Helmerich and Payne Inc (HP) 2014 Q1 法說會逐字稿

Good day, everyone, and welcome to today's first fiscal quarter earnings conference call.

(Operator Instructions)

Please note this call is being recorded. It is now my pleasure to turn the conference over to the Vice President and CFO of Helmerich and Payne, Mr. Juan Pablo Tardio. Please, go ahead.

Thank you, Priscilla, and welcome, everyone. With us today are Hans Helmerich, Chairman and CEO; and John Lindsay, President and COO. As usual, and as defined by the US Private Securities Litigation Reform Act of 1995, 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. I will now turn the call over to Hans Helmerich.

Thanks, Juan Pablo, good morning, everyone. We're pleased with the results of another record quarter announced this morning. I'll leave it to John to describe the particulars, highlighted by our securing an impressive number of 35 fully contracted new build orders since the beginning of our current fiscal year last October 1.

In light of this being my last earnings call prior to my retirement as CEO in March, I hope you'll indulge me in a few personal comments. On each of these calls we receive a list of names that are signed on and will participate in our Q&A session. And, I'm really taken back by how many of you I've known for a good number of years and have developed friendships with.

I spoke at my first energy conference and started engaging with investors over 25 years ago. Those were simpler times. It was way before PowerPoint presentations and webcasts and more than once I was on the phone trying to secure us a slot in the program.

Today, we have 27 analysts that cover us and we can't attend all the conference invitations that we would like to. The process has changed a lot. The level of engagement, the amount of information and sophistication has all dialed way up. In many ways, it seems your jobs have gotten a lot tougher.

But, behind all the changes over the years, some of the fundamental drivers do remain the same. One of the basic building blocks for successful investing is establishing a working knowledge of management. And, understanding how they think, where they want to take the business, how they intend to spend the owner's capital, and the manner in which they will exercise their duty of care over the company's resources.

How will they shape the culture and establish the tone at the top? What level of talent will they surround themselves with? And, how deep is the organization's bench strength? I get it, that these things don't matter to everybody. But, to many of the names on this call they matter a lot. And, the answers don't just pop off the computer screen or always reveal themselves through the financial modeling.

The answers come out the old-fashioned way, having frank conversations with management, asking the tough questions, applying the right amount of skepticism at times, requiring proof, testing for trustworthiness, validating the execution, and then tracking the results. I've seen the rigor of the process up close and have a huge respect for the hard work that it requires.

At the end of the day, you're trying to answer the million dollar question. Do I want to recommend you to my clients? Do I want to own you? Can you deliver the real, long-term value going forward? All of this is to set up and say a couple of things.

Thanks for your engagement with us. It's helped make us a better Company. And, as I look back, it's certainly made me a better manager. Thanks for scrubbing through the numbers, for visiting our rigs, for touring our manufacturing facilities, for making that pilgrimage to Tulsa, talking to our customers, suppliers, and peers. Thanks for digging hard for the answers to your questions.

Will I miss all this, the one on ones, the non-deal road shows, the tours, the conferences? It's not a rhetorical question. I've been honored to be the Company's chief spokesman, knowing all the while the more compelling case for the Company was made when you guys went out and met our folks in the field, our rig managers, superintendents, interacted with our management team and any one of the thousands of H&P employees that make us the world's best at what we do.

It's never been lost on us that we work for you, the owners of the Company. That won't change. So, while you'll see me around in my ongoing role as Chairman, I'll miss the direct engagement, the relationships, the mutual respect, and the personal friendships that are forged over the years of working together. Sharing meals and getting to know one another.

Let me close with one of those quintessential questions we often hear from investors. It usually follows the question, what didn't I ask that I should have? And, it goes like this. What about the Company do you not think Wall Street and investors fully appreciate? The short answer has been the same for a long time.

It is the strength of our culture and the quality of our people, they're loyalty, hard work, and buy-in to our values help drive our quest for a sustainable advantage over our peers. And, our ability to drive measurable value to our customers. Our value proposition breaks down this way. One-third, great iron, two-thirds, organizational excellence.

We're a 94-year-old Company and I've had the rare opportunity of pledging my best efforts to my grandfather, the founder, when I started work with the Company. And then, I had the great pleasure to work with 30 years with my dad. During my 25th year as CEO it's satisfying to manage the succession effort that will build on our successful track record.

John Lindsay is the right leader for the Company's next chapter. I have full confidence in him and our management team and have never felt better about the future of the Company. Over the next 35 days, I'll have a chance to express my appreciation to coworkers, some of our customers, suppliers, and others. But, here's a sincere thanks to you for your support and confidence. Juan Pablo, I'm going to turn the call back to you.

Thank you, very much, Hans. The Company reported a quarterly record level of $264 million in operating income during the first quarter of FY14. We also reported record revenue levels at $889 million for the quarter.

Given the announced new FlexRig commitments from customers and our increased rig construction cadence to approximately three per month beginning in April, we now expect capital expenditures for FY14 to total approximately $950 million. Approximately 60% of this estimate corresponds to our new build program, 30% to maintenance CapEx, and the remainder to other projects.

We expect, at this point, to be able to fully fund our FY14 CapEx program as well as other scheduled commitments from existing cash and from cash to be provided by operating activities during the fiscal year. We're pleased to have seen a significant increase in the number of term contract commitments from customers.

The average number of rigs that we already have under term contracts for the remaining three quarters of FY14 is now 160. And, the average number for all of FY15 is now 106 rigs. About 90% of these rigs correspond to our US Land segment and provide the Company with the benefit of an average pricing level that is still about 5% to 10% higher than current spot market pricing.

Moreover, as some of our rigs that are under term contracts roll off of these term contracts and, as announced, new builds are deployed under new term contracts, the new builds, we expect the average pricing of remaining rigs on term to slightly increase during FY14. Our effective income tax rate for continuing operations during the fiscal quarter was reported at approximately 34.1%. That's for the first fiscal quarter.

And, accordingly, we now expect the effective income tax rate for the rest of the fiscal year to be between 34% and 35%. As relates to our investment portfolio, the holdings remain unchanged compared to the prior quarter. With that, I'll now turn the call over to John. And, after John's comments we will open the call for questions.

Thank you, Juan Pablo, and good morning to everyone on the call. We have long believed the legacy rig replacement cycle in the US would last for many years and we see today it continues to gain strength. Since the peak of activity in 2008 when AC drive rigs had a 15% market share AC drive technology has continued to capture market share through the cycles.

Today, with AC drive rigs commanding 41% market share in the US, which is approximately 700 active rigs, the outlook for AC drive rig growth remains positive. Not only are old conventional SCR mechanical rigs challenged to keep up in the world of unconventional resource plays because of horizontal well complexity, in addition to complexity, well depth and the lateral length continue to increase and customer expectations for drilling performance and safety are elevated to new levels.

Those are among the many reasons we believe H&P, with its industry leader FlexRig, is well positioned to continue to take market share in the US as well as in international markets in the future. As customers increasingly differentiate between efficiencies among service providers, H&P continues to demonstrate the tangible value delivered by our people, technology, and systems.

Now, I will discuss our results for each of our operating segments beginning with the US Land segment where operating income increased by $15.1 million sequentially to $251 million. Revenue days increased over 4%, representing approximately 255 average active rigs in the first fiscal quarter as compared to 245 rigs active in the prior quarter.

An average of approximately 157 rigs operated under term contracts while an average of approximately 98 rigs were active in the spot market. Excluding early termination revenue, average rig revenue per day was in line with our expectations and decreased by $275 in the fourth fiscal quarter to $28,046 per day in the first fiscal quarter.

Average rig expense per day decreased by $704 sequentially to $12,934 per day. Also, excluding early termination revenue, average rig margin per day increased by $429 to $15,112 per day for the first quarter. As the US Land market improves, we are encouraged by increasing customer demand for new FlexRigs.

We have announced 35 new AC drive FlexRigs since the beginning of our 2014 fiscal year and 22 since our last earnings call in November. The 35 new rigs were contracted with 9 exploration and production companies, 7 of the new rigs were delivered in the first fiscal quarter of 2014, 6 have been delivered in January. And, we expect the remaining 22 rigs to be delivered in FY14.

A few additional details on the 35 new builds -- 23 are FlexRig 3s, 11 Flex 5s, and 1 Flex 4. 70% of the new FlexRigs have skid systems for pad drilling. The rigs are scheduled to work in the following basins -- 16 in the Permian, 8 in Oklahoma, 4 in the Eagle Ford, 2 each in the Bakken and Utica, 1 each in the Haynesville, Niobrara, and Woodbine.

We plan to continue our FlexRig new build cadence of two rigs per month through the end of March and then increase the cadence to three rigs per month beginning in April through the end of the fiscal year. We benefit greatly by having the ability to adjust our cadence of new builds in response to market demand and by using accumulated capital spares to quickly respond to market demand, all at a reasonable cost.

Today, our US Land fleet attained another all-time high level of 269 contracted rigs, including 155 under term contracts and 114 operating in the spot market. All active rigs are AC drive FlexRigs. Our US Land fleet utilization is 85% with 46 idle rigs. However, our AC FlexRig utilization has improved to 95% with only 13 idle AC drive rigs today.

We remain the most active contractor in the two highest activity basins in the US with 82 rigs in the Eagle Ford, which is approximately 35% of the market share, and 63 rigs in the Permian which is approximately 15% market share. We expect our second quarter operational outlook for our US Land segment to continue to improve, assuming oil prices remain strong.

Revenue days should increase by approximately 2% as compared to the first fiscal quarter. Excluding early termination revenues in the prior quarter, we expect the average rig revenue per day to be relatively flat during the second fiscal quarter. In addition, we do not expect any early termination revenues during the second fiscal quarter.

Our US Land operation has done an excellent job managing expenses and I fully expect them to continue. However, I believe it is important to put in perspective the seasonality of the second fiscal quarter expense volatility we have experienced in the past.

In addition to the seasonality we also expect a higher than normal number of new build FlexRig activations and relocating several existing rigs from basin to basin in order to meet customer demand. With this in mind, we expect average rig expense per day to increase to slightly over $13,000 per day plus potentially a few percentage points for quarterly expense volatility.

With regards to term contracts, we have already signed commitments for an average of 150 rigs during the second fiscal quarter of 2014, an average of 145 for the remaining three quarters of 2014, and an average of 96 rigs for FY15. We are pleased with the outlook of the US Land market as day rates continue to strengthen for both term contracts as well as the spot market.

Now, moving into the discussion of our offshore segment results where operating income increased by approximately $8.2 million to $18.5 million as compared to the prior quarter as a result of better average margins per active H&P rigs and greater operating income from management contracts.

Revenue days from our rigs remained unchanged sequentially at 736 days as utilization remained constant at 89% for the segment. Excluding the $6.4 million charge that negatively impacted our fourth fiscal quarter, average rig margin per day increased by $772 sequentially to $27,449 per day.

Our offshore outlook remains solid. As of today, we have eight of our rigs active and one rig stacked. We expect eight rigs to remain active through the second fiscal quarter of 2014. As compared to the prior quarter, we expect offshore revenue days to decline by 2% with margins declining to approximately $26,000 per day.

In addition, we expect operating income from management contracts to reduce from approximately $4 million to $2 million as compared to the first quarter. As we look at future quarters, however, we do expect our offshore management contract operating income levels to be in a range closer to $6 million by the fourth quarter of FY14 as a result of new contracts.

I'll now comment on our International Land segment where operating income decreased by approximately $1.1 million to $12.8 million. Revenue days in our international segment decreased 7% to 2,156 days as overall segment utilization decreased from 87% to 82% sequentially. Average rig margin per day decreased by $292 to $10,342 per day.

As of today, the International Land segment has 21 rigs working, 12 of which are AC drive FlexRigs. Of these active rigs, eight are in Argentina, five in Ecuador, four in Colombia and two each are in Bahrain and UAB. A total of eight rigs are idle in the following countries. We have three in Colombia, two in Tunisia, and one each in Argentina, Bahrain, and Ecuador.

As a result, we expect International Land revenue days to decline by approximately 5% to 10%. We expect international margins to be relatively flat in the second fiscal quarter of 2014 as compared to the previous quarter. As we have mentioned previously, we believe the primary driving force behind International Land expansion will be an increased global adoption of horizontal drilling in unconventional resource plays.

Looking forward, we remain optimistic on long-term international growth opportunities. In closing, and in the midst of an improving rig market and an increasingly competitive landscape for contractors, we are well-positioned with the industry's most capable fleet of AC drive land rigs.

Our manufacturing capability allows us to grow our fleet at a faster rate than our competitors. And, because of our customers continuously demonstrating their preference for our service offering, safety, performance, and value proposition, we are able to deliver better returns for our shareholders.

This completes my operating segment remarks. And, prior to turning the call back to Juan Pablo, I would like to recognize Hans for 25 exceptional years of service as CEO. On behalf of the 10,000-plus employees at H&P today, the thousands of H&P retirees and our Board of Directors, Hans, we want to thank you for your leadership and for the example you have set for us all.

The great news for us, this isn't a goodbye. We are pleased and very blessed that you will remain as our Chairman. So, this isn't a goodbye, just an opportunity to write another chapter. And, now, I'll turn the call back to Juan Pablo.

Thanks, John.

Thank you, very much, John. And, Priscilla, we'll now open the call for questions, please.

(Operator Instructions)

Jeff Spittel, Clarkson Capital Markets.

Thanks, good morning, guys. If I could start by saying congratulations to Hans. You've been a classy man and a brilliant leader over the years. I wish you all the best in your retirement.

Thank you, appreciate that.

And, turning to the business at hand, I'm sure you guys have noticed the move in gas prices. Are you starting to see an emergence of some demand from some heretofore sleepy basins. I did hear that there was one rig earmarked for the Haynesville. Maybe just a little more color around that.

I think it may be a little early for demand really to be responding in terms of incremental drilling to gas prices. You are seeing some hedging activity and some guys taking advantage of that and that ends up being positive because it drives activity even if you'd have gas prices back off after the winter. Having said that, we're encouraged that gas prices have responded to cold weather and we'd love to see the type of price levels be sustainable.

Great news. I guess on the crewing front, as you start to -- as you continue the growth in the fleet, could you speak a little bit to the dynamics there in terms of labor costs, escalation prices, and scarcity of putting good people on the rigs?

Well, John can add to this. We haven't seen a lot of labor cost pressure. I think our guys have done a great job over the years, and I go back to we've had two different phases where we were in a four rig per month cadence.

So, we had the challenges of crewing up and training and bringing those guys up to a performance level where they hit the ground, satisfying the customer. So, we have not only a great track record but a system that allows us to do that. As we transition to three rigs per month I think that will go smoothly and our expectation is not really to have a bump in the road in that regard.

Thank you for the time, gentlemen, I'll turn it back.

Thanks.

Brad Handler, Jefferies.

Thanks, good morning, everybody. And, please let me echo my congratulations and best wishes, Hans, for your retirement.

Appreciate it, Brad.

If I could turn to -- I guess if I could turn to your new build orders, maybe some insights that you're deriving about the market from the 35. Do you have a sense as to what extent your -- the orders are for incremental rigs versus replacing, say, an SCR or even a mechanical rig that's trying to do an operator's work today?

It's hard to draw a bright line between those two. I think that it is a function of what you've heard us talk about where as customers move into this development phase of their effort, they become more discriminating and maybe another way to say it less tolerant of underperforming, older rigs. And, so now they have -- they are not doing delineation wells and they're not doing drilling that holds leases. They really have a far sided plan and the effort around a factory type approach.

And, that just is a great match with having better equipment, having better organizational competency driving that effort and partnering with them to get the best efficiencies available. So that's our sense, it's hard for us to know. I think some will be incremental. But, clearly, you think today there are 700-plus SCR mechanical rigs still out there fighting for whatever is in their remaining life. And, they're under the pressure that we help to bring with our AC rig offering.

Right, right. Makes sense, okay. Maybe a complementary question in terms of your own impact on the market. What proportion of the 35 were competitively tendered? Do you know?

Brad, this is John. I don't think -- I would say very few. Historically, at least in the US Land space, we're not doing a lot of major bids. Particularly when you're looking at our long-term customer base, they recognize the value. They like the consistency of the offering. And, they have enough exposure to the market. They know what the market should bear. And so, most of the new rigs have been negotiated contracts.

Understood. That's helpful. And, maybe just as a related, and then I'll pass it on. The nine customers you reference include some new ones, right? How many are new?

There's a couple out of the nine. I believe that's right. A couple that are new.

Got you. Okay. Thank you, very much.

Thanks.

I'd add just one thought which is this -- the size and scale of the new orders and it reflects a choice that customers are making, knowing the other race cars on the track. And, they understand the offering that our peers are bringing to the table. I think it's a compliment to our guys, that we're seeing the proportionality of new build contracts that we're seeing. Thanks.

Byron Pope, Tudor Pickering.

Good morning, guys. Juan Pablo, I appreciate the color during your prepared remarks regarding average dayrates and just wanted to get a sense for the commentary about improving spot market dayrates. You're down to a handful of vital AC rigs. Could you give us a feel for the order of magnitude that you're starting to see upward pricing momentum for your AC rigs working in the spot market?

Thank you, Byron, this is Juan Pablo. I think what we have seen so far, and what we expect for the second fiscal quarter as we provide the outlook guidance operationally, is a slight increase only. Let me make sure that I turn it to John and see if he might have additional comments. Going forward, of course, the market is going to determine what incremental pricing we can attain. We're optimistic in that regard, but I'll yield to John.

Yes, Byron, one thing that we've experienced over the years, of course -- and you've seen it in your career, rigs always drop a whole lot faster than you're able to push pricing later. Fortunately for us, we didn't have a dramatic correction off of the current peak spot market pricing. So, our correction delta isn't quite as much as what a lot of our peers. But, we're continuing to see some strength. We're continuing to see rigs move out of gas basins and move into some oil basins. And, moving rigs around and we're still seeing some churn. Even though our idle AC fleet capacity is only 13, there's still some churn. We'll still have -- some of the those 13 will go to work and then some of those will get released. That churn tends to have a little bit of a downward pressure.

And, I think the other thing is competitor pricing. There's still, at least in some areas, what we would consider somewhat irrational high pricing behavior on SCR and even some AC rigs. I think that all has an influence on -- yes, spot market pricing is improving. It's not improving dramatically but it's improving.

Okay. And then, just a second question in thinking about the cost side of the equation. On the far side of the seasonal impacts in the March quarter and thinking about the startup costs associated with the new build FlexRigs and maybe mobilizing some rigs between basins. My suspicion is that there's -- shouldn't expect any structural migration upward in that fleet average daily cost. I realize it's not easy just maintaining it flat. But, again, I wouldn't think that there would be any structural trend where those costs would necessarily -- fleet average costs would migrate higher over time.

That -- I would agree with you, Byron. As you're moving rigs from basin to basin, you've got some personnel expenses associated with that. When you have new rigs coming out you've got personnel expenses associated with that. And so, those are somewhat one time. And so, I would agree with you, it's not structural.

And then, of course, just the second fiscal quarter volatility we've experienced. Again, I give our guys all the credit in the world. They've done an excellent job on that. And, last year, the costs were much improved over the year before. So, I just wanted to prepare everyone and make certain you realize that there's that possibility for, at least in that quarter, to have some potential cost increase.

Fair enough. Hans, all the best to you in retirement.

Appreciate it. Thanks, Byron.

Jim Wicklund, Credit Suisse.

Hans do you know how to spell retirement?

We were waiting, I thought it took so long because you're in Hawaii, Jim.

I'm laying on the beach, I know I know how to retire. I just can't afford to. I didn't know whether you knew how.

Well, that's fair. I'm going to give it a good shot.

Congratulations, and if you need any hunting partners in your retirement, you let me know.

Guys, you had said a couple of quarters ago that you've got 57 customers who were just fine with the fact that your rigs skid instead of walk. And, we continue to hear more and more about pad drilling and 40 wells off one pad as an extreme, and stuff. Are you studying or contemplating or doing some work on whether or not H&P needs to come up with a walking system?

Well, John and I will both take a shot at that, Jim. I think -- and, you've heard us, and we've talked about it, where all of the rigs we built were sitting around with the best and brightest of the customer and what they're wanting to accomplish. And, there's no secret of what designs are available out there. And so, what result you've seen with our skidding system is what the customer has asked for.

Our capacity to put out a walking system is certainly within our reach. And, again, it's going to be customer driven and directed. I think that what may be missed sometimes in the conversation is the customer is really looking at the overall performance and what the well cycles are and what the efficiency drivers are. And, that's where we're focused as well. But sure, the skidding type and skidding system is important and we will be responsive to the customer on it. I think you saw, just with this last group of 35, all of those will have our traditional skid rail system.

Okay, okay. I was just looking at it for an update. And, if you have 35 good customers, and you've got the good customers, if they're okay with it who are we to complain?

I think it's an element of validation in that regard.

I would agree. In talking to some of the private rig companies out there, the outlook is that for the top tier rigs, you could see a couple thousand dollar dayrate improvement through this year industry wide. And, it strikes me -- Baker Hughes comes out and says the rig count is going to be flat. NOV's got their system that upgrades SCR rigs pretty well. And, we're still adding top tier rigs. Do you guys subscribe to the view that the industry overall could see a couple thousand dollar increase in dayrates through 2014?

I'm going to let John answer that. It's going to be great for the next 30 days but it's going to be hard. I'll let John answer it going forward.

Well, Jim -- thank you, Hans, I appreciate that. Jim, I think to forecast $1,000 to $2,000 dollar a day, I think, is a little premature at this stage of the game. And, particularly, when you say the guys predicting it are the smaller contractors that probably don't have the types of rigs that we're talking about that are really in demand. I don't know. It would be hard to see that right now. You know how the markets work. You've been in this business a very long time and it can change.

The question earlier about natural gas. Do we see an improvement in natural gas drilling as a result of higher prices? That would be one of the things that could increase rig demand. We're seeing nice rig demand for FlexRigs. I think, overall, we would expect to see some rig count increase at current oil prices. I think we'll continue to see the rig count trend up slightly. Again, it's very hard to predict. Is it 50 rigs or 100 rigs is difficult to predict.

Okay. Gentlemen, thank you much. Hans, see you soon.

Thanks, Jim.

Kurt Hallead, RBC Capital Markets.

Hi, good morning, everybody.

Hi, Kurt.

All the smart questions have already been asked on the US Land side. And, I'll, again, throw in a congratulations on the retirement for Hans. Well done, Hans.

Thanks, Kurt.

You're welcome. Let me ask on the international front, we talk about -- service companies talk about the potential for increased unconventional activities throughout the international marketplace. You guys indicated it in your conference call as well. Can we talk maybe timing? And, potential magnitude of that increase and activity? Is that a 2014 event or 2015 event or is it a five-year event?

Well, we've handicapped it over the preceding quarters. And, I think if you look back, we're really just at that inflection point now where the prospects for international drilling have significantly improved. If you go back over the recent years, it's been a tough slug-out there. Kurt, I'm inclined to think it could potentially be impactful, even towards the end of this year.

But, I think it's just hard to imagine that there won't be traction. We just have a great customer roster that we know has keen interest in executing in a way that is similar to what they've accomplished with their supplier complement here in the US. So, I think we'll have an opportunity to participate there. And, it could be sooner than you think but certainly it will be in the time frame that you outline there.

Okay. My follow-up question would be you've talked about returning cash to shareholders through your prepared commentary and so on. Press release indicates an increase in CapEx related to the new build type of programs. You have one of the highest dividend yields -- or highest dividend yield of a land driller and one of the highest related to other larger cap diversified service companies. What's the thought process as you get through this year in terms of that dividend? More modest increases than we've seen in the past?

Well, I think, yes. We've had some nice step change increases, and the last one being as recent as December where we raised it to 2.5% per year. But, I would say the modeling Juan Pablo does and what our projections are, are very much in line with what we're seeing now. And, it reflects this comment you've heard us make about an all of the above strategy where we believe we've got the capability to grow the Company, to add to the fleet, to look hard at international opportunities. And then, at the same time, return meaningful cash to shareholders. And, that will be through, I believe, additional opportunities to grow the dividend and it could also come in an opportunistic way on share buybacks.

So, we're in a great spot to be able to do a lot of these things. As you know, Kurt, our balance sheet would easily lend itself to some leverage with the right opportunity. All of those things are in front of us. And, it gives us a great position to look very hard at the opportunity set ahead.

Okay, very good. And, I just want to make sure I was understanding some of the commentary that came out from John and Juan Pablo. So, to be clear, you are -- the Company, starting to see price increases for the rigs that are rolling off contract as well as when you bring the new rigs in, the price points on the new rigs are above the, say, the last three month, six month period? Is there a way that you could provide a little bit more color around that?

This is Juan Pablo. In looking at how our term contracts affect the average pricing or average rig revenue per day, as we have these roll off during the next several quarters, what we, in general, see is rigs that were contracted, in average, in a better pricing environment. So, it is not surprising to see in many cases where we have a term contract that rolls off and is contracted in a spot rate at a slightly lower dayrate reflecting the current spot market. In average, however -- in addition to that what we see, at the end of the day, as these rigs that are on term contract roll off, as I mentioned in my prepared comments. We do see that the remainder of the term contracts, those that are already in place, yield an average that is slightly higher than what the current average is during the next couple of quarters.

As we look at the spot market itself, as mentioned by John, we have seen rigs -- and the better example is for a particular rig that is in the spot market, that's working under the same conditions, same region, et cetera, we have seen slight improvements in average. And so, as we enter into new build contracts, we are taking advantage of those slight increases. Overall, it really doesn't impact the total average in general, as we mentioned. We expect quarter-to-quarter to have a slight transition in terms of average rig revenue per day.

Okay, that's great. Thank you, so much.

Thank you.

John Daniel, Simmons and Company.

Hi, thanks, good quarter. John, real quick, can you review, again, the longer term outlook in Offshore specifically? You made a comment on operating income and I didn't catch it.

Yes, John, we are -- we've had additional operating income as a result of our management contracts. We've taken over a management contract for one of our customers that will begin to deliver more operating income as the year transitions. And then, we have an international platform rig that's also a management contract. We'll continue to see higher operating income there, again as the year transitions. So, that's the reason for the increases. Juan Pablo, anything else to add?

No, sir.

Does that help?

Yes, it makes -- I thought you said it was going down and I just wanted to make sure that wasn't the case.

It's always possible. I didn't --.

No, no. I was taking copious notes but not good enough. You mentioned that of the new builds, I think 70% will have the skidding system and 30% won't?

Yes. (Multiple speakers) Go ahead.

I was just going to ask why would someone not want that system and where would those type of rigs go?

Well, it's a great question. It's really not basin specific. It's more related to timing of development of the resource, if you want to think about it that way. Effectively, what we had, of the 23 Flex 3s, I believe 13 of those had skid systems and 10 didn't. And, the 10 that didn't are drilling, at least at this phase at this time, the customer is drilling typically well to well. They're drilling one well on a pad and moving. So, they're delineating, holding production. There's a lot of different reasons why.

One of the real advantage, of course, of the Flex 3 is that at a later time when the customer says, you know what, we want to go into development mode, we want to drill two or three or four wells on a pad, then they can add the skid system at a later date. So, that's the reason for it. And, of course, the Flex 5s are purpose built, pad drilling applications.

Okay, all right, thank you. And then, just one final one for me. Someone had asked earlier about, I guess, your views on the idea of new builds continuing to displace legacy rigs. And, I just -- I want to follow up on that theme specific to HP. As you look at the 35 rigs you're building right now are any of those replacing rigs that you currently have operating for the customers that have signed contracts for those 35 rigs?

No, that would not have been the intent. With one exception and that would be if a customer would use a FlexRig as a bridge rig as an example. They've got to start in -- they had to start in November. And, we had an available Flex 3 so the Flex 3 went in and drilled until the new build can be delivered. But, it's not a replacement for technology reasons. It's a replacement in terms of convenience for the customer. And, having a rig sooner than what the new build could deliver.

Fair enough. And then, the last one for me just in terms of as we try to model trajectory here. Are you aware of any customers, at this point, whether it be a new build or existing rig or whatever, where they intend to drop a rig in the next three, six, nine months? Or do you feel like all of these rigs are ultimately incremental to your working count?

Well, to follow up on the example I just gave you, the customer picks up a Flex 3 and then they have a new build that's going to replace it. A couple of things that can happen. One is they replace it and then that rig goes to work for someone else, that rig that had been working as a bridge rig. The other example is a lot of times the customer decides, you know what, I need to keep that rig. So, they bring the new build in and keep the rig that was being used as a bridge rig.

But, we're going to continue, John, to see some churn where customers are making decisions for whatever reason. Which is why you're seeing some rigs move from one basin to the next. Obviously, our rig count in the Permian has grown dramatically. I think we're going to continue to see Permian -- the rig count for us grow in the Permian. So, there's not any examples of those besides that.

Fair enough. Thanks, guys. Good luck, Hans.

Thanks, John.

Tom Curran, FBR Capital Markets.

Good morning, guys. Hans, I've read that of US companies who rely on family members for leadership succession, less than 30% remain viable by the third generation. Those that make it, though, then go on to perform well over time compared to their peers. So, congratulations on beating the odds and best of luck in this next chapter.

Thanks for that comment, Tom.

John, wanted to return to the 35 FlexRig new build awards since the end of the 2013 fiscal year. Sorry, if you've already touched on this. But, could you tell us how they break down by model? And then, the total number of customers you've won those 35 from?

Yes, Tom, 23 are Flex 3s, 11 Flex 5s, and 1 Flex 4. And, those 35 have -- are contracted to nine different customers.

Great. And, I did hear correctly earlier that all 35 do have the skidding rail system?

No, 70%. So, I believe 13 of the 23 Flex 3s were ordered with the skid system. There were 10 that didn't. And, the Flex 4 does not have a skid system.

Okay, so the Flex 4 -- okay, great. And then, when it comes to the indications you've gotten from customers about if and where they might look to first respond, activity-wise, to the continued uptrend in natural gas prices, where most likely would you expect to first deploy rigs as a result? And, would you expect to have to upgrade any of the conventional idle FlexRig 3s to pursue those opportunities or would you expect to be able deploy them as is?

The Flex 3s are all very suitable for drilling in any of the unconventional plays whether they're natural gas or whether they're oil. So, there wouldn't be any needed upgrade at all. I think the Haynesville would be a logical choice. The Eagle Ford, obviously there's a lot of different reservoir in the Eagle Ford and some are higher in gas concentrate. And, I think you could probably see that, that customers would potentially move some rigs over into the Eagle Ford. It would be fairly easy to do that.

But, again, I don't have a sense -- I haven't heard anything directly from customers at this stage saying, hey, oil -- or natural gas is above $5 and we're going to ramp up our drilling programs. Most of what we're hearing about is directed towards oil, oil basins.

But, if we were to start to see that and they requested a skidding system on one of the idle FlexRig 3s would you be able to upgrade it?

Yes, we've continued -- in the last three years, I don't have the numbers right here in front of me, but we've added significant number of Flex 3 skid systems to Flex 3s in the fleet. Both that were idle and then putting to work and then those that customers were using and their program changed to the development mode and they wanted to begin, like I said, drill three or four or five wells on a pad.

Okay, thank you for that. And, last one for me, John, when you look beyond the big four land drillers, how many total tier one rigs would you estimate are out there now? And, across how many different contractors? And, when I say big four, yourselves, Patterson, Nabors, and Precision.

Right. I think first of all, for us, at least from our perspective, tier one is an AC drive rig. I just -- for me, definitionally, to put an SCR rig in the tier one category, to me it doesn't make sense, from a technology perspective and downhole what we're able to deliver and the drilling advantages. We know there's approximately -- in the tier one category there's approximately 700 AC rigs that are active today and another 70 or so, so 10%, that are idle. And, we think it may be as many as 50% of those 70 aren't necessarily well suited for the types of wells that are being drilled in unconventional plays.

So, outside of the top four, it looks like approximately 200 AC rigs are out there owned by smaller companies that are both public and private, best we can tell. So, 200 out of the 700, we have 275 of those today.

Okay. Thanks for all the detailed answers. I appreciate it, John.

Okay, thank you.

Scott Gruber, Bernstein.

Yes, good morning. And, Hans, let me reiterate the congratulations and best of luck in retirement.

Thanks, Scott.

Juan Pablo, I think it was you mentioned the average rate for rigs under term contracts should continue to tick higher as contracts roll. Does that reflect a positive mix shift in terms of more rigs with skidding systems remaining under contract and they generate higher rates?

That is one of the moving variables, Scott. Yes, that you have pricing considerations, you have a mix consideration in terms of the type of rigs that are out there, including whether or not they have skidding systems. You have different regions that command different pricing levels because of their cost structure, et cetera. But, yes that is one of the reasons.

So, overall, you could summarize that by saying positive mix shift on the remaining contracts for a variety of reasons?

Yes.

And then, the early termination fees realized during the quarter, does that reflect contracts that were scrapped during the quarter?

Well, what it reflected is some rigs that were in excess of what the customers' needs were going forward. And, some of that is related to natural gas, moving rigs around. But, the rigs, obviously, still exist and we contract the rigs at a later date.

So, it was very customer specific. It was an interesting phenomenon given that the spot market is tightening up.

Right, but we've seen this now, what, three or four quarters in a row. We've seen customers that are either coming up on the end of their contract or, again, they've got more rigs in their fleet than what they need going forward. So, they're really just balancing their portfolio.

Okay. That's it for me. Thanks.

Thanks, Scott.

Waqar Syed, Goldman Sachs.

Thank you, very much. And, let me join everybody else as well in saying congratulations, Hans, on your retirement. And, thank you for your friendship and support all these last 10 years. And, look forward, again, to maybe seeing you as you still make the rounds.

I do as well. Thanks, Waqar, I've enjoyed it.

Thank you, very much. And, now, just following up on that. 10 years ago you guys -- you were the visionary, you targeted the market, you got a new type of rig. And, that vision has proven right and has been instrumental in the shale revolution. Now, as you look forward for the next several years, maybe next five years or so, do you see any other next step in this integration? Do you see any other hardware that could be put on the rig that could make a difference? Be that, maybe, integration of the [road] receivables or is it providing casing services through a driller or what do you think the next steps could be in this innovation on the drilling rig?

Well, the better person to answer is John, of course. But, I think the way you posed it, Waqar, I'm not sure there's a hardware bolt on, although we continue to look for ways to improve the FlexRig. And, as you know, today's Flex 3, which still represents the largest share of our new order book, has improved and incrementally been made better over time. So, that can continue to happen and we'll be anxious to try to find ways to do that. I think, on the software knowledge capture part of the equation is where a lot of opportunity still lies ahead. And, to drive a consistency across the performance range is still something the customer is very interested in.

If you look at a typical field, we have the uniformity of our offering and you have the opportunity to put the right people in place. But, even so, you have this scattergram of results and how do you tighten that up? How do you reduce the delta of why one rig is still performing better than its twin rig? And, that's just done through better performance and knowledge capture. It's working with the customer and collaborating on where are we introducing human judgment where we can really fine tune that?

And, it sounds maybe simpler than it is. And, you've seen our setup and have followed us closely and know what our capabilities are. And, I think we're in the best position to delivery those incremental improvements in efficiency. And, I think that's being reflected even today in our new build awards.

Great, thank you. And, just the last question on the gas markets. In your view, what is the lead time from when an E&P company wants to pick up rig and when they call you to inquire about a drilling rig for gas drilling? Meaning, that if they want to pick up in the third quarter of this year or fourth quarter or first quarter next year, when would they give you a call to say we'll be needing a rig?

That's a good question. We have lots of just overall inquiries along that line now. They don't necessarily say we're sitting on the fence waiting to drill a gas directed target. But, they are asking about when is our next available slot open? They know that we have fewer and fewer available AC rigs on the sidelines. So, we're getting those calls now. But, your question is a great one in terms of what's the tipping point psychologically when the industry begins to say -- hey, these gas prices provide us an opportunity to go back in the field and drill gas wells. And that, of course, makes a large impact on the prospects of our business.

Right. So, in terms of the volume of incoming calls for gas directed drilling, has that picked up in the last month or so -- or, no, not yet?

Not yet. And, they're not saying to us we have this group of gas wells. Now, having said that, we've got a big customer that has 8,000 known locations that when gas prices improve, they're going to go execute on drilling those. So, it's out there. The potential and opportunity set is out there. And, I -- you probably understand the dynamics better than I do about what are the pricing dynamics that really trigger that renewed effort.

Okay, great. Well, thank you, very much, for all the color. Appreciate that.

Thanks, Waqar.

Thank you. And, we have no further questions at this time.

Thank you very much, Priscilla, and thank you everyone for joining us. Have a good day.

Thank you.

This does conclude today's program. You may disconnect at any time.