Grey Wolf, Inc. Q2 2008 Earnings Call Transcript

Grey Wolf, Inc. (GW)

Q2 2008 Earnings Call Transcript

August 1, 2008 10:00 am ET

Executives

David Wehlmann – EVP, CFO and Secretary

Tom Richards – Chairman, President and CEO

David Crowley – EVP and COO

Analysts

Jim Rollyson – Raymond James

Jeff Tillery – Tudor Pickering Holt

Greg Deff [ph] – CIR Capital [ph]

Presentation

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Grey Wolf, Inc. second quarter 2008 earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator instructions) As a reminder, this conference is being recorded Friday, August 1, 2008.

I would like now to turn the conference over to David Wehlmann, Executive Vice President and Chief Financial Officer. Please go ahead, sir.

David Wehlmann

Thank you. Good morning everyone. We'd like to welcome you to Grey Wolf’s second quarter 2008 earnings conference call and webcast. We released earnings yesterday after the market closed. If you don’t have a copy of that release, one is available through the Investor Relations page on our website at www.gwdrilling.com.

Participating with me today on the call are Tom Richards, our Chairman, President and Chief Executive Officer; and David Crowley, our Executive Vice President and Chief Operating Officer; Ed Jacob, our Senior Vice President of Operations; and Ron Hale, our Senior Vice President of Business Development are also here with us this morning.

We believe that it is in the best interest of our shareholders and the investing community for us to make forward-looking statements in our press releases and in today's conference call. All statements made today that are not statements of historical fact are forward-looking statements. These specific forward-looking statements cover our expectations and projections regarding day rates, average day work revenue and EBITDA per day, rig activity, expected new rig delivery schedules and the cost, availability of term contracts, the future success of turnkey drilling, rig supply and demand, our projected tax rate, interest expense, depreciation and capital expenditures.

These forward-looking statements made in today's call are subject to a number of risks and uncertainties, many of which are beyond our control. Please see our 2007 Annual Report on Form 10-K filed on February 28, 2008 with the SEC for additional information concerning risk factors that could cause Grey Wolf’s actual financial results to differ materially from the projections made in today's conference call.

Now I'd now like to turn the call over to Tom Richards.

Tom Richards

Thank you, David, and good morning to everyone. I will begin by discussing our second quarter ‘08 results as well as recent trends in the US land drilling market. David Crowley will elaborate on these trends and provide details on activity in our various markets. David Wehlmann will then provide more detail on Grey Wolf's quarterly financial results, and I will conclude with a few remarks on our market outlook prior to the Q&A session.

At $0.15 per diluted share, Grey Wolf’s net income for the second quarter this year was level with results for the first quarter and down from $0.19 per share a year ago. Our year-over-year decline in results was anticipated and reflects a dip in day rates that occurred in the past year as the supply of rigs in the market increased. Day rates did regain ground in the second quarter as a number of newly built and refurbished rigs entering market declined in drilling activity intensified. So we believe that second quarter will be the earnings trough of this cycle. As anticipated, higher costs associated with returning stack rigs to work and reductions in average day rates on term contract renewals pressured EBITDA.

Second quarter EBITDA totaled 80.5 million. Day work generated 69.5 million of that total and our turnkey business generated 11 million or 14% of total EBITDA for the quarter, which is a meaningful quarter-over-quarter increase. An average of seven rigs ran on turnkey contracts during the second quarter, and turnkey represented approximately 7% of the total rig day's work.

Grey Wolf’s average number of rigs running in the second quarter increased reaching a 105 compared to an average of 100 rigs running in the first quarter. And third quarter to date, we are averaging 109 rigs working. We have seen a steady uptrend in the US land rig count since mid-January. Solid commodity prices as well as heightened interest of cap unconventional resource plays make it likely that this trend will continue.

Leading edge spot market bid rates have moved to a range of $18,000 to $23,500 per day without fuel or top drives, an increase from the $15,000 to $21,000 level that we reported in our last quarterly conference call. Higher contract renewal levels and greater interest in new long-term contracts also reflect the intensifying drilling activity as we continue into the third quarter and we anticipate continued improvement in day rates.

Grey Wolf’s reputation is staked on providing customers with the premium equipment to provide safe and efficient performance. In line with this mission, Rig 109, our new built-for-purpose PaDSRig, which can drill multiple wells on a single site, rigged up last week in Colorado under a three-year term contract. Rig 110, our second in this series, will be delivered during the fourth quarter and has also committed to drill in the Rocky Mountains under a three-year term contract.

And now I’d like to turn the call over to David Crowley to discuss current market activity.

David Crowley

Thank you, Tom, and good morning to everyone. At Grey Wolf, we are currently marketing 122 rigs with 114 working. There are 66 under term contract, 40 in the spot market, and eight are working under turnkey. The dampening effect of excess supply has been reduced dramatically in the second quarter. While approximately 100 new-builds are expected to enter the Lower 48 market in 2008, demand is expected to outpace supply increases. The US land rig count in the Lower 48 rose 5% in the second quarter and well permitting activity has reached its highest level since 1990, with a 21% second quarter increase compared to the first quarter.

In Grey Wolf’s core markets, there has been a 16% year-to-date 2008 increase in permits compared to the same period in 2007. Given this trend, we could see as many as 200 incremental rigs at work by Q2 2009. Building on the sound performance are Grey Wolf’s operations team. Our marketing team continues to leverage these favorable market trends boosting current rig utilization to 93%.

Of the 15 term contracts that rolled off in the second quarter, 11 were renewed. In the third quarter, we expect seven term contracts to come up for renewal. In addition, we have seen demand rise for new term contracts and we’ve recently added or renewed over a dozen term contracts. This has increased the expected average rigs working under term contracts to 67 for the third quarter and an average of 66 rigs under term contracts for the second half of 2008. These figures do not include any term contracts that we may sign in the future.

We believe the forward commodity prices and our customers’ strong interest in developing significant resource plays should provide a healthy platform for continued upward pressure on day rates. As mentioned previously, we currently have eight rigs working on turnkey contracts. We expect to average seven to nine rigs working in the third quarter of 2008.

Top drives also continue to add additional value at the well site. These units are commanding a premium of up to $3,300 per day in addition to day rates. We currently own a total of 33 units and we have three more new units on order that are expected later this year. Before I recap activity in our various market segments, I want to point out that you can see the breakdown of average rigs running by market area and the press release distributed today. You may also go to our website to see a complete list of rigs.

In the Ark-La-Tex market, the company averaged 24 rigs working out of 28 marketed in the second quarter. 25 are currently working with 18 under term contract and one on turnkey. We currently have two rigs working in the Haynesville shale play in Louisiana. In the Gulf Coast region, we averaged 23 rigs working out of 26 marketed in the second quarter. There are 25 rigs currently working with six under term contracts and five on turnkey.

In our South Texas division, we averaged 28 rigs working out of 30 marketed in the second quarter. There are 28 rigs working today with 14 rigs working under term contracts and two on turnkey. In the Rocky Mountains, we averaged 12 rigs working out of 17 marketed in the second quarter. 16 are at work today with 12 on term contracts.

As Tom previously mentioned, our built-for-purpose PaDSRig 109 recently deployed into the Piceance Basin in Colorado. Our PaDSRig 110 will be deployed in the Pinedale Anticline in Wyoming in the fourth quarter. In addition to 1500 horsepower unit that we deployed into the Bakken area of North Dakota in the first quarter, we have signed two 2-year contracts to move 2 more 1500 horsepower rigs to the Bakken with 1 due to spud in December and the other in January 2009. Both units are currently cold stacked and will undergo significant upgrades from mechanical to SCR, the addition of new solids control, and the insulation of a top drive to name a few. This cost is projected to be $13 million per rig, which is significantly below current new build costs. We expect to have a minimum of 4 rigs in the Bakken by the end of the first quarter of 2009, a market area we had targeted for expansion this year.

The mid-continent market area encompasses West Texas, Oklahoma, New Mexico, and the Barnett Shale area in North Texas. We averaged 16 rigs working of 19 marketed in the second quarter, 18 are at work today. Grey Wolf has recently signed 4 term contracts with a small independent for work in the Fort Stockton area of the Permian. We have a total of 14 rigs working under term contracts in the market. In the southern portion of Mexico, we have two 3000 horsepower rigs drilling under 3-year term contracts. We are actively pursuing opportunities to deploy more units into the northern and central areas of Mexico either directly with Pemex or through established megaservice integrators.

I mentioned previously the sound performance of our operating team and will like to share some key performance indicators comparing the first half of 2008 to 2007. Our daily maintenance CapEx is above last year with some front-end loading of re-certification of mass and substructures and some associated costs for rig re-activations. We expect our CapEx line to come in under 2007 by year-end. Our daily OpEx in the face of an increase for goods and services has improved by 1.5% led by our Mid-continent and Mexico divisions. Our downtime has improved 30%, led by Rocky Mountain and Mid-continent and Gulf Coast divisions.

Turning to personnel with a tightening labor market, Grey Wolf has enjoyed a 22% improvement in attrition led by our South Texas and Ark-La-Tex divisions. Lastly and most importantly on the HSC front we have realized an astounding 44% improvement in our total recordable incident rate led by our Mexican, Mid-continent, Gulf Coast, and Ark-La-Tex divisions.

Grey Wolf has been in the news over the past few months for issues other than drilling wells. Our executive team likes to recognize the focus and commitment of our strong management teams and dedicated rig crews in their exemplary results. That completes my remarks and I would now like to turn it over to David Wehlmann for his financial review.

David Wehlmann

Thanks, David. Starting with the income statement, as Tom outlined, net income for the second quarter of 2008 was $32.3 million or $0.15 per share compared with net income of $41.7 million or $0.19 per share for the second quarter of 2007. Net income for the first quarter of 2008 was $31.3 million or the same $0.15 per share. EBITDA for the second quarter of 2008 totaled $80.5 million compared with $81.9 million for the first quarter of 2008. EBITDA for the second quarter of ‘07 was $91.7 million.

Second quarter day work EBITDA was $69.5 million compared with $73.6 million in the first quarter of this year. Day work EBITDA per rig day was $7,840 in the second quarter and was $8,627 in the first quarter of 2008. This change is related to a decrease in revenue per day as term contract renewals were at lower rates then when they were originally signed and approximately $200 a day in costs associated with putting stacked rigs back to work during the quarter. Turnkey EBITDA per rig day was $16,598, up from $13,642 the previous quarter. You can see our press release for a disclosure on EBITDA per day for day work and turnkey and a reconciliation of EBITDA to net income.

Turning to our balance sheet, we had cash of $313.1 million and working capital of $370 million at June 30th and our debt to total capitalization ratio continues to decline, and is now at 27.5%. Our total long-term debt remains as it has for several years at $275 million and this third quarter interest rate on our $125 million of floating rate convertible notes is 2.7% per annum. $69 million of our $100 million credit line remains available, with the difference being outstanding letters of credit for insurance purposes. Total assets were $1.3 billion and stockholders equity was $725.5 million at the end of the second quarter of this year. Our capital expenditures for the second quarter were $50 million, and for 2008 we are expecting to spend approximately $160 million to $170 million for capital expenditures, which includes the Bakken upgrades that David mentioned.

We currently have 66 rigs working under term contract. On average, we will have approximately 67 rigs working in the third quarter and 66 in the fourth quarter. For 2009 we will have 38 rig years locked up under term and 9 rig years in 2010. This translates into 12,200 days committed for the remaining two quarters of this year, 13,700 rig days in 2009, and 3,100 days in 2010. If you look back during our year-end conference call which was in February, we had 37 rig years committed for 2008. With the recent increase in activity, we now have 60 rig years committed for all of 2008, and 2009 has gone from 18 to 38 in that same time frame. Now, all of these numbers are point in time measurement, and as we add additional term contracts, these numbers will increase.

Now looking forward a little bit into the third quarter of this year, we expect to average between 108 and 111 rigs working with seven to nine of those working under turnkey services. Our average day work EBITDA per day is expected to increase by about $400 to $600 in relation to the second quarter reflecting continuing improvements in our market areas. Depreciation expense of approximately $27.5 million, interest expense of $2.7 million and an effective tax rate of around 37% are expected for the third quarter of 2008.

As we previously reported, the company will also take a pre-tax charge of approximately $17 million, which equates to $0.05 per share on a diluted basis during the third quarter as a result of the termination of the proposed merger with Basic Energy Services, Inc. Now, I would like to turn it back over to Tom for some closing remarks.

Tom Richards

Thank you, David. The outlook for land drilling is very positive with the likelihood of rig counts will continue to trend upward in the second half of this year and well into 2009. The 12-month strip for natural gas exceeds $9.50 per million BTU, and a 12-month strip for oil remains above $125 per barrel. These prices are at historically attractive levels. As we noted in the past, we cannot predict short-term fluctuations in commodity prices, but we do believe the long-term prospects for natural gas are extremely positive.

Our customers appear to agree. It is estimated that natural gas prices in the $7 to $8 range provide attractive returns for our customers and their confidence in ongoing pricing strength at that level or above is prompting ambitious drilling programs at target plays requiring high horsepower equipment that is the hallmark of Grey Wolf. As utilization rates climb day rates will continue to follow contributing to solid results for land drillers.

In addition to the organic growth reflected in expansion of our rig fleet, our board continues to consider other alternatives to enhance shareholder value. Following the July 15th shareholder vote and termination of our merger agreement with Basic Energy Services, the board and management are updating the company’s existing strategic plan and considering opportunities encompassed in acquisitions, merger, the sale of the company, strategic alliances, joint ventures, as well as various financial alternatives.

This process is a process that most corporations undergo on a continuing basis and without public comment. We don’t expect to have any further comment on the elements relating to this review unless and until our board of directors approves a specific agreement or transaction. As such we will not be answering any specific questions with regard to the process at this time. We appreciate your participation on this call and now we will be happy to try to answer any questions that you might have.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) One moment please for the first question. And our first question comes from the line of Jim Rollyson from Raymond James. Please proceed with your questions.

Jim Rollyson – Raymond James

Good morning, gentlemen.

Tom Richards

Good morning, Jim.

David Wehlmann

Hi, Jim.

Jim Rollyson – Raymond James

Hi, Tom. Could you guys maybe talk about opportunities you are seeing out there for deployment of additional rigs? Maybe you have got the new PaDSRigs, you have got the conversion or upgrades you’re talking about for the Bakken, just maybe talk about opportunities for either further upgraded rigs that are stacked or new builds, kind of what you see?

Tom Richards

I will defer that to David Crowley.

David Crowley

Well, the opportunities domestic certainly the Haynesville we are looking for, in the Louisiana looking for 1500 horsepower primarily but up to 2000 horsepower. So, we do have a unit stacked that we could deploy into that area as well as some existing units that we could deploy there. The Marcellus, I look at the Marcellus similar to, say, some of the Chicontepec work in Mexico. They are looking for say 800 horsepower to maybe 1200 horsepower. We do have 3 units stacked to double of that that could address those markets. And then, I guess, lastly as you mentioned the Bakken, we are going to continue to exploit opportunities there, we put 520, our 1500 horsepower rig, in there, Jim, in February this year and on the back of the very quick reputation that we built there we put two more and we expect more to follow. We would like to get a critical mass up there with a significant presence up in the Bakken.

Jim Rollyson – Raymond James

Do you suspect most of that focus right now is on stacked rigs, I mean, do you anticipate getting into the new build site again?

Tom Richards

Now let me – of course. We are rigging up 109 or have rigged it up and it is now working, which is a new addition for us and 110, which is also a new build, which will go to work in the early fourth quarter. And we have built new rigs, incremental new rigs into most of these plays and we will continue to do that. We just have not seen economics as of yet that are acceptable to us, but we will – we have had a history of doing that and we will continue to do that.

Jim Rollyson – Raymond James

Understood, and then as a kind of follow-up, maybe could you talk about what you are seeing in terms of the rate of change of the spot day rates relative to the rate of change of cost just for fuel and oil has gone up?

Tom Richards

David.

David Crowley

The day rates are certainly outpacing. You probably saw from the earlier discussion that we have managed to keep OpEx a little better than flat with last year that is certainly has helped us a great deal in this market. I think the pressure on the operating cost, Jim, going forward would probably be around personnel. It is no secret that you know, as we put new rigs into these markets, and particularly by the way, you know, if you look at markets where the permitting is the strongest that would certainly be the Permian Midcontinent area, the Rockies, and by the way particularly with the Piceance and the Bakken taking off, less so the Pinedale, and then also the Marcellus and Haynesville. Now, we are not in the Marcellus but, you know, we have a pretty competitive base right now for personnel. So, there will be some pressure there, but on the cost of goods and services right now, other than possibly the cost for new building, just daily operating cost, we were managing it so far just with some supply chain management issues et cetera.

Tom Richards

Jim, let me add to that if there is a labor increase or personnel increase as David mentioned our contracts allow us to pass that through, and labor is about 60% of our daily operating cost and you mentioned fuel as well, and there are very few cases that we are paying for fuel on a day work basis. I think the last time we looked at this we had one rig out of the 104 that we working on day work that we were paying fuel. So, you know, what we are talking about is the cost increase on the other 40%, which is going to be relatively minor. So, the day rate increases are certainly outpacing the cost increases.

Jim Rollyson – Raymond James

As, I guess, evidenced by your expectations for margin expansion. Thanks guys.

Tom Richards

Thank you, Jim.

Operator

Our next question comes from the line of Jeff Tillery from Tudor Pickering Holt. Please proceed with your question.

Jeff Tillery – Tudor Pickering Holt

Hi, good morning.

Tom Richards

Good morning, Jeff.

David Wehlmann

Good morning, Jeff.

Jeff Tillery – Tudor Pickering Holt

Could you give us a feel for just kind of the profile of the last ten rigs put back to work, maybe horsepower and what market they have gone into?

David Crowley

Well, we’ve put 1500 horsepower and 2000 horsepower into the Fort Stockton area in the lower Permian. And then as well, as you’ve noticed, we’ve announced two 1500 horsepower rigs going into the Bakken area. And then lastly, we have three 900 horsepower doubles. And we were holding them off the market actually for opportunities international and will be again revisiting that on a weekly basis, but we do have some domestic opportunities here for those units.

Jeff Tillery – Tudor Pickering Holt

And you discussed the two rigs – the two 1500 horsepower rigs going to working in the Bakken acquiring decent amount of capital. Any of the rigs, any of the marketed rigs – are any of your rigs in your fleet now, rigs you don’t think could be put back to work in the next 12 months.

David Crowley

No, no. In fact, with the current bid activity that we have, we would expect to have a 100% utilization of the existing assets with the exception of our Rig 558, the 4,000 horsepower unit. That’s a fairly unique unit and that would take a very specific program. But we would expect to have the other 122 rigs working by the end of the first quarter from today’s vantage point.

Tom Richards

Jeff, one thing that I would mention is that Grey Wolf, unlike a number of our other competitors, has been very aggressive about writing our office assets. And we do not have any rigs on our inventory that are not capable of going to work today, very little capital cost.

Jeff Tillery – Tudor Pickering Holt

Thank you for that. On the new build question that was just asked, Tom, you mentioned that you bid on some new builds into the market, but the economic hasn’t been where you’d like. And is that a function of link [ph] to the contract payback period? Can you just provide a little more color on that?

Tom Richards

Day rate.

Jeff Tillery – Tudor Pickering Holt

Okay. The last question –

Tom Richards

Now let me continue on that vein, is that we see that pricing increasing right now and we expect it to get more favorable. So in effect, you hold out little bit longer, you can get to more favorable rates. That’s our belief anyway and that’s the same policy that we’ve followed in the past.

Jeff Tillery – Tudor Pickering Holt

Okay. That’s helpful. And the last question is just, is there any limitation as you go through the strategic review on your ability to repurchase shares of your own stock?

Tom Richards

None.

Jeff Tillery – Tudor Pickering Holt

Okay. Thank you very much.

Operator

(Operator instructions) And our next question comes from the line of Greg Deff [ph] from CIR Capital [ph]. Please proceed with your questions.

Greg Deff – CIR Capital

Good morning guys.

Tom Richards

Good morning, Greg.

David Wehlmann

Good morning, Greg.

Greg Deff – CIR Capital

Real quick. Just looking for contracted revenue numbers for 2008 and 2009.

David Wehlmann

For 2008, the contracted revenue is $435.5 million and for 2009 it’s $281.4 million.

Greg Deff – CIR Capital

Great. Thanks a lot.

Tom Richards

You bet.

Operator

It seems there are no further audio questions at this time. I will now turn the call back to you. Please continue with your presentation or closing remarks.

Tom Richards

You guys let us off easy today. If there are no further questions, I’d like to thank each of the participants once again for joining us. I wish all of you a happy and productive day. Thank you.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect the lines.

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