Helix Energy Solutions Group Inc (HLX) 2003 Q3 法說會逐字稿

Good morning and welcome to the third quarter earnings release conference call. All lines will be on listen-only mode until the question/answer session. Today's conference is being recorded. If anyone has any objections, you may disconnect at this time. I would now like to introduce Mr. Jim Nelson, Vice Chairman of Cal Drive [sic]. You may begin, sir.

S. James Nelson, Jr.: It's Cal Dive, not Cal Drive these days. Welcome everyone to the third quarter conference call. With me today are our senior management team: Owen Kratz, Chairman and Chief Executive Officer; Wade Pursell, our Chief Financial Officer; Jim Connor, our General Counsel; and from Aberdeen, Scotland, I believe we have Martin Ferron. Martin, are you out there?

I am, Jim.

S. James Nelson, Jr.: How's the weather in Aberdeen?

Pretty cold right now.

S. James Nelson, Jr.: In terms of format today, hopefully all of you have had a chance to look at the two-page shareholder report, the press release and the accompanying financial statement. I'll do a quick overview of some of the third quarter trends. Wade will talk a little bit about some financial matters mostly related to our debt position. Martin will come in and talk a little bit about our operations both in the third quarter but looking also at the fourth quarter activity. And then Owen has got his notes ready. We're all set. However, before we get to that fun, it is time to put our hands across our heart and do our version of the quarterly national anthem, which is Jim Connor doing the forward statement.

James Lewis Connor, III: Good morning. As noted in our press release and associated report, certain statements contained therein in our discussion today are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. For a complete discussion of risk factors we direct your attention to our press release and to our annual report on Form 10-K/A for the year ended December 31, 2002, filed with the Securities and Exchange Commission.

S. James Nelson, Jr.: Thanks, Jim. Let's get into the third quarter report. When you look at the improvements in both our top and bottom line, as well as cash flow, in the third quarter revenues were up 24%, earnings up 200% plus. In nine months our revenue is up 40%, earnings up 80%, cash flow up 84%. That is all coming, of course, in the period where marine construction, subsea market is in a significantly difficult market. That certainly highlights a business model that's combines marine contracting with oil and gas operations with those oil and gas operations providing utilization for our vessels.

In terms of the contracting businesses, the contracting contribution to gross profit was 31% in the third quarter, right on the target that we have for the year. If you look at our oil and gas operations, the combination of high commodity prices and our low-cost operating structure enabled our oil and gas subsidiary, Energy Resource Technology, to deliver 50% gross profit margins. That level of profitability was recognized recently in John S. Harold's (ph) [inaudible] 2003 global upstream performance review where our oil and gas operations were ranked 16th most profitable out of the 132 U.S. oil and gas companies reviewed. We have, of course, in addition to the existing properties and production, oil and gas production on the shelf, a quarter of a billion dollars of oil and gas investments in our Gunnison and Marco Polo Deepwater fields and production facilities which will be coming online in 2004.

Looking specifically at the third quarter, our revenues increased $20 million, 24%, most of that coming in oil and gas. Although the diversity in our contracting businesses was also apparent in a North Sea market, which is challenged. The sea oils volume was down from third quarter a year ago, yet that was more than offset by our Canyon robotics subsidiary and the trenching business that it was doing there in that market during the third quarter. Gross profit margins of 23% were up from 14% in the year-ago quarter and pretty much in line with the second quarter's 24%. You look at our debt position, our run rate in terms of EBITDA is running right about 31%, 32% of revenues. Our total debt was $227 million at the end of the third quarter, essentially unchanged from the beginning of the year. Wade will talk a little about e components of that and items related to Capex and so forth in a minute.

Turning to the operational highlights. Martin will talk more about what's happening in the Deepwater markets both construction and wellups. Two general points in terms of strategy. Utilization was good in the third quarter. Part of that was due to the fact we had four of our DP vessels out of the Gulf either all or part of the quarter. Utilization. One of our other key goals was the utilization of our three major vessels, the Q4000, the Intrepid and the Seawell (ph). What we've learned is that as long as we can keep those in the field, we limit the downside. Through nine months we've had almost 600 days of utilization for those three vessels, or 72%.

Turning to the shelf. We had a fairly good quarter, even in a year when there -- after the second year in a row there's no construction market on the shelf. That reflects the fact that most of our -- reflects our strong market position and our focus on life of field services of inspection maintenance and repair and the fact that we really don't have much competition on the shelf. In the salvage area for the first time in two years our Barge I saw a fair amount of activity working for the customers that are referenced.

Finally, with respect to oil and gas, you can read through the production and pricing figures that are given here in the operations review. The only unusual item is that we did resolve a dispute with an onshore separation facility, which has gone through three different owners. During the third quarter, it was -- they did agree with our calculation and that enabled us to sell 25,000 barrels of crude oil in a one-time transaction. Our margins actually were exactly 49% in the quarter. That reflects -- that was up from 45% in the second quarter. It's due to the improved efficiency that we have got in terms of operating [inaudible] large oil field that we acquired from [inaudible] and Shell.

That's the topics, so I guess the only other thing is with respect to oil and gas we're completing our well exploitation program this year. It's pretty much in line with our expectations. Our goal was to recover about 50% of our current production adding it back to the well exploitation efforts. With that, Wade, why don't you talk a little about some financial stuff?

Sure. On the Capex side, we've done $74 million through nine months now. The primary components being the Gunnison spar, $26 million; the Canyon MSA, $19 million; ERT well work program, $22 million; and the remaining $7 million maintenance Capex. I project in the fourth quarter that we'll do another $24 million of Capex with the major components being the Gunnison spar again for $9 million, another $12 million completing the ERT well work program, and the remaining $3 million being maintenance and other, bringing the total for the year near $100 million. Now, that doesn't include about $9 million that we'll have done for the whole year for [inaudible] work, which doesn't show up in Capex, but it is expenditures that reduce the liability.

On the debt side, Jim mentioned that we're near $230 million now at the end of the third quarter, which is pretty close to where we began the year. The components of that are mostly Myrad (ph), $139 million. We're still floating the interest on that debt around 1.5%. Our revolver is down to $36 million. The Bank One term loan is now up to $35 million. The rates on, I guess the revolver's floating at around 3.4% on the Bank One term loan is still floating at around 3.6%, so good interest rates.

We did enter into a new facility during the quarter, a five-year term loan over in the UK relating to the new trenches in one of the ROV. That's a $12 million dollar facility in the form of a capital lease. We were able to fix the rate on it at 3.29%, and having it over in the UK should help us with our overall tax rate, hopefully. One additional item it, if you are trying to reconcile for the total debt now. With the adoption of the new FASB 150, the near $4.9 million that we had in redeemable stock and subsidiary, that relates to our remaining obligation on the Canyon transaction. That is now being classified as debt under the new FASB as opposed to the mezzanine which is where we had it before. These debt levels at 9/30 put our debt-to-book capitalization at 37%. My projections for the end of the year have that dropping to 36%. We are in compliance with all of our debt covenants and we are actually creating some cushion as we go along. The one that I watch the closest, the debt to trailing EBITDA, for example, is now down below two times versus the 3 1/2 covenant restriction that we have.

I guess one more financial item. I might run through the hedges real quick on the oil and gas side. As of 9/30, and as of today, we have about half of our oil production for the fourth quarter hedged at an average price of $26.63. We have for next year about less than half, about 45% of our proven production, and that doesn't include our Gunnison production. But the proven developed production that we know about right now, we have 45% of that hedged at an average price of $26.30. We have a small hedge in place in July and August of '04 for 16% of our production at $26. On the gas side, for the fourth quarter, we have over half of our estimated production hedged as an average price of $4.31. And then in '04, for January through June '04 we have a little over 40% of our estimated gas production hedged in a no-cost collar with a floor of $5 and a ceiling of $6.60.

S. James Nelson, Jr.: Okay, thank you, Wade. Martin, if you can weigh in on some of the operational highlights and the outlook for the fourth quarter.

Okay, Jim. Starting with Quarter 3 highlights. As mentioned last time, July was a very quiet month, especially for the DP vessels. Then things got considerably better in August and September. In all, we achieved 78% utility for the DP vessels compared with 72% in Quarter 2 and 68% in the corresponding quarter last year. We managed to [inaudible] the Eclipse and the Mystic Viking outside the Gulf of Mexico and picked up a job off Long Island Sound for the Intrepid, which helped make up for slim pickings in home waters. Our shelf contracting fleet had a very good quarter with 67% utility compared with 55% in the second quarter. Same figure in Quarter 3 last year. September was kind to us weatherwise, unlike in the past two years when hurricanes spiritually wiped out all activity. We were particularly pleased in the quarter with the demand for our inspection repair and maintenance services in the surface diving area for the reasons Jim mentioned.

Canyon had a great quarter, their best quarter since we acquired them. And a particular highlight for me was that they successfully introduced state-of-the-art 750 horsepower trenching units on a very challenging job for North [inaudible]. We see a bright future for this asset both in the North Sea and the Gulf of Mexico. Here in the North Sea, we did well to keep the Seawell busy achieving 87% utilization; however, most of it was on non-wellups work for one of the new independent operators in the region. The [inaudible] for this type of work is low, for reasons I will go into later in the call.

Now to Quarter 4, what we see there. Going into the quarter activity levels are pretty robust for the DP fleet, for the Q4000, Intrepid and northern Canyon all employed on the Gunnison project. The latter two vessels will continue on the project into December with the Intrepid then transferring to the Marco Polo project in late December, early January. The Q4000 will finish her job in Gunnison this week and then we'll perform book construction and wellups work for the rest of the quarter. The Eclipse remains in the Middle East, and we hope to keep her there well into next year; however, we will cold stack the Witch Queen rather than perform an expensive dry-docking before demand in the Gulf of Mexico picks up. Uncle John will be taken out of Mexico for [inaudible] towards the end of this month. And at this stage we aren't uncertain whether she will return to Mexico or be deployed back in the Gulf of Mexico in the diving markets.

Activity levels for the shelf contracting fleet are declining to typical seasonal levels and, therefore, we plan to use this opportunity to dry it off to [inaudible] level one in December and January. The Seawell will achieve similar utility to quarter 3, though, again, most of it is on similar low-margin work like we did in Quarter 3. Maybe I'll use this opportunity just to update people on Gunnison and Marco Polo, Jim, yeah?

S. James Nelson, Jr.: That would be fine.

Okay. The heavy construction work has been completed on Gunnison. As I mentioned, we are now busy performing subsea hookup work, and production is right on schedule to commence in the new year. The heavy lift asset we used on Gunnison has now moved over to the Marco Polo web site so the TLP installation operations have started there. These activities, together with completion of pipe lay and now hookup activities are likely to take until early- to mid-January when we will achieve mechanical completion. We were encouraged to hear last week that Anadarko announced that another apparent find in Green Canyon 518, which is known at K2 North. Anadarko also said on that conference call that they fully expect this new discovery, together with K2, to be tied back to Marco Polo by early 2005. I can say that we share that expectation. Okay, Jim. I think that's it for now,. unless you want me to speak about --

S. James Nelson, Jr.: Yeah, while you are talking, Martin, why don't you just talk a little bit about the North Sea market. That was the market that surprised us this year and in terms of what -- just your view of being over there and any thoughts at this point on '04.

Yeah, okay. And generally all service activity in the North Sea has been pretty soft this year. Some are saying that the drilling activity is the worst in the last 25 years. Only 15 of the drill rigs out of 43 available are working today. And the day rates are sort of matching the local temperatures of the mid- to low-40s. The wellups market has been particularly badly hit by the negative tax changes of last year, and the shift of material field ownership from the majors to the new breed of independent operators. Just to put some meat on that bone, out of 13 well operations projects we had budgeted for this year, 9 of them were postponed or canceled leaving us to have to find non-wellups work for over 60% of the Seawell's time. So that was obviously a particular challenge that I'm very pleased our people here managed to succeed with. We kept the vessel busy albeit at near break-even rates in Quarter 3.

Another feature this year is that we will work for more than 160 days for first-time customers, these new breed of independent operators. It's difficult to predict when demand will pick up, and I don't see us planning for that next year. There is some talk of new tax incentives today here in Aberdeen so, obviously, that will help; but I think it will take a little bit of time for the independents to look at what they bought and actually plan to do some wellups work before the market [inaudible] accept.

S. James Nelson, Jr.: Okay. Thank you very much. In terms of '04 and guidance, we will not be taking any questions on that. We have a board meeting on the 10th of December to review our plan. So, Owen, you were going to talk really about some strategic issues as we look at the next couple of years.

Yeah. I mean, there's not much to say left about this year. As Martin just covered, most of the contracts are pretty well set for '03. The remaining variables, the most significant variables, would be just weather and our performance. We are still in the budgeting process and will be until mid-December, so we can't really give any guidance on next year's actual budget yet; but I can give a flavor for how we're looking at the year strategically.

Starting off with construction, we don't -- as Martin said, it goes beyond just the North Sea. We're not seeing anything in the leading indicators that would lead to us expect any kind of a significant increase in activities, especially to the level that would overcome the excess supply in our industry right now. So I'd say we're looking at another year like this last year, a very tough year. The only differences, I think, the pendulum may be swinging back from the extreme on contracting. I think the contractors driven by the dire straits of their balance sheets are taking less contract risk, and I think that bodes well for next year to continue. However, the P&L sheets are still driving aggressive competition for utilization and, of course, that comes at the expense of earnings.

I think there's three things that are key to performing in the construction market going forward. (1) is to minimize the earnings drag of vital assets. Obviously utilization is the biggest driver of profitability with a contractor. So a lot of things we'll be doing will be directed towards minimizing that exposure. (2) Would be to reduce direct cost spending, and (3) is avoiding contract risks, and I think there's been significant improvement in the contracting [inaudible] side, especially here at Cal Dive. More specifically in the regions of the North Sea, I think we're going to be a lot more aggressive towards all-well intervention and not just the high end. So we'll be seeking utilization through more aggressive pursuit of well intervention. I think we're also going to increase our efforts towards construction contribution in that market. And then on the robotic side, I think we're poised to build going forward on the technical success of our new 750 horsepower trencher, so that should bode well. All in all we might -- it's hard not to say that there's got to be improvement over '03. '03 was a tough year over there.

On the Gulf of Mexico side, minimizing the earnings drag of vital assets is really key. Towards that end, we've been working very successfully on reducing the fleet size in the Gulf of Mexico and next year we'll have primarily just the Intrepid and potentially the Uncle John as our fleet, two of our most capable construction assets here. We'll be increasing our marketing of independent ROV work, helping Canyon out. We'll be trying to put the Mystic Viking and Trinidad on a more full-time basis, the Merlin into ROV support, the Q4000 potentially in Mexico and the Witch Queen we are looking at stacking for the year along with keeping the Eclipse for the full year committed to Southeast Asia. So that's quite a bit of difference that we've accomplished this year.

On the shelf side we're going to aggressively maintain our market share. That is the pretty steady state market force driven by inspection, repair and maintenance kind of work. I mentioned that we would bring the Uncle John back and possibly but the Q4000 in Mexico. That begs the question about whether it's our role in well intervention here next year. And I see us continuing to be aggressive in that the Uncle John was a good intervention vessel. And with the rigs available, there's all kinds of opportunities for us to continue to build on the credibility that we've established there now. I mentioned the Eclipse of Southeast Asia. She will be there for the full year. That should help out with the robotics efforts in Southeast Asia allowing us to build a stronger contracting presence in the region. So that's gearing towards future growth.

The biggest thing that we're doing right now, though, is our reorganization of the company. The object here is primarily to gain efficiencies and reduce direct spending, which is the second point I mentioned that's key to profitability. We're actually planning on an increase in SG&A, but that will be coming from incentive raises given to existing personnel with triggers tied to direct spending, so we should see an overall benefit from that.

Moving onto production. We've not been active in the market to the extent that we've made any acquisitions recently. We've been focused more on enhancing the production on our existing acreage. We had the luxury, from being aggressive in the recent years here, of having enough acreage that that could continue for another year, so we're not pressed at all to increase our acquisitions efforts. We'll let the market dictate that. We'll be totally reactive to the market. If we become comfortable with the pricing levels going forward, you could see us get a lot more aggressive on the acquisition side there, especially in the context of PUD (ph) acquisitions. We do have a goal of at least one PUD acquisition next year.

Moving on to Gateway. I think that's a business model that is proving to be very successful for us. We're on the verge of reaping the benefits there with it going into service. And we do anticipate continuing our bidding activity and we would expect one Marco Polo-type of deal during next year, just to give you a flavor for some of the assumptions that we're operating under in our budgeting process. The priority for us, though, will be to hold our debt level at current levels or reduce it. That's a big priority; however, a more detailed capital allocation plan will be presented to everyone at the time that we release the budget. In essence, though, we have very good business models going on right now, and I think the task for us is just to focus on the existing models. We're right on the verge of reaping the harvest on our Gunnison and Marco Polo endeavors, and I think because of that and what we're focusing on internally, our strength relative to our peers will just increase going forward. So I guess to sum it up, spending discipline and patience are going to be the watch words for '04 for us.

S. James Nelson, Jr.: Thank you, Owen. Just to sum up everything. The earnings visibility and cash flow that we have coming from the harvest that Owen mentioned gives us a buffer that buffers the uncertainty surrounding exactly when and what sort of recovery we are going to get in our contracting businesses. With that, we're ready to field questions.

Thank you. At this time, we'd like to begin the question-and-answer session. To ask a question, please press star 1. You will be announced prior to asking your question. To withdraw your question, you may press star 2. Once again, to ask a question, please press star 1. Our first question comes from Jim Rollyson of Raymond James. You may ask your question.

Good morning, guys.

S. James Nelson, Jr.: Good morning, Jim.

Owen, you kind of talked about, I guess, looking at next year with the mindset that things are going to be kind of consistent with this year as an overall market. But at the same time you kind of threw out a few things that were -- sounded like incrementally positive, like Canyon with the new trencher, maybe moving around some assets, again, in different markets, working on the cost side of the equation. So if you kind of assume the market's the same, and I realize you guys will probably get into more detail when you provide your guidance, but do you think your revenue potential and, probably more importantly, your profit margin potential next year is going to be a little bit better even in a flat market?

Speaking just about the construction side?

Yeah.

Because obviously revenues are going to be hugely up next year overall along with profitability --

Just the marine contracting.

The marine contracting? I actually think that revenues -- and this is really guesswork at this point until we assemble all of the pieces of the construction puzzle -- I'd imagine that revenues will be level to slightly down with margins slightly up for a net consistent year next year with this year.

Okay. And, Wade, if you look at the SG&A -- and, again, I realize you'll probably add to this when you give guidance -- but it's been running consistently kind of $8.5, $9 million here. As you go forward into next year and add in Gunnison, your ERT business used to have a big kicker in there for the upside that the bonus is paid out to the ERT guys. Is Gunnison going to flow through in a similar fashion, or is that going to be kind of just a separate stand-alone business?

Separate. It will be a separate stand alone.

Any guess on the run rate for G&A as we go into next year and even the fourth quarter?

We'll give you some really good details in December on that. But as Owen mentioned, it's probably going to be a little higher with what we're doing; but on an overall basis, you should see some reductions take place in other areas on the income statement like above the line.

Sure.

You're speaking, Jim, just of ERT?

No, this is all SG&A --

Oh, okay. I'm sorry.

Sure. And I guess lastly here you talk about Anadarko's announcement on K2. Timing on that potentially at this point?

Martin, did you hear anything on the conference call?

Well, what I'm hearing is that they are targeting early '05 for both K2 and [inaudible] K2. It's unclear whether those two fields are going to be be developed together or separately at this point.

And, obviously, you guys get the flow through through the production facility, but any early indications on whether you'd get the work?

We'll get some of the work. It depends on the pipeline configurations, the pipe sizes in particular. So we're talking to the operatives about that right now.

Okay. Thank you, guys.

James [sic] Stone of UBS, you may ask your question.

S. James Nelson, Jr.: Jamie, are you there?

Yeah, I'm sorry, I was on mute. Trying to be a good citizen. In just -- you mentioned, Martin, talking about the lift chip is out working on Marco Polo now. I guess there's been some stuff in the press that because of the weather problems that you had in the deep gulf this summer that the lift ship is late. Has that set your construction schedule and your production start date or mechanical completion date behind on Marco Polo at this point? And does that change, Jim or Wade, your revenue expectations or profitability expectations for '04 on Marco Polo?

Well, on the construction side of things, we're two to three weeks behind where we had hoped to be at this point. So that's not a material delay considering all of the bad weather that's been prevalent in the Gulf or the heavy lift vessel. It's not a major delay.

In terms of earnings, we had always assumed mechanical connection right around the first of '04 and that we wouldn't see any throughput until sometime late in the first quarter.

Okay. And when did your -- the way the contract works, you get paid part of your number that's coming up at mechanical completion, right, the demand charge?

Yeah.

That's right.

And then throughput charge starts when you have throughput, right?

Right.

Okay. And, Owen, can you talk a little bit about the opportunities for -- I guess we're kind of back where we were at the beginning of the year just looking at the Q4000, should you take it to Mexico, should you not take it to Mexico. What would be involved with the vessel if you did take it to Mexico? Are we still looking at the same sort of accommodations or [inaudible] contract in Mexico? Are the economics any better on that today than they were nine months ago when you talked about it last?

Well, Jamie, it's actually the same contract that we've been talking about all year. I know I've lost a lot of sleep trying to figure out the best course of action here. We have more need for the Uncle John in the Gulf of Mexico right now with what we've done with our fleet deployment. The Capex required for converting a vessel for this contract -- also, there was more Capex involved to put the Uncle John on it than there would be for the Q4000, and I really didn't want to spend the capital. Then with all of the projects in the Gulf of Mexico shifting to the right, what we need there is a tighter market on rigs and more subsea [inaudible]. And we've always anticipated having the Q4000 early in the market so we can build credibility. We've done that now. But with the shift to the right on all of these projects, what's happened is that she's not only early, she's way early. We don't really see that market opening up for her profitably for another two years. So instead of running the risk of working her here at a $2 million-a-year loss, we've elected to go ahead and bid the Q4000 in Mexico essentially on break-even terms.

Okay.

Does that answer or is that --

Well, what we are considering doing is just protecting the downside. Break-even would also be a significant positive cash flow because it's after depreciation.

Yeah. It's not something I like, but it's reacting to the market. And like I said before, the first thing is protecting against the downside of idle assets, drag on earnings, and that's primarily what's motivating it.

Okay. And if in the North Sea market, Martin, for the Seawell, there's been some talk lately about a pick up in well abandonment work. Can you talk about that and perhaps the Seawell's role or potential role in that aspect of the market?

Yeah, we certainly expect a lot of well [inaudible] work next year judging by what the operators are telling us, Jamie. I'm certainly [inaudible] right now and Owen's going to join me tomorrow to discuss how we can maximize our participation in that. So year on year we're certainly expecting to pick up and a lot more utilization from the well abandonment market.

Jamie, that's specifically what I was referring to in my bullet point of becoming more aggressive towards all well intervention in the UK. That's work that we really haven't pursued aggressively, and I think we'll look forward for contribution to utilization this year.

Okay. That's all I have. Thanks.

Bill Herbert of Simmons & Company, you may ask your question.

Good morning.

S. James Nelson, Jr.: Good morning, Bill.

Wade, recognizing that it's early days and you're still in the process of formulating your budget for next year, any early parameters with respect to capital spending guidance for '04? Generalities, nothing more.

I think generally speaking, I stand by what we were talking about last quarter, which is, I believe in the $60, $65 million range.

Okay. $60 to $65 million. And that does not include, perhaps, an equity contribution for the Marco Polo look-alike were to you do another one?

Correct.

Okay.

That's essentially maintenance Capex on the vessels and a well work program for ERT along with some abandonment.

Okay. Can you divulge what the potential capital commitment would be for the Marco Polo look-alike and '04 were you to do that? Because what I'm trying to get a sense here sources of uses of cash and what's going to be left over to the paydown debt which is, obviously, a top priority.

Bill, I think a lot of the answer to that rests in the timing; and we won't really know that until the award -- it depends on when the process starts. But I think your rough numbers, I think you are looking at $70 million total.

It's $70 million total, and what would be your contribution?

That would be our contribution.

Okay.

I think that would be split over '04 and '05.

Yeah.

Okay. Because if you do $65 million in Capex next year excluding this TLP, you've got, at least by my estimates, a pretty decent amount of free cash flow and we would hope that the majority of that would be deployed towards debt paydown. And, Owen, you made the comment that you envisioned sort of being flat to down, basically, is what I understood to you say with respect to as '04 evolves. So can you discuss maybe a little bit more comprehensively what you view as your uses of free cash, and what you'd like to see your capital structure balance sheet look like by the end of next year?

Well, the details will release with the budget.

Okay.

But I can tell you my priority is to see us pay down as much debt as our free cash flow will allow.

Okay.

That is our priority. The only caveat to that would be a Gateway deal or production opportunities that were just off the scale on returns.

Okay.

That's what makes me hedge my statement to saying I don't see us increasing our debt to do that, but I could see keeping our debt at the current levels if the right opportunities presented themselves.

Now, to understand what off the scale returns mean, Marco Polo kind of all in you are looking at a high teens rate of return, if I am not mistaken?

Right.

Okay. Would you characterize that as off the charts or you want something substantially more than that?

Bill, that return is much higher if Marco Polo was full.

Right. I understand -- I'm trying to understand exactly what would qualify as off the charts return that would preclude you from paying down debt?

I can give you that. Overall, I would love to achieve a 15% return on capital in the company. I think historically we've been there. Our aggressive capital expenditures have us below that right now, but I think we'll return to that when the pricing leverage returns in the construction market. So I would say in order to strive towards that goal [inaudible] in excess of 15% return on capital we'd be looking at; and in order to counteract the current trend in the construction market, I'd say we'd be looking at high teens or 20s to justify the capital expense.

And when you are talking about a $70 million commitment with respect to your portion of this, this would be total capital or this would be the equity component?

I believe that's equity component.

Okay. And this will be spread out over two years, '04 and '05? And when do you think, were this to be announced, it would be announced?

I really have no clue there. The guess that the capital component right now is pure guesswork on my part. I haven't been -- all I've given you is what I use from a very top overview for setting aside capital allocations. So what the actual number would be is completely guesswork for me at this point.

Okay. We'll wait until the details are forthcoming. And, then, with respect to the Witch Queen, going to be stacked, what do you think is the likely possibility for that vessel? I guess the question is No. 1, do you have to do a good deal of work here on the vessel; and, if so, is the capital commitment probably more than you are willing to put forth given what the return parameters on that capital investment are likely to be in a difficult offshore construction market? And, accordingly, would that vessel likely be retired if the market kinds of stays the way it is for the foreseeable future?

We're not planning to retire the vessel, Bill. The vessel, systemwise, you have two components of the vessel. Basically, the the systems and then the steel.

Right.

The steel is what needs work on the Witch Queen. The systems are all very modern and new. We just don't see the activity in the market right now justifying the capital for the steel replacement. But steel replacement is something that's very easily done later on, and we have talked with the [inaudible] association for doing that at a later date. So what I'm doing is basically just postponing the capital investment until the market warrants.

And were you -- and should the market support that capital investment, what would be the [inaudible] of the capital investment required to sort of make the vessel more viable?

Between $5 million and $8 million.

All right.

The other option is that she is a very marketable vessel, but I certainly wouldn't even consider of selling. Our balance sheet isn't --

no, sure. Absolutely. And just out of curiosity, Jim or Wade, what's the vessel on the books for?

$8.5 million.

Okay. Thank you.

S. James Nelson, Jr.: I guess the only thing I'd add, your earlier questions, Bill, is that our corporate target is to get our debt-to-total capitalization down to 30% and that is what we're talking about. Let's go to our next question, if we have one.

Gary Russell of Stifel Nicolaus, you may ask your question.

Good morning.

Hey, Gary.

First question, I wanted to get you guys to elaborate a little further, if you would, on the marine construction margins over the next couple of quarters. Given the insurance hit there in the second -- in this third quarter as well as also given Owen's comments to Rollyson about expectation for margins to improve year-over-year.

S. James Nelson, Jr.: Our goal for our DP fleet, the construction fleet this year, is 15%, Gary. And my guess is we'll be pretty close to that.

Okay. Also, more of a [inaudible] question. Deepwater development, the outlook for that over the next year or two, particularly Gulf of Mexico, we've got less rigs drilling in the Deepwater currently. I'm starting to run into questions from people wondering how long does it take for that to lead to the backlog of development projects to start to trail off considerably? And Owen's comments kind of speak to that point already, given your plans to move assets out of the Gulf; but I was wondering if you could comment on your views for that market trend specifically?

S. James Nelson, Jr.: We're moving into a period of development right now, Gary, coming off of that high level drilling activity. earlier. So you'll be seeing in '04, '05, '06, particularly in the Gulf, is developing some of the [inaudible] that have been made and you are seeing an increase in the number of host facilities that are out there.

Okay. Yeah, some of the concerns I'd run into is more looking out a little beyond '04. But what you're saying then is you still feel confident that you've got growth in the outlook for that over the next few years?

S. James Nelson, Jr.: The market will be at least what it is here. And what I'm saying, the drilling, given the Deepwater, you are looking at three to five years down the road before you get to development.

Gary, I mentioned that we don't see any leading indicators leading us to expect any increase in '04. Personally, I would extend that to '05, and I can't see beyond that. I think you first have to see the rig count increase; and, then, from that moment, whenever that moment arrives, then you are looking at at least a year from that point, which is why I'm confident in saying '05 is probably going to be as slow as '04 because you aren't seeing the increase now. And you'd have to see it now in order to see '05. But having said that, I think there are opportunities to make money in this market. It's just a matter of focusing your business model a little bit on the utilization and cost sides. Everybody is going to be bidding low margins here, and the the oversupply's not going away for at least a couple of years but that doesn't mean that there's not opportunities to improve the earnings picture.

Yeah. I think it's -- we've been doing this for 20 years. We've had what, 2 good years, so the other 18 we've learned how to make money in the Gulf market.

And quite honestly, the upside may actually come from a contract and supply rather than an increase in demand.

Okay that's helpful. And then last question, shallow water market, you mentioned you had a real strong quarter here and here in the third quarter, and then you also mentioned your plans to continue to defend your share in that market. Can you talk a little bit about the margin side of that market as well? How it was in the third quarter, and what you see going forward there as well?

They are reasonably good margins, Gary, in the n the 20% range.

Going forward, Martin, you might be able to speak to the current margins a little better than I. But going forward it is a pretty steady state market there for us and we're able to control margins a little better because the demand is not driven by development and we do have such large market share.

S. James Nelson, Jr.: Martin, are you there?

Yeah. I can pitch in on that one, sure. Margins are best, as we mentioned, in the years where we have the highest market share in the shallow water IRM markets. They're there in the 20s and even early 30s. But then the construction work, construction support in the midwater depths, demand for that has been very low this year, so our margins have gone south with that demand.

What you have seen in the evolution of the shelf -- it used to be dominated primarily with just two contractors, ourselves and Stolt (ph). And I think what you are seeing now is the same number of assets that redeployed a little bit, Stolt (ph) has reduced their assets some, we have reduced our assets some, and you've seen some smaller contractors pick up assets. What that means is you have got the same number of assets but actually more competitors, therefore, the bidding gets a little tighter. But again, we're better positioned there to hold the margins up.

S. James Nelson, Jr.: Anything else, Gary?

One last question since you mentioned that name of that company. I'll just ask, have you seen any better behavior from them in terms of bidding, shallow water or deep water?

I believe so. I won't get into any specifics, but I think, in general I think all of the contractors are very cognizant of the fact that they've got to quit taking all of the contract grids for the sake of utilization because the downside of the poor performance is just too great. It's one thing to bid low margins and basically taking the lose less mentality. That's almost acceptable in this kind of a market, as long as you are not taking catastrophic risk. With Tom Merrick (ph) at the helm over there, I know Tom well enough to be confident of what his position on that kind of philosophy is.

Great. That's all have I. Thanks.

James [sic] Stone of UBS, you may ask your question.

Owen, you mentioned that you think that the potential stimulus could come from the supply side of that market not from the demand side. Can you talk about what you are seeing, or can you maybe expand on that thought in terms of a changing balance of supply of assets?

Well, I don't see anything more than you guys do, Jamie. Just the balance sheet and the economic woes of the competitors that think it's creating better competitors. And I think it's inevitable that our industry does go through some consolidation but as to what or when that would happen, I'm as clueless as anyone else. So consolidation in our industry is a very nebulous concept.

S. James Nelson, Jr.: Jamie's also getting at the supply number of vessels in the market in terms of contracting.

That's what I'm getting at. You are seeing right now -- you've got -- let's see. Stolt's (ph) got six vessels that they packaged. You've got probably another six from other contractors. I think come the spring you'll probably see a slew from the Norwegian vessel owners. I think come spring you are going to see a huge number of vessels potentially on the market. I think I read in one of the research reports out of the UK that there's something like 100 ROVs on the market right now. Personally, I don't know who's going to buy them; but they either get purchased through -- which is further consolidation in a sense or they get cut up at some point.

And then --

S. James Nelson, Jr.: Go ahead, Jamie.

You talked about on the ERT side your goal this year on the workover program was to basically replace about 50% of what you produce so that you are kind of on track with that?

S. James Nelson, Jr.: Yeah. If we produce 28 to 30 bcf, our goal would be to add 14, 15 in terms of well exploitation; and it looks like we're on track to do that.

And excluding the impact of Gunnison on production next year, what's kind of the run rate on the core based -- on the core production?

S. James Nelson, Jr.: It's been running 7. I think if we look at next year the number we've looked at is something in the range of coming down to 25. That assumes that we don't do much in the way of well exploitation work.

And is the inventory work, how does that look compared to where you were at the beginning of the year or compared to maybe normal times for your portfolio?

S. James Nelson, Jr.: Well, as Owen mentioned, we picked up a ton of properties with the large Shell and Hess acquisitions. We're only halfway through working on that package, so next year we'll continue to work on that. We've got at least this year and next year in terms of the properties we acquired in late '02.

So it's conceivable that production on the core will be flat next year given that you're more likely than not in an environment where you have plus $4 gas to do those exploitation opportunities?

S. James Nelson, Jr.: That would be a goal, yeah.

All right. That's all I had. Thanks.

Once again, to ask a question, please press star 1. And we have a question from Blake Hutchinson from Howard Weil. You may ask your question.

Good morning, guys.

S. James Nelson, Jr.: Good morning, Blake.

Just checking -- I apologize if I missed this in your earlier commentary -- I know you gave some good guidance as to when the installation of both Marco Polo and Gunnison would take place. Are you able to offer at this point any insights -- because I know it's changed from time to time -- from the partners with regard to the production ramp up from Gunnison posthookup through kind of '04 and into '05?

S. James Nelson, Jr.: That is a Kerr McGee question.

So nothing you guys are able to offer at this point?

S. James Nelson, Jr.: No.

Okay. That's all I had.

At this time, there are no --

S. James Nelson, Jr.: Owen was going to come in a little bit on that question.

Just a follow up. Well, not on that one, on Jamie's. When I mentioned all of the vessels on the market, I just want to be real clear in case there's brokers listening. Don't send me the packages. [general laughter] We're not interested. We will not be buying another vessel this year.

S. James Nelson, Jr.: Any other questions out there?

At this time there are no further questions.

S. James Nelson, Jr.: All right. Thanks, everybody. We'll be here February, what 19th, 20th, something like that, which is a little later because it coincides with completing the annual audit. We will have our board meeting on December 10th to go through our plan for '04 and, obviously, some specific guidance will be forthcoming after that. Thank you very much.