Pride International, Inc. Q2 2008 Earnings Call Transcript

Pride International Inc. (PDE)

Q2 FY08 Earnings Call

August 7, 2008, 11:00 AM ET

Executives

Jeffrey L. Chastain - VP, IR & Communications

Louis A. Raspino - President and CEO

Brian C. Voegele - Sr. VP and CFO

Kevin C. Robert - Sr. VP, Marketing & Business Development

Analysts

Roger Read - Natixis Bleichroeder

Dan Pickering - Tudor Pickering & Co

Ian MacPherson - Simmons & Company

JudsonBailey - Jefferies & Co

Thomas Curran - Wachovia Securities

Brian A. Uhlmer - Pritchard Capital

Gary Stromberg - Lehman Brothers

Collin Gerry - Raymond James

Geoff Kieburtz - Weeden & Co

Robin Shoemaker - Citi Investments

Presentation

Operator

Thank you for waiting, and welcome to the Second Quarter 2008 Earnings Conference Call hosted by Pride Investor Relations. Today's conference is being recorded. As a reminder, your lines are currently muted and will be open at the end for formal presentation for a live Q&A. I'm pleased to introduce your host for today, Jeff Chastain. Please go ahead, sir.

Jeffrey L. Chastain - Vice President, Investor Relations & Communications

Thank you. Good morning and thank you for joining us for this review of second quarter 2008 financial results of Pride International. A copy of the press release covering the financial results, along with supporting statements and schedules is posted on the company's website, that's prideinternational.com. Also you will find historical financials, segment results, supplemental operating statistics and the most recent monthly fleet update, that was issued on August 1.

Joining me on this morning call, on today's call are the following Pride International Executive Officers, Louis Raspino, President and Chief Executive Officer; Rodney Eads, Executive Vice President and Chief Operating Officer; Brain Voegele, Senior Vice President and Chief Financial Officer; Kevin Robert, Senior Vice President of Marketing and Business Development; and Len Travis, Vice President and Chief Accounting Officer.

Before I turn the call over to Louis, I'll remind you that during the course of this conference call, certain forward-looking statements maybe made. These statements may relate to, among other things, our expectations of future performance, demand for drilling services, future results and cash flows and completion of asset sales. Any such forward-looking statements in addition to other information discussed in this call are within the Safe Harbor provided by Federal Securities Regulations. These statements reflect our current views, but actual results could differ materially from those projected due to factors discussed in the call or in our filings with the SEC. Those filings are posted on our website, again that's prideinternational.com. Also note that, we will use various numerical measures in the call today, which are or maybe considered non-GAAP financial measures under Regulation G. You will find the required supplemental financial disclosure for these measures, including the most directly comparable GAAP measure and an associated reconciliation on our website.

With that I will turn the call over to Louise.

Louis A. Raspino - President and Chief Executive Officer

Thanks Jeff, and welcome to every on the call. Following my opening comments, Brian's going to come and talk about the results from a financial perspective, then Kevin's going to give the marketing view and I'm going to return for some closing comments on our go forward strategy.

In Q2, we turned in yet another quarter of record earnings and our results were in excess of the high-end of our guidance. And Brian's going to review those details in a minute. Now our strong financial performance was driven by yet another quarter of solid operating performance in our deepwater fleet. In fact five out of the eight deepwater rigs recorded utilization of 98% or higher. And we have to report the Gulf of Mexico fleet survive the Tropical Storm with no entry our damage to our fleet, even though seven of our rigs were in the direct path of the storm.

Our engineering and technical team continued strong performance in the execution of our shipyard projects with the completion of the $120 million Pride Mexico water depth upgrade. And our shipyard project list for 2008 is down to only one remaining project which is scheduled to begin in November for the deepwater semi across [ph] Brazil. And the projects for the construction our three new ultra deepwater drillships are on schedule, with steel cutting for the first ship planned in just a few months. During the second quarter, the U.S. Gulf market significantly strengthened, with an increase in the number of working jackups and improvement in day rates, extension of backlog through the hurricane season on all but one of our rigs and increasing inquiries for term work.

In Mexico, Pemex focused more intently on its need to renew mat jackup contracts. And during the quarter, we completed extensions on two of our rigs in Mexico; we are currently working on extensions for four additional rigs. Kevin will go over those details.

In our floating fleet, we're proud to announce a contract for Pride South Pacific and the Congo at a rate of $650,000 a day, the highest day rate ever recorded remote semi. From a capital structure perspective, during the quarter we completed the call of our in-the-money convertible bonds. Out payment of the outstanding principles of the bonds, in cash upon conversion, rather than settling through the issuance of shares, essentially had the same effect as the $300 million share repurchase program, retiring 6.7 million shares or 4% of our fully diluted count, while also representing a $300 million reduction in debt, this is a real win-win in the management of our capital structure.

In July, Standard & Poor's revised its outlook on the company, from stable to positive, and indicated a relatively short term timeframe in which they maybe reviewing our rating for a possible upgrade to investment grade. We view this action as a very positive step forward in the execution of our strategy and it represents yet another acknowledgement of the positive changes and consistent performance of Pride over the last three years. And during the quarter, we sharpened our focus on our core operations, by completing the sale of our Gulf of Mexico platform rich [ph] fleet for $66 million. This increase is the total proceeds from divestures of non-core assets during the strategic transformation of Pride to $1.6 billion.

Now I'll turn the call over Brian for a financial perspective.

Brian C. Voegele - Senior Vice President and Chief Financial Officer

Thank you Louis and good morning to everyone. I'm going to take the first few minutes of my time this morning, to highlight key drivers of our financial performance for the second quarter, and then end with some thoughts on what we expect for the third quarter.

Income from continuing operations for the second quarter, totaled a $152 million, or $0.87 per fully diluted share, on revenues of $560 million. Included in these results, was an after-tax gain of $12 million or $0.07 per diluted share, from the sale of our platform rig fleet which closed in May, excluding net gains, income from operations was $140 million or $0.80 per diluted share, exceeding our second quarter guidance of $0.74 to $0.78 per diluted share. Our better than expected results were driven largely by operating performance of our deepwater fleet, which contributed $0.02 per share to the out performance. In addition a lower than expected tax rate and the impact of the convertible bond redemption on our weighted average share count, each contributed one penny per share to the better than expected results.

Adjusted EBITDA on the second quarter was $240 million and reflects a reduction in the contribution from our platform business of $3 million as a result of its sale during the quarter. In addition, adjusted EBITDA for the first quarter was $243 million and included an $11 million gain on the sale of our investment in the land drilling joint venture. Excluding the impact of these gains, second quarter adjusted EBITDA when compared to the first quarter, increased 5%, this increase was largely a result of higher revenue and lower operating costs. Revenues for the second quarter of $560 million reflected a slight increase over first quarter revenues of $557 million. Revenue improvement during the quarter from our floating fleet and our U.S. shallow water business of $16 million and $4 million respectively was largely offset by the decrease in revenue from the completion of the sale of the platform rig business, lower revenue from reimbursables and lower revenue from our international jackup fleet.

Our deepwater fleet, with a $14 million revenue increase from the prior quarter, was the largest contributor to overall revenue improvement. Average daily revenues for the deepwater fleet increased $22,300 per day as a result of a short-term farm out of the Pride Rio de Janeiro to a new customer in Brazil.

During the second quarter, this unit worked under the farm out contract for 70 days at an increased dayrate of $347,000 per day compared to its original contract rate of $142,000 per day. With the farm-out contract complete, the rig has now resumed operations under the original contract at the original contract dayrates. At the same time, the Pride Brazil extended... experienced extended downtime for repair to its subsea control system, causing the rig's utilization to decline to 81% from over 98% in the first quarter.

The impact of this downtime event was muted by outstanding performance from the rest of the deepwater fleet as five out of the seven remaining rigs achieved utilization of 98% or higher during the quarter with the Pride North America achieving 100% utilization. The net impact of the downtime on the Brazil offset by the performance of the rest of the fleet resulted in lower deepwater fleet utilization of 96%, down from 97% in the first quarter.

Our 8-rig deepwater fleet contributed 52% of adjusted EBITDA in the second quarter, up from 45% in the prior quarter. Midwater fleet revenues increased by slightly more than $2 million from the prior quarter. Revenue contribution of the midwater fleet was positively impacted by the Pride South Seas, which was off hire for 75 days during the first quarter to complete its planned upgrade and was operating for the entire second quarter, contributing $20 million more in revenue in the second quarter than the first quarter.

At the same time, the revenue gains during the quarter from the South Seas were largely offset by unplanned repair time in the Pride South Atlantic and Pride Venezuela.

In addition, the Sea Explorer, which worked for the entire first quarter, spent 26 days mobilizing and in the shipyard during the second quarter in preparation for its new one year contract in the Congo. [indiscernible] returned to service in late July at a dayrate of $255,000 a day, an increase from its previous contract dayrate of $137,000 per day. The net effect during the quarter of the South Seas return to service and the downtime events caused overall utilization for the midwater fleet to improve to 68% from 64% in the first quarter.

Revenues from our 28-rig jackup fleet declined $4 million from first quarter levels, largely as a result of the re-contracting challenges we faced in Mexico earlier this quarter.

Negatively impacting revenue for the period, the Pride South Carolina commenced its new contract extension at $84,000 per day, down from $99,500 per day during the first quarter. Also negatively impacting the second quarter, the Pride Alabama worked a total of 29 days during a period and was demobilized with the U.S. and coal stacked after having worked the entire first quarter. At the same time, partially offsetting this revenue loss, the Pride North Dakota spent [ph] the entire quarter after spending 33 days off hire in the first quarter, completing it's plot survey

Also partially offsetting the revenue decline experienced by our international jackup fleet, increases in contracted activity levels and operating at less than 1% mechanical downtime caused utilization of our U.S. fleet to jump to 83% in the second quarter, up from 72% in the first quarter. Utilization improvement in the U.S. Gulf was partially offset by a decrease in average daily revenue of $6000 per day from the first quarter, primarily as result to the rollover of the Pride Kansas contract from $106,000 per day to $70,000 per day. The net impact of the utilization improvement and lower average daily revenue resulted in a $4 million increase in revenue for our U.S. Gulf of Mexico fleet over the first quarter level.

As recently as the fourth quarter of 2007, this same fleet saw utilization of only 58% and, as is apparent, we have seen no improvement activity as customers respond to higher commodity prices and reinitiate drilling programs following repairs to infrastructure damaged during the hurricanes of 2005 and 2006. This activity improvement is supporting a stronger dayrate environment, which is evident in several [ph] contract fixtures disclosed in our most recent fleet status report and is one of several developments supporting the potential for significant earnings growth from the second to third quarter 2008.

In addition, over the course of the last 60 days, we have begun to see encouraging signs out of Mexico. Kevin will have more to say about the Gulf of Mexico jackup market in few minutes.

Operating costs in the second quarter were $285 million, a $9 million decline when compared to the first quarter cost of $294 million. Second quarter operating costs were $2 million lower as a result of the sale of the platform rig business. In addition, second quarter operating costs reflect lower reimbursable expense of $5 million, lower repair costs of $4 million and lower demobilization and inspection costs of $6 million. The reduction from first quarter levels for these items were partially offset by a $4 million increase in operating costs related to activity level improvement during the second quarter. Adjusting for these items, operating costs grew by approximately 1% or $3 million during the quarter with late costs representing most of this increase.

For the third quarter, as in recent quarters, we expect industry inflationary pressures to persist, causing our core operating costs to continue to trend higher, particularly labor and equipment costs. As long as activity levels remain high, we do not foresee a moderation of this trend. Consequently for the third quarter, taking into account these continued cost pressures and reflecting the impact of our worldwide merit increases which were scheduled to be effective on July 1st, we expect the increase in core operating costs to be in the range of 2.5% to 3% with this trend likely to persist into the fourth quarter.

G&A for the second quarter was about $4 million higher than the first quarter. This increase is almost entirely the result of higher spending associated with the implementation of our new ERP system along with increased census costs [ph]. We expect G&A spending during the third quarter to return to levels similar to the first quarter.

The effective tax rate for the second quarter was 24%. During the quarter, we continued to experience the favorable geographic mix of revenues with strong performance in low tax rate jurisdictions contributing greater levels of operating income. Expecting this mix of operating income to continue for the balance of 2008, we expect our effective tax rate to continue to be in the range of 25% for the full year and more importantly, our cash tax rate to be in the range of 15% to 17%.

Now just a few brief comments about capital spending and the redemption of our convertibles before I turn my attention to guidance for the third quarter.

We continue to expect capital expenditures for the full year, including expenditures related to construction of our three ultra-deepwater drill ships to be about $995 million. Our expectation remains unchanged from prior guidance.

During the second quarter, we incurred $188 million of capital expenditures, of which approximately $120 million relates to our drillships under construction. Another $35 million related to the completion of the Pride Mexico water depth upgrade, bringing total capital expenditures for the first half of the year to $507 million.

Aggregate remaining construction obligations are currently $1.5 billion with $303 million expected to be paid during the remainder of the year. We expect to fund these obligations with cash on hand, cash flow from operations and additional borrowings under our credit facility. We also anticipate using available cash in our balance sheet capacity to further fund deepwater expansion. As previously announced, we completed the redemption of our $300 million 3.25% convertible senior notes during May.

During last quarter's call, I highlighted that with our share price trading well above the conversion price, this instrument was treated as equity for purposes of calculating our fully diluted shares. Furthermore, it represented the highest cost of funding in our capital structure, essentially equity with a coupon. With this in mind, we completed the redemption using about $300 million in cash with the net result of having essentially the same effect as a repurchase of 6.7 million shares or 4% of our shares outstanding and a decrease of 5 million shares in our weighted average number shares outstanding for the period, so 176 million shares, ultimately as the full impact of the reduction is reflected in the average, we expect our weighted average number shares to be in a range of 174 to 175 million shares inclusive of common stock equivalence of 1 and 2 million shares.

Now looking ahead to the third quarter. Commencement of new contracts for the Pride Angola, Pride Brazil, Pride Carlos Walter, enterprise Mexico in the aggregate could add almost $800,000 per day of revenue by the end of the third quarter. Along with continued improvements in the Gulf of Mexico jackup daily is expected to drive our revenue and EBITDA in the third quarter to higher levels. Further significant improvement utilization from our midwater fleet is also expected as we are forecasting almost 103 more days operating in Q3 than we achieved in Q2. Considering these drivers along with our expectations on costs and reflecting our lower share count, we expect earnings per share from continuing operations for the third quarter to be in a range of $1 to $1.05 per share, an increase of 25% over earnings per share of $0.80, in the second quarter, excluding any gains from sale of assets. Now I'll turn the call over to Kevin, to discuss our view of the offshore drilling markets.

Kevin C. Robert - Senior Vice President, Marketing & Business Development

Thank you Brian. We continue to experience very strong demand for our drilling services as demonstrated by the excellent contracts that Brian and Louis have mentioned for our new build drillships, our deepwater and midwater floaters and our jackups.

Our revenue backlog was essentially unchanged during this second quarter at just under $9 billion excluding bonus. Bonuses if earned would increase backlog to $10 billion. Overall worldwide jackup markets have remained stable or actually strengthened during the quarter especially in the United States. Floating markets continue to provide attractive contract opportunities for our existing fleet and for new build ultra deepwater rigs.

I'm going to start my market review this morning with shallow water. Last quarter I discussed the uncertainty regarding Pemex's jackup demand and the role of that rigs were filled and satisfying their drilling requirements. During the second quarter, there were a number of positive developments in this area. Further as we expected Pemex has incremental demand for additional independent-leg cantilever jackups. During the quarter they issued a tender for two independent cantilever rigs and we expect a second tender to be issued shortly for four more IC jackups. Five of these six rigs are new requirements and we expect the rigs to come from the U.S. Gulf of Mexico, further tightening the supply of independent-leg cantilever jackups rigs in the United States.

As I mentioned in the last quarter, we've been working closely with Pemex, to understand the future demand from that rigs. Our discussions with Pemex have resulted in extensions of the South Carolina and Colorado, at day rates of 84 and $82,000 per day. We're currently working with Pemex for further extensions of the contracts for the South Carolina, Colorado, Nebraska and Mississippi. We also expect Pemex to soon request extensions of the contracts for the Pride Oklahoma, and to Pride California. Pemex has indicated interest in keeping all of mat rigs working in Mexico, even though they have not yet issued the formal tenders for renewal of our rigs. They are working with us to extend the current contracts for our rigs, falling up into the future to give them time to further define their drilling programs and prepare tenders for our rigs. However, we might experience some break between contracts due to the time required to conduct a tender in Mexico. Pemex continues be under pressured to maintain production, so we expect Pemex to grow their overall jackup demand, by 5-10 independent cantilever rigs, while attempting to keep all of their incoming jackups in the country.

Last quarter I mentioned that we were marketing our mat rigs in the United States in the 60 to $70,000 per day range depending on the rig specification. This market strengthened considerably, during this second quarter as the number of working jackups increased to 61 from 58 and the number of hot stack drilling rigs is down to only one jackup. The U.S. jackup fleet backlog grew by more than 100% during the quarter and now stands at about a 100 days per working rig. Pride U.S. Gulf jackup fleet backlog averages about 110 days per rig, with contracts for all but one of our jackups through the end of the hurricane season. As a result, during the quarter we've been able to obtain contracts for rates as high as $90,000 per day, for the 250 foot cantilever rig to Missouri which is an increase of $20,000 per day for that rig class. We obtained $85,000 per day for the 200 foot mat can [ph] to New Mexico, which was an increase of $15,000 per day for that class and we have achieved rates into the high sixties on our slot rigs which is an increase of $10,000 per day.

We also are seeing enquiries for termwork as long as nine months, due to client concerns about rig availability. The company market for 250 mat soft rigs is about $75,000 per day or higher and the market rate for the 200 and 250 foot mat cantilevers is at 85 and $95,000 per day respectively. We believe that day rates are directionally moving higher due to tightening supply and demand driven by favorable drilling economics, rig shortages and growing demand in Mexico.

Internationally, we didn't have any new contract activity on our six jackups in the Eastern hemisphere but the Pride Montana did begin its new three years contract with Saudi Aramco at a day rate of $130,000 per day which is an increase of almost $90,000 per day from the old rate of 44000. There is lots of speculation right now about the impact of new jackup deliveries on the international jackup market. Assuming that there are no delays in deliveries of new jackups from the shipyards, we expect about 78 new jackups to enter the market from now till the end of 2010. Approximately, 56 of these rigs are available for contracting with six rigs available in 2008 and 25 rigs available in each of 2009 and 2010. We believe incremental demand from now till the end of 2009 is close to 30 rigs with the majority of that demand increase coming from the Middle East. This indicates to us that the market should be able to absorb the new rigs to be delivered in 2008 and 2009 unless operators postpone or cancel their planned tenders. It's too early to tell how 2010 will shake out.

We continue to study opportunities to acquire new jackups that are under construction, but up to this point, we've not seen any opportunities that meet our economic criteria.

Moving on I'll now mention a few points on the floating markets starting with midwater. Our six rig midwater floater fleet is employed in West Africa and Brazil. We continue to move employ a strategy of growing backlog at attractive day rates, during the quarter the Pride Venezuela a 1500 foot water depth more semi obtained a six month contract at a leading day rate of $375,000 per day, an increase of about $120,000 per day from its current contract terms of $256,000. We expect to announce another contract on this rig for a twelve month term in the near future, which will add backlog to March 2010. We're also actively marketing our other two midwater semis available in 2009, the Sea Explore and South Seas which are both 1000 foot more semis.

We hope to have new contracts in place for those rigs by late this year or early 2009. We expected our markets to remain well balanced throughout 2009 and do not expect to see many rigs moving between regions other than some continued movement to South America. Deepwater continues to be a strong and very interesting market, while we grow our deepwater assets through our new build program, we continue to pursue a strategy with our existing fleet to obtain leading edge rates with good contract terms, while having to manage a portfolio that keeps a rig too exposed to shorter term rates.

We have planned to take the Pride South Pacific to the shipyard in mid-2009 but demand for the rig was so strong, we were able to obtain a short term contract for the rig at a rate of $650,000 per day, an increase of more than $200,000 per day from the current day rate. This contract is for two wells with an option for two more wells. If the client elects not to exercise the two well option, we intend to seek another client for the rig for the optional period, therefore we expect the Pride South Pacific to be under contract during all of calendar year 2009.

This contract for the PSP also demonstrates the value that clients can have for rigs that have a good history of performance. The PSP has one of the best drilling records of any rigs that has spotted a well in West Africa. Our commitment to safety and providing efficient well trained crews had as much in obtaining this record contract as did the limited supply of deepwater rigs in West Africa. There is already strong interest in this rig for work in 2010 and we also have client interest in our other deepwater rigs like the Pride North America which further reinforces our view that deepwater markets will remain strong into 2011 and beyond.

On the nuclear front, we continue to make proposals and have focused discussions with clients for contracts against which we could build other deepwater rigs. Clients with ultra-deepwater drilling requirements are challenged to obtain high specification rigs from established drilling contractors for programs in 2010 and 2011.

The activities of Petrobras are putting even more pressure on this market segment as Petrobras matures their plans to add a significant number of ultra-deepwater rigs to its portfolio over the next 5 to 10 years. Petrobras's program to build a large number of rigs at shipyards in Brazil during a period from 2013 to 2017 is likely to impact the availability of components needed to build new rigs for other clients. Since the existing ultra-deepwater fleet is close to fully contracted throughout 2010 and newbuilds may be difficult to obtain, many operators are accelerating their procurement efforts for premium floaters.

Therefore, it continues to be a high priority that we be prepared to participate in the continued growth in the market through the addition of deepwater rig capacity to our fleet either from newbuilds or the acquisition of rigs already under construction.

Thank you. Let me turn the call now back over to Louis.

Louis A. Raspino - President and Chief Executive Officer

Okay, thank you Kevin. As we detailed in our discussions today, our second quarter accomplishments included continued progress on all four fronts of our overall corporate strategy. Those are financial discipline, infrastructure improvements, rationalization of non-core assets and focused growth. And as Brian discussed, the strong growth in earnings from Q2 to Q3 is largely driven by the continued repricing of our rigs from older legacy contracts to much higher market rates.

Actually, we expect to see dramatic growth in earnings and EBITDA through 2012, simply from the continued repricing of our existing fleet to higher current market rates as well as from the start up of our three new ultra-deepwater drillships in 2010 and 2011. All three of these ships already have attractive long-term contracts. The new drillships alone should contribute approximately $450 million of incremental EBITDA per year. And when combined with the repricing of our existing fleet to current market rates over the same time period, we believe Pride will deliver one of the highest growth rates of any of our major offshore drillings peers.

And our strong capital structure combined with our industry leading backlog at approximately 150% of market cap including bonus opportunities and the positive outlook on our debt rating toward investment grade put us in a great position to continue to execute on growth initiatives.

Deepwater activity remains robust on a global scale and customers needs in the near-term are difficult for drilling contractors to meet due to an absence of available units. Some customers have expressed a need for deepwater rig capacity beginning in 2011, 2012 or even as late as 2013, creating the possibilities for additional ultra-deepwater rig construction programs.

Our focus remains on expanding our presence in the premium segment of the offshore drilling business while building on our core competencies in deepwater operations, engineering and construction. In this regard, we have access to a slot, providing for the construction of a fourth ultra-deepwater drillship with a scheduled delivery in late 2011. And we're likely to move foreword soon on committing to that attractive delivery.

Also, we will continue to evaluate additional ways to further our rapid growth in this attractive segment of the offshore business.

And from an asset rationalization perspective, the improving Gulf of Mexico market provides a very strong background to continue pursuing alternatives for divesting our non-core mat-supported jackup fleet.

We have now completed three years of carve out audits for this fleet and we're updating those annual audits with quarterly reviews for the 2008 quarters. In Q1, we segregated our Gulf of Mexico operations under one operating management team, and we're now in discussions with several CEO candidates to form a public market ready executive team to lead our efforts to divest of these assets in a public market transaction.

We believe our share price today does not properly reflect the true value of our mat jackup business and our remaining operations when valued separately. And while divestiture alternatives for the mat jackups include a variety of transactions, given our extremely low basis on these assets, a tax-free distribution to our shareholders appears most attractive at this time. The separation of the mat jackup business from Pride's remaining core operations would better allow our shareholders to realize the full value of Pride as we believe the value of some of the parts is greater than the market valuation for all of Pride as currently configured.

Execution of such a transaction would create two uniquely focused opportunities for investors: NewCo would provide investors a pure play in the Gulf and Mexico shallow water segment of our industry, heavily driven by U.S. natural gas prices. And the company would also provide our employees associated with these assets additional opportunities for career advancement, stability and future growth as their operation would make us the core of NewCo. And for Pride, this transaction would represent another significant step in our strategic transformation. And a tax-free distribution to our shareholders, will provide a strong statement regarding our focus on creating shareholder value by distributing such a large amount of non-core assets in a tax efficient manner.

Following the divestiture, Pride would become a highly focused, almost exclusively floating rig company with a strong focus on the deep and ultra-deepwater. No other major drilling company would be able to match the sharp focus of our remaining asset base. From this new asset and capital and with our strong operations and engineering teams, the remaining Pride International will continue to be financially strong and have stronger access to capital markets and well positioned to continue our aggressive growth in deepwater and other high specification assets, allowing us to be highly competitive in attracting and retaining the best employees in the business and providing a truly unique alternative for investors in the offshore drilling sector. Jeff?

Jeffrey L. Chastain - Vice President, Investor Relations & Communications

Thank you, Louis. Robbie, we now ready to enter a Q&A session. And while you are assembling the queue, I would like to thank everyone in advance for following our one question, one follow up rule to allow us much time as possible to address the questions. Robbie?

Question And Answer

Operator

Thank you. The question and answer session will be conducted electronically. [Operator Instructions]. And we'll go first to Roger Read with Natixis Bleichroeder.

Roger Read - Natixis Bleichroeder

Good morning gentleman.

Louis A. Raspino - President and Chief Executive Officer

Hey Roger.

Roger Read - Natixis Bleichroeder

Sorry if you have a little echo there. The Colorado had been originally talked about as a rig that would be coal stacked, part of that due to an STS required. If you are getting a contract extension in Mexico, what does that mean in terms of future CapEx on that rig?

Unidentified Company Representative

The extensions we are getting, Roger, are taking us out to the maximum amount of time that we can leave the rig in country before we have to demobilize it to yard for a special survey. So those are short-term extensions. And then just like with the Alabama, when the rig gets back here, we'll evaluate the market opportunities and make a decision on whether or not we feel it's justified to invest the capital and keep the rig working. So right now, our plan would still be as it was a couple of months ago is to bring it back and coal stack it unless we feel the market justifies putting the money into the rig.

Roger Read - Natixis Bleichroeder

Okay. So no real change, just a little better extension on it?

Unidentified Company Representative

Correct.

Roger Read - Natixis Bleichroeder

Okay. And then Brian, on the OpEx, 2.5% to 3% per quarter. Could you breakdown for us a little bit maybe some of the components there? And with an eye towards,yesterday we heard commentary about a lot more shipyard downside. I'm under the impression you'll have had the majority of our shipyard downside over the next say 12 to 18 months. Just wondering how you maybe think about '09 at this point?

Brian C. Voegele - Senior Vice President and Chief Financial Officer

Yes, I think from... Roger, let me address your second question on shipyard downside first and then I'll talk a little bit about the operating cost expectations and the inflation, what kind of the underlying drivers. But in terms of shipyard, for the remainder of the year, we've only got one more project to complete and finish executing, and that's on our contract status report. Then as we look into 2009, we're still in the processes of evaluating our project portfolio. And right now from what we can see, we don't think that the projects will be greater than in terms of the number of days out of service. We'll have a greater number of days out of service next year than this year. In other words, we'll have less days out of service. But again, we're still in the very early stages of putting our budget together. And so I hate to put too firm a stake in the ground at this point in time about what our 2009 project portfolio looks like. But I do think it's going to be, just from what we've seen so far, lower in terms of the number days.

As far as the expectations for costs for the remainder... or for the third quarter, that really is primarily being driven by labor costs. We are seeing some increases, continuing to see some increases in equipment costs. But we had a schedule, as I mentioned, we had a scheduled merit increase that went into effect July 1st. And so that's causing some of the ramp up in third quarter costs. We continue to think that because of the labor situation just in the offshore drilling market and with the high activity levels, we are going to be faced with these increasing labor costs for sometime to come. And obviously, we react and try and be proactive about dealing with the labor situation. But sometimes, we are caught with having to react and address disparities that we may see. Our customers don't necessarily have the same merit increase schedules that we have, excuse me, our competitors, and so that can create some dynamics in various operating jurisdictions there, we have to response to deal with, but generally it's all labor based.

Roger Read - Natixis Bleichroeder

Okay. And then anything on the insurance front?

Unidentified Company Representative

No, I think on the insurance front for us, we have a very good insurance record, the company has not had a casualty claim in over 5 years and that when we went up to see the underwriters earlier this year, that was something that was very much noticed, and so our anticipation is that our insurance levels will be coming down. We removed in July and we've actually seen a decrease of about 20% throughout our whole package.

Roger Read - Natixis Bleichroeder

Okay, thank you.

Operator

Thank you. We'll go next to Dan Pickering with Tudor Pickering Group.

Dan Pickering - Tudor Pickering & Co

Good morning. Louis could you talk a little bit about the pacing items for tax-free spend out, you said you've got the carved out [ph] audit, you're doing the quarterly stuff, is it just waiting on a CEO, I mean are you going to push this thing ahead as quickly as you can? Or are there any other issues or market things that you are waiting for right now?

Louis A. Raspino - President and Chief Executive Officer

Dan, we're going to push this ahead as quickly as we can. I mean the gating items of course for our management team, SEC filings and tax rulings, I mean rulings alone could take four to six months. We're going to do everything we can to push this process forward as fast as we can. I hesitate to take myself of into quarter [ph] by giving some deadlines but you could assure that we're going to move it as fast as we can.

Dan Pickering - Tudor Pickering & Co

Okay. So, but it sounds like the longest one is the IRS letter?

Louis A. Raspino - President and Chief Executive Officer

Most likely, yes.

Dan Pickering - Tudor Pickering & Co

Okay. Alright, thank you. Second question if you or someone in your team could provide an update if any on the status of sea drilling, if anything new to tell us there?

Louis A. Raspino - President and Chief Executive Officer

Dan, there is really nothing new to say there. I mean I've said everything that we can say during our last quarterly call, it is not our policy to talk publicly about situations like this, and so really what I said last quarter, is all I could really say for now.

Dan Pickering - Tudor Pickering & Co

Okay and just for those, I mean, would you remind us what you said last quarter?

Louis A. Raspino - President and Chief Executive Officer

No I don't have the script in front of me.

Dan Pickering - Tudor Pickering & Co

Okay. I will grab that change. Good, thank you.

Louis A. Raspino - President and Chief Executive Officer

Good try Dan.

Dan Pickering - Tudor Pickering & Co

Yeah.

Operator

Thank you. We will go next to Ian MacPherson with Simmons & Company.

Ian MacPherson - Simmons & Company

Hey good morning. Louis have you decided, what exactly goes into NewCo, will it be just the 23 jackups between the U.S. and Mexico, full stop or is it still slightly open-ended with respect to other assets?

Louis A. Raspino - President and Chief Executive Officer

Yeah. It's going to be roughly 21, it's going to be just our mat jackups.

Ian MacPherson - Simmons & Company

Okay.

Louis A. Raspino - President and Chief Executive Officer

With 21 jackups.

Ian MacPherson - Simmons & Company

The follow up I guess would be for, I guess for Kevin, you have pretty good visibility that the South Pacific fills out the back of the year, would that be at 650 or would it be at a different day rate?

Kevin C. Robert - Senior Vice President, Marketing & Business Development

My expectation is it would be at that day rate or better.

Ian MacPherson - Simmons & Company

Great. Okay, thanks.

Operator

Thank you. We'll go next to Jud Bailey with Jefferies & Company.

JudsonBailey - Jefferies & Co

Thanks, good morning. Kevin, could you talk a little more about the extensions you are talking, Pemex about I mean the potential links and maybe elaborate a little more just kind of what they are telling you as far as renewing your map?

Kevin C. Robert - Senior Vice President, Marketing & Business Development

Yes, the extensions we are working on are generally running from 30 to a 100 days on those four rigs I mentioned, and those extensions are driven by our work with Pemex to really look with them at their drilling program to see how they can slot already approved in planned wells into rigs that can most capably drill those. I think if they come to us with extensions on the Oklahoma and the California, those could be much longer term than that. So the short term extensions on the existing rigs, or to kind of get them to the point where they can finalize their plans for either new tenders or longer extensions and they appear to have completed that work on the Oklahoma and California. They are dealing with declining production how to get access to more arm legged [ph] rigs that they are finding it difficult and expensive to get. So, I think the delay in more definition is just that they are shuffling wells around amongst their whole fleet. So, we're just working with them best we can to buy as much time. It's interesting to note that the South Carolina extension, when we complete that would be the... an extension of an extension which before now they've never done. So, we see some flexibility in their contracting links that we've never seen before down there.

JudsonBailey - Jefferies & Co

Okay. Some of the contracts or tenders rather, they are looking at pretty long term requirements for the IC units. Do you envision at any point in the future maybe getting similar types of contract extensions on your rigs?

Kevin C. Robert - Senior Vice President, Marketing & Business Development

Yes, on some. I still think there is a question that Pemex is wrestling with on exactly where they worked them at, how many they have, but they've recognized that they need every rig they have. And it doesn't mean that there still won't be like we talk about before, IC's moving from say the Gulf of Mexico up and potentially that means a mat moves back down. So, there is still a lot to shake out, but there is positive things going on in terms of Pemex knowing, they need to keep all of these rigs and they seemed to be focused on and working very hard.

JudsonBailey - Jefferies & Co

Great. Thank you. I will turn it back.

Operator

Thank you. We'll go next to Tom Curran with Wachovia.

Thomas Curran - Wachovia Securities

Good morning guys.

Louis A. Raspino - President and Chief Executive Officer

Good morning Tom.

Thomas Curran - Wachovia Securities

Kevin, just as a follow up on Mexico and, I am sorry, it's like we are beating at that, but how many total mat supported jackups in your fleet could return to the U.S. Gulf, without a firm renewal already in hand, before the tenders you are expecting would primarily get signed?

Kevin C. Robert - Senior Vice President, Marketing & Business Development

Oh boy, that's hard to say. The history down there has been before that we've always had tenders ready to go before the terms expired. And so, in the past I would tend to say that when we didn't have a new contract for a rig, we knew that rig was demobilizing more prominently to the U.S. and you've seen us do in the past with the Texas and the Oklahoma and some other rigs. It's really a new ballgame today, I don't think the Pemex guys can tell us exactly what their plans are yet but when they firm a plan they'd like to get a tender out. So, the most secured thing for us would be to see tenders, no question about it. In the mean time, however the short term extensions are also something in the past they have not been able do for us. So, we are cautiously optimistic but we recognize there is still some thrill out of what you are bringing up. The flipside of that is they clearly need more 253, 300 and 350 ICs, and the last set of bids were in the range of 155 for a 250 IC 185 for a 350, very strong rates. Those kind of rates will attract independent cantilever rigs down to Mexico, and in worse case, if that happened, recognize our 200 foot mat cantilevers work right behind those rigs that leave the Gulf of Mexico. So, either way it works out, I see it positive for the rate environment, we're 100% utilized marketed in both markets, so if worse case you see some movement back and fourth, I don't have a lot of concern about that.

Thomas Curran - Wachovia Securities

Right. And then, so just to clarify your expectations then, if we should see on the fleet status reports over the next few months, some of the rigs that will be rolling over to Mexico show that they're going to be returning to the U.S. Gulf and I would imagine entering the shipyard for at least some standard maintenance work. That doesn't necessarily mean that you are not in ongoing discussions for a renewal contract that would it back south of the border.

Kevin C. Robert - Senior Vice President, Marketing & Business Development

That's an excellent way to put it, I can use the Oklahoma as an example, the sleep status report shows the comps went up this month. We know Pemex has worked of that rig but because of the timings they might not get that work started until November. So, that's what I mean, but we might have some downtime between some of these contracts.

Thomas Curran - Wachovia Securities

Okay. Thanks for the clarification. That's very helpful. I'll turn it back.

Operator

Thank you. We'll go next to James Dow [ph] with Cambridge Investment.

Unidentified Analyst

Louis, can you just talk about some of the ramifications of tax free distribution. Will... exist... surviving company Pride be subject to sort of the same rules in terms of let's say, someone made a bid for Pride that would be validated to tax-free status of NewCo? Would that tax-free distribution affect that or not?

Louis A. Raspino - President and Chief Executive Officer

Brian, why don't you take that?

Brian C. Voegele - Senior Vice President and Chief Financial Officer

Yes.Our situations where a tax-free spend would cause... could cause an issue if you had discussions either spinco or Pride that predated, and it would have to be pretty significant discussions, that predate the actual spend.

Unidentified Analyst

But do they affect either the NewCo... do they affect both NewCo and surviving co?

Brian C. Voegele - Senior Vice President and Chief Financial Officer

They can, and a lot of this becomes a very facts and circumstances type situation or test. And so you really have to get into what the depth of discussions have been to... the point in time proceeding the spin to determine how much of an impact it actually had.

Unidentified Analyst

Okay. That's what I want to know. Thank you.

Operator

Thank you. Next we will go to Brian Uhlmer with Pritchard Capital.

Brian A. Uhlmer - Pritchard Capital

Good morning.

Louis A. Raspino - President and Chief Executive Officer

Good morning Brian.

Brian A. Uhlmer - Pritchard Capital

I had a question for you on your fourth drillship that you are looking to exercise the option on. What do you see the cost escalation on that drillship being? How much capital cost do you think there is going to be on that?

Brian C. Voegele - Senior Vice President and Chief Financial Officer

Well I mean it will be higher than our most drillship for sure. I mean there continues to be cost increases. But I hate to negotiate over the phone here with the shipyards. So I would say that we would expect to see some slight increases, but that's only to be expected. We are also seeing the increases in dayrates.

Brian A. Uhlmer - Pritchard Capital

Okay. And for acquisitions of current rigs that are under construction, you mentioned that, are you looking solely at drillships but or also some of the semi-submersibles and are you looking at any yards worldwide or do you want to stick with the major yards?

Louis A. Raspino - President and Chief Executive Officer

Well I mean we are looking at anything and everything really that's in the market. We look at deepwater semis, we look at deepwater drillships and we look at frankly for premium jackups. But we look at all yards. I mean we are aware of what's out in the market. We just haven't found anything that is under construction in any asset class that we believe is valued attractively enough for us to move on.

Brian A. Uhlmer - Pritchard Capital

Alright, thank you.

Operator

Thank you. We'll go next to Gary Stromberg with Lehman Brothers.

Gary Stromberg - Lehman Brothers

Hi, good morning.

Louis A. Raspino - President and Chief Executive Officer

Good morning.

Gary Stromberg - Lehman Brothers

Can you guys give us some color on spinco cash flow or EBITDA contribution for the second quarter?

Brian C. Voegele - Senior Vice President and Chief Financial Officer

We are really not prepared to do that at the present time of course as we prepare our SEC filings on that company, we'd be in a position to do that. But we actually can't get ahead of ourselves on that right now.

Gary Stromberg - Lehman Brothers

Okay. And then you mentioned there is a low basis. Do you have an approximate number on what the basis is of this business?

Brian C. Voegele - Senior Vice President and Chief Financial Officer

Yes, from a tax standpoint, I think that if you were to assume somewhere in the range of $200 million, you would be pretty close. We continue to put capital into some of these rigs, and so the tax basis will increase slightly, but... from those levels. But when we looked at it here, that range is about where we have been over the last few years.

Gary Stromberg - Lehman Brothers

Okay. And then last one, how much leverage do think you could put on the new spinco. Hercules is around three times. Is that kind of ballpark in terms of leverage for the new entity?

Brian C. Voegele - Senior Vice President and Chief Financial Officer

That's pretty hard to handicap. I think in a spin-off transaction, I think that the... there is going to be some sensitivity about handicapping spinco with high levels of leverage. And obviously because of the way the tax rules work, we really can't put leverage on it that exceeds our tax basis without incurring tax friction that we are trying to avoid. So the efficiency of putting a high level or leverage prior to the spin on this really causes us to lean more towards less leverage, to be honest.

In terms of what spinco could ultimately withstand from a leverage perspective, that will be up to the, really, the new management team that comes in and what they see the growth prospects of the business and how they plan on running the company from the strategic point of view going forward.

Gary Stromberg - Lehman Brothers

Okay. But leverage is helpful in order to create a tax-free transaction, is that right?

Brian C. Voegele - Senior Vice President and Chief Financial Officer

No. To the extent the leverage exceeds our tax basis, it's just as if we sold the company and so it creates a tax liability, and that's the liability we are trying to avoid by spinning.

Gary Stromberg - Lehman Brothers

Got it. Okay.

Brian C. Voegele - Senior Vice President and Chief Financial Officer

And so if we were to put any leverage on it, we would be focused on that dynamic.

Gary Stromberg - Lehman Brothers

Okay, understood. Thank you very much.

Operator

Thank you. We'll go next to Michael Farrow [ph] with Millennium Partners.

Unidentified Analyst

Hi, good morning guys.

Louis A. Raspino - President and Chief Executive Officer

Good morning, Mike.

Unidentified Analyst

I wanted to ask question on tax rate and what that would look like for Pride after the spin, considering now you guys I guess are guiding for 25%. But if we remove all the Gulf jackups,will that tick [ph] the tax rate too?

Brian C. Voegele - Senior Vice President and Chief Financial Officer

I don't have a specific... any specific rate guidance. I can tell you directionally, it would be lower. My gut tells me we are probably below 20% on our effective tax rate. Cash tax rate would be lower than where we are today, which was mid to high teens. And so that would trend lower as well.

Unidentified Analyst

Okay, great. Then the other question is, I heard you guys said that you want to keep the independent-leg jackups within Pride. Can you just run by the thinking there of why it doesn't go with NewCo and why you decided to keep it with Pride?

Louis A. Raspino - President and Chief Executive Officer

Well with NewCo, we are trying to create a U.S. Gulf of Mexico and actually total Gulf of Mexico focused asset base. Those rigs don't necessarily fit in there. Those rigs are much more mobile internationally. And for right now, we've just made the decision that we'd like to hold on to that critical mass and we'll make decisions about that in the years to come.

Unidentified Analyst

Okay, great. Thank you guys.

Operator

Thank you. We'll next to Collin Gerry with Raymond James.

Collin Gerry - Raymond James

Hi, actually my questions have been answered. Thanks.

Louis A. Raspino - President and Chief Executive Officer

Okay.

Operator

We'll go next to Geoff Kieburtz with Weeden.

Geoff Kieburtz - Weeden & Co

Hi. Brian, could you give us an idea of what you think the annual OpEx inflation, just the core inflation rate is looking out into '09 and would it change under circumstances of spinning out NewCo?

Jeffrey L. Chastain - Vice President, Investor Relations & Communications

Geoff, let me interrupt you. Your line is cutting out. Can you may be pick up the handset? Thank you.

Geoff Kieburtz - Weeden & Co

Okay, I thought I was. Let me try one other thing here. How is that?

Jeffrey L. Chastain - Vice President, Investor Relations & Communications

Better.

Geoff Kieburtz - Weeden & Co

Okay. Okay, my question was, can you give us a sense of what you think the annual inflation rate is per day for rig kind of OpEx inflation and how would that change under the circumstances that NewCo was spun out?

Brian C. Voegele - Senior Vice President and Chief Financial Officer

Annual inflation, the guidance we've given on annual inflation is kind of in 13% to 15% range. And I think we are running on that track for this year. Again, we are still in the process of putting together our '09 budget. In fact, it's very early stages. So really don't have any guidance to share with you on '09. And I don't expect, as a result of the spin off, that we would see significant decrease in the inflationary pressures that we see simply because we spun off our mat jackups. I think that the pressures we are seeing are essentially industry wide.

Geoff Kieburtz - Weeden & Co

Okay. And kind of a bigger picture question for you Louis. We have heard different opinions across the contract drilling business about the relative value of diversification and global reach both in terms of geography and asset classes. And you are kind of clearly advocating the benefits of focus. Could you talk a little bit about how you see those trading off?

Louis A. Raspino - President and Chief Executive Officer

Jeff I have talked about this a lot in the past. I am a strong proponent of critical mass, especially in the day and age now where human resources are so difficult to come by. And the larger mass you have, the easier time you have in covering the cost of training and development and recruiting and everything else that goes along with creating the stable workforce. We believe, however, that we have the opportunity here to create something, as I said, is truly unique from a product perspective. And we call it up into the right, which is... up in quality of assets, a technical sophistication of assets. And that's what we are trying to do here. We are trying to create an investment alternative for investors that's not burdened...overly burdened. But an over diversification of classes of assets.

Now within the floaters and the deepwater and ultra-deepwater assets, there is going to be a lot a room for us to do something to grow a large company and a very significantly profitable company. That doesn't mean we won't look at premium jackups, for example. It just means that we don't intend for that to overwhelm the multiple that we are trying to create with a sharp focus on deepwater.

Geoff Kieburtz - Weeden & Co

Great, thank you.

Louis A. Raspino - President and Chief Executive Officer

Okay.

Jeffrey L. Chastain - Vice President, Investor Relations & Communications

Robbie,why don't we take one final question please?

Operator

Okay, we'll take our final question from Robin Shoemaker with Citigroup.

Robin Shoemaker - Citi Investments

Yes, thank you. Louis, wanted to ask you beyond this shipyard slot you have for late 2011, if you were to go beyond that and order an additional rig, what kind of... do you have an available option or is there... what is the timeframe in which you could expect to build and deliver another drillship or a semi?

Louis A. Raspino - President and Chief Executive Officer

Well, Robin, we are talking a lot about one right now. That doesn't mean that two or more could not be in the future. But we make decisions like that very carefully, very slowly based on what we see in the marketplace. Right now because we have access to a very attractive delivery based on what else is available in the market right now, and because we see a lot of interest from our customers, in all likelihood, we'll feel comfortable in moving forward with this commitment. We have opportunities and we have had discussions about more. But we are going to move very carefully here.

Robin Shoemaker - Citi Investments

Okay. Just... and we've seen a number of recent contract signings by between Petrobras and various new... some quite new drilling contractors. I wonder how well you know some of the companies that have signed these 10 year contracts with Petrobras, whether there is any interest in your part in exploring a role in what they are doing given your very strong presence in Brazil.

Louis A. Raspino - President and Chief Executive Officer

We know the companies very well, as I'm sure most contractors do. We have that on our radar screen as a possibility for growth potential in the future. We have an extremely significant presence in Brazil as you noted. We have a very strong relationship with Petrobras, and we are hopeful that we'll find opportunities to lever both our presence and our relationship into what might be developing in Brazil and with Petrobras, not just in Brazil, but around the world in a serious way in the years to come.

Robin Shoemaker - Citi Investments

Okay, thank you.

Louis A. Raspino - President and Chief Executive Officer

Okay.

Jeffrey L. Chastain - Vice President, Investor Relations & Communications

Okay, with that, we'll conclude today's call. I'd like to thank everyone for your participation and we'll remind you that the third quarter call 2008 is scheduled for October 30. Robbie, thanks for coordinating the call and good day to everyone.

Operator

You're welcome. That does conclude today's call. You may disconnect your lines at this time.

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