Hercules Offshore, Inc. Q3 2008 Earnings Call Transcript

Oct.30.08 | About: Hercules Offshore (HERO)

Hercules Offshore, Inc. (NASDAQ:HERO)

Q3 2008 Earnings Call Transcript

October 29, 2008, 11:00 am ET

Executives

Stephen Butz – VP of Finance and Treasurer

John Rynd – CEO and President

Lisa Rodriguez – SVP and CFO

Analysts

Geoff Kieburtz – Weeden & Co.

James West – Barclays Capital

Angie Sedita – Macquarie

Jud Bailey – Jefferies & Co.

Dan Pickering – Tudor, Pickering & Holt

Bill Sanchez – Howard Weil

Arun Jayaram – Credit Suisse

Dan Boyd – Goldman Sachs

Mike Drickamer – Morgan Keegan

Pierre Conner – Capital One

Alan Laws – Merrill Lynch

Ian MacPherson – Simmons & Co.

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2008 Hercules Offshore earnings conference call. My name is Amad [ph], and I'll be your coordinator for today. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Stephen Butz, Vice President, Finance, Treasurer. Please proceed, sir.

Stephen Butz

Good morning. I would like to welcome everyone to our third quarter 2008 earnings conference call. Participating this morning from the Hercules Offshore management team are John Rynd, our Chief Executive Officer and President and Lisa Rodriguez, our Senior Vice President and Chief Financial Officer.

We issued our earnings results and filed an 8-K with the SEC this morning. The press release is available on our Web site at herculesoffshore.com.

Before John begins his remarks, I'd like to remind everyone that this conference call will contain forward-looking statements, including our discussion regarding the outlook for 2008 and beyond. Our actual results may differ materially from those projected in the forward-looking statements. There are a number of known and unknown risks and factors that may cause our actual results to differ from the results discussed in our forward-looking statements. You can obtain more information about these risks and factors in our filings with the SEC, which can be found on our Web site and the SEC's Web site, sec.gov.

John will begin the call with some general remarks and discussion regarding the outlook, and Lisa will detail our third quarter financial results and provide some guidance for the balance of the year, I will then have some brief closing remarks before opening the call for questions-and-answers.

Now it's my pleasure to turn the call over to John.

John Rynd

Thanks, Stephen, and good morning and thank you all for joining us on the call today. As Stephen mentioned, we reported our financial results early this morning. We recorded net income from continuing operations of $33.1 million or $0.33 per diluted share for the third quarter of 2008 compared to net income of $48.7 million or $0.58 per diluted share for the third quarter of 2007.

Were not for the impact of the active hurricane season, we estimate we would have reported net income of approximately $39.5 million or $0.45 per diluted share for the third quarter of 2008.

First before discussing the outlook, I'd like to begin with remarks on the impact of hurricanes Gustav and Ike, which caused a great deal of turmoil in the industry. I'm extremely proud of our employees' response during the time leading up to the storms. We were able to safely and efficiently evacuate approximately 1,400 employees from 42 rigs and at least 32 liftboats for both hurricanes Gustav and Ike without a single incident.

As we previously announced, the storms had a negative impact on our domestic third quarter results and some of the repair expense will carry over into the fourth quarter as the Hercules 78 and Hercules 201 incurred damages. Hercules 201 will require approximately 30 days of shipyard time and the Hercules 78 will require longer as the damage is more extensive than we anticipated and the scope of the repair is being developed.

The storm also destroyed approximately 50 production platforms and three of our competitor's jackup drilling rigs in the Gulf of Mexico. The damage to offshore platforms and pipelines have created additional work for our liftboat fleet in what was already a relatively tight market. We anticipate rates to increase 10% to 15% over the last 45 days of 2008. That should carry into mid first quarter 2009. And of course it is impossible to quantify the effect of the loss of the three competitive rigs from the fleet.

Lisa will expand on the financial impact of the storms in her prepared remarks.

I want to update you on the Hercules 261 and the Amberjack liftboat. The 261 will depart to shipyard in charge on November 2nd and mobilize to its first location for Saudi Aramco. And after acceptance testing by the client, we should commence dayrate on or about November 15th.

In addition, the Amberjack will depart to shipyard on November 1st to commence its initial assignment and should be on contract in Gutter [ph] on November 5th. I will skip any further comments on current market conditions this quarter and give you our take for what it's worth on the outlook as we move into 2009.

As you know oil and gas prices have declined substantially over the last quarter reflecting the robust level of inventories and production growth in the case of natural gas and the uncertain economic outlook and strengthening US dollar in the case of crude oil.

By most accounts drilling economics in our key regions are still reasonably attractive. We have always maintained it is not just the absolute price that matters, but the direction and the customer psychology. On top of the sharply reduced commodity prices and the generally negative economic outlook, credit issues, liquidity and lack of funding will also be a concern for a number of our domestically focused customers.

Given the recent direction of commodity prices coupled with the lack of availability of credit, we are expecting to see a fairly significant reduction in the E&P capital spending in the US in 2009.

International budgets will likely be more resilient given the customer base and longer term plan required for these projects, but we'll likely not experience the same level of growth that we have seen over the last several years. As always, with the nimble customer base that we have in North America, the good news is that budgets can and will quickly be revised higher should outlook improve. Further, with the extremely steep decline rates in most North American natural gas basins and the likely reduction in the onshore rig count, the gas market could correct relatively quickly.

And while we do not expect a significant pull back internationally, should one occur given the lack of significant oil production growth over the last 10 years despite a more than tripling of international capital spending over this period, we would also expect it to be brief and self-correcting as well. Rather than taking a reactive approach as market conditions soften, we will take proactive measures to reduce cost and limit our downside exposure to adverse market conditions.

You might remember as the market weakened in late 2007, we quickly warm stacked a number of our rigs to reduce costs. Should demand falter in 2009, we are ready to do the same again. We have already developed a stacking plan, which includes one incremental jackup, one incremental submersible and two incremental barge rigs. These are incremental to what was shown as warm stacked in our October 23rd fleet status report.

We will be marketing 18 offshore units and 11 barge rigs. Market conditions will dictate our decision to either increase or decrease the number of units that we will ultimately market. Unlike the warm stacking plan of 2007, we will not allocate any additional capital to these units we elect to stack, as this was conducted late last year and the units are in excellent shape.

I am confident once we emerge from this upheaval in the capital markets, our domestic business will rebound significantly for the reasons discussed earlier, i.e. decline rates and reduced rig count.

Despite whatever happens with capital spending, we should reap the benefits during 2009 of our international expansion that we put in place during 2008 where we will have five rigs – where five rigs will commence three-year contracts.

Fully three quarters of our available days in international offshore are already contracted for the next year and on average our international rigs have 553 days of backlog representing about $800 million in revenue. This expansion in backlog should provide a significant amount of cash flow in 2009 and beyond even with a significant reduction in our customers' capital spending.

Further, we have received a number of calls concerning our liquidity, debt covenants and debt payments. Stephen, as mentioned in the opening remarks, will outline the strength of our liquidity and our capital structure.

With that I'll turn the call over to Lisa.

Lisa Rodriguez

Thank you, John. I will provide a little more detail with respect to our financial results for the third quarter as well as provide cost guidance for the fourth quarter.

As John said, the company generated third quarter earnings per share from continuing operations of $0.37 per share versus $0.22 per share during the second quarter. The $0.15 increase in sequential quarterly diluted earnings per share was primarily driven by the continued growth in our international offshore segment and stronger domestic business conditions offset by the impact of the active hurricane season, which impacted results approximately $0.08. As noted in this morning's press release, we have moved the historical results from our land drilling business to discontinued operations.

Now I will discuss in more detail the other segments. Domestic offshore continued a very strong recovery in the third quarter with operating income of $31.3 million, up from $23.6 million in the second quarter as a result of higher dayrate. Average revenues per day per rig increased by approximately $7,000 to $67,400. Utilization was essentially flat at 79%.

We experienced an increase of approximately $1,900 in average operating costs per rig, per day to $29,700 largely due to the full quarter impact of the 11% average wage increase that went into effect in June, the full quarter impact of the Hercules 350, which has higher labor and insurance costs than the rest of our Gulf of Mexico fleet and due to the infection and other costs associated with the hurricanes. We had guided to the mid $28,000 range on our last call. Excluding the hurricanes, we would have been just slightly above that guidance.

Our international offshore segment generated operating income of $34.2 million, up from $27.4 million in the second quarter. Total revenue increased $21 million quarter-over-quarter. The increase was due to Hercules 258 and 260 having full quarter of operations and the commencement of Hercules 28 contract in late August with a slight offset due to the downtime on Hercules 206 for repairs.

Our international operating expenses rose to $50 million in the third quarter. This is approximately $8 million above our guidance primarily due to higher marine services expenses on Hercules 258 and 260 and higher repairs and maintenance including those identified during the U-weld [ph] inspection on Hercules 206.

As I just mentioned the Hercules 258 and 260 contracts include provisions for marine services. These service have a 25% profit margin, which depresses the overall margin for the division, however they contributed $2.4 million in income in the third quarter.

The marine services were a contributing factor to both the sequential increase in revenue and in costs, with incremental revenue and cost over the second quarter of $5 million and $4 million respectively. We expect comparable contribution levels in the fourth quarter.

Our inland segment reported an operating loss of $1.2 million versus a loss of $2.9 million in the second quarter while operating days increased slightly, our average daily revenue decreased to $38,900 from $39,600. Our daily operating costs were up slightly to $22,700 from $21,100 and this was due to the cost associated with the hurricanes as well as the full quarter impact of the wage increase.

Our domestic liftboat segment generated $5.8 million of operating income, up from $3 million in the second quarter. Average utilization increased 81% for the third quarter versus only 64% in the second quarter. Dayrates were stable during the quarter, however, due to the impact of the hurricanes, when many vessels were on standby rates of approximately 40% our average revenue per day, per vessel for the third quarter came in at $8,100 versus nearly $9,000 in the second quarter. If you exclude the impact of the hurricanes, dayrates would have approximated $9,000 or flat with the prior quarter. We have seen dayrates strengthen during October.

Average operating expense per day for the third quarter increased to approximately $3,600 from $3,500 in the second quarter. The operating costs for the third quarter came in slightly above our guidance primarily due to the hurricanes and a wage increase implemented in August as we are experiencing a tight labor pull for our liftboat personnel.

Our international liftboat segment reported operating income of $5.1 million in the third quarter compared with operating income of $6.8 million in the second quarter due to an increase of operating costs.

Revenue for the quarter was flat sequentially with higher average revenues per liftboats per day, up to $17,800 versus $15,300, offset by lower utilization as one of our customers released four vessels during the quarter. All vessels have since returned to work and utilization has returned to the second quarter levels in October.

The increase in operating costs in our international liftboat segment resulted from a number of factors including the 200 class Blackjack entering service in mid May and shipyard expenses on our two vessels in the Middle East.

Delta towing results nearly doubled reported third quarter operating income of $4.5 million compared to $2.3 million in the second quarter.

Now I would like to provide you some cost guidance for the fourth quarter. We anticipate our daily operating costs per rig for domestic offshore to be in the $28,000 to $29,000 range per day, or $60 million to $62 million for the fourth quarter. This does exclude the $10 million of estimated repairs due to hurricane damage that we previously announced.

The impact of the stacking plan that John referenced will further lower our cost in the first quarter. We estimate that costs will be rooted to $8,000 to $10,000 per day on stacked jackups over the next three months. So by mid-Q1, we will see $8,000 to $10,000 per day on these stacked jackups.

International offshore operating costs should be approximately $50 million to $54 million in the fourth quarter. The increase from the third quarter is due to the full quarter impact of the Hercules 208 and the startup of Hercules 261 and 262 in Saudi Arabia offset by lower repairs and maintenance.

In our inland segment we expect daily operating costs per rig to decline to the $20,000 to $21,000 range in the fourth quarter due to the decline in costs on our stacked rigs, which should have costs in the $4,000 per day to $6,000 per day range by the – that will be the ultimate cost savings we will achieve by mid first quarter.

In our domestic liftboat segment we expect daily operating costs per vessel to remain relatively flat in the $3,500 range to $3,600 range in the fourth quarter. We anticipate daily operating costs per vessel for international liftboats to average $5,900 in the fourth quarter, a slight increase due to our startup of operations in the Middle East and the mix shift towards larger class vessels.

G&A expenses are expected to be in the $17 million to $18 million range for the fourth quarter and depreciation is expected to increase to $50.3 million from $47.3 million due large while the increase of $53.3 million in the third quarter from $47.3 million due to the startup 258, 260, 350 and Blackjack in the third quarter. And we expect it to increase again in the fourth quarter due to the international startup of Hercules 261 and 262 and the full quarter impact of Hercules 208.

We expect total depreciation and amortization to be in the $53 million to $54 million range in the fourth quarter. Interest expense will likely increase in the fourth quarter to $16 million to $17 million due to lower capitalized interest.

Moving into 2009, barring any acquisitions, cash interest expense should decline with the repayment of debt.

Now I'll turn it over to Stephen.

Stephen Butz

Thank you, Lisa. In light of the recent events in the global credit markets, I would like to make a few brief comments on our liquidity and capitalization. As of September 30th, we had cash and cash equivalents of approximately $106 million, total debt of $1.15 billion and stockholders equity of $2 billion. Net debt-to-capitalization was just under 35%.

In addition to our current cash balance and the free cash flow we expect to generate, we have access to a $250 million revolving line of credit that does not mature until mid-2012. The line is with a diverse group of 17 lenders with no single commitment greater than $30 million.

We currently do not have any outstanding balance on the line and do not anticipate drawing on the line. There is $223 million available today, only reduced from the $250 million by the $27 million that we have issued in routine letters of credit. Our liquidity is strong and we fully expect it will remain so. Our principle repayment requirements are minimal over the next several years.

Our debt consists of approximately $890 million in a term loan that matures in mid-2013, which requires a minimum of 9 million in annual principle repayments until maturity and $250 million in convertible senior notes, which, of course, do not have any repayment requirements until maturity or the first put date in mid-2013. Our only other debt is a very small amount of senior notes, approximately $10 million of which mature in the fourth quarter of this year and $3.5 million in 2018.

Again, in short, our minimum principle repayment requirements for 2009 through 2012 are approximately only $9 million per year.

Capital expenditures for the first three quarters of 2008 were $198 million including amount related to contract preparation and rig upgrades for a number of our jackup rigs commencing international contracts from 2008. This excludes approximately $320 million for the acquisition of three rigs from Transocean. We anticipate capital expenditures for the fourth quarter of 2008 will be about $45 million as we complete the contract preparations for the Hercules 261 and 262.

While we have not yet completed our budget for 2009, at this point, we would expect to incur capital expenditures of only about $100 million. We expect this reduced level of capital spending coupled with the strong operating cash flow from our international segments, from contracted rigs and liftboats to provide a significant amount of free cash flow to reduce debt during 2009 even with a potential downturn in our domestic segments.

Lastly, I would like to make a few brief comments on our financial covenants. Our term loan and revolving credit facility are governed by a credit agreement that includes two financial covenants that are tested quarterly, a leverage ratio and a fixed charge coverage ratio both of which incorporate last 12 months EBITDA.

We have room under these covenants currently and even have adequate coverage on the downside cases that we have analyzed for 2009 and 2010. In fact we would anticipate, even in a down market, generating a greater level of EBITDA in the first half of 2009 than we did in the first half of 2008 due to the incremental contribution from our international contract.

This coupled with the reduced level of capital spending that I mentioned and the use of free cash flow to repay debt should result in coverage under the covenants actually improving beginning in the first quarter of 2009.

In closing, while we are cognizant of the fact that the global credit crisis and reduced commodity prices will likely result in very conservative capital budget next year across our customer base, we are very comfortable with our liquidity, debt structure and ability to continue generating attractive levels of free cash flow.

With that, we're ready to open the call for questions-and-answers. Operator?

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Geoff Kieburtz with Weeden. You may proceed.

Geoff Kieburtz – Weeden & Co.

Thanks. Good morning.

John Rynd

Good morning, Geoff.

Geoff Kieburtz – Weeden & Co.

Can you tell us a little bit about – you haven't quantified your – the magnitude of the spending or CapEx decline that you expect customers to take. How do you – how are you thinking about where rates might go in conjunction with the declining demand and your proactive efforts to reduce the capacity with the warm stacking?

John Rynd

Well, first on the question on the reduction in capital spending, I think you have to look at what's been announced by the land based guys in North America. They're in the 15% to 20% range on average. As most of our customers domestically are private, we don't have the visibility that you do with the public companies, but if you take that and say, I will expand it to a 25% reduction in CapEx on the offshore and inland segments and then you go back to where rates fell in the fourth quarter and early first quarter – fourth quarter of 2007 and the first quarter of 2008, rates were in the 50 range to 55 range, I think that is very achievable given that we have about 15 less rigs active in the US Gulf of Mexico today than we did a year ago. So that's kind of what we're thinking, Geoff.

Geoff Kieburtz – Weeden & Co.

Okay. All right. And then internationally, I understand you got the three rigs or five rigs starting up the three-year contracts. How are you – are you seeing any evidence that things are sensitive to the downside in the young [ph] contract to-date?

John Rynd

No, just the opposite. In fact the – just the deal flow coming from the international market is still very robust. Just this morning Pemex announced that they were going to reissue the four-rig package that they rescinded last week or ten days ago on October 30th, so that's a vote of confidence, I think people were worried about that. We're still getting very good conversations coming out of the Middle East market from – in Saudi Arabia, Abu Dhabi, Neutral Zone, Qatar. So I think overall, it is not falling off by any stretch.

Geoff Kieburtz – Weeden & Co.

Okay. And could you tell us, overall what do you have your fleet insured for?

John Rynd

I'll give you the range, I don't know the total number, but I'll just kind of give you ranges by asset-class if you will.

Geoff Kieburtz – Weeden & Co.

Okay.

John Rynd

The kind of the commodity rigs in the Gulf of Mexico, the 150s, the 200s and the 250s are in the $45 million to $55 million range. The independent led cantilevers like the 260, 261, 262 are in the $100 million range to $110 million range. And then the 350s at the $150 million range. The submersibles are in the $45 million range. The inland barges are anywhere from about $10 million to $25 million on a range.

Geoff Kieburtz, Weeden & Co.

Okay and the liftboats?

John Rynd

They're anywhere from about 3 to 12, with a little increase value on the international side, but in that range.

Geoff Kieburtz – Weeden & Co.

Appreciate it.

John Rynd

No problem. Thanks, Geoff.

Operator

Your next question is from the line of James West with Barclay Capital. Please proceed.

James West – Barclays Capital

Hey, good morning, guys.

John Rynd

Morning.

Lisa Rodriguez

Morning.

James West – Barclays Capital

John, given this credit market shake out, have you seen any speculative builders of jackups reconsider maybe coming to you and saying we'd like to sell our assets now, given the new outlook?

John Rynd

Well, I think first and foremost what they're trying to do is seek financing. They're going to beat dead horse to either dead or can't and then probably turn. But that could be an opportunity as we progress through 2009.

James West – Barclays Capital

And then do you have any update on Delta Towing? I know you guys have been looking at strategic alternatives there.

John Rynd

Yes, the strategic alternative right now is to run it. We pulled it off the market and we're going to drive some synergies between kind of the Hercules Offshore inland group and the Delta group.

James West – Barclays Capital

Okay, understood. And then on the liftboat fleets you mentioned price increases in the fourth quarter. Have you already put those price increases in place?

John Rynd

We're about to do that. Yes, we've already put our customers on notice and as Lisa mentioned in her prepared remarks, we've already seen aside from that formal notice of rate increase rate improvement through October.

James West – Barclays Capital

Okay, great. That's all I had, thank you.

John Rynd

Thank you.

Operator

Your next question comes from the line of Angie Sedita with Macquarie. Please proceed.

Angie Sedita – Macquarie

Great. Thanks, guys. Hi, guys.

John Rynd

Good morning.

Lisa Rodriguez

Good Morning.

Angie Sedita – Macquarie

First question really is just kind of stress testing the earning. My numbers would show that if you go to break even earnings next year that you're still actually building cash and no covenants issues. Does that seem correct to you?

John Rynd

You're spot on.

Angie Sedita – Macquarie

All right, where would you start to stress test your covenant issues? What would have to occur in the market when you'd get to that bare case scenario?

John Rynd

Go ahead, Stephen.

Stephen Butz

Well, Angie, since both covenants are based on EBITDA, you have to get in the low $200 million range before it could become an issue. And of course, above and beyond that then we could cut capital spending further, there is other things that we could change. I hate to say that would be the line, but without any further cuts to CapEx and things of that nature, that's where things would appear to get tight in late '09. But we have – just based on our outlook for our international business, which again 75% of the days are already booked up, we would expect to generate EBITDA in our international liftboat and drilling business in the $300 million range.

Angie Sedita – Macquarie

Okay. Fair enough. And also is it fair to say that a bigger issue here is certainly not gas prices, gas prices are an issue, but the credit markets are the primary concern and as they start to free up that could start to change the outlook for the sending patterns of E&P companies next year?

John Rynd

Absolutely. I think the – I think people – the second place they look in the morning when they come in is what not gas is doing they're looking at the credit markets. And you could be in a situation where we have very robust and natural gas pricing, but lack of liquidity could stall the start. But I do think as we said in our prepared remarks, once we get this credit market behind us and confidence is back in both the banks and the customers, I do think you'll see capital flow back to our business.

Angie Sedita – Macquarie

So clearly for next year, for 2009, liquidity concerns for Hero is not the issue, it's just earnings and the spending pattern of the E&P companies?

John Rynd

Absolutely.

Angie Sedita – Macquarie

And then finally on the international side, nice to see Pemex step up. Are you expecting another tender, and I guess that was the only question mark as far as the international customers. Everybody else seems to be status quo so far.

John Rynd

Yes, they still have to formally award the previous tender, which was for four jackups, one incumbent and then two from the Gulf of Mexico, one from West Africa, which the earliest they could have awarded that tender was October 17th. In their bylaws they do have a 20-day window to award, so that's going to be what the end of the first week in November where that gets formalized. And then I think everybody that was nervous about this tender that was rescinded last week, we're seeing in hit the desk on October 30th.

Angie Sedita – Macquarie

Great. Thanks. That's all I have.

John Rynd

Thank you.

Operator

Your next question comes from the line of Jud Bailey with Jefferies and Company. Please proceed.

Jud Bailey – Jefferies & Co.

Thank you. Good morning.

John Rynd

Morning, Judd.

Lisa Rodriguez

Hi, Judd.

Jud Bailey – Jefferies & Co.

Hi, John, thoughts or kind of let us know what you're hearing coming out of ONGC in India. I believe they may have delayed a recent jackup tender. Any thoughts there? Also, you're pretty well booked up in West Africa, but just give us a sense of what you're hearing from your customers there?

John Rynd

Okay, Judd, I'm not aware of any international tender that ONGC has cancelled on a jackup front. I may be wrong, but I'm not aware of that. And I think status quo, they just went out for a deep water drill ship, so I think they're going to stay fairly steady as they have historically. If you look at their drilling pattern and number of rigs they keep under contract through the various cycles over the last 25 years, they've been very, very consistent. So we're not as concerned about that as others may be. In West Africa, it's been an interesting market over the last three years with the increase in oil prices and a relatively flat rig demand. It's been a little bit puzzling. I think rig demand there is about 27 rigs and that you can go back to the mid-90s to late-90s and you had the rig count up to 34. But the outlook is still positive. I think that we have tow rigs in that region, the 185 has got an 18-month extension post delivery from shipyard in April of '09 and then the 156 has got to finish up its program with Addex [ph] and Perimco [ph] the firm portion. And we're in discussion with Perimco now on a 9-month to 12-month extension. And we've got some shipyard time on the 156 scheduled for either late this year or early next year depending how the wells shake out. So, yes, we're watching it, but we watch everything close. You can't take anything for granted.

Jud Bailey – Jefferies & Co.

Okay and could you update us on anything – I know you're probably bidding the 350 out internationally. Can you give us any update there?

John Rynd

Yes, we've got an opportunity in west Africa, speaking of that market, and also the tender that's going to come out October 30th from Pemex requires a 350-foot independent leg rig for approximately about I think it's about 785 days (inaudible) so that's one we're looking at.

Jud Bailey – Jefferies & Co.

Okay, great. I'll turn it back. Thank you.

John Rynd

Thank you.

Operator

Your next question comes from the line of Dan Pickering with Tudor, Pickering & Holt. Please proceed.

Dan Pickering – Tudor, Pickering & Holt

Morning, John and team. If you could talk a little bit about sort of the Gulf of Mexico market in terms of dayrates have held up pretty good. Are you guys changing your bidding practice at this point? Has there been any rate erosion and is there any term work available at this point and if so are you bidding for it?

John Rynd

Yes, there is a modest amount of term right now. And I think we, on our last fleet status, we extended a couple of rigs nicely. And one went up and one went down modestly, but no significant change to the rate structure rate environment. We have not seen any erosion in rate. So in a snap shot right now, Dan, everything looks lovely. Things are very solid. We've got good customers with good backlog. But I think as we talked about in our opening remarks, you got to believe you're going to see a pull back in CapEx.

Dan Pickering – Tudor, Pickering & Holt

Sure. And John how does that manifest on the pricing side? I think in response to Geoff's question you felt like 2007 rate levels were good potential for – I mean who leads the market down? Is the guy with the one-off or two-off rigs? What do we watch as analyst?

John Rynd

I would say, Dan, the guys that have only exposure to the Gulf of Mexico and don't have any other flexibility that they got to pay the bills here typically and historically have been the ones that went after utilization. But I think the key thing when we look at the Gulf of Mexico is the limited number of assets that are available to work everyday in the Gulf of Mexico plus as this Pemex tender comes that's going to take two to four incremental rigs out of the Gulf of Mexico. We can see our downside much clearer than even we could see it in the fourth quarter 2007. So I do think to my comment to Geoff, where we got to the 50 range to 55 range that feels very defensible at this point.

Dan Pickering – Tudor, Pickering & Holt

And it sounds like what you're saying is Hercules clearly is not – you guys are going to try to hold the market not run for term or run for rate.

John Rynd

That's correct. With the strength of our international backlog, we don't know – we don't survive just here.

Dan Pickering – Tudor, Pickering & Holt

Okay. That's helpful When Stephen was talking – Stephen, you were talking about debt pay down and free cash generation, your capital spending one, is the $100 million capital spending primarily maintenance capital? Is that what we should think about as the minimum level? And then kind of strategically generating $200 million to $300 million in free cash next year availability on your credit line, do we think about your priorities as paying down debt first and potentially buying rigs second? Or is it the other way around?

Stephen Butz

No, that would be the priority, but –

Dan Pickering – Tudor, Pickering & Holt

What would be the priority?

Stephen Butz

To pay down debt. Going back to your question about maintenance CapEx, $100 million would be our maintenance cap spending although of course if you're in a really bad market and rigs aren't working you would reduce – you could reduce that dramatically.

John Rynd

A large portion of that $100 million is all discretionary.

Dan Pickering – Tudor, Pickering & Holt

Okay. So it's maintenance CapEx to keep the current fleet running appropriately. If the fleet not running, the money doesn't need to be spent?

John Rynd

Exactly.

Dan Pickering – Tudor, Pickering & Holt

All right. That's helpful. And then last question from me. The $156 million you were talking about renegotiation with Perimco, West Africa in general, what are rates doing there? Would you expect – should we be thinking about higher, lower of flattish rates with –

John Rynd

At this point we're looking at relatively flattish rates.

Dan Pickering – Tudor, Pickering & Holt

Great. Thank you very much, guys.

John Rynd

Thank you.

Operator

Your next question comes from the line of Bill Sanchez with Howard Weil. Please proceed.

Bill Sanchez – Howard Weil

Good morning.

John Rynd

Morning.

Lisa Rodriguez

Morning.

Bill Sanchez – Howard Weil

John, just one more follow-up on the Gulf of Mexico jackup market. It sounds like you identified the floor at $50,000 to $55,000. You got rigs I guess identified for stacking here. It sounds like – are you comfortable allowing rig rates to go down that level and continue working what you're working right now? Or do you choose to get more aggressive on the stacking program at some rate level between where we are currently in that particular floor?

John Rynd

I think we can get more aggressive on the stacking.

Bill Sanchez – Howard Weil

Okay. So we shouldn't assume that – okay, enough said. We shouldn't assume everything works at that's working today at $50,000 or $55,000 a dayrate.

John Rynd

Yes, and I think what happens when you get into a period like we saw last year and we've seen through the years in the Gulf of Mexico, if you start bumping below about a 60% to 65% utilization rate on a rig that incremental 30-day well ends up costing you more money that you make. The starting and stopping, you can't layoff the crews because you're about to go back to work. So all of the sudden your cost structure gets out of whack. So that's a thing we watch. We'd like to stack up work and get as much work stacked up behind the rigs that are there and then we'll watch the market from there to whether we add or subtract.

Bill Sanchez – Howard Weil

I guess, Lisa, question for you. You mentioned the $8,000 a day to $10,000 a day on the stack jackups. Is that a blended number for the warm stacked, ready stacked and cold stacked or is that actually the cold stacked operating cost number?

Lisa Rodriguez

That's the warm stacked.

Bill Sanchez – Howard Weil

That's the warm stacked. Okay. Is there a meaningful difference between the costs on the ready stacked versus the warm stacked? I imagine the cold stacked is significantly less.

Lisa Rodriguez

The cold stacked is nominal, so that's significantly less. The ready stacked, you have the majority of your crew already there so that's not that much lower than the working rig. So when you get to warm stacked, that's when you reduce the crew levels, you have less of everything, but clearly, the biggest piece of that is the smaller crew compliments and lower insurance costs.

Bill Sanchez – Howard Weil

Okay. Thank you, all.

John Rynd

Thank you, Bill.

Operator

Your next question comes from the line of Arun Jayaram with Credit Suisse. Please proceed.

Arun Jayaram – Credit Suisse

Good morning, all.

John Rynd

Good morning.

Lisa Rodriguez

Good morning.

Arun Jayaram – Credit Suisse

John, looking at the US Gulf of Mexico, demand had been kind of in a 58 rig to 65 rig environment for most of the summer. It came off to 55 rig last week. If we're in a $7 to $8 gas range based on what your customers are telling in terms of rig demand and extrapolating what you're seeing, where do you see demand – jackup demand in the first half of next year?

John Rynd

I think we got an added question mark on that. Two things, one, as we said many times, it's not just what's the (inaudible) price, what is our customers feel on the direction of that price. If it's seven to eight, going to 10 we can see a pretty quick movement in the rig count. If it's seven to eight going to a perception of five, they're going to hold back. And I would add on top of that. Now we have the issue of access to liquidity, which could stall – we get to that gas price, could stall a recovery. A recovery will come, but it will just stall it. So I think we can get back up to the low-to-mid-60s quite easily. I think on the drop in demand, if I'm not mistaken, A J, is that three of those rigs are sunk –

Arun Jayaram – Credit Suisse

That could be and I need to check in.

John Rynd

Yes. Right.

Arun Jayaram – Credit Suisse

Second question is if there are some – obviously Mexico don't know if those are incremental opportunities or some replacements from that. Right now on my numbers about 23 premium jackups working today in the US Gulf of Mexico. How many – is them that rigs did come back up, how many of those 23 rigs, John, do you think are truly working on independent type leg opportunities or premium jackup opportunities versus where mats could support some of that work?

John Rynd

I think if – you got to take it by water depth, A J. If you take the 250 ILCs you could save I would say probably at least half of those or 70% of those jobs could be done by the mat rigs. Then once you get to the 300-foot and above, that's all premium work. There's no alternative in the Gulf for the mat rigs.

Arun Jayaram – Credit Suisse

That's fair enough. Last question, Lisa, in terms of your AR balances or DSOs, anything perking up in terms of getting you nervous about AR balances et cetera from your customers?

Lisa Rodriguez

No, but that's clearly something we're watching as the credit crunch impacts our customers. So we're monitoring that closely. But there's nothing at this time.

Arun Jayaram – Credit Suisse

All right, thanks a lot.

John Rynd

Thank you.

Operator

Your next question comes from the line of Dan Boyd with Goldman Sachs, please proceed.

Dan Boyd – Goldman Sachs

Hi, thanks. My question is following up on Pemex. There has been some concern out there that as they tender for incremental rigs, they're all going to be independent cantilevers and then you're going to see a number of mat rigs actually come back to the US Gulf of Mexico. What are your comments or thoughts on that?

John Rynd

So far that's been the state of play. I do think that if you look at the day rate and mobilizations charged on the four rig package that's pending approval and then relate that to where the mat rig day rates are, they are spending substantially more amount of money on a per day basis to swap the fleet out. And I'm confident that you're not going to see a total independent leg fleet down in Mexico. We're going to see some swap out continue. We'll see on this bid that's due on the 30th, due out on the 30th of October. Obviously, the 350 is incremental. And then on the 250s we'll match up start dates to the existing expiration dates of the fleet down there and have a better sense.

Dan Boyd – Goldman Sachs

Okay, so only one incremental rig then on the next –

John Rynd

I would say that's a conservative view right now.

Dan Boyd – Goldman Sachs

Okay. And is there a scenario where you could envision cold stacking some of these warm stacked rigs to further reduce costs? What would the level of utilization have to get in your mind before you start to make that decision?

John Rynd

It gets pretty bleak at this point because when you go to the cold stack mode, you're pretty much writing the asset off as far as the marketability for a period of time. And then when the market turns, you have a stigma of trying to enter a cold stacked rig back into the market. And really I think we can get our cost to a level in our warm stacking plan where the incremental saving is going to the cold stack mode may not be worth it.

Dan Boyd – Goldman Sachs

Okay, that's helpful. And then just in terms of overall rig count, I think so far this year we're averaging about 57 jackups in the Gulf and if you're thinking about a 20% to 25% CapEx decline, I would assume (inaudible) 10% or 15% of that decline is probably in price, the other 10% is in activity. That will give you an average jackup count for the year somewhere in the low 50s. Is that consistent with what you're thinking or are you thinking – ?

John Rynd

Yes, you just got to – there's so much uncertainty right now and again I know I keep – don't want to beat a dead horse, but the capital market issues are something we've never dealt with when we're evaluating our business on a go-forward basis. So that's a new area that we've got to get our hands around. But just go back to the November of 2007; we had 43 jackups working in the Gulf of Mexico. That was your 15-year load from June of '92. So is that your bottom? And if you think so, then you plan accordingly. And you can respond to the upside.

Dan Boyd – Goldman Sachs

And that is the scenario that you stress tested at?

John Rynd

Yes.

Dan Boyd – Goldman Sachs

Okay, thanks.

John Rynd

You bet.

Operator

Your next question comes from the line of Mike Drickamer with Morgan Keegan. Please proceed.

Mike Drickamer – Morgan Keegan

Hey, good morning, guys.

John Rynd

Morning.

Lisa Rodriguez

Morning.

Mike Drickamer – Morgan Keegan

John, quick one for you here. How do you decide which rigs you're going to take in warm stack? Is it as simple as which rig doesn't have a contract? Or is there other criteria you consider?

John Rynd

That's the first and foremost criteria to look at if you have any work forward. Secondly, what has been its historical utilization over the last year? Give you an indicator of what you may look going forward. And then you look at what capital need to be sent on that unit to maintain it. If it's at high utilization, it's got some outlook for some work and got low capital associated in 2009, you keep it active. If it's a reverse of those three, that's the first candidate that goes to the warm stack.

Mike Drickamer – Morgan Keegan

Following up on that then, do you guys have a lot of rigs coming up for shipyard surveys in, say, 2009 or '10?

John Rynd

I think generally flattish fleet status on the 23rd of October we have four domestic rigs that have to come in for special surveys. In fact, it's down to three now because the 201 was scheduled for a special survey in 2009 and we're going to take care of that while we're on the dry dock maintaining the repairs. And then in the international market, we've got the 156 that depending on when we finish the wells will be December or January, and then we've got the big special survey due on the 185 that will be sometime December to January we head into the yard and undertake that special survey.

Mike Drickamer – Morgan Keegan

Okay, and then on the jackup side you kind of described the late 2007, early 2008 time frame as what you think you can defend on the jackup side. How about on a liftboat and barge side? Is that time frame also appropriate?

John Rynd

Mike, I think the difference this time is we've got the storm impact relative to the liftboat business, but when you stress test, that's where you stress test too. I don't think it's going to get there on the liftboat side. On the inland barge business, we've been kind of staying at this level for now almost over a year, so I think we could see a modest drop there, I think on the liftboat side, Mike, I think you're going to see a little bit more robust activity through the first quarter due to the damage caused by Ike.

Mike Drickamer – Morgan Keegan

Okay, that's all from me, guys. Thank you.

John Rynd

All right.

Operator

Your next question comes from the line of Pierre Conner with Capital One. Please proceed.

Pierre Conner – Capital One

Good morning, team.

John Rynd

Morning.

Lisa Rodriguez

Morning.

Pierre Conner – Capital One

Hey, John, just wanted to be clear, in the opening remarks, you mentioned about should demand fall through you have a stacked plan in place. Are you progressing with that stacked plan or were you looking for a few more indicators?

John Rynd

No, we're starting to put in place right now.

Pierre Conner – Capital One

And I guess, my assumption is, you have a lot of variability you can increase that plan as necessary. What kind of indicators are you looking for to be more aggressive than that in your stacked plan?

John Rynd

Well, I think as – we've got a – what we call a watch list to rigs. And again it goes back to our conversation with Mike was part of it is work forward, historic utilization, what capital is assigned to it, so as those rigs come up if we don't have any near-term future for it that may be a candidate to pull it in. But again we have to be flexible in that and that this market can change quickly. So we do have flexibility to accelerate it or stop and go the other direction if we see a recovery.

Pierre Conner – Capital One

Yes, strange [ph] anything today. On the opportunities for moving the rigs out so the 350 potentially West Africa or Pemex, can you give us a number for what would be required? I'm assuming that would be in addition to the $100 million for international on that rig, if any?

John Rynd

Yes, the Pemex number, we got a pretty good handle on. It's around the $15 million range to $20 million range for Pemex. And the opportunity in West Africa is right in that range as well.

Pierre Conner – Capital One

Okay, $15 million, $20 million there. On – two more, on international ops, given that your perspective on the recent increase in activity for the liftboat business has been as a result of damage and that will come to some conclusion. Do you still pursue international liftboat? Are there many remaining out there for the current Gulf fleet or just the larger liftboats? What's the opportunity for additional move out?

John Rynd

We're very excited about the opportunities in 2009 to expand the international liftboat operations both in West Africa and the Middle East. So we're not going to let a nice run here domestically in our liftboats over the last three months, that could last nine months change our minds on the longer term view of where we think those liftboats need to be deployed.

Pierre Conner – Capital One

And you've seen no change in those opportunities at this point obviously and you're thinking as you still would have those on maintenance level type work with CapEx internationally would be somewhat restrained – ?

John Rynd

Yes, I think that we're seeing in fact constant conversations with our guys internationally. The opportunity sets growing.

Pierre Conner – Capital One

Okay. Coming back to the jackup, sorry, are there any other international mat opportunities at all in the other Latin American countries?

John Rynd

Nothing eminent.

Pierre Conner – Capital One

Okay.

John Rynd

We know of a couple opportunities that may come to the market in the first quarter that we're tracking closely, but it's nothing eminent.

Pierre Conner – Capital One

Okay. All right. Very good. Thanks for all the information. I'll turn it back.

John Rynd

Thank you.

Operator

Your next question comes from the line of Alan Laws with Merrill Lynch. Please proceed.

Alan Laws – Merrill Lynch

Good morning. Couple follow-up questions I guess. On the stacking side of things here, you made a few comments on that and I got a few questions to ask. What price level or utilization levels would you take them out at? Like when you're looking forward, you're saying first quarter you'll see some more warm stacking. What do you think that level has to be before you take them out?

John Rynd

It's really not an overall level. It's on an asset-by-asset basis. If we can achieve high utilization and good rates, we'll keep them working. If we think that there's going to be too many chasing too few, and we've got as I mentioned I think one of the key factors on this is what capital needs to be required, invested in that rigs in 2009 will be a key factor in that we pull it off until we get a better view because we can turn around quickly and respond to an increase in the market. As I mentioned in the opening remarks, last year when we went to the stack plan we allocated almost $8 million of capital to put back into the rigs because the rigs had been running almost flat out since 2005, all of them needed some catch-up capital. We've done that. So now it's just get the crews on, fully crewed and go. We don't have a capital infusion that's going to delay the return. So we're okay on both sides of this. We can respond quickly to the down case and we'll be able to respond quickly if things turn quicker.

Alan Laws – Merrill Lynch

So you're not going to be – ?

John Rynd

We do it on a day-by-day, month-by-month, rig-by-rig opportunity and if we're seeing more positives than negatives or more negatives than positives, that's going to impact our thought process.

Alan Laws – Merrill Lynch

The current level of marketed fleet, if you do take them out on a warm stack basis, you're not going to want to build backlog on the other rigs before you reactivate the warm stacked rig?

John Rynd

Yes, we will. We just – same plan that we had in effect in the fourth quarter 2007 and through the first quarter of this year, build backlog and then bringing the incremental rigs in with a nice contract, 45-day to 90-day contract, same philosophy.

Lisa Rodriguez

One of the things that I mentioned is that it takes a three-month period to wind your costs down on those rigs that you're warm stacking. So what you don't want to do, as John mentioned, you don't want to put it out there on a 30-day job and then have a sit for 30-days because you'll be carrying that full cost while in sitting, waiting for the next job. You want to be able to have a job – several jobs lined up or some terms.

Alan Laws – Merrill Lynch

But the price level as far where the rate gets to, if you get to the 50 to 55 there that you were talking about as a floor, if you see the market dip below that, is that a sign for you to start stacking more equipment? Or is it something you take that because of that leg issue on costs?

John Rynd

Again it's more just a global account – a total picture of what's going on that just say it's a rate a line in the sand if we have a more negative view that things are not going to get any better we may accelerate. If we think we can see some positive signs, we'll continue to work the rigs.

Alan Laws – Merrill Lynch

And I have a follow-up –

John Rynd

We can't give you any definites because it's a very fluid situation.

Alan Laws – Merrill Lynch

Sure. On the Pemex side, what's been – you worked some quite a while and what's been your experience in terms of when the bank account kind of runs dry and you look at this cost advantage to mats over to ILCs you've been pretty clear over the last six months time. There is no real advantage for the type of wells they're drilling to use, the independent leg rigs. What's the chance that they could wholesale swap back towards the mats?

John Rynd

Wholesale, I think is probably too strong a term. But I think as they come up, let's say just – they look at 2009 drilling activity, would not swap out those that are going to expire mid-to-late 2009. They just retain that existing fleet of mat rigs, which is my belief is what's going to happen.

Alan Laws – Merrill Lynch

Okay. And then, on the customer side, at our conference earlier this month you sort of mentioned that if you look at the spectrum of customers, there were some that weren't very based and they were pretty comfortable even with the volatility. Some were modestly concerned, and others were kind of in a panic, kind of financial backdrop and commodity prices. At that time I think you were politically courteous and said, one third, one third, one third in each bucket. Has that changed over the month? And is there a difference between the public versus the private – ?

John Rynd

No, if anything I think that that's been fairly consistent. I would say the – on the panic side that may have been too strong a term, but I would say concerned over panic, but that group is – I think you may have more – the concern may have grown as this thing has continued. But I think we're seeing that those that have liquidity, that have big acreage positions in the Gulf of Mexico or have very robust projects are going to, they're telling us they're going to continue. There are some on the margin that, hey, we've got to lay down an incremental rig until we get a handle on where this things going to end up being. And again, I think somebody, I think, it was Angie, asked earlier; it's not the gas prices driving this natural gas prices. This is being driven by capital market concerns.

Alan Laws – Merrill Lynch

So it's the public companies that have more concern here than say the private?

John Rynd

I wouldn't say that. I think it's again, it's a mixed bag.

Alan Laws – Merrill Lynch

All right, that's all I have. Thanks, John.

John Rynd

As they well capitalized and have funds and have prospects and they're charging ahead and some aren't.

Stephen Butz

Operator, we have time for one further question.

Operator

And your last question comes from the line of Ian MacPherson with Simmons and Company. Please proceed.

Ian MacPherson – Simmons & Co.

Hi, John, glad to get in under the wire. Curious about how the – how your downside case for the inland barge fleet compares with the offshore and if you could offer any cliff notes on how to think about the downside case for those?

John Rynd

Yes, I think as we look at the downside case, we're – there's a couple less rigs running. Say we've got nine operating. Rates are modestly off and cost as Lisa detailed are relatively flat. Again, that's a small market with two big players. You have a little bit better visibility on the business.

Ian MacPherson – Simmons & Co.

Okay. So you don't really see rates going below the low-30s there then necessarily?

Lisa Rodriguez

No, we don't, but and that's one where like John said we'll have more visibility so we'll have more clarity on what our stacking plan needs to be sooner probably rather than later.

Ian MacPherson – Simmons & Co.

Okay. I'll let us finish with that. Thanks a lot.

John Rynd

Thank you.

Stephen Butz

All right. I'd just like to thank everyone for joining our call and for your continued interest in Hercules. Thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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