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Hercules Offshore, Inc. (NASDAQ:HERO)

Q4 2009 Earnings Call Transcript

March 2, 2010 11:00 am ET

Executives

Steven Butz – VP, Finance and Treasurer

John Rynd – CEO and President

Lisa Rodriguez – SVP and CFO

Analysts

Collin Gerry – Raymond James

Rob MacKenzie – FBR Capital Markets

Jeff Tillery – Tudor Pickering Holt

Ian Macpherson – Simmons & Company

Pierre Conner – Capital One Southcoast

Mike Urban – Deutsche Bank

Robin Shoemaker – Citi

Geoff Kieburtz – Weeden

Operator

Good day, ladies and gentlemen, and welcome to the Q4 2009 Hercules Offshore earnings conference call. My name is Veronica and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today, Mr. Steven Butz, Vice President Finance and Treasurer. Please proceed.

Steven Butz

Thank you, Veronica. Good morning. I would like to welcome everyone to our fourth quarter 2009 earnings conference call. Participating this morning from 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 today, but before John begins his remarks, I'd like to remind everyone that this conference call will contain forward-looking statements. All statements other than statements of historical fact that address our remaining outlook for 2009 and beyond, activities, events or developments that we expect, estimate, 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 discuss our fourth quarter 2009 financial results and provide cost guidance for the full year 2010. I will then provide an update on cash flow, liquidity and capitalization before opening the call for questions and answers. Now, it's my pleasure to turn the call over to John.

John Rynd

Good morning. Thank you for joining the call today. As previously mentioned, we reported our financial reports before the market opened today. After excluding certain items, we recorded a net loss from continuing operations of $25.8 million or $0.23 per diluted share for the fourth quarter 2009 compared with income from continuing operations of $36.2 million or $0.41 per diluted share in the fourth quarter of 2008.

For the full year 2009, also after excluding certain items, we recorded a net loss from continuing operations of $75.2 million or $0.77 per diluted share versus income from continuing operations of $92.9 million or $1.04 per diluted share in 2008. The fourth quarter decrease in our earnings per share from the comparable quarter in 2008 was due to the depressed activity levels that had impacted our domestic segments coupled with our establishment of an accounts receivable reserve and related expenses associated with the Hercules 185. Otherwise, our international business segment produced solid results that have helped offset the weakness in our domestic segments.

Now, I would like to provide a little more detail regarding the Hercules 185 and its impact on our results. On January 26, we announced that we were establishing an accounts receivable reserve of $29.8 million related to the customer of the Hercules 185.

We also announced that we would be taking a non-cash charge of $7.3 million to fully impair the related deferred mobilization and contract preparation costs, somewhat offset by a $2.6 million reduction in previously accrued contract related operating cost that are not expect to be settled if the receivable is not collected.

Taken together, these items were expected to reduce our fourth quarter 2009 results by a net of $34.4 million. Since that time, we received a payment of $3 million and have recently established a helpful dialogue with the customer regarding receivable. Therefore, accounts receivable reserve at December 31 associated with this customer is $26.8 million rather than the previously announced $29.8 million.

Including the effect of the other two items mentioned, the net impact of this event on fourth quarter 2009 results is 31.6 million, rather than the previously estimated 34.4 million. Despite the recent payment, which is encouraging sign, the collectibility of the receivable remains uncertain, thus far we have established the reserve.

At this point, for accounting purposes, we are not recognizing any revenue related to the Hercules 185 from this particular customer until collectibility is reasonably assured. The rig recently mobilized from Angola to Port-Gentil, Gabon and is currently jacked up adjacent to the Hercules 156 and continues to wait on instructions from our customer. However, we have the right to market the Hercules 185 during the time the rig is waiting on instructions.

And we will be able to substitute another rig for the Hercules 185 if it receives a contract during the idle time. We remain hopeful that this situation will be resolved in a timely manner. I would like now to reflect -- take a moment to reflect on our accomplishments during the year when most of the world was engulfed in a deep economic downturn and we saw benchmark crude oil prices drop to low of approximately $34 per barrel and her you have natural gas prices drop to a low of $1.83 per MMBtu.

Fortunately, as a financial crisis began, we quickly took proactive steps to try and minimize its effect and insulate our business as much as possible. We reduced our capital expenditures and deferred dry docking expenditures excluding acquisitions of 2008 by 67% year-over-year. As a result of our aggressive cost cutting efforts, which included our stacking plan reduction in force, voluntary furlough program, suspension of 401-k contribution, executive pay cuts and numerous other initiatives, we were also able to reduce our operating expenses by 117.6 million or 19% despite incurring expenses for the entire year on a number of rigs that either reentered service or joined our fleet during 2008 or early 2009.

Including the Hercules 260, 261, 262, 350 and 208, in fact in our domestic focus segments, we reduced our operating expenses by nearly $150 million in 2009. However, much of our attention was also focused on strengthening our capital structure and maintaining ample liquidity.

We secured amendment chart credit facility, which provided meaningful covenant relief through life of the loan. In addition, we have retired approximately $270 million in outstanding debt and reduced our 2013 maturities by about 50% since September 2008, much of this debt repayment coming from opportunistic purchases of our convertible debt at extremely depressed prices.

Additionally, in a move to capitalize on growing demand in one of our core regions and further, our international expansion efforts, we mobilized four relatively large liftboats through West Africa from the U.S. Gulf of Mexico. I'm happy to report three of these liftboats have found work and are generating much higher margins that could have been realized in the U.S.

Following the October dissolution of the agreement, to market, manage and operate Mosvold's two new build jackup rigs as a result of their dispute with the shipyard. We continue to seek similar opportunities to build on our core competencies and improve our returns.

In December, we entered into an agreement with MENAdrill to market, manage and operate worldwide two new build 300-foot independent-leg Friede & Goldman design Super M2 rigs. We also entered into an agreement with an affiliate of Scheyer [ph] Drilling and production to market, manage, and operate an ultra-high specification, 400-foot Capital Fells [ph] Class N jackup that is under construction and is currently scheduled to be delivered in the second half of 2010.

This particular agreement, however, is limited to just specified opportunity in the Middle East. We will continue to look for opportunities similar to MENAdrill and Scheyer [ph] agreements, in an effort to expand our operating and geographic footprints and improve our cash flow, while conserving capital.

We divested of approximately 26 million of assets in 2009 and recently entered into an agreement to sell the retired jack ups Hercules 191 and Hercules 255 for $10 million and six retired barges for $3 million. The jackups have been cold stacked for approximately nine years and the barge rigs have been cold stacked on average for a decade.

Under the agreement, the jack up rigs cannot be reactivated for drilling purposes and the barge rigs must be scrapped. The sale of these assets not only brings the obvious benefit of cash but also eliminates any ongoing costs associated with maintenance and insurance.

I am very proud to report that in addition to the above accomplishments, our health safety and environmental performance set a company record with plus 40% improvement on most key metrics, a testament to our HS&E and operations team to produce these results in a very challenging environment.

All of these tasks could not have been accomplished without the hard work and dedication of our employees and our Board of Directors. In early December, we announced that our former Chairman, John Reynolds, decided to resign with effect to December 31, 2009 to focus on other business interests.

Tom Bates, Jr. has been the director of the company since its inception in 2004, has assumed the role of chairman. I would like to officially congratulate Mr. Bates on behalf of all the Hercules Offshore employees and thanks Mr. Reynolds for his years of dedicated services to the company.

I will now discuss market conditions in the outlook for each of our core business segments. It is becoming more clear about the day that the virtually downturn is behind us. The recovery has been led by higher oil and gas prices and strong capital market conditions, which have brought improved operator capital budgets for 2010.

We expect capital spending both in the U.S. and internationally to increase this year. The fact using data provider by ODS-Petrodata and Barclays, we estimate debt on average the top 20 U.S. Gulf of Mexico shallow water leaseholder will increase to 2010, domestic spending by approximately 17%.

Combine these data point with our discussions with operators and I am confident the results will be increased activity for services. The shallow water domestic drilling market was hit extremely hard over the past year but activity is on an upward trend. The domestic contract to jackup rig count is more than doubled to 39 from the low of 15 contracted rigs over the summer.

As a reminder, the previous energy low domestic working rig count was 42 rigs in 1992. The number of that rigs actively marketed in the U.S. Gulf of Mexico standard 48. The increase in backlog that we and our competitors have experienced recently is equally as important as the increase in rig count.

We are not only seeing more r demand for rigs but demand for longer contracts relative to a year ago. Our average days backlog per marketed shallow water rig has increased to 92 days from 19 in August. According to the Meadows [ph] management service, U.S. Gulf of Mexico approves shallow water drilling plans, have trended higher since the summer.

In January, plans for 21wells were filed versus only eight during August. Bidding activity is also having a meaningful move to the upside, in fact, we sent out 19 bids in January versus a low of five bids in July. We anticipate marketing 12 jackups of domestic offshore for the near future including the Hercules 205, which has secured a contract and has currently mobilized them back to the U.S. Gulf of Mexico from Mexico.

If the economics and outlook justify reactivations, we will evaluate them on a case-by- case basis. However, as of today, we are more focused on the backlog on our existing marketing fleet rather than increasing capacity. Since our last quarterly conference call, our outlook for the international jackup market has become slightly more positive but overall our optimism remains measured.

Oil prices have held strong between $17 and $18 per barrel and as we mentioned earlier, we expect international capital spending to increase year-over-year. The percentage increase in capital spending may translate into an even higher percentage of increased activity as oil field service costs have come down meaningful since the onset of the downturn.

On the new build jackup rig front, there are currently 26 rigs that may occasionally be delivered in 2010 versus the 37 we reference on the last call. And of the 26, we expect a delivery of some of these rigs to be pushed in the next year. As a side note, approximately seven of the 26 new builds expected to be delivered this year are being built in China which tends to be a fairly captive market.

However, there are also currently roughly 80 jackups out in the international markets, which is why we are still somewhat cautious on the overall market. Since the trough in global jackup demand of 318 jackups under contract in August 2009 to the current demand of 340 jackups, the U.S. Gulf of Mexico has accounted for 19 of the 22 rig increase.

Nonetheless, we do have six of nine international rigs under contract into 2011 excluding the Hercules 185 which is currently contracted into 2011 but does not meet our revenue recognition criteria today. We were recently awarded a 440 day contract for platform rig 3 that will keep the rig working for PEMAX in Mexico into 2011. The prospects for the 156 and the Hercules 170 are improving as we have been having good dialog with customers although no contracts have been signed and the market is still highly competitive.

The inland barge rig count has also improved to 18 rigs from a low of five rigs during September of 2009 due in parts to strong oil prices and stable natural gas prices. We expect the inland barge markets of rig count to hover between 15 and 20 contracted units for the near future and our plan is to continue to market three of our inland barges and we are fairly certain we can keep these active.

Moving on to the domestic liftboats while we did incur over lower standby rates over the holidays, underlying day rates in the segment have held up over the past few months especially considering utilization has declined as a result of normal seasonality.

With the MMS becoming more strict about forcing P&A and forcing P&A requirements and the fact that higher insurance on incentivizing operators to perform the P&A work, we believe utilization will increase in second quarter as winter weather dissipates. However, we estimated up to four new build liftboats may be added to the U.S. Gulf of Mexico fleet by year end. But it is possible some of these potential additions could be offset by mobilization to other regions.

Our international liftboats segment has performed well and we expect the performance to continue. Utilization for our larger lift boats remains strong and we believe that the economic recovery should make way for the increased utilization of our smaller lift boats as well.

As I mentioned earlier, three of the vessels we mobilized to West Africa in the fourth quarter of 2009 have secured contracts or commitments at day rates that have resulted in higher profit margins that we could have realized in the U.S. We will continue to monitor the international lift boat market to identify any potential opportunities that make economic sense but we don't see anything in the near term.

In closing, I am very pleased with how we are able to manage the business in a down market, making great strides with respect to strengthen our capital structure and positioning the company to benefit from the recovery -- we see starting to take hold. Now, I will turn the floor over to Lisa to discuss our financials.

Lisa Rodriguez

Thank you, John. I will walk through our results for the fourth quarter, comparing them to the third quarter as well as provide cost expectations guidance for 2010. Steven will then discuss capitalization, cash flow and liquidity. For the fourth quarter, we reported a loss from continuing operations of $0.23 per share, compared to a loss of $0.38 per share in the third quarter. The $0.38 in the third quarter excludes the effects of a $15-million charge related to the amendment of our credit facility.

As we previously announced and as John discussed, our fourth quarter results include the impact of charges related to our operations in Angola. Our general and administrative expenses include the establishment of an accounts receivable reserve of $26.8 million, in addition, operating expenses include a net charge of $4.8 million related to the write-off of deferred mobilization and contract prep costs partially offset by the reversal of certain liabilities that will not be settled if payment is not received from our customer. On a net basis, these charges increased our operating loss by $31.6 million or $20.5 million on an after-tax basis equivalent to approximately $0.18 per diluted share.

Now, I will address the operating results and cost expectations by segment starting with domestic offshores. Our domestic offshore segment reported an operating loss of $34.5 million in the fourth quarter, a slight improvement from an operating loss of $35.3 million in the prior quarter. Revenue increased $6.8 million due to an increase in activity with the number of operating days increasing by 61%, offset in part by a 15% decline in average revenue per rig per day as we continue to work off older backlog at high -- that was at higher rates.

Operating costs of $43.8 million were $7.4 million higher than the third quarter, due in part to the increased activity and also due to $5 million of repair and maintenance expenses for various rig repairs. These were primarily repairs related to damage incurred during hurricane Ida. The average operating cost per rig per day of our 11 marketed rigs was approximately $35,800. This is inclusive of surveys cost and the aforementioned higher than normal level of repairs and maintenance. Average operating costs per rig on our cold stacked unit was 46,700 per day.

During 2010, we estimate domestic offshore operating cost to be approximately $38 to $41 million per quarter. Our average daily operating costs per rig for domestic offshore is expected to range between $29,000 to $30,000 for marketed rigs that includes the Hercules 350 which has an average cost of about $35,000 per day.

In an effort to reduce our operating expenses, we are planning to cluster our cold stack jackup throughout all of 2010, meaning we will stack a number of rigs together in one location, which will enable us to reduce labor, fuel, transportation and other expenses. This will continue to drive down our costs on our cold stacked rigs. The initiative is underway currently and therefore the first quarter will not see the full benefit that we estimated could save over $10 million on an annualized basis. International Offshore, the results as I mentioned were impacted by the net charge of $31.6 million related to Hercules 185.

Excluding this charge, the segment generated operating income of $42.8 million in the fourth quarter. A significant increase from the previous quarter operating income of 26.7 million, due largely to the increased profitability on Hercules 208 and Hercules 260. As both rigs experienced down time in the third quarter.

International offshore operating costs are expected to be in the $37 to $39 million range for the first quarter. If you assume Hercules 156, 170 and 185 are all idle the reminder of the year. We would expect operating costs to average between $31 and $33 million per quarter beginning in the second quarter.

The daily operating costs for these stacked rigs are only expected to be an $8,000 to $12,000 per day range. Inland, we reported an operating loss of $11.9 million in our Inland segment for the fourth quarter versus an operating loss of 13.5 million in the prior quarter.

The demand for Inland barges increased, we recorded 237 operating days up from a 116 operating days in the third quarter. Average revenue per day per rig decreased slightly to approximately $18,350 and the fourth quarter from the $21,000 level.

Operating expenses increased slightly as well to $8 million compared to $7.4 million in the third quarter, due to the increased utilization. For the Inland segment, we expect our daily operating costs per rig to average between 17,000 to 18,000 per day for marketed rigs in 2010. We also expect costs to be approximately $1,600 per day per rig on stacked barges for the full year. But for the first quarter it will be slightly higher approximately $2,000 per day per rig.

In our Domestic Liftboat segment we recorded operating income of approximately $350,000, a decrease from the $960,000 of operating income in the third quarter. Typical seasonality led to lower utilization, which declined to 63% in the fourth quarter, compared to 69% in the third quarter. And lower average revenue per liftboat per day of $6,800 in the fourth quarter from $7,800 in the third quarter.

As John mentioned, the lower average revenue was a result of standby time at reduced rate think heard over the holidays. In our Domestic Liftboat segment we with expect daily operating costs per vessel to be in the $3,200 to $3,300 per day range.

International Liftboat segment generated operating income of $4.6 million in the fourth quarter, which compared favorably to the $2.6 million we recorded in the third quarter. The increase can be attributed primarily to the revenue generated by three of the four vessels that we transported from the Gulf of Mexico to West Africa to begin to earn dayrate in the fourth quarter.

Average revenue per liftboat per day increased to $22,000 per day compared to the third quarter average of $19,400. Operating costs increased to an average of $8,600 per liftboat per day in fourth quarter from $7,900 in the third quarter.

Both the third and fourth quarters included costs related to the transport of the four vessels. So looking ahead, we expect to operating costs will range between $6,700 and $7,300 per liftboat per day in 2010, or approximately $15 to $16 million per quarter.

Delta Towing reported an operating loss of $1.4 million, a significant improvement from the third quarter loss of $3.9 million. This division benefited from an increased in rig moving activity and an increase in non-oilfield activity. We exited the fourth quarter with positive EBITDA in December.

Turning to general and administrative, our general and administrative expenses were $17.2 million in the fourth quarter. If you exclude the $26.8 million allowance for doubtful accounts related to Hercules 185. They sensually in line with the third quarter G&A of $16.8 million, we expect general and administrative expenses to be 15 to $16 million per quarter. And we also expect depreciation and amortization expense to be about $51 million per quarter.

Our income tax rate for the fourth quarter was 60%. This was higher than anticipated, higher anticipated benefit with primarily due to a favorable settlement of prior year state income tax audits. The settlements will result in state tax refunds of slightly more than $12 million. We expect our tax rate in 2010 to be in the 35 to 40% range.

Now, I will turn the call over to Steven to discuss capitalization, cash flow and liquidity.

Steven Butz

Thank you, Lisa. Interest expense for the fourth quarter was $23.5 million slightly lower than third quarter interest expense of $24.1 million. We expect interest expense to approximate $22 million for each of the first three quarters in 2010 and then decline to the $17 to $18 million range in the fourth quarter as our interest rate color expires.

Of course this guidance excludes any reduction in our debt, changes in marketing interest rates and changes in fair value on our interest rate derivatives. In the fourth quarter, we generated cash flow from operations of $18 million. We also reported capital expenditures and deferred drydocking costs of only $7 million, well below our previous guidance of $15 million.

We will continue to remain vigilant in our cost-control efforts. However, we will spend the money necessary to maintain our fleet for size performance with minimal downtime. Looking ahead upcoming quarters, we currently expect capital expenditures to increase modestly from fourth quarter levels, but remain below the 2009 average.

As such we forecast our capital expenditures and deferred drydocking costs for 2010 to approximate $60 million and be first half loaded. This level of capital spend does not include reactivation of rigs from cold-stacked. As John mentioned earlier, the economics and outlook justified reactivations, our level of capital expenditures would increase.

Exiting 2009, our liquidity remains strong and approximately $306 million consisting of unrestricted cash and cash equivalents of approximately $141 million and $165 million of availability under our revolving credit facility. At year-end, total debt was $862 million and stockholder equity was $979 million for net debt to capitalization ratio of approximately 42%.

That concludes our prepared remarks for the call. So we are now ready to open the floor for questions and answers. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Collin Gerry from Raymond James. Please proceed.

Collin Gerry – Raymond James

Hi, good morning, everyone.

Steven Butz

Good morning.

Lisa Rodriguez

Good morning.

Collin Gerry – Raymond James

So you mentioned some, some I guess tempered enthusiasm on the Gulf of Mexico market. We have seen activity come back last I've checked we got 36 jackups working in the Gulf, 16 of which are on that side. What's kind of your guy telling you where that number can go based on what you are hearing from customers or just based on what you are seeing on your radar screen?

John Rynd

Well, I think there's still upside. We are marketing 12 units and we currently have a 11 committed. So we want to get the 12 committed and where in dialogue with a number of customers to get that taking care of, nothing signed yet. And right now, if you look at I mentioned we had 19 bids is January. The deal flow is still very robust, it can move to the upside. We are not predicting 100% utilization yet, we are still on the ascending part of the curve. I think it' been evident in our actions and others that people are building backlog first. And you have to have days contracted forward before you have any pricing power and then allow the market to absorb additional equipment.

So, there’s still a work in progress, but we are very pleased with activity levels that started in the fourth quarter, when gas was still in the $4 handle, really when this activity surge kicked-off. So still optimistic, but again remembering where we come from that does temper some of the enthusiasm.

Collin Gerry – Raymond James

Right. And are customers, are you seeing any sort of trends in terms of wanting to lock a rig up for a longer term to take advantage of lower dayrates? Is that happening at all? We haven't seen it in the contracts too much, one or two discussions?

John Rynd

I think, we are seeing it, I mean, if you look at the backlog build that we’ve had from a low of 19 in August to currently on our shallow-water fleets at 92 days. Yeah, I think there's propensity to go along because where the rate structures are. I think, it also speaks, if you look at the customers who are contracting the rigs, about the top five leaseholders now all have rigs, multiple rigs under contract and those are the customers that can string together, three, six, nine, 12 months of work together and we’re seeing that happen. If you just look at Chevron, W&T, Apache, those guys that matters that have significant acreage positions are taking advantage of it.

Collin Gerry – Raymond James

Okay. And then last one for me. On the reactivation side, kind of outline your strategy there. I mean, how would you be willing to reactivate rigs at current rigs, would you like to see backlog build and maybe rates move up a little bit before you start, put some capital to work on new -- on bringing rigs back?

John Rynd

Yes. As I mentioned, we’ve got one, one of our actively marketed rigs is not contracted yet, so that’s a first out of the two. And we’re having positive dialogue with that to happen.

And then, so the 13th rig, it will be a factor of term and dayrate. And where our existing to rate rig fleet backlog is, we did not want to be competing against ourselves. If we don’t see, the continue move upward in demand, so we are watching it. We know the numbers. We have kind of hit list of rig that will be the first, three or four out of it, it becomes there and we’ll be ready when it does. But we’re going to be cautious with it. We’re going to get a full pay back. We’re not going to have any risk capital out there.

Collin Gerry – Raymond James

Okay. That's it for me. Thanks.

Operator

Your next question comes from the line of Rob MacKenzie from FBR Capital Markets. Please proceed.

Rob MacKenzie – FBR Capital Markets

Good morning all.

John Rynd

Good morning.

Rob MacKenzie – FBR Capital Markets

A question for you, I guess, first John on the Hercules 185. I guess it’s my impression that the customer for that rig really doesn't have any work to subcontract that out for. Would be -- is that seemingly accurate?

And second, would your negotiations be around kind of deferring the contract commitment to a better of the market?

John Rynd

On the work side, Rob, he does have work, it just got delayed, contracts in place, the works there it’s just been a pause in the program. And as we mentioned on the prepared remarks, we’re hopeful for a positive result out of this. But in the meantime, we can market the rig and find work elsewhere in the West African coast.

And if we get a job for the 185 and the queue -- the well queue gets back in sequence in Angola, we can -- the 156 is available, we can move that in. So we’ve got a fair amount of flexibility, again, we’re hopeful that we get a positive commercial resolution.

Rob MacKenzie – FBR Capital Markets

Okay. Thanks. And then, I guess, my other question is more, big picture strategic view. How are you thinking about using the current downturn in the market to potentially make a transformational change to Hercules?

John Rynd

Rob, that's a good question and something we spend a lot of time on. As you know, how we’ve grown from an initial four-rig purchase from Parker in 2004 acquisition, that’s how we’ve grown, I think, we have fairly good at it. It’s a little early right now for us to stretch the balance sheet. But we were always evaluating opportunities and right now there is nothing has come across the desk that is so compelling to step out of we are evaluating it basically weekly.

Rob MacKenzie – FBR Capital Markets

Okay. Is there anything out there that you think, you could affect negotiated sales for where you might have less competition?

John Rynd

Yeah. Everything is negotiable, but, yes, I think, there is, those opportunities are there.

Rob MacKenzie – FBR Capital Markets

Would you look to stay and potentially modernize the jackup fleet or would you be more inclined to you had the rig and compete for a deepwater rigs?

John Rynd

We’re not interested in deepwater at this point. So we’re going to stick to our core business, shallow-water oil services and that's inclusive of liftboats, which we like very much.

Rob MacKenzie – FBR Capital Markets

Great. Thank you.

Operator

Your next question comes from the line of Jeff Tillery from Tudor Pickering Holt. Please proceed.

Jeff Tillery – Tudor Pickering Holt

Hi. Good morning.

John Rynd

Good morning, Jeff.

Lisa Rodriguez

Good morning.

Jeff Tillery – Tudor Pickering Holt

John, doesn't sound like you are seeing customers kind of back off, the activity increase many dollar with the recent decline in gas prices, is that fair?

And then, could you give us some more color in the U.S. offshore, in term of oil and gas mix, in terms of what you’re drilling for today?

John Rynd

Yeah. We have not seen the corresponding pull back as gas prices have retreated nor did we see a corresponding uptick that you could see when gas moves in the low 4s to the low 6s. It’s been a very consistent demand level, really starting in October of 2009, with no spikes up either way as the near time gas prices moved around.

I would say about, as typical about 85% of our business is still natural gas driven in the Gulf of Mexico. One of our, we do have customers that have either oil or significant liquids production.

And if you look on the barge side, I think the initial move on the barges as we started to come off bottom where we, in September, with four barges. At one point, I think, we got to 12 barges running in 2009, eight of those were on oil driven projects. So that's where we saw the first move go, it’s a little more oily up and down the inland waters.

Jeff Tillery – Tudor Pickering Holt

Okay. That makes sense. For 170 and 156 you sound more optimistic than you’ve been probably in the past seven to nine months for opportunity for those. If everything work perfectly, when is the earliest you could see those rigs working, is that kind of mid-year?

John Rynd

Yes. Mid-year to -- third to fourth quarter.

Jeff Tillery – Tudor Pickering Holt

Okay. And then last question just on the MENAdrill and Scheyer [ph]. Are those economics roughly similar to what you were able to secure on the monthly deal?

John Rynd

Yes. Very similar.

Jeff Tillery – Tudor Pickering Holt

So, it is basically a marketing operational, obviously you guys provide you to achieve some sort of fee for that?

John Rynd

That’s correct.

Jeff Tillery – Tudor Pickering Holt

Okay. Thank you.

John Rynd

You're welcome.

Operator

Your next question comes from the line of Ian Macpherson from Simmons & Company. Please proceed.

Ian Macpherson – Simmons & Company

Good morning, everyone.

John Rynd

Good morning.

Lisa Rodriguez

Good morning.

Ian Macpherson – Simmons & Company

The decision to cluster stack, does that impacted all the cost of unstacking the first three or four, are you making a compromise there on sort of the near-term optionality versus cost severance for this year? Or if not, can you just update us on how those unstacking costs look today for those?

John Rynd

Yeah. It doesn't really impact the unstacking cost, the only marginal increase in costs, is when you move a rig out of the cluster stack instead of getting it off location with two tugs, we have to have three tugs. That's the only incremental cost and that's marginal at best.

We have easily five rigs up to seven rigs that we can reactivate kind of into $3 to $4 million range and kind of the 36 -- 30 to 60-day range. And again, we are watching the market. We are watching for an application for one of those that could apply and get the full pay back in the contract. So it’s an evolving exercise as the market continues to stay strong and improve.

Ian Macpherson – Simmons & Company

Okay. And regarding the price and dynamics maybe I’m perhaps looking too closely at the decimal points. But it seem like here and there we’ve seen kind of still 5% to 10% dayrate increases on contracts, re-pricing. Is it, is there anything to that or you’re able to kind of slide in some improvement here and there with this environment?

John Rynd

Now, you’re looking at the decimal points, is right, we have been able to slide in marginal improvements to further expand the margins.

Ian Macpherson – Simmons & Company

Is that continue, you think from here forward, at the same pace?

John Rynd

Rates tend to go lock-step. They go up, everybody looks around to see where the next level of demand, is it constant, going up, going down, so we tend to move and stay step right on the way up and right now, I think it's, you could probably, push rates marginally. Again, you still have about a 10-rig overhang of the active marketing fleet. So it’s very tough to get significant pricing power with an overhang.

Ian Macpherson – Simmons & Company

Yeah. And then just lastly back on these new management contracts. When would be the earliest that you could start collecting fee revenue on these? And is there any possibility for getting an equity option with any of these rigs or not?

John Rynd

We can probably on revenue best case fourth quarter this year.

Ian Macpherson – Simmons & Company

Okay.

John Rynd

And as far as the equity side, we’ll deal with that after we get up and running and we have good relationships. That is always an option, we did not bake it into the deal when we negotiated the terms and conditions.

Ian MacPherson – Simmons & Company

Okay. Great. Thank you.

Operator

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

Pierre Conner – Capital One Southcoast

Good morning all.

John Rynd

Good morning.

Lisa Rodriguez

Good morning.

Pierre Conner – Capital One Southcoast

I think you just asked a question about the optionality in those operating and management contracts, just to be clear, you don’t have anything firm on purchase, but obviously it’s an agreement that assuming how it gets worked you would approximate interested in?

John Rynd

Yes.

Pierre Conner – Capital One Southcoast

Okay. Specifically, then I guess, Lisa, I just want to double check on your cold stack cost. In the Gulf of Mexico, you mentioned the savings, if you move to the clustered stack, when implemented, you gave us an operated, where are we now on the cold stack cost and maybe on a per rig with that, what are those numbers?

Lisa Rodriguez

We had 6,700 per day in the fourth quarter and we are looking at to be get those down to the $5,000 range.

Pierre Conner – Capital One Southcoast

When you implement the cluster?

Lisa Rodriguez

Yes. We are doing that currently. During the first quarter clustering them which we have done this in the past. And then we declustered during hurricane season. This year we are clustering and leaving them clustered throughout the year which will allow us to reduce -- which allowed us to reduce the headcount as well as catering fuel, et cetera.

Pierre Conner – Capital One Southcoast

And nothing meaningful in terms of incremental cost to move them all together that you are going to carry?

John Rynd

No. Not really.

Pierre Conner – Capital One Southcoast

Okay. Got it.

John Rynd

Did it opportunistically.

Pierre Conner – Capital One Southcoast

Okay. And then, a question for Steven. Appreciate the commentary on the liquidity and could you remind us this question that’s out there, where are you covenants that you already negotiated in terms of -- and what’s the timeframe on that?

Steven Butz

Sure, Pierre. First, before I turn the question, I guess for those people on the call that aren't familiar with our covenant package, I’ll give you a quick recap of that. We have three financial covenants that we are required to comply with. The first is a maximum leverage ratio which is our total debt divided by last 12 months EBITDA. That’s defined in the current agreement. Currently, we are not required to comply with this particular covenant until the third quarter 2010 numbers are released. And at that time, the requirement is a maximum of eight times. And it steps down gradually thereafter.

Secondly, we have a minimum fixed charge coverage ratio which is last 12 months EBITDA divided by fix charges also as defined in the credit agreement. And this covenant definition includes a basket whereby we can add up to 130 million to the numerator to EBITDA, as needed to maintain compliance. We haven't used any of this basket to date. So we are required to maintain a ratio of at least one times through 2011 and then the level gradually steps up from there.

And lastly, we have a requirement that we maintain a minimum level of liquidity consisting of unrestricted cash and equivalent and unused capacity under our revolver at least to $100 million through 2011. That steps down thereafter. Today, we have over $300 million of liquidity under that covenant.

For the fourth quarter, we are in compliance with all the covenants. Again, the leverage ratio, we are not required to comply with at this time. But the ratio was 5.32. Now, as you know, looking forward, we don't give earnings guidance, so we can't tell you exactly where we think we would stand. What we can tell you is that while the accounts receivable reserve related to the 185, obviously that's a negative but since the time we entered in the amendment that back in July '09, the industry was really at low point. We’ve built in cushion what we have thought we need at that time.

Since that time, the industry had a fairly significant recovery, particularly in domestic offshore, our own domestic offshore rig count I think reach from 4 to 11 over that period. We’ve also secured the lengthy contract extension on platform 3 in Mexico. You might remember previously we expected all three rigs in Mexico to come back to the U.S. and then also furthermore in the call we issued approximately $90 million equity that really wasn't foreseen at that time. And that also provides additional cushion under the covenants.

Pierre Conner – Capital One Southcoast

Perfect. Thank you, Steven. That's just what I was look for and it does so over the one I was going to throw back to John and let him comment about next -- what you think the sort of activity and next steps are coming out prematurely related to jackups?

John Rynd

Yeah. I tell you, we know the state of play as of today. In the next couple of months we anticipate they will publish nine tenders and seven of those nine are renewals of existing contracts, three of the seven are for extension of existing platform rigs and four are for extension of existing jackups under contract. It appears that there will be two incremental requirements coming out of this package and one is for a 300 foot cantilever to start June of 2010 for roughly a little over a thousand days. And the second incremental job would be 1000 horsepower platform rig to commence in July for roughly a thousand days. Beyond that it’s kind of chatter and but as that, as far as what we know is set to be published, that's it.

Pierre Conner – Capital One Southcoast

Great. Very good. Thank you all.

John Rynd

Thank you.

Operator

Your next question comes from the line of Mike Urban from Deutsche Bank. Please proceed.

Mike Urban – Deutsche Bank

Thanks. Good morning.

John Rynd

Good morning.

Mike Urban – Deutsche Bank

Wanted to follow up on the M&A question from earlier, from what we have been hearing at least, it does seem like you are finally seeing some movement on asset prices out there. I guess less so for new builds than existing assets. Are you, as you monitor the market, are you indeed seeing that and seeing some -- the assets come down a little bit?

John Rynd

Yeah. On the existing equipment around the world, definitely the -- as prices starting to reflect current conditions and current outlooks, still been a little bit surprise in conversations with the new builds that there is -- the drilling is still quite a ways.

Mike Urban – Deutsche Bank

Okay. And it sounds like you are not terribly close to anything, but, if you were to get to point, where something was compelling, I guess given the balance sheet, how they could deal, do you think you can do – I mean I guess from what Steven was saying, it sounds like, you have to maintain a minimum of say $100 million, I guess you could go up to $200 million but that would really put you, limit your flexibility. So, I'm just wondering, what kind of size of deal you might be able to do, again, if something became available that was really interesting?

John Rynd

Well, Mike, the capital markets have been fairly strong. So they appear to be open for significant size, now of course we have to look at the mix of consideration. On any acquisition, with our leverage ratio, where it is, until we get that down to 3.75 times, which was the previous requirement, the considerations for a smaller deal would be equity. Now, for a larger deal, you could envision redoing your credit agreement for a real significant deal.

Mike Urban – Deutsche Bank

Okay. So you see you think there's some flexibility out there and if it is really attractive you could, you wouldn't rule out issuing equity?

John Rynd

That's right. I mean it would have to meet our return requirements first and foremost, but the capital markets are fairly -- reasonably attractive right now and open.

Mike Urban – Deutsche Bank

That's all for me. Thank you.

John Rynd

Thank you.

Operator

Your next question comes from the line of Robin Shoemaker from Citi. Please proceed.

Robin Shoemaker – Citi

Thank you. John, how do you think the industry is going to come out this year, on your insurance negotiations?

John Rynd

Very good question. In fact, we are leaving Sunday to head that way to find out. I think that we budgeted our cost year-over-year to be flat. Now, obviously, we would like to get more coverage for that same dollar than we got in this previous renewal package. And we will see nobody that I'm aware of has actually inked their renewal. So, that's always kind of a Tell-Tell sign of the first couple of guys to get their deal done, how the market is heading. We are optimistic that it is going to be flat on the cost side.

And hopefully we can get more coverage because, really, the current situation, it is not manageable longer term. Something has got to give. We got to come up with a better way to get it done and understanding they have to make money. We've got to manage our business as well. So it is going be a mutually agreed solution. I think it is best if we walk away flat year-over-year. We probably will just be, okay, with it. Hopefully we can get more coverage around the edges.

Robin Shoemaker – Citi

So they kind of on a flat scenario, that kind of keeps your cold stacking costs kind of minimally 5000 a day or something like that.

John Rynd

That's correct, yeah.

Robin Shoemaker – Citi

Okay. Just one other question I had for you, I was looking at these sky rigs and they appear to be, very high end jack-ups. Are these harsh environment jack-ups or these high pressure, high temperature, how are they equipped?

John Rynd

All of the above. They're harsh environment, high pressure, high temperature.

Robin Shoemaker – Citi

Okay. And, so your -- how to you assess that market, that niche of the market?

John Rynd

If you look at the HPHT, we have seen an increase in demand, globally, on the HPHT market. We have a HPHT rig working for our good customer in India – ONGC, off the east coast of India. And we just seen here, domestically, with the McMoRan success, we have seen it in Egypt. We have seen a move in the Middle East, to some more HPHT. So, I think it's being gaining momentum over the last 12 to 15 months.

Robin Shoemaker – Citi

Okay. So that's kind of what you're, that's the market you are targeting for these rigs.

John Rynd

That's correct.

Robin Shoemaker – Citi

The mini drill rigs seem to be 300-foot kind of your basic, IOC 300-foot jackup, right?

John Rynd

Yeah. With the appropriate upgrades to a relative to what a rig was built 25 years ago.

Robin Shoemaker – Citi

Yeah.

John Rynd

But more on the standard end of the spectrum.0

Robin Shoemaker – Citi

Right. Thank you.

Operator

Your next question comes from the line of Geoff Kieburtz from Weeden. Please proceed.

Geoff Kieburtz – Weeden

Thanks. Just got a couple of follow ups, John, on the PEMEX tenders that you were referring earlier, do you have any information on whether these are going to contain requirements in terms of, when the rig was built.

John Rynd

It looks like the incremental jackup tender. The 300-foot cantilever may require it to be advantage of ten years or less.

Geoff Kieburtz – Weeden

Okay. But the --

John Rynd

We won't know until the documents actually released.

Geoff Kieburtz – Weeden

But on the other ones that are against, existing contracts, no such requirements?

John Rynd

It looks like they're going be renewals of their contracts in probably, you know maybe that 20% type period.

Geoff Kieburtz – Weeden

Okay. Okay, so, those may be extensions, then rather than outright now contracts?

John Rynd

The question is going to be when the bids actually come out, how strict they are on the ten year rule. There has been a lot of talk, but again we haven't seen it in print yet. So we don't want to get in front of ourselves.

Geoff Kieburtz – Weeden

Okay. And just to clarify, in terms of reactivations -- you have said a couple of times you are not going to go. You are not going to put any speculative capital at risk. So, a minimal requirement would be that you would earn back the reactivation capital in the primary term of the contract?

John Rynd

That's the target right now. If we think this thing has got significant legs we may want to get 75 or 8o, but, right now the target internally is get the cash back.

Geoff Kieburtz – Weeden

Okay, okay. And this may just be an oversight on my part, but can you just talk a little bit about the increase in the international revenue per rig day? It jumped up there sequentially and kind of caught me by surprise.

John Rynd

I think that due to mix, as we had less rigs working in Mexico, the 206 came back in October which was a lower rate.

Geoff Kieburtz – Weeden

Okay.

John Rynd

Off my head.

Lisa Rodriguez

And we also had a lower rate for a short period during the third quarter on Hercules 208. It was at a standby rate.

Geoff Kieburtz – Weeden

Okay. But there weren't any unusual or bonuses or special payments that were received in the fourth quarter?

John Rynd

No just mix.

Geoff Kieburtz – Weeden

Okay. Thanks very much.

John Rynd

Thank you.

Operator

Ladies and gentlemen, that concludes the question-and-answer session. I will now hand the call over to Mr. Steven Butz for closing remarks.

Steven Butz

Sure. I would just like to thank everyone for joining our call. Please don't hesitate to call us with follow up questions. We look forward to visiting with you again next quarter. Thank you.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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Source: Hercules Offshore, Inc. Q4 2009 Earnings Call Transcript
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