Helmerich and Payne Inc (HP) 2010 Q4 法說會逐字稿

Hello, and welcome to the Helmerich & Payne fourth quarter and fiscal year end earnings conference call. At this time, all participants are in a listen-only mode. Later, there will be an opportunity to answer questions. (Operator Instructions). At this time it is my pleasure to turn the conference over to Juan Pablo Tardio, Vice President and CFO for Helmerich & Payne. Please go ahead.

Thank you and welcome, everyone. With us today are Hans Helmerich, President and CEO, John Lindsay, Executive Vice President of US and International Operations, and Mike Drickamer, Director of Investor Relations. I'll make some general introductory comments, and will then turn the call to Hans, for his and John's comments.

All usual, all forward-looking statements made during this call are based on current expectations and assumptions that are subject to risks and uncertainties as discussed in the Company's annual report on Form 10-K, and quarterly reports on Form 10-Q. The Company's actual results may differ materially from those indicated or implied by such forward-looking statements. We will also be making reference to certain non-GAAP financial measures, such as segment operating income and operating statistics. You may find the GAAP reconciliation comments and calculations on the last page of today's press release.

Income from continuing operations during the fiscal year resulted in approximately $286 million, equivalent to $2.66 in diluted earnings per share. On a quarterly basis, income from continuing operations for the fourth quarter increased to $0.77 in diluted earnings per share from $0.61 during the third quarter. Once again, our US land operations segment continued to drive our increasing quarterly earnings, delivering significant sequential growth in segment revenue, operating income and revenue days.

The Company's debt level continues to decline to $360 million at the end of the fiscal year, resulting in a debt to cap ratio of approximately 11%. Capital spending was approximately $330 million, and net cash provided from operating activities was approximately $460 million during the fiscal year. Our fiscal 2011 capital spending level will be primarily driven by our new-build construction program, as it adapts to market demand for incremental FlexRigs during the year.

Given the number of customer commitments that we already have for new FlexRigs to be completed during the fiscal year, and the level of rig component orders that are required to ensure our ability to effectively respond to additional new FlexRig demand, our current capital spending estimate for fiscal 2011 is approximately $600 million. Depreciation expense for the fourth quarter was reported at approximately $73 million, which included extraordinary adjustments of approximately $3 million that are not expected to recur during the following quarter. Given the continuing growth of our FlexRig fleet, we expect our total annual depreciation expense to increase to approximately $300 million during fiscal 2011.

General and administrative expenses are expected to total approximately $85 million and interest expenses after capitalized interest are expected to total approximately $14 million during fiscal 2011. Our investment portfolio, primarily comprised of 8 million shares of Atwood Oceanics and 967,500 shares of Schlumberger, recently had a pretax market value of approximately $380 million, and an after-tax value of approximately $240 million. Our tax rate for continuing operations during fiscal 2011 is at this point expected to be approximately 37%.

We have no additional news related to Venezuela. As reported last quarter, our Venezuelan business was classified as a discontinued operation after the property and equipment of our Venezuela subsidiary was seized by the Venezuela government. We will continue to evaluate and work on available remedies that may enable the Company to be compensated for the seized asset and unpaid invoices. I will now turn the call to Hans Helmerich, President and CEO, and after Hans and John have made their comments, we will open the call for questions.

Thank you, Juan Pablo. Good morning, everyone. Let me take the opportunity to reflect on some of the milestones that stand out for 2010. Juan Pablo already mentioned Venezuela, which was certainly our most disappointing milestone of the year. And while perhaps receiving more than its fair share of attention, it is now behind us and we've moved forward.

2010 was a year of transition and recovery. And the Street fought its way back from a dramatic once in a 30-year freefall that started in the early fall of 2008 and bottomed in June of 2009. In terms of utilization, margins, operating income and returns, we outpaced our land drilling peers during the recovery that unfolded in the second half of 2009, and continued through our fiscal year 2010. Industry wide activity steadily improved through the year, as the US land count currently stands at 80% of the number of rigs that were running in October of 2008.

For the Company's rig count, we've exceeded that percentage. During 2010 we reactivated nearly 90 rigs, our largest single year effort ever. In fact, we recently crossed the threshold of running 190 rigs in the US, surpassing our previous record during the cyclical peak, and achieving the highest level of activity in the US in the Company's history. In addition to better utilization levels, we outpaced our peers by maintaining significantly higher premiums, and the average rig revenue in margins during all parts of the cycle. We ended our fiscal year with over $24,000 of average revenue per day and with an average spot market pricing reaching approximately $22,000 during the fourth quarter, a $2,000 sequential improvement over the prior quarter.

Another milestone worthy of mentioning is our new-build effort in 2010. In a year where natural gas prices have fallen in half, we were pleased to be able to secure 23 new FlexRig orders since March of 2010, all secured by long-term contracts at favorable returns. These new orders help us maintain our market leadership of providing customers AC powered rigs.

Here is a breakout. Three quarters of our US fleet is AC powered, compared to our largest and second largest competitors at approximately 33% and 6% respectively. Our experience gives us a simple but profound advantage that enables us to build rigs for a lower cost and contract them at higher dayrates than our peers. That experience represents more than the aggregated 560 rig years of running HC power technology in the field, but also the captured learnings of more than ten years of our own design and integrated manufacturing effort. Stated more directly, we keep getting better at what we do.

Earlier this month, we rolled off the line our 100th FlexRig 3, the flagship of our fleet. We held a celebration at Greensport, Texas, our assembly facility. It was a good day on several counts. First, when we read so much about the diminished level of manufacturing in our country today, it's nice to have the opportunity to recognize the efforts of our guys who have built over 200 FlexRigs in that facility. We handed barbecue to over 250 workers, handed each one of them a crisp $100 bill to commemorate the milestone, and thanked them for doing what they do better than anybody in the world.

The 100th Flex 3 on display contained multiple feature enhancements and improvements compared to its earliest counter part. These improvements come from eating your own cooking and a Company-wide focus for our design and engineering effort all the way through our field operations to constantly improve and drive innovations that enhance performance. The leadership team involved in the design, coordination, the assembly, training, safety, remote monitoring, marketing and actual operations and field execution, were all well represented save for one. Alan Orr was unable to attend for the same health considerations that prompted his early retirement since our last call in July.

Many of you knew Alan and it's appropriate to recognize and thank him on this call, not only for the lead role he played in the design of the FlexRig, but for the host of innovations he and his team introduced to the land drilling business. Alan joined H&P as a rough neck after graduating from West Point. He worked his way up through our field operations and held several leadership positions, culminating in his most recent role as Executive Vice President of Engineering and Development. Five years ago, he was named the Contractor of the Year by the International Association of Drilling Contractors for innovations in safety, efficiency and technical achievements. I'm proud to be able to express on behalf of the whole Company our thanks to Alan for his 35 years of loyal service.

I'd be remiss not to mention two final milestones for 2010. The Company celebrated it's 90th year anniversary, and we recognized my dad, Walt Helmerich, for his 60th year of his involvement with H&P. He started fresh out of Harvard Business School in 1950 and continues today as the Company's Chairman. We're very thankful for his leadership and hugely indebted to him and many other loyal employees past and present, that have built the Company's reputation the old-fashioned way, brick by brick, preset to pon-preset.

Our job going forward is to vigorously defend and enhance a powerful combination, being the world's oldest and most experienced land contract driller, and at the same time, the most innovative and forward-thinking. That is the charge we embrace heading into 2011. As we look to next year, we expect the standard uncertainty that attends this business to prevail. That uncertainty today centers on short-term downward pressure on natural gas pricing, and whether or not the long-awaiting pullback in the gas directed rig count finally occurs. We've already guessed wrong on this score earlier this year, as natural gas prices continued to fall.

But our general thoughts really remain the same, the clear customer preference for high-performing rigs in a bifurcated market will leave the brunt of any pullback to be borne by older, lower-performing assets. Absent an unforeseen pull back in oil prices, the historically high oil directed rig count will help buffer any overall downward adjustment. Should one occur, we still believe we have opportunities to continue to gain market share, even if the overall rig count falls below the current level of 685 rigs in the US.

Our growth opportunities will be governed by a capital discipline that served our shareholders well. We will continue to focus on leveraging the unique set of organizational competencies to satisfy our customers as they pursue increasingly complex drilling targets for both oil and gas. At this point, I'd like to turn the call over to John for his comments.

Thank you Hans, and good morning. We are encouraged by the opportunities ahead as our new and long-term customers continue to exploit oil and liquid rich plays in a low natural gas price environment, and FlexRigs remain in high demand.

As we said in the past, the unconventional plays require mostly horizontal and/or directional drilling, enabling better and more cost effective reservoir performance. More complex drilling favors FlexRigs as they are a catalyst for drilling efficiencies and safety performance. The following comments will describe the fourth quarter results and the first fiscal quarter of 2011 outlook for our three operating segments.

And I'll start with US land. Our fiscal fourth quarter land results benefited from the last of our idle FlexRigs returning to work. During fiscal fourth quarter, the average number of rigs working increased by 19 rigs to 177, including an average of 120 under term contracts and 57 in spot market. With the higher level of activity, total US land segment revenues increased 19% sequentially to $436 million.

As a result, US land segment operating income increased 15% sequentially to $118.9 million. Excluding the favorable impact of revenues from early termination and the new-build delays during both quarters, average rig revenue per day increased over $1,000 a day sequentially to about $24,000 per day as average dayrates for rigs in the spot market increased by over $2,000 to about $22,000 per day during the fourth quarter. Average rig expense per day increased about $500 per day to slightly over $13,000, but about $350 per day of the increased expenses we do not expect to incur going forward.

Excluding the favorable impact of revenues from early contract terminations and customer-requested new build delivery delays, average rig margin per day increased over $500 per day to approximately $11,000. Our fiscal first quarter of 2011 will benefit from a full quarter contribution from the FlexRigs that went back to work in the fourth quarter, continued growth from FlexRig new-build deliveries and the return of rigs from Mexico.

As of today, we have 190 contracted rigs, including 132 under term contracts and 58 in the spot market. Of the 58 rigs in the spot market, 54 were FlexRigs. As Hans mentioned, the 190 rigs surpass our previous record during the last cyclical peak in 2008 and represent the highest level of US activity in the 90-year history of the Company.

Of the 132 rigs currently under term contracts, 64 are scheduled to reprice during fiscal 2011. The repricing is expected to have a slightly favorable impact on our average daily revenue during the first fiscal quarter. The average day rate for rigs under term contracts expiring after 2011 is about $1,200 a day, above the mentioned current average for all rigs under term contract.

Late in fiscal fourth quarter, two of the six rigs previously assigned to operations in Mexico returned to the US and are currently under contract. The remaining four rigs will be discussed in more detail in the international segment. We expect total revenue days for the US land segment to increase approximately 5% to 7%.

Excluding the favorable impact of revenue in the fourth quarter from early contract terminations and customer requested new-build delivery delays, we expect average rig revenue per day to increase by over $500 per day in both the average term and the spot rate in the first fiscal quarter. We do not expect significant revenues from early contract terminations in the next few quarters or customer requested new build delivery delays.

I'll talk briefly about our new builds. Today, we announced contracts supporting the construction of four additional FlexRig 3s all with three-year firm term contracts. With these four rigs, we've announced 163 new-build Flex 3s and 4s since 2005, including 23 Flex 3s since March of 2010. 12 of these rigs are currently under construction and are expected to be completed during the first three quarters of fiscal 2011. The 23 new FlexRig 3s announced during the last eight months for US Land are being activated in some of the most attractive basins in the US, including the Eagle Ford, Cana, Woodford and Bakken, Bone Spring and the Haynesville. All of the rigs will be drilling more complex, horizontal and directional wells as customers extend laterals and drill more multi lateral wells.

In our off shore segment, the off shore segment benefited from better than expected operating margins. Segment operating income for off shore increased 17% sequentially to $13.1 million, despite a 7% decrease in revenues. Total revenue days during the fiscal fourth quarter of 644 days were essentially flat sequentially. Average rig margin per day of $22,581 was positively impacted by approximately $2,000 due to a reduction of certain expenses in the quarter. Excluding this benefit, average rig margin per day was essentially flat sequentially.

Looking forward to the first fiscal quarter of 2011, two of the rigs that were on stand-by during the fourth quarter are expected to return to work toward the end of the first quarter. Rigs on stand-by still generate revenue days so revenue days are expected to be flat sequentially. Additionally, excluding the $2,000 per day benefit during the fourth quarter, average rig margins per day are expected to decrease by less than 5% sequentially.

The international land segment benefited from about $6 million of early contract termination revenue from two rigs previously assigned to operations in Mexico and this set the stage for better than expected quarter. International land segment revenues increased 16% sequentially to $69.8 million, and segment operating income increased almost 57% to $15.5 million. Total international land revenue days increased 5% during the quarter to 1,976 days, as we had an incremental rig go to work in Columbia and our first FlexRig began operations in the Middle East.

Excluding the favorable impact from early termination revenues, average rig revenue per day decreased about $600 per day to a little over $30,000 per day, and the average rig margin per day declined by $664 to $9,528 from $10,192 during the third quarter. Going forward, our international segment will be positively impacted by the full quarter operations of the FlexRig that started work during the fourth quarter in Bahrain as well as the rig in Columbia. Our second FlexRig in Bahrain recently spud its first well, and we have now receive aid contract for a third FlexRig in Bahrain, which will transfer from the US for a start-up expected during the third fiscal quarter.

We currently have 28 rigs assigned to the international land segment, including three FlexRigs for Bahrain, and four remaining FlexRigs in Mexico. With the four rigs in Mexico now expected to return to the US, the first two quarters of fiscal 2011, total revenue days for the first quarter are expected to decrease by about 7% from the fourth quarter.

Including the favorable impact from the early termination revenues, average rig margin per day in the first quarter is expected to decrease by less than 5%. Excluding this favorable impact from early termination revenues, average rig margin per day is expected to increase a little over 5% sequentially. This increase in average rig margin per day is a combination of increased activity in the Middle East and decreased activity in Mexico, where the rigs were contracted at lower day rates in late 2009.

I should also mention the early success in our new operation in Bahrain. Since spud of the first well in July, the first FlexRig 4 has drilled 13 wells and the most recent was a record well including the rig move of about 4.5 days. For a first start-up in the Middle East, we're pleased with the early results.

And in summary, it's clear that many of our competitors have now embraced AC-powered rigs and we believe this supports our long-held position that AC-powered rigs could ultimately displace the majority of the old legacy mechanical fleet of rigs. Today, approximately 700 mechanical rigs are active in the US, and it's estimated that about half of the rigs may be drilling nonvertical, more complex wells, whereas previously those rigs may have been drilling vertical wells. This recent industry shift to drilling more complex wells, and that's both oil and gas wells, long-term, creates performance challenges and limitations for contractors with mechanical rigs with regard to drilling efficiency, environmental and safety performance.

The industry's most likely going through a rig replacement phase, not a rig retooling phase, like the last five years, and that phase clearly favors H&P. H&P has been designing and building AC drive Flex 3s since 2002 and we believe our first mover advantage has enabled us to capture over 40% of the AC rig market share. Our experienced and captured learnings should enable us to continue our market share growth of the AC fleet in the US and international markets.

Finally, our fiscal 2010 was another very good year with respect to our safety performance, especially considering we put nearly 90 rigs to work in 12 months in the US, and had two new start-ups in two countries. Of course this achievement would not have been possible without our long term field employees, they're coaching of many new rig employees and mentoring by our management teams to advance the H&P culture, and we want to thank all of those personnel who have made a difference, and I'll turn the call back to JP.

Thank you, John. Now, we will open the call for questions. Mark?

(Operator Instructions). We'll take our first question from Waqar Syed with Macquarie. Please go ahead. Your line is open.

Good morning. My question on your CapEx, could you provide some breakdown between maintenance CapEx and growth CapEx for fiscal 2011?

Hello. Waqar, this is Juan Pablo; yes we can do that. The $600 million estimate, approximately 30% will be directed to maintenance CapEx, but 40% to 50% will be directed to the new-build commitment that we have. And the remainder will be special projects and whatever purchases we need to make for the continuity or potential continuity of our new build fleet.

So this $600 million has investments in it beyond the rig building you announced; is that right?

Some, yes.

Okay. What would be the pace at which you can build a rig on a monthly basis?

Hi, Waqar, it's Hans. As you know, we've been quite a range of cadence. We've recently been at one rig a month. That's been increased to two rigs. We can go to three rigs pretty seamlessly. And you remember in 2007 and 2008 where we were at four rigs per month. So I think practically speaking, we're in that two to three rig per month cadence.

Okay. So if a customer now comes to you for a new-build, what is the earliest you can deliver a rig to them?

That would be in a five to six month time frame.

Okay. That's very helpful. Hans, any updates on your direction drilling tool that you were developing?

We mentioned in the last webcast that I think we're still just moving closer toward commercialization. There was a slight mention in the 10-K that really had to do more with a contractual milestone. But I think it's just steady ahead. And we're beginning to focus more on how we would bring that to the customer and what approach we would take there, Waqar.

Right now it's about $3.5 million on average, kind of quarterly R&D expenses. When do you expect them to go away and how should we be thinking for next year?

I think for the foreseeable future, $3.5 million to $4 million is probably still a good number. And we hope to have an update and maybe some more clarity in the next couple of quarters.

Okay. And just one last question from me. One of the large service companies had a major analyst day recently and one of the things that they mentioned was that the whole downhole assembly, they are looking for better interaction, better interface with the top drive and with the driller, and that Company doesn't have its own drilling rigs. But I was just curious if you guys are talking to any of the major service companies regarding that kind of interface between top drives with bottom assembly, and that kind of software?

That's been an area of interest for us for a long time and we have had conversations with service folks with this notion of closing the loop and doing just what you said, being able to communicate better with downhole tools and assemblies, and I think we've got the most attractive platform and with our automation, that most sophisticated approach on the surface to be able to make that a possibility. So, yes, it is an area of keen interest for us.

Okay. Thank you very much.

Thank you.

We will go next to the site of Tom Curran with Wells Fargo. Please go ahead. Your line is open.

Good morning, guys.

Good morning.

I was hoping for an update on both outstanding bids in and expected potential upcoming tenders in the Middle East and North Africa?

Tom, this is John. I can't really speak to any directly right now. I mean obviously, we've had the growth that we've seen in Bahrain and that's our first entry point. And that's been encouraging. We're now to three rigs. And I think there is still some slight improvement. I mean, obviously, there is the opportunities in Iraq and other Middle East opportunities that are out there. We do not have anything on the horizon right now in Iraq somewhere like that.

We do continue to work two Flex 3s in North Africa and that continues to be encouraging work. We're in Tunisia, which is a fairly small market, but I think it offers opportunities in Algeria. So I think there is still some opportunities. I can't think of any big tenders out there right now particularly.

How about maybe from a customer perspective from this point forward, if, and as you were to add incremental rigs in that region, does it seem more likely that you'd be adding them under contracts with NOCs IOCs, and if it's the latter, are there any of your customers that in terms of just conversations are alluding to needs at some point in the feature, even though it may not have reached a firm tendering or even quantified status yet?

Well I think one of the advantages that we've had as we've worked for the IOCs here in the US and we've had success there, obviously they have interest in taking the FlexRig technology and utilizing it in other areas around the world, and I do think that continues to offer some potential for us. As we've said now for several years, the international growth has been slower than what we've expected. The performance has been outstanding.

There is the NOC component that at times complicates it, but I think that we continue to see potential break-throughs on how to make that happen, because obviously we're talking about a FlexRig that is much higher investment than what you would have with local contractor content that is already in all of these countries and that's really the challenge. And but I think with the performance that we've seen, the IOCs and ultimately I think the NOCs will take ways to get to technology in the country.

And then last question sticking with the international arena here, could you share an update on the latest outlook for Argentina, in terms of how that market seems to be evolving heading in 2011?

Well we have five rigs working in Argentina now, four are FlexRigs. There is potential for another rig to go to work in Argentina. Probably the biggest challenge we've had down there are just labor-related, labor union challenges. I don't see any major growth in 2011. I mean that obviously could change. But I don't see that happening right now. I think it could get to be a situation where we put a couple of the large conventional rigs back to work. I don't have any -- really any forecast for additional FlexRigs in Argentina right now.

So it sounds as if the two most promising markets in Latin America likely remain to be Columbia and Ecuador heading into 2011?

Yes. That's what it looks like right now. And then also internationally, thinking about eastern Europe, we've brought that up in the past too and when you look at eastern Europe and see some of the IOCs, the Marathons, the Exxon, Chevron, ConocoPhillips, customers of ours that have used FlexRigs for a long time, I still think that's more than likely in 2012, I think there is some talk of some work in late 2011, but again these things tend to take longer so I'd be surprised if it happens in 2011.

Great. Thanks for all of the color. It's been very helpful. I'll turn it back.

We'll go next to the site of John Daniel with Simmons & Company. Please go ahead. Your line is open.

Hi, guys. John, can you give us a walk through the change in the day rates in fiscal 2011 again. I missed a part of that commentary. As the rigs roll off?

I think there is 64 that roll off in 2011 and in general we think that whether the rigs roll off into term or whether they roll off into spot market, we think there is a possibility of some slight improvement in the rates. Because a lot of the term contract we put together in 2009 and in 2010 and in some cases those rates are less than what the average is today. But there are also rigs that are rolling off that have rates that are higher than average.

Right.

So we think in general it will have some slight improvement.

Okay. And then when you look at the spot market today, you mentioned 58 rigs in the spot, which 54 are FlexRigs. What keeps you or the customer from signing long-term contracts, particularly on those FlexRigs?

Well, we already have a pretty nice book of business on term contracts. But as we already mentioned, we've got those 64 that are going to roll off. And I really think we will see some of those rigs roll off of term into spot, but I think we'll also see some roll into term. I think as far as the rigs that are in the spot market, it's going to be basin by basin specific, and there may be some basins that operators are willing to term up and we don't necessarily want to term up and vice versa. But there is not a whole lot of science behind it, but we're obviously looking at the trends and what the outlook looks like and we're making decisions on that.

Just one more for me. In the Permian Basin I think you had 19 rigs there a couple of months ago. I don't know what the count is today. But as you are doing more horizontal work over there and so forth, how does the price -- you can give us any color in terms of changes in dayrates going more towards the Permian, leaving legacy market like the Haynesville?

I do have some data. Since the peak of 2008, we've little more than doubled our rig count in Permian work. And these may not all be working now but I know we have committed at least 25 in the Permian and that's been a real improvement for us. We're really excited about that. The Permian has been one of the tougher areas for us to break into. Obviously, like you say, as the drilling gets more complex, more horizontals and laterals, it's going to favor FlexRig.

I think we'll continue to see rigs migrate in the Permian but I'm also encouraged by our smaller rig fleet, our Flex 4s. We're starting to see a lot of activity pick up in the Permian there and some of that work is straight vertical wells. But we're able to impact the cycle times pretty dramatically and so that's causing a lot of demand for our Flex 4s. So we're excited about that. So it's really a combination. I think we could see more rigs working in the Sprayberry and the Wolfberry and also seeing more rigs migrate to the Bone Spring and other areas going horizontal.

Is it reasonable to assume that as that points out the nature of the competition that could have a downward pressure on the pricing next year on a blended basis?

I really do not see that. Again, I think from -- I can't really speak to the competitors rig. I think there is a possibility there could be downward pricing on some of the older conventional rigs, because of the performance differential, but what we've been saying is an increase in the FlexRig pricing, that's been pretty encouraging and again we continue to move rigs into that basin. And there is also new-build opportunities in that basin as well which we continue to have ongoing discussions with customers on new-builds and that's one of the basins that we're having the discussions.

Okay. That's it for me. Thanks, guys.

(Operator Instructions). We'll go next to the site of Dave Wilson with Howard Weil. Please go ahead, your line is open.

Good morning gentlemen, and thank you for taking my questions. First off on the new builds and in given your approach to the new-builds and the reticence to build on spec, do you feel that you've missed out on any near-term opportunities in the spot market because you haven't had a new-build available or do you think you have enough rigs rolling off contracts that kind of meet those spot demands?

Well, Dave, this is Hans. If we were willing to put in the queue a bunch of new builds, we could work them all on the spot today. But I think that it gets back to what you mentioned, capital discipline and a balance of really wanting to work with the customer and getting the sponsorship prior to doing that. As you know, we have peers that are willing to be more speculative and have a higher risk profile and build without contractual coverage. But, like you said, we're reluctant to do that.

Okay. And then just on kind of switching gears a little bit on the refurbished SCR rigs, how long do you think those will continue to be competitive. Right now they are good, but at some point in the future do these get replaced by these new builds. In other words, do you think operators are content using these rigs going forward, or given the chance, they'll take a new-build, albeit at a higher price?

That's a good question, because if you think the bookends being the AC-drive rigs on the one end, and the other end being the mechanical rigs. John mentioned that there are 700 mechanical rigs running today. Something fewer than just 200 in shale plays. So those are clearly the most vulnerable to being replaced.

Then that buffer middle area of the SCR rigs, we know that we can take market share from those rigs just based on our performance and customer preference. Some of those have had, as you know, money put back into them, but they are still older rigs and there are limitations to what you can do with an SCR rig. So I think it's a situation where clearly the most vulnerable asset class is the mechanical rigs but we like our chances in competing head to head with SCR rigs and we see the customer gravitating to the higher performing AC rigs.

Thanks for that. And that's it for me, Jay. Thank you.

We'll go next to the site of Scott Gruber with Bernstein Research. Please go ahead. Your line is open.

Good morning, gentlemen.

Good morning.

I wanted to continue that same line of inquiry. Do you believe that substitution of the AC units for the mechanical and the SCR rigs would actually accelerate as the industry shifts them to more complex drilling on the oil side? Does that present the opportunity to accelerate the substitution?

I think it does, Scott. I mean, I think that what -- first of all, we're pleased that you have I think the highest level in over 13 years of oil-directed drilling so you have this new feature in a cycle where we're all not just totally dependent upon gas prices and gas-directed drilling. Other part of that is that oil-directed drilling is more complex, more challenging, the laterals -- first you have the laterals involved, and then second they're getting longer and so all of those features favor what we're doing. So I think the trend is exactly what you imply in your question, that it's going to favor the higher performing rigs.

Now the one time I could see is the growing backlog in the oil side of the business. Is that a real impediment or is the backlog just concentrated to be within the AC rigs within the oil plays?

Oh, if I follow your question, I think the backlog out there, we know of some of that. It's less in our customer class and the type of folks that -- and it's more in the medium to smaller operators. I hope that's responsive to what you're asking.

I was curious as to the backlog. We may have a grasp of within the -- particularly the SCR rigs, with these emerging plays, just due to their presence and due to the tightness of the market, whether that would actually present an impediment to displacement over the next 12 months? I was wondering if you have a sense of the backlog for the SCR units in the emerging plays?

Well, John you might have better than I do. The SCR rigs are kind of breaking through that 70% utilization threshold. The problem is, they are still priced on pretty skinny margins and so will they play a larger role in terms of head to head competition, and I think it gets back to what we've seen over the months and years, which is certainly their performance is preferred to a mechanical rig's performance, but it doesn't match what the AC-drive rigs can do.

So the customer -- and we've seen this not just in this most recent uptick but in a full cycle over a period of years, the customer is gravitating to the better performance and you cannot achieve that even with a refurbished, and spent some money on an SCR rig so it still favors us.

I think the best thing to say is that the best SCR and mechanical rigs are working today so. If we have 70%, 75% SCR utilization, the remaining rigs are going to need, I would suspect, a pretty substantial investment, adding top drives and probably larger pumps and additional engine horsepower. I would imagine there is a lot of investment needed to be made in those rigs or I would suspect they'd by working today.

Okay. That's it for me. I'll turn it back.

We'll go next to the site of Robin Shoemaker with Citi. Please go ahead. Your line is open.

Yes. Good morning. Thank you. I wanted to ask about -- it sounds, from what you're saying, that the spot and term rates are roughly at parity now. Is that true of FlexRig 2 and 4 as well as the FlexRig 3? And is there a significant term market for 2 and 4-type rigs?

Robin, this is John. The spot and the term market, as far as our average rates, there is a difference of about $2,000 a day. Now there is a range in both spot and term based on the type of work you're doing and the performance of the rig. And so, no, we do not see the same pricing for our Flex 1s and 2s as what we have on our Flex 3s. And the Flex 4s, again, depending on what basin they are in and what type of work they're doing, there is a pretty large variation in the dayrates that they're commanding today.

Okay. So on the FlexRig 3s and I think the 1s that you're bringing back from Mexico are of that type, is your preference to put those into the spot or the term market?

It's really going to be dependent upon what the market is at that particular time. I think as we said that we're not exactly certain on the timing on when they're going to come back in and back into the US. I would say at this stage, with the contract mix that we have right now, we really do not have a preference. I think I would just as soon see the rigs work in spot market and that would be fine with us.

Robin, this is Hans. Just when you think 70% of our active rates are under term, it puts us in a nice position of not having to really push to build an additional book of term contracts. And so it gets back to and it was true in an earlier question, it just gets back to the customers' view of the world and money and how much they're willing to -- we're certainly not willing to go on the lower range and term-up. We would go on the upper range and term up. So I think we're in a nice position of having that flexibility.

Yes. And so then on your 38 conventional rigs, are you just not really pursuing opportunities for many of those rigs at current rates? Kind of your choice as opposed to not being able to find work for these rigs?

Well that's a good question. I think to start with, we really do not have many customers that have interest in SCR rigs. Our particular customers, they just -- we just do not really get into that discussion. I think from H&P's perspective, we do not have a real clear insight into what the market rates would be, but I think if the rates are in the high teens, then it's going to be difficult for us to be interested in putting those rigs to work at that kind of pricing. And I think as we get on the pricing we would require, it probably becomes less feasible for our customers, the customer would have less desire. But I have to tell you, we just really haven't had any conversations with customers. There is not a demand out this for SCR rigs from our perspective.

And that plays into a kind of bifurcated market theme and the rates and the market potential for the rigs, you're asking about now, Robin, are a third of what we're getting on our Flex 3. So the margins are just so skinny, but then when you start looking at having to put some money into those rigs and then not being able to term up any kind of return on that incremental investment, that's what has given us pause today.

Right. So your utilization calculated on the total fleet is probably as high as it gets currently until you see some improvement in rates for those more conventional rigs?

That's correct.

Okay. Understood. Thank you.

Thank you.

We'll go next to the site of Arun Jayaram with Credit Suisse. Please go ahead, your line is open.

Good morning, gentlemen. John, I wanted to get your take on some of the emerging plays we're seeing at the Niobrara, and Avalon shale in Bone Springs. Obviously you guys are committing more CapEx next year and seeing healthy interest in new-builds, but you can talk about some of the emerging markets out there?

Well, Arun, we do have rigs working in both of those plays. The best I can tell last check, the Niobrara, I want to say there is around 20 rigs. There is not a lot of rigs in there running but we have close to a handful. And it seems to me, at least it appears, that our customers are in drilling and trying to figure out how best to exploit the reservoir and how many rigs to add in the future.

I really do not have any data points handy that would say how much growth there would be. It seems like, again the same way with the Bone Spring, that we do not hear a lot coming out of our customers, but when you look at the number of rigs working there compared to six, nine, 12 months ago, it's a pretty dramatic increase in activity. We've recently moved a few rigs -- I want to say we've moved one or two out of the Barnett. There may have been one out of the Haynesville, I'm trying to remember.

But there is clearly a demand for additional rigs out there. And I get the impression that they are still trying to understand the reservoir and how best to drill it and what kind of lateral length and those types of things. But I really do not have any data points as far as how large either one of those plays could be.

As you think about new-builds, what would be the top three markets as you think -- are the customers putting these new builds? Is the Bakken, Eagle Ford, Granite Wash? I'm trying to understand where the new builds are going to?

Our new builds I would say probably at least a third of them have gone -- or are going to the Eagle Ford. There are some in the Bone Spring and the Bakken and the Woodford. I don't know that we've had any new builds in the Granite Wash but there is some demand there. Those seem to be the most attractive areas with the most demand but I would say the Eagle Ford far outpaces any of the other basins as far as the demand pull.

Okay. Second question, Hans, for you and two of your major competitors in the US have made some significant investments in pressure pumping. As you know, pressure pumping has taken -- in terms of well cost, a bigger percentage of the overall cost of the well. What are your thoughts about pressure pumping? You guys have had obviously a very good engineering staff at H&P. Is this something you are looking at and what is your strategy regarding this?

Well we're watching it and as we talk about it internally, I think the bar we set is can we add value or is there an opportunity to differentiate yourself in that market? And our takeaway is that it's a difficult market to achieve that in and that some of the service guys, one comes that mind, has the best position. So what we want to do, Arun, is focus on what we do best and we still see some running room and continue to improve and continue to take advantage of opportunities that we see in front of us, we mentioned some already. So again, I could say more in terms of just why that doesn't have a lot of attraction to us, but we wish our peers well in pursuing it.

Sounds good. So you're not working on a flex pump or something like that?

No.

All right. Thanks a lot, Hans.

Thanks.

Thanks, Arun.

And it looks like our final question in queue comes from Mike Breard with Hodges Capital. Please go ahead. Your line is open.

Congratulations on a good quarter. Just out of curiosity, your first FlexRig 3 that you built could drill a well in 20 days. How long would it take your 100th FlexRig 3? In other word, how much gradual improvement have you made in the rigs?

It's hard to line it up in that kind of horse race. But it's a great question. And it makes a point that I think we've seen a huge efficiency capture in well cycle times between that first one and the one we celebrated here a few weeks ago. And a lot of those innovations are incremental.

But our approach to innovation is it doesn't have to be the home run ball, it can be your operating guys and field guys feeding back small incremental improvements that when you aggregate those, they make a real difference. And I guess I would say, we've captured that 30% and 40% lead and now it's hand-to-hand combat to go 2%, 3%, 4% type efficiency gains, all of which still are important. So that's really how I would describe to you that most recent Flex 3, is that it continues to be a better tool, it's something that the customer has embraced and I think if you and I were to look at them side by side, you'd draw the same conclusion.

Okay. And is there much differentiation at all between the dayrates on the older FlexRigs and the new ones? Other than market conditions?

No, not really. And part of that is because we have things that we know make it better, we retrofit the older rigs with those improvements.

Okay. Thank you.

Thanks.

And that completes our questions.

Thank you very much, Mark. Our next quarterly credit card is scheduled for January 27th, 2011 at 10 AM Central Time. Thank you for joining us and have a good day.

This concludes today's conference. We thank you for your participation and hope that you have a good day.