Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Transocean Ltd. (NYSE:RIG)

Q2 2011 Earnings Call

August 4, 2011 10:00 am ET

Executives

Thad Vayda – VP, IR

Steven Newman – President & CEO

Ricardo Rosa – SVP and CFO

Terry Bonno – VP, Marketing

Analysts

Kurt Hallead – RBC Capital Markets

Arun Jayaram – Credit Suisse

Ange Sedita – UBS

Collin Gerry – Raymond James

Robin Shoemaker – Citi

Joe Hill – Tudor Pickering

Douglas Clifford – Omega Advisors

Doug Becker – BOA

Robert MacKenzie – FBR & Company

Matt Conlan – Wells Fargo Securities

Operator

Good day, everyone. Welcome to the second-quarter 2011 results call for Transocean Limited. Today’s conference is being recorded. At this time, for opening remarks and introductions, I would like to turn the conference over to Mr. Thad Vayda, Vice President of Investor Relations. Please go ahead, sir.

Thad Vayda

Thank you, Liya. Good morning and welcome to Transocean’s second-quarter 2011 earnings conference call. A copy of the press release covering our second quarter’s financial results along with supporting statements and schedules is posted on the company’s Web site at deepwater.com. We’ve also posted a file containing four charts that may be referenced during this morning’s call. That file can be found on the company’s Web site by selecting Investor Relations, Quarterly Toolkit and then PowerPoint Charts.

The charts include average contracts at dayrates by rig type, out of service rig months, operating and maintenance cost trends, free cash flow from backlog and debt maturities. The Quarterly Toolkit also has four additional financial tables for your convenience covering first, revenue efficiency, then other revenue details, daily operating and maintenance costs by rig type and contract intangible revenues.

Joining me this morning are Steven Newman, Chief Executive Officer; Ricardo Rosa, Senior Vice President and Chief Financial Officer; and Terry Bonno, Vice President, Marketing.

Before, I turn the call over to Steven, I’d like to point out that during the course of this call, participants may make certain forward-looking statements regarding various matters related to our business and company that are not historical facts, including future financial performance, operating results and the prospects for the contract drilling business. Such statements are based on the current expectations and certain assumptions of management and are therefore subject to certain risks and uncertainties.

As you know, it’s inherently difficult to make projections or other forward-looking statements in a cyclical industry since the risks, assumptions and uncertainties involved in these forward-looking statements include the level of crude oil and natural gas prices, rig demand and operational and other risks, which are described in the company’s most recent most Form 10-K and other filings with the US Securities and Exchange Commission.

Should one or more of these risks and uncertainties materialize or underlying assumptions prove incorrect, actual results may vary materially from those indicated. Transocean neither intends nor assumes any obligation to update or revise these forward-looking statements in light of the development, which differ from those anticipated. Also note that we may use various numerical measures on the call today that are or may be considered non-GAAP financial measures under Reg G.

As I indicated earlier, you will find the required supplemental financial disclosure for these measures, including the most directly comparable GAAP measure and an associated reconciliation on our Web site at deepwater.com under Investor Relations, Quarterly Toolkit, and Non-GAAP Financial Measures and Reconciliations. Finally, to give more people an opportunity to participate on this call, please limit your questions to one initial question and one follow-up.

Thank you for your time. I’ll now turn the call over to Steven Newman. Steven?

Steven Newman

Thanks, Thad. Hello everyone and thank you for joining us today. At the outset, I’d like to take a second to officially welcome Thad, who has taken over the Investor Relations function. Thad brings with him a wealth of experience while working on the sales side, and he is a former Transocean employee who we’re excited to have back on the team. He’ll beginning to know many of you going forward.

Now, on to our results, our reported second quarter earnings were $0.48 per diluted share. After adjusting for discontinued operations and the other items noted in our press release, adjusted diluted earnings per share would have been $0.59, which does not take into account the impact of Macondo related items. This compared to $0.53 for the first quarter of 2011.

Adjusted earnings per share were up $0.06 sequentially as increased revenues more than offset increased costs and a higher annual effective tax rate. Ricardo will walk you through the details of our financial results shortly, followed by Terry who’ll provide some color on the market.

First though, I want to make a few comments. During the second quarter, we saw continued improvement in the underlying fundamentals of our business as strong commodity prices supported continued improvements in demand throughout the market.

We built on the first quarter’s strong contracting performance with an additional $1.5 billion in new contracts between our April and July Fleet Status Reports. We’re encouraged by contract awards and extensions across Transocean’s entire fleet, and I expect recent discoveries offshore Ghana, Brazil, Vietnam, and the US Gulf of Mexico will drive global drilling and demand for our rigs.

While Terry will give you more details on the worldwide market and the various asset classes shortly, there’re a couple of key fixtures I’d like to highlight. Reflective of the tightening Ultra-Deepwater market and our continuing strong operating relationship with BP. BP has exercised their six-month option on the Discoverer Enterprise and agreed on an additional one year extension with the one year extension at a rate of $492,000 a day.

During the quarter, the Key Gibraltar went back to work for Chevron in Thailand following her reactivation. We signed a three-well contract with ONGC in India for the M.G. Hulme and Rig 141 secured a two year contract with Gupco, a BP joint venture in Egypt. These are just a few examples of returning idle equipment back to work and further support our view of the continuing recovery in the offshore markets.

I’m also pleased to announce that during the second-quarter, our revenue efficiency improved to 92.1%, two percentage points higher than what we reported in the first quarter. We have been focused on this area for several quarters now and our comprehensive improvement program is delivering measurable results.

As a reminder, of the main components of the program, we are focused on continually enhancing equipment reliability, which involves thorough inspections by Transocean and third-party experts to understand the baseline condition of the equipment, standardize maintenance plans to ensure the equipment meet Transocean’s high standards, and regular testing to make certain the equipment performs as required. As the numbers show, we are seeing meaningful progress towards our objective of being back to historical levels by the end of this year.

As part of our plan to strategically position Transocean for the long-term, during the quarter, we also continued to make progress in our efforts to optimize the competitive make up of our fleet. Over the last couple of months, we have finalized deals to sell three Jackups and a swamp barge with other divestiture opportunities at various stages of progress.

We also exercised an option at Keppel FELS for the construction of a third Super B Class High-Spec Jackups and we’re in advanced discussions with the customer to finalize the contract for this unit. This brings our high-spec jackup newbuild construction program to four units.

Now to an area that we’ve received a number of investor questions on the past couple of quarters. As we have said before, we remained firm in our belief that building on speculation is not good for the industry or Transocean, and that excess supply will have a negative impact on dayrates and asset utilization.

In addition to the impact on the supply and demand dynamic, customers have consistently voiced their desire to have rigs built to their exact specifications based on identified future work and operating environments, and our preference is to build something that closely meets our customers’ needs and expectations.

Just as important as the assets being built is having the teams in place to run them and we pride ourselves on having the best people in our business. This depth of expertise combined with our strong balance sheet will provide us the flexibility to take advantage of potential opportunities as they arise in the market.

Finally, it’s important to keep in mind that we just completed a 10 rig $7 billion newbuild program that positions us well in the Ultra-Deepwater market for the long term, as it gives us the world’s largest high-spec fleet and a true competitive advantage in the marketplace.

We’ll continue to look for opportunities to reinvest in our business while remaining disciplined in how we deploy our capital. Even with our strict criteria for contract-backed newbuilds, we’ve successfully built an unparallel leadership position in our business and I seen no reason why remaining discipline going forward will force us to abandon our leadership role.

In addition to our ongoing reinvestment in our business in June, we made our first quarterly distribution of the approximately $1 billion annual dividend, our shareholders approved at the May shareholders meeting. Our ability to continue to invest in our business and return excess cash to our shareholders reflects our long-held disciplined approach to capital deployment underpinned by strengthening market fundamentals.

Before turning the call over to Ricardo, I do want to make some brief comments on Macondo. First, in early June, we filed a response to the Coast Guard’s preliminary report. That preliminary report was critical of all parties involved with the Macondo well, including Transocean.

In our response, we disputed four key assertions made by the US Coast Guard. Specifically, we concluded the following; ignition did not result from poorly maintained equipment. The BOP was properly maintained. The engines on the rig did not fail to shut down upon detection of gas and the general alarm did not fail to operate automatically. We hope that the US Coast Guard will take our recommendations, which were supported by the findings of our internal investigation into account for their final report. Our full response to the Coast Guard can be found on our Web site.

Second, on June 22, we released our internal investigation report which confirmed that the Macondo incident was the result of a succession of interrelated well design and construction decisions that comprised the integrity of the well and compounded the risk of its failure. I’d like to extend my sincere thanks to everyone who contributed to the preparation and delivery of this report.

Finally, we continue to believe that through a legally binding contract with Transocean, BP agreed to assume full responsibility for the costs and liability of any pollution, contamination and environmental damage caused by hydrocarbons that leaked from the Macondo well. That contract indemnifies Transocean against all such claims.

Let me conclude by thanking the worldwide team of Transocean employees. Our operating results are improving and we continue to make progress towards our vision of an incident-free workplace. I appreciate your efforts and focus on safe and efficient operations.

With that, I’ll turn the call over to Ricardo to take you through the numbers. Ricardo?

Ricardo Rosa

Thank you, Steven, and good morning, everyone. As Steven has mentioned, we reported net income of $155 million or $0.48 per diluted share for the second quarter of 2011. Excluding the $25 million loss on impairment relating to three jackups reclassified as held for sale, $13 million of net charges relating to discrete tax items and $2 million in income from discontinued operations, our adjusted diluted earnings were $0.59 per share. This represents an improvement of $0.06 per share versus adjusted earnings in the previous quarter.

Increased revenue from Ultra-Deepwater rigs led to improve its profitability this quarter, and largely reflects three primary drivers

First, higher activity in the Gulf of Mexico with all BOP recertifications now complete, the absence of special standby rates and the Deepwater Pathfinder operating throughout the quarter.

Second, the commencement of operations of the newbuild Deepwater Champion at 100% efficiency in the Black Sea. And third, a 4 and 6 percentage point improvement in revenue efficiency for the Ultra-Deepwater and Deepwater rig categories, respectively compared with the first quarter, reflecting the impact of the initiatives that Steven discussed earlier.

32 rig month of shipyard out of service time in the quarter was three months lower than in the first quarter but remain higher than we anticipated, due to extended projects impacting a number of rigs including the Deepwater Discovery combined with increased contract preparation work mainly in response to new contracts in West Africa. Delays incurred by the original equipment manufacturers conducting BOP recertifications are having an ongoing impact.

Total operating and maintenance expenses increased $133 million compared with the first quarter, including $104 million related to contract drilling due to the higher maintenance cost on several rigs combined with annual pay rises and contract preparation shipyards. The remaining $29 million increase was due mainly to higher drilling management services activity.

The non-cash $25 million impairment loss on the three standard jackups held for sale does not signal a pattern of losses on future asset sale. More importantly, it reflects our continued efforts to execute our strategy of disposing of non-core assets.

The second quarter was also adversely impacted by an adjustment to our year-to-date annual effective tax rate to 22.6%, up from 19.3%. The adjustment reflects lower margins in certain lower tax rate and deemed profit locations due in part to out of service time in addition to increased activity in some higher tax jurisdictions. The increased annual effective tax rate compared to the first quarter impacted diluted earnings per share by $0.05 in the second quarter.

Looking beyond the second quarter, revenue efficiency in shipyard related out of service time remained critical factors in improving our profitability. Steven has already discussed our focus on improving revenue efficiency. So I will provide some color on future shipyard activity.

As you’ll remember, in previous calls I provided some directional guidance on higher anticipated out of service base for certain rig categories, including our expectation that the relative mix of out of service time would be more heavily weighted toward our Ultra-Deepwater floaters due to the timing of the 10-year special periodic surveys required by several units. These and other factors have carried through multiple reporting periods including the second quarter.

In addition to the Special Periodic Survey work we have completed a number of life enhancements, conducted BOP related work imposed by NTL-05 and other BOP project as well as rising river holes, trust to change out and contract preparation to meet customers’ specifications.

Furthermore, as you know, we are coming through an exceptional period in which we have felt the impact of a lingering post-Macondo environment driving out-of-service timing costs, much of which relate to the Ultra-Deepwater category. We believe that shipyard work required by our Ultra-Deepwater rig will be reduced in the second half, and the focus of our efforts will be more on certain deepwater and midwater units.

Our Web site Chart No. 2 reflects the projected out-of-service time reported in our last Fleet Status Report at July 13th, and highlights that we are expecting out-of-service time to decrease in the third and fourth quarters of 2011. These projections are directionally correct but need to be adjusted for approximately three months of on-through repairs on the Marianas following the unexpected anchor-handling incident in Ghana as well as shipyard expansions totaling approximately five months, which impact certain high-specification floaters and will be spread across third and fourth quarters. The projections do not include any rig reactivations which may result from new contract awards.

Looking into 2012, we currently expect revenue losses from out-of-service days to be lower when compared to 2011, as the mix of Special Periodic Surveys and major shipyards favor non-Ultra-Deepwater rig. However, assuming demand continues to strengthen, the number of reactivations is expected to increase, and may include certain midwater and deepwater units with higher reactivation costs in jackups. As a result, we believe total shipyard expenditures are unlikely to decline in 2012.

I now would like to provide you with some updates to our cost guidance for the remainder of 2011. We’re now projecting our operating and maintenance expenses to increase from the upper end of the range of $5.4 billion to $5.7 billion to the range of $5.6 billion to $5.8 billion, due mainly to the combined impact of first, the cost of previously mentioned shipyard expansion and the planned repair of the Marianas; second, wage increases and other inflationary pressures on our in-service rig operating costs in certain countries including Brazil, Angola and United Kingdom.

Included in the operating and maintenance expense for the second quarter is $26 million in Macondo well related costs. We’re prudently revising our 2011 guidance for these costs from $100 million to $135 million in view of the uncertainties surrounding the outcome of the Interpleader filed our excess liability underwriters with a multi-district litigation. This increase is included in the revised total year range I have just provided of $5.6 billion to $5.8 billion.

Moving down the statement of operations, we expect the range of net interest expense to be between $550 million and $570 million compared to the previous guidance of $570 million to $590 million, mainly due to recent measures to rebalance the mix of fixed and floating rate debt. Our annual effective tax rate is expected to be in the range of 21% to 23%, up 2 percentage points from our previous guidance of 19% to 21% for the reasons I articulated earlier. Capital expenditures are projected to remain unchanged at approximately $1.1 billion.

Cash flow generated by operations in the quarter was $340 million, adversely impacted by a $230 million net increase in working capital. We expect operating cash flow to improve in the second half of this year with fewer out-of-service days and improving efficiency. Our cash flow will also benefit from the proceeds of our non-core asset disposals. Our liquidity remains strong with the consolidated cash balance of $3.4 billion and an undrawn $2 billion revolving credit facility, and we continue to pay down our debt obligations in line with our long-term balance sheet strategy.

With that, I will hand it over to Terry to update you on the markets.

Terry Bonno

Thanks, Ricardo, and hello to everyone. Before I get started, I’d like to say that if we had delayed the call by just an hour or so, we may have had even more positive news to report. Because as of today we’ve already received two contracts, so it’s been a high level of activity for sure. I’d also like to say that the contract backlog that I’m going to report is from the period of January 1 through today.

So with that, I’d like to make a few general comments. 2011 has been an exciting year thus far with continued successes for Transocean in contracting our worldwide fleet. Year-to-date, we’ve executed over 4.5 billion of contracts with 2 billion executed since the last earnings call. From ongoing discussions with our customers, we expect this positive trend to continue for the remainder of the year.

Tendering and contracting activity in the worldwide Ultra-Deepwater market has been very strong and more than a dozen fixtures in the last quarter. Petrobras is again in the market looking to fulfill its long-term demand and coupled with the return of the US Gulf of Mexico to a somewhat normal activity level has led to a substantial firming up of this market segment with less than a handful of units being available globally through the end of 2011.

Contracting activity in the deepwater market has picked up slightly from first quarter level, and while there is continued rig availability, especially more units, we believe that as the remaining Ultra-Deepwater capacity is committed, utilization and rate should further improve in this segment. Midwater activity increased during the second quarter with multiple fixtures, especially in the U.K. and Norwegian sectors of the North Sea. Based on the outstanding tenders and inquiries received, we believe this trend should continue not only in the North Sea, but also in India and Southeast Asia.

Saudi Aramco and Pemex continue to the lead the charge in tendering and contracting activity in the premium and standard jackup market segment. This combined with strong demand in Southeast Asia and the North Sea has led to unfulfilled requirements for certain programs helping to firm out dayrates and creating new opportunities for standard units which could lead to reactivation of some of our cold stacked units.

Let’s now look at the various market segments beginning with the Ultra-Deepwater market. The Gulf of Mexico, Brazil and West Africa continue to be at the forefront of Ultra-Deepwater activity. In the last few months more than a dozen fixtures have been reported with dayrates generally ranging from 450,000 to 500,000.

Tendering activity has risen sharply with 26 tenders and inquiries currently outstanding. After securing three Ultra-Deepwater units in previous tender exercises Petrobras has issued another three tenders. One for 21 Ultra-Deepwater units to be built in Brazil for pre-sell development, a second tender for a 1,200 meter unit and a third tender for a 1,500 meter units. We expect Petrobras to take up to four units from the international fleet for these programs.

We’re also pleased to see an improving view of future opportunities in the US Gulf of Mexico as evidenced by our ability to close the fixture on the enterprise as Steven mentioned earlier. Demonstrating the continued streams of the West Africa Ultra-Deepwater market we recently executed a contract on the Sedco Energy for two years at 440,000 a day in Ghana. We’re very bullish on Ultra-Deepwater market and we are now in discussions for opportunities in late 2012 and beyond.

Turning to the deepwater market, contracting activity remains wide. However, we expect improving demand in the second half of 2011 with Brazil, West Africa and Australia providing opportunities for our available deepwater fleet.

As a reflection of the low level of tendering in deepwater, we secured a midwater opportunity for the M.G. Hulme, which as you know is a deepwater unit in India for three wells approximately one year of work at $260,000 a day. Additionally, we have just extended the Discoverer Seven Seas for a 173 days at 295K a day bridging the gap until the upcoming tendering opportunity in India.

Turning our attention to the worldwide midwater floater market, the tendering and contracting activity has continued at a brisk pace throughout the second quarter. We’re seeing high tendering activity in the North Sea, India and South East Asia. There is limited availability in the U.K. and Norway and demand continues to outpace supply.

After discussions with several customers for our only available harsh environment semi in Norway in 2012, we contracted the Transocean winter for one year at $455,000 a day. Additionally, since our last call, we’ve been able to secure the following significant fixtures, the Transocean prospect 18 months at 245,000 a day in the U.K. and this is the first long-term fixture since 2008.

Transocean Arctic four wells that are approximately 240 days at 395K in Norway; Sedco 714 one year at $255 a day in the U.K.; Transocean Amirante five wells approximately 300 days at 247K in Egypt; Actinia two wells are approximately 100 days at 190K in Malaysia. We’re also in advanced discussions on multiple midwater units with our customers in the U.K., West Africa, Asia and Australia and expect to close on these prospects shortly. This confirms our belief that the midwater market tendering type will continue to be strong over the remainder of 2011.

Moving to the jackup market, as we discussed last quarter, the contracting pace in this segment, especially the premium market has significantly picked up. This has not only exerted upward pressure on the dayrate for premium equipment, but it has also provided contracting opportunities for the standard jackups. This positive development is underscored by us being able to secure a significant number of contracts across our jackup fleet adding $684 million in contract extensions during the quarter. This reflects a total of five rigs returning to active duty for the second quarter 2011.

Based on ongoing discussions with our customers, we’re very confident that this trend will continue and we will be able to secure additional contracts for active fleet as well as reactivate some of our stacked units under attractive commercial conditions. In conclusion, tendering, contracting and overall demand activity for the first half of 2011 has exceeded our expectations and we believe that strong commodity pricing will continue to provide opportunity for all rig classes for the second half of 2011 and ‘12.

We continue to execute leading edge dayrate in all asset classes. Additionally, our year-to-date contracted backlog of $4.5 billion is representative of 19 countries with a top five countries located outside of the Golden Triangle, demonstrating our ability to differentiate with the depth of global offering that meets the needs of our diverse customer base, with our focus on service delivery.

Our global footprint, versatile fleet portfolio, and industry leading position uniquely provides us with the strong competitive advantage to further benefit in this market.

That concludes my overview in the market, so I’ll turn it back to you, Steven.

Steven Newman

Thank very much. Operator, we are now ready to take some questions.

Question-and-Answer Session

Operator

(Operator instructions) And we’ll take our first question from Kurt Hallead with RBC Capital Markets.

Kurt Hallead - RBC Capital Markets

Good morning. How are you?

Steven Newman

Good. How are you?

Kurt Hallead - RBC Capital Markets

Thank you. I’m doing well. Thanks so much. I wanted to focus initially here on the revenue efficiency factor. So Steven, you’d reference this as a primary focal point a few quarters back. You’ve gone from, I guess, under 90% now to 92%, a good progress. What was the ultimate target that you think is realistically achievable?

Steven Newman

I think, we do a pretty good job with our fleet status reports on our quarterly results of showing you our historical performance in revenue efficiency. So that’s what I’ve tried to guide the analysts and the investors to think about is getting back to that historical level of efficiency.

Kurt Hallead - RBC Capital Markets

Terry, from a market standpoint, sounded very upbeat, you kind of tease us there with a couple of contracts. They’ve already been signed. Is there anything that you can expand upon on that?

Terry Bonno

Just to reiterate the fact that it’s been incredibly active for us. I mean we signed this quarter 28 contracts and that’s from our last earnings call to today. So for us, it’s been an incredibly active, and just to give you a little bit of a writedown there, 17 of those were jackups. So we’ve got a lot of opportunity out there. Customers are urgent, and we think it’s very positive as we move forward into the second half of ‘11 and into ‘12.

Kurt Hallead - RBC Capital Markets

Then I just was wondering if there is any updates that I guess the Swiss authorities were looking at potentially changing the tax rates over there and how that may impact your dividend, any updates on that front?

Steven Newman

No, Kurt, we continue to monitor regulatory framework here in Switzerland and what’s happening in the legislature. There hasn’t been any real movement since what we’ve been talking about over the last quarter or so.

Kurt Hallead - RBC Capital Markets

Okay, great, that’s it from me, thank you.

Operator

Thank you. Our next question comes from Arun Jayaram with Credit Suisse.

Arun Jayaram - Credit Suisse

Good morning.

Steven Newman

Good morning.

Arun Jayaram - Credit Suisse

Terry or Steven, I wanted to ask you a little bit about Mexico. You guys sit here with quite a few jackups idle internationally and Mexico has what appears to be a pretty large shortage and they are offering some term. So the question for you would be why isn’t Transocean participating in some of the Pemex tenders?

Terry Bonno

What we’re doing is we have tried to get into Mexico on a couple of occasions. We haven’t had the right equipment available at the right time, as you know it’s a very specific window to get in there. So you have to hit a window and we haven’t had a rig that we have been able to hit that window that doesn’t attract significant penalty. However, what we’re seeing and I think, it’s very interesting and we’re following closely is that they are now contacting the contractors directly saying, “Look, with our increased demand, we’re looking for ways that we can meet our demands that we need.” So there maybe a little flexibility, we’re hoping for that, so that we can’t participate in that market. It’s not that we don’t want to, we do. We very much do because we see it as an opportunity leading into deepwater market. So we’re looking at it very hard and we hope that we’ll be able to have some success there.

Steven Newman

You’ve touched on a key opportunity for us. Mexico is a big market and we’re not currently present there, and so we’ve spent a lot of time evaluating how to get in the Mexico and I think, we have a really active and productive dialog with Pemex. We’ve told them we want to be there and they’ve told us they want us there. We’re just looking for the right opportunity, the right vehicle to get in there.

Arun Jayaram - Credit Suisse

It sounds like you may be participating going forward. Second question, Steven, you know Terry just mentioned that similar leading-edge rates in the Ultra-Deepwater now pushing close to 500, just looking at your valuation relative to some of the Ultra-Deepwater peer such as Seadrill illustrates that you have a very depressed valuation. So I was wondering if you and the Board are looking at perhaps some more optimal structures where you can capture the value of your backlog and the inherent asset value of your Ultra-Deepwater fleet.

Steven Newman

I’m not sure what you have in mind when you talk about optimal structure. It’s an ongoing dialog with the Board and we recognize that we think there are opportunities out there and our stock price doesn’t reflect what we think the underlying valuation of the company. It doesn’t reflect the underlying fundamentals. So there are things that we’re in active discussion with the Board about how to address that.

Arun Jayaram - Credit Suisse

I mean could this include maybe a spin-off more of the commodity assets versus your really high-spec and frontier kind of assets?

Steven Newman

Yes, I don’t want to hedge the Board in on the wide ranging discussion they are having, but we’ve been pretty vocal about our desire to rationalize the Transocean fleet. We want to be focused on high-specification drilling, high-spec floating and high-spec jackups. I think, in the last couple of quarters, we’ve demonstrated our efforts to execute against that strategy. So the Board has endorsed that strategy and what we continue to discuss with the Board are the alternative means of executing that strategy most efficiently.

Arun Jayaram - Credit Suisse

Fair enough. Thank you very much.

Operator

Our next question comes from Ange Sedita with UBS.

Ange Sedita - UBS

Hey, thanks and good morning. I’m trying to get some of your thoughts on rig expectations for the Ultra-Deepwater markets. Obviously, we’re moving a little bit towards 500, but do you think to move to $500,000 or even beyond that we need to see both a pickup of permitting in the Gulf of Mexico and also Petrobras picking up a number of incremental rigs. Give us your thoughts on our rates leading into the back half of the year and early next year.

Terry Bonno

Ange, thanks for the question. Good to have you on the call. If you look at what currently is available out there to pickup in the market, I think, it’s about seven rigs, as they finish up this year, and then you’re going to have some more certainly come available in 2012. Right now with programs out there, they certainly can absorb that fleet, it’s going to depend on customer urgency. Now I believe that we’re about to see a $500,000 fixture in the next couple of weeks and I think, it’s imminent because I believe that few of our customers need to have some of their programs drilled in a timely manner.

I also believe that there is certainly some demand that needs to be fulfilled in the US Gulf of Mexico and you can certainly see that with as we look at the major discovery that happens in the Gulf of Mexico with ExxonMobil in Hadrian. That was with a form out rig. So you’ve got some really, really positive news there that certainly the US Gulf of Mexico has great opportunity for the customer base and they are slowly becoming more familiar with the process to get their permits through and I think, it’s just going to take a little bit of time and it won’t be the old normal, but it will be a new normal and that there is lot of opportunities, so I think, that it’s looking very positive.

Ange Sedita - UBS

And then as a follow-up to that, are you concerned by the slowing of permitting in the Gulf of Mexico as of late? Is there any risk that rigs that are working today could become idle if we don’t see a pickup in permits? Then second, you also mentioned reactivating some cold stacked rigs. Is that focused on jackups as well as floaters? I would assume that’s more of 2012 event as far as large quantity of rigs and specific regions?

Terry Bonno

To answer the first question, I can only speak from our customers base and our conversations that we have with our customers, and they are confident that we can work through 2011 and the rigs that we currently have on full standby are those that are waiting to go back to work with some permit. So from our perspective, the customers are saying that they are going to be able to get some permits.

And then your second question was about the cold stacked fleet. We’re looking at opportunity, things are picking up and we can see that in the Deepwater fleet that there is some opportunity out there and some long-term opportunity. So we’re looking at some growth areas, where we feel like we can reactivate. And then into jackups, we’ve got some opportunities where are some jackups, so we can also reactivate. So as we said, things are really picking up, it’s obviously, profitable reactivation, and we’re very encouraged.

Ange Sedita - UBS

All right, thanks, Terry.

Terry Bonno

Thank you.

Operator

Our next question comes from Collin Gerry with Raymond James.

Collin Gerry - Raymond James

Hi, good morning, guys.

Steven Newman

Hello, Collin.

Collin Gerry - Raymond James

So I wanted to follow-up on the cost side. The addendum that you have, which is very helpful by the way, it looks like daily operating cost, like if I just look at high-spec floaters and midwater floaters went up in the quarter. I guess I’m trying to understand that a little bit, does that have to do with labor or is it some of this downtime or kind of the revenue efficiency stuff showing up in the cost line too? Maybe help understand that a little bit more.

Ricardo Rosa

This is Ricardo. As far as the high-specification floaters are concerned, I am assuming you’re looking at the schedule on daily operating and maintenance costs. What it is, is a combination of the higher maintenance costs that we saw in the last quarter across the fleet has affected several rigs and is attributable largely to the timing of certain maintenance projects that takes place whiles the rigs are active, and there tends to be an uptick in general in the second quarter as compared to the first.

In addition to that, what you have is a slight change in rig mix, because we are seeing now a greater wake in favor of the Ultra-Deepwater units that are now all active with the newbuilds all commissioned and working. Of course, we have a reduction in the active rig count of the lower-spec deepwater assets. There are two certain cost pressures that we are seeing and that we had warned our investors about that they would take place in the course of the year, and they relate very much to the wage pressures that I highlighted in my prepared comments and that are beginning to flow through our costs effective the second quarter. I think, the question of maintenance and the pressure of wage increases compounded as well with the weak dollar and the exchange rate effect there is being reflected in the increased average daily operating costs for both rig categories.

Collin Gerry - Raymond James

Just to follow-up, it looks like they went up in every rig category of jackups, midwater and the floater side or the high-spec side. Does your new cost guidance assume that those are flat for the balance of the year or are we assuming in that cost guidance that those daily operating costs kind of come back down? In others words, is this a one-time issue or is that the new normal in your cost guidance?

Ricardo Rosa

I have dictated that it’s the new normal. What you will see, however, is an uptick compared to the costs that we incurred in the first quarter. Our cost guidance for the second half of the year takes into account the increased expenses associated with Macondo, as I highlighted in my comments, and also includes continued relatively high levels of shipyard expenses and increased activity from drilling management services. So I would say that the in-service cost will have a slight uptick, yes, but it wouldn’t be significant.

Collin Gerry - Raymond James

And then the last one for me, I want to stay kind of on the income statement. This might be somewhat of a dumb question, but when you reactivate a rig and maybe it cost $20 million for a jackup or $50 million for a floater, I’m not sure how much it would be, does that cost show up on the operating expense side in the income statement or is that a capital cost that flows through the balance sheet?

Ricardo Rosa

We have three accounting treatments with respect to the reactivation cost of the rig, and it depends on the nature of the costs incurred. We have upgrade costs where we’re actually improving the specifications of the rig, those tend to be capitalized. We have costs that are specifically attributable to the contract that we’re preparing the rig for and those we refer to as contract preparation costs and they will be deferred over the life of the contract. Then there is that what I’ve described as catch up maintenance, getting the rig ready to go back to work and be accepted by the customer and that will be treated as expense.

Collin Gerry - Raymond James

Right. So just kind of setting aside that like in the event that you order reactivate handful of rigs. It’s now like will we see $115 million or $100 million or like a big spike in operating expenses at a quarter or would it be a little bit more muted as they would be allocated into the various buckets?

Ricardo Rosa

It’s difficult to give you any firm guidance on that because it really depends on the mix of expense, whether it’s upgrade as opposed to maintenance or contract breadth [ph]. What I would say is that there is a tendency when you reactivate a rig to have upfront expenses.

Collin Gerry - Raymond James

Okay, that’s it from me, thanks so much, guys.

Steven Newman

All right, Collin.

Operator

Thank you. Our next question comes from Robin Shoemaker with Citi.

Robin Shoemaker - Citi

Thank you. Steven, I wanted to ask you about this issue that’s come up regarding this additional out of service time. How forcefully can you push your customers in terms of sharing the costs of these enhanced safety upgrades and equipment efficiency standards that we see applying across the board, in the case of existing contracts, which may not have provisions for this, but on new contracts as well?

Steven Newman

Yes, I think, that’s an excellent question, Robin, and it really boils down to a case by case basis. It depends on the negotiating dynamic. It depends on what the driver is for the enhancement. So if we’re operating under an existing contract and the regulator changes regulations and we have a change in regulations pause in the contract, we’ve been in a very good position to get our customers to help bear the cost of that. If it’s a new contract and the customer sets that expectation upfront and we know it going into the negotiations we might not get it covered in the way of a lump-sum reimbursement, but we might get it built into the dayrate and so it just really depends on, number one, what the driver is for those enhancements and, number two, are we talking about a new contract or an existing contract, where is the negotiating dynamics, who’s got the leverage, it’s difficult to give you a very comprehensive crisp one size, that’s how I’ll answer.

Robin Shoemaker - Citi

Because you cited some cases where an OEM manufacturer couldn’t recertify and do the work on the BOP required, so I guess in those cases where you go to zero dayrate then it’s kind of on your dime as opposed to the customer in most case?

Steven Newman

There are circumstances were in order for us to put the rig to work, we’ve got to incur some incremental expenditures that we weren’t planning on.

Robin Shoemaker - Citi

One other question then, on your decision to exercise the option to build a third jackup at Keppel FELS, is there another opportunity with Chevron like you did with the first two? Or how did you arrive at the decision to exercise that option? Are there any more options related to jackups at KFELS?

Steven Newman

On the first part of your question, Rob, and I’ll give you two perspectives. Knowing how we feel about building on spec, you can take some comfort in the fact that there was a very well developed opportunity there. The other thing you ought to know about us is that we don’t talk about a contract until it’s done, dusted and signed. So there is an opportunity there and once we get the contracts signed, we will happy to alert all of you to it. There are additional options available at Keppel FELS and as those option dates approach, we’ll take into consideration just how comfortable we are we’d be able to execute a contract.

Robin Shoemaker - Citi

Okay, all right, thank you, Steven.

Operator

Our next question comes from Joe Hill with Tudor Pickering.

Joe Hill - Tudor Pickering

Good afternoon.

Steven Newman

Hi, Joe.

Joe Hill - Tudor Pickering

Guys, I apologize if I missed this. But Ricardo, did you give DD&A and G&A guidance for the back half?

Ricardo Rosa

No, I didn’t, Joe.

Joe Hill - Tudor Pickering

Would you care to?

Ricardo Rosa

No, the guidance remains the same as it’s given at the beginning of the year. It remains unchanged and that’s my comment on it.

Joe Hill - Tudor Pickering

Fair enough. When I think about the maintenance work and quality assurance work that’s been going on for the last several months for the fleet. Are there any takeaways with regards to both what you are seeing in the third-party search in the BOPs and what you are seeing in other areas of repair and maintenance? Are there any general trends or observations you can make?

Steven Newman

That’s an interesting question, Joe. I think, the observation I would make is that the more we can do to help our vendors plan for work and manage work and then deliver work, the better off we are. So in terms of bringing our vendors into our discussions about asset management and fleet planning and our anticipated schedules for major maintenance work and overhauls; the more they know about that, the better off they are in terms of allowing for and preparing for their own resource needs.

Once our equipment gets into their shop, the more we can do to help them, expedite work to make sure that things remain on tract within their work planning streams, the better off we are. If we’ve got people at the back end of their shop when the vendor tells us that a particular piece of equipment is ready to go; if our people have been there and been active participants in the factory acceptance testing then we are that much more confident that when the piece of kit arrives on our rig, it really is ready to go. So that’s a key takeaway I would give you, the more we can do to help our vendors plan for, execute and deliver quality work the better off we are.

Joe Hill - Tudor Pickering

Then this last question here is a little bit of Kentucky vintage, but with regards to the tender pipeline you’re seeing today, obviously it’s strengthened, it’s pretty active. The market obviously is rolling over here. I think, we’re $90 in crude now. What price would you anticipate your customers begin backing off tendering activity? Is it $85? Is it $80? Are we there yet? Do you have any opinions on that?

Terry Bonno

I think, we probably would have to ask our customers that question. As far as an opinion, we started seeing this increase in activity when they gained confidence in $8 barrel mark. Once they had a full year of it, then the demand started coming out. So I think, it was a confidence boost. So each customer has a different return that he is looking for and they are all very dependent upon the parts of the world that they’re working as you know. So I think, that the comfort level was $80 for most of them and that’s when we start seeing the demand.

Joe Hill - Tudor Pickering

Then Terry, this last question is for you. The Seven Seas you got re-signed for little bit, any update on the equipment you had in West Africa that rolled off the Sedneth from 140 to 135?

Terry Bonno

They haven’t rolled off, they are still working. So as of now, I mean the 135 is under contract and have been on a five-month contract for a while, I don’t have the paper in front of me. The 140 we are in the process of moving to shipyard, and we’re very optimistic of follow-on work and we really can’t talk about it right now, but we are optimistic about it.

Joe Hill - Tudor Pickering

I’m sorry, the 135 rolls off at the end of the month, okay.

Terry Bonno

Yes. Just to give you a little bit more color, there are numerous opportunities out there that we have both of those rigs bid too.

Joe Hill - Tudor Pickering

Okay, that’s it from me, thanks, guys.

Terry Bonno

Thanks.

Steven Newman

Thanks, Joe.

Operator

Our next question comes from Douglas Clifford with Omega Advisors.

Douglas Clifford - Omega Advisors

Hi, good morning. Steven, could you comment on the sustainability of your dividend and how do you look at it as a variable dividend or something that the Board and management place [ph] will be maintained for an extended period?

Steven Newman

Yes, when we went into the discussions about return of cash to our shareholders, Doug, we wanted to make sure that whatever we did we could stand behind as a sustaining activity going forward. So when we looked at that $1 billion a year distribution last year pre-Macondo, we put it in the context of a wide variety of scenarios and we felt comfortable that it was sustainable under that variety of scenarios. Now, obviously, Macondo introduced the regulatory wrinkle here in Switzerland with respect to the commercial registrars blocking our ability to execute the distribution in the form of a par value reduction. We opted for a different vehicle this year in form of the dividend as additional paid-in capital that doesn’t have any Swiss regulatory involvement.

So we think that’s a vehicle that we can avail ourselves of even in the context of Macondo and we think that under a variety of scenarios it’s a sustainable dividend. Now, that doesn’t remove the discussion from the Boardroom, and what the Board will look at as they prepare for making that recommendation on an annual basis to the shareholders is what’s our outlook for the business, what are our prospects for reinvestment in our business, what does the debt portfolio look like, but as we have prepared scenarios for the Board in the context of those discussions, Board’s been comfortable with thinking about the $1 billion dividend as they’re recurring sustainable dividend.

Douglas Clifford - Omega Advisors

Thank you.

Operator

Our next question comes from Doug Becker with BOA.

Doug Becker - BOA

Thanks. Terry, you mentioned the potential for Petrobras to pickup four rigs out of the 1,200 and 1,500 meter tenders. How much of that do you view as incremental demand versus high grading of some of the midwater rigs? What’s the timing of announcements? Our understanding is that the bids were due yesterday.

Terry Bonno

They actually extended the tender for a couple of weeks, and I think, that it’s incremental, they need the rigs. I guess you are alluding to the release as the diamond rigs, thinking that that maybe actually actual replacement of some of the other midwater fleets. But I think, that what these units are, they are going to be used on the sub-salt wells that they have and that we do believe it’s incremental demand and we also believe that they are going to continue to take more Ultra-Deepwater rigs as their demand arises, and I know they’ve just come out with a five-year plan and that’s one of the footnotes, is that we will reassess our demands as the situation arises. So we are optimistic that they will continue to pull more rigs in.

Doug Becker - BOA

Thanks. And then Steven, do you see the market moving in a way that’s going to require upgrades of four ram BOPs or potentially adding a second BOP to existing rigs to meet new equipment standards or just reduce downtime?

Steven Newman

I think, the question about second BOPs to reduce non-productive time is an interesting. One in fact, Chevron made that decision on the newbuilds that we recently built for them. The turnaround time for between wells maintenance on the BOPs was becoming the critical path item when you move a dual activity rig from one location to the next. So it’s possible that our customers could make that kind of a commercial evaluation and decide that it makes sense for them to incur the upfront cost of the capital required to have a second BOP on the rig. The challenge is do you always have a hole or a rig shape that can accommodate a full second BOP. So I’m not sure that in every case that’s a practical, technical solution just because of the constraints of deck load and deck space on some of the older equipment.

Question about four ram stacks, most of the equipment today is four ram, and the challenge becomes how you outfit those four rams. If the customer or the regulator wants to increase the number of shear rams contained in the stack, then you’ve got to worry about whether or not you’ve got enough ram cavities available to have the flexibility and redundancy you’d want in normal pipe rams. It’s not just an ongoing conversation we have with our customers, our customers play an integral role at the outset of every contract and almost at the outset of every well, making sure that the BOP is kitted out the way they want to kit it out.

Thad Vayda

Operator, we are approaching an hour. We’d like to have questions from two more callers, please. Thank you.

Operator

Our next question comes from Robert MacKenzie with FBR & Company.

Robert MacKenzie - FBR & Company

Question for you, I guess, shifting away from operations per se again, what can you tell us, if anything, about where you stand vis-à-vis settling any kind of issues with BP and/or the government, recognize your contract, indemnifies, we’ve seen some of the other parties settle or some payments? Is that something you guys are actively exploring at this point and where would that stand?

Steven Newman

I don’t want to be too public about the nature of those discussions. I’ll tell you that there is an ongoing dialog with BP. I think, we have a responsibility as a key vendor to BP and we certainly feel an obligation to them as one of our largest customers to have an ongoing dialog. We talk about the current operations around the world that we’re conducting with BP and we talk about Macondo. I don’t want to say too much about exactly what we talk about when we talk about Macondo.

Robert MacKenzie - FBR & Company

Moving onto another issue, permitting in the US Gulf, the pace as we see it is less than half of what it would take to sustain 30 plus rigs in the US Gulf. What are you hearing from your customers and/or the regulators if you’re speaking to them directly about whether that’s going to change anytime soon?

Terry Bonno

Well, there has been some interesting articles written about that lately and the fact that you know there will be some more pressure put on the regulators in order to speed up the process, because quite frankly, we need the jobs, we need the revenues, and now is the time to do that. I think, the customers going through the process of understanding what’s required in order to get their permits and, again, I answered this a little bit earlier and what our customers are saying is that they believe they will have the permit to keep our rigs working through the end of this year. Then we also have some of our other rigs that are on standby, that are with BP and they are also working to get their permit. So we don’t hear a lot of the struggle that we understand some of our other peer groups are saying that they are having with their customers. So our customer base is getting, I think,, a bit more comfortable with the process. No, I don’t think it’s going to speed up overnight, but I think, that as we move along this path that it will become a more efficient process.

Robert MacKenzie - FBR & Company

Another regulatory question, if I may, since we’re at the end. What have you heard about the prospect of regulators perhaps making four ram stacks obsolete or as you mentioned a very difficult to kit out with appropriate pipe rams. Is that something you think is a high probability, low probability? How would you handicap that?

Steven Newman

I don’t know how to handicap it Rob, but what I’ll tell you is that it’s not a move that I see gaining steam. There is lot of discussion in the US about it, but I don’t hear a lot about that from other international markets.

Robert MacKenzie - FBR & Company

Thanks.

Operator

Our next question comes from Matt Conlan with Wells Fargo Securities.

Matt Conlan - Wells Fargo Securities

Steve, you mentioned early in the call that you don’t think your stock price reflects the value of the company. I agree. I mean what are the prospects of dusting off your share repurchase program? Are there any regulatory restrictions preventing you from dusting that off?

Steven Newman

Matt, that’s off part of our ongoing dialog with the Board about returning cash to the shareholders, and so as we think about the deployment of cash in our business, first thing we’d like to do is reinvest in our business and so, our marketing team around the world are scouring for opportunities that meet our financial criteria, that give us opportunity to grow our business. We think that’s the first thing the shareholders would like to us do is profitably grow our business.

Second thing, we focus on is the investment grade quality of our balance sheet. We’re comfortable with the strength of the balance sheet. We want to make sure we remain investment grade quality. So we’ll continue to pay attention to that and then third thing we do and we’ve demonstrated our disciplined approach to doing this is returning cash to our shareholders.

Now, when we get to the point of returning cash to the shareholders, then it’s just a question of the vehicle we opt to do that. We’re in the process now of executing the approximately $1 billion that the shareholders approved in May; we’ve made the first quarterly installment. We expect to follow through on the remainder of that and we’ll continue to have the dialog with the Board about opportunity for investment, quality of the balance sheet and the vehicles for returning cash back to the shareholders.

Matt Conlan - Wells Fargo Securities

Terry, now that we’re at the end of the hour, have you gotten any updates on those contracts, whether they could be disclosed?

Terry Bonno

No, my cell phone didn’t ping me, but it’s been a great day, we had two, which is part of the report that we gave, so we are happy with the two we got before the bell.

Steven Newman

We don’t want any cell phones going off in the midst of our call. It might distract us.

Matt Conlan - Wells Fargo Securities

Okay, great, thanks, guys.

Steven Newman

Thank you all. I appreciate you joining us for our call and the continuing interest in the company and we’ll talk to you next quarter.

Operator

Ladies and gentlemen that does conclude today’s presentation. Thank you for your attendance. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Transocean CEO Discusses Q2 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts