all makes sense. Last one from me before I turn off. I'm sorry Mark. I fell behind a little bit when you were giving the fourth quarter revenue guidance. Could you run through that for me one more time the total and then the components?

[Mey Lovell Mark-Anthony, Transocean Ltd.]

Sure. Let me just get back to the page.

[Ian Macpherson, Simmons & Company International]

Sorry about that. Thanks.

[Mey Lovell Mark-Anthony, Transocean Ltd.]

No problem. I said we're going to be down 11% quarter-on-quarter. Part of that's because the Clear Leader is going to be end of October. That amortization runs out. So, that's the biggest driver of that and then we also got a couple other contracts that are ending in the fourth quarter.

[Ian Macpherson, Simmons & Company International]

Okay. And then for reimbursables and the Songa intangibles amortization, did you give those as well?

[Mey Lovell Mark-Anthony, Transocean Ltd.]

Yes. Songa's amortization is going to be right around $30 million per quarter.

[Ian Macpherson, Simmons & Company International]

Okay. So, that's flat.

[Mey Lovell Mark-Anthony, Transocean Ltd.]

Yes.

[Ian Macpherson, Simmons & Company International]

Reimbursables?

[Mey Lovell Mark-Anthony, Transocean Ltd.]

I think that was $22 million.

[Ian Macpherson, Simmons & Company International]

$22 million? Got it. Sorry about that. Thanks, guys. Good quarter.

[Mey Lovell Mark-Anthony, Transocean Ltd.]

Thank you.

[Jeremy D. Thigpen, Transocean Ltd.]

Thanks, Ian.

[Operator]

This concludes the Q&A. Sir, I'll turn it back to you.

[Bradley Alexander, Transocean Ltd.]

Thank you, Brandon, and thank you to everyone for your participation on today's call. If you have any further questions, please feel free to contact me. We look forward to talking with you again when we report our fourth quarter 2018 results. Have a nice day.

[Operator]

Thank you. Ladies and gentlemen, this concludes today's event. You may now disconnect your lines. Have a great day.