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Helmerich & Payne, Inc. (NYSE:HP)

F2Q08 (Qtr End 03/31/08) Earnings Call

May 1, 2008 11:00 am ET

Executives

Doug Fears - VP and CFO

Hans Helmerich - President and CEO

John Lindsay - EVP, US and International Operations

Analysts

Mike Drickamer - Morgan Keegan

Kevin Pollard - J.P. Morgan

Michael Breard - Hodges Capital Management

Operator

Welcome to today's teleconference. At this time all participants are in listen-only mode. Later you will have the opportunity to ask questions during our Q&A session. Please note this call may be recorded. And now I'll turn the call over to Mr. Doug Fears, Vice President and CFO. Sir, you may begin.

Doug Fears

Thank you, Tommy and good morning, everyone. Welcome to Helmerich & Paynes’ conference call and web cast to discuss the Company’s second quarter earnings. With us today are Hans Helmerich, President and CEO, Executive Vice President John Lindsay and Alan Orr, and Juan Pablo Tardio, Director of Investor Relations. As you know, much of the information provided today involves risks and uncertainties that could significantly impact expected results and that are discussed in our most recent 10-K. We will also be making reference to certain non-GAAP financial measures such as segment operating income and some operating statistics. You may find the GAAP reconciliation comments and calculations on the last page of today's press release.

This morning Helmerich & Payne reported net income of approximately $102 million or $0.96 per diluted share for its second fiscal quarter ended March 31, 2008. This compares with net income of approximately $107 million or $1.02 per diluted share during last year's second fiscal quarter ended March 31, 2007. Included in this year's second quarter net income are $0.04 per share of after tax gains from the sale of portfolio securities and drilling equipment.

Included in net income for the second fiscal quarter of 2007 was approximately $0.18 per share from after tax gains related to the sale of two platform rigs and $0.05 per share from after tax gains related to an insurance adjustment. Although the company experienced declines in its offshore and international businesses, our US land rig segment continued to perform at historically high levels while continuing to establish itself as the performance leader in the land rig industry. The company recorded its 17th straight quarter of revenue day increases and maintained a high utilization rate of 94% for the second fiscal quarter.

Average revenue per day for the quarter reached an all time high of $24, 415 per day. Although the company recorded a sequential margin decline of $253 per day, it still commands a significant premium over our competitors in the US land rig industry. As mentioned in the announcement, the international segment operating profit for this quarter was negatively impacted by an adjustment of $5.9 million or $0.04 per share after tax relating to the depreciation of certain assets recorded in prior years.

Capital expenditures during the quarter were $172 million, bringing the total for the six-month period to approximately $322 million. Our capital budget for the year is approximately $650 million, but will rise with additional commitment to build. At March 31, our stock portfolio had a market value of $489 million and our most recent evaluation for the portfolio totaled approximately $565 million. If you assume the entire portfolio was sold and taxes were paid, the net proceeds would total approximately $340 million.

Although our effective tax rate went up slightly compared to the previous quarter, we still expect the overall effective rate for the year to average somewhere between 36.5% and 37%. I'd now like to turn the call over to Hans Helmerich, President and CEO and after Hans and John Lindsay have made their comments, we will open the call up for questions. Hans?

Hans Helmerich

Thanks, Dough. Good morning. The company's second fiscal quarter experienced some declines across all of our business segments. Most, if not all, of these factors represented transitional matters and not developing trends. As we move into the second half of the fiscal year, we expect to deliver operating income growth in all three of our drilling markets.

We will continue to detail on our call today the issues of costs, one-time adjustments and rig transitions that impacted the second quarter. More broadly, the first half of our 2008 fiscal year has been quite strong. In a softer market that saw over 400 competitor rigs sidelined, our utilization for the US land fleet remained at 94%, while the FlexRigs worked 100% of the time.

Our customers reward us with significant day rate premiums compared to our competitors and our growth in activity days make steady and impressive progress while our top peers lost market share. Our rig order book has continued to grow providing valuable continuity to our manufacturing and assembling effort. That area continues to execute well with on time and on budget deliveries.

As we move into the second half of our fiscal year and look at developing trends, the backdrop has turned decidingly better. As always, the primary driver is commodity price environment and we have seen a dramatic improvement in the natural gas prices coming out of the recent winter. The cold weather was one of several variables that now combine to dispel a cloud of concern that has hung over the natural gas markets for the last two years.

Predictably, higher prices and a bullish natural gas outlook will embolden customers to increase their E&P budgets as 2008 continues to unfold. It appears that the market has already called the bottom and is asking if we are on the front end of another up cycle. And if so, what will be different this time. One possible difference will be the plight of hundreds of rigs sidelined by customers over the last 18 months even when offered deeply discounted day rates.

In previous up cycles most of these rigs would find their way back into service and eventually enjoy some pricing improvements. But since late 2006 the land rig market has been highly segmented with customers showing a strong preference for high efficiency rigs.

Increasingly in fact the legacy rigs are proving unsuitable for the more demanding and growing unconventional gas place. Absent and aggressive cyclical upswing on the scale of what we saw in early 2006 which for many reasons we do not expect, this segment of legacy rigs may well languish under pressure of both softer pricing and lower activity levels.

We believe we can sustain our strong leadership in the new build segment of the business. It's difficult to identify clear matrix of scorecard but we know we have won a significant share of the new build opportunities. Of course we don't win them all. The customers tell us in those cases our competition is requiring less term or no term at all and they are willing to take substantially lower day rates.

Putting it another way, we know of no case where competitor matched or exceeded our terms and was awarded the project. Our brand leadership continues to be driven by a combination of best in class rig design and field performance.

We have been pleased with the pace of new build orders in this recent market with one third of our order book having been secured after the peak of the latest cycle. In addition to today's announcement, we would anticipate ongoing customer conversations to yield additional new build orders in the second half of our current fiscal year.

With that, I'd like to turn the call over to John Lindsay for his comments.

John Lindsay

Good morning. Second quarter was a transitional quarter in many respects. Dramatic commodity price increases, improved US land activity and rig mobilizations, all setting the stage for a very good third and fourth quarter. What has been consistent is H&P's drilling and safety performance. Our performance continues to garner interest from our current and future customers for more new build FlexRigs.

As we discussed in the last call, during the second fiscal quarter the offshore and international segment experienced the mobilization of the three offshore rigs and four existing international land rigs from country to country. The transition is behind us now and we should be poised for a strong third and fourth quarter. The US land segment should continue to improve in the third quarter as a result of strong natural gas prices, increases in rig activity and spot market rates finding bottom.

Following are some details on the activity and trends as we discuss our three operating segments. First, an overview of US land. Today we have 95% activity with 166 out of 175 rigs working, up 10 working rigs since the last webcast. Our active rig count is at 30 rigs or 22% since the second quarter webcast a year ago. We anticipate an average of 166 rigs working during the third fiscal quarter.

The announcement of three additional new rigs brings the total FlexRigs count in US land to 139 rigs of which 136 are working today. The three new builds are scheduled for delivery during the third quarter for a total of six new FlexRigs delivered in the third fiscal quarter. We are encouraged by ongoing contract negotiations for more new FlexRigs and we are pleased with the progress with those negotiations.

Nine convention rigs are idle today compared to 11 rigs during the last call. We believe that at least three of the nine rigs will be active by the end of the third quarter and should contribute fully in the fourth fiscal quarter. Of our currently active fleet of 166 rigs, 67 are in the spot market and the remaining 99 active rigs including 86 new builds are under term contracts. About 56% of our potential revenue days for fiscal 2008 and 50% for 2009 are under term contract.

Average rig revenue per day for H&P's entire US land segment increased sequentially $409 per day to $24,414. We expect average rig revenues per day for rigs under term contracts and rigs in the spot market to remain relatively flat for the third quarter. There is clearly a high demand for quality rigs as a result of higher natural gas prices. And so it is possible that we could see day rates improve going into the fourth quarter.

Average expense per day increased by $662 from quarter-to-quarter as a result of higher maintenance and supply costs and slightly increased labor costs. We commented in the last call that the first fiscal quarter costs were substantially lower than the previous two quarters and we did not anticipate the lower cost to be sustainable. When comparing the second fiscal quarter cost to the average of the last four quarters, costs were up only 2%, in contrast to oil field inflationary cost increases of 7.3% over the last 12 months.

FlexRigs continue to deliver outstanding fuel performance, resulting in better personnel safety and reduced drilling times for our customers. This is a value proposition confirmed by the continued support of our customers to contract FlexRigs with attractive rates and term contracts. A powerful thing continues in the unconventional resource plays like the Barnett shale where horizontal drilling is required to get the most efficient production and FlexRigs are best suited to tackle the difficult drilling and gas factory performance that is required.

And moving to our offshore operations where average activity in our offshore segment increased sequentially from 5 to 5.6 active rigs out of a total of 9 available rigs during the second fiscal quarter. We expect activity for the third fiscal quarter to increase to an average of 7 plus rigs working. Average rig margin per day increased by $2,608 to $12,065. This decline was mostly attributable to startup expenses during the quarter. This expense will be more than offset by mobilization and holding revenues to be allocated during the first year of operation.

Eight of nine platform rigs are now active. The average rig margin per day for the third fiscal quarter is expected to be in the high teens and increased to the low 20s in the fourth fiscal quarter. The 9th rig is contracted and expected to commence operations in the Gulf of Mexico in early to mid-calendar 2009 and is currently in the shipyard undergoing upgrade.

Now turning to international operations where as expected average international operating activity declined by approximately two rigs to slightly under 20 rigs, as full rigs mobilized between countries to commence work under new contracts during the second quarter. Today 22 of 27 rigs are active in international operation. Activity should improve to 24 rigs by the end of the third fiscal quarter. An average of about 21 active rigs is expected for the third quarter. Average rig margins per day increased by $227 to $14,396 for the quarter, but are expected to be negatively impacted by 5% to 10% during the third fiscal quarter given the high level of mobilization activity. This decline should be offset by an increase of similar scale in the fourth fiscal quarter once all rigs have commenced operations and are able to fully contribute to the bottom line.

The first of seven new international FlexRigs is expected to commence operations in the first month of the first fiscal quarter of 2009. The remaining rigs will commence work at the rate of one per month. We continue to view the international market as having great opportunity as evidenced by our bid activity and ongoing conversations regarding FlexRigs performance and potential expansion areas.

In closing, the best illustration of future growth for H&P should be viewed by the announcement of 20 new builds during the last three earnings calls. One third committed to international expansion and two thirds capturing additional market share in US land. H&P is active and growing in the unconventional resource play. The Barnett, Piance, Baffin and Woodford shale and in West Texas in California. We have rigs running in the Haynesville area and we are developing plans for entering the active Marcellus areas.

H&P's focus will remain on executing on the value proposition to our customers. And it is that execution which will produce our growth into the future and continue to provide returns for shareholders. I'll turn the call back to Doug.

Dough Fears

Thank you, John. We would now like to open the call to questions, Tony.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from Mike Drickamer with Morgan Keegan. Please go ahead. Your line is open.

Mike Drickamer - Morgan Keegan

Hi. Good morning, guys.

Hans Helmerich

Morning.

Mike Drickamer - Morgan Keegan

Hans, could I get you to qualify here just to make sure I understood what you said, right you believe there are 400 idle rigs on the sideline?

Hans Helmerich

Well, I think that the number reached and exceeded that. I don't know what it would be Mike, as of this week. I think there have probably been some of those rigs have returned to work.

Mike Drickamer - Morgan Keegan

Okay. And the vast majority of those idle rigs though are legacy rigs.

Hans Helmerich

I think what we saw happen was the rig count didn't as you know decline in a precipitous way, but the rigs that were idle during the last 18 months were pushed out of the bottom of the food chain, because I think that once the customers had a chance to absorb some of the new builds that was clearly their preference. So I would expect those rigs sidelined today are the rigs that are most challenged in terms of their acceptability to customers.

Mike Drickamer - Morgan Keegan

Okay. I guess where I'm trying to go with this how many of those rigs, how high could we get the rig count here. Do those rigs come back or those rigs, as you commented there's a lower spec rigs are going to have a tough time working here.

Hans Helmerich

Yeah, I think that is an important thing to watch as we go forward and the difference in this cycle that I was trying to point out is the customer has expressed a preference for new builds. So as the cycle improves the notion that those rigs automatically reengage and go back into the market, I think is an assumption we can't make. They will have to compete against the customer preference for new build high efficiency rigs.

So it's a guessing game Mike, but I think you could have a couple of hundred of those rigs that don't ever return to work and if you look at that in the context of what should be the natural attrition in an industry that the average rig in some cases exceeds 30 years, the attrition should be in our opinion between a 100 rigs to 150 rigs. So it wouldn't be a surprise at all for 200 of those rigs to remain sidelined.

Mike Drickamer - Morgan Keegan

Okay. Then one more on, we'll pull up a little bit here. Hans, you talked about, you expect to announce additional new build announcements in the back half of the year. Can you quantify perhaps as a range how many new rigs you expect to build, comparable to the 10 rigs we have seen over the past two quarters or….?

Hans Helmerich

As we have always been reluctant to try to put a hard number on that. I think that we're going to see the opportunity to and I think we have stated this before too in fiscal year 2008 to have about 25 and perhaps more new builds in that. So it's probably all I can say Mike, in terms of a number. But I would say that we're confident that we're going to see additional new orders we may build something in the next 30 days or so.

Mike Drickamer - Morgan Keegan

Okay. So would you take and then announce them in 30 days or you'll just wait till the next conference call as you have done in the past couple quarters?

John Lindsay

Well, yeah, that's always a question in our minds. We’d love for the customers to cooperate and arrange things for our conference calls, but they don't. And so if it's a sizable order then you guys should know about, and we will tell you about it as it comes to the table.

Mike Drickamer - Morgan Keegan

Right. I'll turn it back.

Doug Fears

Thanks.

Operator

(Operator Instructions). Meanwhile we will move to Kevin Pollard with J.P. Morgan. Please go ahead, your line is open.

Kevin Pollard - J.P. Morgan

Thanks, good morning guys.

Doug Fears

Morning.

Kevin Pollard - J.P. Morgan

I just wanted to kind of follow-up on some of my questions on the outlook for new build. would it be fair to say it would surprise you if the new orders didn't pick up quite a bit over say the next 12 months versus the previous four quarters, given the increase in commodity prices and of course the time you put on shale place, et cetera?

Doug Fears

Yeah, I think those trends that you identify are very positive. And we have been in a softer cycle and I think one of the interesting things as when you think of the cycle peaking in the fall of 2006, day rates coming down, typically at that point you would have no opportunity to build new, you wouldn't be able to sign long-term contracts. As we mentioned earlier, a third of our order book has come after that peak in 2006.

Now, clearly as you mention, the market is more upbeat about the direction of natural gas prices. They have already taken a very nice bounce. There seems to be more and more momentum behind these shale plays and unconventional gas plays. And so I think we're going to see additional opportunities for new build.

Kevin Pollard - J.P. Morgan

Have you noticed an increase I guess, I don't know urgency is the right word or, you know, inquiry level for new FlexRigs in the last 90 days versus where we were kind of at the beginning of the year?

Doug Fears

Well, I think there's a certain lag effect and I'm not sure if we have seen, just trying to address your question in the last 90 days has it been more. I think we have been pleased with the ongoing interest that the customer's had. When we think of the shale plays and what they require in terms of extended reach and the higher capability rig, I think the customer has a long view and is making preparations for their execution in terms of the drilling program. So, but I do believe as I said earlier, we're going to see some fruit from the ongoing conversations we had with customers now.

Kevin Pollard - J.P. Morgan

Okay. And are you seeing any trend of at least in the near-term and perhaps maybe you can comment on the three new builds this quarter, are they existing customers just using more FlexRigs or are you seeing additional, I guess new adopters for lack of a better word kind of like you saw last quarter with a couple smaller independent?

Doug Fears

I think a little bit of both. John, do you want to.

John Lindsay

Kevin, this is John Lindsay. We have for the most part, these have been existing customers. I think what's interesting about it though is it's customers in some cases taking rigs into areas that we haven't had much of a footprint in, for instance West Texas. In those cases replacing older convention rigs, but we do continue to see interest from new customers and that's encouraging to us as well. It seems like every year there's another handful of operators, that and the light bulb kind of comes on and they begin to understand the value proposition. So we're encouraged by that.

Kevin Pollard - J.P. Morgan

Okay. My last question just real quickly, you touched on in your comment, you know, John, I was wondering if you could comment on the Marcellus it’s a little bit more. We're hearing from most of the operators they are saying given the unique requirements of that market require almost exclusively purpose built rigs, I was wondering if you could comment on, what type of assets, how the FlexRigs will be modified or a new version come up with that would be suitable for that line?

John Lindsay

I think if you just look at the success that we have had, our engineering group has been really on top of new areas, consider the FLEX 4 where we came in and designed a rig that was really purpose built to drill pad type wells, we're drilling 22 wells in a single pad with FLEX 4S. We have done some things with smaller, more mobile rigs, and I think there's a lot of components in place with the FlexRigs now obviously starting with AC drive and building on the success that we have already had in all these other non-conventional plays. So yeah, I think there will be a purpose built nature to it, but that's part of the process that we're working on.

Kevin Pollard - J.P. Morgan

So probably a little early to tell exactly what role you're going to play in that market.

Dough Fears

Yeah, you think about it there has not been a whole lot of wells drilled out there. There are some early encouraging signs and we want to be out there with the right rig on the ground, so that's why we have the kind of the investigation ongoing and trying to figure out what the best rig design is.

Kevin Pollard - J.P. Morgan

Alright, thanks guys, I appreciate it.

Hans Helmerich

Thank you.

Operator

(Operator Instructions) Meanwhile, we have a question from Michael Breard with Hodges Capital Management. Please go ahead, your line is open.

Michael Breard - Hodges Capital Management

Yes. I was wondering what you're seeing in terms of day rates just in the last couple of months. Has there been an increase where you have spot rigs available?

John Lindsay

Mike, this is John. What we have primarily seen is a flattening out. We have stopped seeing the downward pricing pressure as you can imagine. It's still been a little early for real pricing increases. We have seen a few in a small way, but in general I think we would best describe it as spot pricing has flattened with now, I guess some upper potential in pricing, but we haven't seen a lot of that yet.

Michael Breard - Hodges Capital Management

Okay, thanks.

John Lindsay

Still a lot of rigs out there, still a lot of rigs out there competing, trying to get back into the market,

Michael Breard - Hodges Capital Management

Yes.

John Lindsay

So that's why we see that, I think.

Michael Breard - Hodges Capital Management

Okay, thank you.

Operator

At this time we have no further questions.

Doug Fears

Alright. Well, thank everybody for joining us today. If there are no further questions have a good day, good-bye.

Operator

This does conclude today's teleconference. You may disconnect at any time and have a great day.

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