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Hornbeck Offshore Services, Inc. (NYSE:HOS)

Q2 2008 Earnings Call Transcript

July 31, 2008 10:00 am ET

Executives

Ken Denard, DRG&E, Inc. - IR

Todd Hornbeck - Chairman, President and CEO

Jim Harp - EVP and CFO

Analysts

David Smith - JP Morgan

Robin Shoemaker - Citigroup

Mark Brown - Pritchard Capital Partners

Judson Bailey - Jefferies & Company

Bo McKenzie - Lafayette Capital

Sonny Randhawa - Banc of America Securities

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Hornbeck Offshore Services second quarter conference call. During today’s presentation all parties will be in a listen-only mode. Following the presentation, the conference will be open for question. (Operator Instructions). This call is being recorded today, Thursday, July 31st, 2008.

I would now like to turn the conference over to Ken Dennard, Managing Partner of DRG&E. Please go ahead, sir.

Ken Dennard

Thank you, Makayla, and good morning everyone. We appreciate you joining us for Hornbeck Offshore’s conference call to review second quarter 2008 results. We’d also like to welcome our internet participants listening to the call over the web.

Please note that information reported on this call speaks only as of today, July 31st, 2008, and therefore, you are advised that time sensitive information may no longer be accurate at the time of any replay listening. During today’s conference Todd and Jim will make certain projections about future financial performance, operations and events that are not statements of historical fact and thus constitute forward-looking statements.

As noted in today’s press release, these forward-looking statements are subject to risks, uncertainties and other factors that may cause the company’s actual performance to be materially different from those which are projected today. In the company’s 2007 Form 10-K and in today’s press release announcing the earnings, you can locate additional information about factors that could cause the results to materially differ from those projected in the forward-looking statements. Our Form 10-K and today’s press release are located under the Investor Relations, SEC filings section of the website, which is www.hornbeckoffshore.com and are also available through the SEC in their website.

This earnings call also contains references to EBITDA, which is a non-GAAP financial measure. A reconciliation of this financial measure to the most directly comparable GAAP financial measure is provided in the press release issued by the company this morning.

I would now like to turn the call over to Todd Hornbeck, Chairman, President and CEO of Hornbeck Offshore. Todd?

Todd Hornbeck

Thank you, Ken, and good morning everyone. Welcome to our second quarter 2008 earnings conference call. Joining me today is Mr. Jim Harp, our Executive Vice President and Chief Financial Officer.

Our agenda for today’s call is to review our second quarter 2008 financial results, provide a brief overview of our current market conditions and update you on our newbuild programs. After reviewing these matters, Jim and I will be available for questions.

Let’s begin with our OSV segment. As expected, market conditions for new generation OSVs remained strong. Our quarterly OSV segment revenue, EBITDA, operating income and net income hit all-time highs in the second quarter of 2008, exceeding the previous highs set in the fourth quarter 2007.

Dayrates for our new generation fleet in the second quarter were over $22,000 a day on full practical utilization of 97%. Our conventional OSVs also contributed to these strong results, as effective dayrates for non-domestic vessels increased nearly $3,400 per day or 69% over the last quarter.

Current OSV market demand drivers are strong for all vessel classes. In fact, ODS-Petrodata recently reported that all OSVs in the Gulf of Mexico, both new generation and conventional that are available to work, are working. This certainly is consistent with our experience and observations. We have not seen evidence of a slowdown of activity, especially for vessels working in the deepwater and ultra-deepwater and do not expect to see one in the foreseeable future.

Additional supply has easily been absorbed into the market as OSV newbuilds have delivered. We continue to believe that strong market conditions for our new generation OSVs will last over multiple years, as supported by the following.

The demand for deepwater and ultra-deepwater rigs rated for 3,000 foot water depth and deeper has not subdued, as the number of floaters in service is woefully short of operators’ requirements. Floating rig utilization remains almost at 100% as deepwater exploration continues to expand, prompting further shipyard orders. Last quarter, we reported an estimated 75 new floaters, a number that now stands at 93, split between semisubmersibles and drill ships.

In the Gulf of Mexico, there are currently 42 semisubmersible rigs, next generation jack-ups and drill ships exploring the deepwater, with some rig contracts extending out over the next five years.

There are also approximately 34 semisubmersibles, spars and TLPs currently in production with roughly 17 additional floating production facilities, comprised of semisubmersibles, spars, TLPs and FPSOs, and 21 additional floating drilling rigs that are expected to come on line in the Gulf of Mexico between now and the end of 2011.

Our updated internal estimates of OSV supply, indicate that 200 US flag new generation OSVs are currently in service, of which we believe 147 are working in US Gulf of Mexico, with the remaining 53 in foreign markets or non-oilfield services. Not included in that figure are 53 announced OSVs that are currently planned or under construction at US shipyards with deliveries ranging from the remainder of this year, through 2011.

Once all currently announced domestic newbuilds have been delivered by the end of 2011, and assuming that none of them leave for foreign or non-oilfield markets, which we believe some will do that, we expect that the visible supply of 200 new generation vessels in the US Gulf of Mexico will still be below our current estimate of visible demand.

During the second quarter of this year, six US flag new generation OSVs were delivered into service in the Gulf of Mexico. Looking forward, we estimate that 11 newbuild US flag OSVs will be delivered to the Gulf of Mexico on various dates in the third quarter of 2008, with a total of 3 more expected to be delivered in the fourth quarter of 2008, including three from ourselves, Hornbeck Offshore.

Subsea and specialty vessel market. Demand fundamentals for our DP-2 OSVs that service specialty projects such as ROV support, deepwater mooring support remain strong. So are the market trends for our MPSVs that will support subsea construction and inspection, maintenance and repair or IMR work.

As a reminder, industry analysts forecast that offshore capital expenditures through 2012 will be roughly $109 billion in the aggregate. The expenditures will be for floating production systems, drilling and completing subsea wells, flow lines and control lines in subsea hardware and surface completed wells in deepwater worldwide.

These deepwater projects include the installation of an estimated 1,270 subsea trees, 300 templates and manifolds, 68 platforms and roughly 8,000 miles of pipeline. And that’s what’s known today, not what’s going to be known in the future.

Fuel development in the US Gulf of Mexico is forecasted by ODS-Petrodata to continue at a steady pace, with an estimated 54 projects under construction and another 120 projects in the design phase or under study. With these favorable macro conditions in mind, we have positioned ourselves to capture long-term growth opportunities with quality customers that yield returns commensurate with our investment parameters.

We are accomplishing this by leveraging our diverse modern fleet and high quality and committed workforce in the charters that expand our geographic reach as well as our service offerings.

Today, our vessels and crews are at work supporting high-end military operations, well stimulation projects, ROV and subsea construction activities, deepwater mooring installations, well test and flow-back operations, as well as providing deepwater supply services in markets ranging from the US Gulf of Mexico to Latin America to the Middle East.

50% of our fleet is now either in specialty service or foreign markets which is consistent with our strategy. Our diverse vessel service offerings are enhanced by our port facilities, our in-house engineering team, industry leading safety performance and the company’s commitment to hiring and training the best workforce.

As we prepare to accept the delivery of our first 2 MPSVs, the company is poised to apply its resources and experience in order to support our customers in their challenging environments.

Since our last call in May, we have continued to add contract coverage to our 2008 and beyond. For the remainder of 2008, over 65% of a projected new generation OSV vessel days have now been committed to time charters with 14 of our 37 vessels currently contracted beyond the end of the year.

We also are beginning to see more contract coverage in 2009, where we currently have almost 35% of our expanding new generation vessel days chartered. The vessels beginning construction under the OSV newbuild program are in high demand and we’re seeing long-term charters at attractive dayrates.

Of the remaining 14 OSVs under construction, we have been awarded multiyear contracts for 10 vessels for an aggregate total of about 45 years, averaging 4.5 years at $30,000 per day. This represents about $475 million of pro forma contracted revenue.

Now, let’s turn to our tug and tank barge operations. Our tug and tank barge fleet has historically produced a steady cash flow stream with periods of seasonal fluctuations. During our last earnings call, we reported that we were experiencing overall softening of market conditions in the Northeast transportation market. These tank barge market conditions have continued, especially with our single-hulled equipment.

Based on an EIA data report, demand in the Northeast US is down by about 4.5% or about 8.8 million barrels per month from the five-year average. We are optimistic that these market conditions are transitory in nature and are primary attributable to high petroleum product inventory levels resulting from weak customer demand, driven by record high commodity prices.

We believe that the current weakness in the single-hull tank barge market should eventually correct itself as the economy adjusts to higher commodity prices and consumer demand reverts back to normal levels. Notwithstanding the current flat demand for single-hull barges, dayrates and utilization for double-hull barges remain relatively firm.

As a result of our two newbuild programs, our double-hull tank barge fleet is one of the youngest among our tank barge peers, with an average age of only three years, versus an industry average of nearly nine years. Our new equipment is powered by nine higher horsepower tugs, eight of which have been substantially rebuilt in the past two years. These double-hull barges have consistently produced strong results since we first began delivering them in 2005.

With the substantial recent impending growth of our OSV segment, the tug and tank barge segment currently represents approximately 15 to 17% of our consolidated results. We have retained J.P. Morgan to act as our financial adviser in a thorough review of strategic alternatives for this business, which is well underway and progressing as planned. We’ll inform you as to any developments on this matter when appropriate.

I’ll now give you a quick update on a few of our attractive growth initiatives. Our MPSV program continues with four vessels; two US flag 370 class DP-2 vessels and two foreign built T22 DP-3 vessels. The 370 class MPSVs will have the largest liquid mud capacity of any vessel in the world and their Jones Act qualification will permit them to operate in the growing Gulf of Mexico deepwater market, as well as other deepwater provinces around the world.

The T-22 class MPSVs will be the first DP-3 vessels owned and operated by US vessel owner and expand our capability in worldwide subsea construction and support. The first 2 MPSVs are expected to deliver this year. In fact, the T-22 class Achiever is currently undergoing sea trials today. Our internal estimate of total cost for this four vessel program remains at approximately $450 million.

OSV Newbuild Program No. 4. As we announced in today’s press release, we have made some changes in our OSV program to enhance the capabilities of eight vessels and increase the size of two vessels. For the most part, this is customer driven and is all related to specialty work, which includes ROV support, deepwater mooring, well stimulation and military.

Inclusive of these three recently announced vessel deliveries, the aggregate cost of our 4th OSV Newbuild Program is expected to be approximately $480 million. We expect this newbuild program to contribute roughly $100 million in annual EBITDA after all the vessels are delivered.

Tug and Tank Barge Newbuild Program No. 2. We completed this program mid-July with the delivery of the final rebuilt tug. The final projected cost for this program is roughly $77 million as previously reported.

Our 180 conventional OSVs. In keeping with our strategy of being a pure play new generation vessel operator, we will continue to pursue the rationalization of our conventional vessels, which we believe, are non-core assets. During the second quarter 2008, we sold 1 foreign flag conventional OSV, the Cape Scott, for net cash proceeds of approximately $3.1 million, which resulted in a $2 million gain on sale of assets.

At this time, I’d like to turn the call over to Jim, to review our second quarter financial results.

Jim Harp

Thanks, Todd. Good morning, everyone. As reported this morning, we had another record quarter in our new-gen OSV segment and have a lot of exciting developments underway, as we strategically position our growing fleet to maximize our long-term returns.

As a reminder, unless otherwise noted, the OSV dayrates and utilization information that we refer to in this call, reflects the operating data for the 37 new-generation OSVs in our current fleet and does not include our nine conventional vessels which we consider to be non-core assets.

Another item that I wanted to point out to you is the expanded presentation for our TTB fleet operating statistics. You may have noted in our press release this morning that we are now providing tug and tank barge dayrate and utilization information, stratified by hull type, double-hull versus single-hull barges. This expanded data should further illustrate the bifurcated market dynamics currently at play within our TTB fleet.

Moving into our second quarter financial results, our second quarter diluted earnings per share were $0.94 per share or 11% higher than the year ago quarter, on a weighted average share count of roughly 27.2 million diluted shares. Our second quarter EBITDA was $53.8 million.

As Todd mentioned a moment ago, included in our second quarter results was a gain of roughly $2 million or $0.05 per diluted share after tax, resulting from the sale of the Cape Scott, a foreign flag conventional vessel that was acquired as part of the Sea Mar Fleet.

After making adjustments to EBITDA required to compute ratios used in the financial covenants of certain of our credit agreements, adjusted EBITDA for the second quarter of ‘08 was $56.7 million. For additional information regarding EBITDA and adjusted EBITDA as non-GAAP financial measures, please refer to Note 10 to the data tables in this morning’s earnings release.

Moving into our segmented data, first with the OSV segment, our average new-generation OSV dayrates for the second quarter of 2008 were about $800 higher than the year ago quarter and about $1,100 higher than the sequential quarter. This sequential increase was largely the result of one of our 200 class OSVs working 39 more days while performing specialty services at an average dayrate in excess of $65,000.

Utilization for the second quarter was roughly 97% compared to 92% for the first quarter of ‘08, and in line with the prior quarter of 96 to 97%. With average dayrates above $22,000 for the second quarter of ‘08, our effective or utilization adjusted fleet-wide new-gen OSV dayrates were also up roughly $800 over the second quarter of ‘07 and about $2,000 sequentially.

As a reminder, based on our current operating cost structure and share count, each $1,000 change in our effective new-generation average OSV dayrate on our current fleet of 37 new-gen vessels, should result in a $13.5 million change to our annualized revenue, EBITDA and pre-tax net income. This translates into a potential change in diluted EPS of roughly $0.32 per year for each $1,000 change in effective new-gen OSV dayrates.

To be clear, this sensitivity analysis does not include the effect of any operating leverage from our non-conventional vessels or any additional new-generation OSV or MPSV newbuilds that are scheduled to come on line over the next couple of years.

Speaking of our non-core conventional OSVs, they also contributed to our record second quarter OSV results, as effective dayrates for our 9 domestic vessels of $8,300, increased nearly $3,400 or 69% over the sequential quarter. While average dayrates for conventional vessels remain in the $9,000 to $10,000 range, we experienced a major step change in utilization for this fleet since the first quarter.

As anticipated, during the second quarter of 2008, increased demand for the conventional OSV fleet was primarily driven by the normal seasonal return of shallow water offshore construction and repair activity on the shelf. For the second quarter, our fleet of 9 conventional OSVs achieved utilization of 90%, up from 51.5% in the first quarter of '08.

OSV segment operating margins were 49% for the second quarter compared to 43% for the sequential period, a 6-point increase, and 56% for the year-ago period, about a 7% decrease. The year-over-year decrease in OSV operating margin was primarily due to higher crew wages and an increase in the cost to maintain and operate our vessels. This sequential margin increase was due to the $2,000 step-up in effective dayrates on the same OpEx base.

Moving into the Tug and Tank Barge segment, our revenues from that segment decreased to $1 million or about 4% to $25.5 million for the second quarter of '08, compared to the same period in '07. The decrease in revenues was primarily the result of an overall decrease in demand for our single-hull vessels, as Todd mentioned earlier. The decrease in revenues was partially offset by the full quarter contribution from 3 newbuild double-hull tank barges, the Energy 6506, 6507 and 6508, which were placed in service on various dates during the latter half of '07 and the first quarter of '08.

Our double-hull tank barge average dayrates were about $22,500 for the quarter, which was in line with the year-ago quarter. Our double-hull tank barge utilization was 94% for the second quarter of '08, compared to 99% for the second quarter of '07, primarily due to a market driven shift in contract mix from time charters to COAs.

Our single-hull tank barge average dayrates were about $20,500 for this quarter, an increase of 39% over the $14,700 we posted for the second quarter of '07. The increase in our single-hull tank barge average dayrates was due to an upstream services contract that we performed during the quarter as Todd mentioned. Excluding that upstream job, our single-hull average dayrate would have been about $16,300, which was up $1,600 year-over-year but roughly in line with the $16,900 we reported in the sequential period.

Our single-hull tank barge utilization was 37% for the quarter ended June 30, '08 compared to 87% for the same period in '07, due to recent soft market conditions in the Northeast US for our single-hull tank barges, which led to our decision to stack 4 of those vessels on various dates during the second quarter of '08. Our effective single-hull tank barge utilization, which excludes the impact of stacked tank barges, was 50% for the second quarter of '08 on our active vessels.

The unfavorable revenue impact of stacking 4 single-hull barges and 1 tug is expected to be partially offset by the reduced operating expenses associated with the lower cost of maintaining stacked equipment, including the reduction in cost for 3 in-charter tugs whose contracts were not renewed. The cost savings from these initiatives, no operating expense for 4 single-hull barges and 1 company-owned tug and 3 in-chartered third party tugs is projected to be about $4.5 million in the aggregate for the second half of 2008.

Moving into operating expense, on a segmented basis, cash OpEx for the second quarter of '08 was $28.4 million for the OSV segment and $14.9 million for the TTB segment. We expect our 2008 cash OpEx on a per vessel day basis to increase between 5 and 10% over comparable 2007 levels, due in part to an increase in FAS 123R compensation expense.

As 2008 marks the third consecutive year that we have granted restricted stock units to our mariners, we expect incremental FAS 123(NYSE:R) expense to contribute to our OpEx per day trending higher year-over-year, and then leveling out in 2009. However, we have found that our unique strategy of using this element of compensation for mariners has enhanced our recruitment and retention of high-quality personnel in a competitive labor market.

Moving into G&A, as a percentage of revenue, our second quarter general and administrative expenses of $9.4 million are roughly 9% of revenue, which is at the low end of our 2008 guidance range of 9% to 10% of revenues. Our quarterly year-over-year G&A increases were primarily driven by higher personnel costs shoreside, due to our substantial fleet growth and greater FAS 123(R) stock-based compensation expense related to RSU awards granted to shore-based employees. G&A costs for the quarter were allocated 60% to the OSV fleet and 40% to the TTB fleet. For the balance of 2008, we expect G&A to remain in the 9% to 10% range.

Moving into our balance sheet, I will now review some of our key balance sheet related items for the second quarter. On June 30th, our cash position was just under $20 million, our total debt was $590 million and our book equity was $619 million. We are currently paying a blended average cash coupon of about 4.1% on our $590 million in total debt, which is comprised of our [6.8] senior unsecured notes due 2014 of $300 million, and our [1.625] convertible senior notes due 2026 of $250 million, and the $40 million balance that was outstanding under our revolving credit facility at quarter end.

As of July 30th, yesterday, our cash position was approximately $35 million and our outstanding revolver balance was $100 million even. Since quarter-end, we have drawn an additional $60 million for major milestone payments under our MPSV program, including the sea trials for the Achiever.

Our pricing grid on funded draws under our facility ranges from 50 to 150 bps over LIBOR. Based on our current leverage ratio as defined under the credit agreement, we are borrowing at LIBOR plus 100 bps today, for a floating rate of roughly 3.8% on outstandings under that facility. The extent and timing of further revolver draws are primarily dependent upon the timing of shipyard schedules and the achievement of construction milestones.

Depending on a host of variables and modeling assumptions, including whether and/or when we may sell certain additional non-core assets, we are now projecting a peak aggregate construction draw, under our revolver, of somewhere around $200 million to occur in early to mid-2009. However, any such draw is projected to be repaid in full sometime during mid-2010.

We then project to rebuild our cash position back to about $150 million by the end of 2010, which should mark the completion of all vessels under our remaining newbuild and conversion programs. Stated another way, by the end of 2010, we expect to have zero drawn on our revolver, $550 million in permanent debt or long-term debt, and a $150 million in cash for a net debt position at that point of $400 million.

Our gross CapEx budget, excluding the August 2007 Sea Mar fleet acquisition, is currently at around $1 billion, of which we have already paid roughly $551 million through June 2008. The remaining $456 million is expected to be paid over the next couple of years, with about $220 million of that figure to be incurred in the second half of 2008. These costs will be funded primarily by cash on hand, projected free cash flow from operations and additional revolver draws. All of these figures are outlined in detail in this morning's press release.

Moving into drydock activity, for the full year of 2008, according to our current maintenance CapEx plans, we plan to drydock 9 new-generation OSVs covering about 186 days out of service.

During the second quarter, we drydocked 2 OSVs at a cost of $1.9 million, representing roughly 32 days of downtime. During the third quarter we expect to drydock 4 OSVs, representing roughly 84 days out of service. However, due to our spot contracting strategy, which is designed to maximize our effective dayrates, we are guiding to the 90% range for utilization in this segment for fiscal 2008.

Our total projected drydocking costs for 2008 for the OSV fleet are estimated to be around $9.9 million. Note that this amount only reflects the drydocking cost for 9 of the 18 OSVs to be drydocked during ‘08. The other 9 vessels to be drydocked during this year are recently acquired Sea Mar vessels, whose drydock costs under our accounting methodology, were included in our purchase price allocation, which was finalized effective April 1, 2008. These costs are currently running through vessel capital improvements in the maintenance CapEx table in our press release, not through drydocking cash outlays.

In our tug and tank barge fleet, we plan to drydock 5 double-hull barges, 5 single-hull barges and 4 tugs in fiscal 2008. During the second quarter of '08, we drydocked 2 single-hull barges at a total cost of $2 million and had 81 barge days out of service. During the third quarter of 2008, we expect to drydock 1 single-hull barge and 1 double-hull barge, including its conversion from black oil service to dual service, such that it can work on both black and clean product movements, for a total of 105 barge days out of service.

We also plan to drydock the last tugs scheduled for 2008 during the quarter. For fiscal 2008, we now project a total drydock cost of around $9 million for the TTB fleet.

Wrapping up with forward guidance, as a reminder, all of the forward-looking guidance figures include a full year contribution from our August 2007 acquisition of the Sea Mar fleet and recent TTB newbuild deliveries, as well as a partial year contribution from projected 2008 deliveries from our ongoing OSV and MPSV growth CapEx projects.

This morning we reaffirmed our EBITDA guidance for the full year 2008 of $220 million to $240 million and updated our diluted earnings per share guidance solely to reflect our current estimates of below the EBITDA line items such as depreciation, amortization, net interest expense and income taxes. Our updated full-year 2008 diluted EPS is now expected to be in the range of $3.72 to $4.20. Again, all of this is detailed in our press release.

The pro forma run rate EBITDA illustration included in the tables of our press release this morning, reflects the assumptions outlined in Footnote 11 to that table, which among other assumptions includes an anticipated incremental full-year run rate contribution from the acquired Sea Mar vessels, as well as all vessels recently delivered under and/or that are currently under construction or conversion in one of our active newbuild programs, which are 4 MPSVs, 16 OSVs, 3 tank barges and 4 tugs, as though such vessels were in the water as of January 1, 2008.

Based on these assumptions, we are projecting pro forma run rate EBITDA of $402 million and pro forma diluted earnings per share of $6.79 per share. This is not intended to represent forward earnings guidance with respect to any specific calendar year, but is rather indicative of what we believe to be the potential annual EBITDA and earnings generating capacity of our pro forma fleet, assuming size-adjusted costs for our larger vessels consistent with our current cost structure, if all such vessels were operational for the entire calendar year 2008, which they will not be. The primary reason for the increase in that pro forma run rate EBITDA figure over the last quarter is that we have marked to market the dayrates for the 12 of 16 OSV newbuilds from the former assumed spot deck to their anticipated actual contract dayrates, which Todd outlined earlier exceed 30,000 a day.

With that, I will turn it back to Todd for any further comments or to entertain questions.

Todd Hornbeck

I think at this point we would like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions).Our first question comes from the line of David Smith from JP Morgan. Please go ahead.

David Smith - JP Morgan

Hi. Good morning.

Todd Hornbeck

Good morning.

David Smith - JP Morgan

I was wondering if I could get some color on what's behind the delays in the sulfur tanker conversions? Very slight delays, but just looking for some color there. And maybe also why the CapEx is creeping up with those delays?

Todd Hornbeck

I think we've got a pretty good handle on the CapEx. The delays in construction is just normal delays that we're seeing allover the world in construction, either with rigs or boats or any marine construction today. It's pushed out another month or so and we don't see anything alarming there past that.

David Smith - JP Morgan

And wondering if we could get some color around the marketing opportunities for those? We're looking at fourth quarter delivery, it's almost August. I'm wondering what we could expect to see there?

Todd Hornbeck

Well, I think we've covered that pretty well in the past. We're seeing a lot of robust opportunities for those vessels. We want to get them to the Gulf. We anticipate having the first MPSV we'd like to put her in the spot market in the Gulf of Mexico, run her through her paces and show the clientele exactly what the capabilities are of the vessel. But, we're getting a lot of demand for the vessel domestically and internationally.

Operator

Thank you. Our next question comes from the line of Robin Shoemaker from Citigroup. Please go ahead.

Robin Shoemaker - Citigroup

Yes, good morning, Todd and Jim.

Todd Hornbeck

Good morning.

Robin Shoemaker - Citigroup

I wanted to ask you just to review and comment on your strategies, spot versus term strategy that you've had historically, is it still the same exposure to both? You described some term contracts that looked awfully attractive. Is there any major or subtle change in your strategy on that?

Todd Hornbeck

No, I think we've been pretty consistent. Our fleet's growing and we're seeing some great opportunities to do some multiyear charters and at those attractive day rates, we think it's a good deal for the company and the returns. We still have an ample part of our fleet that is exposed to the spot market to capture the upside of the market as it continues to improve. So it's a pretty balanced plan.

Robin Shoemaker - Citigroup

Okay. And in terms of the latest editions to the deepwater fleet in the Gulf of Mexico and the supply vessels that are being contracted to support those, are you seeing any greater intensity of supply boats per vessel, anything that would suggest and I ask this, because you gave a projection of OSV availability and the market's absorption, the 200 vessels when the current fleet program is completed. What was your kind of vessel per rig, OSV per rig that was kind of embedded in that projection or assumption about the absorption of new OSVs?

Todd Hornbeck

You know, Robin, we have always -- because using the historical boat to rig multiplier that's been used by the industry for decades of 2 to 1 for drilling activity, that ratio supports our position that the number of new vessels coming will still not exceed the demand for such vessels. However, we have always said and believe that the appropriate multiple is somewhere between 3 and 4, because of the phenomena that's occurred in the past 10 years since we've been in business, with the market stepping further out from shore and the boat to rig intensity going up due to the complexity and higher volumetric requirements of mud and the linear requirements of pipe, etcetera.

To put it at 3 to 4 would only gild the lily and make the apparent undersupply even greater. And so we've tended to use the 2 to 1 for conservatism, but we certainly anecdotally believe that the number probably is somewhere closer to 3 to 4. We have seen some recent research that corroborates that, which didn't surprise us.

Operator

Thank you. (Operator Instructions). Our next question comes from the line of Mark Brown from Pritchard Capital Partners. Please go ahead.

Mark Brown - Pritchard Capital Partners

You talked about operating cost per day leveling off in '09. That sounds encouraging. Is there any particular reason why you don't expect those costs to continue going up?

Jim Harp

Just to be clear, I didn't mean to imply, I'm glad you asked the question, since I think I may have been misunderstood. When I said that, I was referring solely to FAS 123R and what I meant by that is we've now got three tranches in and it's a three-year clip vessel, so as they roll through, that as a line item ought to stabilize as a contributing factor to year-over-year increases in the per-day costs, because we'll have a full load in the system.

But I didn't intend to apply that to the entire cash OpEx per day of which that is only a part. We've certainly not given '09 over '08 guidance. ‘08 over '07 we said is 5% to 10%, which is clearly leveling off from say the year-ago levels because of the big ramp-up in labor costs from '07 over '06, we were pretty substantial. So hopefully that clarifies. I'll let Todd cover some further --

Todd Hornbeck

Yes, let me cover also, when we say 5% to 10%, bear in mind that in our contracting today for multi-year charters, included in our contracting is cost increase protection, so we are getting that type of protection for actual cost increases on labor and insurance and things of that nature.

Mark Brown - Pritchard Capital Partners

Okay. Thank you.

Jim Harp

Thanks.

Operator

Thank you. Our next question comes from the line of Judson Bailey from Jefferies & Company. Please go ahead.

Judson Bailey - Jefferies & Company

Thank you. Good morning.

Jim Harp

Good morning.

Todd Hornbeck

Good morning.

Judson Bailey - Jefferies & Company

Todd, can you give us a sense of the magnitude of the day rates increases that you're seeing for your 200 and 220 vessels, maybe over the last 30 or 60 days, just in absolute numbers?

Todd Hornbeck

Yes, it's been very robust. The market is extremely good right now and we think it's going to continue. The 200 class vessels, which when we say 200 class we're meaning anywhere from 1,600 deadweight tons to about 2,400-2,500 deadweight tons. Our average of that class vessel, which we have 20 of those vessels, is about 2,000 deadweight tons to 2,100 deadweight tons. That class is anywhere from $25,000 to $27,500 per day now; 240 classes are going in the $30,000 range to mid 30s; 265 - 280 classes are in the $40,000 to $50,000 range.

Judson Bailey - Jefferies & Company

Okay. That's helpful. So the upgrade on your two newbuilds, the 290 range you're going to have potentially a $5,000 to $10,000 step-up in the rate once those are delivered, is that fair?

Todd Hornbeck

Yes, we're seeing that on our 265s today that are currently trading in the market, in that price range in the mid 40s.

Operator

Thank you. (Operator Instructions). Our next question comes from the line of Bo McKenzie from Lafayette Capital. Please go ahead.

Bo McKenzie - Lafayette Capital

Hi guys. Hey Jim, I think I sort of like went ADD when you were talking about the pro forma run rate. I specifically wanted to know about the 10 vessels that Todd had spoken of that were tied up for collectively 45 years at an average $30,000 a day. Is that included in that pro forma run-rate long-term or is the pro forma run-rate assuming all the vessels were in the water January 1st at what the current day rates are today?

Jim Harp

I think the former. But to be clear, the $30,000-plus dayrate for the 12 of the 16 new OSVs that we're building is included in the new $402 million run-rate. That's the primary catalyst to take it from $373 million to $402 million from last quarter's level to this quarter's level. One of the most significant adjustments, if not the only adjustment is to mark-to-market what used to be a dayrate assumption before those vessels were committed to charters on what we consider to be a fairly conservative spot deck, well below what Todd just said, is we're actually realizing we have not taken to the hoop the step change in spot rates for the uncontracted vessels. We've left them alone.

That new step-up in the run-rate is not just us marking to market all the modeling assumptions on what has not yet materialized. We left that the same, including the 4 MPSVs, and only adjusted to actualize for the 12 vessels that are now committed to contracts. We marked them to their contract dayrate, which is substantially higher than what we were formerly modeling for that class vessel.

Todd Hornbeck

I'd like to make a point also about it. We announced this morning an additional $80 million of CapEx on that program, and all of the upgrades that we're putting on the vessels are going to be paid out during their initial charter term. So, paid out over an average of 4.5 years. And that's just the initial charter. So the option years attributable to those vessels, we've already got the $80 million paid for, plus now we've got all these enhancements for longer-term than what we have in the 4.5 years. It's paid for on the initial term and I think that's important to know.

Jim Harp

The bottom line, Bo, is we've marked those to market. The rest, we did not tinker with the underlying assumptions, so as to be apples and apples with the baseline we've given you in the past.

Operator

Thank you. Our next question comes from the line of Sonny Randhawa from Banc of America Securities. Please go ahead.

Sonny Randhawa - Banc of America Securities

Good morning, guys.

Jim Harp

Good morning.

Sonny Randhawa - Banc of America Securities

I had a question on the TTB segment. I had to step off for a little bit. Given the weakness in refined product demand right now, do you guys see the sale of the segment extending into 2009 or will the retirement of the single-hull fleet sort of act as a catalyst to expedite that a little bit?

Todd Hornbeck

We haven't communicated to anyone that we're selling the business. We said we're going under a strategic review of the business to see what all our alternatives are. Even though the commodities are moving and the oil is moving at a slower pace right now, that can whip back very, very quickly. And we have positioned our fleet to where even though we've stacked some vessels, they're ready to go to work.

And you know, things can change very quickly in that market. If we have a cold winter it can pop up very drastically. So, even though we're going through a bit of a lull right now, we expect the long-term opportunity in that market still to be a growing market over the coming years. And we'll just take this time to review our position in that market, recognizing that it's 15% to 17% of our total results this year. With all of the new construction coming on, on the exploratory side, it's going to go to about 10%. So, it's time for us to look at that strategically.

Operator

Thank you. (Operator Instructions). Our next question comes from the line of Mark Brown from Pritchard Capital Partners. Please go ahead.

Mark Brown - Pritchard Capital Partners

Hi. You might have mentioned this, but on the MPSV the two options for building US shipyards, what are you thinking about in terms of how you make the decision of when to exercise those options or if you're going to do that?

Todd Hornbeck

I'd like to keep that confidential right now. You know, we are very, very bullish on the market going forward, domestically and internationally. We have two of these designs currently being delivered into the market. We're in a total project of 4 MPSVs. And I can tell you that we still remain very, very bullish. So, we're going to look at the alternatives of those vessels currently that we're building, plus additional newbuilds, whether they're in the US market or foreign markets.

Operator

Thank you. There are no further questions in the queue. I would like to turn it back to Todd for any closing remarks.

Todd Hornbeck

I'd like to thank everybody for joining us on the call. It's been an exciting market. The market continues to improve and we look forward to talking to you in about 90 days. Thank you.

Operator

Ladies and gentlemen, this concludes the Hornbeck Offshore Services second quarter conference call. If you'd like to listen to a replay of today's conference please dial 303-590-3000 and entering the access code of 11116410. Thank you for your participation. You may now disconnect.

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Source: Hornbeck Offshore Services, Inc. Q2 2008 Earnings Call Transcript
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