Helmerich and Payne Inc (HP) 2006 Q4 法說會逐字稿

Good day. [OPERATOR INSTRUCTIONS]

At this time I'd like to turn the call over to Mr. Doug Fears, Vice President and CFO of Helmerich & Payne. Please go ahead, sir.

Good morning, everyone, and welcome to Helmerich & Payne's conference call and webcast to discuss the Company's fourth quarter and fiscal year earnings. With us today are Hans Helmerich, President and CEO, John Lindsay and Alan Orr, both Executive Vice Presidents of the Company's wholly owned subsidiary, Helmerich & Payne International Drilling Company, Juan Pablo Tardio, the manager of investor relation, and I'm Doug Fears, Chief Financial Officer. And as always, we'll be making forward-looking statements and estimates today. We'll be rounding some numbers in hopes of adding clarity to our comments. And as always, we're going to be attempting to be as accurate as possible with our comments and information, but it's important for you to know that much of this information provides -- that we provide involves risk and uncertainties that could significantly impact expected results. There is a discussion about these risks and uncertainties in our public filings, the most important of which is the 10-K filed December 13, 2005. You may obtain this filing, along with a copy of today's press release, on our website.

This morning, Helmerich & Payne reported record net income of $293.8 million or $2.77 per diluted share from operating revenues of a little over $1.2 billion for the fiscal year ended September 30, 2006. This compares with net income of $127.6 million or $1.23 per diluted share from revenues of a little over $800 million for last year's fiscal year. Included in net income were gains from the sale of portfolio securities of $0.12 per share in 2006 and $0.16 per share during fiscal 2005. Net income for the fourth quarter of fiscal 2006 was $98.5 million or $0.93 per diluted share from operating revenues of $358.8 million compared to net income last year of $36.1 million or $0.34 per diluted share from operating revenues of $233.3 million. Included in net income were gains from the sale of portfolio securities of $0.05 for the firth -- for the fourth quarter of this year and less than $0.01 per share during the fourth quarter of last year.

Before Hans and John make their comments, let me touch on a few financial items. As mentioned in the press release, the Company's effective tax rate for this year's fourth quarter was 27.2% compared with 37.8% for the previous quarter, the reduction being primarily due to certain adjustments to deferred tax accounts in some of our international locations. We estimate that the positive effect of the reduced effective tax rate helped improve this quarter's income by approximately $0.12 per share, and we're estimating that the effective tax rate for fiscal 2007 will be in the 38% range. You'll notice that total G&A expenses for the entire fiscal year 2006 were up by over $10 million from the 2005 total. Most of that increase was due to equity-based accounting expense or stock option expense. We're estimating that the equity-based compensation expense to be lower in 2007 and that expenses related to our pension plan will be significantly lower. Therefore, we're estimating for your modeling purposes that total G&A will most likely decline slightly for fiscal 2007 compared to 2006 totals.

At September 30, the stock portfolio had a market value of approximately $335 million. Currently that market value is about $313 million or an after-tax value of approximately $2 per Helmerich & Payne share. Our capital expenditures for the September quarter totaled $206 million, bringing the total fiscal 2006 to $529 million. Our estimated 2007 capital budget is approximately $750 million. The Company is currently negotiating a line of credit with a bank syndicate to help fund the capital spending in excess of our cash flow and any potential security sales. The Company also announced today that, during the fourth quarter of fiscal 2006, it had purchased over 1.3 million shares of Helmerich & Payne stock. To date, during the first quarter of fiscal 2007, the Company has purchased an additional 282,000 shares of the Company stock for a total of a little over two million shares. To partially fund the purchases, the Company sold 150,000 shares of Schlumberger during September and an additional 500,000 shares to date since October 1. In total, the sale of 650,000 shares of Schlumberger has generated pretax proceeds of a little over $39 million.

I would now like to turn the call over to Hans Helmerich, President and CEO. And after Hans and John have made their comments we will open the call to questions. Hans?

Thanks, Doug. Good morning, everyone. We're pleased to post another year of record earnings in 2006. As you noticed in our release, our earnings for the current year more than doubled our previous all-time high of a year ago. We're proud -- we're proud of those very strong results, and while satisfying, we know investors are trying to discern between yesterday's news and future trends, particularly the possible repercussions of a warm winter and the resultant downward pressure on gas prices. The Street seems to have already weighed in on the side of a sluggish 2007, judging just by the historically low multiples on current and projected earnings. I think investors are applying patterns they've seen from previous cycles; drilling economics suffer from lower prices, rig counts and day rates fall, and the future earnings sag. We tend to be more bullish on the cycle, pricing and drilling economics going forward. We see any pricing softness as being self-correcting and short term in duration.

But skipping over more discussion on what we consider to be strong long-term fundamentals, let's go straight to a question we hear frequently. Assuming a flat go-forward or even some pullback in U.S. land drilling market, how are you guys positioned to weather what may lay ahead? Here the focus goes to contracted drilling days in 2007. How much of the fleet is protected under long-term contract? 50% of our potential activity days are contracted in '07. While that's slightly stronger than peer average we would argue that our uncontracted or spec rigs are not apples-and-apples with our peers. In fact, 32 of 56 of the rigs we have in the spot market are FlexRigs. These rigs have worked at premium day rates and near 100% activity since their introduction. Our remaining uncontracted rigs compare quite favorably to their older and less capable counterparts.

In short, having the newest fleet in the business, where completed buildout will feature 75% FlexRigs in the U.S. land segment, positions us well for the future. Of course the other big difference, besides having a strong base of contracted days and attractive rigs in the spot market, we also will be adding activity days throughout 2007. We have an average of 104 rigs during the fourth fiscal quarter. Currently we expect this average to grow to over 130 rigs for all of fiscal '07 and we plan to begin fiscal '08 with over 150 rigs running. The bottom line is we're able to deliver significant growth without the tailwind of ever-expanding day rate margins.

The other question most asked concerns the market pulse in terms of pricing our rig turnover today. John Lindsay will speak to this more fully in a moment, but I wanted just to add a couple of highlights. First an important market touchstone was today's announcement of seven additional FlexRig orders, bringing our new build order book to 73. Considering that these last orders were secured in a time of market uncertainty and natural gas price volatility, they may provide us a lens on what might be different this time around in the current cycle. Let me repeat a question I mentioned on our last webcast: Why would a customer -- ours tend to be heavily weighted toward the larger, more stable and forward looking -- why would that customer simply not sit on the sidelines during this current term of uncertainty and see if a shakeup does occur and frees up some available rigs?

While some players will pursue that course, what's different today is a large number of customers have experienced the value proposition of a FlexRig. Older, conventional rigs that may shake loose are simply not suitable for a customer's desire for a more productive rig. This demand for a drilling solution that provides well cost savings through improved efficiencies, safety, reliability, is driving a very rational segmentation in the industry's drilling fleet. As we've said before, a significant retooling is occurring that will continue to provide us with growth opportunities. Now we know it won't fly totally counter to market dynamics, but we do believe it means a couple of things. Our business model is not limited to just day rate direction and what that might have. And secondly, by designing and rolling out highly innovative rigs and then building an organization focused on field execution that exceeds the customer's expectation, that combines for a powerful brand. Our job is to enhance and build that brand even in uncertain times and we fully intend to do just that.

It's fitting before turning the call over to John that we recognize and thank all the H&P folks that contributed so much to this effort. It really is because of them that we can report today that the Company's record breking -- record breaking success, so I want thank them. And, John, I'll turn the call over to you.

Thank you, Hans, and good morning. Drilling operations, which include land, offshore, and international operating segments as shown in the segment reporting on the press release, reported the fifth consecutive record level of segment operating income this quarter at $127.6 million as compared to $119 million last quarter. Hans mentioned an important market touchstone, and I will talk about a few more details in a moment. But first, let me turn to our operating performance and our U.S. land, offshore and international operating segments, and in each segment, I will talk about margins and a few activity highlights. So let's start with U.S. land and discussing our margins for the fourth quarter.

U.S. land daily margins achieved a record of $13,288 per day and continue to lead the industry by a wide margin. This margin is 20% higher when compared to the combined average of our four largest competitors. Keep in mind the new builds that are in the field now were contracted, in some cases, up to 20 months ago. Those early day rates are understandably lower than the spot rates today and act as a drag on our average day rates in the fleet. But even with the impact of the new builds, slowing the growth of H&P's average rig margins per day, our sequential quarterly increase of $350 is also higher than the average of our four largest competitors combined. Day rates on the spot market continue to be of interest. For the fourth quarter, rig revenue per day corresponding to rigs in the U.S. land spot market averaged approximately $27,200, up $1,200 per day compared to the third quarter. While we don't expect to see rate increases overall, we do expect rates to remain firm. 32 of 56 rigs or 50% -- 57% of the rigs in the spot market are FlexRigs and we expect the FlexRigs will continue to perform well.

Activity and growth of the H&P fleet remains a positive trend. The previously existing fleet of 89 rigs that was active on December, 2005, remained fully employed during the firth -- fourth quarter, and all of the rigs are active today. As is the normal course of business, we have rigs released by operators for various reasons. But each rig that has been released has been contracted by other operators, and those operators are typically looking to upgrade their fleet. Of the 28 new FlexRigs that have been complete to date, 27 are either working or moving to their first location in U.S. land, for a total active rig count of 116 rigs. Now keep in mind, the 28th rig is working. It's working in Tunisia. We believe that this rig count launches H&P from the fifth largest to the third largest active rigs working contractor in U.S. land.

As announced, we will be adding an average of three to four new FlexRigs per month to the active fleet through 2007. And keep in mind, the U.S. land rig fleet, including the 72 new builds that will be added, will then total 162 rigs. H&P has experienced a quarterly sequential growth of 8.2 average active rigs. That is greater growth than that of our four largest competitors combined. This is a clear indication of how the quality of our existing fleet and our FlexRig construction program will provide significant growth leverage going forward, as attrition rates for low-performing rigs on the market becomes more evident.

Another very positive indicator of H&P's future activity corresponds to the quality of our customer base, which is comprised of over 80% super majors, majors, and very large independents. Drilling programs for these customers has historically been long-term focused and less volatile, and we believe this trend will continue. Costs have continued to be very dynamic. We mentioned in the last conference call we were actually able to reduce M&S costs by $142 a day, but the fourth quarter saw overall M&S up. We've seen an increase in average rig expense of approximately $500 per day for the quarter. We expect to continue to see slight increases in costs and expect that costs associated with labor and M&S, covered by producer price index, should be passed through to most of our customers.

I do want to talk about Flex 4 performance to date. We have over 140 wells drilled. Over 65% of the wells are under the customer's target curve. Safety performance is 80% better than the industry standard. Flex 4's overall, if you look at them and compare them with Flex 3 performance at a similar time period when we built Flex 3, we're actually ahead of Flex 3. And finally, the first Flex 4 that we put in the field to date has drilled over 35 wells, 240,000 feet of hole, and all of the wells are directional and no safety incidents have occurred.

I'll now talk about our offshore operations, and as we discussed in our previous webcast, there has been uncertainty in regard to our platform activity in the Gulf of Mexico for the fourth quarter of '06 and the first quarter of '07. And that uncertainty continues. The margins were down sequentially 2% or $224 per day to $14,497. This was driven primarily by the release of two rigs and subsequent demobilization to the yard and stackout. Our activity, six rigs are currently active compared to eight rigs in the previous quarter, consistent with our previous quarter's conference call. We expect an 18% sequential reduction in activity for first quarter of fiscal year '07, which may be offset by an expected increase of a similar proportion in average rig margin per day.

In addition to the six active rigs, rig 201 is undergoing repairs and is waiting on the customers' platform. The rig has a term contract commitment and should begin operations in the second fiscal quarter of '07. Now we -- we do have prospects for second, third, and fourth quarters for three of the platform rigs, but nothing is firm. From an operating basis we expect comparable earnings in 2007 compared to 2006. We mentioned in the news release that we have entered into a purchase option agreement to sell two platform rigs, and we expect that, if the option is exercised, the transaction will close in the second quarter of '07. We see this as an excellent opportunity for H&P, after taking an impairment charge in 2004, and now having an opportunity to see an attractive gain on two inactive assets.

Now turning to international operations, our average rig operating margins increased 2% or $175 per day to $9, 777 in the fourth quarter versus the third quarter. We see that as an -- as impressive margin improvement, increasing 106% from the fourth quarter of '05, of $4,752, to the $9,777. And each of the four quarters during the fiscal year of '06 resulted in an increase in operating margins versus the previous quarter. Day rates have also increased in each of the four quarters during '06, ending with an average of $25,243 a day for the international fleet of 27 rigs. Seven of the 27 rigs are under term contracts. The average length of the remaining term is 15 months. The other 20 rigs are expected to continue to work with existing clients during 2007, and we anticipate there will be upward movement on rates.

The activity remains strong in each of our operating areas. Customers continue to express their desires to contract FlexRigs in several of our established areas. It is our expectations that these areas offer good potential. But it's also our experience that international opportunities take longer to develop than expected. Our first Flex 3 recently finished drilling its first well in Tunisia, North Africa. The mobilization and the startup was accomplished incident free, and the well was spud ahead of schedule. FlexRigs technologies performed well and the early success we believe will certainly H&P help in its efforts in marketing our FlexRigs in North Africa. We continue to pursue other opportunities for our new rigs in several regions of the world. Among the areas of most interest today appear to be North Africa, which we mentioned, Indonesia, India, and Russia.

Hans mentioned a market touchstone with today's announcement of seven additional FlexRigs and the positive impact for H&P with the 73 new rigs. But the real prize beyond that is we believe there remains the potential for more new-build contracts. No contractor in the business is in a better position than H&P to capitalize on the ongoing retooling effort. We continue to see potential opportunities for more new FlexRigs, and it -- and if you consider the following trends. First, in the -- in U.S. there are approximately 1,000 what we consider very old, conventional rigs that average 30 years in age. Many have been without major refurbishment and they are mechanically incapable of competing with H&P's new FlexRigs. We believe these rigs will suffer through more attrition as new rigs come into the market. There's also approximately 500 rigs in the international land market that could potentially suffer by attrition, as well. These numbers don't include Russia, China, Iraq, or Iran.

The second trend is unconventional gas plays require a gas manufacturing approach to drilling efficiencies. Operators need to drill literally hundreds of wells per year, and are charged with delivering 4,000 to 8,000 wells in the next five to ten years. There are huge cost savings and net present value gains for operators that are willing to invest in FlexRigs. As we continue to help our customers deliver total well cost savings, FlexRig 3's and FlexRig 4's will continue to provide the opportunity for H&P to penetrate new markets. As a clear demonstration of our new build competitive advantage, H&P will deliver more new builds in the U.S. land market during 2006 than the rest of our large competitors combined. If you consider that our new FlexRigs cover a depth range from 3,000 to 20,000 feet, that accounts for 97% of the wells drilled in the U.S.. The FlexRigs outsized AC drive technology, computerized control systems, electronic drillers, top drives, iron roughnecks, pipe handling systems, quick move times, and the FlexRig quality, drilling performance, and safety by design our customer expects. These rigs have passed the prototype stages and this allows H&P a wide offering of rig types to meet our customers' demand.

Finally, our reputation for operating excellence and a world-class safety record, combined with the outstanding track record of our FlexRigs and our previously existing fleet of rigs, makes us a very desirable contractor for operators in several areas around the world. And as Hans mentioned, this would not be possible without the tireless dedication and efforts of the people that make H&P a great place to work. We want to thank all those employees for another great year and look forward to a good year in 2007. And I'll turn the program back to Doug.

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

Thank you. [OPERATOR INSTRUCTIONS] Our first question will come from Arun Jayaram with Credit Suisse . Please go ahead.

Good morning.

Good morning, Arun.

John, I was wondering if you could give us what rates have done in the last 90 days. Typically you provide us some details on how the -- how land rig rates have moved since the last quarterly conference call.

As far as what we've seen, we've -- in general I think we've just seen rates flat. We haven't really seen an increase in rates, if that's what you're asking.

Okay. John, can you also give us your rig count assumptions for the platform rig business for -- for December and -- and the first quarter?

Yes. We think we'll remain at the six rigs active as we have right now.

Okay. Final question. Record margins, they were up $350 sequentially. I had actually modeled in a decline in margins coincident with the mix shift as you add some of the new builds to the fleet, but obviously margins were up. Does that decline happen in the December quarter, and if so, what do you think the magnitude of the decline would be, as you add in new builds?

Arun, this is Doug. Yes, I would guess with you. And that's what it is, it's a guess today that the average margin for the entire U.S. land rig fleet of H&P would probably decline. Some of that's based on a guesstimate that spot margins will be flat quarter-to-quarter, September quarter to December quarter. And then as we've mentioned, our new builds, margins right now are lower than the spot market margins -- the spot market margins. But those margins on new builds climb over time, as we go down the line. So that's a long-winded way of saying, yes, you're likely to see average margin declines for the December quarter.

Okay. Thanks a lot, guys.

Thank you. Next we'll move to the site of Stacy Nieuwoudt with Pickering Energy Partners. Please go ahead.

Good morning, guys.

Good morning.

On your new builds you announced this morning, can you tell us how many are Flex 3 and Flex 4?

Yes. Of the seven new builds that we announced, Stacy, two are FlexRig 3's and five are FlexRig 4's.

Okay, great. And then turning to international exposure, you mentioned some regions that you think could be attractive going forward. Can you walk us through what kind of rates in turn you would require and the number of rigs in each region for -- to justify further expansion?

It's -- it's really too early at this stage, Stacy. I think at this stage of the game, you know, the challenges in the international markets are getting the technology in the country to start with. And that's kind of the -- what we're working our way through now. But what we can say is that we're going to try to model what we've done in the U.S. But it's -- it's far too early to talk about the rates at this stage.

Stacy, this is Hans. I think we would expect attractive and comparable returns to what we're seeing in the U.S. We -- we won't go into international opportunities, you know, in terms of a loss leader. I mean, we're expecting to get attractive returns on our equipment and services, and so that -- that would be an important thing to remember.

Of course. And then during the quarter, international drilling improved despite -- sequentially, despite last quarter being impacted by Venezuelan back billing. Can you walk us through what kind of repricing opportunities you expect in 2007.

This is Doug. Generally speaking, what we've done during 2006, of course, is just moved day rates up as the market has provided those opportunities. And it's -- we're going to continue to be aggressive in 2007, but I would be careful about projecting the same kind of increases that we saw in '06. I think it will generally be kind of flat and maybe slightly increase in terms of margins.

We think there's an opportunity in -- in some of the areas to have some continuing improvement in pricing. But I do agree with -- with Doug, we've got to be cautious in how we -- as far as modeling that.

That's very helpful. Thanks, guys.

Thank you. Our next question will come from Mike Drickamer with Morgan Keegan. Please go ahead.

Good morning, guys. I want to follow up on the seven new builds. What's your average cost to build these rigs? What are you projecting your average cost?

Mike, I think what we're saying is that -- and this is really for competitive reasons -- we're looking at our total order book of 73 rigs and saying that the average price is $15 million over that order book. Now, these latest rigs will have some specifications that are higher at customers' request, so you'll be able to move that price up some. But that's about as specific as we want to be.

Okay. Then Hans or John, I don't know which of you want to handle this, but 32 of the 56 rigs in the spot market are FlexRigs. That number sounds a little high to me. But how many of those are -- I guess what would be termed perpetually committed, where they've been with the same operator and the -- you know, the operators keep them on a [inaudible] basis?

Mike, a good portion of those are -- are in that -- in that situation where they're -- where they're typically repriced. They're well-to-well contracts, but they worked for the same operator for some period of time. But nevertheless, they're -- they're not on long-term commitments and that's what we're differentiating there.

Okay. Last question just for modeling purposes. How many rigs did you have in the active fleet at then of the September quarter? You gave how many you have now. How many did you have at the end of the September quarter?

See, that would be 113, I believe.

Great. That's all from me, guys. Thanks a lot.

Thanks, Mike.

Thank you. Our next question will come from Mike Breard with Samco Capital Markets. Please go ahead.

Great quarter. I just a couple of questions, one on your manufacturing. Have you -- you had mentioned you would be delivering three to four new rigs. Obviously some of the rigs with a higher spec -- higher specs would take a little longer to make. But are you pretty well stabilized there at three or four, or are you still trying to increase that to average four and then possibly a little more?

That's a good question. I think when we say three or four, Mike, we see the challenges of achieving a four rig per month cadence. We have done that. We did it last month and we see ourselves doing that going forward. At the same time, we realize the difficulties there, so we say three or four. I think it's safe to say today that we don't really have a goal of pushing that to five or six, so that's why -- that's why we worded it that way.

Okay. And then just one quick question about the market. And how many different operators are you working for now as compared to, say, six months ago? In other words, how has the industry recognition of your rigs improved?

Well, I'm going to let John or JP jump in with that number difference. But I think clearly what we've seen happen is as the customer has the FlexRigs and now the newer Flex 4s, there's lots of talk between customers. And so some of the best marketing that we have is when customers are able to just give, if you will, testimonials on the performance that they're seeing in the field. So that's one piece, and I think we've landed on -- on the count here in term of that's different. But I think that is more dynamic than maybe a difference of the two numbers. Do you have something on that?

Mike, we're -- overall, we're working for around 30 to 35 different operators. And that -- but that number really hasn't changed much over the year. I think what -- what has changed and what has continued to improve for H&P is that there's more and more operators every year that understand more clearly what the FlexRig has to offer. And what we've seen are some new customers come into the fold that have -- that have picked up new build rigs. And so that's -- that's obviously a positive for us. And I think that's one of the advantages that remain with having FlexRigs in the spot market is you have that opportunity to take that FlexRig and go to work for someone you haven't worked for before. Demonstrate performance and then see them commit to new builds, which is, as a matter of fact, what we did and one of the seven rigs that we've announced at new builds. So that's what we see as the opportunity going forward and not only in the U.S. land but in other operating areas, as well.

So essentially you've really just scratched the surface of potential customers is one way of looking at it?

I think that's possible. You know, there's obviously a lot of -- lot of variables there. But what we've seen since 2001, really, is each year capturing another several operators that understand what we're doing and see the value of the rigs that we're providing.

Okay. Thank you.

Thank you. The next question comes from Robert Trace, Sterne, Agee. Please go ahead.

Gentlemen, good morning.

Good morning.

I've got a couple of questions. The first one is that ever-elusive attrition question, and you suggested that it should be -- attrition should become more evident going forward. Can you help us to understand what exactly you mean by more evident and, perhaps, what key metrics you look for? And then if you can, maybe even touch on what kind of net numbers you might be envisioning by the end of next year or '08.

Robert, I'll let these guys add in -- add into this, but I think one point is the age of the fleet. We've talked about before, you know, now is approaching 30-plus years. With -- with as strong a cycle as we've experienced in the last 18 months, and the prices and the just strong demand for rigs, anything that could be dragged to the starting line had a chance to work. And so I -- I think there's been a artificially -- there's been kind of an artificial cap on attrition that now, depending on where this market goes, people will be more discriminating. So that's one thing difficult to quantify.

I think one of the things that you'll also see is, as we have peers introduce newer rigs, I think the net adds will be an important to trace, and that's public information that you guys can look at. On H&P's account, we've been able to add rigs and they've become positive net adds to the fleet. We're not -- we're not having to sideline older rigs. So I think there are some data points out there, and I'll let these guys jump in and add to that.

Yes, Robert, this is Juan Pablo. Just to add a little more color to that, if you take a look at our largest competitors in general, you'll see that they've put out close to 30 to 40 rigs during this year, and what has hit the -- the number in terms of rig count and activity is half of that. So the question is, well, what is happening to the rest of those -- of those rigs? And we'll be keeping an eye on those numbers as I'm sure everybody will.

Thank you. The -- the next is do I understand that correctly, on a per-month basis we can look at deliverability of three to four units?

Yes.

Is there -- can you describe if there's any deliverability risk to where that would -- that would change?

Well, it's a -- it's a constant challenge, and it's a big effort. We -- we have, thankfully, the experience of having built 50 FlexRigs before and we had a very aggressive target, I think, when we said we wanted to build one rig a week. And we've gone through a summer. We talked some earlier in the summer about some cost pressure and we had some production delays and so, I think our guys have just done a herculean job in establishing a four-rig-per-month cadence. But we also -- you know, a big part of that, in addition to the manufacturing side, is the supply chain management. And again, we have very strong relationships with our suppliers. We have guys that work that hard and -- and we don't see any overwhelming challenges there. But there are lots of moving parts, and I think that it's a fair question. And sure, there are challenges that affect it, even things like the weather. So it's something that takes real effort and vigilance, but I think our guys are doing a great job.

Would it be fair, Hans, then to suggest that we should or could model three per month? Or it'd be pushing it to suggest that we should add four per month to grow volume metrically?

Yes, I think that -- of course, we always tend to be a little conservative, but -- you know, I think as we look forward, we're seeing a four-month cadence. Now we've got, of course, a couple big holidays coming up, but I think we've got -- we're wired around that. And so I wouldn't scare you back into just three a month. I think that may be too conservative.

Okay. And if I can, last question. Cost. Two things. One, cost pressures, inflation pressure on cost, for two areas. One, current operations at the rig level. And if you could quickly detail whether it's insurance, labor or you're seeing, and what kind of inflation number we can expect, 5%, 10%, 15% going forward? And also to labor, materials cost on the construction of the new FlexRigs going forward? Those two, and then I'll turn it back over. And I appreciate it very much.

Sure. Thanks for your questions. I'll start with your second question then let John speak to operations. I think on the construction, manufacturing side, you've read, as we all have, in terms of welder, fitters, just a huge demand on those skilled positions. So we recognized that early. I think we came out with the information as we saw it early on. And today we've been able to hold the line that makes that 16% number that we reported still a good number. So again, they're challenges associated with that going forward, but we feel good about where we are today. And then John, I'll let you touch on that operational cost side.

Robert, the -- you know, in U.S. we costs were up $500, like I mentioned, and that was primarily due to maintenance and supply costs. And you know, in the previous quarter M&S costs were actually down. And in the previous quarter costs overall were up, but that was primarily related to labor in the previous quarter. I think as far as modeling it going forward, it's hard to say for sure. We do think there's going to continue to be a trend of -- of cost pressures, and I don't think it will change on M&S or labor. I think the positive for H&P is that we do have a cost pass-through provision. And you know, on the M&S side you can't get all of it, but you can get a good portion of it. So again I don't think we're going to see the same type of $500 increases, but I do think we'll continue to see some as long as the market remains as strong as it is, and it's still very strong.

Thank you. And I guess I leave you the thought that you're talking about really segmentation, a bifurcated market, old rugs leaving. But it seems to me that, given the advantages that a FlexRig has over conventional rigs, you see new, conventional rigs being built. There's even got to be segmentation going forward between Flex and a new build conventional that would be based on a 30-year-old manufacturing design. Isn't that true?

That's -- that's a fair observation. And I think what we're seeing in the market is there -- the demand from some of our peers was interpreted as just what we need are additional units and don't encumber us with lots of innovation, better design, some features like that. They just wanted yesterday's tractor because it was still plowing. And we've taken a different approach strategically, and we're trying to push the very best in terms of drilling efficiencies and innovation, and we'll continue to do that. We've got efforts on-going today. So in the universe of new build, there is a large portion of those that are based on what we think is a -- a 20-plus--year-old design.

Fair enough, thank you very much, John and Hans. I'll turn it over.

Thanks, Robert. Thank you. The next question comes from Jason Podraza with Howard Weil. Please go ahead.

Good morning, guys.

Good morning, Jason.

Just want to frame the latest agreement here with the seven new FlexRigs. I know you don't give specifics, but just directionally on the margin side on those rigs, trying to compare those to current spot rate or spot margin, and also, say, the last round of -- it was a half dozen or dozen rigs that you announced earlier this year, directionally where the rates of these latest seven compare to those metrics or margins?

Well, you're right. We're sensitive in talking, Jason, about the seven and what the margins are. I think we've said before that we've got to target return on invested capital in the high teens. You know, we think of that as being 18%, and these rigs would qualify for that. But, really, it's difficult for us to -- because of just how competitive it is to spell out much more detail right now.

But, is it safe to say that there wasn't any measurable degradation in the rates that you received in the latest round versus previous awards a few months back?

No, there's fair and that's true.

Okay.

Not only that, we're still talking about a firm three-year deal. We're still talking about, I think, a very fair and -- and strong contract. And again, my reluctance to more should not be interpreted as a degradation in the returns of the rigs.

Fair enough. Moving on, when you look away from both the rigs you have in the spot market and away from the 28 new builds that have been delivered under three and four-year terms here, you've got another segment of the fleet that's kind of under term arrangement, as well. Just trying to get a sense for those number of rigs that may see their term contract expire in '07? And based on the age of when those original contracts were signed, what opportunity those have in terms of repricing, perhaps, you know, coming up to a much higher spot rate today than when they were originally signed?

We can give you more detail on that and I'll let John do that.

Jason, we have five of those 33 rigs that are currently term contracts. Five of those expire in the second fiscal quarter of '07, ten in the third quarter and five in the fourth quarter.

And Jason, this is Doug. Just to clarify, those 33 are term contracts, non new build. And I heard you just make that distinction, but just to clarify for the other listeners.

And just given the age of when those current term contracts were originally signed, you would expect that in many cases you would be able to reprice those higher than what they were on their term contract, by rolling to the then spot market?

If we were repricing today, yes. It's obviously hard to -- to predict second quarter, third quarter, fourth quarter. But generally speaking we would think so.

Thank a lot, guys. Good quarter.

Thank you. The next question comes from Pierre Conner with Capital One. Please go ahead.

Gentlemen.

Good morning.

John, just a quick recap on the new build -- the recent orders, rather. Will you say that the customer mix on these additional seven is representative of your current customer mix relative to majors and independents and such?

Yes, it is.

Okay. Moving on to international, John, the opportunities for international that you're looking at. You've got the rig in Tunisia. Would you characterize for us what do you think about relative to those opportunities for moving any existing operating rigs out of operations in the U.S,. If there's ones, twos versus -- are all these opportunities you're looking at internationally potentially, you know, new build packages?

I think our first thought would be they would be new builds. And -- and obviously it's -- it would be a challenge to pull, say, a Flex 3 out of this robust market, no matter what kind of contract we had internationally because you've got that -- that loss of revenue stream there. So our first thought would be that it would be a complete new build, and that's what we're talking about now. I wouldn't -- wouldn't completely rule out an existing rig, but I think, in general, it would be a new rig.

Okay. Let me ask this question on the margins and new build one more time, maybe a different way. Is there a way to give us some perspective on when the inflection point occurs during delivery, if you were to assume current margins are static such that the new build deliveries begin to be accretive to the margins. At what point in the delivery schedule does that occur? You indicated, of course, that in the next quarter, potentially, those being ordered some 20 month ago in some cases, that those were before the market was tighter than it is now. Can we look at it that way?

Yes, I think JP's got that, Pierre.

Hi, Pierre. This is Juan Pablo. We would see that happening, given those assumptions, on the second fiscal quarter of '07.

Got it. Excellent. Okay. I'm sorry, jumping around a little bit. Back maybe to John on costs. You mentioned that, you know, all these [inaudible] would be maybe under IADC contracts with labor pass-throughs. But also M&S pass-throughs or are your pass-throughs on cost only on the labor side?

No, there's -- there are pass-throughs on the PPI increases, but that references -- you know, that one is not always 100% on existing rigs. It is 100% on term contracts. All of our term contract have that provision, but some of our rigs that would be on spot market pricing, it may be more difficult to capture that if you had a large maintenance supply cost.

Got it. Okay. Last one. Hans, I'm assuming that the current delivery would be scheduled out through the end of calendar '07, if I called this afternoon to order some rigs, that that would be my earliest delivery date. And if that's the case -- and you guys have worked hard on getting your supply chains down and such -- is there anything you'd look at or consider or outsource, is there any potential to accelerate deliveries?

Well, that's something that we're scrubbing today and looking at different opportunities. It's not far enough along to really talk much about. But I think the effort that we're undertaking to look at that and see what our opportunities are speaks to our sense that this cycle has a long way to run. You were asking earlier, Pierre, bout international. We think that we're going to be very competitive in international markets. We've got customers that are very interested in applying the FlexRig technologies to opportunities hey have overseas. So that drives us to say, can we solve for something beyond four rigs per month?

Yes. And maybe put this t this way along that same line. Do you feel like you're missing some opportunity because your delivery schedule is -- is later?

Well, there's no question about it. I think we're -- we know that we've got customers that -- and I can appreciate it when you're a year out and then you're asked to sign a three-year commitment, we know that we've pushed some customers to competitors.

Got you. Understand.

One other -- one follow-up on that, Pierre. I think the positive end is that we do have customers that are talking to us -- I mean, continue to talk about, well, we've got these new build, but keep in mine we've got potential in '08 and '09. I mean, they're still talking about those kind of programs that I've never seen in my career where people talking that far out. Again, that's an opportunity that H&P has.

Gentlemen, thank you very much. I'll turn it back.

Thanks.

Thank you. We have -- our next question will come from Mark Close with Oppenheimer and Close. Please go ahead.

Good morning. Most of my questions have been answered. I wondered if you could -- on your future cash needs, you know, you mentioned that you're going to use probably a combination of debt and/or security sales. I wondered if you would consider monetizing any of the real estate assets? And also, if you could bring us up to date on where are you on the buy-back I'd appreciate it. Thanks.

Okay. In terms of real estate, we are -- we are looking at opportunities to monetize. And in fact, we do that on an ongoing way. We'll be influenced by, you know, certain conditions here in Tulsa. But instead of trying to package that up and -- and do something all at once, we're constantly looking at different opportunities to do what you suggest. Then the other point was an update on our repurchase. We have slightly over two million shares we've repurchased. We are operating under a four million share authorization. And so it's something that the board looks at on a regular basis. We have uses for our cash going forward, and that's really what we're focused on -- on driving. But we will be opportunistic and looking at repurchases going forward.

Thank you.

Thank you.

Our next question will come from Thad Vayda with Stifel Nicolaus. Please go ahead.

Morning. Just a quick question on the non-FlexRig portion of your U.S. fleet. Given your view of the cycle line, how inclined are you to renew your older rigs on a non-contract -- more on a speculative basis?

Thad, when you say renew --

Replace. Take an old rig out of service and put a new rig in.

Well, that's -- that's a fair question. I think we made an early effort, and those rigs reflect it now to bring those rigs up to a superior market condition. So we've made that investment, and in some ways we see where the future is a FlexRig, but we don't want to compete again a capable rig that's a conventional rig. The other part of it is just the size, with those being 2,000, 3,000 horsepowers. Those still address a market need so that, again, it would encourage us to -- as long as those provide good return -- to keep that going. But, you know, you've asked the question and I think the sale of the -- the potential sale of the two platform rigs shows a willingness to continue to look at how do we renew our fleet, how do we keep it and push it to be even younger and newer. And so we'll look at opportunities to do that.

Okay. Out of curiosity, when did you start negotiating with this current slate of three customers on these seven incremental rigs,just approximately? Was it two quarters ago?

Oh, I think the interest has been there. I know one of them was a previous user of FlexRigs, and so they were very sold on the performance. But -- but I think that -- the fact is in terms of inking the deal, it was recent enough that they saw -- their lens was the current market conditions today. So it -- it would have been in terms of start point summer, and ending point recently enough for them to fully see what's going on, and their commitment to -- the go-forward was such that the FlexRig of the resolution.

Okay. Thank you.

Yes,

Thank you. Our final question in queue is a follow-up from Robert Trace with Sterne Agee. Please go ahead.

Hans, a follow-up here. And I'm going to key off of something you just said a minute ago, a younger, newer fleet goal. Given that, how should we view the offshore business? I know it's been a source of technology, but financially and given the sales of two, I think you said, inactive units with six going forward, is that a -- is that a piece we should just model into perpetuity? If we integrate the function of those competing offshore versus on -- the need from onshore?

Yes, it's a good question, and it's a difficult one to answer because that business is changing so much. We're in a niche that I think we're clearly the dominant player in, and we're seeing more opportunities in deeper applications. So the conventional shelf is an area where customers are going away from. You know, when you look at it, Robert, in terms of percentage of our overall drilling business, it's less than 10%, Doug?

Right.

And so, in terms of modeling, I don't know how much guidance to give you. I think as we go forward -- you know, the other difference in that business has been we used to build a new platform for $15 or $20 million. Now those numbers are three or four times that, so it's -- it's a different type of business. We're talking to customers today about managing the construction effort, design effort., Doing some labor contracts, but where they actually own -- because it's so built for purpose they own the rig itself. You know, having said that, we have contracts that go well beyond 2008, so it's a business that we're going to have some involvement in. And you mentioned a good point earlier, which was some technology transfer and having a front row on some of the innovation that we have been a leader in migrating back to land applications. So there's -- there's some synergy there, as well. I don't know if that gave you, you know, enough to go on.

I suppose it does. And at some point I guess it could be possible that we might see a -- you might suggest that one day you'd exit the platform business, because that's heart of the question.

Yes. And that's something that you heard us talk about really since the impairment in '04 is being willing to look at all of our options. And I think we're in that position today. So, if you know someone who'll take our breath away on that, then we would certainly look at that.

All right. Thank you.

Thank you. At this time we have no further questions.

Thank you. We appreciate everybody joining us today. Have a good day and good-bye.

Once again this does conclude today's teleconference. You may disconnect at any time.