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Hercules Offshore, Inc. (NASDAQ:HERO)

Q1 2009 Earnings Call Transcript

April 28, 2009 11:00 am ET

Executives

Stephen Butz – VP, Finance and Treasurer

John Rynd – CEO and President

Lisa Rodriguez – SVP and CFO

Analysts

Angie Sedita – Macquarie

James West – Barclays Capital

Mike Urban – Deutsche Bank

Arun Jayaram – Credit Suisse

Jeff Tillery – Tudor Pickering Holt

Robin Shoemaker – Citigroup

Mike Drickamer – Morgan Keegan

Waqar Syed – Tristone Capital

Ole Slorer – Morgan Stanley

Pierre Conner – Capital One Southcoast

Ian MacPherson – Simmons and Company

Geoff Kieburtz – Weeden

Christopher Boucek [ph] – Raymond James

Operator

Good day and welcome to the first quarter 2009 Hercules Offshore earnings conference call. My name is Candice and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session after management remarks. (Operator instructions).

I would now like to turn the presentation over to your host for today's conference, Vice President, Finance and Treasurer Mr. Stephen Butz. Sir, you may proceed.

Stephen Butz

Thank you, Candice. Good morning, I would like to welcome everyone to our first quarter 2009 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.

This morning we issued our financial results and filed an 8-K with the SEC. The press release is available on our website at herculesoffshore.com. We will follow our normal format this morning. But before John begins his remarks, I would like to remind everyone that this conference call will contain forward-looking statements. All statements other than statements of historical fact that address our outlook for 2009 and beyond, activities, events or developments that we expect, project, believe or anticipate will or may occur in the future are forward-looking statements.

Forward-looking statements by their nature involve substantial risks and uncertainties that could significantly affect expected results, and actual future results could differ materially from those described in such statements. You can obtain more information about these risks and factors in our filings with the SEC, which can be found on our website and the SEC's website, sec.gov.

John will begin the call with some general remarks and discussion regarding the outlook and Lisa will detail our first quarter financial results and provide cost guidance for the remainder of 2009. I will then have some closing remarks before opening the call for questions and answers.

Now I am happy to turn the call over to John.

John Rynd

Thank you, Stephen, and good morning and thank you for joining the call today. As previously mentioned we reported our financial results before the market opened today. We recorded a net loss from continuing operations of $4.5 million or $0.05 loss per diluted share for the first quarter 2009, compared with income from continuing operations of $4.9 million or $0.05 per diluted share for the first quarter of 2008.

Our first quarter decrease in earnings per share from the comparable quarter in 2008 was primarily due to weak activity levels in Domestic Offshore, Inland, Delta Towing, somewhat offset by strong growth in our international offshore sector. Lisa will cover the financials in greater detail later in the call.

Our outlook has not changed dramatically since our last conference call on February 10th. At that time we cautioned that the drilling business, particularly in the US was headed for a historic slowdown and international regions were also poised to slow dramatically. Unfortunately this outlook has continued to play out.

Our liftboat business has and is expected to fair much better, but of course, is not entirely immune. Jackup Drilling activity in the US Gulf of Mexico is now at a low, not seen since the early days of the industry. The contracted rig count is off 48% from the June highs of 2008. The inland barge market has been impacted to an even greater degree with the rig count off 79% from its recent high of 38 units contracted in June of '08.

To try and put this in perspective on the impact quarter-over-quarter to Hercules, in our domestic offshore segment, revenues declined by 46%, utilization days declined by 43% and in our inland segment, revenues declined about 66% and utilization days declined by 69%, all in just 90 days.

During the first quarter not only did most customers slow down, in fact many simply stopped programs altogether. Citing the same issues we have talked about for the last six months; lack of access to capital, borrowing base re-determinations, high service costs, weak commodity prices and thus poor well economics.

While the capital markets have certainly improved relative to the fall of 2008, they are still much weaker than we have seen in many years and commodity prices, natural gas in particular, are still very soft. However, at a given commodity price well economics are improving with the recalibration that has and is occurring in service costs, but importantly many of our customers still have strong long-term drilling prospects.

We believe the current low natural gas prices, while they may be with us until the economy improves, are ultimately unsustainable. So, as well economics improve with reduce service costs and higher natural gas prices at some point we are confident we will eventually experience a sharp rebound in activity.

In the near-term, after a very quiet first quarter we have seen a modest increase in bids during April for programs in the US Gulf. Based on this bidding we believe we can maintain a rig count of 7 to 10 rigs in our domestic offshore segment during the second quarter. However, we remain cautious about activity levels for late summer as we will be in the heart of hurricane season.

The inland market remains dormant. We do not have any barges working today. But based on recent bids, we may be able to put 1 or 2 rigs to work over the next month or two.

The international regions we participate in and really all international regions for that matter are becoming increasingly competitive. With less work, shorter jobs and more rigs bidding on those opportunities, as you would expect day rates are declining in that environment.

In fact, international jackup backlog has already declined by approximately 190 days from the peak level to reach during late 2006. Since our last conference call in February exclusive of China and the Caspian Sea, there have only been 18 incremental international jackup contracts, six of which are from Pemex.

By our count, this brings the year-to-date 2009 incremental jackup contracts to 30, again exclusive of China and the Caspian Sea, of an active international jackup fleet of 352, which is exclusive of the 15 non-contracted new build jackups scheduled for delivery in 2009.

The Hercules 185 is now expected in part to shipyard the first week of June and be on contract the third week of June to commence a 18-month contract at 150,000 a day with ADC in Angola. We do not anticipate any work this year for 156 or 110 in West Africa, Trinidad, respectively. We are in the early stages of discussing with (inaudible) relative to an extension on the 170.

Moving onto our liftboat business, the outlook is more stable. While utilization has declined somewhat both in the US and West Africa, it has remained strong relative to decline in activity seen in domestic drilling. Utilization for March was 59% and 56% in the US and International, respectively. As of today, it stands at 63% and 60%, respectively.

Day rates have declined in a 20% rise in the US, but still allow us to generate a reasonable margin. The liftboat Whale Shark to be ready to part to shipyard in the Middle East on May 15th, the year reform a short-term job for Hercules drilling and then be available.

We remain optimistic that we have our superior work in the region upon completion of the work for us.

Now, I would like to provide an update on our cost reduction measures. While we continue to see greater ways to enhance the top line; we believe it is imperative to reduce our cost structure significantly based on current and expected activity levels over the next year.

In our high fixed cost business such as ours, unfortunately, this entails coast packing our equipment and reducing head count. In addition, to D-Calais [ph] other cost saving initiatives that we have implemented.

Since our last conference call, we have decided to stack an additional 2 jackups, 5 inland barges and 1 domestic liftboat. We are now actively marketing 12 domestic offshore rigs, 2 inland barges and 42 domestic liftboats. This represents an additional 2 domestic offshore rigs and we will be coast stacking in the near-term most of what we publish in our Fleet Stats report last week.

We will continue to market 11 offshore rigs internationally and 20 international liftboats. As I mentioned in our last call, we intent to keep this assets in class so we will be better position to respond when activity inevitably rebounds.

Along with the stacking we have significantly reduced the size of our workforce. These along with other measures have had the effect of reducing our reported operating expense and general and administrative expenses by nearly $33 million during the first quarter of 2009 relative to the third quarter of 2008 when this downturn began, or a reduction of $132 million on an annualized basis. Further, many of these cost reduction measures took place during the first quarter and through April and we will not see the full benefit of these in our financial results into the second and third quarters.

While these are certainly trying times, I cannot be more confident that we have the right team in place to be able challenges ahead. Last but most importantly I want to tank all of our shareholders for your continued support and the comments you have shown in our management team.

Now I will turn the call over to Lisa.

Lisa Rodriguez

Thank you, John. I will provide more detail with effect to our financial results for the first quarter comparing it to the sequential quarter as I typically do, and as well I will provide cost guidance for the remainder of 2009.

During the first quarter of 2009 we recorded a loss from continuing operations of $0.05 per share compared to earnings of $0.42 per share during the fourth quarter of 2008, excluding the effect of non-recurring item. Our domestic offshore segment recorded an operating loss of $12 million in the first quarter, which was down significantly compared to operating income of $30 million in the prior quarter.

Revenue declined by $50.6 million on slightly lower average revenue per day. Utilization was down 13% from the fourth quarter to 62%, on significantly lower available days due to our stacking plans. Actual utilized days decreased 43% sequentially.

Total operating costs declined by almost 11% in the first quarter to $54.4 million as we began to realize some of the benefits from our stacking plan. We exited the quarter at a lower rate and we expect to see additional reductions in this second quarter.

I typically also address operating costs per day for this segment, however, the trend truly isn't meaningful this quarter. Due to the impact of the cost of the shore based support and the cold stacked rigs being spread over a significantly lower number of available days, as well as the transition of working rigs to cold stack. That is we had cost per rig at the higher marketed rigs run rate as we prepare them for cold stacking.

Our international offshore segment generated operating income of $42.9 million inline with segment income in the fourth quarter. Revenues increased to $103.5 million from $93.2 million in the fourth quarter with the fourth quarter impact of Hercules 261 and the late January startup of Hercules 262 in Saudi Arabia, offset in part by the Hercules 156 rolling of contract and the ship yard project on Hercules 185.

First quarter utilization of our available international fleet was 94% with average revenues per day per rig of $130,000 nearly inline with utilization of 92% and revenue per day per rig of $128,000 in the quarter.

International operating expenses were $44.1 million in the first quarter up from $37.3 million reported in the fourth quarter, due to the fourth quarter impacts of our commencement of our operations in Saudi Arabia.

We reported an operating loss of $16.2 million in our inland segment during the first quarter versus an operating loss of $8.5 million in the fourth quarter, primarily resulting from a continued deterioration of the overall inland drilling rig count. As sequential increase of approximately $4000 in average revenue per day per rig was more than offset by the steep decline in operating days. The 298 days from 951 days. We reduced our available days by nearly 50% through our stacking effort which helped to drive a reduction in operating expense to $20.3 million from $29 million in the previous quarter.

Like in our domestic offshore segment, we expect to see even more significant decline in our cost in the second quarter.

In our domestic liftboat segment, we generated $3 million of operating income a decrease from $12.3 million in the fourth quarter, mainly driven by a reduction in our utilization rate to 63% from 81%. Average revenue per liftboat per day declined slightly to $9,300 in the first quarter from $9,900 in the fourth quarter. You might remember our fourth quarter utilization and day rate were positively impacted by the active hurricane season in the Gulf of Mexico as many liftboats were put to work on hurricane related repair job.

The hurricane repair work was largely completed during the first quarter. However, the first quarter is typically the seasonal low point for liftboat utilization in the Gulf of Mexico due to rougher weather.

Operating expenses increased slightly to $14.1 million in the first quarter versus $13.3 million in the prior quarter.

The international liftboat segment generated operating income of $6.9 million in the first quarter compared with $10.9 million in the fourth quarter, due primarily to a decline in utilization in West Africa which led to an $8.3 million reduction in revenue.

Overall, utilization declined to 54% in the first quarter from 78% in the prior quarter. Average revenue per day per liftboat was $20,300 essentially inline with the prior quarter.

Delta towing reported an operating loss of $4.3 million compared to operating income of $200,000 in the fourth quarter. Delta's results are largely driven by support for drilling related activity both offshore and in new transition zone. So its results have been impacted by the same soft demand as our domestic offshore and inland segments.

General and administrative expenses were $16.3 million for the first quarter, down from $23.4 million in the fourth quarter and $17.4 million in the third quarter of 2008. Fourth quarter expenses did include $6.5 million of unusual items. So, when you adjust for those items in the fourth quarter, G&A expenses have declined slightly in the fourth quarter compared to the third quarter, and again in the first quarter compared to the fourth quarter, as we continue to implement cost reduction efforts.

Capital expenditures and deferred dry docking expenses for the first quarter were $37 million, of which approximately 70% related to contract preparation and upgrades for a number of our international jackup rigs and liftboats that commenced contracts or are commencing contracts in the first half of 2009. That includes the Hercules 262, 185 and Amberjack and Whale Shark liftboats. We anticipate capital expenditures and dry dock expenses for the remainder of 2009 will approximate $60 million, largely related to maintenance.

Now I would like to provide some additional guidance for the remainder of 2009. For domestic offshore, we expect our daily operating costs per rig to range between $29,000 and $31,000 for working and marketed rigs during 2009. And that does include the Hercules 350 which runs about $40,000 per day.

The impact for our stacking plan will continue to lower our costs from the second quarter as we realize full quarter benefits of rigs that have been cold-stacked during the first quarter. It takes approximately 45 days after we decide to cold-stack a rig to completely reduce the cost. At that point we estimate that costs will be approximately 7,500 per day per rig on cold-stacked rigs.

International offshore operating costs are expected to range between $47 million and $49 million in the second quarter. The remainder of the year will be subject to activity levels. These amounts include amortization and mobilization costs of over $800,000 per quarter and $7 million of expenses related to provision of marine services on the Hercules 258 and 260 contracts that are billed to the customer separate from this stated day rate.

For the inland segment, we expect our operating costs per rig to be in the $12,000 to $20,000 per day for marketed rigs during 2009, and that completely depends on crewing levels. We expect that costs will be down to approximately $4,000 per day per rig on cold-stacked barges during the second quarter.

In our domestic liftboat segment we expect daily operating cost per vessel to decline slightly to the $3100 to $3300 per day range for 2009. We anticipate daily operating costs per vessel for our international liftboats to increase to an average of approximately $6,500 for the final three quarters of 2009 due to a mix shift to larger vessels with the addition of the Amberjack and Whale Shark in the Middle East.

General and administrative expenses expected to be approximately $16 million per quarter for the remainder of the year. And we anticipate depreciation and amortization expense to range between $50 million and $52 million per quarter.

Interest expense will likely decline slightly in the second quarter to just under $15 million due to the retirement of $20 million in debt early in the second quarter and lower floating interest rates. We expect interest expense to be in the $15 million range per quarter for the remainder of the year. Of course, this could change with additional debt reductions or changes in interest rates.

Now I will turn the call over to Stephen.

Stephen Butz

Thank you, Lisa. I would like to spend a few moments discussing our financial covenants, liquidity and capitalization. As we have discussed on our previous conference calls, our senior secured credit facility includes two financial covenants. We are continuing to monitor our forecasted compliance with these covenants closely. If at some point we determine that we will need more cushion under these covenants and have better visibility as to what we would need, we would likely seek an amendment of our credit agreement at that time. However, at this stage we are continuing to focus on the things that we can control that will help improve these ratios, such as reducing our cost structure further and on initiatives such as non-core asset sales which could generate additional proceeds that could be used for debt retirement.

Despite both an extremely challenging environment and the impact of international capital projects, we still generated significant cash during the first quarter. Our cash and equivalents increased by $52 million to $158 million versus $106 million at year-end. Additionally, our availability under our $250 million revolving credit facility stands at approximately $236 million, only limited by $14 million in letters of credit that we have issued, leaving us with overall liquidity of nearly $400 million.

Furthermore, with our planned reduction in capital spending in the next three quarters, coupled with additional expected cost reductions in our domestic offshore and inland businesses, we still expect to generate positive free cash flow prior to any voluntary debt repayment or any changes in our credit facility even at historic to present activity level.

At quarter end March 31, our total debt stood at just under $1.03 billion. However, during April we purchased 20 million of our convertible senior notes for approximately $6 million or at an average of about 30% at par. Since the beginning of the fourth quarter we have now reduced our debt by nearly $126 million, using cash of less than $69 million, saving the company over $57 million.

In closing, along with our cost reduction and other proactive measures, we will continue to seek other avenues to mitigate the negative impact of adverse market conditions that we are facing.

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

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions). Our first question will come from the line of Angie Sedita of Macquarie. You may proceed.

Angie Sedita – Macquarie

Alright. Thanks. Good quarter, guys.

John Rynd

Thank you.

Angie Sedita – Macquarie

John, you signed the contracts on the 203 and 350 in the Gulf of Mexico one of them actually at a pretty decent rate and the other one essentially a market rate. Can you give us a little bit of inside into conversations with customers what's driving them to pick up the rates, is it the rigs low day rates? Is it project driven? And given where gas prices are, hard to believe that the economics work so could you give us the mind-set there?

John Rynd

Yes, Angie, good question. I think it's a combination of both. I think it is project driven. These people were fortunately had capital to spend. Service costs are coming down. You have seen our average day rates are down roughly 50% from their highs and with the decimation in the North American land rig count all service costs are starting to recalibrate. So some people opportunistically are taking advantage of that. I think as we said in our prepared remarks, we have seen a modest uptick kind of coming off bottom here. I think we are cautious about activity levels as we mentioned as we get into the heart of the hurricane season.

Angie Sedita – Macquarie

Okay. And then on the hurricane season, can you give us a little bit of insight on your windstorm insurance and when you are up to renew and details on cost?

John Rynd

Yes. We don't have the details yet on cost as we are in the market right now. Our goal is to, A, protect the balance sheet from any losses to that magnitude, try to reduce the overall insurance package cost but at the same time there's limited coverage, little of capital in the market and I think that you are going to get not as much coverage as we have seen over the last three or four years. Your self-insured retention is probably going to go up.

Angie Sedita – Macquarie

Okay. And then finally, you touched on the covenants, etcetera. Any update with any conversations with the banks on that front?

Stephen Butz

No. I mean as we said in our last call, we have been in constant discussions with our agent bank, our lenders, other financial institutions and advisors and we are just continuing to monitor, monitor our forecast and compliance. Really across the board the advice was that we needed to wait until we had better visibility as to if we actually were going to breach the covenants and as to what we would need if in fact that was going to happen.

Angie Sedita – Macquarie

Okay. Great, guys. Thanks. Good quarter.

Stephen Butz

Thank you.

Operator

Our next question will come from the line of James West of Barclays Capital. You may proceed.

James West – Barclays Capital

Hey, good morning, guys.

John Rynd

Good morning.

Lisa Rodriguez

Good morning.

James West – Barclays Capital

John, just wanted to follow-up a little bit on Angie's question, given that service costs have come in, your rates are down. The customers in the Gulf of Mexico that you have talked to that still can't access credit, do you have a sense of if they could access the credit markets how many rigs you could put back to work?

John Rynd

I think right new the increase would be modest and I say that because of outlook through the summer on natural gas prices and hurricane season. Now if you say we are through the shoulder months, we are through hurricane season and I think the uptick could be a little greater. I think right now people are going, there's more downside than upside to gas right now, hurricane season, let me just play it careful right here.

James West – Barclays Capital

Okay. That makes sense. And then also in your conversations, when you talk about the economics of some of these wells, do you get a sense on how much further we need to see overall service costs drop before the economics do actually make sense?

John Rynd

Well, I will tell you what, we have heard on more than one occasion from our customers, commodity prices are in the 2004 levels and service costs are 1.5 times where they were in 2004. And we are off 50%. So, we think we have got we play our share of the game and got our skin in it, if you will.

James West – Barclays Capital

Okay. Make sense. Thanks, John.

Operator

Our next question will come from the line of Mike Urban of Deutsche Bank. Please proceed.

Mike Urban – Deutsche Bank

Hi, good morning.

John Rynd

Good morning.

Lisa Rodriguez

Good morning, Mike.

Mike Urban – Deutsche Bank

First question I wanted to spend on the balance sheet and we talked about this a little bit in the past, but is there any thought even with the stock where it is at doing an equity raise? I realized it would be pretty dilutive at these levels but given the concern over the balance sheet we have seen with some other names not directly in your space but in the oil service industry more broadly go out and do equity races, even though they were dilutive were viewed positively because it just takes balance sheet out of question and you get back to focusing on the business and on the operations.

John Rynd

Michael, we are not contemplating that. That's kind of last resort at this point. We think we have many other levers to pull before we have to go there. So, it is always out there but at the bottom of our list to do anything dilutive at this point.

Mike Urban – Deutsche Bank

Okay. And the second one, more of an operating question, have you seen any change in the competitive dynamic out there? And what I mean specifically and maybe too early to tell, you now got in Seahawk you will have kind of a pure play competitor. Is there a sense that they would view anything differently, in other words, you don't have price back stopping with a pure play, you only have this set of assets, these math assets in the Gulf any change in the behavior there or again too early to tell?

John Rynd

It's early to tell. I will say they have put together a very strong management team, we know some of them very well but again it is a little too early to tell.

Mike Urban – Deutsche Bank

I figured that you might know something about that team. That's all from me, thanks.

John Rynd

Thank you.

Operator

Our next question will come from the line of Arun Jayaram of Credit Suisse. You may proceed.

Arun Jayaram – Credit Suisse

Yes. Good morning. John, I was wondering if you could provide us an update on what you are seeing from Pemex, I think that 2006 which got extended a little bit, but what are your thoughts are with Pemex and the future of mat rigs in Mexico?

John Rynd

I think as those of us who have followed Pemex for over the last 15 years know that it changes almost weekly. A case in point, three weeks ago we received notice of early termination on the 206 and we got that rescinded and we could be down no longer than through our original contract period. So that is a pretty significant change in a short order. There was talk earlier of coming out for a package of five, 300-foot cantilevers, that has gone quiet. Again, that may resurface in a week.

I would say on the question to the mat rigs, I think that ultimately over the course of the next year, if they stick to what appears what they are going to stick to the mat rigs will come back to the Gulf of Mexico.

Arun Jayaram – Credit Suisse

What gives you that, what kind of confidence is the right word, but your sense that mat rigs may return?

John Rynd

Well, I think you have seen in the recent bidding that I think they have procured about six incremental jackups since this year actually.

They have all been independent leg rigs and historically when they bid for a 250 ILC, they would almost bid a 200 mat cantilever, they always viewed those as equal assets. The recent 250 ILC bids have not been inclusive of 200 mat cantilevers.

Arun Jayaram – Credit Suisse

Makes sense. Secondly, John, we have not yet modeled this agreement you talked about with Mosvold a few months back. Can you give us a little bit of an update or are you willing to give us some framework to that agreement.

John Rynd

We are not willing to give the kind of the numbers side of it yet. Again as we talked about in the last call, we have got what we think may be a competitive advantage that we don't want to be out public yet. That being said the units were schedule for delivery the first unit in December of this year, give it 60 to 75 days of commissioning, etcetera, so that you can see the unit in the first quarter of 2010. The second unit somewhere, late second quarter or early third quarter 2010. We have already started bidding those on appropriate tenders. Obviously we have not won anything, otherwise we would make that announcement.

Arun Jayaram – Credit Suisse

And is there any CapEx associated with that?

Stephen Butz

We will not, no. That's a no-risk deal for us. We marketed and manage the assets.

Arun Jayaram – Credit Suisse

Fair enough. Last question, John, we have seen a little bit of or a pretty meaningful pullback in the West African jackup market. Can you comment on what you are seeing, the liftboats there was a notable improvement on some of the March data on the liftboat side in West Africa. Can you comment on what you were seeing in the liftboat business.

John Rynd

Yes. The primary consumer of liftboats in West Africa is Chevron. They released four of our boats throughout the first quarter. And unlike last year, when those kind of the same tendency happened in the first and early second quarter of 2008 we were able to put the boats right to work from to some of the smaller E&Ps or some of their construction firms. Well, that work is not there. And I think that's a perfect sign of just access to capital, low commodity prices, that marginal player is not there to boost up the kind of spot market liftboats.

The drilling activity, it is what you see. There is very little incremental new activity in West Africa. I think we have seen a modest uptick. I think we can hold on own the remainder of the year where you saw us exit March.

Arun Jayaram – Credit Suisse

And the liftboat side is being bit more resilient type of thing?

John Rynd

Yes. Again it is lower cost, its well maintenance, it's what we have seen historically in a down cycle in drilling, we tend to not be a cyclical in liftboats.

Arun Jayaram – Credit Suisse

Last question, Lisa, on the collections side is there anything that has you nervous about the receivables, that kind of thing?

Lisa Rodriguez

No.

Arun Jayaram – Credit Suisse

Are say sales outstanding running?

Lisa Rodriguez

No. We have had very strong collections. Day sales outstanding is up slightly but that's due to more expenses being billed and not yet collected and so when that comes in it that will make a dramatic impact on day sales outstanding. As you remember we reserved $4.5 million in the fourth quarter, allowance for doubtful accounts but no material adjustments since then.

Arun Jayaram – Credit Suisse

Okay. Thanks a lot, guys. I appreciate it.

Operator

Our next question will come from the line of Jeff Tillery of Tudor Pickering Holt. Please proceed.

Jeff Tillery – Tudor Pickering Holt

Hi, good morning. In your prepared remarks, John, you mentioned the rig 170 rolling off in the Middle East. Can you just discuss how you feel about handicapping that rig staying at working gutter?

John Rynd

I would say right now we are probably 50/50.

Jeff Tillery – Tudor Pickering Holt

Okay. And I would assume that there is no priced option if that rig stays working there, it would be more or less whatever the market rate is.

John Rynd

Whatever the market will bear, you are right.

Jeff Tillery – Tudor Pickering Holt

And could you just discuss kind of the next quarter or so outlook for the domestic liftboat on the utilization side, as to whether you are seeing continued price pressure there or not?

John Rynd

I think if we see price pressure, it will be modest from this point, not say we are beyond any more price pressure but I don't think you will see another 20% leg down like we have seen. And I think that utilizations would stay kind of where we are right now in the low 60s, it looks like. We have taken a little different tack than we had previously. We went ahead and tried to secure term work, if you will, i.e., 60 days at a lick instead of being just seven days at a time. And we focused on a few key customers to try to get a volume of work and take some of the utilization risk out of the domestic liftboat business.

Jeff Tillery – Tudor Pickering Holt

And my last question, as you look at the prospects for rig 350, how would you handicap that rig being in the US Gulf of Mexico at the end of this year?

John Rynd

100%. It is going to be here.

Jeff Tillery – Tudor Pickering Holt

Okay, alright. Thank you very much.

John Rynd

Thank you.

Operator

Our next question will come from the line of Robin Shoemaker of Citigroup. Please proceed.

Robin Shoemaker – Citigroup

Hey John.

John Rynd

Good morning, Robin.

Robin Shoemaker – Citigroup

Good morning. I just wanted to ask you about your take on the overall jackup market. Clearly such an exodus of rigs over the recent years. Pemex seems to have some more requirements. Do you believe the premium jackups in the Gulf of Mexico will continue to leave the market or that there will be sufficient opportunities for this size of that premium fleet to continue to decline?

John Rynd

I think there's a chance that the premium fleet in the Gulf of Mexico continue to decline and of course, I think right now where we are in the market globally, there will be very few opportunities to move a jackup from the western hemisphere to the eastern hemisphere, A, just cost now with availability in that region, also with the new builds coming on, I don't, last year we moved three rigs west to east. I don't think you will really see that unless it's a very high specific certain type rig. And so, I think the ability to move rigs, certainly premium rigs out of the Gulf of Mexico will be to South America. Mexico, Trinidad, Venezuela.

Robin Shoemaker – Citigroup

So are mobilization expenses recoverable now or in terms of bidding a rig into an international market? Are you bidding it without mob fees or would someone who is bidding fair on in the Gulf of Mexico bidding it without mob fee.

John Rynd

What we are seeing so far everyone is still trying to achieve full mobilization fees. We have not seen an instance where someone is willing to amortize that over the term of the contract.

Robin Shoemaker – Citigroup

Yes. Okay. And then the only other question I had was on your continuing to repurchase the convertible senior notes, I am sure there's a return calculation that you have on that. Could you share with us why you think that that is a good use of capital, apart from just deleveraging?

Stephen Butz

Well it is very deleveraging, in fact we did use a lot less cash to retire that debt than our other debt but as far as return metrics I think the recent yield to put is in the high 30s or around 40%, still very high return.

Robin Shoemaker – Citigroup

Yes, okay. Thank you.

Lisa Rodriguez

Thank you.

Operator

Our next question will come from the line of Mike Drickamer of Morgan Keegan. You may proceed.

Mike Drickamer – Morgan Keegan

Hey, good morning, guys.

John Rynd

Good morning, Mike.

Mike Drickamer – Morgan Keegan

Lisa or Steve, I don't know who wants to take this one but can you comment on your line of credit availability if you were to, say approach some of your debt covenants?

Lisa Rodriguez

We have I mean, if we breached the covenant at that point we would not have access to our line of credit but up until the point that we breach it we would have access.

Mike Drickamer – Morgan Keegan

Okay. So at some time in the future if you do find you have to take and renegotiate that would be involved with that, correct?

Lisa Rodriguez

It is all tied together. So when we renegotiate the covenants it would be apply to the line of credit and the term loan.

Mike Drickamer – Morgan Keegan

Alright, John, just thinking into the future here, with premium jackups leaving the Gulf of Mexico, leaving mostly mats here in the Gulf of Mexico. What do you think that does to Gulf of Mexico drilling activity going forward? Does it change the dynamic of wells being drilled now?

John Rynd

Not dramatically, Mike. I think that not all the premium rigs will leave, they are just not going to have the opportunity to all get out of here, so you will have a fleet of premium rigs here that will probably, at the right time we will be able to achieve a nice premium, given the lack of numbers of those assets in the Gulf of Mexico. Most of the wells being drilled from a well-depth perspective in the Gulf of Mexico are drilled very capable by a mat rig. The only deciding factor is water depth. Now I know there is McMurran [ph] and BP and Chevron will drill the ultra deep tests but those are one or two a year, three a year, the most of the wells are commodity wells being drilled by commodity rigs.

Mike Drickamer – Morgan Keegan

Alright. Thanks a lot, guys.

John Rynd

Thank you.

Operator

Our next question will come from the line of Waqar Syed of Tristone Capital. You may proceed.

Waqar Syed – Tristone Capital

Good morning, John. Questions about asset sales. I understand you were looking to sell some assets. How is that progressing?

John Rynd

We elected to market the retired assets. That's the key, the retired assets is the assets that had been cold-stacked, both the inland barges and the jackups for over a decade. So then when we started cold stacking late last year and early this year we changed that to the retired status and moved the recently cold-stacked into cold stack so we can differentiate. So, we had no plans of the assets that we have marketed for sale of ever refurbishing those and bringing them back into the market.

So, there is some interest, there is some cog there is a lot of tire kicking, as far as coming to the table with money we haven't seen a great interest there. We have got, I guess three deals kind of cooking, if you will, that have matured from tire kicking to price discussions. I would say at this point we are not overly confident that anything gets done in the near-term. Again, it goes back more to the credit issue than anything else.

Waqar Syed – Tristone Capital

Sure. And, secondly, on your international contracts, you have a couple of contracts, with ONGC with Saudi Aramco. A number of these contracts are now well above where the spot rate is, is there any discussion from Saudi Aramco about renegotiating those contracts or even ONGC pushing for that. I understand with Aramco there are some cancellation clauses as well in the contracts.

John Rynd

Yes. There has been no discussion between Hercules and Saudi Aramco or ONGC regarding those contracts. While you would say we are above the spot market, we are still of the active fleets operating in those regions, mid to third tier. So we don't have we are not at the market highs, very fair rate for us and very fair rate for our customer, we are performing on the well site as we should so at this point no discussion.

Waqar Syed – Tristone Capital

Alright. Thank you, sir. Thank you very much.

Operator

Our next question will come from the line of Ole Slorer of Morgan Stanley. You may proceed.

Ole Slorer – Morgan Stanley

Thank you. Lisa, wonder whether you could just elaborate a little bit more on the working capital it generates a little bit more free cash flow a little bit larger net debt reduction in the quarter. Mostly we were looking for and it looks like it was a pretty favorable move in working capital.

Lisa Rodriguez

Yes, once we had very strong collections throughout the quarter. That was the most notable part on the working capital and so we continue to have strong collections, both domestic and international.

Ole Slorer – Morgan Stanley

So, will that reverse again in the second and third quarter or we will be able to hold it at that level?

Lisa Rodriguez

Well, I forecast that working capital continues to be a source of cash throughout 2009.

Ole Slorer – Morgan Stanley

Okay. I think you mentioned that. I just wanted to make surely that I got that right. And could you also just run us through the amortization side, relatively to how you see the internally generated cash flow and cash at hand because what we have seen from the shipping side where every single company has renegotiated covenant as of late, is a very big difference between companies that renegotiate payment terms and those who don't.

John Rynd

Yes. You are speaking of amortization of our principal?

Ole Slorer – Morgan Stanley

Yes.

John Rynd

Yes. It is very minimal repayment requirements, it is about 1% per year of the original term loan balance, so about 9 million per year required and then there is also excess cash flow so to speak, but of course, that only kicks in to the extent that you generate a lot of cash. So, just over 2 million a quarter.

Ole Slorer – Morgan Stanley

Okay. So even on a very conservative Gulf of Mexico outlook there shouldn't be any need to renegotiate the amortization structures on the debt.

John Rynd

Yes. That's right. And the loan, in fact, doesn't mature until mid-2013. Our revolving credit is only mid-2012 but the term loan in mid-2013 with a bullet payment.

Ole Slorer – Morgan Stanley

Okay. Well, thanks for clarifying that. Just wanted to make sure.

John Rynd

Sure. Thank you.

Operator

Our next question will come from the line of Pierre Conner of Capital One Southcoast. You may proceed.

Pierre Conner – Capital One Southcoast

Good morning, everybody.

John Rynd

Good morning.

Pierre Conner – Capital One Southcoast

John, I am sorry, I may have missed, but did you say which additional rigs you plan to cold-stack that have come up since the April 23rd fleet status?

John Rynd

No, Pierre. We are flexible depending on success on some bids we have outstanding. So, we always have three or four of them that may be candidates depending on how activity turns out and so those two are not named at this point.

Pierre Conner – Capital One Southcoast

Okay. But the two of the jackups, John?

John Rynd

Yes, two of the jackups.

Pierre Conner – Capital One Southcoast

Two jackups? Okay. Let's see. Covered lot of the things but just quickly, the platform rig for Pemex coming to conclusion of the current contract, and did you mention what you thought the outlook there was on extension?

John Rynd

Well, I think consistent with our general comments on Pemex, it changes weekly. We will probably get a short-term extension it looks like potentially that will buy us time for them to release a tender for a longer term extension but stay tuned.

Pierre Conner – Capital One Southcoast

Got it. Okay. And let's see, a couple of cleanup things, now you mentioned in domestic liftboat, certainly weather impacted in March. I think the weather was pretty bad. But you don't expect utilization to meaningfully pick back up?

John Rynd

We are going to stay in the low 60s range, Pierre.

Pierre Conner – Capital One Southcoast

Okay. And then some additional pressure on rates but not another 20%?

John Rynd

I don't think so but never say never. But I think we have seen that drop and we are kind of off the post hurricane highs, which if you go back to any previous hurricane cycle it tends to happen. So, I think we have found a happy medium here for everybody.

Pierre Conner – Capital One Southcoast

Okay. Lastly, John, you are a student of the new build inventory of jackups and now not directly impacts your business but what's your current thinking on and what are you hearing relative to potential cancellations out of that order book?

John Rynd

We haven't seen over the last 60 days any more chatter about people pushing back and their canceling delivery other than what was kind of announced really at the fourth quarter year-end 2008 conference call notes from seadrill and rolling and others. But I think if you look at the order book, and really more back half 2010 and 2011, I think you could easily come up with 18 to 25 of those jackups that will be significantly delayed or not delivered.

Pierre Conner – Capital One Southcoast

Okay. Great.

John Rynd

Does that help?

Pierre Conner – Capital One Southcoast

Yes, absolutely. Alright, thanks very much. I will turn it back.

John Rynd

Thank you.

Operator

Our next question will come from the line of Ian MacPherson of Simmons and Company. Please proceed.

Ian MacPherson – Simmons and Company

Hey, good morning.

John Rynd

Good morning.

Ian MacPherson – Simmons and Company

John, you said you thought near-term demand visibility for your domestic offshore fleet would probably support activity of seven to ten rigs?

John Rynd

That's correct. We have ten contracted this morning.

Ian MacPherson – Simmons and Company

Okay. And so 12 is probably the right number that you want in the marketed fleet against that demand scenario?

John Rynd

That's our current thought process.

Ian MacPherson – Simmons and Company

Okay. With respect to the inland barge fleet, I am curious how much sense it makes for you to keep a few rigs marketable to chase one or two opportunities at a time. Are there more cost savings that could be had by shuttering that cold-stack into fleet indefinitely?

John Rynd

No. We have looked at that weekly for the last six months. You know, we are eternal optimists here. The business is going to get better at some point. We want to have that optionality

And we think that with our cost-cutting measures that we have implemented and further cost-cutting measures, the "carrying costs" if that operation are well worth it to have the optionality to respond to the market when it returns.

Lisa Rodriguez

And the other thing I mentioned Ian in my notes is that we were able to reduce the costs even on the marketed rigs because we are lowering the crews because we can shift the crews between the jackups and the barges, so even the ones that are marketed are not necessarily carrying full crews.

Ian MacPherson – Simmons and Company

Got it, okay. And then Lisa, if I could ask one more follow-up with you, you mentioned the line of credit gets frozen in the event that your covenants come into play. What else do we need to be aware of specifically or with regard to ramifications of covenant issues?

Lisa Rodriguez

I think that's the main ramification. I mean, obviously we are going to do everything we can to either avoid a breach or amend the covenant, to avoid a breach. So I would envision us taking actions prior to the actual breaching being incurred.

Ian MacPherson – Simmons and Company

Alright. Thanks a lot.

John Rynd

Thank you.

Operator

Our next question will come from the line of Geoff Kieburtz of Weeden. You may proceed.

Geoff Kieburtz – Weeden

Thanks, good morning. Lisa I would like to just follow-on that last comment. Can you give us some idea of what kind of time frame you think would be necessary to successfully negotiate an amendment to the covenants?

Lisa Rodriguez

I think the whole process from what we are being told takes four to six weeks but it's better to do it when you have visibility like Stephen mentioned.

Geoff Kieburtz – Weeden

Alright. Considering that you may not have that luxury, and it does sound like things are getting, a little bit better but having eight weeks of visibility could be a difficult thing to achieve in this market environment, unless I am not understanding your description well.

Lisa Rodriguez

The way the covenants forecast you have a breach at the time you file your certificate, which you file at the time that you file your 10-Q or your 10-K. So, we would have the entire quarter and a few weeks of following quarter to take any action that we deem necessary.

Geoff Kieburtz – Weeden

Okay, great. Alright. That helps. The increase in bidding that you mentioned, John, are you able to discern whether this is, a market turn or is it just seasonal or is it not possible to discriminate?

John Rynd

It is not a market turn. And I say that because we are going to be heading into hurricane season. And we are very concerned, given Ike and Gustav, that you are going to have less desire this hurricane season than we had in '07 and '08. So, it is a near-term kind of bottom uptick but I think we may test it again August, September, September, October, that timeframe, those three months will be interesting to watch.

Geoff Kieburtz – Weeden

Okay. Alright. From the bidding discussions, gas prices remain pretty challenging here. Are you thinking that this is an indication that projects that have been kind of on hold are now economic because rates have come down enough or is there any color that you can attribute to those customer interests?

John Rynd

Yes. I think its people who have had capital. They have seen costs, not just rig rates, but all costs come down. Some of it is lease expirations, they don't want to lose the lease, some of it are deals that are coming together. They feel it is an opportunistic time to take advantage of that. There's no kind of move one direction that, yes, our customers are calling bottom on gas and feel that gas is on the upside, etcetera. I think it is still a little bit of a mixed bag to get a clear few.

Geoff Kieburtz – Weeden

Okay. A couple other small ones, on that retired asset sale, would that be done with some sort of protection against those assets coming back and competing with you?

John Rynd

Yes, we have by and large every asset has a drill restriction attached to it.

Geoff Kieburtz – Weeden

Okay. And on the Mosvold deal, have you detected any other interest of doing something similar to what you have got arranged with Mosvold.

John Rynd

Yes. We have had some early discussions with some other parties that are getting close to delivery of spec new builds but nothing's matured yet to feel confident that we are going to put a handicap the success of it.

Geoff Kieburtz – Weeden

Sure. And last question, Lisa, you mentioned kind of the crew sharing between the barges and the jackups. Is that part of that ongoing cost efficiency improvement that you expect to flow into the second quarter, were you realizing a large part of that benefit in the first quarter?

Lisa Rodriguez

No. A lot of that on the inland side, some of those reducing those to a partial crew and planning that if we do go back to work, that we borrow some from the jackup fleet, that's a fairly new initiative.

Geoff Kieburtz – Weeden

Okay. So should see more of that in coming quarters?

Lisa Rodriguez

Yes. And as I mentioned, we're bringing down our stacked inland costs from our previous guidance, we are bringing that down to about 4,000 per day. Previously we had said 4500 per day. And then the marketed is, 12 to 18 or so depending on the crewing levels, and that's due to sharing of crew.

Geoff Kieburtz – Weeden

And the 7500 cold-stack costs on the jackup was also including that effect.

Lisa Rodriguez

Yes.

Geoff Kieburtz – Weeden

Okay.

Lisa Rodriguez

It doesn't directly impact on the cold stack of the jackup as it does some of the marketed rigs.

Geoff Kieburtz – Weeden

Okay. Fair enough. Thank you.

Stephen Butz

Candace we have time for one final question.

Operator

Thank you, sir. Our final question will come from the line of Christopher Boucek [ph] of Raymond James. You may proceed.

Christopher Boucek – Raymond James

Hi, guys, thanks for letting me have the last question, I just wanted to clear something up real quick. Was I right in hearing there were some sort of cancellation provisions on the Saudi Aramco and ONGC contracts. I know that Saudi Aramco canceled a coupled other but I was under the impression that yours were iron clad.

John Rynd

All of Saudi contracts have cancellations provisions but there is also remuneration back to us for early termination.

Christopher Boucek – Raymond James

Okay, alright. That’s just wanted to make sure on that. And unrelated follow-up, looking to the Gulf of Mexico you currently are looking for a seven to ten demand, you are going to run 12 rigs, as you head into hurricane season, help me out with this, if demand is going to fall could you stack in capacity just for a three, four, five-month time span.

John Rynd

Yes, we could.

Christopher Boucek – Raymond James

Okay, perfect.

John Rynd

Again where we are today, we have said in our prepared remarks, from our fleet status of last week to this morning, we have earmarked two more to be cold-stacked, that's probably it. We will go to war with the 12 that we are marketing right now.

Christopher Boucek – Raymond James

Okay, alright, I appreciate it. Sounds good.

John Rynd

Thank you.

Stephen Butz

Alright. I would just like to thank everyone for joining our call and we look forward to visiting with you again next quarter. Thank you.

Operator

Thank you, sir. And thank you for your participation in today's conference. You may now disconnect. Have a great day.

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