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Hercules Offshore (NASDAQ:HERO)

Q2 2013 Earnings Call

July 31, 2013 10:00 am ET

Executives

Son P. Vann - Vice President of Investor Relations & Planning

John T. Rynd - Chief Executive Officer, President and Executive Director

Stephen M. Butz - Chief Financial Officer and Executive Vice President

Analysts

David Wilson - Howard Weil Incorporated, Research Division

Gregory Lewis - Crédit Suisse AG, Research Division

Ian Macpherson - Simmons & Company International, Research Division

John Booth Lowe - Cowen and Company, LLC, Research Division

Collin Gerry - Raymond James & Associates, Inc., Research Division

Byron K. Pope - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

Nigel Browne - Macquarie Research

Ryan Fitzgibbon - Global Hunter Securities, LLC, Research Division

Kathryn O'Connor - Deutsche Bank AG, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 Hercules Offshore Earnings Conference Call. My name is Deborah, and I'll be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. And I'd now like to turn the call over to Mr. Son Vann, Vice President of Investor Relations and Planning. Please proceed, sir.

Son P. Vann

Thank you, Deborah. Good morning, and welcome, everyone, to our second quarter 2013 earnings call. With me today are John Rynd, Chief Executive Officer and President; and Stephen Butz, Executive Vice President and Chief Financial Officer, along with members of our senior management team, including Jim Noe, Executive Vice President; Troy Carson, Senior Vice President and Chief Accounting Officer; Beau Thompson, General Counsel; and Craig Muirhead, Vice President and Treasurer.

This morning, we issued our second quarter results and filed an 8-K with the SEC. The press release is available on our website, herculesoffshore.com. John will begin the call with some broad remarks regarding our quarterly performance, current market conditions and recent company events. Stephen will follow with a more detailed financial discussion and provide cost guidance for 2013. We will then open the call up for Q&A.

Before we begin, let me remind everyone that our call will contain forward-looking statements. Except for statements of historical facts, all statements that address our outlook for 2013 and beyond, as well as activities, events or developments that we expect, estimate, project, believe or anticipate may or will occur in the future, are forward-looking statements.

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

With that, let me call -- turn the call over to John Rynd.

John T. Rynd

Good morning, everyone, and thanks for joining us today. While the purpose of today's call is to review our second quarter results and provide an update as to our outlook, I would like to start the call this morning with an update on the recent well control incident at South Timbalier 220.

Just to recap what has been disclosed since last week, on the morning of July 23, we experienced a well control incident on the Hercules 265 while drilling a natural gas well for ultra oil and gas at South Timbalier 220 in the U.S. Gulf of Mexico. We safely evacuated and secured all 44 personnel on board that afternoon, incurring no injuries in the process. Later that evening, the natural gas flowing -- falling from the well ignited. Flames emanating from the well spread to our rig, mainly through the cantilever and drilling package, which sustained heavy damage. Sometime during the late evening hours of July 24, the fire subsided at the well apparently bridged over. By the morning of July 25, it appeared that the fire was reduced to a small residual flame. Recently, this flame has also been extinguished.

Over the past few days, a site assessment has been completed by a third-party well control specialist. The operator, working closely with BSEE, is formulating options to primarily secure the well and have made preparations to drill a relief well. We will not put people on board the Hercules 265 for an assessment until the South Timbalier 220 well is killed and secure. So until we have our people on the rig, we cannot confirm the condition or provide much detail on the current condition of the rig, other than to say the pictures and video images appear to show that the rig sustained significant damage.

As you might expect, given the infancy of the investigation and in light of the fact that the incident is subject of an ongoing investigation, we will not be able to provide much additional commentary on this matter at this time. This incident highlights the importance of safety training and crisis response in our industry. That we safely evacuated all 44 personnel on board in an orderly and timely fashion demonstrates the emphasis our company places on our training of our people and our overall culture of safety.

We also made it a priority to immediately coordinate our response efforts with the customer, the U.S. Coast Guard and BSEE. We will continue to do so as the operations move to primarily secure the well and to do a salvage operation. There are a lot of details to sort through going forward, but I want to commend everyone involved in the response efforts thus far to make sure what was a difficult situation injury free. We're also grateful for the assistance that both the BSEE and the Coast Guard have provided.

Moving on to the financials. This morning we reported second quarter 2013 financial results, which reflect the impact of a number of transactions that were announced during the quarter. These transactions included the acquisition of Discovery Offshore and the divestiture of the Domestic Liftboat and Inland segments, which are treated as discontinued operations.

For the second quarter of 2013, we reported net income from continuing operations of $16.6 million or $0.10 per diluted share compared to a loss of $52.5 million or $0.33 per diluted share for the second quarter of 2012. The second quarter marked a strategic period for the company as we took significant actions to high-grade our asset base and better position the company for long-term growth.

The acquisition of Discovery Offshore is a big step forward in our fleet renewal process, while the sale of Domestic Liftboats and Inland eliminates some of our lowest performing assets. Anyone who has followed Hercules over the past 2 years knows that our intent when we formed Discovery back in January of 2011 was to own these rigs outright. The question was when.

With the improvement in our core markets over the past 18 months and the visibility that we now have with the remainder of our business, this allowed us to accelerate the timeframe of when we thought it was possible to acquire Discovery. Our sale of the Inland and Domestic Liftboats segments, which generated approximately $100 million of proceeds from assets that produced only $10 million of cash flow, allowed us to buy Discovery without the need to issue equity.

The strategic rationale for owning Discovery is the same today as it was in 2011. We need to diversify our operations, binding a mix of higher specification and newer assets. While we believe our current fleet has many years of life remaining, it is important for us to add assets that have a longer run rate to generate returns and are more resilient during industry downturns. We also need to add higher-spec assets to broaden our service offerings, particularly for international markets that are seeking more robust equipment.

Longer term, these newer assets that improve our earnings visibility, lower our cost of capital and keep us competitive. In terms of contracting status of the Discovery rigs, we are actively bidding on a number of opportunities in various regions, both on short- and long-term jobs. We're taking a slightly different approach to marketing these rigs than we've done in the past. Under Discovery's ownership, we focused our marketing efforts almost exclusively on long-term opportunities. We had to do this to reduce risks for Discovery as a company with only 2 assets and to help facilitate standalone Discovery financing, reduce the cost of financing and to minimize the need for and the size of a follow-on Discovery equity offering.

While there are still long-term opportunities available, the timing of start dates and contract-specific requirements provided challenges. This approach limited the scope of opportunities that we can legitimately pursue, and ultimately, we also haven't been the low bidder on the contracts that have been awarded.

Throughout our marketing efforts, we've identified a number of shorter-term opportunities, 12 months or less, that we elected not to aggressively pursue either because of limited term or the timing conflicted with certain long-term opportunities. Now that these rigs are under Hercules ownership, given our more diverse fleet and stronger capital structure, Hercules can be more flexible with the type of jobs we can pursue, still targeting long-term work for these rigs, but also looking at attractive short-term jobs in the interim. I am confident that we will have a contract in the near term on both rigs and place these rigs on dayrate by late this year or early 2014 after mobilization and final outfitting.

Turning our attention to the U.S. Gulf of Mexico jackup market. Industry conditions remained tight, with limited rig availability for rest of the year. Of the 35 drilling-capable jackup rigs market in the region, all but one are currently under contract, and the average backlog of these rigs is approximately 6 months.

Looking at our fleet of 18 marketed rigs, we have limited availability in 2013 and already have 6 rigs that are contracted well into the second quarter of 2014. Average backlog continues to hover around 200 days per rig.

Backlog at our current marketed fleet may be greater given the condition of the Hercules 265 and the possibility that the contracted backlog in this rig could get transferred to other rigs in our fleet.

Frac-ing [ph] remains strong. In recent months, we have moved leading-edge rates for our 200-foot mat canti rigs up to $107,000 per day, an increase of $5,000, and we see positive price momentum continuing, albeit at a measured pace. Most of the drilling remains focused on oil and liquids. Gulf of Mexico operators continue to benefit from the premium prices for Louisiana Light Sweet crude. The much anticipated widening of the spreads between Brent and LLS prices has yet to occur. In fact, LLS remains priced at a premium to Brent.

There hasn't been much natural gas-directed drilling, and with gas prices pulling back to the mid-$3 level, we don't expect that to be a source of incremental demand anytime soon. We continue to market a second rig reactivation. Estimated cost remain in the $20 million range, and the financial return on reactivation still appears attractive at today's leading-edge rates. However, we need to absorb some near-term availability on a few units before aggressively pursuing a second reactivation.

The determination of whether or not the Hercules 265 is going to be repaired may also have an impact on our thinking. The soonest that a reactivation could realistically be completed is sometime during the first half of next year.

Beyond our reactivation, we expect little, if any, rigs coming back to the Gulf of Mexico in the near term. Our market intelligence indicates that all rigs in Mexico with contracts expiring this year will be extended by PEMEX.

Outside of Mexico, the international marketed jackup fleet is running at 94% utilization. And on balance, it remains more favorable for contracts to keep their rigs overseas rather than move them to the U.S. Gulf of Mexico. Due to the continued strength and demand in dayrates, this continues to be the strongest I've seen the Gulf of Mexico in my career.

One area that we are monitoring closely is the new order book, which continues to grow. Currently, there are 114 new-build jackup rigs set to be delivered through early 2017, of which approximately 90 rigs are uncontracted. So far, new builds have been absorbed in an orderly fashion. Most of these rigs are targeting international markets.

Over the last 12 months, the international jackup rig fleet, excluding rigs under construction, has increased by approximately 28. Over that same period, rigs under contract have increased by 37 or about a 10% year-over-year growth in international demand.

If demand expands at mid-single-digit growth rate over the next 3 years, we think it should be enough to absorb the new builds without significant market disruption to the existing fleet. Of course, a lot could happen in 3 years, and we'll have to wait and see what opportunities may come about over that period.

As for our international jackup fleet, excluding the Discovery rigs, we have a good mix of contract coverage. We now have 3 rigs working for Saudi Aramco under long-term contracts.

The Hercules 266 was placed into service at the beginning of the second quarter and will be contracted for the next 3 years. The Hercules 261 and 262 have contract coverage through the third quarter 2014. Thereafter, we are confident that these rigs would secure new long-term contracts with good upside to the current average dayrate of 80,000.

We have been delayed on the start up with the Hercules 267, primarily due to bureaucratic difficulties in obtaining work visas for Angola, a situation that is impacting the entire industry in Angola. We are using all our appropriate lawful means to get these visas, and we're hopeful to get them any day now. Once in hand, the rig will go on contract with 3 years at 109,000 per day.

The Hercules 260 is contracted through mid-2014 in West Africa. We are confident that the rig will be picked up after the current terms, as the market in West Africa is quite strong.

In our shortest-term international rig, the Hercules 208 is on the contract through the end of the third quarter, after which it will undergo a special survey. We are in discussions with the customer for the 208 after it leaves the shipyard with good upside to the current rate.

Turning to our International Liftboat business. In West Africa, our utilization experienced some softness in the recent quarter, partly due to planned shipyard time on the recently acquired Titan 2, which we renamed the Bull Ray, to complete its regulatory survey and on Tigershark for leg repairs. Both vessels were effectively off-hire of the entire quarter.

As a result, utilization during the second quarter 2013 averaged only 67% compared to 75% for the second quarter 2012. Because these are 2 of our largest, highest-earning vessels in West Africa, this also impacted average dayrates, with decline to approximately 20,800 during the second quarter of '13 compared to 23,400 for the same period last year.

Despite the weakness in our second quarter utilization in West Africa, activity levels in the region are very strong. Since early July, utilization in West Africa has averaged closer to 75% to 80%, and the Bull Ray has been on contract at approximately 60,000 per day. This contract runs through the end of the year, with an option to extend up to 2 months, and we are fielding a number of long-term opportunities for the vessel in 2014.

We're also close to finalizing negotiations with all of our local Nigerian labor unions and think that the risk of the work stoppage has been largely reduced. Liftboat activity in the Middle East is also quite robust. Utilization on the 3 vessels we have in the region averaged 95% for the second quarter. One of the vessels, the Whale Shark, is on a 2-year contract that extends through the end of 2014. The 2 other vessels will conclude their current contracts during late August. We expect these vessels to be off hire for a month or so in preparation for their next assignment.

Finally on our various sales processes, we closed the sale of both Domestic Liftboats and Inland for proceeds of $54.5 million and $45 million, respectively. We also retained working capital of approximately $12.5 million. We also had the PEMEX sales agreements on Hercules 27 for $5 million, which is expected to close within the next few weeks.

In closing, our acquisition of Discovery, coupled with the sale of Inland and Domestic Liftboats, is truly transformative for the company. Going forward, Hercules Offshore will be defined by our world-class employees and safety culture, our market-leading fleet of jackups in the U.S. Gulf of Mexico, our high-graded specialized international drilling fleet and our high-margin International Liftboat fleet. Our revenues will be more evenly balanced between domestic and international region, with a greater percentage of this revenue generated from newer, higher-spec equipment that tend to command long-term contracts and higher margins over the cycle. I am confident that we will find attractive contract for the Discovery rigs shortly.

We will also continue to seek opportunities to grow our fleet, both from acquisitions and through rig reactivations. In all the moves that we have completed over the last 2 quarters, coupled with the strong visibility that we have within our existing asset base, I am very excited about the direction of our company is headed.

With that, let me turn the call over to Stephen.

Stephen M. Butz

Thank you, John, and good morning, everyone. In keeping with our normal practice, my comments will focus on sequential comparison and the quarterly results. I'll also provide an update to our 2013 cost guidance and capital spending plan before opening the call for Q&A.

For the second quarter, we reported net income from continuing operations of $0.10 per share compared to $0.25 per share in the first quarter of 2013. However, both quarters included unusual items that we highlighted in a non-GAAP schedule. After adjusting for the impact of these items, EPS was essentially flat at $0.01 in the second quarter versus $0.02 in the first quarter. The relatively high effective income tax rate in the second quarter negated the significant operational improvement we saw with our EBITDA from continuing operations increasing to $71 million from $53 million in the first quarter.

The recent divestitures of our Inland assets and Domestic Liftboats impacted the presentation of our financial statements as the current and historical results generated from these assets are now presented as discontinued operations. While the sale of Domestic Liftboats included virtually the entire segment, with the exception of working capital, the Inland sales did not include Hercules 27, 52, our training rig and various spare equipment. The Hercules 27 is expected to be sold to another buyer and close during early August. So this rig has been included and held for sale on our balance sheet and in discontinued operations on our income statement. Conversely, the operating results for the other Inland assets that were retained have been reclassified and will continue to be reported in our Domestic Offshore segment.

In addition to the divestitures, on June 24, we acquired a majority ownership of Discovery Offshore, which then required us to begin consolidating their operating results in late June. The second quarter 2013 results also included a gain of $14.9 million or $0.09 per share to reflect the fair market value of our equity investment in Discovery Offshore at our tender price of NOK 15 per share. We've presented this gain on the non-GAAP schedule so you can review our financial results excluding its effects.

Next, I'll cover our segment results starting with Domestic Offshore. Operating income of $40 million for the second quarter was flat with first quarter 2013 results. Higher average dayrates were offset by a reduction in utilization and an increase in operating cost. Average revenue per day increased by 8% in the second quarter to $84,300 as our domestic fleet continues to roll contracts forward at higher rates. Based on our contract coverage and assuming timely completion of special surveys, we expect the average revenue per day to increase to the mid-$90,000 range by the fourth quarter of 2013.

Second quarter utilization, however, declined to 89% from 96% in the first quarter. We had several rigs that incurred downtime for equipment replacement, refurbishment, inspections and miscellaneous repairs. As we disclosed in our prior fleet status reports, utilization during the latter half of this year will also be impacted by 4 special surveys in our fleet, one of which is currently underway and a second, which is scheduled to commence shortly.

Domestic Offshore operating expenses increased to $66 million from $60 million. Much of this increase can be attributed to incremental operating cost on the Hercules 209, which completed its reactivation and went into service in May, as well as higher repair and maintenance expense. We expect to incur third quarter operating expenses for Domestic Offshore in the low $70 million range, reflecting a full quarter of results on the 209 and additional labor and burden.

While we believe we have adequate insurance coverage for the South Timbalier 220 incident involving the Hercules 265, this guidance is exclusive of any additional costs that are not covered by insurance as it is simply too early in the recovery process to tell whether or not the rig will be repaired. If repaired, we would incur the deductible of $5 million. The rig is insured for $50 million.

Our International Offshore segment reported an operating loss of $3.3 million compared to a loss of $12.2 million in the first quarter. Revenues increased to $49 million from $32 million in the prior quarter, primarily from higher utilization, which improved to 78% from 60%. We generated 150 additional operating days during the second quarter, with the commencement of the Hercules 266 in Saudi Arabia and the Hercules 208 and 260, incurring less downtime than during the prior quarter.

Our average revenue per day during the second quarter was essentially flat. Current operating costs of $34 million include $1.7 million loss on a pending agreement to dispose of the Hercules 185 hull. Incremental costs related to the addition of the 266 were partially offset by reduced costs on the Hercules 260 as it underwent repairs during the first quarter.

We expect operating costs for International Offshore to be in the low- to mid-$30 million range during the third quarter as incremental cost on the commencement of the Hercules 267 in Angola are somewhat offset by the absence of expenses on the Hercules 185. Looking into the fourth quarter, we expect International Offshore operating expenses to increase by another $4 million or $5 million to reflect a full quarter of operations on the Hercules 267 and assume the late year startup for the Discovery Triumph.

Now turning to our International Liftboat segment. Operating income increased to $9.9 million from $5.2 million in the first quarter, primarily on higher average dayrates and lower operating costs. Average dayrates rose 5% during the second quarter to 24,200, as we had a slightly greater mix of our revenue days generated from larger vessels. And average pricing on many of our larger-class vessels were slightly above first quarter levels.

Activity in the Middle East was particularly strong. Nonetheless, our second quarter utilization declined modestly to 70% from 72% as we had less activity on our smaller-class vessels. As John mentioned, we should see some improvement in utilization during the third quarter as there were a few vessels in West Africa that were off hire while in dry dock during the second quarter. But they've completed their shipyard time and have been on the payroll since early July.

Operating expenses declined by $2.7 million to $20 million despite the addition of the Bull Ray, mainly because first quarter expenses were negatively impacted by a $2.6 million impairment of a cold-stacked vessel that was sold in West Africa. We estimate operating expenses will average in the low $20 million range per quarter for the second half of the year, reflecting slightly higher labor and burden.

Moving on to other income statement and cash flow items. General and administrative expenses increased to $21 million from $19 million in the first quarter. During the second quarter, we incurred $3 million in transaction costs related to the purchase of Discovery Offshore. We expect G&A expense to range from $19 million to $20 million per quarter for the remainder of the year.

Depreciation and amortization expense of $38 million is up from $35 million in the first quarter, largely due to incremental depreciation associated with the Hercules 266. We expect third quarter depreciation to approximate $40 million as we incur additional expense on the 267, with potentially a further increase into the fourth quarter, depending on the timing of startup of the Discovery Triumph.

Interest expense was $18 million compared to $17 million in the first quarter. We capitalized $1.5 million of interest during the second quarter compared to $2.3 million in the first quarter. We expect interest expense will increase to approximately $21 million in the third and fourth quarters, reflecting the July issuance of $400 million in unsecured notes and the increased capitalization of interest, primarily related to the construction financing of the Discovery rigs. As both rigs commence operations in our capitalized interest declines, we would expect interest expense to be in the $28 million to $29 million range per quarter, prior to a potential refinance of our 10.5% senior notes.

Our effective income tax rate for the second quarter was 42%. However, after adjusting the results for the Discovery investment gain, our rate was 87%. As we experienced in late 2012 with operations in a number of jurisdictions and when operating at relatively low levels of income, you can get rates that are not particularly meaningful. Recently, certain of our foreign operations have been operating near breakeven. However, in those countries, we pay tax on a deemed profit or revenue basis, resulting in a high effective income tax rate. As our profitability improves going forward, we expect our rate to decline to the low 30% to 40% range in the -- for the remainder of the year. Lastly, and most importantly on taxes and similar to our previous guidance, cash taxes are expected to approximate only $15 million for 2013.

As for capital and dry docking expenditures, we spent $36 million during the second quarter and $81 million year-to-date. Approximately 1/2 of year-to-date expenditures have been for growth initiatives, such as the reactivation of the Hercules 209 and for initial contract preparation work on the Hercules 266 and 267. Year-to-date, we also spent $178 million on acquisitions, including $81 million for additional Discovery shares and $97 million for the first quarter purchases of the Hercules 267 and Bull Ray.

For the second half of 2013, we estimate total capital and dry dockings expenditures will range between $460 million and $490 million, the majority of which are for final shipyard installments on the Discovery rigs, totaling approximately $334 million. We're also budgeting between $75 million and $90 million for owner furnished equipment, spares, mobilization cost and capitalized interest for the Discovery rig. Of course, the exact amounts will ultimately depend on where and to whom the rigs are contracted, but right now this represents our base case. Our CapEx guidance also excludes any amount for additional reactivation.

With respect to our balance sheet and liquidity, as previously mentioned, we spent approximately $81 million to acquire additional Discovery shares and repaid $61 million in convertible notes during the second quarter, which led to a reduction in cash and equivalents to approximately $41 million at quarter end. However, cash has rebounded sharply since that time. Shortly after quarter end, we closed on approximately $100 million in asset sales of Domestic Liftboats and Inland barges and completed the issuance of $400 million of senior unsecured notes.

On the other hand, we also paid the final shipyard installment for the Discovery Triumph, bringing our consolidated cash position today to approximately $350 million in advance of the final $167 million installment payment on the Discovery Resilience which is due on October.

Further strengthening our balance sheet, we amended our revolving credit facility, increasing the size to $150 million, extending the term to 5 years and reducing the pricing. However, usage on our revolver will be limited to $75 million until we take out our current 10.5% senior notes.

In closing, we had a number of strategic accomplishments during the second quarter, including the agreements to sell Domestic Liftboats, Inland and the acquisition of Discovery Offshore. Our company is now a more focused growth platform, better positioned to generate attractive returns over a longer horizon.

Last week's incident at South Timbalier 220 and the damage to the Hercules 265 is extremely unfortunate, and of course, the out-of-service time or perhaps, even the loss of the rig, will have a small offset to some of the new assets we have entering service. However, all in all, we are extremely grateful to our crew and their quick but careful response to the incident in ensuring no injuries were sustained.

Nonetheless, as we look forward, our financial results should improve dramatically as we begin to see the full impact of numerous new assets in the Hercules portfolio: the Hercules 266 in Saudi Arabia; the Hercules 209 reactivation in the U.S. Gulf of Mexico; the Hercules 267 in Angola; the Bull Ray in West Africa; and of course, the world-class Discovery Triumph and Discovery Resilience. We should also benefit from continued improvement in our financial results, stemming from the strong backlog in Domestic Offshore and gradually improved rates as we move through the next several quarters.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Dave Wilson of Howard Weil.

David Wilson - Howard Weil Incorporated, Research Division

First and foremost, I want to express my relief that everyone was able to get off the 265 safely. At the end of the day, I think that's paramount. I wanted to start my line of questions today, or just a couple, on Discovery Offshore. John, I know you addressed some of this in your prepared remarks, but I was wondering if you could expand a little bit as to the timing of the Discovery acquisition and why you chose to do it when you did rather than waiting, possibly, for those rigs to get contracted.

John T. Rynd

Yes, great question. First, I want to thank you for your comments. If you look at the timing, I think we touched on that in the prepared remarks. Given our view of where our base business was, the asset sales, the Domestic Liftboats and Inland did not require the need of equity. And if you remember, the final shipyard payment was due August 1 on the first rig. And with no near-term work activity apparent at that time for the Triumph, albeit bids outstanding, we felt like the financing hurdle and the potential dilution to the existing Discovery shareholders was really going to be a tough deal. We felt it was the best move for all stakeholders involved to make a move at that time.

David Wilson - Howard Weil Incorporated, Research Division

Got it. And then just separate one. In your discussions with Arena, have you guys come up with suitable solution yet? I know it's still very early, but as far as the rig to replace the 265, I would imagine that it might require a lot of work.

John T. Rynd

[indiscernible] but we are juggling the remaining rigs that have availability, which are few, as you know, from our fleet status to fulfill our obligations to Arena. And we think we can carry that out.

David Wilson - Howard Weil Incorporated, Research Division

Okay. And then just one final one, I'll sneak it in here. You saw some of this last year, and I was wondering if you could speak to the industry's desire, basically, the contract hurricane season? I know you've touched on it before, but judging by the fleet's recent fleet status reports, it appears that's the case again this year. Is the short answer just crude oil and liquid prices, or supply and demand and rigs in the Gulf, what do you attribute that to?

John T. Rynd

Both. Combining pricing that they're targeting, obviously, is very robust. The rig market is extremely tight. So we don't see that. As you mentioned, just looking at our fleet status, we do have a couple of rigs short, but we're not concerned about them at this point.

Operator

Your next question comes from the line of Gregory Lewis of Credit Suisse.

Gregory Lewis - Crédit Suisse AG, Research Division

John, could you talk a little bit about sort of the rigs -- a little bit of an outlook in terms of the Gulf of Mexico? I mean, clearly, Hercules, it deals with a lot of smaller private operators on the shelf in the U.S. Gulf. I mean, given the 2 recent events, the one with your rig with Walter [ph] and the other one a couple weeks ago, has there been any slowdown or change in activity from some of the smaller E&Ps that are on the shelf? Is that something that has happened? Or is it sort of just business as usual?

John T. Rynd

It appears, right now, to be business as usual.

Gregory Lewis - Crédit Suisse AG, Research Division

Okay, great. And then, just in thinking about the international rig fleet. Clearly, it was an improvement quarter-over-quarter in terms of the operating income line. As we think about this going out over the next few quarters, I guess there's one rig that's going to step up in -- it steps up in rate and it should provide a boost to the international rig fleet. I mean, how should we think about that segment, exclusive of the Discovery rigs because clearly, when the Discovery rigs, the International segment bounces in the profitability. But when we think about the leg, how should we sort of think about the legacy international rigs over the next 1 to 2 years?

John T. Rynd

Yes. I think we're -- very good questions. Our exposure's really down to 2 rigs. If you look at our contract status, as you know, with Saudi Aramco and the 267, when it gets the visa situation sorted, it will go on a 3-year contract term. So as we mentioned, the 208 is our nearest-term availability. It finishes at the end of this quarter, goes to Singapore for a scheduled 90-day, 5-year survey. We are in discussions with a customer to use a rig immediately upon departure from Singapore and an uptick to its current rate in a nice duration program, not extra long length but nice solid duration. Then that leads us back to the 260. The 260's contracted through May of '14. That current operator has been pleased with the performance, has a fair amount of acreage position in the areas where we've been working for that operator, so that's one obvious place that we stay there. If that does not work out for whatever reason, the demand in West Africa is still very strong, so we think the outlook for the 260, work-wise, is very solid. Rate-wise, we've got a pretty solid rate for that rig right now. There could be some upside to it at renewal into May of '14.

Operator

And your next question comes from the line of Ian Macpherson of Simmons.

Ian Macpherson - Simmons & Company International, Research Division

John, you, in your opening remarks, expressed some desire to continue to modernize, and I thought it was really good [ph] that you were able to pull off the Discovery acquisition the way that you did from a debt financing standpoint. So can you maybe elaborate a little bit as to what you're thinking with regard to your wish list for acquisitions, more high-spec jackups and what you might contemplate in terms of financing and what you're thinking of in terms of timeline?

John T. Rynd

Yes. I think that obviously, they continue to move to newer, more higher-capacity equipment is obvious in the moves we've made this year. I mean, don't forget the Liftboat business, it's our highest-margin business, so there's opportunities there as well. On the rig side, as we kind of outlaid in the opening remarks, there's 114 rigs under construction. It doesn't feel right to order a couple more right now, to be honest with you, and look at a delivery in '15 or early '16 given what's ahead of you in the queue because if you remember, when we ordered the Discovery rigs, we were -- the Discovery rigs were number 40 and 41 in the queue. So that leads us to just monitor the rigs that are being built off spec and see if -- as they get closer to completion, if there's an opportunity there. That's really the game plan on the new site right now. But also, I think as we've shown this year with the acquisition of the 267 and last year with the 266, if opportunities present themselves even with the legacy fleet, that we can then tie it into a multi-year, contracted, very attractive returns, we'll still, and are still pursuing those opportunities. And then to the financing question, that'll just be one of the economics of the acquisition, where we -- where as the capital markets -- that all that, as you know, is a pretty moving target and pretty fluid up to the point where you want to get the deal done.

Ian Macpherson - Simmons & Company International, Research Division

Very true. As a separate follow-up question, just with regard to Timbalier 220, do you think that we're going to see -- have you ready seen any sort of immediate response, or do you anticipate some sort of reaction from BSEE with regard to an impact on the pace of permitting, or in some way, renewed circumspection with the regard to rig and equipment certifications, et cetera? Or do you think that there is a plausible case that business, as usual, will continue in the shelf after a period of investigation?

John T. Rynd

Well, I think, first and foremost, hats off to BSEE for the way they responded to the incident. They worked very closely with us through all parts of it and still work very closely today. So it's -- they're doing a great job assisting in this operation. So it's a little early, Ian, to kind of speculate what may come forward with more inspections, more regulations, et cetera. But right now, it appears to be business as usual.

Operator

And your next question comes from the line of JB Lowe of Cowen and Company.

John Booth Lowe - Cowen and Company, LLC, Research Division

Just a follow-up question on the acquisition side of the business. Would you guys be willing to take over a rig that is already being built on the yard, say, on spec, rather than ordering just a new build?

John T. Rynd

I would say, right now, if that opportunity prevailed itself, yes. And again, as I mentioned earlier, you're going to be ahead of the other rigs that are going to be delivered. And that, right now, just feels maybe a better way to go if that opportunity is available.

John Booth Lowe - Cowen and Company, LLC, Research Division

Okay, fair enough. And just on the international jackup side, the -- I know you talked about the 08 and the 60 that are rolling off next, but looking out for the 61 and 62, would there be any reason why those rigs wouldn't roll on to higher rates when they came off contract at the end of '14? I know it's a little bit early, but is there anything about those rigs that would preclude them from doing that?

John T. Rynd

No. I think right now, our bias is that they will renew with the existing client at rates above their current level, which averages 80,000 between the 2 of them.

John Booth Lowe - Cowen and Company, LLC, Research Division

Right. Okay. and then lastly, on the International Liftboats, I know that you said that it's your highest-margin business. Are you seeing clients looking to sign up longer-term work and extending out contracts farther than usual, maybe on the higher-spec assets you guys have there?

John T. Rynd

Yes, you nailed it. On the higher spec assets, term is availing itself.

Operator

And the next question is from the line of Collin Gerry of Raymond James.

Collin Gerry - Raymond James & Associates, Inc., Research Division

Congrats on the safety procedures, getting everybody off safely. I know it's a dangerous business, you can prevent everything. So congrats on having the right procedures.

John T. Rynd

Thank you.

Collin Gerry - Raymond James & Associates, Inc., Research Division

I want to talk a little bit, and I might have missed it if you discussed it earlier, but -- so we saw a relatively large landmark deal on the shelf with your customer base. In the past, we've seen the nature of A&D activity, the buyer can either accelerate capital going into the Gulf or kind of use it as a opportunity to harvest cash flow from it. Have you gotten a sense -- and this is a pretty big jackup user and shelf flare. Have you gotten a sense of what the goal from the new owner of those assets would be? Would it be to accelerate capital on the shelf or same as what it was before?

John T. Rynd

I would say our bias, as we look at that situation is that they could accelerate capital. Remember, Apache's a very large, diverse global operation and every year, everybody has to battle for capital allocation from corporate. And it gets divvied out for various reasons, principally driven by returns, I assume. And so you've got a new order that is solely focused on those shelf properties, which are the largest leaseholder on the shelf. So I think our bias is bullish.

Collin Gerry - Raymond James & Associates, Inc., Research Division

And from a capitalization perspective, your -- I don't know much about the company, but they do have capital behind and to where they would be able to accelerate capital?

John T. Rynd

It appears that way.

Collin Gerry - Raymond James & Associates, Inc., Research Division

Okay. Well, that's certainly good color. The other question I had, and this is a little more esoteric, but we saw the landmark or the big manufacturer report and talked to us yesterday, and one of the themes that kind of came up was the shipyards are just are really tight trying to get these rigs out, whether it be getting pressure from control equipment or fab-ing things up and outsourcing costs, and just there's so much activity on new rig construction going on. And it kind of throws in the question, delays on the deliverability, which is an issue that's plagued this industry in the past. Is that something that you see fear with -- as it relates to your Discovery rigs and maybe even other rigs coming down the pipe that you're kind of watching from an M&A perspective? Or just from an industry perspective, do you think that's something we could run into in 2014?

John T. Rynd

I think that as you look out in '14 and '15 deliveries, and we've seen this already, not all the rigs that are scheduled to be delivered in that calendar year will be delivered. I think we are not at risk of that. The Triumph was delivered 47 days early. We -- the Resilience is scheduled for the 2nd week of October. It appears it's going to be on time and on budget. So we're not going to face that with the 2 Discovery assets. But if you look at the order book this year, the preponderance of the new orders came out of the Chinese shipyards. And really, the bona fide Chinese shipyard is [indiscernible], which is building a lot of jackups. I think their delivery is improving. I would say, if you were looking out, especially from an acquisitive standpoint, you'd have to do a lot of due diligence on the yard -- pardon me, Deborah?

Operator

You wish to take your next question?

John T. Rynd

Ma'am, we're still answering the existing caller, Collin Gerry with Raymond James. Deborah, I think we're good. We're going to finish answer the question we're currently on, Collin. So I just think as you look out on a yard that does not have a significant track record of delivering jackups, you have to factor that in as you're looking at a potential acquisition.

Collin Gerry - Raymond James & Associates, Inc., Research Division

So it sounds like the fervent thing from our end is to maybe take a closer look at some of the shipyards and risk adjust some of the delivery timetables.

John T. Rynd

Yes, and also look at the designs they're building.

Operator

And your next question comes from the line of Byron Pope of Tudor, Pickering, Holt.

Byron K. Pope - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

To circle back, John, you mentioned that you all are still looking at a potential second reactivation, order of magnitude, $20 million and -- but realistically, it'd be kind of first half of 2014. Just curious as to what you all are looking to in terms of signpost, in terms of making that go, no-go decision, just given that the demand side of the equation continues to be fairly robust in the Gulf.

John T. Rynd

Yes. I would say there's 2 factors right now. One is we do have some near-term availability. So we want to get that tucked away in a nice position to kind of open the runway for that. And if that continues, if our backlog continues to hover around the 200-plus days and dayrates stay on their upward bias, yes, we'll probably pull the trigger. Now, of course, coming into that, kind of rethinking that whole equation, is what's the ultimate situation on the 265 that may accelerate reactivation.

Byron K. Pope - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

And then just a second question. I don't want you to have to bid against yourself necessarily, but just in thinking in terms of ballpark, let's say if the Triumph or the Resilience were to work in the North Sea versus another international jackup market, just how are you thinking about dayrate ranges, given where leading-edge dayrates are [indiscernible]?

John T. Rynd

If you've seen where the recent fixtures of like assets have been, it's been between a $200,000 to $230,000 range, subject to term, the length of the term, what the mobilization was, et cetera. So that's kind of, in our fairway, where we've been approaching the market. I think outside of the North Sea, rates are going to be at the lower end of that range, and that's really associated with your margins are going to be the same because your operating costs will be less. So you're -- it's really, you're looking at -- obviously, you have to pay attention to the market, but you're really just trying to equate the equal margin across the various regions, operating costs, taxes, et cetera.

Operator

And your next question comes from the line of Nigel Browne of Macquarie.

Nigel Browne - Macquarie Research

Just wanted to get your thoughts on how the Gulf of Mexico shallow water market has changed. We've seen a migration from sort of gas to oil for obvious reasons. But given some of the successes of 1 or 2 operators going horizontally or just being more aggressive at targeting some of the tracks and structures around the salt domes that the Gulf of Mexico is known for, do you see or have you heard anything from your customers about ramping up activity from sort of conventional remediation type production to more aggressive geological structures, perhaps going horizontally? And is -- are your jackups in the region sort of the tool of choice in order to develop a program such as that?

John T. Rynd

Yes, very, very good observation, a very good question, Nigel. Yes, we are seeing some more lateral sessions on a few of the wells we're drilling for few specific customers. And we also have a rather large player in the Gulf of Mexico who's going after those traps on a pure exploration play. So I guess in conversations with our customers, some of the bigger customers, there is a fair amount of pure exploration work still to be carried out. And then coupled with revamping of the seismic, they're saying some of these latter horizontal sections turn out to be fairly productive for them. So that's all good news for us. And to date, that work is all well-suited for our rigs. Those wells do not outpace the capability of all our assets.

Nigel Browne - Macquarie Research

And if I could just ask one follow-up to sort of tease that out. Do you have any sort of indicative proportion of your U.S. Gulf of Mexico fleet that's drilling horizontal/directional wells as a percentage right now?

John T. Rynd

I would say, on the directional well, a lot of work is directional. And that's been going on for quite some time now. On the horizontals, I think we've done a couple of the horizontal section wells.

Nigel Browne - Macquarie Research

Okay. And as this becomes more sort of intensive, is it fair to say that a given well might take a longer period of time or consume a lot more drilling rig days? Or is it sort of indifferent either way?

John T. Rynd

Well, I would say what we've experienced so far, and I'll differentiate kind of from the drilling around the salt domes to the horizontals, the horizontals are not taking any great amount of rig time. They're -- so far, to date, they have been very -- 1,000-foot 1,800-foot horizontal sections that don't really require significantly more rig time to drill the well. The wells that are being drilled around the salt domes are taking -- are longer than your typical Gulf of Mexico well. They are pure exploration wells, and that always add challenges. And they're deeper, and so yes, you have more casing strength to run, et cetera. So those are -- appear to be taking a bigger chunk of rig time.

Nigel Browne - Macquarie Research

All right. Just one last quick one, and then I'll relinquish the line. Just wondering how are you looking -- you had a number of rigs go through [ph] 5 years for these programs [ph]. Just sort of peeking into 2014, do you see a sort of abatement on the maintenance CapEx side, just excluding the Discovery rigs?

John T. Rynd

Yes. I think that as we look into -- well, we got 4 more to carry out this year and then we've got 4 -- 3 scheduled for next year, so it should come down. And then our maintenance capital on the Discovery rigs will be fairly light, relative to the existing fleet.

Operator

The next question comes from the line of Ryan Fitzgibbon of Global Hunter Securities.

Ryan Fitzgibbon - Global Hunter Securities, LLC, Research Division

John, in your prepared remarks, you mentioned Gulf of Mexico is the best you've seen in your career. Can you give us some feedback as to what customers are telling you in terms of contracts? And right now, really just trying to get a better understanding of what the push back is on pricing and what kind of momentum you see in the back half of this year.

John T. Rynd

Yes. We have not had any push back on pricing to date. And I would say, in our conversation with our customers, the outlook into '14, by and large, is still very, very robust. And I think that's also evident by our fleet status where we have 6 rigs already contracted into the second quarter of '14 and 1 rig already committed into the first quarter of 2015. So there -- we're experiencing that bullishness.

Ryan Fitzgibbon - Global Hunter Securities, LLC, Research Division

If you had to make a guess, do you think this cycle, you see rates go back to where you saw the last cycle peak at?

John T. Rynd

I am the worst procrastinator in the world or predictor, or whatever the right word is. I'm not very good at it, whatever it is. But saying that, yes, I think that it's achievable to reach or exceed previous peak dayrates. Why? They're chasing a commodity that's got a very robust price deck. There's fewer rigs than there was in the previous cycles, and we have more operators. We have 35 customers today, and we had 23 customers in 2009. So all of those factors will lead you to bias, yes, there's the potential to get to or above previous peak, but I'm not predicting it will happen. We'll take it when we get it.

Ryan Fitzgibbon - Global Hunter Securities, LLC, Research Division

Second question for me is on the cost side for our Domestic Offshore. Have you -- I guess, Stephen, in your guidance, did you include any labor wage increases in there? And then would we expect to see any pickup in insurance costs? And would that -- do you think you'd be able to pass those on to the customers?

Stephen M. Butz

Yes. We did include some wage inflation in that in -- during -- for our third quarter guidance and the guidance moving forward. With respect to insurance, we, in fact, just completed our renewal in May, and so that policy will remain in effect until next May. And so at this point, it's too early to tell what we would see at next year's renewal. Of course, it's never good when you have claims. But at the same time, probably, a bigger factor is what are the amount of claims for the overall industry.

Son P. Vann

Operator, given the time, we'll probably have time for one more question.

Operator

The next question comes from the line of Kathryn O'Connor of Deutsche Bank.

Kathryn O'Connor - Deutsche Bank AG, Research Division

I think that I've heard you talk a little bit about this before, but maybe you could just give us a refresh. I know that you haven't been the low bidder in terms of trying to bid out those Discovery assets. And can you just give us an update on why you think your view is somewhat differentiated than the other people that are participating in some of those processes?

John T. Rynd

One, I'm bullish about the whole jackup market globally, so that tends to lead yourself to be bullish on pricing. I think these assets bring to the table a very effective tool for our customers and effectively and efficiently and safely drill their wells. And that should be -- we shouldn't give that service away. And as we look at the cost to move a rig from Singapore to somewhere in the world and the incremental equipment that is required to meet certain contract-specific requirements of a customer, we should not absorb all that cost. So it's been a combination of our view on dayrates and our view on how that capital should be allocated and who should pay for that capital has put us at the high end of these ranges as we bid these jobs.

Kathryn O'Connor - Deutsche Bank AG, Research Division

And then any comments on some of the other rigs that are comparable to the Discovery rigs that have seen some issues in terms of their specs and [indiscernible].

John T. Rynd

Yes. I mean, the other competitive units that are comparable to the super A's are effectively outfitted identically. They're very, very close, from a competitive standpoint, of all the issues or the items that a customer looks at: water depth; cantilever reach; hook load; capacity to carry mud; et cetera, they're all very, very close. There has been an issue in the industry on a certain design of jackup that has really -- we have not seen a resolution to that issue. There may be one, but we have not seen it. And I saw on one of the people that are building those rigs, they have accepted contracts recently. So obviously, there's got to be a comfort level, otherwise both parties wouldn't agree to go -- accept the contract. But we have not seen a public statement with what is the fix of the issue. And I'm not saying there isn't one, just saying we have not seen it.

Kathryn O'Connor - Deutsche Bank AG, Research Division

Okay. And then I know you've said you're looking at shorter-term contracts in -- for those Discovery assets than you have looked at in the past. What does shorter mean? And what did longer mean when you were looking at the contracts before?

John T. Rynd

Short could be one well, anywhere from one well to greater than a year.

Stephen M. Butz

Kathryn, of course, we continue to target longer-term contracts as well, so there may be a situation where we would contract them for some short-term and then continue to bid on longer-term work and hopefully, stack that work on.

John T. Rynd

Just some of the opportunities, as Stephen mentioned, the longer-term work may not start for 180 days, so we can pick up a 1- or 2-well opportunity to bridge the gap for the timing to start the longer-term opportunity.

Kathryn O'Connor - Deutsche Bank AG, Research Division

Right. Okay. So we can expect maybe some combination of shorter- and longer-term contracts together?

John T. Rynd

That's a potential.

Kathryn O'Connor - Deutsche Bank AG, Research Division

Okay. And then just one last one, if I can sneak it in, combining a few different things that people have talked about. It seems like you have a bias towards acceleration for the new owner of the Apache assets in the Gulf of Mexico, and tying in the idea that you're not sure whether or not you've lost your 265, plus the fact that I've heard you say before that you have more customers than rigs and jackup rigs in the Gulf of Mexico. How does that make you think about trying to fill up your existing contracts that you still have open before you bring on the last couple that you have earmarked for possible reactivation? Because it sounds to me like while you don't want to commit to the fact that the market could be, in fact, accelerating versus just staying robust, the individual statements that you're making do come together to make it seem that way. Any comments on that?

John T. Rynd

Yes, I think we're just going to continue to be prudent in our approach to reactivating an additional rig. $20 million is a heck of a lot of money, so we're going to make sure -- we may be conservative, so be it. It's a $20 million investment, and we want to make sure we get a return on that $20 million. Our bias is that things are very positive, and there's probably room for the rig. But as I mentioned, we've got a couple of rigs that have some near-term availability. Let's get those fussed [ph] out. And then the whole other issue around what's the ultimate demise of the 265 could factor into, do we pull the trigger on the reactivation sooner rather than later.

Operator

I would now like to turn the call over to Son Vann for closing remarks.

Son P. Vann

Thanks, Deborah, and thanks, everyone, for joining us today. A replay of this call will be available on our website in a couple of hours. And as always, if you have any questions, feel free to give us a call. Thanks a lot.

Operator

Thank you. Thank you for joining today's conference. This concludes your presentation. You may now disconnect, and have a good day.

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