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Executives

Stephen M. Butz - Vice President Finance and Treasurer

Randall D. Stilley - Chief Executive Officer and President

John T. Rynd - Executive Vice President and Chief Operating Officer

Lisa W. Rodriguez - Senior Vice President and Chief Financial Officer

Analysts

Angeline Sedita - Lehman Brothers

Jeff Tillery - Tudor Pickering

Geoff Kieburtz – Citi

Pierre Conner - Capital One Southcoast

Bill Sanchez – Howard

Michael Farah - Merrill Lynch

Ken Sill - Credit Suisse

Scott Gill - Simmons

Hercules Offshore (HERO) Q4 2007 Earnings Call January 31, 2008 11:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the fourth quarter 2007 Hercules Offshore earnings conference call. (Operator Instructions) I would like to now turn the call over to your host for today, Mr. Stephen Butz. Please proceed, sir.

Stephen M. Butz

Good morning. I would like to welcome everyone to our fourth quarter and full year 2007 earnings conference call. Participating this morning from Hercules management team are Randy Stilley, our Chief Executive Officer and President; John Rynd, Executive Vice President and Chief Operating Officer; and Lisa Rodriguez, our Senior Vice President and Chief Financial Officer.

This morning, we issued our earnings announcement 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 Randy begins his remarks, I’d like to remind everyone that this conference call will contain forward-looking statements, including our discussion regarding the outlook for 2008 and beyond. Our actual results may differ materially from those projected in the forward-looking statements.

There are a number of known and unknown risks and factors that may cause our actual results to differ from the results discussed in our forward-looking statements. You can obtain more information about these risks and factors in our filings with SEC which can be found on our website and the SEC’s website, sec.gov.

Now it is my pleasure to turn the call over to Randy.

Randall D. Stilley

Good morning and thank you for joining the call today. I will begin with some general remarks including our operating highlights from the fourth quarter. John will provide our current view of the market and Lisa will review the fourth quarter financial results and provide some forward-looking commentary on costs. Then we will open up the call for Q&A.

As Stephen mentioned, before the market opened today we reported our financial results. We recorded net income of $31.3 million or $0.35 per diluted share for the fourth quarter of 2007 versus net income of $35.5 million or $1.09 per share in the fourth quarter of 2006.

For the full year 2007, we reported net income of $136.5 million or $2.29 per diluted share versus net income of $119.1 million or $3.70 per diluted share in the prior year. The decline in our earnings per share relative to 2006 was mainly driven by a downturn in drilling activity in the U.S. Gulf of Mexico resulting in a corresponding decline on our average domestic offshore utilization and day rates.

On our last quarterly conference call, we outlined the proactive measures we were taking in response to declining demand and weakening day rates for our rigs. We warm-stacked six of our domestic offshore rigs and one of our inland drilling barges, and I am pleased to report that these actions have largely been a success.

This allowed us to cut the average operating cost for our domestic offshore rigs by roughly 15%, and we also completed some needed maintenance and refurbishment work on rigs that have been working almost continuously for the past several years.

As John will explain later, we believe the demand for domestic jack-ups will continue to improve and thanks to our actions in 2007, we’ll be in a better position to maximize utilization in a strengthening environment.

Sequentially, our daily operating costs declined by $2,200 in our domestic offshore segment and in the inland barges, our daily operating costs came in $3,800 below our guidance at the time of the acquisition, or $800 below our guidance last quarter. Should we delay the reactivation of our warm-stack rigs, I would expect an additional modest decline in costs. We also took this opportunity to step up training of offshore personnel during the fourth quarter.

I would like to add that operating cost performance, even outside of our performance in the drilling segment already mentioned, has been exceptional. Our daily operating cost in every ongoing business segment declined during the quarter with the sole exception of a slight increase in international lift boats and our general and administrative expenses came in approximately $3 million below our previous guidance.

Now, I will provide some operating highlights and discuss the outlook for each of our business segments. I’ll start off with our Domestic Offshore segment. As a result of a slowdown in our customers’ drilling activity in the Gulf of Mexico, demand dropped to only 26 stack-ups at one point, and our utilization weakened to 56% in the fourth quarter from 70% in the third quarter.

Additionally, our revenue per day experienced a sequential decline of approximately $14,000 averaging $62,800 during the fourth quarter as much of our domestic fleet rolled off old contracts and repriced at market rates. Currently our domestic offshore utilization is approximately 60%.

Demand and utilization appear poised to experience a modest recovery during the first quarter from the extremely low levels experienced during the fourth quarter. I believe our average utilization for the first quarter will exceed fourth quarter levels as a result of the slight increase that we have experienced during January and customer indications of work to begin over the next several weeks. However, our average day rate will likely declined to mid- $50,000 range during Q1 reflecting our most recently announced contract fixtures.

Leading edge rates for the class of rigs that we operate in U.S. Gulf of Mexico are currently in the $50,000 to $60,000 range, down slightly from the $55,000 to $65,000 range at the end of the third quarter. While this slippage was disappointing, the pace of decline was much slower than in the third quarter and we believe day rates have bottomed. While we expect day rates to remain in this range through most of the first quarter, if demand continues to improve we could see rates improve during the second quarter.

In our International Offshore segment, we had average revenue per day increasing to $89,500 in the fourth quarter from $86,000 in the prior quarter. We expect this average rate to trend higher during 2008 as we have a number of units going to work at substantially higher day rates, including the Hercules 260 at a $143,000 a day in India, the Hercules 208 at a $110,000 in Malaysia, and the Hercules 156 at a $135,000 in West Africa.

As stated during previous calls, we’re committed to continuing our expansion in international markets, further diversifying beyond the U.S. Gulf of Mexico. We’ve made significant progress toward this objective during the quarter, securing two three-year contracts at attractive rates for our rigs in India. Our international backlog now stands at approximately 525 days up from 365 days at the time of our last conference call.

We also anticipate securing a long-term contract for Hercules 170 in the Middle East where it is presently completing a contract for Occidental. More importantly, all of our rigs in close proximity to the new build jack-ups in Southeast Asia and India are contracted into 2011, somewhat insulating us from any potential regional weakness that might occur during 2009 and 2010 as these rigs enter the market.

Our utilization of marketed rigs internationally was 89%, down from 100% in the third quarter. This flat decline was largely driven by Hercules 156, which finished its contract in Brazil and entered the shipyard for maintenance and contract preparation work prior to commencing a dry tow for its contract in West Africa. We have completed the shipyard work on the 156 and are mobilizing the rig to West Africa at this time.

Hercules 208 and 260 were not available since both were undergoing refurbishment and upgrade, and Hercules 205 was unavailable for service during part of the quarter due to damages sustained in early 2007. Repairs to the 205 were successfully completed and the rigs are back working for PEMEX, and the 260 is currently en route to India.

The inland barge drilling market was also affected by the slowdown of our domestic customers’ drilling activity during the fourth quarter. Our utilization declined to 72% from 83% during the prior quarter. However, day rates exhibited greater stability than jack-ups in US Gulf and we generated average revenue per day of $47,300 in the fourth quarter, up about $600 per day from the prior quarter.

Inland barge activity has slowed recently and we are currently experiencing utilization about 65%. Given the lengthy permitting process that operators must go through prior to drilling a well, activity for inland barges sometimes lags what we experience offshore. While we thought that activity hit bottom in late 2007, we appear to be seeing an additional slowdown in barge drilling similar to that experienced with jack-ups late last year. Our average revenue per day is currently in the low $40,000 range. However, based on recent discoveries and discussions with our customers, we remain optimistic about the deeper targets in the inland barge area, and believe this will generate good growth opportunities for Hercules as the trend toward deeper drilling in shallow water expands.

Now, to talk a little bit about our domestic lift boats. The domestic lift boat market has softened somewhat since our last conference call, primarily due to two factors.

First during December and January, we experienced very rough weather in the Gulf of Mexico and as you know lift boats cannot mobilize if the seas are greater than 5 feet, so we have experienced an inordinate amount of weather-related downtime.

Secondly, nine lift boats were delivered last year into the market where demand has been fairly stable. These lift boats were ordered after the active 2005 hurricane season. As a result of these factors, utilization declined slightly to 65% from 68% in the prior quarter and our revenue per day declined to $11,700 from $12,500 over the same period, primarily due to weather delays and lower utilization of our larger lift boats.

We are about halfway through the new build order book as there are still nine more vessels to be delivered, most of those during 2008.

During the first quarter to-date, the weather situation has been even worse than what we have experienced in December. During January, our utilization was in the low 40% range and day rates have declined slightly. But we still expect demand to pick up during February and March, as the weather typically improves throughout the first quarter and pending projects get underway.

To talk a little bit about our international lift boats, our West Africa lift boat business continues to experience very favorable fundamentals. Our average revenue per day increased to $13,500 during the fourth quarter, up from $13,000 in the third quarter and $11,000 per day in the second quarter. Utilization remains strong at 82%. Furthermore, security concerns have improved recently and we are optimistic that this trend will continue.

Results for our other segment, consisting of delta towing as well as our former fleet of nine land rigs as previously reported, we sold the land rig fleet in late December for $107 million. I was pleased that we completed this transaction so quickly after the acquisition of TODCO at such an attractive price. This enables us to exit an asset class in a geographic region that were not strategic for us to participate in and continue to focus management attention on our core assets and markets. After removing the land rigs from our results, this segment generated revenue of $16.9 million and operating income of $5.9 million.

With that, I will turn the call over to John.

John T. Rynd

Thank you, Randy. Good morning. I will focus my comments this morning on two main areas. First, I would like to go into a little more depth on the fundamentals in the Gulf of Mexico drilling market, since this segment admittedly drives a lot of the upside in our financial results.

Secondly, we would like to update you on a number of our international assets that will be coming into service during the first half of 2008 and should have a positive impact on our results.

Jack-up demand in the US Gulf of Mexico is currently at 55 rigs versus a total supply of 80, up nine rigs from a low of 46 in October of ‘07. 12 rigs are currently cold stacked, included five that we control with the remaining 70 being workover rigs or having water depth capability of less than 100 feet. That brings the marketed supply to 68. One rig, the Bob Keller, is headed to Saudi Arabia for a multi-year contract, further reducing supply to 67.

Furthermore, there are always a handful of rigs in the shipyard for maintenance. Currently there are three units in shipyards. If we assumed at any given time three rigs remain in the yard, the effective marketed supply is 64 leaving an overhang of nine rigs versus current demand.

While demand has averaged 90 rigs in the U.S. Gulf of Mexico from 2002 through mid-2006, we don’t necessarily think it’ll go back to that level again unless gas prices increased materially. However, we do believe with natural gas prices where they are today and even modestly lower, the market could support a base level jack-up demand in the 60s to low 70s.

We believe that the low level of drilling activity during 2007 partly reflects the maturity of the U.S. Gulf market, but was even more of an anomaly driven by the significant property transfers that we have talked about in a number of our calls and the general pessimistic view towards gas prices that many of our customers shared during 2007.

As I mentioned, over the past three to three-and-a half months we have experienced a plus or minus 20% increase in jack-up demand. Based on the level of inquiries we continue to receive we believe demand will improve throughout the first quarter. We are also seeing more requests from operators for term contracts ranging from three months to one year. A review of preliminary budgets of the top customers in the U.S. reveal an average increase of nearly 7%. These budgets are based on an average natural gas price of between $6.75 and $7.25 an M. Should the current strip price of plus or minus $8 an Mcf hold, history tells us that the operators will increase their budgets throughout the year.

Offshore capital spending growth will be driven by attractive well economics, increased optimism regarding natural gas prices, and an increase in activity from operators that have acquired properties during the last two years, shifting their focus from debt repayment and valuation of prospects to drilling. WNT Offshore and Mariner Energy are two prime examples of this. We should also see an increase in drilling activity due to the positive Gulf of Mexico lease sale 205 from this past summer of ‘07.

While we expect the recent upturn in demand trends to continue, we believe the trend for ever lower supply in the Gulf of Mexico also continues. As we have said before, an average of one jack-up has left the U.S. Gulf every month over the last six years.

While new builds entering the market during 2008 will certainly fill some of the incremental growth and demand in international markets, as long as a significant margin difference between international markets and the Gulf of Mexico exist, rigs will continue to migrate to the highest returns, exiting the Gulf of Mexico. Opportunities to move rigs from the Gulf of Mexico will be primarily driven by Mexico, the Middle East, and West Africa. We continue to believe that we will see a modest increase in demand and a reduction in supply leading to a much tighter supply demand balance throughout 2008.

As Randy mentioned, the inland barge businesses has softened. Well permits in 2007 were off 26% versus 2006, and well permits for well depths greater than 15,000 were off 46%. So, not only have activities slowed, our days on locations have decreased as well. That being said, I think we should be able to achieve close to 75% utilization with our barge fleet over the near term up from the current 65%.

Now I would like to update you on a few specific items in our international offshore and international lift boat segments which should have a positive impact on our financial results in 2008 and beyond.

As Randy mentioned, the Hercules 260 is currently en route to India and will arrive February 2nd. We will have up to two months of contract preparation time upon arrival, and the rig should commence its three-year contract with ONGC by late March at a rate of $143,000 a day.

The Hercules 258 that is operating in India will remain with [Terrin] until mid-March at $140,000 a day. It then has about a month-and-a-half of contract prep work for its three-year contract with ONGC at a $111,000 a day, which should begin late April.

The Hercules 208 refurbishment is progressing but during the last quarter we pushed back the expected completion date by one month to April of ‘08 at which time the rig will begin a three-year contract with Murphy, Malaysia at a $110,000 a day.

The Hercules 156, as Randy mentioned, departed Brazil this morning after finished its contract prep work and ABS inspection repairs. The rigs will arrive in Cameroon on about February 20th and we will commence a six-month contract with ADEX at a $135,000 a day. A refurbishment of the 200 class lift boat Blackjack that we acquired in June of 2007 is still on track for a late first quarter start-up, and we are in negotiations with a number of operators at very attractive day rates and terms.

As I mentioned, we expect each of these units to not only provide incremental growth in earnings during 2008, but also in 2009 as we receive full-year contributions from the additions of these assets to our fleet.

I will now turn the call over to Lisa.

Lisa W. Rodriguez

Thank you, John. As Randy mentioned, I will provide a little more detail with respect to our financial results for the quarter as well as provide an update on estimated costs and capital spending for 2008. Year-over-year comparisons of the quarterly results in absolute terms are not relevant for Hercules given the timing of the TODCO acquisition which closed on July 11th. Therefore, I will focus my comments on the sequential comparison.

As I pointed out last quarter, under the rules of purchase accounting the results for the third quarter do not include any contribution from the TODCO assets for the first 11 days of the third quarter. We generated fully diluted earnings per share of $0.35 during the fourth quarter versus $0.61 per share during the third quarter, excluding acquisitions and severance-related charges that we took in the third quarter. The $0.26 sequential reduction in quarterly earnings per share was primarily driven by the following:

Domestic offshore accounted for approximately $0.20. The decline was primarily revenue driven and it was split 60-40 between declining day rates and a reduction in utilizations. The higher tax rate in the US tempers the domestic impact on earnings per share.

Inland accounted for approximately $0.04 due to the lower utilization. Our land segment realized a $0.04 decline quarter on quarter due to downtime. The downtime was incurred in part as we were preparing the rigs for sale. These operational declines were offset by a $0.02 benefit from our tax rate. Last quarter we had a catch-up tax provision to the annualized rate due to the TODCO acquisition which we did not have this quarter. The overall rate benefit obviously was more than $0.02 but the majority of that is due to the mix of earnings; that is the lower domestic earnings.

In our domestic offshore segment, operating income declined to $6.5 million in the fourth quarter as a result of the market-related weakness that both Randy and John discussed. Our utilization declined 14% versus the prior quarter to approximately 56%, and average revenue per day declined by about $14,000 to $62,800 as a result of the repricing of the majority of our fleet at lower rates.

Average operating costs per day declined to $23,400 in the fourth quarter from $25,600 in the third quarter. This operating cost performance was slightly better than our guidance due to the success of our warm stack plan. Average operating cost for the marketed rigs was $26,400 and the cost for the six offshore rigs that were warm stacked during the quarter was $15,700.

As we mentioned last quarter, we accelerated maintenance on the warm stacked rigs. If you exclude the incremental repair and maintenance costs, the normalized daily operating cost on the warm stacked rigs was approximately $11,400. Should the market remain softer in the first quarter, we would expect to improve on this further reducing the cost to the $8,000 to $10,000 range.

In our international offshore segment, operating income increased to $24.6 million from $21.7 million in the third quarter partly as a result of increased operating days from the inclusion of the TODCO assets for the full quarter. Our average revenue per day increased to $89,500 from $85,700. Utilization of available fleet was 89%, down from 100% during the third quarter largely due to downtime on the Hercules 205 and 156.

Our average daily operating expenses were $32,600 down from $38,900 in the third quarter due partly to the fact that Hercules 205 was considered in the available days but we incurred limited expenses on the rig during the quarter. This coupled with good cost performance on our other rigs.

We generated operating income of $14.1 million in our inland segment during the fourth quarter, down from the $19.6 million in the third quarter. Our average revenue per day was essentially flat at $47,300 versus $46,700 per day in the prior quarter. However, utilization declined to 72% from 83% as our customers’ activity trailed off the last several months of the year much like the trend we experienced in domestic offshore.

Daily operating cost came in at $19,200 also below our guidance of $20,000. We reduced our operating cost to $9,500 per day on the one drilling barge that was warm stacked during the quarter.

Now turning to Domestic lift boats segment. We reported operating income of $10.9 million, down from $12.5 million in the third quarter. This was due to a reduction in our average revenue per day to $11,700 from $12,500 and a modest decline in utilization. These declines were largely a result of seasonality as well as increased supply in the larger class of lift boats. Again, like our other segments, we were able to reduce our daily operating cost to just under $3,400 from $3,900 in the prior quarter.

Operating income generated by the international lift boats segment decreased to $5.2 million in the fourth quarter from $6.7 million in the third quarter. This decline was primarily driven by a reduction in our utilization to 82% from 88%. It was somewhat offset by an increase in average revenue per day to $13,500 from $13,100 in the prior quarter.

As Randy mentioned, we also generated operating income of $5.9 million from Delta Towing, up from $4.4 million in the prior quarter. Operating income for the land drilling business, which was sold on December 31st was $600,000, down from the $5.3 million in the third quarter, as I mentioned earlier.

General and administrative expenses were $13.3 million in the fourth quarter, down from $15.4 million in the third quarter excluding the non-recurring charge. This was largely due to lower compensation-related expenses.

Our income tax rate was 25% for the fourth quarter, down from 38% in the third quarter. As I mentioned earlier, the third quarter rate included a catch-up from the TODCO acquisition. Otherwise, the third quarter would have been approximately 34%. So the decline from 34% to the 25% in the fourth quarter is due to the change in geographic mix of our earnings.

Randy and John already covered the outlook for the top line, but I would like to provide some cost guidance for the first quarter as well as for the full year 2008. We expect our daily operating costs for domestic offshore to average approximately $25,500 in 2008, starting the year slightly below $23,000 per day but finishing the year in the $27,500 per day range as we expect to put our warm-stacked rigs back to work.

In our international offshore segment, we expect our operating costs to increase to about $32 million in the first quarter and then up to $36 million to $37 million per quarter thereafter. And this is largely due to the recent start up of Hercules 205 in Mexico, as well as the commencement of the operations on Hercules 208 and 260, as well as the amortization of mobilization expenses related to Hercules 156.

In our inland segment, we expect daily operating costs to approximate $21,000 per day for the year, up slightly from the fourth quarter levels and this will be due to slightly higher labor as well as repair and maintenance expenses. And of course should the market conditions remain weak we would likely be able to improve on this just like we have for the last two consecutive quarters.

We don’t expect a significant change in our cost for the domestic lift boat segment from where we were in the second and third quarters of 2007; that is approximately $3,700 to $3,800 per day. We expect international lift boat daily operating cost to remain in the $5,500 range.

General and administrative expenses are expected to range between $15 million and $16 million per quarter. Depreciation and amortization is expected to be approximately $215 million for 2008. That would be starting in the high $40 million range and increasing to close to $60 million by year end.

Based on current rates, we would expect interest expense to decline throughout 2008 from approximately $17 million in the first quarter to approximately $14 million in the fourth quarter. This interest expense guidance assumes the minimal required debt repayment, and that we would continue to build the cash reserves.

Our income tax rate is expected to be in the mid 30% during 2008 although I would like to point out that we only expect to incur approximately $30 million to $40 million in cash tax during 2008 due to the NOLs that we acquired as part of the TODCO acquisition.

Now I will just make a couple of brief comments on the balance sheet. As of December 31st, we had cash and cash equivalents of approximately $252 million; total debt was approximately $929 million and we had equity over just $2 billion. Net debt-to-capitalization is 25%.

Our total capital expenditures for 2008 are expected to be approximately $175 million. We would classify about $110 million of the expenditures as maintenance capital; other capital expenditures include $21 million for contract prep work related to our rigs in India, $10 million to complete the refurbishment of Hercules 208 in Malaysia, and approximately $15 million for repairs and for leg extension on the Hercules 185 in Africa.

The capital expenditures on the legacy TODCO rigs have been largely as we anticipated; there were no major surprises. However, we are planning on standardizing the top drives and cranes to reduce unplanned downtime. This reliability CapEx would approximate $17 million.

In closing, despite relatively soft market conditions in the U.S. Gulf of Mexico, we still generated approximately $100 million in operating cash flow during the fourth quarter. As we mentioned earlier, we have a number of assets that are entering service internationally at attractive day rates during the first half of 2008 which gives us greater visibility to improving cash flow as we enter 2008.

Operator, we would now like to turn the call over for Q&A.

Question-and-Answer Session

Operator

Your first question comes from the line of Angeline Sedita - Lehman Brothers.

Angeline Sedita - Lehman Brothers

First on the five rigs that are currently stacked, could you give us some color there on your conversations as to returning some of these rigs back into the fleet? How many? And is the interest from the E&P companies driven here by gas prices or are we seeing some of the companies actually come back in 2008 versus where there were in 2007?

John T. Rynd

On the warm-stacked assets we’ve got work to do on two of the five that’s quickly wrapping up and I think by the end of this week, early next week we’ll be moving two of those to the ready-stack mode. I think over the next 45 days, Angie, we are fairly confident that we can put probably an incremental five rigs to work if things work out as we plan. The challenge will be it’s a well-to-well market. So we put five incremental rigs to work, we got to build backlog with the existing fleet. So it will be a constant challenge.

On who’s coming back I think it’s a combination of a number of things. I think gas prices where they are today, and with the better storage outlook has increased some of the activity as they have more confidence. I think as we mentioned in the prepared remarks, a couple of the big guys that have made some significant acquisitions over the last two years are getting their drilling programs in line.

Angeline Sedita - Lehman Brothers

So five incrementals you’re saying of the five that are stacked now that you’re going to return all five to the fleet?

John T. Rynd

One is ready-stacked and should go to work, and then we could take two of the warm stack rigs and go to work.

Angeline Sedita - Lehman Brothers

On the PEMEX side have you had any conversations there, any color on if they’re still interested in taking 12 to 13 jack-ups out of the Gulf and the timing? Or is it still unclear?

John T. Rynd

I think it’s somewhat unclear. I think from a 40,000 foot view, Angie, they’ve got 35 jack-ups under contract right now down there. We know 13 come off their primary term contracts this year. We’re getting good indications that all 13 will be re-tendered for. So we are, at worst kind, of net zero and then there is still talk of anywhere from five to 12 incremental rigs as we progress through 2008. I would say we’ll probably be more back-half loaded. Does that give a clearer picture? It’s not a doomsday event. It looks like they are going to maintain as a minimum their current fleet with some upside.

Operator

Your next question comes from the line of Jeff Tillery - Tudor Pickering.

Jeff Tillery - Tudor Pickering

I just want to follow-up on the last question, John. The last fleet size report, three ready-stacked rigs and six warm-stacked, so all three of the ready-stacked go back to work? I know you have jobs booked on at least one of those as of last week, so that has meant two of the warm stacked, is that correct?

John T. Rynd

We have also the rig that’s coming out of the yard, 253. It wasn’t classified as stacked, it was in the shipyard. We secured work for it, we’ve secured work for one of the cold-stacked jack-ups and we’re close to securing work for one of the warm-stacked jack-ups, and one of the warm-stacked submersibles. We’re close to finalizing that. So like I said, currently the idle five warm-stacked, at least two we’ve got commitments to go back to work on and we are working on others.

The challenge will be we also have got two weeks on this rig and another seven days on that rig so it will be a mix of putting rigs back into work on programs that have length. All these have 60 plus days or greater of work which was our target, and then we’ve got to build backlog on the existing active fleet.

Jeff Tillery - Tudor Pickering

So based on the sound of that, there is no thought that any of those six warm-stacked rigs move to cold-stacked over the course of the year? It sounds like you are definitely more encouraged you can find work for all six of those at some point this year?

John T. Rynd

Absolutely.

Jeff Tillery - Tudor Pickering

In the inland barge segment you talked about utilization picking up from 65% back to 75% back to where you guys were the October, November timeframe. What are you seeing there that gives you that comfort?

John T. Rynd

Conversation with customers on rig specific opportunities.

Jeff Tillery - Tudor Pickering

Okay. So it’s moved to the rig specific discussion as opposed to just kind of general talk in the market?

John T. Rynd

It is still very similar to the jack-up market, it’s well-to-well, minimal backlog, so you get two contracts and you have one come off. So it’s still going to be a challenge, but I do think we can move it up from the current 65% to the 75%, 80%.

Jeff Tillery - Tudor Pickering

When Lisa was walking through the CapEx you talked about some of the specific work to be done on rig 185. When is that supposed to occur? How long is that suppose to take? Just so we are gauging utilization appropriately on that.

John T. Rynd

We come off contract in July, plus or minus, in Angola. We are going to go to a shipyard in South Africa. We’ve got a fairly significant work list to catch up on ABS issues, that’s the primary driver for going into shipyard. We’re also fabricating a 30-foot leg extension. That rig is build to be a 150-foot class rig, it currently has enough leg to work up to 120 foot. The incremental downtime associated with the stay is minimal so we will probably do that. So we are going to be in the yard plus or minus a 120 days, if everything goes well.

Randall D. Stilley

We are marketing the rig for follow-on work late in the fourth quarter in West Africa.

Jeff Tillery - Tudor Pickering

Concerning the M&A market you guys have been fairly acquisitive. What do you see in terms of opportunities or anticipate in terms of opportunities this year? Is there anything that you would rule out? Would you acquire a floater business? I know the Transocean guys sold those two floaters in the North Sea, is that something that interest you or no?

John T. Rynd

No, we’re going to stay very focused on the shallow water oil service side of the business and not getting into the floater business. On the opportunity sets I think they are the same ones we’ve talked about for the last six months. We think that coming out of the Transocean/GlobalSantaFe merger, as the year progresses I think they’ll re-evaluate their fleet and they will sell three, six, nine, 12 eventually. So that’s an opportunity we are paying close attention to. Obviously there are other one-offs of other people that are remixing their fleet, if you will.

Operator

Your next question comes from the line of Geoff Kieburtz - Citi.

Geoff Kieburtz - Citi

John, we’ve been hearing from most folks with exposure in the Gulf of Mexico here’s what the supply is, here’s what demand is, if supply shrinks, we are going to get a boost to rates. You have given us an update on this. What do you think has happened? Why has the demand been sliding steadily and what do you think is going to turn this around?

John T. Rynd

2007 was probably the perfect storm in that you had continued weak gas prices. You came off 2006 that had been very robust. The last four to five months of 2006, nobody really reined in their spending, and gas prices were cut in half. That took a while as we entered 2007 for people to get back their balance sheets in a comfortable area. When they got their balance sheets comfortable, the gas price was still in question. So we just never built any momentum through 2007.

At the same time as we talked numerous times, the amount of property transfers also impacted activity levels. There were other opportunities for some of the smaller E&P guys to get fairly active that were involved in either potentially a sale or a purchase. So the focus was not drilling wells.

I think as we progressed already early into 2008 we’re being helped, as I mentioned earlier, by gas prices, the people that had bought properties are now getting their hands around the prospects. It is a confidence I think in gas prices and also back to business.

Geoff Kieburtz - Citi

When you look at sort of more publicly visible indicators like permitting activity and so on do you see support for the kind of tone that you’re describing in your dialog with customers?

Randall D. Stilley

Yes.

Geoff Kieburtz - Citi

So you do see a turn in?

John T. Rynd

Yes, we have seen it. I mean we bottomed early October with about 43 jack-ups under contract. I think we have sustained about a 46 rig count for a period of time there. So we are up almost ten rigs from there and we have been able to maintain north of 50 here for six weeks now, I guess. So as Randy mentioned we’re off bottom. I think the question is, what’s the upside? We will watch it. I think it will be gas price driven. A lot of it will be the incremental activity.

The other question is I think we watch a lot is are we going to sustain activity during hurricane season?

Geoff Kieburtz - Citi

As you look at the prospects for putting all of the warm-stacked rigs back to work, do you think that’s got to happen before rates can start moving up?

John T. Rynd

I think we will see. We have seen some marginal improvement in rates. I think it’s been lead by the independent rigs, which is historically what happens. We have seen some modest improvements 5% to 10% across the fleet. As Randy mentioned, we are in the 50%, 60% range now, not much above that.

So I think that the acceleration in rates, you’ll have to get everything back to work, build backlog and then you have pricing power.

Geoff Kieburtz - Citi

As you look at what you are currently evaluating in terms of opportunities to move assets out of the Gulf of Mexico the way I would phrase the question is, at what point in the year would you start to become disappointed if you haven’t secured another opportunity to move into another rig out of the Gulf?

John T. Rynd

It’ll be in the third quarter, I think. If we don’t see anything in the first half that gives us confidence we could be disappointed there. Remember, we are somewhat limited in what we can move. Principally with the mat rigs it’s going to be a couple of areas that the opportunities will present themselves.

Randall D. Stilley

Geoff, I wouldn’t plan on us necessarily moving additional rigs out of the Gulf of Mexico. I think we will be disappointed if we didn’t see other people moving rigs out.

Geoff Kieburtz - Citi

But it’s not necessarily a part of the Hercules plan?

Randall D. Stilley

Not for 2008, because I think the opportunities we are going to see primarily for additional mat rig moves are going to be either late in the year or early next year.

Geoff Kieburtz - Citi

On the domestic lift boat business with nine more to come into the market, realistically should we be thinking that, that rates will continue to be under pressure and maybe weaken further from what you have given us as the current spot?

Randall D. Stilley

I think it depends a lot on the weather and demand as we get into the spring and summer. What we’ve seen so far most of the new builds that are coming into the market are going to be the larger size lift boats the 175, 200 class and larger. I think we could see some additional pricing pressure in that class of lift boat, but there is a pretty big gap still between what we charge for those bigger lift boats and the midsize and smaller size lift boats. So, I don’t think it’s going to be across the fleet. I think if we see any pressure at all, it will be primarily on those bigger lift boats.

Operator

Your next question comes from Pierre Conner - Capital One Southcoast.

Pierre Conner - Capital One Southcoast

John, first to clarify on Jeff’s question you answered about moving rigs. What did that imply about your interest in further opportunities with PEMEX if indeed they did move towards incremental rigs?

John T. Rynd

We would definitely be looking very hard to grow our presence with PEMEX in Mexico. No question that if an opportunity presented itself we would go after it.

Pierre Conner - Capital One Southcoast

That was more of a comment about outside of the Gulf.

John T. Rynd

Yes.

Pierre Conner - Capital One Southcoast

And then on opportunities internationally for lift boats, Randy, what are they, when? Give us some color on that timing, maybe, and then how do you get them there, given that you don’t have quite as many jack-ups moving around and the ability to piggyback on a jack-up dry move?

Randall D. Stilley

Well I think our best opportunities, as we have talked about before, are going to be West Africa where we think we will have an opportunity to move a couple lift boats there later this year. And quite frankly, if you can put two lift boats on a heavy lift, you could probably justify the mobilization. You wouldn’t probably want to move just one lift boat but two you could probably get away with that.

And other than that, I think we’re continuing to see opportunities for lift boats at least talked about in the Middle East. We just got a bid from Qatar yesterday, for a mid to larger-sized lift boat. I think we will see some additional tenders show up in the Middle East during the year. Some of those will probably require a new build lift boat which will be a later delivery probably in 2009 or later. But I think there will be an opportunity to move some existing lift boats with Gulf of Mexico specs into that market earlier on.

Pierre Conner - Capital One Southcoast

Into the Middle East that is?

Randall D. Stilley

And fortunately we do have rigs still going to the Middle East so that’s a place that we probably could piggyback onto a heavy lift.

Pierre Conner - Capital One Southcoast

Back to domestically on the barge side, John, you mentioned that your discussions with customers implied a little bit higher utilization and so you probably mentioned more about the depth of those wells, and would they lean you towards anything that could push you to where you want to upgrade a rig for some very deep drilling?

John T. Rynd

Near-term, Pierre, no. It’s all the spot market. As I mentioned permits for the deeper wells are down dramatically. We had permits in 2006 to drill 69 wells in greater than 15,000 foot depths and there was 43 roughly in 2007. But I think as we progress, that opportunity to upgrade will strengthen. As we see the McMoRan success, we have seen some of the majors start kicking around the tires in the barge business as they look to employ their capital where they are getting shut out around the world in some places and with these gas prices where they are, potential reservoir size, these cash-on-cash returns are fairly attractive for them. It is a quick payback. So I do think we’ll be in a position to upgrade a barge as we progress through 2008; a significant upgrade.

Pierre Conner - Capital One Southcoast

Okay. Along those lines relative to upgrades, more so though on the equipment that warm stack I think Lisa mentioned that you were evaluating upgrades, expand on that. Would those be capitalized, would they be at the direction of any customers that might want larger top drives or a more consistent type of equipment?

John T. Rynd

We call it the reliability CapEx, Pierre, because we have a large number of top drives that have caused us a significant downtime and cost through 2007 and already in 2008. We have a plan in place to get out of those top drives and go to another vendor. That’s the reliability piece.

On the barge side, it would be customer-specific driven upgrade significant enough that we will need a contract to justify.

Pierre Conner - Capital One Southcoast

One last one the transition in the rigs, the jack-ups that you’d planned to go back to work here maybe in the next month-and-a-half, John, if I can ask it this way. Can you characterize those customers as traditional mat rig players that are getting active again, or are some of those customers traditional ILC customers that now because of the economics have decided to go after the mat rigs?

John T. Rynd

No I think it’s more your traditional mat guys. If you look at who we’re talking to, they run a mixed fleet. They have always consumed some mat rigs, because the economics, the day rate spread is not that great between the 250 ILC and the 250 mat cantilever right now is about 10% so it is not compelling enough to make a shift like that.

Operator

Your next question comes from Michael Farah - Merrill Lynch.

Michael Farah - Merrill Lynch

Can you give us your thoughts in general on the health of the international jack-up markets? PEMEX looks like it may disappoint somewhat in ‘08, and Saudi as far as I understand is a little quiet right now. How do you see the global markets progressing through the year as new capacity arrives?

John T. Rynd

I think when you are on our side of the fence, for PEMEX to disappoint would mean they turn rigs loose. Any incremental rig is upside. There was talk early in a year, late 2007, they could require up to 12 rigs incremental. We are somewhere between zero and 12. I do think with oil prices where they are, with their production challenge that they face on the shelf in Mexico, eventually they are going to require more assets.

They have got a very aggressive program for 2008 in just the number of wells drilled. The growth in the number of wells is skewed to the land side. But if you look at their deepwater opportunities, if they are successful that production hits 2012, 2013. So I think that they are going to continue to be a very key customer in the global jack-up market.

In Saudi, they are sitting on four tenders right now we understand that they have been sitting on for quite sometime. So everybody anticipates is it a week, is it two, is it three for those rigs to be decided upon. Any conversations with people in the region they can grow that fleet another four to eight rigs through 2008. Again, their timing has been disappointing in that we were sitting here last year at this time talking about these four rigs. So it’s been a year.

There is other incremental opportunities in the region outside of Saudi Arabia that could probably consume four incremental rigs. I think India needs plus or minus easily three more rigs through 2008, and we are seeing an uptick in demand in West Africa along the whole West African coast that by the end of ‘08 could require six additional rigs.

So I think that you got pretty healthy backlog in the current fleet and we are comfortable most of the rigs coming out if not all the rigs this year will be absorbed.

Michael Farah - Merrill Lynch

Going back to PEMEX quickly if they are slow to act in terms of taking on incremental rigs and potentially taking some from the US Gulf does that change the timing or the thesis about a US Gulf snapback if they don’t really take any supply out of the domestic market?

John T. Rynd

No, I think that you can make a very solid case that the Gulf of Mexico supply and demand will be in balance without any further rigs leaving. You’ve got a current nine rig overhang that means rig count has to get in the low 60s. We averaged over 90 rigs from 2002 to 2006. So, I think the PEMEX would accelerate it, but it is not the silver bullet. We can be fine here even without PEMEX.

Michael Farah - Merrill Lynch

In 2007, hurricane season really hurt the prospect of a snapback in the US Gulf. What do you think happens this year when hurricane season rolls around?

John T. Rynd

I don’t know, I think the pullback in 2007 to be honest, caught us by surprise the depth of it. We did not experience that much of a pullback when 2006 was even fresher on everybody’s mind. I think that it wasn’t just hurricane season, I think that was a driver but it was also weak gas market, it was the property transfers like I said, a kind of a perfect storm hit us. As we enter hurricane season this year, I think if gas prices are solid I think we’ll do better through hurricane season than we have done the last two.

The level just depends, I think, on if all the rigs are working, the markets tight, the people that have programs are going to be hesitant to release rigs during hurricane season in the thought that they may not get them back as we exit hurricane season. So it’ll take another couple of months for us to get a better read probably on what’s going to happen during hurricane season.

Operator

Your next question comes from the line of Ken Sill - Credit Suisse. Please proceed.

Ken Sill - Credit Suisse

Hi, good morning. Just wanted to clarify earlier in your comments you said that you thought your customer plans for this year were predicated on gas prices from the low 6s to the low 7s. So, obviously strips were above 8. At what point do you think the flex starts coming into their expectations for planning? Is it gas below 8, gas below 7, I mean, do you have much of an idea for that right now?

Randall D. Stilley

Ken, I think it’s definitely below 7 before they start even thinking about changing anything at this point.

Ken Sill - Credit Suisse

So they just started the year with pretty conservative expectations?

Randall D. Stilley

Exactly.

Ken Sill - Credit Suisse

You would have to get below those. I wanted to make sure that I understood that one. Curious on standardizing the cranes and the top drives what are you standardizing on?

John T. Rynd

We don’t have many choices right now. So, you could probably guess which one we’re standardizing on.

Ken Sill - Credit Suisse

Okay. That would be the big guy that provides everything?

John T. Rynd

Yes.

Ken Sill - Credit Suisse

Same for the cranes or that’s somebody else?

John T. Rynd

Somebody else.

Operator

Your next question comes from Bill Sanchez - Howard.

Bill Sanchez - Howard

Lisa, you did a very good job of laying out the expectations on the average cost side here both domestically and internationally. I’m just curious if you look at the rigs domestically that worked entirely for during ‘07 and you compared that with the expected cost inflations that are going to be in ‘08. How much do you see there, John, on just active rig versus active rig year-over-year, and then maybe you could do the same for us in the international markets?

Is there any kind of cost inflation protection you guys are going to get that we should be modeling from a revenue perspective? I imagine if you do have that, that’s on the international side.

John T. Rynd

Yes. With the short-term nature of the Gulf of Mexico, it’s hard to get that kind of protection on the pass throughs. It is only typically on your term contracts of six months or greater we had that provision in the contracts.

Bill, I think in the first half we modeled about a 5% uptick, and I think we are going to have to watch the back half of the year specifically on the labor cost, as there are about 44 new drilling rigs entering the market through 2008, both jack-ups and floaters. And I think we will feel it first probably on the international front and then it could potentially trickle here on the labor cost. We have been fairly flat labor cost since the first quarter of 2006. And I think that we’re seeing a little uptick in activity, international markets strong, you’ve got new capacity in the market that has the demand that we could see wage pressure in the back half.

Bill Sanchez - Howard

So the 5% uptick is in the first half that’s primarily international or is that company as a whole?

John T. Rynd

The company as a whole. As we progress through this quarter and into next, we’ll get a better feel for really the back half, and it is really probably going to be labor driven, as most of the spikes that we have experienced on the parts and materials has somewhat leveled.

Bill Sanchez - Howard

But a double-digit may for the full year may be reasonable on active rig ‘07 versus active rig ‘08?

Stephen M. Butz

No Bill. It depends a lot too on our insurance costs. About mid-year, we will be renewing our insurance, and there is a good likelihood that we’ll see our insurance costs in the Gulf of Mexico go down.

Lisa W. Rodriguez

Maybe a bit lower than double-digit.

Operator

Your final question comes from Scott Gill - Simmons.

Scott Gill - Simmons

Randy, you may have gone through this and so I apologize. I know you talked about January domestic lift boats having low utilization to recover somewhat here February, March and you got nine more lift boats -- or the industry does -- entering the market during the year. Against that backdrop, did you give guidance for what your day rate expectations for domestic lift boats are going to be through ‘08?

Randall D. Stilley

We haven’t. At this point in time, it is probably too early to say. It looks like we are continuing to build backlog in the lift boat business due to weather delays. Most of the work we do is either regulatory or maintenance work anyway, with a little bit of weather intervention work thrown in. So our expectation is we’ll see activity go up later this quarter as we get into the second quarter, depending on what happens during hurricane season. It’s anybody’s guess, but I think at this point in time we are not expecting a huge change in day rates.

Scott Gill - Simmons

All right. Fairly safe for us to model flattish rate expectations through the year?

Randall D. Stilley

I think so. At this point, that’s about the best anybody can guess.

Scott Gill - Simmons

John, a lot of talk here on Mexico and opportunities for incremental rigs back half of the year. If you were to look at that opportunity set, where do you think rates for your type of rigs would be if you were to bid into that market later in ‘08?

John T. Rynd

I think you would have to have a six figure day rate.

Scott Gill - Simmons

For your rates even with the US market at closer to $60,000 a day?

John T. Rynd

I’m not saying that’s where people are going to bid, but I think that’s where your starting point should be. I think it’ll depend a lot, Scott, for us we have about probably a minimum $15 million incremental investment that is primarily PEMEX specific to their contract specs. A three-year deal you may be below that, you get your capital back. One-year deal, how much capital are you willing to expose to the market? We’ve seen Pride renew down there, on location in the 80 to 90 range. So it could be somewhere between 80 and 110. I think it will depend on rig, term, those issues.

Stephen M. Butz

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

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Source: Hercules Offshore Q4 2007 Earnings Call Transcript
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