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Parker Drilling Co. (NYSE:PKD)

Q2 2012 Results Earnings Call

August 2, 2012 11:00 AM ET

Executives

Richard Bajenski – Director, Investor Relations

Bobby Parker – Chairman, President and CEO

Kirk Brassfield – Senior Vice President and CFO

Analysts

Walt Chancellor – Stephens, Inc.

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Parker Drilling Second Quarter 2012 Conference Call. During today’s presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be open for your questions. (Operator Instructions)

Today’s conference is being recorded, August 2, 2012. I would now like to turn the conference over to Richard Bajenski. Please go ahead, sir.

Richard Bajenski

Thank you, Alicia. Good morning to you and our audience. And thank you for joining the Parker Drilling 2012 second quarter conference call. This is Richard Bajenski, Director of Investor Relations. And joining me today are Bobby Parker, Chairman, CEO and President; and Kirk Brassfield, Senior Vice President and Chief Financial Officer.

In the course of our comments today, we may make statements regarding management’s expectations for the company’s future performance that we believe will be informative and beneficial to our shareholders.

These statements are considered forward-looking statements within the meaning of the Securities Act. And these forward-looking statements speaks only as of the date of this call, and actual results may differ materially due to the various factors we have referenced in our public filings and other factors addressed during this call, including changes in market conditions affecting our industry.

We will also refer to non-GAAP financial measures, such as adjusted EBITDA and non-routine items. Please refer to the table in our current press release or on the company’s website for a definition of adjusted EBITDA and a reconciliation of this measure to the comparable GAAP measure and for further information regarding non-routine items.

Bobby Parker will begin our review today. Bobby?

Bobby Parker

Thanks, Rich. And I want to welcome everyone to our conference call. Earlier today we reported our 2012 second quarter results. We achieved year-to-year increases in revenues, adjusted EBITDA, net income and earnings per share.

In addition, our U.S. Barge Drilling and International Drilling segments contributed a greater portion of our earnings, demonstrating the balance and diversity of our sources of revenue and earnings growth. Kirk and I will review operational and financial performance in detail in a moment, before hand though an update on our CEO search and other topics.

Our CEO search is ongoing and has been led by the Board, assisted by an outside search firm. There is not much more that can be said about a project like this until it is complete and we have an executive onboard, until then, one of my objections is to maintain the momentum in our business operations.

There are two other areas that I’m focused on. First, is to get the AADU rig completed and working. We are making good progress on this. One rig is scheduled to begin acceptance testing today. Once accepted by BP, it will move to its first location and begin operations that could be before year end.

The second rig is scheduled to begin testing shortly after the first rig has gone through the process. Our people on the North Slope have never been busier, working to complete the rigs and they are training for rig operations.

They made great progress since earlier this year and I want to thank them for the perseverance, their dedicated work and their safety performance. Our safety record on the North Slope has been terrific. Year-to-date we have had no reportable injuries.

Our second area of focus is to reestablish momentum in our international rig fleet utilization. Our current rig utilization is not where we wanted to be and it will trend lower before it improves. We have been working vigilantly to remedy that.

As a result of our efforts and an increase in E&P spending, our tender activity has increased significantly and we have been actively submitting tenders in all of our key markets and developing opportunities in some promising new markets.

A particular focus of that work is our under utilized fleet of nine rings in Kazakhstan, only two of the nine Kazakhstan rigs are working today and we have been actively tendering them for work in country and through the CIS and other regions.

We’re also accessing other options for these rigs including potential sales. One of my personal priorities has been a commitment to maintain our focus on safety throughout the company.

Our people have done a good job of maintaining that focus, being watchful of their own safety as well as the safety of those they work with. As a result, our company-wide safety performance today is better than it was this time last year and significantly better than our target, everyone should be committed for this effort has to taken to achieve that.

Turning now to market trends as we see them, demand for the rental tools in the U.S. land drilling market has slowed as footage drilled and the overall rig count have leveled off. As a result, we are seeing more than adequate supplies of drill pipe and related products in most of our key markets as rental tools supplier bring to the market previously ordered equipment.

I would expect this oversupply condition will rebalance itself relatively quickly as it usually does through the normal wear and loss of pipe as they used. In the meantime, equipment utilization and pricing are trending lower.

The Gulf of Mexico shallow water barge drilling market appears study today, supported by oil prices that make drilling even in small reservoirs a good cash flow decision. Most recently, almost all of the industry’s available barge rigs have been working and many operators have multi-well drilling programs to execute.

There is, however, a shortage of deep gas drilling programs in this market. So some of our deepest drilling rigs might go through patches of idle time or continue to be used to drill shallower wells at corresponding day rates.

Although, we are seeing stronger utilization today, it should be noted that we are entering the typically more active part of the hurricane season and some operators may choose to postpone drilling during the coming months to avoid drilling delays and extra cost caused by storm events.

In the international market, prices for oil and natural gas have been a stimulus to exploration and development drilling. Through our current international rig utilization rate is low and trending lower, we have been experiencing higher levels of tendering activity recently, significantly above where it has been. Not all of this will lead to contracted work for Parker but it was a good indication.

As this unfolds more broadly, I expect it to lead to more demand for our contract drilling services, as well as a technical advice and expertise we provide to those with projects in more remote and challenging location.

That concludes my remarks for now. I’ll turn it over to Kirk Brassfield to discuss our operating and financial performance. Kirk?

Kirk Brassfield

Thanks, Bobby. For the 2012 second quarter we achieved a 4% year-to-year increase in revenues, producing a 9% increase in operating gross margins, a 7% increase in adjusted EBITDA and a 35% increase in adjusted net income.

For the quarter, our earnings were $0.17 per diluted share and $0.18 per share when adjusted for non-routine items, a 38% increase from the comparable results from last year second quarter.

Revenues and segment gross margins for the Rental Tools segment continued to grow compared to the 2011 second quarter. Revenues were $65 million, gross margin was $42.5 million and gross margin as a percent of revenue was 65.3%.

The growth and performance of this business is attributable to the continued demand for premium Rental Tools, driven by the expanded use of lateral drilling in U.S. land drilling markets, particularly in the oil and wet gas plays, our expanded rail tools inventory, the geographic shift by operating from dry gas oil fields to oil and wet gas fields and our ability to efficiently position our products to best meet those shipping customer needs in a timely manner.

The U.S. Barge Drilling segment reported second-quarter revenues of $33.3 million, gross margin of $14.5 million and gross margin as a percentage of revenue of 43.6%. All of these reflect significant increases from the prior year second quarter. The Barge Drilling business continued to benefit from increased utilization and higher day rates.

Our second-quarter average utilization was 85% compared with the 2011 second quarter utilization of 81%. Our reported average utilization is based on a marketable fleet of 13 Barge rigs, which includes two rigs that would require capital outweighs before they would operate. Excluding these two rigs, we were effectively a full utilization of our marketed fleets of 11 drilling Barges.

In addition to reaching full utilizations in the second quarter, we also were able to increase our average day rate by 23% to [31.09] from 26,000 into the 2011 second quarter. And we were able to accomplish this, while our ultra deep Barge rigs were drilling shallower wells, some of the time at corresponding day rates.

Today, all of our available 11 Barge rigs are at work. And our current average day rate is approximately $34,000. Most of our rigs are engaged in drilling for oil, as this is also true for most of the industry, Gulf of Mexico Barge drilling fleet.

The U.S. Drilling segment recorded no revenues from the 2012 and 2011 second quarters. Its business reported in each period are those associated with the preparations being made to support the AADU rigs.

Let me address the financial impact that will occur as the rigs move through the acceptance process and then on to drilling. As each rig is presented for acceptance testing, it is deem to be substantially complete and ready for its intended use. At that time, we will seek capitalizing rig related costs and depreciation of each rig will begin.

The majority of costs incurred after that time are expected to be recorded as an operating expense, which we estimate will be at least $1.5 million per rig per month. We expect that there’ll be some months ahead in which we will have little or no revenues from these rigs. Revenues will be generated only after rig has been accepted by BP, move to these locations and began operations. As a result, the segment gross margins are likely to reflect losses during the remainder of the year.

Our International Drilling segment reported second quarter revenue of $76.9 million, gross margin of $18.2 million and gross margin as a percent of revenue of 23.7%. Compared to the 2011 second quarter, segment revenues, gross margins and gross margin percent all improved to the increased utilization in the higher average day rate for the Parker fleet, up from the Parker fleet.

Offset primarily by much lower revenues from reimbursable expenses in our O&M projects, our international rig fleet utilization was 51% during this 2012 second quarter. The comparable utilization for last year’s second quarter was 48%. In the Latin America region, our 10 rig fleet operated 70% utilization and ahead of last years second quarter average utilization of 67%.

The year-to-year improvement was primarily due to the reengagement in Mexico of a previously idle rig. In this region, we have three planned rigs idle, two of which recently completed contracted work in Colombia. All three are either included in recently submitted tenders or are at the subject of discussions with operators in the area.

In the Eastern Hemisphere region, our 16-rig fleet operated at 39% compared with the prior year second quarter average utilization of 36%. The utilization increase was primarily the result of putting two previously idle rigs to work in Nigeria earlier this year.

During the 2012 second quarter, our Caspian Sea drilling barge completed its work in the (inaudible) field and is currently idle and at zero day rate. We are in discussion with the operators about their plans for the rig, while we also seek other work in the region. In addition to the rigs we have idle in Kazakhstan. We have two rigs idle in New Zealand, and one rig idle in Indonesia. We continue to market these in the region.

The International Drilling segment O&M projects had lower revenues and gross margins in the 2012 second quarter compared with the 2011 second quarter, primarily due to the completion in late 2011 of the Yastreb rig move on Sakhalin Island.

Personally offsetting this were increased contributions from the Coral Sea project in Papua New Guinea, a new rig management contract in China and a ramp-up to operating status from one status from the Orlan platform off the Sakhalin Island, Russia.

Beginning this week, our work on Sakhalin Island, with Exxon Neftegas Ltd., moves to a new chapter. With the exploration of one of the original O&M contracts, ENL initiated a tender for a new consolidated contract covering the existing two operations, which are the Oster brand rig and Orlan platform and adding the under construction for Berkut platform..

We were successful in winning the new consolidated contract, expanding the scope of our involvement with ENL on Sakhalin Island and replacing a significant portion of the financial contribution that the original contracts had provided. The new consolidated contract is expected to produce revenues around $350 million during its five-year term.

Our initial work under the new contract will focus on the two programs we previously operated, the Oscar rig and the Orlan platform and will expand to include the Berkut platform, when it is activated which is expected to occur in late 2013 or early 2014.

The initial EBITDA of the new consolidated contract is expected to be approximately $1 million to $1.5 million per quarter. It will significantly increase from there when the Berkut platform is activated, and an additional content is added to the work scope, which is already begun to occur.

Our technical services segment revenues were $3.7 million for the 2012 second quarter, and gross margin was a loss of $258,000. Revenues are lower than in the 2011 second quarter reflecting primarily the completion in 2011 of the pre-operations activity related to the Liberty project in Alaska, and the transition of the Sakhalin Island, Berkut platform project from its engineering phase for a less revenue intensive construction phase.

The construction contract segment recorded no revenues or gross margin for 2012 second quarter, now that the work on the Liberty project has ceased. BP recently announced it will not proceed with its Liberty project as originally designed.

While, we had hoped we would be in line to operate that rig once it ready for drilling, BPs announcement does not impact any of our current activity, nor does it affect the expectations for our AADU rig deployment. G&A expense in the second quarter was $7.4 million compared with the prior year’s quarter expense of $7.9 million. Both years included expenses related to DOJ, SEC and Parker investigations.

Excluding these, adjusted G&A expense for 2012 second quarter was $7.1 million compared with the similarly adjusted G&A expense of $5.5 million for the 2011 second quarter. This increase was primarily due to higher professional fees. Total interest cost in the 2012 second quarter was $11.9 million with $8.9 million reported as interest expense and $3 million being capitalized. Much of the capitalized interest is related to the AADU rig construction.

This capitalization of the AADU rig construction will see being capitalized as rigs are presented for acceptance testing. In the prior year’s second quarter, total interest was $10.5 million with $5.8 million recorded as expense and $4.7 million capitalized. The increase in interest expense is primarily the result of the April refinancing of our 208 first hand convertible notes that matured in July.

We issued a $125 million at ad on notes to our senior secured notes, and later completed a tender offer for the convertible notes. We have effectively refinanced the convertibles and extended the debt maturity to 2018. In executing the refinancing, we also incurred debt extinguishments cost of $1.6 million, which reduced earnings per share by $0.01 in the second quarter.

Our effective tax rate for the quarter was 33%, well below the prior year’s second quarter rate of 49%. The primary factor leading to the lower rate in the 2007 -- 2012 second quarter was our ability to utilize net operating losses. In addition, we benefited from the realization of previous tax deductions that we had reserved against due to uncertainties and those conditions of uncertainty have been resolved.

We expect the tax rate for the remainder of the year to be just below 40%. Before turning to other financial matters, let me summarize some of the current or upcoming events that will impact our near-term financial performance. Between now and the end of the year each of our two AADU rigs is expected to move from a condition of capitalizing cost to one of expensing costs.

We expect this to add expense in the third and fourth quarter with no significant revenue to be generated until each of these rigs begin operating for the end of this year or in early 2013. Our Caspian Sea barge rig 257 is expected to be at a low dayrate or the idle for the rest of 2012.

The recently awarded consolidated O&M contract for ENL Sakhalin Island project will produce revenues and earnings lower than the previous now expired contracts. Initially, revenues and earnings of the new consolidated contract will reflect the operation of the two ongoing drilling programs, the Yastreb rig in the Orlan platform and I expected to increase when the Berkut platform is activated.

Turning to other financial matters, our cash balance at quarter end was $77.5 million compared to $97.9 million at the end of 2011. Second quarter capital expenditures were $50.1 million bringing our year-to-date capital spent to $109.5 million. Included in that are Alaska rig construction spending of $48.5 million year-to-date, we currently estimate our overall capital costs for the AADU rigs will be approximately $400 million including capitalized interest.

Including the 2011 asset impairment charge, the net book value is expected to be approximately $230 million. Rental tools expenditures of $41.6 million were capitalized year-to-date. At the end of the second quarter, we had $481 million of debt outstanding or a net deposition of $403.6 million. Our net debt to net capitalization ratio quarter end was 40.4%.

We believe our balance sheet is in good shape and that our operational performance, and strategic balance and diversity to provide cash flows that will allow us to continue to be successful and grow profitably.

That is the operation and financial review, I’ll turn it back to Bobby for comments on the outlook and then we will take questions. Bobby?

Bobby Parker

Thanks, Kirk. We had a good second quarter with continued gains in several of our businesses. However, shifting trends in U.S. land drilling in the current market uncertainty about the outlook for all the natural gas prices has begun to lead to slower growth in some of the markets, and has us alert for changing conditions that might further impact our business.

We believe that our competitive advantage, geographic and market diversity, and other strategic strengths position us to face this market challenges and take advantage of competitive opportunities to produce relatively resilient operating results. We expect market conditions for rental tools to reflect the recent softening in U.S. land drilling activity and a more typical competitive environment, as rental tool suppliers rebalance their available inventory.

We believe the usage of rental tool by U.S. land operators will continue driven by the broadening application of lateral drilling in the trend toward more complex well designs. In addition, the growing activity in the Gulf of Mexico, both on the Shelf and in deepwater is expected to be expanded source of business for opportunities for rental tool segment.

Given market conditions we do plan -- we do not plan on placing orders for drilled pipe for the remainder of the year. We believe our available stock including previously ordered equipment new to arrive in the second half will be sufficient to meet customer requirements.

Drilling remains active in the Gulf of Mexico barge drilling market with oil and liquid rich natural gas targets, being the predominant focus. If market prices for these commodities remained around the current level there should be good support for continued drilling in the shallow waters of the Gulf of Mexico.

Further interest in developing deep gas plays in this area could provide some additional growth opportunities. It remains to be seen what the recent strengthening and domestic natural gas prices may due to overall drilling activity in the U.S., both for U.S. land as well as the shallow and deepwater areas.

Our international rig fleet is expected to experience declining utilization in the near term. As current drilling contracts expire, not all of them are expected to be renewed. Drilling redeployment opportunities for international fleet and additional contracts for our OEM portfolio take time to develop.

Though there appears to be a growing interest among international operators to expand land drilling in several regions where we are focused. These are longer term developments. Any tender or contract wins in the next few months are most likely to have the greatest impact in 2013.

We have substantially completed several of the projects that were contributors to our technical service segment, revenues and earnings for the first six months of 2012 and expect a lower level of activity for the remainder of the year. We are engaged in some early stage engineering and development projects that could transform into more expensive technical services or activity later this year.

To summarize, the near-term outlook for our markets are slowing demand and some early pressure that will impact utilization and operating margins. Volatility and cyclicality are normal characteristics of our market and I believe we are well prepared to deal with them.

Add to that, the impact of the specific advance that Kirk listed, and we expect reduced levels of revenues and earnings until market strength and our initiatives in Alaska and internationally begin to take effect.

That concludes my remarks. Operator, we are ready to take questions from the audience.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from the line of John Keller with Stephens, Inc. Please go ahead.

Walt Chancellor – Stephens, Inc.

Good morning. This is Walt Chancellor for John Keller.

Bobby Parker

Hi, Walt.

Walt Chancellor – Stephens, Inc.

So, as we look out to ‘13 internationally, where are some of these specific pockets of demand and that tender activity that you’re seeing?

Bobby Parker

Walt, it’s fairly widespread, the majority of it would be in the Latin America region. And there is some still in North Africa, but it generally spread throughout. We’re seeing really a great number of tenders. And it’s just a good -- it was spread out throughout the regions that we operate in.

Our weaker area of the Far East still remains, I guess, you’d say a weaker area of tenders, but other operational areas that we work and remain, at least we have tenders for those areas. Kazakhstan is still an issue. While we are tendering inside of Kazakhstan, there are still not a lot of tenders in that particular country at this time.

Walt Chancellor – Stephens, Inc.

Okay. And just shifting gears to rental tools. In your remarks, you talked about strength in the Gulf of Mexico. If you could refresh us, how many landing streams are in the portfolio right now or in the inventory in the Gulf?

Bobby Parker

We have the ability of up to nine…

Walt Chancellor – Stephens, Inc.

Okay.

Bobby Parker

…landings streams in the Gulf of Mexico and inventory. And we currently today have six that are out on work today. And we have other tenders out for additional work.

Walt Chancellor – Stephens, Inc.

And do you all see that as an area to maybe deploy some more capital as we look out into ‘13?

Bobby Parker

Yeah. Walt, as I mentioned in the comment, we’re certainly not adding any drill pipe right now just due to the conditions at market. But landing streams is one area that we would -- if we view the market and talk to our customers that’s one area that we could and probably will add some capital to in 2013.

Walt Chancellor – Stephens, Inc.

Okay. And then, I guess, coming back to land as we see this situation with the rig count sort of going sideways, utilization. I guess, pricing coming down, where do you all see margins sort of normalizing? And I know, it’s a dynamic situation and it may not be easy to provide a specific answer on that one.

Bobby Parker

That is. And to -- the barge rig helps drive that number. So I would think being around that 20%. Concerning the second quarter, the barge rigs worked very little and that does tend to be a higher margin item.

So I would see for the international land that would probably be around 20% area -- to where we are today 23%.

Walt Chancellor – Stephens, Inc.

And on rentals, where do you see that normalizing?

Bobby Parker

I think the number we’re at now is a good number. I think its 65% for the second quarter.

Walt Chancellor – Stephens, Inc.

Okay. And then, I guess, finally on barges, very strong day rates right now, strong utilization. You mentioned there are some multi well programs out there. Have you seen a step change in the level of backlog or visibility or term commitment to operators are willing to make in this environment?

Bobby Parker

Well, we really haven’t. It’s just been good steady work. Well-to-well, even though there are some multi well programs, the commitments are well-to-well. We’ve not really seen a build up in backlog. As you’re probably familiar, the shelf jackup business is doing well in the backlog and the backlog in that business continues to increase.

And I would say the barge business correlates to that segment as well as anything. So that gives us, I guess, you could say hope for a continued strength in the barge business given how well the shelf jackup is doing.

Walt Chancellor – Stephens, Inc.

All right. Great. Thank you all very much.

Bobby Parker

Yeah. Thanks, Walt.

Operator

Thank you. (Operator Instructions) And I’m showing no further questions at this time. I’d like to turn the conference back to management for any closing remarks.

Richard Bajenski

Thank you, Alicia. And I want to reach out to everyone on our call today and thank you for joining us. We appreciate your interest in Parker Drilling and look forward to speaking to you at least this time at the end of next quarter and at times in between now and then. Have a good day.

Operator

Ladies and gentlemen, this concludes the Parker Drilling second quarter 2012 conference call. Thank you for your participation. You may now disconnect.

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