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Executives

Juan Pablo Tardio - VP and CFO

Hans Helmerich - President and CEO

John Lindsay - EVP and COO

Mike Drickamer - Director of IR

Analysts

Robin Shoemaker - Citi

Arun Jayaram - Credit Suisse

Scott Gruber - Bernstein Research

Joe Hill - Tudor, Pickering, Holt

Victor Marchon - RBC Capital Markets

Dave Wilson - Howard Weil

John Daniel - Simmons & Company

Thomas Curran - Wells Fargo

Waqar Syed - Macquarie Capital

Thad Vayda - Stifel Nicolaus

Mike Breard - Hodges Capital

Helmerich & Payne Inc. (HP) Q1 2011 Earnings Call January 27, 2011 11:00 AM ET

Operator

Good day, and welcome to the Helmerich & Payne first quarter earnings conference call. All lines are currently in a listen-only mode. Later, you will have the opportunity to ask questions during the question-and-answer session. And please note the call is being recorded. It's now my pleasure to turn the conference over to Juan Pablo Tardio, Vice President and CFO at Helmerich & Payne, Inc. Please go ahead.

Juan Pablo Tardio

Thank you and welcome, everyone. With us today are Hans Helmerich, President and CEO, John Lindsay, Executive Vice President and COO, and Mike Drickamer, Director of Investor Relations. I will make some general introductory comments and will then turn the call to Hans for his and John's comments.

As usual, all forward-looking statements made during this call are based on current expectations and assumptions that are subject to risks and uncertainties as discussed in the company's annual report on Form 10-K and quarterly reports on Form 10-Q. The company's actual results may differ materially from those indicated or implied by such forward-looking statements. We will also be making reference to certain non-GAAP financial measures, such as segment operating income and operating statistics. You may find the GAAP reconciliation comments and calculations on the last page of today's press release.

Income from continuing operations during the first fiscal quarter resulted in approximately $104 million or $0.96 in diluted earnings per share, representing a 25% increase in earnings as compared to the immediately preceding quarter. The significant improvement was primarily driven by a 33% increase in operating income corresponding to our US Land Operations, which sequentially reported a 6% increase in quarterly revenue days and a 15% increase in average rig margins per day.

Although, we expect market conditions in the US to remain strong and perhaps even continue to improve during the second fiscal quarter, we also expect to experience a decline in our International land segment in terms of both activity and margins. Given the increased number of customer commitments that we have for new FlexRigs to be completed this year and the level of rig component orders that are required to ensure our ability to effectively respond to additional new FlexRig demand, our capital spending estimate for fiscal 2011 has increased from $600 million, as previously disclosed, to approximately $750 million.

At this point, we plan to fully fund the capital spending from existing cash and from cash to be provided by operating activities during the remainder of the fiscal year. If needed, however, we have ample access to additional funding through our existing $400 million revolving credit facility. The company's debt level declined from $360 million at the end of the last fiscal year to $350 million at the end of this first fiscal quarter, and the corresponding debt to cap ratio remains at approximately 11%. Interest expenses after capitalized interest are expected to total slightly under $4 million per quarter during the remainder of fiscal 2011.

Our investment portfolio, primarily comprised of 8 million shares of Atwood Oceanics and 967,500 shares of Schlumberger, recently had a pre-tax market value of slightly over $400 million, and an after-tax value of approximately $260 million. Our tax rate for continuing operations during the remaining quarters of fiscal 2011 is at this point, expected to be approximately 37%.

I will now turn the call to Hans Helmerich, President and CEO, and after Hans and John Lindsay have made their comments, we will open the call for questions.

Hans Helmerich

Thanks, Juan Pablo, and good morning. We are encouraged by the progress we posted during the company's first quarter. Our US domestic business was stronger than we had expected, achieving both increases in revenues and declines in expenses. We're also pleased to announce eight additional new build orders. Before John takes us through the operating detail, allow me to make a couple of comments on general market conditions.

Strong oil prices and the ability of our customers to shift their drilling targets to oil and gas liquids rich plays has been a very positive driver for the service providers in the US market. For at least 30 years, the fortunes of the domestic oilfield service business were closely tied to the ups and downs of natural gas pricing. While natural gas will be critical to the future of the domestic energy picture and to our business, we now have nearly 60% of our US fleet drilling for oil and gas liquids versus a more traditional dry gas target.

As the oil count marches toward the 800 rig level, customers are incorporating much of the new technology and complex well designs that have made the gas shale plays such a game changer. Not long ago, a shift to oil drilling would have been considered a negative for us since so much of the activity used to be shallow, vertical, bread-and-butter type drilling. Well that has changed today; with the strong emphasis on directional and horizontal drilling, the new mix plays to our strengths.

Consider the Permian Basin and activity there since the peak of October 2008. We've seen our rig count more than double in that market as customers favor the higher performing rigs to match their more complex well designs. At the same time, our two largest competitors have seen their activity levels fall approximately 27% and 40%, respectively, in that same market. It is consistent with the theme we have addressed for a long time.

Older conventional equipment is increasingly less suitable to the customer needs in today's drilling complexity for both oil and gas. This same customer preference is helping drive demand for the company's new builds. Our sense is that the 700 mechanical rigs currently active are the most vulnerable to these powerful trends, particularly the nearly 200 mechanical rigs running today in shale plays. Most of these lower end rigs have been heavily discounted to secure work coming off the huge downturn the industry suffered in 2009. As industry average dayrates move up from those lows, it acts only to provide customers with further incentive to trade up to a more suitable drilling solution.

How do we see the market developing for land rig construction? Do we anticipate another 2006, 2008 type building cycle? Or will the land business follow its offshore brethren in adding significant capacity? In fact, a friend recently called the largely speculative 30 plus offshore new build announcements an arms race. Or maybe so, but the conditions driving the offshore construction and that surge do not transfer to the land space.

First, there are no shipyards with discount pricing or favorable financial terms, and while oil is an increasingly important component of land drilling, it is the primary driver for the offshore equation. The uncertainty of future gas prices weighs heavier on the land side and should provide some moderation to future capacity additions.

In terms of capacity additions, we can account for approximately 65 land rigs in the works today. We represent over 20% of that total, and with 100% of our new builds under long-term contract with attractive financial returns. Most of our peers appear to be committed not to build on spec with the exception of just a few, and some are now engaged in pressure pumping and are currently adding capacity there. We are staying focused and trying to take full advantage of our integrated manufacturing effort, while others canceled, delayed, or horse traded away new build orders in the last downturn, we never stopped our building program.

Even in fiscal 2009, we completed 31 FlexRigs followed by 14 completed FlexRigs last year. This month, we will increase our production cadence to three rigs per month with plans to roll out 12 rigs by the end of the summer. We're served well by a unique flexibility to adjust our manufacturing capacity to respond to a range of customer demand, while it is difficult to predict the pace and the scale of customer demand for the second half of 2011, we still believe a domestic fleet that offers customers less than 20% AC-drive rigs will continue to give us additional opportunities to respond to the customer's preference for a more robust and efficient drilling solution.

That demand will begin to translate in a more meaningful way into international opportunities as interest and momentum is beginning to grow in those markets. But that is most likely a 2012 development. In the meantime, our international contribution will actually become smaller before it begins to grow again, as John will explain shortly. That said, increasing drilling complexity and a focus on better efficiencies and requirements for strong safety and operational performance should all provide a positive environment for us to build shareholder value and capture market share both in the US and internationally.

So, with those comments, I would like to turn the call over to John.

John Lindsay

Good morning. As Hans described in his comments, our customers continue to move toward oil and liquid rich plays and along with that transition, the intensity of more complex wells has increased. One example of increasing complexity is the length of laterals and horizontal wells drilled today versus 2008. A recent report suggests that average lateral lengths have increased approximately 40% to over 5,000 feet and leading edge laterals have increased in some cases 100% to 150% to 8,000 to 10,000 feet in unconventional plays like the Eagle Ford, Marcellus and Woodford.

These trends favor FlexRigs, and it is more likely that older, less capable rigs will continue to be replaced by new build AC-drive rigs like FlexRigs. The following operation summary will describe the first fiscal quarter 2011 results and the second fiscal quarter 2011 outlook for our three operating segments, and I will start with the US Land segment, where first fiscal quarter 2011 US Land results benefited from a combination of higher activity levels, improved pricing and lower average rig expense per day given reduced spending on rig activations.

Total US Land segment revenues increased 9% sequentially to $476 million. During the first fiscal quarter, we completed the construction of seven new build FlexRigs and had another three FlexRigs return to the US from Mexico. Considering these rigs plus the full-quarter impact of previous new builds, the average number of rigs working increased by 10 to 187 rigs, including an average of 129 under term contracts and 58 in the spot market.

Average rig revenue per day increased sequentially by over $500 per day to $24,950 as the average dayrate for rigs in the spot market increased $1500 to approximately 23,500. Average rig expense per day decreased by over $1,100 per day due in part to a decrease in maintenance and supply costs related to a decline in spending on rig reactivations and a continued effort by our field leadership to lower costs. As a result, US Land segment operating income increased by over 33% sequentially to over $158 million.

Our fiscal second quarter for US Land will benefit from continued growth of the FlexRig Fleet. Today, we announced contracts supporting the construction of eight additional FlexRig3s. Each of these rigs are contracted under multi-year term contracts at rates that provide attractive returns. Since 2005, we have now announced the construction of 171 new FlexRigs, including 31 rigs since March of 2010. Including the eight announced today, we currently have 14 rigs left to be completed.

Since December 31st of 2010, we've completed three new builds, and we expect to complete an additional six new builds during the second fiscal quarter. The remaining eight new builds are planned to be completed during calendar 2011. Demand for new build FlexRigs continues to be the strongest in oil and liquid rich markets, including the Eagle Ford, Cana Woodford, Bakken and Permian. As Hans suggested, we are especially proud of the growth we've been able to achieve in the Permian, as many of our competitors tried to label Permian as a market that did not need FlexRig technology, while our competitors are excited about the opportunities to put conventional rigs back to work, given the number of idle rigs they have in this market, the fact remains that we're growing market share with FlexRigs because they lower customers' costs and deliver more wells per year.

Considering the additional new build announcements plus the return of the last rigs from Mexico, we now expect total revenue days in the US Land segment to increase between 3% and 4% in the fiscal second quarter. As of today, we have 198 contracted rigs, including 131 under term contracts and 67 in spot market. Of the 67 rigs in the spot market, 63 are FlexRigs.

We expect average rig revenue per day will increase between $400 and $500 per day for the second fiscal quarter. Of the 131 rigs currently under term contracts, 50 are scheduled to re-price during the remainder of fiscal 2011. Including only rigs that are already under fixed commitments, we expect to have an average of 119 rigs under term contract in fiscal 2011 and 76 rigs in fiscal 2012.

Average rig expense per day is expected to remain flat as spending for previously reactivated rigs levels out. While we've seen some wage pressures in a few basins, we don't expect the second fiscal quarter to be significantly affected by weight increases.

In our offshore segment, it was impacted by the mobilization of one of our seven active rigs to a new contract. Total revenue days during the fiscal first quarter fell 9% sequentially to 587 days as a result of the mobilization to the new project. Average rig market per day of $18,065 was affected by the lower revenue associated with the rig mobilization, as well as the impact of approximately $2,000 per day related to a reduction of certain expenses during the fourth quarter that favorably affected that quarter and did not occur in the first quarter.

Accordingly, segment operating income for the offshore segment decreased to $9 million. For the second fiscal quarter, the rig that mobilized during the first quarter is now on dayrate. However, one of the rigs on which we have a management contract were cold stack. Our management contracts are not included in our per-day calculations. Accordingly, the number of revenue days during the fiscal second quarter are expected to increase approximately 5% sequentially.

Average rig margin per day is expected to increase by 15% to 20% sequentially. However, this will be offset by an unfavorable impact to the segment's operating income of approximately $2 million associated with less management contract revenue.

The International land segment had reduced activity levels related to the return of FlexRigs from Mexico to the US And average rig margins were negatively impacted by a retroactive labor adjustment in Argentina. International land segment revenues decreased slightly to $69 million while segment operating income decreased 7% to $14 million.

During the fiscal first quarter, three additional rigs returned to the US from Mexico. Accordingly, the number of revenue days decreased by about 3%. To-date, five of the six FlexRigs previously assigned to Mexico have returned to the US and all five are working. The six FlexRigs should return by the end of January. Excluding the favorable results from the early termination revenues, the average rig margin per day in the first fiscal quarter declined by $579 to $8,949 compared to $9,528 during the fourth quarter, due primarily to an increase in labor expenses associated with the retroactive labor adjustment in Argentina.

For the second fiscal quarter of 2011, while the company will benefit from putting the FlexRigs back to work in the US at higher margins than they would have earned in Mexico, segment income for the International segment will be negatively impacted by ceasing operations in Mexico.

With the mobilization of five FlexRigs back from Mexico, we currently have 24 rigs assigned in the International land segment. In the fiscal second quarter, two of our rigs in Ecuador rolled off contract as we work to negotiate new contract terms. We expect both of these rigs to return to work in the fiscal third quarter, but they may remain idle for the remainder of the second quarter.

Additionally, one of our rigs in Tunisia is mobilizing from one contract to another, and as a result of the recent political unrest, the rig now is expected to have some downtime in the second quarter. Accordingly, total revenue days during the second fiscal quarter are expected to decrease by about 25% sequentially and average rig margin per day, including early termination revenues is expected to decrease by about 35% to 40% in the second quarter as compared to the first quarter.

Even though the short-term activity outlook for our International segment is expected to decline in fiscal year 2011, longer-term, the outlook is encouraging. As our customers look at unconventional resource plays in areas like Eastern Europe, the opportunities in 2012 and beyond for additional FlexRigs is very promising.

Another area of opportunity for FlexRigs internationally is in the Middle East, and recent performance achievements by our first two FlexRig in Bahrain would support that belief. The two FlexRig4s have set drilling records and most recently completed a 4.1-day full well cycle, including rig move, whereas a competitor large conventional rig averages about nine days to drill the well without a rig move.

FlexRig4s are also averaging one-day rig moves versus the competitor rig taking five days to move. A third FlexRig4M is currently in Houston being prepared for export to Bahrain with an expected fiscal third-quarter start.

In summary, the US Land industry trend of more complex horizontal and directional wells continues. Whether oil, gas, or liquid-rich production is the target, more and more operators trust H&P to provide FlexRigs. This ongoing complexity factor may not offer opportunities for lower technology rigs and product offerings but should provide more opportunities for companies like H&P with advanced technology, AC-Drive rig fleets, quality personnel, and the critical organizational support systems.

And with that I will turn the call back to JP, Juan Pablo.

Juan Pablo Tardio

Thank you, John. And operator, we will now open the call for questions, please.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question will come from Robin Shoemaker with Citi. Please go ahead.

Robin Shoemaker - Citi

Yes, thank you. Great quarter. And just wanted to ask about the continued progress on expenses which is such a big part of the margin. So, it sounds like it is more of a sustainable trend, given that you are not reactivating rigs, and you're working, I guess, companywide on some cost reduction initiatives. But a few other companies here that have reported have talked about some inflation in wages, freight, materials, et cetera, fuel. So, what is your expectation about just the general cost per day trend in the US Land?

John Lindsay

Robin, this is John. I believe that you are right, in that it isn't a level that is sustainable. Obviously, we reported that we thought next quarter expenses would be flat. Clearly, the last two or three quarters were impacted by the number of reactivations we have. We put 90 rigs back to work in a year, and so that had a large impact. I think if you just look at where our expenses are today, and specifically maintenance and supply costs, they're back in a more normalized range like you would have expected back in a '08, '09 timeframe. And so, again, we think that where we are now is sustainable.

Robin Shoemaker - Citi

Okay. I know this is kind of a sensitive topic also; on the new contracts, would you characterize these as similar economic terms to the ones that you first reported back in March of '010? Or has the term contract market improved from that time?

Hans Helmerich

Well, Robin, I think we've been pleased from the time you referenced, March of '010, and the type of contracts we have been able to sign in terms of the nice returns that are provided there, and then also we have multi-year terms. So, I think there might have been a slight improvement, but I think we are exactly kind of in the bandwidth where we had hoped to be. So, not a big change.

Robin Shoemaker - Citi

Okay. So, probably not back at the levels you were signing in late 2007, 2008 if I read you correctly?

Hans Helmerich

Yes, that's correct.

Robin Shoemaker - Citi

Okay, thank you.

Operator

Thank you. Our next question will come from Arun Jayaram with Credit Suisse. Please go ahead.

Arun Jayaram - Credit Suisse

Good morning gentlemen. Nice results. Hans, I wanted to talk to you about opportunities for the FlexRig technology in European shales and shales outside of the US seems to be, obviously, a very niche market today, but it could be something of some future growth. And perhaps maybe talk about maybe some of the dialogue you're having about that today.

Hans Helmerich

Well, we are hearing from customers that have used FlexRigs and are familiar with what they are capable of. I think there's building momentum and progress in those shales. Part of that is reflected by the JVs and the willingness of some of those players to learn more about the shale plays that we have now in the US So, part of what we said earlier is that we think that continues to move forward in developing '011, but that it really begins to be a little more clear in 2012 for us.

John can jump in. We have been having customer conversations and so, I think there is an intention there and a focus and the suitability for what we do, I think, is a great match. So, we are upbeat about that.

Arun Jayaram - Credit Suisse

Are there any countries, Hans, where you could cite some of the demand or conversations at least?

Hans Helmerich

John, do you want to talk about if there any specific ones? Poland has been an area and again, some of the players are familiar to you, and you know that they are our customers, but what else would you add to that, John?

John Lindsay

I think, clearly, at least right now, Poland seems to be the country that there's the most interest, the most acreage positions. I think Romania is another country. I'm trying to think of others. No others really come to mind. Again, I think this is a slower trend rather than a faster trend. The best I can understand, our customers are still in there evaluating and trying to delineate and understand how to complete the wells, drill the wells, all those kind of things. But, I think longer term, again, it does offer us some upside.

Arun Jayaram - Credit Suisse

Okay. Second question, guys, obviously, there's been a pretty sharp decline in the Haynesville market. What are you seeing with the rigs that have been somewhat displaced? Are you seeing those move out? Does that have any impact on the broader market for higher spec rigs?

John Lindsay

Arun we've had, if you're referencing our particular rigs, we've had some of our FlexRigs, most of them Flex3s that customers have moved out of the Haynesville and they have moved them to the Eagle Ford, to the Permian, and I guess in a few cases, they've gone into the Cana Woodford. I don't really know about what some of the other rigs have done. I'm sure, because of the size of the rig fleet there, that some of those rigs are going into the basins I just mentioned and displacing, in some cases, some of their own rigs because some of the other rigs are going to be smaller. Does that answer your question?

Arun Jayaram - Credit Suisse

That does. But it does seem as though some of the dislocations haven't had a broad impact on the market because rates seem to be going higher, et cetera. And you still see pretty good interest in new builds. Is that fair?

Hans Helmerich

Yes, I think just to that part of your question, when you have that kind of displacement out of a major basin, it becomes a source that, in some way, competes with the new build market, which blends to just a larger point we're making, which is, we think the go-forward is there's going to be steady, and we are encouraged by the progress we're making. But we don't see, we see it being moderate and steady, which we've said for a long time is a more favorable outlook for us than a real strong ramp up and a real frothy new build environment. So, we actually like that as a factor.

Arun Jayaram - Credit Suisse

Okay. Thanks a lot, gentlemen.

Operator

Thank you. Our next question will come from Scott Gruber with Bernstein Research. Please go ahead.

Scott Gruber - Bernstein Research

Good morning, gentlemen. You highlighted the trend toward longer horizontals in the US, and arguably the operators in the Bakken led that trend. Are the Bakken rigs drilling these extended laterals, are they all AC rigs? Or is there a mix of AC and SCR rigs drilling those wells?

John Lindsay

Scott, I think there's, if you're just talking industry wide, there is a mix. It's AC, SCR. I think there's far fewer AC rigs in that market. But in addition to that, best we can tell, there's quite a few mechanical rigs that continue to work in that basin as well. And again, I don't know the details on the rigs, on whether they're outfitted with top drives or not. But as the laterals get longer, I think, customers experience that the mechanical rigs continue to be challenged to deliver the well cycles that are required. And so I think that it's obvious that those rigs will ultimately be displaced. I think that there's a lot of contractors in the Bakken today that are in the process of trying to upgrade their mechanical rigs.

From our perspective, most of what we have in the basin are AC. We do have a few of our SCR rigs that are the FlexRig2s that we've built. And we have I think two of those in there, but the rest of the rigs are all AC-Drive. It seems to be the clear choice, the clear desire, from our customers is to go with the AC-Drive technology.

Scott Gruber - Bernstein Research

Right. And clearly it makes sense over the long-term. But are you actually hearing inquiries today from the customer base to displace some of those mechanical rigs and SCR units, particularly on these extended lateral wells?

John Lindsay

Yes. I think at least with our customers, most of our customers aren't using mechanical rigs, but we do hear anecdotally that contractors are upgrading mechanical rigs and/or replacing mechanical rigs with upgraded, either an SCR rig, or I'm sure a new build AC.

Scott Gruber - Bernstein Research

Okay. And then, on another topic, do you know how many of your rigs today are working on pad operations, in the US?

John Lindsay

Scott, I don't have an exact number. If I were going to throw out a number, I would think it would be probably 25 or 30 rigs. We have what, Mike, between 40 and 50 S-type rigs. And so, most of those are doing pad work, so there's about 44 or so S rigs, and most of those are going to be drilling some sort of pad work. It may only be two or three wells. In some cases it may be as many as 20 wells on a single pad. I think that trend, as we've said in the past, I think that trend continues. I think in areas like the Marcellus, in any area that has BLM land, any areas that are near cities, they're going to want to have less surface disturbance; they're going to want to drill additional wells on a pad. And as these wells are horizontal, all you are doing is adding the directional component to the well. But again, that begins to challenge older rigs, conventional rigs, because they had difficulty doing the directional or more difficulty doing the directional and horizontal work.

Scott Gruber - Bernstein Research

Right. Now, where could you see that number going in the next 12 months? Could you see that 25 number getting up to 35, 40?

John Lindsay

As far as our total fleet?

Scott Gruber - Bernstein Research

Yes.

John Lindsay

Yes, I think we probably have in the range of 30 to 40 rigs that are doing pad work, just the S rigs. If I said 25, I apologize. I think it's going to be more like 30 to 40, and I'm just thinking of the S rigs. We also have other FlexRigs that have skid packages on them as well. So that's something we will look at as far as our total rig count. Yes, I do believe it will increase. I don't know what the total rig count in the Marcellus is today, but from my impression in talking with customers, the rigs that are working in the Marcellus today, more and more of those are going to go to more pad-type work. So, whatever percentage of that, let's see. Marcellus is, we're I think in the 90 to 100 rigs running in the Marcellus. And so, I don't know what percentage of that fleet today is drilling pad, but I think we would be fairly certain that in the next 6 to 12 months, that is going to continue to increase. They're going to be more and more. So that's something we will talk about and try to report out next time.

Scott Gruber - Bernstein Research

Okay, great. Thanks for the color.

Operator

Thank you. Our next question will come from Joe Hill with Tudor, Pickering, Holt. Please go ahead.

Joe Hill - Tudor, Pickering, Holt

Great quarter, guys. Hans, you said that you think the new build market is going to be improving moderately and in a steady fashion. What's your rig count expectation around this for the industry?

Hans Helmerich

Well, I think, we've said, Joe, for a long-time, it doesn't have to continue an upward movement, 1700 and beyond because I think there's going to be like you've heard us say, displacement opportunities. And clearly, as you add more AC rigs and better rigs, it's not a one to one offset. You're going to be able to displace more than one lower performing rig. So, we probably don't have a scientific number or range, but I think even if you are in a 1200-type rig count, we're going to continue to be able to build market share in that type of rig count.

Joe Hill - Tudor, Pickering, Holt

Okay. That's very interesting. So, I mean you just announced eight new builds with contracts behind them. If the rig count is relatively flat this year, would you anticipate a similar pace of increase or would it be a little higher, a little lower? Do you have a sense?

Hans Helmerich

Well, we've been encouraged by just the pace and the rig order amount we have, and that's been in the backdrop of an increasing rig count. So, does it dial back a little bit if you have a flat rig count through 2011? It may, but it's hard to see where the customer takes a clear preference and how that directly translates, but we would anticipate that we're going to continue to see those kind of opportunities. It's just hard for me to give you a number.

Joe Hill - Tudor, Pickering, Holt

Okay. And then finally, for John, Argentina has been drilling a few things in terms of granting concessions and potentially trying to test up some shales, maybe the Neuquen basin. Do you have any particular opinion on whether or not that results in better activity for you guys? I know you are talking about 2012. Is that one of the areas?

John Lindsay

Joe, I think, Argentina always offers us some more potential upside. As you know, we're active in Argentina today, and I think anytime you have the potential for large numbers of rigs in an unconventional play, a shale play, then I think you have to consider H&P as being one of the players that would go in. I think there's other challenges. Argentina, that we've had, and I think a lot of contractors have had in terms of the workforce and the labor unions and those challenges that we see in our operations. We would be helpful that we could get those situations resolved, if that could happen, that would be a lot more encouraging for us. I think just as far as the technical side and the type of rig that's required, no doubt, we've got the right rig; we've got the right infrastructure. I think it's just working on those things that tend to be bothersome that causes you not to hit your numbers, not to be able to make your margins that you expect.

Joe Hill - Tudor, Pickering, Holt

Got you. Okay. I'll turn it over. Thanks, guys.

Operator

Thank you. Our next question comes from Victor Marchon with RBC Capital Markets. Please go ahead.

Victor Marchon - RBC Capital Markets

Thank you. Good morning, everyone. First question, just on the international side, the margin expectation for the second fiscal quarter, I'm sorry I missed that. Can you guys just repeat that?

John Lindsay

Yes. We are expecting in the second quarter revenue days to decrease by about 25% sequentially and average rig margin per day, including the early termination revenues, decrease by 35% to 40% in the second quarter.

Victor Marchon - RBC Capital Markets

Okay. And then looking at, if you could comment at all and looking past that quarter, or this quarter that we're in, how does the margin progression look past that to the extent of getting back to you guys to where you guys had been in that low double-digit range before you started to see the impact of the early terminations and moving the rigs out of Mexico? Is there a progression or a trend line you can give to us?

John Lindsay

Well, with the six rigs moving out of Mexico, and in addition to that, we have the two rigs in Ecuador, again, we think those rigs will go back to work and should impact positively the third quarter. We're not really certain where those rigs, as far as activity in the second quarter. But if you just look at the total number of rigs we have internationally compared to what we have had, it's obviously going to be fewer. So that's why we're saying really I think if you just consider 2011 in general, 2012 seems to have a brighter outlook. It's just we think it's going to continue to be soft for the reasons we've just mentioned through the rest of 2011.

Victor Marchon - RBC Capital Markets

And just switching gears to the US on the pricing side, you had mentioned that the spot market or spot pricing was 23,500 in December quarter. What is the expectation for the March quarter on the spot market?

John Lindsay

Well Victor, that's hard to nail it exactly. We have rigs, the 50 rigs that are going to roll off of term most likely, I would think that 75% of those at least would roll into the spot. Some of those rigs are going to have the potential to price. Some of those are going to price below the average. Some are going to price above the average. Again, I think in general, we are thinking and we said in general $400 to $500 a day for the quarter. I think the spot market pricing will be slightly more than that, and I think the term market, term pricing would be slightly less than that.

Victor Marchon - RBC Capital Markets

And would that go, because I know you guys had mentioned on the last call when you're looking at fiscal year 2011 at that point, the re-pricings on the terms would be potentially a slight benefit with some below and some above. I guess that, as you just mentioned, that would still hold in looking out for the full fiscal year?

John Lindsay

That's the way we're looking at it right now, yes.

Victor Marchon - RBC Capital Markets

Great. Thank you guys and great quarter.

Operator

Thank you. Our next question comes from Dave Wilson with Howard Weil. Please go ahead.

Dave Wilson - Howard Weil

Good morning, gentlemen. Just real quickly, and I know you touched on it a little bit here, but regarding international, has the timing or desire to grow there been delayed since we're seeing such a good terms here in the US and utilization? As far as allocating capital here domestically and internationally, how are you guys thinking about that right now?

Hans Helmerich

Dave, I don't think it's a reflection of our outlook or view. Really it's more of a demand pull type situation. We see momentum building and opportunities that like we said earlier, are going to show up more visibly in 2012. So, our approach is, we are interested in growing that footprint. We would anticipate the demand to be there, but it's not so much that type of trade-off. And let me just add, both in terms of capacity and then balance sheet, we're not capital constrained. And so, yes, it's not a reflection of us saying let's stay closer to home.

Dave Wilson - Howard Weil

Okay. Now, as far as some of these in Eastern Europe, is there any significant modifications you'd like to be making to any of the FlexRigs to work over there?

John Lindsay

Dave, I think we're still analyzing that. We've had some folks on the ground over there and looking at that. I don't think that they're going to be substantial in nature, but I think there will be some modifications that will be needed. I'm not exactly certain to what extent at this stage. I think most of that's going to have to do with transportation, size of loads and those types of things. So again, I think we can work within those constraints.

Dave Wilson - Howard Weil

Okay, great. That's it for me. Thank you.

Operator

(Operator Instructions). Our next question comes from John Daniel with Simmons & Company. Please go ahead.

John Daniel - Simmons & Company

Good morning, guys. Hans, you mentioned that you're building a fleet two to three rigs per month I mean, you get done by the summer. Should we assume that the rate of construction though continues for all of calendar 2011, perhaps to be ready for international demand next year?

Hans Helmerich

Well, it will be, again, demand pull for us and we will want to see the contractual opportunities. So, we won't just build in, in terms of anticipation or trying to kind of load the queue. But you are right, today, in January, we're at three rigs per month. We will sustain that through the summertime, and then we will have better demand visibility and go from there.

John Daniel - Simmons & Company

Okay. Alternatively, should we perhaps see you guys become less assertive with future price increases and focus more on market share gains given the competitive advantage on the new builds?

Hans Helmerich

Well that's a loaded question. Yes, I think that we're used to being the pricing leader and we also have been fortunate to continue to build market share. As you know, we have, over the last three or four years, doubled our market share and we still see it as running room to go. But I'm probably not going to give out anymore of the secret sauce on how we will play between those two dynamics.

John Daniel - Simmons & Company

Alright, fair enough. Last one for me, just as you look at markets like say Poland or Romania, do you sense that the customers over there value the efficiency concept? Are they like some other international customers who are more do you solely focused on lowest possible dayrate? Have they made that transition yet?

Hans Helmerich

Yes, that's a good question. Clearly international in general is more price point sensitive, and I think it will take some time to win over converts. But at the same time, they're very keen on understanding and being able to exploit that opportunity, and they are spending a lot of money today in these JV arrangements to have a front seat to all of this. And so, everything we're hearing, we would anticipate that they're going to want to hit the ground with the best drilling solution, and that's what kind of makes us upbeat about it.

John Daniel - Simmons & Company

Okay. So, would you ever consider sending one rig over sort of call it like crack, to get them addicted to it at a low rate, build from there?

Hans Helmerich

I think we probably, let us play with that concept, but no, I think that, the truth is, we've built an awareness and a brand recognition, and the majors that we have as part of our customer roster right now really don't need the convincing. And I think you've heard me say, that's probably our first leg in, is with that type of relationship where we have a good, on-the-ground working relationship and they have performance expectations of us and we will hit the ground there. And we've seen this in other international markets. Then, that becomes a beacon or an attraction to other folks, and NOCs and additional customers, so it will probably be done that way.

John Daniel - Simmons & Company

Okay. Fair enough. Good quarter, guys.

Operator

(Operator Instructions). Our next question comes from Thomas Curran with Wells Fargo. Please go ahead.

Thomas Curran - Wells Fargo

Good morning, guys. I'll just echo my peers and congratulate you on an outstanding quarter. I'm curious. So, you haven't hesitated to nearly pull out of Mexico entirely. We've heard some starkly conflicting news flow about what exactly Pemex seems to be gearing up to do in 2011, and there's both bullish and bearish outlooks out there. Should the bullish one begin to materialize, would you be willing to move back in? And if so, how would you most likely go about it in terms of where would you deploy the rigs from?

Hans Helmerich

Well, we hear some of the same conflicting reports that you do. I think where you may see the first wave of improvement will be offshore, and then it really requires better clarity and visibility on what the plans might be onshore. You are aware, as many are, that there are real security concerns there and that will factor in. But longer-term, Mexico is attractive market for us, and we would like to participate. So, it's hard for us to see that happening certainly in '011, and it wouldn't be at the top of our list even as we round the corner into '012.

Thomas Curran - Wells Fargo

Okay. Would you be willing to maintain or even expand the footprint you have in Argentina from this point forward? Is the unconventional opportunity there seemingly attractive enough that you would be willing to pursue it despite the frustrations associated with the union labor costs? Or might we see you also look to reduce your presence in Argentina?

Hans Helmerich

Well, longer term, it's a little bit like Mexico and some other countries there; they have long-term potential that we would like to participate in, and so then it is a matter of seeing what line of sight you have now and some of the complexities, and you've mentioned the union issues and others, and just trying to make progress and resolve those.

We like Argentina as a longer-term market, but we will go slow for the next couple quarters and just see how that develops. But I'm an optimist, and I think longer term, it's going to be a good place to be.

Thomas Curran - Wells Fargo

Okay. And last one for me on the US side, currently, about 60 of the 360 rigs working in the Permian are drilling horizontally. What is your best read on just how large the horizontal market within the Permian could become?

John Lindsay

Tom, this is John. I think not only the Permian, I think all of the basins, the bottom line is the customer can exploit, get better recovery drilling horizontally in an unconventional as well as a conventional reservoir. So, I think that trend is going to continue, and it's hard to say at what pace and at what rate and how quickly is it half of the market? How quickly does it continue to gain a percentage? But, I think it's clear that that's where customers are going. The costs associated with drilling horizontally now, being able to get the cycle times down, in some cases, we are drilling wells horizontally as fast as we were drilling them vertically with a lot less reservoir exposure. And so, if a customer looks at that, they're going to continue the trend of going more horizontal. And I think the Permian is going to be no different than the other basins.

I guess the question is, is really on the unconventional versus the conventional reservoirs and I think overtime, that will happen. I think that speaks to our market share gain as we talked about on the call, is that that's what we have seen. We have more than doubled our size there. We continue to gain market share. We continue to have interest, and we have some new customers that we had not worked for before, and that's encouraging as well.

Thomas Curran - Wells Fargo

That all makes sense. Thanks for the color, guys. I'll turn it back.

Operator

Thank you. Our next question comes from Waqar Syed with Macquarie Capital. Please go ahead.

Waqar Syed - Macquarie Capital

Good morning and, again, great quarter. Congratulations. I have a couple of questions first on international, especially European market. Do you know if anyone has capability to manufacture FlexRig-type rigs locally in Europe? Any of your European competitors, do they have that capability?

Hans Helmerich

DEUTAG, of course, is a long-term player there. I don't know what their current appetite is for new builds. So, that's the first one that comes to mind, Waqar.

John Lindsay

But, Waqar, I think too, when you say FlexRig-type capability, I think when you think about DEUTAG and I think other European manufacturers, I think they tend to build much larger rigs, not fast moving rigs. I can't really speak to the AC side of the design, but I don't see those guys exploiting other markets around the world with a FlexRig type of rig. And, I can't really think of anyone. I can't think of anybody, from our perspective, there's nobody in the world that builds a rig like a FlexRig. Now there's people that build AC-Drive rigs, but I don't see that it has, that their rigs have the same value proposition that we have been able to display.

Obviously, we haven't talked about it today. We have talked about in the past, but we have an engineering effort that no other contractor can match. We have a manufacturing effort that no other contractor can match. And so again, I think that makes a huge difference. I really can't think of any other manufacturer in the world that has built as many AC-Drive rigs, and they haven't built FlexRigs, over the last five years.

Waqar Syed - Macquarie Capital

Sure. Now, the Asian Europeans had a very robust drilling, they had a number of drilling companies that are working all over the Middle East. But they had really low end mechanical that really low-end rigs. Are you aware if they've made any advancements in improving the quality of the fleet that they could be competitive in these unconventional plays in Eastern Europe?

John Lindsay

I'm not aware of it. I think maybe another anecdotal example would be we have a lot of the IOCs that we provide a large portion, if not all of their unconventional work here in the US They're coming to H&P and they're talking to H&P about rigs in the future. I'm sure they're talking to other folks as well. I think what they end up doing is utilizing the local contractor content in order to delineate wells and understand how they're going to do it. But from a production standpoint, when you get to the gas manufacturing effort, they're going to use an H&P. They're going to use FlexRigs.

Waqar Syed - Macquarie Capital

Sure. Also, now you've had these FlexRigs working in the US for like five years or so, some of the equipment on the rigs probably from the early generation rigs needs to be maybe upgraded or replaced or just normal wear and tear kind of maintenance. What are the challenges that you're facing? And has the cost of M&S per rig, changing at all? It used to be the rule of thumb was something around $800 to $1,000 a day in kind of maintenance costs for kind of a normal rig. Is that number changing, dropping down or going up for you guys? And then, I guess, we can think about the rest of the industry as well.

John Lindsay

Well, Waqar, I've been with H&P for 24 years and I think in 1990, we might have had $800 a day M&S. So, I think to answer your question, if you look at, we've had Flex3s working since 2002, and no doubt, M&S is higher today on a Flex3 than it was then, but we've had oilfield inflation, obviously, overtime. But if you look at the Flex3 M&S overtime, it's been within a band. Obviously, when you have a large number of rigs stacked like the industry had in 2009, and then you reactivate those rigs coming out of stack, you're going to have some startup expenses. I think that's what we saw over the last three quarters or so.

Again, I think we're going to be back in, in kind of this normal range if you will. As far as just long-term costs, that's part of the organizational support. That's part of what H&P I think does a very good job of, is that we have the critical spares, we have the critical overhaul processes, we have the maintenance systems in order to maintain these rigs the way they need to be.

Waqar Syed - Macquarie Capital

So, let me ask a different way, that organizational change, at what point in the cycle once you introduce these new rigs, does it become the most important factor in continuing to run these rigs at very high efficiency? And I just want to think about some of the other companies that have introduced more recently the new FlexRigs and may not have the organizational support such evolved. At what point do they start to feel the pain?

Hans Helmerich

Well, Waqar, you've followed us a long-time, and we have felt that field execution, that organizational support that you're talking about. And you've seen that. We're in our third generation of that effort. No one has put that type of commitment and resource into doing that. And so, I think you are onto something that's very germane and that is, as people, now, you said other people are doing FlexRigs, but as they do their version of an AC rig, and look, customers have seen those now on the ground for a couple of three years, and we are still leading with new orders and customer commitments.

So, I think exactly what you are saying comes to bear, and the effort and resources that we have around supporting our AC-Drive rigs, the ability for us to reduce downtime, to support the equipment in the field, to bring the average well in a field closer and closer to the best well in a field is a march and a drive that represents a lot of effort, and it becomes much more the harder thing to duplicate or to match us with, not just putting out your version of an AC-Drive rig.

Waqar Syed - Macquarie Capital

Sure.

John Lindsay

I think the other advantage, Waqar, is keep in mind that our fleet is standardized. Since 2002, the Flex3s and the Flex4s have very standardized components, and that helps, whereas the competitor, they have AC-Drive rigs plus they have, in most cases, a very large conventional fleet that they have to keep up with and maintaining and that's a different business altogether.

Waqar Syed - Macquarie Capital

Sure. Great. Thank you very much.

Operator

Your next question comes from Thad Vayda with Stifel Nicolaus. Please go ahead.

Thad Vayda - Stifel Nicolaus

Good morning, everyone. Just had a couple of quick ones, please, and I apologize if you covered this earlier and I just didn't hear it. Of the eight new build rigs, how many operators comprise those orders? And are there any new ones in the mix? And also, if you could share perhaps where these are going to be deployed or you believe they're going to be deployed?

John Lindsay

Thad, in general, what we've said on, relative to the 31, we've talked a large percentage of those are going to the Eagle Ford. A large percentage are going to the Cana Woodford. We also have rigs going to the Bakken, the Permian, the Marcellus, the Haynesville, are kind of the primary areas. But by far, the Eagle Ford and the Cana Woodford are the areas that have the largest percentage. As far as customers, I think it was three or four customers that made up the eight rigs.

Thad Vayda - Stifel Nicolaus

Okay. Anybody new or are they all folks that have ordered from you in the past?

John Lindsay

I believe these are all longtime customers.

Thad Vayda - Stifel Nicolaus

Great. And bookkeeping, can you tell me how many, in the US, how many rigs are currently still stacked and are any of those non-marketed rigs?

John Lindsay

As far as the industry or H&P?

Thad Vayda - Stifel Nicolaus

No, no, no, I'm sorry. Just in your fleet.

John Lindsay

The rigs that we have that are stacked are conventional, our conventional fleet. And there's 36 total. I think that's right, yes. And those rigs, I wouldn't say that they're not marketed because those rigs recently worked and probably most of those rigs were stacked in the '08, '09 timeframe and so obviously those rigs are capable of going to work. But the pricing that the market has out there today is not at a place where we think it makes sense to put those rigs back to work.

Thad Vayda - Stifel Nicolaus

Great. That's it for me. Thank you very much, gentlemen.

Juan Pablo Tardio

And operator, perhaps we have time for one more question, please.

Operator

Okay. Our next question will come from Mike Breard with Hodges Capital. Please go ahead.

Mike Breard - Hodges Capital

Thank you. Congratulations on a great quarter. Could you give us just an update on your directional drilling program?

Hans Helmerich

Mike, I think since our last call, we feel like we've still made some progress there. I think there will be, in our filing, an additional payment that was long anticipated contractually because it represents a progress milestone. We haven't really had that much change in terms of what we reported last time. But we continue to think through what type of model we bring that to market with, and I think we're making some progress there. So, there's really not a lot new to report.

Mike Breard - Hodges Capital

Okay. Thanks very much.

Juan Pablo Tardio

Alright. Well, thank you very much for joining us today, and have a good day. Thank you, operator.

Operator

This does conclude today's teleconference. You may now disconnect your lines and have a wonderful day.

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