Hercules Offshore Inc. Q1 2010 Earnings Call Transcript

Executives

Steven Butz - VP of Finance and Treasurer

John Rynd - CEO and President

Lisa Rodriguez - SVP and CFO

Troy Carson - VP and Corporate Controller

Analysts

Christopher Buchek - Raymond James

Geoff Kieburtz - Weeden & Company

Hercules Offshore Inc. (HERO) Q1 2010 Earnings Call Transcript April 29, 2010 11:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the first quarter 2010 Hercules Offshore earnings conference call. My name is Marcia and I will be your coordinator for today's call. At this time, all participants are in listen-only mode. We will conduct a question and answer session toward the end of this conference. (Operator Instructions)

I would now like to turn the call over to Mr. Steven Butz, Vice President of Finance and Treasurer. Please proceed, sir

Steven Butz

Thank you, Marcia. Good morning. I would like to welcome everyone to our first quarter 2010 earnings conference call. Participating this morning from the Hercules Offshore management team are John Rynd, our Chief Executive Officer and President, Lisa Rodriguez, our Senior Vice President and Chief Financial Officer and Troy Carson, our Vice President and Corporate Controller.

This morning, we issued our financial results and filed an 8-Kwith 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 the 2010 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. They can significantly affect expected results and actual 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 at which can be found on our website and the SEC's website at SEC.gov.

John will begin the call with some general remarks and discussion regarding the outlook, and Lisa will discuss our first quarter 2010 financial results, and provide cost guidance for the remainder of the year. I will then provide an update on our cash flow, liquidity and capitalization before opening the call for questions and answers.

Now, my pleasure to turn the call over to John.

John Rynd

Good morning. Thanks for joining us today. First, I want to begin by expressing our heart felt sympathy for our many friends at Transocean. Many in the Hercules family have friends and associates at Transocean and our concerns and prayers are with them.

This morning, we reported our financial results for the first quarter 2010, which show a net loss from continuing operations of $16 million, or a $0.14 loss per diluted share compared with a loss of continuing operations of $4.5 million or $0.05 per diluted share for the first quarter 2009.

While the results were slightly behind our results from the year ago quarter, I am pleased that we have continued to narrow the operating loss from the fourth quarter 2009 in our domestic offshore inland and Delta Towing segments.

I will now discuss the outlook for each of our core segments. We have experienced a substantial improvement in demand in our domestic offshore business over the last two quarters. During the fall of 2009, shallow water bidding activity picked up significantly as did drilling plans filed with the minerals and management service.

To give some reference, shallow water drilling plans filed by the MMS have increased from 8 in June of 2009 to 27 last month. This increase in demand began while natural gas prices were still fairly weak in the $2 to $4 range for much of the fall, as gas prices improved into the winter and moved north of $6 the improving trend and activity and bidding continued.

Since that time, natural gas prices have come down under pressure and as many of you know, are now again in the low $4 range. However, as an industry, we have been able to maintain steady activity levels of backlog. There are currently 41 jackup rigs contracted in the U.S. Gulf of Mexico, up substantially from the July of 2009 low of 15 rigs contracted. But also up nicely from 28 at the start of the year, when natural gas prices reached their recent peak.

Market and supply stands at 48 for current market utilization of 85%. While 10 of our jackups are cold-stacked all 12 of our marketed jackups are now contracted. We find the resiliency of the shallow water rig count in the face of relatively soft natural gas pricing to be encouraging.

We believe there are a number of reasons for the recent relative stability in demand. First and foremost, 2009 was an aberration, while depressed natural gas prices certainly adversely impacted demand, there were many other external factors that play as a result of the financial crisis. Many companies in general were going to put the brakes on any programs that were not already committed regardless of gas price.

Due to the uncertainty in the capital markets and global economy, more simply put, we believe that a certain amount of activity is merely getting the industry back to a more normal base level demand that is not as price sensitive in the short-term.

Additionally, and as expected some customers are trying to take advantage of the lowest oil field service costs in years.

Lastly, it appears, as we mentioned on the last call, as though many of our working rigs are targeting oil, our natural gas prospects with our liquid content to capitalize on attractive oil prices.

Bidding activity has been fairly consistent since the fourth quarter of 2009 and we are currently sending out bids in the mid-to-high 30,000 per day range, which is a marked improvement from day rates in the high 20,000 per day range, we were just seeing a few months ago.

We are continuing to focus on securing backlog for our marketed rigs into and through hurricane season. We recently received contracts of Hercules 120, Hercules 173 and the Hercules 350 with Chevron that will extend through hurricane season into yearend and our domestic offshore backlog now stands at an average of 108 days per marketed rig, a figure that segment has not seen since the acquisition of TODCO.

Additionally, the Hercules 205 was mobilized buyback to U.S. Gulf of Mexico during the first quarter of this year and was added to our marketed fleet. After a brief visit to the shipyard the rig began its first job back in the U.S. in mid April.

We currently have five jackups contracted into or through peak hurricane season and we have near-term opportunities to contract three more. We are gaining confidence that we will maintain a solid utilization through hurricane season.

We continue to evaluate reactivations of our coal stack units on a case-by-case basis. However, I don't anticipate, we'll be marketing any coal stack rigs in the near-term based on current day rates. Our focus remains on continue to build backlog on our 12 marketed jackups.

The outlook for inland segment remains muted. The large majority of inland customer base is comprised of smaller independent companies that have not come back to the market in a meaningful way. Furthermore, some of our other inland customers have the option and have chosen to redirect capital to the onshore shale plays.

As with our domestic offshore segment our inland strategy remains focused on achieving solid utilization on the three barge rigs that we are currently marketing continuing reducing our cost and keeping our cold-stacked rigs well maintained, so we can preserve the earnings upside when the activity recovers.

We continue to make good progress on divesting our retired assets. On our last quarterly earnings call, we announced that we had entered into an agreement to sell the retired jackups Hercules 191 and Hercules 255 for 10 million. We have since closed on the sale of Hercules 191 and we expect to close on Hercules 255 by the end of the second quarter.

Additionally, we also announced in our last call that we entered into an agreement to sell six of retired barge rigs for $3 million and we have since closed on the sale of all six rigs.

The international offshore market continues to have some challenges. The demand appears poised for growth, held by the stability and strength of oil prices. There are currently plus or minus 70 idle jackup rigs in the international market and 26 new builds are scheduled to be delivered by yearend.

Hercules 185 mobilized the Gabon during the first quarter in an effort to reduced cost and the rig is currently stacked next to the Hercules 156. We continue to have positive dialogue with customers on potential second half 2010 work for Hercules 156, Hercules 170 and the Hercules 185.

Platform rig, three commenced a 440 day contract in February for Pemex in Mexico. With respect to the most recent round of Pemex tenders announced on January 28^th for five jackup rigs, it appears as though at least three of the five rigs will be required to be 10 years old or newer and the rigs will also need to be equipped with three 2200 horsepower mud pumps.

The implementation of these rules would likely attract the interest of some of the new build assets that have recently been delivered or are scheduled to be delivered soon. However, Pemex recently reversed their position for a not coming 300-foot independent-leg cantilevered tender from the 10-year role to accepting a rig upgraded since the year 2,000.

On our last call, we disclosed that we received a $3 million payment from our customer related to the accounts receivable reserve on the Hercules 185. As of today, we have nothing meaningful to report, although, we continue to maintain a dialogue with the customer who in turn continues to seek payment from its customer and the end user of the rig [Sanago].

For now, we continue to strive for commercial resolution to this situation. However, we will pursue all available avenues, protect our rights under the contract, if necessary. The MENAdrill and Skeie new build rigs we agree to manage are still on schedule for delivery later this year and we continue to pursue work for these rigs.

Moving on to the domestic liftboat segment, utilization has increased over the past month but activity is not rebound as quickly as we had anticipated. However, we took advantage of some of the first quarter downtime by accelerating the dry dock schedules on some of our vessels, thus providing additional availability for these vessels later in the year.

Demand for the larger vessels was soft during the first quarter due to the noticeable absence of one of the larger operators, but we expect demand to tick up throughout the second quarter and into the second half of the year.

We continue to expect utilization across all classes that tread higher, as operators are incentives to perform their [PNA] work. Our international liftboat segment performed below our expectations during the first quarter despite three of larger liftboats that we mobilized to West Africa in the fourth quarter of the year, of last year, securing work in solid margins.

The short fall versus our expectations for this segment was driven by a number of project delays and a certain cases, cancellations. Looking ahead, we expect the utilization for our largest liftboats to track higher the next two quarters, as we expect several of these projects to commence in the next few months.

We remain hopeful that activity levels on our smaller vessels will improve throughout the year, as the economy improves and our customers gain access to capital. We are currently in final stages of binding our insurance coverage for the 2010/2011 policy year. Despite negotiating the renewal in the midst of the tragic incident in deepwater horizon, we expect to secure more coverage for about the same level of premiums, as last year.

Lastly, I would like to take this opportunity to publicly congratulate the domestic offshore operation and health safety environmental teams and especially as dedicated crew members of the Hercules 253 for winning the 2009 MMS safety award for excellence from the Lake Charles district. This is an outstanding achievement and one we are all very proud of.

In summary, we have started to benefit from the current recovery, due in part to the way we're able to manage our business through the downturn. Generally speaking, visibility is getting better and I'm confident, we are positioned to take advantage of the upturn.

Now, I'll turn the floor over to Lisa.

Lisa Rodriguez

Thank you, John. I will walk through our results for the first quarter, comparing it to the fourth quarter of 2009 as well as provide our cost expectations for the remainder of the year. Then, we'll discuss our debt service expense, cash flow and liquidity.

For the first quarter, we recorded a loss from continuing operations of $0.14 per share compared to a loss of $0.23 per share in the fourth quarter 2009. Our results this quarter did benefit from an effective income tax rate of 62%. We are pleased to report that during this first quarter, we reached a compromised settlement with the Mexican tax authorities for the years 2004 to 2007 in the amount of $10.8 million.

We expect to pay this amount during the second quarter. This settlement resulted in a net income tax benefit of approximately $6.2 million, or $0.05 per share in our first quarter 2010 results. We expect our consolidated income tax rate to range between 45% and 50% for the remainder of the year.

Now, I'll address the operating results in our cost expectations by segment, starting with domestic offshore. Our domestic offshore segment reported an operating loss of $30.1 million in the first quarter an improvement from an operating loss of $34.5 million in the prior quarter.

The increase was a result of higher revenue and lower handrail costs, offset by higher G&A, as a result of an establishment of an allowance for doubtful accounts. I'll speak to the allowance later on.

Revenue increased by $3.2 million due to an increase in activity, with a number of operating days increasing by 21%. This was offset in part by a 7% decline in average revenue per rig per day, as we worked off older backlog that was at higher day rates.

Operating costs of $39.2 million were $4.7 million lower than the fourth quarter. As the fourth quarter included about $5 million of rig repairs that were primarily related to damage incurred during Hurricane Ida. The average operating cost per rig per day for our 11 marketed rigs was 32,800, which includes the higher operating cost of the Hercules 350 and it also includes the allocation of our shore based costs.

Our Domestic Offshore segment also recorded $1 million of operating costs on Hercules 205 in the first quarter, as the rig mobilized to the U.S. Gulf of Mexico in March. This rig has now been added to our marketed fleet in the U.S., bringing our total number of marketed rigs in the region to 12.

Average operating costs per rig on our [compact] units were reduced to approximately $4,800 per day from $6,700 per day in the fourth quarter. This was largely as a result of our cluster stacking initiative, which we described on our fourth quarter conference call.

We estimate Domestic Offshore operating costs to be between $38 million and $41 million per quarter for the remainder of 2010, excluding any gain or loss on asset sales. This is in line slightly higher than first quarter levels, despite the fact future quarters will have the full impact of the addition of Hercules 205 to the domestic offshore fleet.

Our average daily operating costs on a per rig basis for domestic offshore are expected to range between 30,000 and 33,000 for marketed rates. And this does include the allocation of shore based costs and is in line with first quarter results.

International offshore, this segment generated operating income of $22.5 million in the first quarter, which is an increase of $11.3 million from the fourth quarter. However, the fourth quarter results included a net expense of $31.6 million associated with the reserve we established related to Hercules 185.

Revenue declined sequentially $25 million, of which slightly over half was due to Hercules 185 no longer meeting the criteria for revenue recognition. The remainder of the decline was due to the impact of Mexico. Our fourth quarter revenue included 115 operating days for Hercules 205 and 206 in Mexico, where as we only had 32 operating days for those rigs in the first quarter, as both jackups had returned to the domestic fleet.

By firm rig three was all idle for part of the first quarter that commenced a 440-day contract at $55,000 per day in February. International offshore operating costs are expected to decline slightly to the $31 million to $33 million range per quarter for the remainder of the year. This is under the case that Hercules 166, 170 and 185 all remain idle. Of course, if we were successful in marketing and our marketing efforts for these rigs, the cost would increase from this level as we currently only expect to incur average cost in the $8,000 to $10,000 range per day per rig for these units while they are idle.

Inland, we reported an operating loss of $5.3 million in our inland segment for the first quarter versus an operating loss of $11.9 million in the prior quarter. The quarter-over-quarter improvement was partially driven by the reversal of a bad debt allowance in the amount of $3.5 million and a $1.8 million gain realized on the sale of three barges.

Demand for inland barges has remained steady of late. We reported 240 operating dates compared to 237 operating days in the fourth quarter. Average revenue per rig per day has increased slightly to approximately $19,800 in the first quarter, from approximately $18,350 in the fourth quarter.

Operating expenses decreased to $5.7 million compared to $8 million in the fourth quarter due in part to the $1.8 million gain related to the sale of the three retired barges. We expect our inland segment daily operating costs per rig to approximate $18,000 per day for marketed rates and $1500 per rig per day on cold-stacked barges for the second quarter.

Domestic Liftboats, in our Domestic Liftboat segment, we reported an operating loss of approximately $2.6 million, a decrease from the $353,000 of operating income in the fourth quarter, utilization declined to 51% in the first quarter compared to 63% in the prior quarter, an average revenue per liftboat per day declined to $6,600 from $6,800 in the fourth quarter.

We anticipate domestic liftboats operating cost per vessel to be in the $3,200 per day range during the second quarter, up just slightly from first quarter levels, as our utilization is expected to increase. The international liftboat segment generated operating income of $5.3 million in the first quarter versus the $4.6 million, we recorded in the fourth quarter, average revenue per liftboat of $22,100 is essentially flat with fourth quarter levels.

Operating costs decreased to an average of $6,700 per liftboat per day in the first quarter from $8,600 in the fourth quarter. As the fourth quarter included costs related to the transportation of the four vessels from the U.S. Gulf of Mexico to West Africa. Looking ahead, we expect operating costs will range between $15 million and $16 million per quarter for the remainder of the year.

Delta Towing recorded an operating loss of $941,000 compared to the prior quarter loss of $1.4 million, as a result of slightly higher day rates and very effective cost controls. Our consolidated general and administrative expenses were considerably lower, at $12.3 million for the first quarter compared to $17.2 million in the fourth quarter.

The prior quarter $17.2 million excludes $26.8 million allowance for accounts that we established on related to Hercules 185, while this concludes the reversal of $3.5 million bad debt allowance in the inland segment that was partially offset by $2.1 million allowance we established in domestic offshore.

So, net we had a benefit of $1.4 million in the allowance for doubtful accounts in the first quarter. We also benefited from compensation expense being lower. Compensation expense in the first quarter includes a downward adjustment of $1.8 million, due to a revision of our estimated for future rate on equity based compensation.

We expect general and administrative expense to be approximately $15 million to $16 million on a go forward basis for the remainder of the year. We also expect depreciation and amortization expense to approximately $50 million per quarter for the remainder of 2010.

Now, I will turn the call over to Steven.

Steven Butz

Thank you, Lisa. Our liquidity at the end of the first quarter was approximately $295 million which consisted of unrestricted cash and cash equivalents of roughly $130 million and availability under our revolving credit facility of $165 million. The total expense under our revolving credit facility remains at $175 million, however there are currently approximately $10 million in routine letters of credit outstanding.

We ended the first quarter with total debt of $861 million and stockholders equity of $964 million for a net debt to capitalization ratio of approximately 43%. As a reminder, we had minimal principal repayment requirements for the next three years at only approximately $5 million per year through 2012.

Interest expense for the first quarter was $21.7 million, slightly lower than our fourth quarter interest expense of $23.5 million. We expect interest expense to remain roughly in line with first quarter levels between $21 million and $22 million for the next two quarters, but then decline to the $17 million to $18 million range in the fourth quarter due to the third quarter 2010 exploration of our interest rate collar, which is above current market rates.

Of course, this guidance excludes any reduction in our debt or changes in market interest rates. In the first quarter, cash flow from operations was essentially breakeven. However, it is worth noting that our second quarter operating cash flow will be impacted by the expected payments related to the Mexican tax settlement, which Lisa highlighted and a semiannual interest payment on our senior secured notes, which was paid in April.

These will be somewhat offset by asset sale proceeds, as this week, we closed on the sale of retired tack of Hercules 191 for $5 million and as John mentioned we expect to close on the Hercules 255 for $5 million in May. These rigs have been cold-stacked for approximately nine years.

Capital expenditures and deferred dry docking costs for the first quarter were only $8.9 million significantly down from $36.6 million in the year ago quarter. We currently anticipate capital expenditures and deferred dry docking costs for the remainder of 2010 will approximate $50 million.

To market conditions improve and we make the decision to expand our marketed fleet by reactivating idle rigs this capital expenditure guidance would obviously increase.

And Marcia, with that, we're ready to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions)

And your first question comes from the line of Christopher Buchek from Raymond James. Please proceed.

Christopher Buchek - Raymond James

Hi, guys. Great quarter. I had a broader question on the Gulf of Mexico jackup market. I was hoping you could help me out. Your backlog is up to almost four months of rig. You got three rigs contracted through the end of the year and several others that could soon be contracted into hurricane season. I'm just wondering, when do we see that next-- that change in day rates and at what daily level do we really need before we start getting rig reactivations? It sounds like from a backlog perspective, we're pretty close to being there already?

John Rynd

Good question. I think the step change in day rates is going to be totally dependent on activity levels, if we foresee activity levels staying solid for everybody's fleet throughout the hurricane season that may be the next impetus, we enter the fourth quarter your question on reactivations, we need a little help in day rates. The backlog to your point is getting close to where it may make sense from a market dilution standpoint to reactivate. As I said in the opening comments, we're not there yet. There's got to be probably a sequence of about three events happen to have us pull the trigger. But, again, as I said, we're very comfortable getting a lot of confidence that we'll maintain solid utilization through hurricane season

Christopher Buchek - Raymond James

Okay. And one quick follow-up. When I look at your Gulf of Mexico jackup fleet, could you breakout the percentage that's drilling oil, oil leaded drilling verse gas drilling and how that relates to three, six, nine, 12 months ago?

John Rynd

I would say it's really hard to get an exact number. I mean, because we know that the Gulf of Mexico is heavily dominated by natural gas. But, and this is not a scientific study by any stretch, but in conversation with our customers, I would say of our 12 jackups working today, easily 10 of them are kind of gas/oil type prospects. And then, we saw that really, as we mentioned on our call couple of months ago, that there was a move more to a liquid rich opportunity. So, and again, it's not an exact science when they're drilling either. But, we're seeing a little more effort, more fluids type, oily type prospects.

Christopher Buchek - Raymond James

Okay. And one quick question on the international market. Looks like, you got several rigs that are re-pricing in 2011 and I'm wondering, a lot of the activity we're seeing, new tenders of contracts that begin in '010, early '11. So, far as internationally, are we seeing continued activity increases like we saw in January and February or has that kind of tempered?

John Rynd

I wouldn't say it's tempered. It's steady. And we're coming off bottom, there's no question bottom is behind us. And as we progress through the year, all stay solid where it is, you're going to see jackup activity continue to increase in all the regions, all the jackup regions around the globe.

Christopher Buchek - Raymond James

Okay. Forgive me if this was in your press release, but do you see many opportunities for your three idle rigs in two half '10 or was that more of an '011?

John Rynd

No, I think, it's the 156, the 170 and the 185 all have real opportunities that we're pursuing to have a second half 2010 start date.

Christopher Buchek - Raymond James

Okay. Thanks. I'll turn it back.

John Rynd

Thank you.

Operator

And your next question comes from the line of Geoff Kieburtz from Weeden & Company. Please proceed