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Hornbeck Offshore Services, Inc. (NYSE:HOS)

Q4 2012 Earnings Call

February 7, 2013 10:00 am ET

Executives

Todd Hornbeck – Chairman, President and Chief Executive Officer

James O. Harp Jr. – Chief Financial Officer, Executive Vice President

Analysts

Todd Scholl – Clarkson Capital Markets

Mark Brown – Citigroup

Jon Donnell – Howard Weil

Joseph Gibney – Capital One Southcoast, Inc.

Jeff Spittel – Global Hunter Securities

Jeff Tillery – Tudor, Pickering, Holt

David Anderson – JPMorgan

David Smith – Johnson Rice & Company

Matt Conlan – Wells Fargo

Fotis Giannakoulis – Morgan Stanley

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Hornbeck Offshore’s fourth quarter earnings conference call. During today’s presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be opened for your questions. (Operator Instructions)

Today’s conference is being recorded, February 7, 2013. I would now like to turn the conference over to Ken Dennard of DRG&L. Please go ahead, sir.

Ken Dennard – DRG&L, IR

Thanks, Alicia and good morning, everyone. We appreciate you joining us for the Hornbeck Offshore's conference call to review fourth quarter 2012 results and recent developments. We also welcome Internet participants listening to the call over the web.

Please note that the information reported on the call today speaks only as of today, February 7, 2013, therefore you are advised that time-sensitive information may no longer be accurate as of the time of any replay listening. During today’s conference call, Todd and Jim will make certain projections about future financial performance, liquidity, operations and events that are not statements of historical fact and thus constitute forward-looking statements.

These forward-looking statements are subject to risks, uncertainties and other factors that may cause such future matters, including the company’s actual future performance to be materially different from that which is projected today.

You can locate additional information about factors that could cause the company’s results to materially differ from those projected in the forward-looking statements here in the Hornbeck’s SEC filings and yesterday’s press release under the Investor Relations section of the Company’s website www.hornbeckoffshore.com, or through the SEC website at www.sec.gov.

This earnings call also contains references to EBITDA, which is a non-GAAP financial measure. A reconciliation of this financial measure to the most readily comparable GAAP financial measure is provided in the press release issued by the company.

Finally, the company uses its website as a means of disclosing material non-public information and for complying with disclosure obligations under SEC Regulation FD. Such disclosures will be included in the company’s website under the heading Investors-IR Home. Accordingly, investors should monitor that portion of the company’s website in addition to following the company’s press releases, SEC filings, public conference calls and webcasts.

Now with that behind me and I would like to turn the call over to Todd Hornbeck, Chairman, President and CEO of Hornbeck Offshore. Todd?

Todd Hornbeck

Thank you, Ken. Good morning everyone and welcome to our fourth quarter 2012 investor conference call. This morning, I’ll review with you our quarterly 2012 annual results as well as update you on our strategic process and outlook for 2013. Jim will take you through the numbers in detail following my remarks.

We announced last night another solid quarter to finish off what was a strong year for the company. Operating income for the quarter was $32.5 million which yielded a respectable operating margin of 24.4%, an improvement over last quarter.

Net income of $11.3 million or $0.31 per share diluted share also showed a sequential quarter-over-quarter improvement. On an annual basis, the big story was revenue growth which pushed the company pass the $500 million revenue threshold for the first time in its history.

Total revenues were $513, a 34% improvement over last year and the revenue growth came from strong high-spec OSV dayrates that prevailed in the Gulf of Mexico during the year, which we were able to capture with available spot vessels. Our operating margin for the year of 23.7% was a significant improvement over last year’s margins of 14.4% and compared favorably with margins previously reported by our public company peers.

We put 2011’s net loss behind this with an annual net income of $37 million or $1.3 per diluted share in 2012 excluding a $6 million loss on early extinguishment of debt, our EBITDA for the year was $209 million or roughly inline with our internal forecast formulated at the outset of 2012.

Fourth quarter utilization for new generation OSV fleet was 84%. The real story here however is that utilization for DP-2 high-spec fleet was 96% for the fourth quarter which was an improvement over the prior quarter that was also strong. If you remove the impact of regulatory drydockings during the quarter, our high-spec equipment was at full practical utilization of 99%.

This tight utilization allowed us to move rates from a third quarter average of 29,500 per day to an average of 31,000 per day across the high-spec fleet. The opposite was the case with respect to our DP-1 class vessels which we saw an average dayrate fall of about 1700 per day to around 14,000, while utilization grew slightly from 62% to 69%.

So overall, we are pleased with how we finished 2012 and see it as a further validation of the strategic direction we embarked upon at the beginning of the year. To reiterate our strategic plan, it is compromised to the following three elements, to maximize our optionality in the deepwater Gulf of Mexico to be in position to serve our clients as the recovery continues to take hold.

To enhance our geographic and service diversity in order to hold a leading position over high-spec new generation vessels in all three of our core markets which include the deepwater and ultra deepwater Gulf of Mexico, Mexico and Brazil and to participate in shaping the Post-Macondo competitive and regulatory landscape in the offshore energy space. Throughout 2012, we advanced each of these strategic elements, 2013 should be no different.

As I mentioned earlier, we finished 2012 by crossing the $500 million revenue milestone, what is important however is quality of those revenue in terms of their relevance to our strategy to maximize optionality in the deepwater Gulf of Mexico and how that strategy furthers our ultimate goal of value creation for our shareholders.

Our revenue growth came principally from the dayrate expansion that we were able to capture because of our market view that the Gulf of Mexico was poised for deepwater recovery and our strategic commitment to be in position to meet that market as it materialize.

We’ve resisted natural temptation to overly subscribed long-term charters in a low-rate environment and elected to keep a number of our vessels available in the spot market. This was based on our positive view of the Gulf of Mexico’s resiliency as a core region and its expected turnaround.

The same view that propelled the November 2011 launch of our most recent newbuild program. By being in position in the Gulf of Mexico with the right vessels to meet customers Post-Macondo requirements we were able to grow our revenues and expand our customer portfolio as the recovery in the Gulf of Mexico gradually improved in 2012.

Equally important, our strategy of maximizing optionality in the Gulf of Mexico also helped us overcome key challenges that we faced during the year. We were put into a significant test early in 2012 as we confronted a 30% across the board mariner wage increase driven by workforce constraints.

Our short contracting position enabled us to mitigate some of the effects of this wage increase through spot pricing. Also helpful was our disciplined contracting practices that allow us to seek cost escalations in appropriate situations. To restate the obvious, the Post-Macondo Gulf of Mexico is one in which operating costs are being driven by customer and regulatory forces beyond our control and which have not yet stabilized.

We are ever mindful of this dynamic as well with the volatility inherit in our business. We believe that in this kind of environment there are clear benefits to be derived from a proper mix of a stable platform of revenues provided by long-term contract pictures at good returns, combined with vessels having shorter or spot terms, maximizing optionality is a key driver to success over the long term.

We spend a lot of time trying to understand what the proper mix of long and short term contracts should be at any given point in time and we got it right in 2012. We also advanced our plan to deepen our geographic diversity by strengthening the footprint we have in Brazil and Mexico where we invested further in our in-country infrastructure so as to be in a position as those markets continue to develop.

Our long-term view in Brazil is that it’s preeminence as a deepwater drilling region will offer us significant opportunities, particularly as our HOS Max vessels are delivered. Those vessels will have large capacities necessary for remote ultra deepwater drilling regions, such as pre-soft Brazilian markets. We see Petrobras making significant investments intended to spin the logistical bottlenecks that have hampered its ability to take full advantage of its offshore fleet.

As those chokepoints get worked out over the next few years, we think that our HOS Max vessels will be preferred over the 3,000 deadweight ton vessels which dominate Pterobras’s fleet today. We decline the opportunity to renew with Petrobras four 240 class vessels with charters in this summer.

The dayrates to those vessels in the low 20s simply do not make sense given operating cost in Brazil and alternative dayrates that are achievable in other markets, or perhaps even with customers other than Petrobras in Brazil should we elect to keep the vessels in that region. Our four remaining charters with Petrobras extended into the third quarter are four remaining after we take these four out will remain to the third quarter of 2015.

But those are in the high 20 range, 27,000, to 28,000 a day. While our fleet there would be smaller in the short run, we see the reduction is only a time slice. Brazil remains a significant part of our long-term future. The third aspect of our strategic plan which should play a leading role in shaping the Post-Macondo vessel landscape will surge in 2012 through the continuation and expansion of our HOS Max vessel newbuild program.

We consider the future, particularly in our core deepwater and ultra deepwater markets, we see three significant patterns emerging, first, it is increasingly clear if not definitive that DP-2 is the deepwater standard. Second, in ultra deepwater vessel size matters as distance from shore, well depth and cargo efficiency becomes the significant drivers in managing logistics.

Finally, the need to manage regulatory and compliance risk continues to drive a flight to quality and to vessel solutions that present the least amount of regulatory risk. With these realities in mind, we have looked critically at our fleet and sought customer input to discern what attributes matter most in vessel design and capabilities.

The analysis drove our decision to expand our HOS Max vessel newbuild program and also to retrofit six of our 200 class vessels in the DP-2, 240 class vessels. The retrofit program is now underway and we will consider expanding it if and when other of our 200 class candidate vessels becomes commercially available as they roll-off long-term contracts in foreign markets.

Likewise, we are considering the upgrade or disposition of certain other vessels that do not optimize our deepwater and ultra deepwater profile. Such as our DP-1 220s, all but one of these 220s has been reactivated. So, we will work this year to see what is in the highest and best use of that asset class.

Turning to 2012, we also recognized the landscape for our tank barge fleet was changing and so we installed wafer recovery systems in three of our vessels last year. Following those vessel improvements, the tank barge fleet has found a solid way of supporting Eagle Ford Crude Trans, Trans Gulf Movements, as well as well testing in the Gulf of Mexico and more recently, Bakken Shale related demand on the east coast.

We believe that we saw the bottom of the tank barge market a while ago and the recovery path is clearly insight for this segment of our business. We’ve recently contracted one of our 60,000 barrel and that’s our smallest tank barge units for $20,000 per day, which we hope is a sign of additional rate expansion opportunities in that market.

Yesterday, we announced the latest developments in our upstream newbuild program which further advances our strategic effort to be a leader in the Post-Macondo Gulf of Mexico. We are going to add to our newbuild program by exercising options up to four additional vessels at this time. These additional vessels will be comprised of either Jones Act qualified HOS Max class MPSVs or a combination of MPSVs and additional HOS Max OSVs.

We have not yet finalized our discussions with the shipyards. What we have determined however is that now it’s the time to go forward with the construction of up to eight Jones Act qualified MPSVs. As you know, over the last several years, we have expanded our presence in the sub sea construction and IRM well and by providing construction vessels to a variety of customers principally in the Gulf of Mexico through our T-22 class MPSVs.

Those are the HOS Iron Horse and the HOS Achiever. There are usually somewhere between 30 and 40 foreign-flagged vessels providing sub sea construction services in the Gulf of Mexico in any given time. In the Gulf of Mexico sub sea construction activity is required to be served by two vessels, a Jones Act qualified supply vessel that transports items to their offshore location and a foreign-flagged construction vessel such as the HOS Iron Horse, which performs the installation activity.

We have for some time observed a clear preference by our customers for a one-step Jones Act solution which would provide improved efficiencies derived from a single US-flagged vessel as well as greater regulatory certainty as compliance questions come in – questions continue to arise from the use of foreign-flagged vessels in the sub sea Gulf of Mexico.

In the Post-Macondo Gulf of Mexico we see this Jones Act preference as a long term trend not only for construction vessels but for vessels of all types working offshore. Part of this preference may stem from the comfort that our customers in the Gulf of Mexico drive from the high operating standards of the US vessel owners and crews who are regulated by the US Coastguard one of the most exacting marine regulators in the world.

The first two domestic MPSVs that we plan to construct will be based on the HOS Max 310 design and it will position us with premier Jones Act qualified MPSVs. Our customers will benefit from gained efficiencies by using a single vessel to both transport and install sub sea infrastructure, which cannot be accomplished with a foreign-flagged vessel.

The experience we have developed with construction vessels through our P-22 class MPSVs has led us to conclude that the Jones Act market for this class of vessel is extremely well matched to our core deepwater and ultra deepwater competencies. By leveraging our HOS Max class design and attractive shipyard pricing, we believe that we can introduce this class vessel into the market at a advantageous price point and in relatively a short period of time.

Our HOS Max MPSVs will complement our T-22 class MPSVs which while not Jones Act qualified have developed an excellent pedigree in the Gulf of Mexico and will remain available for non-Jones Act required operations or alternatively can be deployed to other regions of the world.

In addition, our T-22 class MPSVs are excellent platforms to provide full tow operations. For example, you may recall the HOS Achiever, one year full tow contract a few years back supporting the Perdido’s Spar installation project in the Gulf of Mexico.

Our current plans for the first two of our new class of Jones-Act qualified HOS Max MPSVs will feature in IMO Special Purpose Ship or SPS code-ready class notation. A 250 ton heat compensated knuckle boom crane, helideck, moonpool, docking stations for two work class RLVs and accommodations for 73 people and which will make them not just like construction vessels but also that notation of MPSVs as they all will have liquid carrying capability. So we still be procuring methanol, liquid mud and dry bulk as a cargo vessel under sub-chapter L.

Looking ahead to 2013, we began the year with a continuation of the favorable market conditions that we saw in the last quarter of 2012. We currently have 409% of our new generation vessel days contrast and compared to 59% at this time last year leading at dayrates for high-spec 242 65 class vessels are in the $38,000 to $42,000 range compared to about $30,000 per day last year at this time.

43% of the available vessel days for high-spec equipment are eligible for repricing during 2013 and in a tight market. The month of December was a month most active, we can remember in terms of customers’ enquiries and tender activity for upcoming drilling programs in and outside of the US Gulf of Mexico.

We are seeing a considerable amount of customer interest in our HOS Max vessels, the first five of which will be delivered this year. We get a lot of questions about the timing of the contracting of HOS Max vessels and whether we’ll place them on long term charters, the answer is the same as its always been for our entire fleet.

We want to optimize our mix of long and short term contracts and obtained the best contractual terms that we can. Under the right circumstances, we definitely consider long term agreements. But being disciplined about how we contract is a work habit that we have always emphasized and over the years has served us well. There are 42 floaters available in the Gulf of Mexico, 33 of which are actively working. We expect at least one additional incremental deepwater drilling unit to arrive in the Gulf of Mexico during this year.

Although there are other opportunities for additional units to come in and we’re watching that very closely. There are 156 deepwater permits issued in 2012 which is inline with 2008, 2009 levels, 51 permits were issued in the last four months of 2012 and 12 permits for operations in water depths exceeding 500 feet were issued in January.

So clearly, we are seeing short-term demand drivers that are consistent with our long-term view. We are also mindful that including our five HOS Max vessels, a total of 27 incremental new generations vessels will be delivered from domestic yards this year. None are as large as the spec – or as specialized as our HOS Max vessels and we don’t know that all of these vessels will necessarily work in the Gulf of Mexico. But obviously, these vessels are part of the competitive field.

As we reflect on the last 12 months, I can say that 2012 was a stronger year with exceptional performance on a variety of fronts and that our management team has positioned the company to drive growth and create value for our stockholders going forward. As you know, when we began our latest organic growth initiative at the end of 2011, we also set out to strengthen our company’s balance sheet, such that we could emerge from our growth program not only with the larger fleet but delevering on a net debt basis as well.

We get long term ROIC focus growth fundamental to our success in fulfilling our mission to be the company of choice for our investors. We took additional steps in 2012 in that direction by refinancing two tranches of term debt on favorable terms, lowering their coupons, extending the maturities, and lowering our exposure to the equity dilution.

We remain discipline in how we finance our growth and will not sacrifice sound balance sheet management in order to expand. We regularly stress test our capital structure through trough case modeling scenarios and remain satisfied that we have ample sources of liquidity to just see us through our current building and retrofit programs and planned repurchase of our 1.6% notes as well as unexpected events.

The rather significant and growing annual cash flow generation capacity of our current and pro forma fleet further strengthens our confidence in that regard. In closing, with 2012 in the review mirror and I planned in effect for 2013 and beyond, our first priority is continued execution of our strategic vision.

We will do so this year and in the years to come by adhering to the work ethic and business practices that have served us well since our company’s inception. First and foremost of which is to work with integrity and professionalism in all that we do. We look forward to a great year. Jim?

James Harp Jr.

Thanks, Todd and a good morning to everyone. Before I get started, I would like to point out that we expanded the forward-looking guidance information contained in the data tables to our press release yesterday afternoon to provide quarterly and annual guidance for 2013 and initiated annual guidance for 2014 for various categories of financial and operational data that will assist you in updating.

We will continue to update this information quarterly to reflect our latest market assumptions with each of our earnings releases in 2013 and beyond. Keep in mind this information is based on the current market environment which is always subject to change. For your convenience, we post the four pages of data tables that are in our press release in downloadable excel format on our website each quarter.

I encourage you, those of you who maintain your own financial models on our company to use the detailed information that we provide to true-up your models as necessary, particularly below the EBITDA line.

Moving into our fourth quarter financial results, our fourth quarter diluted EPS from operations was $0.31 per diluted share, up 55% from the sequential quarter. Our weighted average share count of roughly 36.1 million diluted shares was about 4.5 million higher than the fourth quarter of 2011 due to our November 2011 equity offering.

Our EBITDA was $55.1 million for the fourth quarter of 2012, down slightly from $56.7 million for the year ago quarter, but up $7 million sequentially. Adjusted EBITDA, which is the starting point that we use to compute ratios for the financial covenants in our revolving credit agreement was $58.5 million for the fourth quarter of 2012.

The year-over-year EPS and EBITDA trends were largely due to a significant mariner wage increase in April 2012 coupled with the incremental cost associated with hiring and training qualified mariners to operate our pending newbuild deliveries along with higher shore side incentive compensation expense during the fourth quarter of 2012.

For additional information regarding EBITDA and adjusted EBITDA as a non-GAAP financial measure please refer to the data tables in yesterday’s earnings release including Note 11.

Moving into our segmented data, starting with our upstream division, our upstream revenue for the fourth quarter of 2012 was roughly $3.5 million higher than the sequential quarter, primarily due to higher effective dayrates for our larger DP-2 equipment in the Gulf of Mexico, partially offset by lower utilization for our MPSVs.

Operating income was $29.7 million or 25% of revenues in the current quarter, compared to $24.5 million or 21% of revenues for the sequential quarter. Average new gen OSV dayrates for the fourth quarter of 2012 were approximately $24,000, in line with the third quarter of 2012. Utilization for our full fleet of 51 new gen OSVs for the fourth quarter of 2012 was 84%, compared to 80% for the third quarter, which resulted in roughly a $1100 increase in effective dayrates sequentially.

The sequential increase in new gen OSV utilization was largely due to increased demand for the company’s high-spec OSVs, effective new gen OSV utilization for our active fleet which excludes the impact of stack vessels was 86% for the fourth quarter of 2012 compared to 93% for the year ago quarter, but 83% for the sequential quarter.

MPSV utilization was 80% for the fourth quarter of 2012, compared to 89% for the year ago quarter and 91% for the sequential quarter. The sequential decrease in utilization is due to the drydocking of one of our MPSVs on a term contract in October and the unanticipated cancellation of a charter for an MPSV that was working in the spot market which resulted in 63 days of aggregate downtime MPSV downtime for these two reasons.

Moving into our downstream segment, that segment represents about 11% of our consolidated revenues for the most recent quarter and continues to show signs of rapid improvement. Our fourth quarter results were positively impacted by improved market conditions in our core downstream markets. Our annualized EBITDA run rate for the downstream segment continues to increase having exited 2012 at the $25 million level and apparently heading higher based on leading edge dayrates.

In addition, our downstream operating margin for the fourth quarter of 2012 was 19%, up from 4% for the year ago period and 14% sequentially. Downstream operating margins for 2013 are expected to remain in the mid to high teens with six of nine barges scheduled for regulatory drydockings this year, downstream utilization is expected to be in the mid to high 80s for 2013 while the Eagle Ford and Bakken shale trends have favorably driven demand for these vessels over the past year, we believe that downstream results should continue to improve even further when the US economy and the timing of which is not predictable.

Moving into operating expenses, on a segmented basis, cash OpEx for the fourth quarter 2012 was roughly $58 million for the upstream segment and $7 million for the downstream segment. For full calendar 2013, aggregate cash operating expenses for our upstream segment are projected to be in the range of $253 million the $263 million, and for our downstream segment, aggregate cash OpEx are projected to be in the range of $27 million to $29 million.

Included in our cash OpEx guidance is the incremental investment in human capital we need to recruit, train and crew our rapidly expanding fleet, commencing with the first 300 class newbuild deliveries this June.

For example, as Todd has mentioned on previous calls, we expect to have about 100 incremental mariners in training riding in the fleet this year, at an annual cost of about $12 million or $3 million per quarter which is already baked into our cash OpEx guidance. In addition, our 2013 operating cost projection include roughly $4 million in cost for the likely demobilization of four vessels out of Brazil mid-year, not counting the estimated 120 days of aggregate commercial downtime or 30 days each for that voyage.

Consistent with our cash OpEx guidance with prior periods, these estimated ranges are good faith estimates based on best available information as of today and are only intended to cover our currently anticipated geographic footprint, charter mix and industry market conditions.

Moving into overhead or general and administrative expenses, our fourth quarter G&A expenses of $12.3 million were 9.2% of revenues, compared to $12.9 million or 10.1% of revenues for the third quarter of 2012. G&A costs for the fourth quarter were allocated 92% to the upstream fleet and 8% to the downstream fleet.

The sequential increase in G&A expense was mainly attributable to an $800,000 increase in our bad debt reserve, during the third quarter primarily related to a bankruptcy filing by an upstream customer. Our fourth quarter 2012 G&A to revenue margin was at the low end of our recent historical range of 9% to 11%. For the calendar 2013, G&A expenses are expected to be in the range of $53 million to $55 million and also within our historical margin range.

Moving into our balance sheet related items, I will now review a few of our key balance sheet items for the fourth quarter. Beginning with liquidity, our total cash and cash equivalents at quarter end was roughly $577 million, which puts our net debt position as of December 31, 2012 at $513 million, up from $414 million a year ago. The only debt instrument we have with a variable interest rate structure is our $300 million revolving credit facility, which remains undrawn.

We have a blended average fixed cash coupon of about 4.3% on $1.2 billion of total outstanding face value of long-term, unsecured debt. Due to the change in timing of certain interest payment dates associated with our high yield bond refinancing in March 2012 and our convertible senior notes offering in August 2012, our cash debt service for fiscal 2012 was only $38.6 million.

For fiscal 2013, we expect to incur a full-year run rate of cash debt service in the amount of $53.1 million, including a small portion of cash interest expense related to a potential revolver draw in the fourth quarter of 2013.

Our projected 2013 run rate of gross interest expense for Generally Accepted Accounting Principles or GAAP reporting purposes, before capitalized construction period interest is about $79 million, which includes about $11 million of non-cash imputed OID on our one and five-eighths convertible notes and $9 million of non-cash imputed OID on our 1.5% convertible senior notes.

The earliest that any of our outstanding debt facilities would be payable is November 2013, which is the first possible put call date for our one and five-eighths convertible senior notes. However you will remember that we issued our 1.5% convertible notes in August in anticipation of paying off the one and five-eights convertible notes this November.

Upon retirement of those notes, the earliest next maturity of any of our bond charges is 2017 and beyond. Based on our projected average construction work in progress balance for fiscal 2013 related to our OSV newbuild program and OSV retrofit program, we expect to capitalize approximately $34 million of interest expense to the balance sheet this year.

We also project to earn approximately $1.3 million in interest income on our average invested cash balance projected resulting in a projected net interest expense for the year of about $43 million. Our effective tax rate for GAAP income statement purposes was roughly 38% for fiscal 2012. However on a cash basis we only paid income taxes of $1.3 million last year, we expect to pay about $1.8 million in cash taxes for the full-year 2013 and are projecting an annual GAAP tax rate to be roughly 37% for the next two years.

Moving into our maintenance and other capital expenditure activity, yesterday we introduced a new tabular form of providing guidance disclosure for historical and projected regulatory drydocking activity including for the first time, vessel headcount and commercial downtime by asset class as well as expected cash outlays for 2013 by quarter and for the full year 2014.

Historically, we gave that type of detailed information narratively on this conference call rather than continuing that practice in the interest of time and Q&A, I would simply refer you to the data tables on page 13 of 16 included with our release yesterday afternoon. However in brief summary, we plan to drydock 20 OSVs in 2013 and 23 OSVs in 2014 with 562 days and 622 days of budgeted downtime respectively.

We also expect to drydock two MPSVs in each of 2013 and 2014 with 80 and 60 days of budgeted downtime respectively. As a brief recap on our OSV newbuild program number 5, as Todd mentioned we have expanded our fifth OSV newbuild program yet again by four vessels to a total of 24 vessels and announced our intentions to ultimately build up to eight Jones-Act qualified MPSVs.

The first two vessel commitments to be reconfigured as a new class of domestic MPSVs will be based upon the HOS Max 310 vessels design. The other two vessels announced yesterday were either the HOS Max 320 class OSVs or more Jones-Act MPSVs. We haven’t completed our alternative analysis on those vessels yet but we are finalizing those plans soon.

In our press release yesterday, we provided updated cost projections for this program assuming that we would build two additional HOS Max 320 class OSVs along with the two HOS Max 310 class MPSVs for an aggregate incremental cost of approximately $260 million or roughly $45 million per OSV and $85 million per MPSV before capitalized construction period interest.

These four newly planned vessels are all expected to deliver in the first, second or third quarters of 2015 just in time for an expected surge in sub sea construction activity in the 2015 to 2017 timeframe. This announcement increases the aggregate budget for our newbuild program excluding construction period interest to approximately $1.16 billion, of which $499 million, $328 million and $59 million is expected to be incurred in 2013, 2014, and 2015 respectively.

From the commencements of this program, through December 31 of 2012, we have already incurred about $275 million or 24% of the total program cost, including $88 million that was spent during the fourth quarter of 2012. Our plans to upgrade six of our super 200 class DP-1 OSVs into 240 class DP-2 OSVs continues on time and on budget at $50 million in the aggregate.

The first two vessels – to shipyard in December 2012 projects redeliveries of one vessel in April, one vessel in May, two in August and two in December of 2013. Together with the cash on hand and available capacity under our currently undrawn $300 million revolving credit facility and based on the key assumptions outlined in our earnings release in August call, we expect to generate sufficient cash flow from operations to cover all of our growth capital expenditures related to our 24 vessel HOS Max newbuild program, our six vessel 200 class OSV retrofit program, the planned retirement of our one and five-eights convertible notes in November of this year and all of our annually recurring cash debt service, maintenance CapEx and cash income taxes for the remainder of fiscal 2013 and for the full duration of various growth initiatives which are currently scheduled to be completed in 2015.

With that, I will turn it back to Todd for any further comments or to entertain questions.

Todd Hornbeck

All right. I think that concludes our prepared remarks and please open it up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from the line of Todd Scholl with Clarkson Capital Markets. Please go ahead.

Todd Scholl – Clarkson Capital Markets

Good morning guys.

Todd Hornbeck

Good morning.

James O. Harp Jr.

Good morning.

Todd Scholl – Clarkson Capital Markets

Congratulations on a great quarter.

Todd Hornbeck

All right. Thank you.

Todd Scholl – Clarkson Capital Markets

Just, wanted just touch base on kind of the decision to build the MPSVs, we’ve heard a number of indications that 2013 we might see better kind of Jones-Act enforcing around some of those foreign-flagged vessels. But it almost seems like from your comments that this decision with economy irrespective of what happens there, did you think that there is an opportunity in that market for US-flagged vessels that can do both the light construction work and carry the equipment out to the site. Is that a fair statement and is that basically what the decision was based around?

Todd Hornbeck

Well, it’s a couple of things, you know we’ve been servicing that market now for a number of years and we’ve been in a – it’s been from 2008 at the peak we’ve been through a pretty severe trough with either the financial markets fallen pieces and then the Macondo in the moratorium and now we are moving back out of it. And as you know we have two high-spec vessels in that market and just seeing how those vessels operate the efficiency and how we can protect our cost on our newbuilds, we think we can be competitive building Jones-Act MPSVs with our newbuild program that we currently have in the domestic market both foreign market. And we get the added advantage that we can do liquids and we can do cargo transportation and enhance the efficiency to our customers. So it’s a win-win for our customers and for us. So with that market being about 30 or 40 vessels and as all those drilling activity takes place that we get something. So in 2015 and beyond we think that market could greatly expand to weather for 50 vessels, and have eight vessels or even more we expanded in that marketplace is a good position for us.

Todd Scholl – Clarkson Capital Markets

Okay, great. And I do want to also kind of follow-up on some commentary that you made on kind of the DP-1 market during the quarter. It sounded like that, you said that the utilization takes up in that market but the dayrates are actually down. Could you explain maybe what was the driver behind that disconnect? Why we would see utilizations getting better in kind of a higher permitting environment but not the day rates kind of follow through as well?

Todd Hornbeck

Well, there is not the discipline in that market segment that we enjoy in the high-spec equipment. There is a – it’s a very fragmented market and we saw in the not only in the fourth quarter but proceeding the third quarter where it was much lower utilization. A lot of the competition in that market really severely dropped their rates coming off of the third quarter. So we are up to try to get some utilization and not just sit available the whole time we dropped some of our pricing just to get five more points to utilization. On an economic basis it probably worked out a little bit better, but we are anticipating that that market is going to probably tighten up a little bit as construction season comes on by the end of the first quarter. We anticipate we will get a little bit better in the DP-1 market particularly with what’s going on in Mexico trying to roll the footprint and add new rigs and jack up rigs. So we see that markets tightens a little bit but, long term strategy for us is the cycle out of the DP-1 equipment in high-spec deepwater. So that’s really not our market segment long-term even though I think it will be a viable market for someone going forward that has more of a footprint in that market, we are just a fringe player now in that business segment, particularly with our stretch program.

Operator

Thank you. Our next question comes from the line of Mark Brown with Citigroup. Please go ahead.

Mark Brown – Citigroup

Hey guys, good morning.

Todd Hornbeck

Good morning.

James O. Harp Jr.

Good morning.

Mark Brown – Citigroup

Just wanted to check on the – just following up with the DP-1 commentary, approximately how many vessels do you still have that are candidates for a stretch program and how are you going to determine whether to put them through a stretch program or divest them as you mentioned were the two options are considering?

Todd Hornbeck

Six of them we are looking to divest as of now the 220s and the other ones are really candidates for stretching when they come back. We currently have two of them in cutter that are on long term contracts. It would then be available for stretching until the end of 2015 they go through their contracts through 2014. So most likely we’ll get re-upped on the current contracts that they are on, if they didn’t, then we’d come back and stretch those. So that’s somewhere way up into the future. The remainder of the stretch candidates are on long term contracts in Mexico on various degrees to mature, so I expect the Mexican vessels to be re-upped for multi-year charters. So we may not be able to really have any candidates to stretch if they came available probably for a couple of years, we have one original 200 that we build that’s floating in the spot market in the Gulf of Mexico because of her capacities she is a highest spec of the DP-1 equipment. She stays pretty much utilized, but if there is an opportunity in a window that opens up, we might stretch here. So, really within the next year I really anticipate only one candidate potentially become available.

Mark Brown – Citigroup

All right, thank you. And my follow-up question was just on the tug and tank barge business that certainly performed better than we had expected and you mentioned that you have a contract at $20,000 a day on a 60,000 barrel barge. And wanted to see if that’s something that you think would you be able to replicate in the future?

Todd Hornbeck

Yes, as the contract roll on the 100s and the 135s, there are probably in that $16,000 to $18,000 rigs. I think the leading edge term contracts are – I think that market is tighter and tighter and it should be in the mid-20s. We are anticipating the market to go with that equipment under time charter basis. So back to the earnings power that produces a real good return on invested capital.

Operator

Thank you. Our next question comes from the line of John Donnell with Howard Weil. Please go ahead.

Jon Donnell – Howard Weil

Good morning guys. A question regarding the increase we saw in the high-spec day rates there. Clearly, that’s a nice bump and actually it sounds like it’s above the longer term contract you signed to the 300 class vessel last quarter. I was wondering if you could just give us a little more detail about those contracts – were they relatively short term in nature or was it just one customer-specific and you kind of – what’s the implication as we look ahead?

Todd Hornbeck

It’s across the board. It’s between 60 days to six months to eight month contracts just really across the board. I mean the market is really, really tight. Of course the much larger vessel that we contracted is really long, long time, you are talking about 38 five contract that was done on one of the 300. Well, that really in our minds is a four year plus contract. So, apples and oranges, and you got to really look at the type of contracts that underlying. In some of these leading rates as you are dealing with the market today, there can be riggers and additional DPOs and a lot of extra equipment, or not extra equipment, extra people put on the vessels and services that will make that trend that mark that dayrate trend up. But I think you are seeing our earnings power is equally trending up as well. Now the 38 five is – it doesn’t have all those extra cost in it.

Jon Donnell – Howard Weil

Okay, can you give us a feel for how much of your high-spec fleet has rolled over these higher day rates and is this still concentrated in the Gulf of Mexico?

Todd Hornbeck

On the call, 48% or 43% gets to roll this year of what we have available. So we expect those to trend on up but like the stuff in Brazil that’s coming out that will be an opportunity to trend up and we do have some legacy contracts that are at lower rates that will trend up as well. So this build what you are asking is our day rate expansion and margin expansion left in the fleet now I tell you absolutely.

Operator

Thank you. Our next question comes from the line of Joe Gibney with Capital One. Please go ahead.

Joseph Gibney – Capital One Southcoast, Inc.

Thanks, good morning. You guys covered a lot of ground in the release and commentary, just one quick one for me, Jim, I appreciate the color on the drydock time, I was just curious of the 20 vessels on the new gen side in 2013, what portion of those of those are out of current fleet or almost all of them are exclusively out of your spot fleet? I was just kind of curious.

James O. Harp Jr.

About half and half.

Joseph Gibney – Capital One Southcoast, Inc.

About half and half. All right appreciate it. Thanks guys, that’s all I had.

Operator

Thank you. Our next question comes from the line of Jeff Spittel with Global Hunter Securities. Please go ahead.

Jeff Spittel – Global Hunter Securities

Thanks, good morning.

Todd Hornbeck

Good morning.

Jeff Spittel – Global Hunter Securities

If you could just talk about the leading edge rates fallen up on John’s question, I guess in the past which you’ve seen these nice bumps as the market has tightened a little bit. It’s taken a little bit of digesting period for some of your competitors to catch up to that leading edge deck. Given that things are seem to be tightening pretty rapidly, how long do you think that digesting process is over the course of next couple of quarters and I would assume it means you are going to be able to reprice and move rates up independent or what’s going on with that?

James O. Harp Jr.

I can’t because a lot of vessels were termed out in the low rate environment we chose play more of the short game and in the spot game. So it really have to look at how many vessels are coming for pricing availability and the newbuild vessels are of course coming into the market is a market that will see the pricing on those vessels. But really available vessels to roll into the market from our competitors, probably there is not a lot. Because a lot of them were termed out.

Jeff Spittel – Global Hunter Securities

Good news and then just a housekeeping question on Brazil, when we do that repositioning mid-year it will be down to – is it six boats in country?

James O. Harp Jr.

Four boats.

Jeff Spittel – Global Hunter Securities

Four boats, okay, that’s all I had. Great quarter guys.

James O. Harp Jr.

Okay, thank you.

Operator

Thank you. Our next question comes from the line of Jeff Tillery with Tudor, Pickering, Holt. Please go ahead.

Jeff Tillery – Tudor, Pickering, Holt

Hi, good morning.

Todd Hornbeck

Good morning.

Jeff Tillery – Tudor, Pickering, Holt

You guys covered a lot of ground on the way you talk about the opportunity for the newbuild MPSVs, could you talk on about just the financial side on those? Do you see that as more of a term market? How do you guys look at the economics around building these new vessels?

Todd Hornbeck

You are talking about the MPSVs or the…

Jeff Tillery – Tudor, Pickering, Holt

The MPSVs.

Todd Hornbeck

Yes, I think, it’s going to trend more to a term market. Remember those vessels will start delivering in the mid 2015. So what we see in that market segment up in for sub sea construction in our work is pretty robust. So, we think it will be termed up.

Jeff Tillery – Tudor, Pickering, Holt

And then around the operating cost guidance, as you think about the risks and as you go through this year and what you guys try to calibrate in guidance, what do you see as the greatest risk that may make that inflection higher?

Todd Hornbeck

Well, it’s always the mariner shortage, as new vessels come into the market which we saw in last year where there was across the board wage increase and it’s a competitive landscape. I hope we worked very, very hard over the last year to try to protect ourselves from cost inflation in various ways, not just pricing but really working with our customers directly and showing them that it’s advantageous for us to keep our crews and not have a lot of turnover. So if we do have to meet the market, maybe we can pass some of those cost on as it happens. So we don’t have a lot of friction in crew turnover.

Jeff Tillery – Tudor, Pickering, Holt

All right. Thank you guys.

Operator

Thank you. Our next question comes from the line of David Anderson with JPMorgan. Please go ahead.

David Anderson – JPMorgan

Hey guys, I was just wondering when you guys looking at the newbuild programs and you are deciding to exercise more options, how are you guys making that decision. Is it based on kind of a return assumption? Is it a return hurt that you guys have in there and if so what kind of dayrates are you assuming on there? Do you still kind of – from where to where, I can use like a 10% move or a 15%? Just one of you just give a little more color in terms of how you make those decisions?

Todd Hornbeck

Well, I mean, there is a lot of variables in making that decision. As you know, one is market demand, also market – our customers preference and where are they are going to be drilling and the type of equipment they want, given the day where a service if they are trending to the higher spud deepwater equipment for their main stage business and their fundamental, they recognize the cost of these vessels. And they are planning for that cost. So, our return on invested capital has always been the same in the teens, so our pricing will fluctuate with that type of return and that is going to be driven by what the customer wants and as far what type of service, what type of risk during the contract and what costs are trending. So we will always maintain the analysis to build being able to secure what we think long-term contracts or real high utilization through the markets in the teens on a return on invested capital basis. And we see this market really trending to the real high-spec equipment, we are going to own the largest fleet of high-spec equipment in the Gulf and have a market presence there as the leader and as some of these other emerging markets take off like Mexico and French Guiana and Trinidad is going to start doing some additional drilling as well, we may reorganize the fleet on the below the 300s to other markets. So, we look at the trends and how we are going to service our customers and get the return at the same time, so it’s not a direct binary black and white answer that can give you, since we’ve been doing this our whole career and we think we’ve got, we got to know what the customers want.

David Anderson – JPMorgan

All right, that’s helpful. And Todd in your comments in the beginning you were talking – just want to quick comment on Brazil, I’m probably sure I heard you right, you sound a little more positive about Brazil, now than you have in prior calls. Did I misunderstand you and has something kind of changed in your view to get yourself – to get you more bullish on the Brazilian market?

Todd Hornbeck

I’ve always been bullish on what they are doing, never – not been bullish, these are all time segments in other calls, Brazil is going through a growth, but it’s unprecedented, it has a tremendous amount of logistical problems, management problems as far as just that type of growth shore side infrastructure problems and what we see long term out is extremely positive and what we see the steps that Petrobras are making today out in the future will enable us to maybe come back in, in a more meaningful impact to that market with our 300 class. We think that’s going to change like it’s changing in the Gulf of Mexico from a 3000 dead weight ton backbone of the market deadweight ton vessel to a our 300 class 6000 deadweight ton and above, because logistical support shore side in the future will be there. Right now that is a big chokepoint and bottleneck which has created a lot of extenuating circumstances like downtime and penalties and all these other things that are associated with Brazil that are complex that is not just analogous for Hornbeck Offshore but for the entire market. So, we think it’s better for us to trend out that lower mid-sized deepwater equipment, put it in markets that are going to be much more attractive for the equipment and for the returns and get ready for the 300s to go in when those chokepoints are released.

Operator

Thank you. Our next question comes from the line of (inaudible). Please go ahead.

Unidentified Analyst

Hi, thanks. Todd, you laid an interesting thesis for the Jones-Act MPSVs to really be able to replace or to displace some of the incumbent capacity. How do you view the Gulf of Mexico OSV market in terms of the ability to the remaining lags to just sort of displace DP-1 capacity? How much industry-wide is that DP-1 capacity that stands to be phased out over the next few years?

Todd Hornbeck

There is a lot of people changing their DP-1 equipment to DP-2 equipment investing in the equipment even on the shelf. But the shelf market can remain a DP-1 market. We don’t see that there is a lot of problems with that. It’s really apples and oranges between the two, it’s a bifurcated market. We are talking about DP-2 being the standard for deepwater and ultra deepwater. We think the construction in the shelf up normal day-to-day got variety vessels that will serve as the shelf market will be primarily DP-1 equipment, probably the generation one DP-1 equipment that was built between 1996 and 2001, will be this is now the shelf replacement fleet and that’s a market segment that we chose and that we just – we’re not a meaningful part of that market and we just don’t want to be a fringe player. We’d like to site a lot of that equipment and focus on our main deepwater and ultra deepwater markets.

Unidentified Analyst

Good, thanks. And then the follow-up question, you had really significant increase sequentially in the high-spec rates, so in fact the question is whether leading edge rates have started going up or if that is still trending? Where do you think that – what we feel and flatter up when you report next quarter do you think?

Todd Hornbeck

That’s hard for me to say, because it’s a very dynamic market. A lot of things, you just read this past week about the boat issue with all the rigs and anything we are in a regulatory volatile market to try to get that 90 day it’s almost impossible for any company to do that. I think the market is very robust. I think it’s growing, or it’s going to continue to grow throughout 2013, 2014, 2015 and 2016 with what’s coming and I think, you know it’s volatile from quarter-to-quarter and if anybody is trying to base a quarter of the trend, I think they are missing the big picture in my personal opinion. But we just don’t operate the company that way. So, to be put in that – in a point of that position, because my preference is going up because that’s where I think it should be. But, there is things that can alter markets very quickly like this situation that just got on our doorstep the next day. I don’t think that’s going to impact the quarter at all. Don’t get me wrong that one incident is not going to have adverse impact on us. I don’t believe, but you see how things can just come about sudden and we have to be prepared for that and I think we are and we are in position and I think the market continues to trend up. So the long term earnings power in my prediction is going to grow.

Operator

Thank you. Our next question comes from the line of David Smith with Johnson Rice your line is open. Please go ahead.

David Smith – Johnson Rice & Company

Great, can you guys hear me okay?

Todd Hornbeck

Yes.

David Smith – Johnson Rice & Company

Perfect, thanks for that. Just wanted to follow-up one more time on that, that the topic of the spot rate increase. If you could help us think through the jump in rate, it doesn’t look like we added more than two or three deepwater rigs to the working rig count since November. So I am just trying to understand what it was that helped increase the dayrate structure by 20% in such a short time and if that was really just a function of you guys being one of the few left with the spot availability?

Todd Hornbeck

Well it has to do with all those things, you know, it has to do when you talk about adding three deepwater rigs that’s a mouthful. That’s not like adding three jack ups. The intensity of the equipment on the rigs is huge. You can talk about anywhere from four to six to seven vessels, wafers, so you could talk about twenty boats when you say three deepwater rigs. That is a huge move. And we are heading now into construction season, March, so people are getting geared up for that construction season as we use to know it on the shelf is not the same today in the Gulf of Mexico. Shelf construction season will soak up some assets but when you talk about deepwater construction season, different kettle of fish. Big vessels, big needs, deepwater, a lot of assets required. So, and then the other function did we have some of the only availability probably so, but that’s the strategic plan that’s staying shorter going long. I mean, we still have vessels rolling and we have, we are looking at long term contracts equally as we are looking at spot picture to get in outside of the US Gulf of Mexico and the backlog is building on opportunities for terming out equipment.

David Smith – Johnson Rice & Company

Okay, good. Thank you. And I just have a quick follow-up which I think you partly answered which is looking at the – in the Gulf we’ve got kind of 38 market that’s active, two look like they might move out in April and July and but we get a lot more back in the fourth quarter of 2012 and just trying to think through what the impact of construction season can be when we look at absorbing the capacity that’s been delivered out of the US shipyards this year?

Todd Hornbeck

That’s a good question. It’s not something that is clear. Usually these deepwater projects of course everybody wants to do it as efficiently as they can but in our experience as these big mega projects take hold, that soak up a lot more equipment that it was anticipated. So there is few big projects that are going to happen this summer and I wouldn’t be surprised if we didn’t see additional equipment come into the Gulf that hadn’t been announced today.

David Smith – Johnson Rice & Company

Okay, appreciate it. Great quarter and thanks for the answers.

Todd Hornbeck

Thank you.

Operator

Thank you. Our next question comes from the line of Matt Conlan with Wells Fargo. Please go ahead.

Matt Conlan – Wells Fargo

Hey guys, again nice quarter. Given that you discussed wage inflation is something that’s largely at a control, have you been able to include adequate cost escalation provisions in your term contracts in order to protect the margins?

Todd Hornbeck

We think we have – we were – I said this in the last couple of conference calls, we – in the last couple of calls we’ve had people say, hey, the rates have plateaued they have flattened down. Remember, last year we basically doubled the rate structure in the Gulf and really had an accelerated push up and then it plateaued, but we’ve really worked last year and working with our customers in showing them the true cost increases that we see in our industry and with all this equipment and what they want to achieve and what they want to do going forward, there could be more cost inflation coming and so we worked with them very, very closely to get the true cost protection and true cost protection in my mind is not because accidents or incidents that drive insurance cost up that’s hopefully is not in our fleet but industry-wide insurance programs, I am not talking about that cost protection, I am talking about labor, because that’s where the true cost inflation is for us in a meaningful and I think we’ve got that pretty well than start.

Matt Conlan – Wells Fargo

Okay, terrific and on unrelated, what your role in transporting Bakken crude on the east coast? Are you taking it from the rails to the refineries?

Todd Hornbeck

Yes, there is a lot of rails to refiners is the primary way right now and we’ll see that expands but that whole market is changing over and I think there can be a lot of dayrate expansion in the barge fleet, not only out of the Eagle Ford and on the East coast and if we have the economy rebound at all with intermodal transportation and just consumption, that’s just going to add fuel to the fire. Right now, remember this whole thing has changed over because of the shale plays, but we are not even talking about when regular consumption resumes as we had in 2008 and 2007 just from the economy. If we had any economy expansion at all we are really talking about an undersupplied market.

Operator

Thank you. Our next question comes from the line of Fotis Giannakoulis with Morgan Stanley. Please go ahead.

Fotis Giannakoulis – Morgan Stanley

Yes, hi guys and thank you.

Todd Hornbeck

Good morning.

James O. Harp Jr.

Good morning.

Fotis Giannakoulis – Morgan Stanley

I want to ask about your expansion in the MPSV sector, you mentioned that you are considering whether you will have four MPSV, two additional MPSVs to go with two more regular high-spec OSVs. What would it determine the season and when do you expect to make a certain decision?

Todd Hornbeck

We expect to make – we are in negotiation with the yards now. We have several yards bidding on MPSV designs for us and we hope to make a decision in a relatively short amount of time, maybe within the next 30 days or so. And it’s going to be driven by price, availability and timing to the market and we are very comfortable that we’ll do two MPSVs because of some of the pricing indications that we have and engineering and in the available delivery times. So we are comfortable that two are in the bag and we are negotiating the other two right now. But it will be those factors. But it will be before – it will be now basically. We are fluid – and it’s happening now.

Fotis Giannakoulis – Morgan Stanley

Have you started any discussions with customers regarding contracting these vessels and is there any thought that these vessels maybe contracted for longer term periods? And also if you can comment, what do you think that the rates of these MPSVs will be compared to the existing ones? Is there going to be any difference in the specs and their earning capacity? And also if you can give us an estimate on the running costs?

Todd Hornbeck

Well, I think we gave in our press release what we thought the cost of the vessels would be. I want to be a little cagey here in telling you what the dayrates are going to be. We are in conversations with several clients about long term contracts of these vessels. And right now, it’s competitive. So I don’t want to play my hand on a public conference call and when we contract then we’ll give you the news. But we wouldn’t be doing this if there wasn’t a good return for the company and a good position. And it complements our fleet. We are doing this type of work now. So this is not some new venture for us. This is what we do.

Operator

Thank you. At this time I’d like to turn the conference back to management for any closing remarks.

Todd Hornbeck

Thank you very much for joining us in the call. We look forward to talking to you about the next quarter and everyone have a wonderful 2013. Thank you.

Operator

Ladies and gentlemen, this concludes our conference for today. If you would like to listen to a replay of today’s call, you may do so by dialing 303-590-3030 and entering the access code of 4594721 followed by the pound sign. Thank you for your participation. You may now disconnect.

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