Good day, ladies and gentlemen, and welcome to the Halliburton Operational Update Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touch-tone phone. As a reminder, this conference is being recorded. I'd like to introduce your host for today's conference, Mr. Lance Loeffler, Vice President of Investor Relations. Sir, please begin.
Good morning, welcome to the Halliburton First Quarter Operational and Business Update Conference Call. Today's call is being webcast, a replay will be made available on Halliburton's website for seven days. Joining me today are Dave Lesar, CEO, Jeff Miller, President, and Robb Boyle, Interim CFO. As a reminder, some of our comments today, including those relating to expected revenue, earnings, margins, market share, and costs, constitute forward-looking statements reflecting Halliburton's views about future events. These matters involve risks and uncertainties that could cause our actual results to materially differ from our forward-looking statements. These risks are discussed in Halliburton's Form 10-K for the year ended December 31st, 2016, recent current reports on Form 8-K, and other Securities and Exchange Commission filings. We undertake no obligation to revise or update publicly any forward-looking statements for any reason. I'll turn the call over to Dave.
Thank you, Lance, good morning to everyone. The landscape of North America market has changed dramatically in the last nine months. Our customer base has essentially separated itself into three main groups: those looking to grow production by outspending cash flow, those looking to improve returns by living inside their cash flow, and finally, those companies that are proving up reserves and preparing themselves for sale. This diverse and exciting market has created a surge of activity and supports my thesis that the animal spirits are back in U.S. land. Today, they are continuing to run hard. I'm going to talk today about how this has impacted our view and approach to the market as the quarter progressed. With the historically severe downturn in our rearview mirror, we find ourselves speeding along with the rapid land rig count growth.
As of today, U.S. land has added over 267 rigs since the start of the fourth quarter, which is nearly two rigs per day. In the first quarter alone, we have seen 25% sequential growth in U.S. land rig count. As you know, the severity of the downturn made it hard to cut costs fast enough to preserve our margins. In today's rapid recovery, it is hard to efficiently add resources and equipment to handle the increasing demand, especially if you are trying to maintain your market share, which we believe we are doing. The bottom line is, I love the market outlook for U.S. unconventionals, particularly as it has become the global swing producer, that is a position that operators will likely not want to give up. Of course, we don't want to give up our market share there either.
This explosive growth is providing us with a unique set of opportunities today. The tactical responses we made this quarter are creating a foundation for a profitable future. First, most importantly, the recovery has now matured to the point where we see a path to normalized margins and want to seize these normalized margins in the fastest way possible and with the largest impact possible. We do that by maintaining our market share. It will come as no surprise that we have experienced a substantial increase in demand for our land-based services. In fact, we expect our U.S. land revenue growth to be up 25% quarter-over-quarter. It is fair to say that this growth has not come without the expected operational inefficiencies. As you know, we earned historically high market share in the downturn through service quality and technology differentiation.
As previously discussed, in the fourth quarter of 2016, we traded some of that share to improve our margins. As we entered Q1, we said that we were going to maintain the optionality of being able to continue with that approach or being able to fight to maintain market share. As we saw the huge increase in Q1 rig count and the path to normalized margins developing, we pivoted to the option of preserving market share. To do that, we took the following actions. We made the decision to bring back more equipment more rapidly than we planned at the start of the year, trading short-term margin pain to maintain our market share to achieve longer-term margin gain, thus allowing increased future revenue in a rapidly growing market.
The newly activated equipment is being added at an accelerated rate. We are ensuring that it will be profitable, meets market demand, and stabilizes our market share. Based on current customer demand, we are deploying nearly double the pressure pumping equipment than we originally anticipated reactivating for the entire year. We are bringing that reactivated equipment out in the first six months of the year instead of over the course of the year. This was a costly short-term decision, one that will pay dividends as the year goes on. We said on our fourth quarter call the cost associated with equipment reactivation averages approximately $0.01 per share per spread we bring it back.
By doubling this rate of activation and accelerating it to the front half of the year, we are in effect front-loading much of the hit to income to the beginning of the year. I believe that was the smart thing to do for the future profitability profile we will have from getting this equipment deployed earlier. In pressure pumping, we began by reactivating the easiest equipment and are now creating new spreads using existing chassis and tractors equipped with brand-new Q10 pumps. Essentially, we are adding new Q10 fleets at half the cost of building new. A perfectly good bargain, I would say. We are also reactivating other stacked land-based equipment, particularly in our cementing business, where we are adding nearly 30% more equipment to meet increased demand in the first half of the year. This, of course, will also temporarily increase our cost.
This significant ramp-up in the reactivation of equipment has also caused a knock-on effect to our cost structure. For example, by quarter end, we expect to have hired over 2,000 field employees in U.S. Land alone. This, of course, creates increased personnel and training carrying costs as they get ready to staff this equipment without the benefit of any near-term additional revenue. The rapid increase in demand has also impacted the historical model by which we went to market in an upturn. Traditionally, we have enjoyed a head start to move pricing with our customers at a pace which both preceded and offset the impact of rising supply chain costs. However, with the dramatic shift in activity from such a deep trough, our suppliers are just as eager to raise prices where tightness exists. Believe me, they are trying to do it.
In addition to equipment and personnel, our largest source of cost inflation is sand. While contracted sand currently meets approximately 60% of our needs, historically high demand has made us turn to the spot market more than anticipated at the start of the year. We have found ourselves as an industry in a short-term situation that is tighter than we would like because there are not adequate winter stockpiles for the level of activity growth we've seen this quarter. Today, some grades on the spot market are close to double that of contracted pricing. This has hit us by approximately $50 million in inflationary costs in the first quarter. I believe this will correct itself because adequate sand volumes exist and pricing will ultimately abate as spring arrives, mining begins, and new capacity comes online.
In addition to sand, we are actively managing the inflating costs around third-party trucking and labor. The trucking industry grows and shrinks with the cycle. With increasing activity in sand volumes, the current supply of trucks is not yet adequate across all basins. As always happens, supply will eventually rise to meet demand. In the Gulf of Mexico, we were recently informed that we were awarded work from an IOC on 5 deepwater rigs. This is an exciting opportunity that includes a full suite of services from our Drilling and Evaluation division and is a testament to the strength and customer acceptance of not only our drilling but also our wireline technologies. This award has resulted in mobilization costs that were not anticipated at the start of the year.
The short-term cost associated with this mobilization is worth the multiple years of service that we will provide to this customer. Turning to the international markets. That market is still a grind. Our customers are focused on cost-cutting, and we are being impacted by pricing pressures and activity delays. The combination of seasonal and economic pressures, coupled with the continued softness in the commodity price, has led to sluggish activities this quarter. In the international markets, we do not expect to see an inflection until the latter part of 2017. In the meantime, our international customers remain focused on cash flow, and traditional contracting cycles will likely mute any dramatic rebound off the bottom. In conclusion, the good news is that the actions that we've taken this quarter provide long-term profitable opportunities, and we believe that the cost challenges we face today are transitory in nature.
Nonetheless, they will have an impact on our financial performance this quarter. Therefore, we expect the net impact of these factors translate into an earnings per share in the low single digits for the first quarter, not including the premium paid earlier this month to redeem $1.4 billion in long-term debt. As we look further into 2017, I really like how North America is shaping up. I expect as we execute our strategy that our revenue will continue to meet or exceed rig count growth in 2017. After we absorb the impact of the additional equipment and personnel expenses, our margins should accelerate towards the end of the year. In my view, nothing has fundamentally changed in our North America business that would preclude us from achieving the margins and returns our investors have come to expect.
I also believe that capturing and holding market share was way more important than the cost impact of the decisions we made during the quarter. We are protecting what we built during the downturn. We are the execution company. In this quarter, we executed a fast switch to holding market share, which we believe will provide benefit not only in the latter part of 2017, but for years to come. With that, let's open it up for questions.
Thank you. Ladies and gentlemen, at this time, if you have a question, please press star and then one on your touch tone phone. If your question has been answered or you wish to remove yourself from queue, you can do so by pressing the pound key. If you do have a question, that is star and then one. Also, please limit yourself to one initial question and one follow-up. Our first question is from Bill Herbert of Simmons & Company International. Your line is open.
Thanks. Good morning. Thanks for the call, Dave, and the update. Very well summarized and laid out. If your EPS, you think is going to be tracking towards the low single digits for the quarter, then it looks like it's kind of a flat margin quarter-on-quarter for North America at kind of a 1.5%-2% range for reasons that you expressed. You also reflected or imparted that the kind of operational challenges that you're confronting in Q1 are transitory. I'm just curious with regard to when you look back in 2010, 2011, and you had a similar frenzied pace of activity ramp, North American margins consistently or incrementals were 40%-45%. Is there any reason to believe that you cannot hit that glide path this time around?
Absolutely not, Bill. I think, if you look back to 2010, that was more of a gas market.
Yeah.
I think the similarities are pretty close to what we're looking at today. A very quick ramp-up. Customers that, for a variety of reasons, need work done now, need it done quickly. We are coming off a historical trough, so what we have to add back is sort of unprecedented in not only the amount but the rate that we have to add it back. As I said in the call here a couple of minutes ago, in my view, it was clearly the smart decision to accelerate bringing equipment into the market. We love the market. We love the direction it's going. Eventually, we were going to have to bring this cost back, so why not front load it? Why not get it in the system and have the revenue-generating capacity that comes with it?
As I said, we see a path to normalize margins now, and to get to those normalized margins, we're going to need incrementals along the lines of those you suggest.
Okay. With regard to the magnitude of the front loading that you're doing with regard to the reactivation, is it safe to say that some of the lingering kind of ramp up and reactivation friction and also supply chain cost inflation is going to spill over into Q2, and while incrementals are likely going to be improved sequentially, they're not going to hit that glide path that we talked about earlier?
No, I think that's a fair statement. We're clearly not just going to shut off the cost adds at the end of the quarter. Some will bleed into Q2. Not all of the equipment we're bringing back will be out until Q2. The infrastructure costs will be there, certainly, we would expect that incremental margins would be higher in Q2, then we would hit the glide path later in the year.
Okay. Thank you.
Thank you. Our next question is from Jim Wicklund of Credit Suisse. Your line is open.
Good morning, guys. I have to say that this is absolutely no surprise whatsoever, it's good of you to do the call. I would assume that accrual of bonuses and retention bonuses and there's all sorts of things that in addition to inflation and accelerated placement is going to take place in the first quarter. My question is really more around international at this point. Dave, you note the sluggishness of international the inflection will happen later in the year. Is this a change from three months ago or two and a half months ago into the fourth quarter? Has the international outlook changed?
No. I think, Jim, that we were always, I would say, on the more conservative end of the view of the reality of the international market, that it was not really poised to spring back quickly this year, that it was going to continue to be arm to arm combat in terms of pricing pressure from customers, projects that continue to get either downsized or pushed to the right. I think that market is playing out about how we thought. Maybe some of the pricing pressure is a little greater than we thought, and that's going to be reflected, I think, in some margin pressure for the next quarter or two. I think that the bouncing around, but generally to the downside of commodity prices, has caused our IOC customers to, again, relook at projects.
If you talk to them, they can point to a particular project that is good, and it might be going forward, but you're not hearing about a number of projects by customer that are going forward. I think we're just taking a more pragmatic, conservative view of the international markets, pretty consistent with what we've thought in the past. We've been on the conservative side, and that really hasn't changed. The bottom line is, we're going to participate in that market when it bounces back with the market share we have or more. We just have to wait for it to happen, but we're not really counting on it until the latter part of the year.
Okay, Dave, I appreciate that. I would assume that all the pressure pumping companies have talked about getting somewhere in the neighborhood of a 25% pricing improvement since the beginning of the year. Is that along the magnitude that Halliburton has seen as well?
Yeah, I think that's a good ballpark number.
Okay. Thanks for the call, Dave.
Okay.
Our next question is from Angie Sedita of UBS. Your line is open.
Hey, Angie.
Thanks. Good morning. Hi, Dave. Thanks. I agree. We really appreciate the call. Jim is spot on, that is to be expected given the surge of the rig count in Q1. Q1 and Q2 both are affected here by the higher cost and starting to go back to more normalized, well, new levels in Q3, Q4. When do you think we could start to see these normalized margins? Is that more likely a 2018 effect as far as middle to second half of 2018? Any thoughts on where we could be on North American margins as we exit 2017?
I think, Angie, if the U.S. continues to grow at the rate or even abates a little bit, obviously because we are market share focused at this point in time, because we see the long-term benefits, if it continues to grow, obviously we're going to have to continue to feed in high investment. To some extent, it's a bet on the direction of the rig count. As we look at the market, getting to those normalized margins, as you know, actually comes faster than people think once you hit that break point. I'm not going to predict when that break point is. I think that the decision we made this quarter to basically front load as much of the cost as we can will, in hindsight, turn out to be a smart decision.
Yeah. Fair enough. As an unrelated follow-up, is it fair to think that given the speed of the unstacking here, that you could have by the end of the year, unstacked the majority of your idle fleet? Have you seen any change in E&P behavior given where oil prices have recently slid to?
No, I think to the latter part of the question, not really an impact from our customers yet. As I said, they've got their own essentially individual agendas that they need to meet, especially those that are preparing themselves for sale or those that are public. There is certainly some concern there about where commodity prices have gone, but we haven't really seen it show up in any kind of an activity change at this point in time.
Thank you. Our next question is from Judd Bailey of Wells Fargo. Your line is open.
Thanks. Good morning. Dave, just to follow back up on the comment regarding normalized margins, I appreciate it's difficult to predict when you get there. Just to make sure everyone's on the same page, just how do you think about normalized margins, and when you ultimately get there? Is that a mid-teens, high teens, 20%? Just want to make sure we're thinking about that correctly.
No, our view in normalized margins is 20% plus.
Okay. That's helpful. Thanks. My follow-up question is, just to make sure I'm thinking about it correctly again, if your U.S. revenue is up roughly 25% this quarter, it sounds like to me that the bulk of the reactivations is going to be felt in the second quarter. Is it unrealistic to think that the second quarter revenue growth should materially exceed first quarter, if we're thinking about the cadence of reactivations correctly?
Yeah. It's a good point, Judd, in that obviously, we have brought some equipment back that is actually working and generating revenues, we also have sort of the cost slug coming through the system right now on equipment that has not been in the field, which will go out there. Also, it depends on the cadence of the rig count increase, because clearly, if it continues to increase at the rate that it has, we will have to look at bringing even more equipment out to maintain the market we have. I suspect that if the sort of pace of the rig count stays consistent, then we should be able to start adding incrementally to our margins as we go forward, even as we're adding more cost.
I think to go back, as was just pointed out to me, I didn't answer the front end of Angie's question in terms of the reactivation. We're getting to the point where what's left to reactivate is pretty old equipment, and we will have to be making a decision here, probably at the end of the second quarter, as to whether to flip over to build entirely new or continue to reactivate some of the old.
Okay. It sounds like you would be comfortable with 2Q revenue growth potentially being higher if everything kind of continues on its current path, roughly relative to that 25% growth in 1Q.
I'll let Jeff answer that one.
Yeah, no, that's right.
Okay.
As you described it, Rig count continues to move, we continue to bring equipment out that clearly we would expect second quarter revenues to exceed the first.
Yeah. I guess one way to think about it is, we had a big increase in the rig count last week. If you get a couple of big increases right at the end of the quarter, clearly those rigs are drilling, we have not moved into completion mode on them. That would spill over into a future month or a future quarter.
Okay, great. I'll turn it back. Thanks.
Thank you. Our next question is from Waqar Syed of Goldman Sachs. Your line is open.
Thank you. In terms of your reactivations, are they already spoken for? Are you doing most of it is still on a proactive basis?
Look, Waqar, equipment is spoken for. The equipment that we're bringing out, we're bringing out and placing in a position to earn, obviously, higher margins. Very thoughtful about where that equipment goes. It has a plan. It's not sitting on the sidelines. That should be incrementally improving our margins.
Has the pricing been set on that? I just wanted to also understand how, in these new contracts, you're trying to protect yourself from further escalation in input costs.
Yeah. Right now we are being very careful in terms of what we sign up. The reality is, we are maintaining all the flexibility that we can in terms of pricing, and particularly around inputs and the ability to relook at contracts. As we see escalation in input costs and other things, maintaining flexibility as we go into the market right now.
Would the cost of any further escalation in sand prices that's in the second or third quarter, would that be a pass-through for the new equipment that's coming in? Or are you protected there?
Yeah, I'm not going to get into the mechanics of how we price each contract, but know that as we take these into account, and it becomes evident in the market what the price of sand is doing, we'll have ways to manage that prospectively with customers.
Okay. Could you maybe talk about broadly on the macro pressure pumping supply/demand, what's the level of reactivations now in the industry? How much capacity can still be reactivated? What's your thoughts there?
Yeah. Waqar, if I go back, I guess, to the summer of last year, I talked about 900 as the new 2,000. I think it's playing out exactly the way we thought in terms of the amount of activity that the current rig count is driving us up to a level of activity that is consuming the available capacity in the marketplace. I also think that our view is that the cost to activate equipment is going to demand a higher price, and so that equipment won't come into the market unless it's at a margin that's acceptable. This is what we expected to see.
Thank you. Our next question is from Sean Meakim of JP Morgan. Your line is open.
Thanks. Morning. Just maybe a different way to ask that previous question, have you been at all surprised by the pace of competitors reactivating, ordering new fleets, the amount of capital coming in and being available to some of your smaller competitors?
Yeah, I think they see the same market that we do. I think that from our perspective, we're dead focused on making returns right now and moving a bigger piece of the market ahead. Let's see. We've built the business around service quality and making better wells, and I feel comfortable that that absolutely wins over the long term.
Okay. Fair enough. Just, you didn't touch much on capital deployment in your prepared remarks. Maybe could you talk about the impact of some of these changes to cash flow this year and perhaps some additional spending on equipment, et cetera, and then how you're thinking about this point in the cycle, deploying capital towards M&A versus kind of what you have line of sight with your existing fleet in North America?
Yeah, I'll go back to what Dave said. These are the sort of decisions we make based on what we see at mid-year. Right now, we haven't changed our guidance around CapEx and what we need to spend there. On the M&A front, we've been pretty clear in terms of our focus has been around M&A around lift, more organic around chemicals, and my view of that hasn't changed. If we see a particular technology or things that make sense to incorporate into our business, we'll move on those. Beyond that, we are sort of viewing the production space the way we always have.
We're going to wrap up here, but I just want to make one last comment. Part of the reason we want to do the call today is just to sensitize you to where the market is, the decisions that we made, and also recall, I'm not going to be able to be on the 2Q call, or the first quarter call here coming up in April, and just wanted to give you the benefit of where I think we are in the business, why we're making the decisions we're making, all of which I think are certainly in the best interest of our long-term shareholders. We like this market, we like where it's headed, and there's no reason, as the number one service company in North America, that we shouldn't be out front in it. With that, we'll sign off for the day.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes your program. You may now disconnect.