Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Nabors Industries Ltd. (NYSE:NBR)

Q2 2008 Earnings Call

July 23, 2008 11:00 am ET

Executives

Dennis Smith - Director of Corporate Development

Gene Isenberg - Chairman and CEO

Joe Hudson - President, US Land Drilling Business

Nick Petronio - President, Pool Well Service

Jerry Shanklin - President, Offshore

James Payne - Chairman and CEO of Shona Energy Company, LLC.

Bruce Koch - VP and CFO

Analysts

John Fitzgerald - Raymond James

Byron Pope - Tudor Pickering

Kevin Simpson - Miller Tabak

Dan Boyd - Goldman Sachs

Kevin Pollard - JPMorgan Chase

Doug Becker - Banc of America

Roger Read - Natixis Bleichroeder

Rob McKinsey - FBR Capital Markets

Kurt Hallead - Royal Bank of Canada

Alan Laws - Merrill Lynch

Operator

Welcome to the Nabors Industries' Second Quarter 2008 Earnings Call. At this time all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session and instructions. (Operator Instructions). As a reminder, this call is being recorded today, Wednesday, July 23, 2008.

I'd now like to turn the conference over to Mr. Dennis Smith. Please go ahead, sir.

Dennis Smith

Good morning, everyone and welcome to our conference call this quarter. With us today are the usual participants we have, myself and Gene Isenberg, our Chairman and CEO, Tony Petrello, our President and COO, Bruce Koch, our CFO, who has taken our general counsel and all presidents of our major business divisions.

We'll follow the same format we always do, where Gene will give some opening remarks about the quarter as well as how we see the outlook for 20 or 30 minutes, and we'll open it up to question-and-answers and limit the call to one hour.

So I want to remind everybody that obviously we're talking about the forward-looking statements under the SEC Securities and Exchange Act, and as such there's a lot of uncertainty going forward and we encourage you to look at our filings in the 10-Ks, and Qs. Gene, if you want to go ahead and get started?

Gene Isenberg

Sure. Welcome again to the conference call for the second quarter. As usual, we have posted to the Nabors' website a series of slides that contain details about the performance of the various segments of the company for your reference and we'll try to hit the highlights of the quarter and our current outlook.

Let me begin by saying that operating income, which we have always considered to be the most relevant metric of the performance of the company improved sequentially in virtually all of the units over the first quarter.

The only exceptions were Canada and Alaska which were predictably were down due to seasonal effects, although both performed better than we had expected them to.

As a result, operating income for the quarter was $266 million, but in my opinion, it should be adjusted upwards for the $8 million non-cash pre-tax charge we incurred from the reduction in value of forward hedges in our first reserved E&P joint-ventures, and we'll discuss E&P a little later.

The company's overall operational performance was ahead of expectations; however for the earnings per share did not fully reflect the strength of our performance for three reasons, which I'll go over very quickly.

First, we incurred a significant increase in our effective tax rate, and the way this happens is as follows. We project every quarter what we think that the income and tax rate will be for the rest of the year, and because of the increase in domestic and Canadian income compared to previous expectations, the forecast becomes approximately 25% instead of approximately 23%., so the accounting rules require that we make an adjustment for the second, third and fourth quarters in this quarter.

So, our tax rate goes to 27% for the quarter, compared to an expectation for the year of around 25. That in itself is about $.03 a share. The aforementioned after-tax impact of the hedges, which really locked in some pretty good margins, but that, was essentially $0.02 a share.

And then there's a complicated thing which I won't get into in our convertible, which in effect had 2 million shares outstanding, more than will be eventually, and that was another penny and so that add, we really should have on an apples-to-apples basis $0.06 more in EPS. $0.06 more in EPS.

Before we get into the business units, let me discuss a couple of other issues of potential significance that transpired during the quarter. Our investment income was quite good at $25 million, good indication that the issues that plagued us last year are behind us. This included a gain in the market value of a portion of our HH holdings, which are held for sale.

In the last few weeks, we have redeemed $700 million in outstanding zero coupon, zero yield convertibles due 2023, and the remaining $82 million in zero coupon, 2.5% notes due in 2021.

Unfortunately, the large appreciation in the Nabors' stock price indicated and created a large premium that valued the 2023 conversion. This amounted to nearly $250 million, which was settled in shares upon the conversion of the notes as I have previously mentioned.

Our capital structure and cash position remained quite healthy, but we are seeing a pretty substantial increase and attractive investment opportunities. And we now estimate that capital expenditures this year will be as high as $2 billion.

As a result, we reopened our February offering of $575 million and 10--year, 6.15% common coupon notes due 2013. They were 10-year notes, and we placed an additional $400 million last week bringing the total to $975.

Let me also again emphasize that these investments generally will be back-to-back with term contracts as is the case with the over 20 new build contracts commitments we now have from customers, which we'll discuss later and which we have secured during this quarter alone.

With respect to our E&P investments, they are coming along pretty nicely, we'll discuss those in more detail, but we commonly lock in pretty good returns through commodity price hedges.

I wanted to highlight another area, where two accounts rules, one currently enforced, and one that will take effect in 2009 will further impact our earnings per share going forward. Both are related to our $2.75 billion convertible issue.

Specifically the way we did the convert was a conventional convert, which took us to 4583 conversion price, then we an augmented that by a derivative call spread, which de facto means that the economic dilution doesn't start till the stock price gets over $54.64.

However, the accounting rules are such that when we go over 45, we get economic dilution and we don't take credit for the hedge that we have in place for the call. So, economically, we'll have more dilution indicated on the balance sheet, but it won't be real.

Beginning in January, we'll also be required to record non-cash interest expense on amount equal to the difference between the nominal coupon, which is 0.94 on this $2.75 billion convert.

And our basic interest rates, which we estimate to be around 6.2%, the effect of this will not only have a $0.25 per share impact in '09, but also we'll have to retroactively restate the previous years where this convert and the other convert were in effect.

Neither of these issues have any impact whatsoever on the real performance of our company. But rather they are just accounting rules, which unfortunately do affect our reported GAAP earnings.

Now let me turn to the business units.

Lower 48, I think, we'll all be able to say with pretty definitive certainty that the client that characterized the US drilling operation, and in fact later I'll talk about the Canadian one bottomed out in the first quarter.

And this unit concluded the first quarter with an increase in operating income, more importantly performance in this unit is improving rapidly with the average recount up almost 17 rigs sequentially to 242.3 in the second quarter, and since then it's up another 17 rigs at 257.

Average day rate margins were essentially flat at $8,900 a day. You may recall, we had earlier expected a pretty substantial decline. And as I explained in some detail last time, and I won't go into as much detail, there are really two conflicting, or three conflicting elements to the day rate.

The legacy rigs, which had been contracted at pretty high prices at the peak in 2006 are coming off contract and coming at lower rates. The rates however are higher than we had projected and they are continuing to go higher.

The other component is our new build fleet, and the new build fleet, we had 75 rigs in operation and we've had issues, which are totally behind us now but in effect, the average margin in those rigs this quarter compared to the comparable quarter last year were up $3,000 today.

In addition, we took stack rigs and put them to work. When you add all that together, the good stuff overcame the bad stuff, namely the high price rigs rolling off and in the future, it will get better, and in the fourth quarter materially better, and beyond that, even better.

However the most important single thing that happened in the first quarter from our viewpoint with respect to ND, USA is that we have recently secured a significant number of new builds, all at significantly higher rates than previous new rig contracts, and we have a very significant number under negotiation in contract.

For example, we have 32 rigs now working in the Haynesville Shale, compared to 20 at the beginning of the year and we expect to have 40 or 50, probably closer to 50 by the end of the year.

Also, we have kind of a unique advantage, if an operator needs a rig, and he really wants a built for purpose specialty design new-built, and he needs a good rig right away, we probably uniquely can give him a rig to bridge the gap between his requirements right now and when he will get the new-built which could be 9, 10, 11, 12, 13 months from now.

So, this allows our customers and ourselves to have our cake and eat it, if we can get decent rates, or pretty good rates on the existing rigs and we can lock in new builds, usually at three-year basis, and at an increasingly better margins.

Anyway, the demand for new PACE rigs is the best testimony to the efficiency and the effectiveness of our overall drilling program and we're setting records and we're breaking our own records.

And one of the things I enjoyed the most is recently we got a copy of a letter that a major oil company's CEO sent to his field management congratulating them on the new record set by one of our PACE rigs in Wamsutter, and I won't mention the operator, but who else operates in Wamsutter where our major competitor has twice as many new rigs as we do and have been operating these rigs longer than we do, and I won't mention the competitor, but everybody knows who it is.

Looking ahead, we anticipate continued increases on our rig count throughout the balance of the year with average rates up modestly in the third quarter, that balance I discussed earlier, and much more significantly in the fourth quarter and frankly beyond.

The rig count currently stands at 257, and 156 of these are in long-term contracts, and as new rig opportunities come up for existing rigs, we're balancing the deployment or our commitment against the expectation of increasing market. So if the rate isn't as good enough, we'll do a short-term deal. And if it's good enough, we'll do a multiple-year deal. And the ideal way for us to do it is to tie that in with new builds.

Nabors' offshore, the US offshore unit posted a pretty good quarterly increase in income, perhaps as good as it ever has and we expect to maintain as big an increase as it's ever had. We expect to maintain this level through the end of the year, which is a notable change from previous years where there was a big drop offs because of hurricane expectations and the like.

And the jackup markets have improved, the barge rigs are improving. We have added barge rigs, so that we now have four essentially state-of-the-art barge rigs and we have such a pretty good demand for our barge rigs that we're tentatively or firmly going ahead to build one 2,000 horsepower rig, almost certainly we'll build a 1,500 horsepower rig.

And we'll do three Super Sundowners some time in the next nine months.

Anyway, all those rigs are pretty much employed and the margins are good and these are rigs that we can employ both in the US, Gulf and internationally US well servicing, this unit is obviously not doing as well as we would have liked, but we did post a slight improvement over the prior quarter, although still well below the comparable year ago quarter.

The basic goal in business is still limited, but we are encouraged by recent developments and trends. We recently implemented price increases in certain markets which were absorbed surprisingly readily. Rig hour has improved significantly from 260 to 270 odd sequentially and we are increasingly optimistic about higher third quarter results.

All hundred of our new rigs, 8,8,500 horsepower Millennium rigs and 2,220 horsepower singles are operating very, very satisfactorily after a protracted debugging period. Custer recognition of the inherited manage of the new technology is increasing, broadly and it has taken a long time, but we think it's here now.

We will take delivery of the first 10 of the 400 horsepower version of these rigs in the next couple of months, and we have a deal with National Oilwells that when we agree that these things are operating essentially flawlessly, which we think they will, we have potentially 90 additional ones to order.

Nabors Alaska, this was down seasonally as expected, but still more than 60% above the same quarter last year. Results reflected higher average day rates for legacy rigs, and late 2007 deployment of two new-built helicopter rigs for Murdock's exploration under long-term contracts.

We expect the third quarter to be down seasonally, but the more important thing overall is that we have a brand new 1,500 horsepower hybrid rig, stem drilling, with coil tubing and AC rig, it's the biggest one in the world, the only one in the world and there are applications from the existing depth which is probably 1800 meters to 5,000 meters all over the world including in Russia and this is on a five year deal which will provide a good return. There are opportunities for two more like that in Alaska alone and this is where Nabors has really a technological edge.

We're also working and this is pretty significant too, we have a number of rigs that have been working for while. In Alaska, there are some new technological developments and we're working with National Oilwells [three, four] division on upgrading these rigs, so that they will again be with the new technology and adapting to different road conditions, adapting to different well housing conditions will probably be the most effective and productive rigs on the North Slope.

And I think the important part of this as a new rig to do maybe you can do with these rigs can do, it's going to cost $80 million and we get our rigs from where they're at now to where they will be as functional as the new rig promised to be, but we're not sure will be, for 25% of the $80 million.

Unfortunately Alaska is not as big overall as it once was, but our position I think is increasingly solidified in an increasingly attractive market. International, as expected this unit showed substantial improvement during the quarter.

These results were achieved in spite of issues related to the start up of several rigs, particularly our higher margin jackups. Let me just overall say that whatever else is happening this year, the market is really good.

This year, in spite of these hiccups, we will have essentially a 40% increase in operating income compared to last year and we'll I think bigger than 40% increase in '09 versus '08.

And in the conversation we get into where these rigs are going and where they are coming from but every big producing area in the world, including now, Russia but more particularly Saudi Arabia, North Africa, Mexico, Columbia, we have sort of a leading position which we're exploiting as we go.

Nabors Canada posted a loss during the quarter. The biggest loss by quite a bit since I've been here, 21 years. I don't know what happened before that, but that's the bad news. The good news is the outlook for this unit is improving and improving dramatically.

We expect the second half of the year to be better, although the timing and extent of this recovery is still hard to predict and we still have weather issues in Canada but beyond that the outlook is much better with a better gas price, better net backs for the Canadian step in, probably even more particularly the increase in the shale activity, Horn River and Montney and British Columbia and the Bakken shale in Saskatchewan.

We have several rigs committed to these areas, including a heli-portable rig that's going to go in the Horn River and the big advantage of that is number one, it's our acreage so we can show how we can drill but also, it's going to be on a pad, so we'll get away from this 300 day year in Canada. We should be drilling 365 days a year and our demonstration will -- that this is feasible and economic will get a convinced to do that.

But pretty soon we'll get a much better picture of what's going on in Canada and I think it's going to be certainly a whole bunch better than what we had expected as recently as three months ago and it might be really good.

Other operating units are all doing well. Seasonal slowdown in Alaska construction is hiding or not hiding but is as expected, but we're doing really well in Canada. In Canrig and EPOCH and Ryan all the other manufacturing and other technical divisions are doing well.

Oil and gas will become more significant as the results later this year and into 2009 as we see meaningful productions from what have been pretty good investments so far. In fact, amazingly good investments so far, and I talk to you early about the hedges. These hedges really lock in better margins than we had expected when we made the investments.

We have nice acreage positions. You could call them good, but it's only good relative to the small size of E&P to Nabors industries and all of the significant shale plays. British Columbia's Horn River and Montney, well the Louisiana's Haynesville, Fayetteville Shales in Arkansas, Mississippi and Alabama Barnett Shale, Bakken shale, and all of these we have decent positions from the size of our operation.

But it does two important things for us apart from making money on E&P. It gives us a real understanding of what kind of rigs are needed in the area and it helps us market our rigs to other operators in the area.

Also, we're using, because they're the best rigs available, we're use a lot of our own rigs on some of these place. Let me conclude my comments by saying, I think, this quarter, we'll be at the lowest we see for some time, and this is probably the first time in a while that almost all of our units are going good.

I'm personally satisfied on a couple of fronts. One is that our domestic rigs hiccups have been resolved, both in terms of the drilling rigs and workover rigs and the customer acceptance in both cases bodes for a great future.

My personal convictions on natural gas, and I'm still more bullish than most, I think, are coming to pass. I think I can't see the possibility of LNG negatively impacting price in the United States for a long time.

To me, it's almost a non-sequitur to think that we might have too much gas long-term because we need the hydrocarbons and our agreement with (inaudible) statement that switching gas to transportation will bridge us for long time. Anyway, overall I think the outlook is really good and the proof of pudding is in the commitments that we're getting now and the commitments will turn to operating income down the road.

That covers my comments. Denny?

Dennis Smith

Patty, we're now ready for questions, please?

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). Our first question comes from the line of John Fitzgerald from Raymond James. Please go ahead.

John Fitzgerald - Raymond James

Good morning, guys.

Dennis Smith

Hi.

John Fitzgerald - Raymond James

It’s a question on the US offshore and I guess, correct me if I'm wrong, but you had two previously stacked jackups that you guys deployed in the past month or so on one well contracts. What's the market looking like right now as far as keeping these rigs working after that and/or putting additional stacked capacity that you guys have to work in the Gulf?

Dennis Smith

I am going to turn it to Jerry Shanklin.

Jerry Shanklin

Well, the jackup market is getting better. It's still, like you said, 1Z, 2Z type wells and we're trying to do our best to keep operators lined up so that we don't have gaps. We haven't succeeded in doing that in the past, but we're hopeful that with the additional work, we'll be able to move from operator to operator without any down time.

John Fitzgerald - Raymond James

Okay, that helps. And internationally, could you guys give some color on, you were around 122 rigs at the end of the quarter. Give some color on where you are kind of sitting now and where you think you could exit the year at?

Dennis Smith

Go ahead, Jim.

James Payne

I think as Gene mentioned we are seeing future activity, future rigs coming up in the Middle East, in North Africa, and of course in Russia. And also, there's indications that obviously, Mexico is putting more land rigs to work and we are going to have a play in that.

John Fitzgerald - Raymond James

Okay, I guess that does it for me now. Thanks.

James Payne

Yeah, thank you.

Operator

Thank you. And our next question comes from the line of Byron Pope from Tudor Pickering. Please go ahead.

Byron Pope - Tudor Pickering

Good morning, guys.

Dennis Smith

Hi, Byron.

Byron Pope - Tudor Pickering

For the 20 incremental term contracts that you just announced, say it sounded like most of those are for the US. Could you give us the split, US versus international, on those incremental 20?

Dennis Smith

Actually, we have over 20 and almost 20 of US and the difference is international which is pretty small at the moment. Actually signed.

Byron Pope - Tudor Pickering

Okay. And then just in the context of E&Ps continuing to ramp their CapEx spend. Give us a feel for order of magnitude, the number of new-built rigs that you guys could deliver to customers as we think about the next 12-18 months?

Dennis Smith

That's a good question. The number of inquiries and this is the US and Canada. Canada, my guess is that we're pretty confident that we'll do at least 10 incremental new builds and we don't have an enormous fleet size in Canada. And then in the lower 48, I personally think we've got 20 committed.

I think we could get another 15 or 20 by the end of the year. These shale plays are really increasingly significant, both in terms of the attractiveness of the plays, the need for quality rigs, and ultimately the production of gas in the country.

Byron Pope - Tudor Pickering

Okay, and then just with regard to you mentioned you guys have the ability to use perhaps some of your older rigs as bridge rigs, so to speak for E&P customers, until you deliver new build rigs.

Of your existing marketed but idle fleet, where are we now in terms of the rigs that are still marketed but idle in terms of its horsepower ranges? What types of rigs do you anticipate could come back to work out of your existing fleet?

Dennis Smith

I could take the rest of the conversation. Let me summarize quickly. now we are down to 65 stacked rigs, and we're slightly lower now and we think 20 of them are likely to go back to work and they are mostly in the thousand horsepower range.

The real small ones, we're not sure, 500 horsepower mechanical, and rest we're not sure. They will ever work and if they do, it will be a lucky strike extra. But we have a fair number of rigs.

But we also have a much more significant number relative to all our competitors who are typically competitors competing with us with quality new-builts.

Byron Pope - Tudor Pickering

Okay. And then last question for me. Just in terms of leading edge day rates, if you will for, let's call it, a 1,500 horsepower rig that wants to go to work and the Bakken, or maybe the Haynesville, what are you seeing in terms of movement on the spot market again for the larger rigs?

Gene Isenberg

Same as the generalization, 25.

Byron Pope - Tudor Pickering

Okay, all right. Thank you.

Operator

Thank you. And our next question comes from the line of Kevin Simpson from Miller Tabak. Please go ahead.

Kevin Simpson - Miller Tabak

Good morning, Gene.

Gene Isenberg

Hi, Kevin.

Kevin Simpson - Miller Tabak

Going from zero new-builds to 20 in one quarter is pretty impressive, but wonder what kind of margins you're getting on those new builds relative to what you had before. Did you have to cut price to get people to sign up?

Gene Isenberg

Actually, it's been exactly the opposite. Number one, the prices are higher, I would say. The new prices 26.5 and CapEx on these new rigs is probably going up, so that may go up. But the important thing for us is that we can put these new rigs out and get 90-plus percent of the margin from virtually day one, compared to what happened last year.

So let's assume 10 cost, is that good, 10 or 11 cost, so 26.5 you're talking about a way higher margin that we can expect. But these are the newest ones, these aren't going to hit the P&L until next year or so.

Kevin Simpson - Miller Tabak

Right.

Gene Isenberg

But they're been more interested three things. The quality of the rig, the delivery of the new build, and what we can give them as a bridge rate, maybe you can figure it, because even when gas prices is way down to like 10.25, these things are unbelievably attractive for the E&P companies.

Kevin Simpson - Miller Tabak

Okay, better than I thought. Just another US question, it's kind of more macro, I don't know whether Joe is there, but in terms of interfacing directly with the customer, I think it was on the Baker call yesterday.

There were too many calls to keep up with. There was a comment that much of the activity is based off of much lower gas price economics, but that some kind of unspecified amount of incremental activity is really betting on $11, $12 gas. And I'm wondering, Joe, if you're there, whether you can see that in that kind of aggressive price in some of the work that you're getting incrementally.

Joe Hudson

Obviously it plays a part with the improvement, but I think also everybody is looking at the deliverability of the gas, or the opportunity for them to put the bid in the ground, if fact that there are not enough rigs and it goes from the Bakken up North to the Haynesville across.

The new build rig is developing or delivering I would say very significant improvement in operational efficiency, so I think the operator sees this and he is moving forward with the contracts.

Gene Isenberg

Kevin, we can give a qualified answer from our own viewpoint as an operator. We have stuff in almost all of the shales and almost all of the plays now. I mean we're tiny, but we have background in all these, I'd say we don't have anything that doesn't work at 8 bucks or less.

Kevin Simpson - Miller Tabak

Okay. I would assume you'd be more prudent than some of the marginal operators, so I guess, Joe, of the rig count you have out there now and maybe with increment hopeful, do you see a lot of risk to the count if a year from now, gas is $9?

Joe Hudson

I wouldn't say $9. One, the issue is the new builds we have in place, that's kind of the balance that we bring. We currently have 150-plus rigs on turn. We're looking at adding incremental 20-plus long-term. So I don't really see a lot of exposure to us in the next year as a result of that, no.

Gene Isenberg

Kevin, there's also the cash flow effective higher prices , so I mean, the economics can be really good at 9, 8, 7, 6, but they have more cash flow to do more stuff at the higher prices. So it's not that it's totally impaired, but the pure economics of any of the plays work at 9 bucks.

Joe Hudson

Yeah.

Gene Isenberg

But the cash flow means you're constant planning on every single play you could have. It's the ample money to spend pretty obviously you [intended] to do it.

Kevin Simpson - Miller Tabak

No doubt. I was just really focusing on issue of economics, I was surprised with your statement yesterday. Okay, that's it for me. Thanks.

Gene Isenberg

Thanks.

Operator

Thank you. And our next question comes from the line of Dan Boyd from Goldman Sachs. Please go ahead.

Dan Boyd - Goldman Sachs

Yeah, thanks. Taking a look at the international segment, of those 13 rigs that may start up in Q4, are they already contract? And if so, how do the margins compare to the segment average of I guess about 14.7?

Joe Hudson

The rigs that are starting up in 4Q, they're on the contract, or the contract is just being finalized. So they're going to go to work and what was your second question?

Dan Boyd - Goldman Sachs

How do those margins compare to the quarterly average of 14.7?

Joe Hudson

We see the margins still going up.

Dan Boyd - Goldman Sachs

Okay. Did you still see upside to pricing internationally and is that increasing over and above what you're seeing on the cost side?

Joe Hudson

I think it depends a bit on the area you're in, but in general, yes. There's still opportunity for better margins.

Dan Boyd - Goldman Sachs

Okay. And then just one for Gene on Canada, you mentioned that the second half of this year is going to show a big improvement. How would you say that that improvement will compare relative to the second half of last year and I understand.

Gene Isenberg

I think we'll be better.

Dan Boyd - Goldman Sachs

Better than last years?

Gene Isenberg

Yeah, but it's still lousy.

Dan Boyd - Goldman Sachs

But that's still a pretty big improvement.

Gene Isenberg

Yes, I think domestic has changed pretty dramatically with the gas price. I think Canada has changed pretty dramatically because it was unusually depressed. The prices were unusually bad. And in addition, they have the new shale plays which everybody up there including ourselves, are excited about.

Dan Boyd - Goldman Sachs

So, 3Q could also be better than last years 3Q?

Gene Isenberg

I think so.

Dan Boyd - Goldman Sachs

All right. Great, thanks.

Gene Isenberg

But it's still not good.

Operator

Thank you. And our next question comes from the line of Kevin Pollard from JPMorgan Chase. Please go ahead.

Kevin Pollard - JPMorgan Chase

Hi, good morning, Gene.

Gene Isenberg

Hi.

Kevin Pollard - JPMorgan Chase

I wanted to touch on your comments on the international segment. You're sticking with the 40% year-over-year op income target for '08, and indicated that it might be greater than that in '09.

A lot of the increase that we've been seeing in '08, I guess has been driven by re-pricing of some older contract rollovers. I was wondering with your view on '09 being up a similar amount, is that more of the same continued re-pricing of contracts or is that driven more by new rig commitments, additional rigs you'll be deploying in that segment?

Joe Hudson

I think it's rigs that work a partial year this year and had hiccups, and number one they're going to work. A full year next year and presumably have fewer hiccups because they already have fewer hiccups, then there will be improved pricing on rollovers and there will be new builds.

A whole bunch of stuff, but I think the improvements on existing rigs is still significant part internationally, although the new builds are not trivial.

Kevin Pollard - JPMorgan Chase

Right.

Joe Hudson

New contracts.

Kevin Pollard - JPMorgan Chase

Well, I know your bidding activity in your bid list, you regularly show us is fairly lengthy in terms of the number of rigs. I'm wondering, how much of that are you counting on in your 40% target there? Is it fairly minimal at this point?

Joe Hudson

I would say yeah. I would say that we've frankly currently overestimate our international earnings and we're trying to be a little bit more conservative.

Kevin Pollard - JPMorgan Chase

Okay. Thanks and if I could switch over to some questions on the new builds for the US real quick. In terms of the 20 or so rigs that you have in hand, when will those begin to deploy and actually start contributing to the P&L, the first 1 to 5 or so for example?

Gene Isenberg

The first part or second part?

Kevin Pollard - JPMorgan Chase

Of '09?

Gene Isenberg

Late first or second.

Kevin Pollard - JPMorgan Chase

Okay.

Gene Isenberg

To start.

Kevin Pollard - JPMorgan Chase

And in terms of lead times for additional, you mentioned you might be able to get another 15 or 20 new-built commitments this year. If I committed to you today, when could I have that rig in terms of when you could get it out?

Gene Isenberg

I'd say a year.

Kevin Pollard - JPMorgan Chase

Okay. So on the first 20, we're looking at for the most part a first half of '09 contribution with.

Gene Isenberg

Commencing domestic.

Kevin Pollard - JPMorgan Chase

Right, on the domestic rigs and then if you're successful on the additional 15 or 20 that would be kind of a second half of '09?

Gene Isenberg

Commencement.

Kevin Pollard - JPMorgan Chase

Okay. All right, thanks, that's all I had Gene.

Gene Isenberg

Thanks.

Operator

Thank you. And our next question comes from the line of Doug Becker from Banc of America. Please go ahead.

Doug Becker - Banc of America

Thanks. Just want to touch base on Well Servicing a little bit. You mentioned that price competition has been very stiff there. Has that settled down and is there any region that's particularly still weak?

Gene Isenberg

Yes, it's settled down and we've increased prices in some of the regions which are obviously not the hottest reasons. Nick, you want to tell them about what you think?

Nick Petronio

In some of our Markets, we were able to move rates as Gene talked about, particularly in California and West Texas. South Texas is still very competitive, East Texas and the mid-continent region is still very competitive. We see some opportunities later, but not at the present time.

Doug Becker - Banc of America

And in regions we are able to increase pricing, are those exceeding the higher labor and fuel costs?

Nick Petronio

Yes. We basically increased our rates such that we're getting some of the margin that we lost back through our cost increases since our last rate increase.

Doug Becker - Banc of America

Okay. And just in terms of the new capacity, how much of that would be replacement versus just, I guess adding incrementally to your fleet?

Nick Petronio

So far our prospective.

Joe Hudson

When the 18 rigs were deployed initially out of 18, 19 were basically replacements and the rest went to new markets primarily in the Rocky Mountains into Louisiana, into Mississippi, markets that we were growing in.

Some of that has changed the supply and demand that other rigs entering the market the last six or eight months, but initially 19 rigs were replacement and the rest were basically enhancement rigs.

Doug Becker - Banc of America

Okay. And when you do retire rigs, are those actually cutup, or are they sold into other markets?

Joe Hudson

They're destroyed. We actually witness the destruction, take photographs, and nothing is sold. Not one component is sold.

Gene Isenberg

I have tried to sneak some sales and they won't let me.

Joe Hudson

We destroy the rigs and we keep what we can use for our own use.

Doug Becker - Banc of America

Okay. And then just a clarification, Gene, did you say that the new rigs are costing $26.5 million?

Gene Isenberg

No.

Doug Becker - Banc of America

Okay.

Gene Isenberg

Not even for international.

Doug Becker - Banc of America

That's why. How much of those new rigs costing?

Gene Isenberg

I would say drilling rigs domestically, Canada maybe 18, or maybe a little less than that paradox domestically and in international, I think the round number is 25 26, 27.

Doug Becker - Banc of America

Okay. Perfect. Thank you very much.

Operator

Thank you. And our next question comes from the line of Roger Read from Natixis Bleichroeder. Please go ahead.

Roger Read - Natixis Bleichroeder

Yeah. Good morning, gentlemen.

Gene Isenberg

Hi.

Roger Read - Natixis Bleichroeder

Gene, just real quick. On the comments you made on international, how it should grow here in the second half or what the numbers ought to be in the second half to reach just about 40% growth rate '08 versus '07?

I mean it looks like you'd be talking about or at least as I'm figuring the numbers about $0.10 incremental improvement Q3 versus Q2. And then as you look at Canada, obviously up seasonally in the other businesses generally improving, is that the level of magnitude you're talking about in terms of, this is probably the bottom here of these last four quarters where the numbers have been relatively consistent around $0.70?

Gene Isenberg

I don’t know. I haven't translated to numbers per share. But yeah, this will be the worst quarter both cyclically and seasonally, and maybe even turn wise, I don't know.

But certainly cyclically and seasonally this will be the low quarter, and I don't think we'll break all of the records this year, but we'll probably do better than we did last year considering that we started off way worse in important areas and I'm looking for sizeable improvements beyond that.

Although we haven't quantified that at all, But if we have the kind of progress even implementing the stuff that we told you that we committed to today if we have price for the year for some of that stuff and next year it's going to be a better year, and our ingredients that make for 2010 better than 2009.

Roger Read - Natixis Bleichroeder

Okay. And then my other question, you talked about potentially adding rigs in Canada.

Gene Isenberg

Yes.

Roger Read - Natixis Bleichroeder

The pricing up there, obviously Q2 was a very tough quarter. Pricing up there has been some of the worst in the world over the last couple of years, pricing trends anyway. What are you seeing in terms of rates up there or cash margins up there and returns that would say you'd be considering building rigs there at roughly the same timeframe that we're talking about the US seeing much better scenario and obviously international.

Gene Isenberg

In the first place, a lot of the rigs are available to come to domestic market or to the international market. Secondly, there are developments there that make it likely that some of the rigs will have 365-day utilizations compared to 300. Even though the projection is the economics are done on $300 a day.

Anyway they won't get approved and they certainly won't go to Canada if we don't get at least the 15% plus return on total capital employed including working capital. And I think they've been pretty pessimistic out there because they've been beaten down pretty badly. But I would say I think there's reason.

And for example, we have 100% of Shell's business. Shell made an acquisition up there where a competitor has eight or nine rigs or seven or eight rigs. Safe to say it's plus or minus, working for Shell and we're going to replace those with better quality rigs, as soon as those expire.

And there are other things like that including our own activities in the Horn River and Bakken Shale and our process activities and our own include our joint-venture with First Reserve.

Roger Read - Natixis Bleichroeder

Okay, thank you.

Operator

Thank you. And our next question comes from the line of Rob McKenzie from FBR Capital Markets. Please go ahead.

Rob McKinsey - FBR Capital Markets

Thank you. Gene, I'd like you to try and put your E&P hat on for a second here again. And I don't disagree with you that long-term there may not be too much gas but I'd be interested your perspective shorter term with the rapid development of some of these reserves plays. How you view the risk of near-term oversupply before demand catches up?

Gene Isenberg

It could easily be. And I don't know and I respect some of our sell side friends who think there is more serious risk than short-term. But to me, it's my personal view it's an oxymoron to say that you're going to have too much natural gas, which is the best hydrocarbon fuel around. And there's no reason it shouldn't be used. Not just in generating electricity but there's no real reason it shouldn't be used in transportation.

I mean, even Venezuela is making 35% of their cars operating on compressed gas. So I can't see it short-term and whatever else it is, we have to operate long-term and so long as our important customers like, you know who they are, they're ordering rigs and they're seeing economics, so some of those are so big they don't hedge, for example. So I don't really see, number one, I don't have an opinion on short-term.

Rob McKinsey - FBR Capital Markets

Okay.

Gene Isenberg

Number two, I don't think the short-term is going to be material in the overall big picture.

Rob McKinsey - FBR Capital Markets

Sure. But in that environment, would you then expect to see perhaps more of a bifurcate of the land rig market wherein this case, it looks like some of the bigger rigs, 1,200 horsepower on up continue to be fully utilized while there's considerable risk to the older 7,000 horsepower rigs?

Gene Isenberg

I would say not 7,000 thousand. I would say sub 7,500 horsepower. Because some of our state-of-the-art rigs that are setting all kinds of records including the one I quoted in Wamsutter is 750 horsepower. That's probably our best single rig. They're all very good, that's probably our best single new-built.

Rob McKinsey - FBR Capital Markets

Okay. That's it for me for now. Thank you.

Operator

Thank you. And our next question comes from the line of Kurt Hallead from Royal Bank of Canada. Please go ahead.

Kurt Hallead - Royal Bank of Canada

Hi, good morning.

Joe Hudson

Good morning, Kurt.

Kurt Hallead - Royal Bank of Canada

On Alaska, Gene, you referenced prospect of 40% increase in operating income '09 versus '08. I'm just curious as to is that a combination of rig years and margin, or is it purely margin or is it purely rig years?

Gene Isenberg

It's both. We have, I don't remember, did we had the heli-rigs working full year last year?

Joe Hudson

No. They didn't start until December and February.

Gene Isenberg

Okay, so we have those rigs working full time. We have the bulk of the year, I don't know whether it's going to be 9, 10, or 11 months and I think it's 11 months of this hybrid 15,000 coil tubing and stem drilling rig I told you about.

And also, we're going to get improvements the extent of which I can't tell you on the legacy rigs, when I said that we have three or four rigs, three in particular that are going to be working and we're going to make them as efficient as the best new build, you can build today and the capital investment will be maybe even 25% as much.

We're not going to do that for free So we'll have new builds, new rigs, new deployments of old rigs, and increased margins and the only problem is that Alaska isn't 10 times as big as it is for us.

Kurt Hallead - Royal Bank of Canada

Okay. And you referenced the fact that you got 100 rigs I think available in the spot market right now, 156 are still on contract, that contract number going up when these new deliveries come in. What's your best guess on the flow through of margin as we get through the back half of the year given that split between spot and contract, what kind of increments and margins do you expect back half of the year?

Gene Isenberg

Well, bare in mind that three, four months ago, we were looking for $1,000 drop in margins between the first quarter and the fourth quarter. Now, the second quarter was essentially same as first quarter. I think the third quarter will be pretty close. In other words, it will be a tiny bit better and then I think we start getting better in the fourth quarter and thereafter.

Kurt Hallead - Royal Bank of Canada

And then is there any way to calibrate this $0.25 impact from this FASB change on your convert? Do you know if that's already in the consensus number or not?

Gene Isenberg

I have no idea, sir. All I know is it means absolutely nothing in reality.

Kurt Hallead - Royal Bank of Canada

Yeah, I understand that.

Gene Isenberg

10% is our new sales, right?

Kurt Hallead - Royal Bank of Canada

All right, that's good. Thanks, appreciate it.

Gene Isenberg

Thank you. Operator, we are approaching the one-hour limit here, why don't we just take one more call, please?

Operator

Absolutely. Our final question will come from the line of Alan Laws from Merrill Lynch. Please go ahead.

Alan Laws - Merrill Lynch

Good morning. I've got a couple of here. You mentioned as sort of a follow-up to Kurt's question, you mentioned better than expected rollover rates in the US market in Q2. What margins are they rolling off at, and what margins are you getting on the rigs coming off the fence?

Gene Isenberg

I know the rates have been probably 1000, 1,500 higher than we expected, but I don't know. Joe, can you help with the absolute numbers?

Joe Hudson

Well, the term contract rollover rates actually in the second quarter were down a 200, 300, bucks for those rollovers, we anticipate those in the third quarter to be of a significant change upside.

Gene Isenberg

But the contracts we did in 2006 compared to what they rolled over to.

Alan Laws - Merrill Lynch

How did they compare to the average though? You're at about 8,900. Are they above that?

Joe Hudson

I'm sorry, I didn't get that?

Gene Isenberg

Some of those were as high as 18,000, it was a big mix. But they were probably coming down. The long-term contracts, probably coming down on average $3,000 to $4,000.

Joe Hudson

Yeah, the average rate actually went down $300.

Gene Isenberg

But they're renewing, Allen, I'd say $1,500 better than we expected, yeah, but still below the old average.

Alan Laws - Merrill Lynch

Okay. But below the old average for those contracts, but are they above the 8,900 you have for the whole fleet?

Gene Isenberg

No. They are below.

Alan Laws - Merrill Lynch

Okay. And that's the same type of rate that you're reactivating like rigs off the fence at?

Joe Hudson

It's getting higher, because reactivating on a today basis and these were second quarter basis, so I'd say the re activations I've seen are around 23 or 24.

Alan Laws - Merrill Lynch

Okay.

Joe Hudson

It's pretty good.

Alan Laws - Merrill Lynch

Sure, okay, because they're in the sweet spot thousand horsepower sweet spot I guess right?

Joe Hudson

1,500 has become the sweet spot with Haynesville side.

Alan Laws - Merrill Lynch

Okay, that leads to my next question and the shale plays in Canada. In Canada, can you talk maybe a little bit about rig specification for those emerging shale plays and how you stack up with your higher horsepower and specialty rig fleet in that market? You'd mentioned heli-portable rigs as one differentiator.

Joe Hudson

What we're doing and for example, the Horn River, we're getting ready to deploy a heli-rig here, on pad and in Canada, we have a helicopter company, construction company and we're going to actually construct the pad with no road access in places generally flooded with our, it's called airborne isn't it?

Gene Isenberg

Yes.

Joe Hudson

We have a division there that can do it and frankly needs the business and it's not, I don't know if it's just 750 horsepower rig there?

Gene Isenberg

Yes.

Joe Hudson

750 horsepower rig. Typical of 1,000 horsepower rig was 500,000 kind of work load is what they're building generally and it would be in that ballpark for that operation, and it will be a pad type rig, so it will have probably a walking system or some description.

And I think as far as I know, none of these are going to be really deep. They're all going to be relatively shallow, and we don't really have any great knowledge that as to how the total measured depth is going to be in terms of what the fracing is going to look like.

Alan Laws - Merrill Lynch

Okay, thanks. One last one on international, how much re-pricing upside is included in your expectations for the international growth from where we are today, or is it growth entirely based on rig count increase and deployments?

Gene Isenberg

How much margin increase are you kind of expecting year-on-year?

Bruce Koch

Year-on-year?

Gene Isenberg

'09 versus '08?

Bruce Koch

I think in our forecast, we're very conservative, but we pretty much just forecast the cost increases and we put that in our revenue at this point from the forecast side.

Joe Hudson

I think I would define, Alan. there is an increase in margins year-on-year, but a thousand bucks a day.

Bruce Koch

Maybe a thousand, maybe 1,500, 2,000.

Alan Laws - Merrill Lynch

A lot of us are still waiting for the jackups for the starting up.

Gene Isenberg

I think that's a monster thing, if you have a jackup working for six months, making the gross rate of 135 and netting probably 80 or something 85.

Alan Laws - Merrill Lynch

Sure, we've seen a step up for average day rate when you back it out from Q1 to Q2 with the one jackup getting.

Gene Isenberg

At least two jackups and increases almost everything and new build, new rigs, it's pretty complicated because we have really an interesting accrued sale internationally and day rate from 185 down to 25.

Alan Laws - Merrill Lynch

When you look at where you exited 2007 versus where you expect to exit 2008, what do you think the number of rig increase is going to be?

Gene Isenberg

Internationally?

Alan Laws - Merrill Lynch

Yes.

Joe Hudson

I think we're close to 130 rigs, 130 plus rigs at the end of '08, and I think in '09, I think about 10, 15 rigs that go on top of that.

Alan Laws - Merrill Lynch

Okay, perfect. '07?

Bruce Koch

Full year average is 115.

Alan Laws - Merrill Lynch

115?

Bruce Koch

Average, yeah.

Alan Laws - Merrill Lynch

So we're going from 115 to 130 and then maybe 140 to 145?

Joe Hudson

About 10, 15 rigs a year, that's basically the gross we've had on rig numbers.

Alan Laws - Merrill Lynch

Great, that's all I had. Thank you very much.

Gene Isenberg

Anyway, I want to thank you all for joining us and if you have detailed questions you can get the answers offline and [Denny] and volunteers to stay here until midnight to help you and we're pretty optimistic despite the stocks performance today, because I think here we have for the first time in quite a while a confluence of really attractive opportunities both price-wise and drilling opportunity-wise for both gas in North America and oil internationally and kind of a unique situation which should be right down our alley. Anyway thank you for joining us.

Dennis Smith

Thank you, ladies and gentlemen. That concludes our call.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Nabors Industries Ltd. Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts