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Edited Transcript of SHLF.OL earnings conference call or presentation 13-Nov-19 2:00pm GMT

Q3 2019 Shelf Drilling Ltd Earnings Call

Dec 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Shelf Drilling Ltd earnings conference call or presentation Wednesday, November 13, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David J. Mullen

Shelf Drilling, Ltd. - CEO & Director

* Greg O’Brien

Shelf Drilling, Ltd. - Executive VP & CFO

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Conference Call Participants

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* Cameron Schulze;PPM America, Inc;Analyst

* Erwan Kerouredan

RBC Capital Markets, Research Division - Assistant VP

* Lukas Daul

ABG Sundal Collier Holding ASA, Research Division - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to today's Shelf Drilling Q3 2019 Earnings Call. (Operator Instructions) I also must advise you, this conference is being recorded today, 13th of November 2019.

I'll now hand you over to your first speaker, David Mullen.

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David J. Mullen, Shelf Drilling, Ltd. - CEO & Director [2]

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Thank you, operator, and welcome, everyone, to Shelf Drilling's Quarter 3 2019 Earnings Call. Joining me on the call today is Greg O'Brien, the Shelf Drilling's CFO.

Earlier this morning, we published the Shelf Drilling Limited financial statements for quarter 3, 2019 as well as our latest fleet status report on the Investor Relations page of our company website. In addition to our press release and the financial statements, we also published a short presentation with highlights from the third quarter and guidance for the fourth quarter. A recording of this call will be made available on our website within the next few days.

Before we begin, let me remind everyone that our call will contain forward-looking statements. Except for statements of historical facts, all statements that address our outlook for 2019 and beyond, activities, events or developments that we expect, estimate, project, believe or anticipate may or will occur in the future are forward-looking statements.

Forward-looking statements involve substantial risks and uncertainties that could significantly affect expected results. Actual future results could differ materially from those described in such statements. Also note that we may use non-GAAP financial measures in our call today. If we do, you will find a supplemental disclosure for these measures and an associated reconciliation in our financial reports.

I will provide an overview of the company's performance for quarter 3, 2019, and share my latest views on the jack-up market. I'll then hand over to Greg to walk through the financials before we open up the floor for question and answers.

As always, I would like to start the commentary on our earnings call with our safety performance. We had an outstanding safety performance year-to-date 2019. The total recordable incident rate as of 30th of September 2019 is 0.2, the best level we have achieved over an extended period of time. In 2019, we had a 5-month period of 0 recordable incident rates between April and August across our entire fleet. Additionally, we achieved a milestone of no loss of containment so far this year.

Safety performance will always be a key consideration amongst our customers in securing contracting opportunities, and we are pleased to see that our focus on rigorous planning for all activities on our rigs is leading to further improvement in what was already an industry-leading safety performance.

The fleet-wide uptime performance for quarter 3 was 99.4%. The year-to-date uptime performance is 99.3%. This is an outstanding uptime performance over an extended period of time. Our rigs continues to deliver outstanding operations against the customer key performance indicators. Our 2 newbuilds, the Shelf Drilling Chaophraya, Shelf Drilling Krathong, lead the way in terms of efficient drilling performance, as they both continue to set new standards and break new records for Chevron in the Gulf of Thailand.

The performance of the 2 rigs was a key factor -- key contributing factor to the recent contract award on the Shelf Drilling sector. Saudi Aramco monitors and benchmarks a number of key performance indicators, including safety, drilling efficiency, uptime performance and national content. Our rigs have consistently performed in the top-tier category, and as a consequence, we recently received a short-term extension, whilst we continue to negotiate a longer-term deal for the 4 rigs rolling off contract.

Safety and operating performance will be a key differentiator in securing contract and optimizing financial performance. Quarter 2 and quarter 3 has been an intense period for out-of-service projects with 7 rigs expected to return to our commence operations following project completion before year-end. The High Island V completed the planned shipyard project late August and is back to service under a 3-year contract with Saudi Aramco. The Key Singapore commenced a new contract with ENI, Tunisia, in mid-September. There was a delay to the start-up due to adverse weather during the rig move.

Shelf Drilling Scepter is concluding contract preparation for its multiyear contract with Chevron in the Gulf of Thailand. The estimated stock date for the rig is early December. The Shelf Drilling Achiever's contract preparation and upgrade project is also near completion. The rig is expected to commence contract with Saudi Aramco in December. The Shelf Drilling Journey's rig readiness is ongoing as we market the rig for 2020 opportunities.

With several new awards in India, we have 4 rigs on various stages of contract preparation. The F.G. McClintock, the C.E. Thornton and the Parameswara are scheduled to re-enter service during quarter 4, 2019, while the Trident II is expected to begin its contract in March 2020.

In Nigeria, Shelf Drilling Resourceful had a short out-of-service period whilst renewing its temporary importation permit, and the Trident XIV had a similar break whilst doing some equipment recertification.

There was also a longer-than-expected idle time on the Adriatic 1 and Baltic before commencing their respective new contracts with Conoil and Total in mid-October. Consequently, we had an average of 2.5 rigs in operation during quarter 3. All 5 rigs in the region are now back in service as of mid-October 2019.

Total revenue for the quarter decreased $5 million on a sequential basis from $137.1 million in quarter 2, 2019 to $132 million in quarter 3 2019. The drop in revenue quarter-over-quarter was primarily due to lower activity in Nigeria. This was partially offset by the start-up of 3 new contracts in India, UAE and Tunisia as well as higher uptime and revenue efficiency across the fleet.

Adjusted EBITDA for quarter 3 2019 was $32 million compared to $40.4 million in quarter 2, 2019, down due to primarily lower revenue. We expect our revenue and EBITDA numbers to significantly improve beginning in quarter 4, 2019, as a total of 7 new rig contracts are scheduled to commence during the period. Greg will provide you more details on both quarter 3 and quarter 4, 2019.

Oil prices trended lower in quarter 3 on concerns of slowing demand, growth and easing tensions in the Gulf region. Despite these recent price fluctuations, we continue to see a strong recovery in the jack-up market. Global number of contracted jack-up rigs has continued to increase, growing by 23% from a low of 311 rigs in early 2017 to 383 rigs in November 2019. All key regions have experienced reduced availability of rigs in increasingly active tendering environment. The Middle East and China contracted rig counts are at all-time highs, with further awards expected in the Middle East towards the end of the year and early next year.

We are also seeing an increase in Mexico since January 2019, from 21 to 29 contracted units with additional awards expected by Pemex and other customers in quarter 4. The stranded newbuild hang -- overhang is becoming less and less of an issue as more and more of the stranded rigs are being absorbed into the market.

We have added significantly to our backlog in 2019. Year-to-date, we have added 34 rig years, reflecting a unique operating platform and a much improved jack-up market. Since the beginning of quarter 3, we have executed the following contracts in addition to the ones on our last call in August. In the Middle East, we secured 4-month extension for each of the High Island II, High Island IV, Main Pass I and Main Pass IV with Saudi Aramco. We also executed a 3-year extension on the High Island VII with ADNOC drilling in addition to the 6-month extension announced previously.

In Egypt, we executed 165-day extension on Rig 141 with Gempetco until quarter 2 2020. We secured a 3-year award for the Trident II with ONGC, expected to commence in March 2020. We also executed a 2-well contract for the Parameswara with HOEC. The contract includes 2 option wells. Our fleet in India is now fully contracted. In West Africa, we have secured 1 firm well plus 1 option well contract for the Baltic with Total in Nigeria.

As of September 30, our contracted backlog was $977 million with 29 contracted jack-ups. Subsequently, we have executed further contracts totaling $151 million and the number of jack-ups under contract has increased to 31 jack-ups, representing a 91% market utilization across our 34 active rigs. In all, we have added more than $630 million of backlog since the beginning of 2019 for an implied book-to-bill ratio of approximately 1.5x.

We continue to see a very solid pipeline of near-term marketing opportunities and expect utilization and dayrates to further tighten in the coming months. With a differentiated operating track record and our strong customer relationships, we believe we are very well positioned as the jack-up market continues to recover.

I will now hand over to Greg, who will walk you through the financials.

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Greg O’Brien, Shelf Drilling, Ltd. - Executive VP & CFO [3]

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Thanks, David. Revenue for Q3 was $132 million, which included $125 million of dayrate revenue, $4 million of mobilization and bonus revenue and $3 million of recharges and other revenue. Total revenue fell by $5 million or 4% relative to Q2 2019, primarily due to lower effective utilization, resulting from the completion of 3 contracts during Q2 and Q3 in Nigeria and India, and planned out-of-service time for 2 other rigs in Nigeria and 1 rig in Saudi Arabia. In Nigeria, revenue fell by $9 million sequentially, mainly due to the contract completions on the Adriatic I and Baltic in mid Q2 and early Q3 2019, respectively.

The out-of service time in Q3, primarily related to the completion of the 3-month shipyard project in Saudi for the High Island V, which commenced in June, and the planned shutdown on the Trident XIV in Nigeria for equipment recertification. This was partly offset by the full quarter of operations for the compact driller in UAE and Ron Tappmeyer in India, which both started in Q2 2019, the new contract, which started in September for the Key Singapore and Tunisia as well as higher uptime and revenue efficiency across the fleet.

Average dayrate decreased from $66,200 per day in Q2 to $64,700 in Q3. Effective utilization, which is our measure of blended revenue efficiency was 65% in Q3, down from 66% in Q2.

Operating and maintenance expenses of $91.4 million in Q3 were largely comparable with Q2 2019. The increase in India and Nigeria for 5 rigs preparing for new contracts scheduled to commence in Q4 and incremental expenses associated with the short out-of-service periods on 2 contracted rigs in Nigeria were mostly offset by cost reductions across the rest of the fleet.

G&A expenses were $12.8 million in Q3 2019, up from $12 million in Q2, primarily due to higher noncash share-based compensation expense as well as increased support costs associated with the integration and deployment of our recently acquired newbuild rigs.

Adjusted EBITDA was $32 million for the period, representing a margin of 24% compared to $40 million and a margin of 29% in the previous quarter. We had a total of $4 million of adjustments in Q3, primarily for expenses associated with the reactivation and contract prep of the Shelf Drilling Scepter, which will be completed in the coming weeks.

Income tax expense of $3.2 million in Q3 was in line with Q2. The Q3 tax expense represented 2.4% of revenue for the period, slightly lower than our typical range of 3% to 3.5% of revenue. Net interest expense was $20 million for the quarter, in line with Q2. Noncash depreciation and amortization expenses totaled $40 million in Q3, substantially comparable with Q2, and the net loss for the quarter was $36 million.

Capital expenditures and deferred costs totaled $64 million in Q3 compared to $163 million in Q2. This included $33 million in Q3 relating to the reactivation and operations readiness projects on our 3 recently acquired rigs, the Shelf Drilling Scepter, Achiever and Journey. Capital spending across the rest of the business increased to $31 million in Q3, up from $26 million in Q2, mainly due to a higher level of costs associated with the project for the High Island V in Saudi and an increase in contract preparation activities in India. The contract prep projects for the Key Singapore was also completed in Q3 2019.

Net debt increased by $46 million in Q3 to $863 million as of September 30, 2019. Our cash balance was $46 million, down from $71 million at the end of Q2, and we borrowed $20 million under our revolving credit facility during the third quarter. The cash flow deficit during the quarter was in line with our expectations and driven by several factors. First, we made cash payments for interest of $38 million compared to $1 million in Q2. Our next biannual interest payment on our 2025 notes will be made in February 2020. Second, we incurred total cost of $37 million associated with our ongoing efforts to deploy the 3 recently acquired premium jack-ups. These projects will be substantially complete by the end of 2019. We also had a higher-than-normal level of maintenance capital spending on the back of the recent contract awards earlier in 2019.

Finally, we experienced a trough in run rate revenue and EBITDA in Q2 and Q3 2019, particularly in India and Nigeria, ahead of an uplift in utilization in those 2 countries in the coming quarters.

As David mentioned, we built strong momentum on the contracting front in 2019 that provides us confidence that operating results will improve in the fourth quarter.

On Slide 16 of our presentation published this morning, we included guidance on certain financial metrics for Q4 2019. Revenue is expected to increase by approximately 20% sequentially versus Q3 as 7 contracts are scheduled to start in Q4, 3 during the month of October and 4 in December. The guided revenue range for Q4 is $156 million to $161 million compared to $132 million in Q3.

With respect to capital spending, we expect a total of $45 million to $55 million in Q4. This includes $27 million to $32 million associated with our rig acquisition projects. The Scepter and Achiever will commence multiyear contracts in December and capital requirement should be minimal for several years thereafter on those 2 rigs. The operational readiness activity on the Journey will likely continue into the beginning of next year as we continue to market this rig for contract opportunities scheduled for the first half of 2020. But the major investments associated with these 3 rigs, will be substantially completed by year-end 2019.

Maintenance capital spending guidance for Q4 is $18 million to $23 million compared to an average for the last 2 quarters of $28 million. This would bring total sustaining CapEx for calendar year 2019 to approximately $100 million. The lower run rate in Q4 that we expect follows the commencement of 6 new multiyear contracts from the beginning of April to the end of 2019.

In summary, we continue to see encouraging trends in the jack-up market with rising utilization and dayrates in 2019, and our backlog and cash flow visibility have increased in recent months. Our debt maturity profile and strong liquidity position create flexibility and support for the growth projects that we're completing in 2019. The third quarter represents an inflection point for the business. As illustrated in the financial guidance published this morning, we expect a significant improvement in revenue and operating results beginning in Q4 2019 and believe that the recent contract awards and investments in our fleet will drive a material increase in cash flow in 2020.

With that, we'd like to open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Erwan Kerouredan.

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Erwan Kerouredan, RBC Capital Markets, Research Division - Assistant VP [2]

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Erwan Kerouredan from RBC, Royal Bank of Canada. I've got one question, please. Part of last quarter's presentation was around capitalizing on opportunities in the downturn with illustrative acquisition economics, which doesn't necessarily come across that much in today's presentation. So can you confirm the priority level remains the same and what's the current view on opportunistic acquisitions?

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David J. Mullen, Shelf Drilling, Ltd. - CEO & Director [3]

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Okay. Thanks for the question, Erwan. So yes, we continue to look at opportunities. But I would say that at this point in time, we see it's -- the priority is to very much look at our current fleet and drive positive cash flow in 2020 and beyond. Sometimes an opportunity comes, that's too good to turn down. But as I said, our -- we'll look at that as it happens. But it's very much our focus to drive towards positive cash flows, and we see a clear path to that in the calendar year 2020.

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Operator [4]

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Your next question comes from the line of Lukas Daul.

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Lukas Daul, ABG Sundal Collier Holding ASA, Research Division - Analyst [5]

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David, I was wondering if you could talk a little bit about the dayrate momentum. It seems that finally, there are some increases in dayrates, maybe not to the levels that we might have been expecting a year ago or so. But what is your view on the trajectory going forward, given that we are only 15% down from the peak rig count in 2014. And the question really is how much further up can we go on the rig count? And how is that going to drive the dayrates?

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David J. Mullen, Shelf Drilling, Ltd. - CEO & Director [6]

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Yes. Well, in the short presentation that we provided on Page 6, we have an illustration of the -- how we've seen the dayrates move region by region. In aggregate, we've seen dayrates move by 40%, which is pretty much in line with what we expected. I'd say it's actually to some extent, topped our expectations. In India, we've seen dayrates move by as much as 60%. In West Africa, it's been a little bit slower, but it's coming off a much higher basis, so we saw a 25%. But the dayrate movement we've seen so far is pretty much in line with what we would have expected.

We continue to see a lot of a high level of tendering activity. So I'm anticipating that the dayrates will continue to move between now and year-end and into 2020. Dayrates are range bound somewhere a little bit less than 100 to 70 in most regions for premium jack-ups and we imagine that by 2020, we'll see dayrates beyond the $100,000 a day. As the market tightens, I think there's plenty of room for dayrates to move. We're not anywhere close to operators pain threshold when it comes to rig operating rates.

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Greg O’Brien, Shelf Drilling, Ltd. - Executive VP & CFO [7]

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Yes, Lukas, this is Greg. And one point I would add is that we do believe there's room to run on the rig count. I mean the rig count globally has accelerated pretty meaningfully in the last year. I mean we're up in pretty much every major basin, but we don't think that's necessarily going to stop or go the other way. I mean David mentioned tendering activity that we see short to medium term, we think there'll continue to be rig additions in the Middle East over the next 6 months. We think there'll be additional tenders with ONGC. So we think the rig count should continue to move higher, which obviously helps grind utilization higher. I'd say the benchmark dayrate for premium jack-ups across the areas where we work was probably around 80, 6 to 9 months ago. There have been a number of fixtures at kind of closer to the 90 level or a little bit higher in some cases of late. That's another decent leg up. We think that trajectory should continue.

So I think the rate and margin environment is clearly better today than it's been in some time.

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David J. Mullen, Shelf Drilling, Ltd. - CEO & Director [8]

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And just to continue to add a bit more to that, the full cycle economics in the shallow water is really -- it's very compelling. It's -- if you look at the Arabian Gulf, the cost of -- full cost of lifting the barrel is very, very low. And it's similarly low in places like Nigeria. It's -- most of the regions you see with shallow water are short-cycle economics and very low breakeven cost. So it's -- we're just seeing a lot of activity where production increases in shallow water is making up for production declines onshore. Net-net, you're not really having a big increase. So it's an activity that we see will have a lot of legs.

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Lukas Daul, ABG Sundal Collier Holding ASA, Research Division - Analyst [9]

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Well, that's good color. And how do you sort of see these dynamics that you just described sort of impacting the pipeline -- the tendering pipeline? Do you see that -- I don't know, there might be more long-term jobs coming into the tender pipeline? Do you maybe see that the lead time for the work that you are discussing is increasing? Are there -- are those signs visible? Or obviously, you sit closest to that, can you sort of put some color on that?

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David J. Mullen, Shelf Drilling, Ltd. - CEO & Director [10]

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Yes. Look, I mean, most of the opportunities in the Middle East are 3 to 5 years. And we're even talking about opportunities that go beyond 5 years. So definitely, operators are looking to lock in more and more term. And we're also seeing this phenomena, which we haven't seen for quite some time where operators are looking at forward start dates. And we've seen operators more and more looking at forward start dates that are 12 months and sometimes 18 months out in time. And that's really a sign that people are looking to lock-in rig capacity because they're fearful that when the time comes, the dayrates may be a lot higher as there might be -- there might just not be enough rigs available. So all indications are in the positive vein in terms of how we see the market from 2020 and beyond.

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Lukas Daul, ABG Sundal Collier Holding ASA, Research Division - Analyst [11]

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Okay. So with all the boxes sort of ticked for being at or close to the inflection point, how are you thinking about fixing your rigs going forward? Is it maybe time to become a little bit more greedy and start playing the market a bit more?

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David J. Mullen, Shelf Drilling, Ltd. - CEO & Director [12]

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Well, I think we've got a pretty sizable fleet. So when you've got a large fleet, you can play the portfolio games. I think it's fine to fix at current rates, where we see good margins, and we've got a healthy blend between old and newer rigs. So -- and we're -- for us, it's very important to have the right relationship with our customer. And so it's -- you have to play that game carefully.

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Greg O’Brien, Shelf Drilling, Ltd. - Executive VP & CFO [13]

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The only point I would add is, I think, there's a reason the Journey is not contracted yet. I mean the 2 new builds that we acquired from China Merchants, we acquired at the same time. We're more or less preparing them in parallel, and we've been trying to hold out for a rate and margin on that rig that we're very happy with. There was one opportunity for a single rig that we lost on price because we were trying to push for a number we thought was -- we'd be pretty happy with. So I think we definitely could have put that rig to work by now. It's not that we're short contract opportunities for the rig, but that's essentially the last high-end rig that we have available, short-to-medium term. And that's the one we are trying to help kind of move pricing a little bit. So as David mentioned, it depends on the asset and the location and country, but we don't have a huge amount of capacity left. We only have 3 idle rigs at the moment. We do have some rigs that are on shorter-term contracts in certain markets, but it does feel like there is a little bit of inability to push pricing in certain circumstances.

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David J. Mullen, Shelf Drilling, Ltd. - CEO & Director [14]

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Yes. And it's probably a right point to mention the 2 bareboat charter rigs. So we have the 2 bareboat charter rigs, and because there's an underlying bareboat charter cost, there is also a significant cost to take them out of the shipyard and put them into operation. We don't see that the current dayrate environment supports that with a good economic return. So we imagine we would need something well north of $100,000 a day to support the 2 bareboat charter rigs. So we do see that we've got plenty of -- we've got plenty of upside as the day rate continues to migrate. And Greg is absolutely right. I mean the Journey, we've been in no rush to anchor a contract. It's the only premium jack-up we've currently got available, so we want to get it under the right contract.

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Operator [15]

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Next question comes from the line of Cameron Schulze.

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Cameron Schulze;PPM America, Inc;Analyst, [16]

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Cam Schulze from PPM here. Can you talk a little bit about your approach to utilizing the revolver? Any minimum cash balance that you guys would be comfortable with? Any covenants that we might need to be aware of, and all of that given the recent repurchase authorization?

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David J. Mullen, Shelf Drilling, Ltd. - CEO & Director [17]

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I'll let Greg answer that one.

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Greg O’Brien, Shelf Drilling, Ltd. - Executive VP & CFO [18]

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Yes, sure. Yes. So in terms of minimum cash, I'd say $20 million to $30 million is probably the right figure to use. We obviously need cash in each location to fund day-to-day operations. That's sort of the minimum level we'd get down to before we essentially need external capital. The revolver is a $225 million facility that we upsized last year. We've communicated that we consider using some of that for the right growth opportunities that's kind of short-to-medium-term funding in nature. And so the deal we did with China Merchants earlier this year, we felt fit in that box. We financed the purchase price with equity, but we're funding the deployment costs out of cash flow and liquidity in the business. When you just sort of wash through what we're doing in 2019, it's somewhere between kind of $50 million to $75 million of likely need on the facility to fund putting all those rigs to work, and that's something we're obviously comfortable with. We think it leaves a very healthy level of liquidity in the business. In terms of covenants, we do have a quarterly maintenance covenant under the revolver that's tested at 5x through the end of 2020. We've said in the past, there are some differences in the way that's calculated versus our reported EBITDA numbers. The biggest point is that for the rigs that we've acquired in recent months, once we have a contract, we have forward EBITDA credit until those rigs are reflected in our trailing numbers. So the Scepter and the Achiever are good examples, 2 recent premium jack-up acquisitions. Those rigs are contracted as of September 30. They haven't started yet. So we get to essentially bridge our EBITDA for covenant purposes until we have a full 12 months of operations. So we're obviously comfortable with the covenant level now. We think that will continue through next year. So no concerns in the financial covenants we have in the facility.

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Operator [19]

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We have no further questions coming from the phone lines. (Operator Instructions)

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David J. Mullen, Shelf Drilling, Ltd. - CEO & Director [20]

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Okay. Operator, if there are no further questions, I'd just like to take the opportunity to thank everybody for joining our call, and we look forward to talking to you at the Q4 earnings call. Thank you very much.

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Operator [21]

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Ladies and gentlemen, this does conclude our conference call for today. Thank you for participating. You may now disconnect.