General

6 Months Ended

Jun. 30, 2011

1. General

Hercules Offshore, Inc., a Delaware corporation, and its majority owned subsidiaries (the “Company”) provide shallow-water drilling and marine services to the oil and natural gas exploration and production industry globally through its Domestic Offshore, International Offshore, Inland, Domestic Liftboats and International Liftboats segments (See Note 12). At June 30, 2011, the Company owned a fleet of 50 jackup rigs, 17 barge rigs, two submersible rigs, one platform rig, and 60 liftboat vessels and operated an additional five liftboat vessels owned by a third party. The Company’s diverse fleet is capable of providing services such as oil and gas exploration and development drilling, well service, platform inspection, maintenance and decommissioning operations in several key shallow water provinces around the world.

In May 2011, the Company completed the sale of substantially all of Delta Towing’s assets and certain liabilities (See Note 5). Accordingly, the Company has recast certain prior period financial information to reflect the results of operations of the Delta Towing assets as discontinued operations for all periods presented.

In February 2011, the Company entered into an asset purchase agreement (the “Asset Purchase Agreement”) with Seahawk Drilling, Inc. and certain of its subsidiaries (“Seahawk”), pursuant to which Seahawk agreed to sell the Company 20 jackup rigs and related assets, accounts receivable, accounts payable and certain contractual rights. On April 27, 2011, the Company completed the Seahawk asset purchase (See Note 4).

The consolidated financial statements of the Company are unaudited; however, they include all adjustments of a normal recurring nature which, in the opinion of management, are necessary to present fairly the Company’s Consolidated Balance Sheet at June 30, 2011, Consolidated Statements of Operations and Consolidated Statements of Comprehensive Loss for the three and six months ended June 30, 2011 and 2010, and Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010. Although the Company believes the disclosures in these financial statements are adequate to make the interim information presented not misleading, certain information relating to the Company’s organization and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted in this Form 10-Q pursuant to Securities and Exchange Commission rules and regulations. These financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2010 and the notes thereto included in the Company’s Annual Report on Form 10-K, as amended on Form 8-K filed July 8, 2011. The results of operations for the three and six months ended June 30, 2011 are not necessarily indicative of the results expected for the full year.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. On an ongoing basis, the Company evaluates its estimates, including those related to bad debts, investments, derivatives, property and equipment, income taxes, insurance, percentage-of-completion, employment benefits and contingent liabilities. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.

Investigations

On April 4, 2011, the Company received a subpoena issued by the Securities and Exchange Commission (“SEC”) requesting the delivery of certain documents to the SEC in connection with its investigation into possible violations of the securities laws, including possible violations of the Foreign Corrupt Practices Act (“FCPA”) in certain international jurisdictions where the Company conducts operations. The Company was also notified by the Department of Justice (“DOJ”) on April 5, 2011, that certain of the Company’s activities are under review by the DOJ.

The Company, through the Audit Committee of the Board of Directors, has engaged an outside law firm with significant experience in FCPA-related matters to conduct an internal review, and intends to cooperate with the SEC and DOJ in their investigations. At this time, it is not possible to predict the outcome of the investigations, the expenses the Company will incur associated with these matters, or the impact on the price of the Company’s common stock or other securities as a result of these investigations.

Permanent Importation

On May 16, 2011, the Company initiated the permanent importation of Rig 3, its platform rig under contract in Mexico, and related equipment and spares into Mexico, at a net cost of approximately $8 million. The net cost consists of a cash payment of approximately $13 million, including approximately $5 million of value added tax, which the Company expects to fully recover as provided by Mexican law.

Revenue Recognition

Revenue generated from the Company’s contracts is recognized as services are performed, as long as collectability is reasonably assured. For certain contracts, the Company may receive lump-sum fees for the mobilization of equipment and personnel. Mobilization fees received and costs incurred to mobilize a rig from one market to another under contracts longer than ninety days are recognized as services are performed over the term of the related drilling contract. Additionally, the initial fair value of the warrants and 500,000 shares issued from Discovery Offshore have been recorded to deferred revenue to be amortized over 30 years, the estimated useful life of the two new-build Discovery Offshore rigs (See Note 3). Amounts related to deferred revenue, including revenue deferred related to the Company’s construction management agreements with Discovery Offshore as well as the warrants and 500,000 additional shares received from Discovery Offshore, and deferred expenses are summarized below (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
Revenue deferred	$	1,492	$	—	$	26,025	$	600
Expense deferred		2,149		—		3,498		—
Deferred Revenue recognized		5,543		5,295		10,775		10,222
Deferred Expense recognized		633		760		1,219		1,761

For certain contracts, the Company may receive fees from its customers for capital improvements to its rigs. Such fees are deferred and recognized as services are performed over the term of the related contract. The Company capitalizes such capital improvements and depreciates them over the useful life of the asset.

The balances related to the Company’s Deferred Costs and Deferred Revenue are as follows (in thousands):


		As of		As of
	Balance Sheet	June 30,		December 31,
	Classification	2011		2010
Assets:
Deferred Expense-Current Portion	Other	$	4,149	$	1,824
Deferred Expense-Non-Current Portion	Other Assets, Net		3,126		3,172
Liabilities:
Deferred Revenue-Current Portion	Other Current Liabilities		12,126		12,628
Deferred Revenue-Non-Current Portion	Other Liabilities		15,752		—

Percentage-of-Completion

The Company is using the percentage-of-completion method of accounting for its revenue and related costs associated with its construction management agreements with Discovery Offshore, combining the construction management agreements, based on a cost-to-cost method. Any revisions in revenue, cost or the progress towards completion, will be treated as a change in accounting estimate and will be accounted for using the cumulative catch-up method. As of June 30, 2011, $14.0 million has been recorded as a deferred revenue liability of which $0.8 million was recognized during the three and six months ended June 30, 2011 under the percentage-of-completion method of accounting. Additionally, $0.7 million in cost was recognized during the three and six months ended June 30, 2011 under the percentage-of-completion method of accounting related to activities associated with the performance of contract obligations.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are stated at the historical carrying amount net of write-offs and allowance for doubtful accounts. Management of the Company monitors the accounts receivable from its customers for any collectability issues. An allowance for doubtful accounts is established based on reviews of individual customer accounts, recent loss experience, current economic conditions, and other pertinent factors. Accounts deemed uncollectible are charged to the allowance. The Company had an allowance of $20.9 million and $29.8 million at June 30, 2011 and December 31, 2010, respectively. The change in the Company’s allowance during the six months ended June 30, 2011 related primarily to a payment received from a customer in its International Offshore segment.

Other Assets

Other assets consist of drydocking costs for marine vessels, a derivative asset, other intangible assets, deferred income taxes, deferred operating expenses, financing fees, investments and deposits. Drydocking costs are capitalized at cost and amortized on the straight-line method over a period of 12 months. Drydocking costs, net of accumulated amortization, at June 30, 2011 and December 31, 2010, were $6.4 million and $5.9 million, respectively. Amortization expense for drydocking costs was $4.1 million and $7.8 million for the three and six months ended June 30, 2011 and $3.4 million and $7.6 million for the three and six months ended June 30, 2010, respectively.

Financing fees are deferred and amortized over the life of the applicable debt instrument. However, in the event of an early repayment of debt or certain debt amendments, the related unamortized deferred financing fees are expensed in connection with the repayment or amendment (See Note 6). Unamortized deferred financing fees at June 30, 2011 and December 31, 2010 were $11.1 million and $11.4 million, respectively. Amortization expense for financing fees was $1.0 million and $1.9 million for the three and six months ended June 30, 2011, respectively and $0.8 million and $1.7 million for the three and six months ended June 30, 2010, respectively, and is included in Interest Expense on the Consolidated Statements of Operations.

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand, demand deposits with banks and all highly liquid investments with original maturities of three months or less.

Restricted Cash

The Company’s restricted cash balance supports surety bonds related to the Company’s Mexico and U.S. operations.