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. 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 and a replay will be made available on Halliburton's website for 7 days. Joining me today are Dave Lasar, CEO Jeff Miller, President and Rob Voyles, 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 ks for the year ended December 31, 2016, recent current reports on Form 8 ks and other Securities and Exchange Commission filings. We undertake no obligation to revise or update publicly any forward looking statements for any reason. Now I'll turn the call over to Dave.
Thank you, Lance, and good morning to everyone. The landscape of North America market has changed dramatically in the last 9 months. Our customer base has essentially separated itself into 3 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. And 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 Q4, which is nearly 2 rigs per day. In the Q1 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. And 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 and that is a position that operators will likely not want to give up. So 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 and most importantly, the recovery has now matured to the point where we see a path to normalize margins and want to seize these normalized margins in the fastest way possible and with the largest impact possible and 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. But 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. And as previously discussed, in the Q4 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 normalize margins developing, we pivoted to the option of preserving market share. And 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, but 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, and we are bringing that reactivated equipment out in the first 6 months of the year instead of over the course of the year. Now this was a costly short term decision, but one that will pay dividends as the year goes on. We said on our Q4 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. But 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 and 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 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 $50,000,000 in inflationary costs in the Q1. 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 3rd party trucking and labor. The trucking industry grows and shrinks with the cycle and with increasing activity in sand volumes, the current supply of trucks is not And 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 reward 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. So 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 the net impact of these factors translate into an earnings per share in the low single digits for the Q1, not including the premium paid earlier this month to redeem $1,400,000,000 in long term debt. So 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. And 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 Our first question is from Bill Herbert of Simmons 11. Your line is open.
Thanks. Good morning. Thanks for the call, Dave, and the update very well summarized and laid out. So 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 1.5% to 2% range for reasons that you expressed. And 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 2010, 2011 and you had a similar frenzied pace of activity ramp. North American margins consistently or incrementals were 40% to 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 the 2010, that was more of a gas market. But 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. And 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.
But 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. And 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? Because 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. And then 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 back will be out until Q2. The infrastructure costs will be there. But certainly, we would expect that incremental margins would be higher in Q2 and then we would hit the glide path later in the year. 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. So, it's good of you to do the call. But I would assume that accrual of bonuses and retention bonuses bonuses and there's all sorts of things that in addition to inflation and accelerated placement is going to take place in the Q1. My question is really more around international at this point.
Dave, you note the sluggishness of international and the inflection will happen later in the year. Is this a change from 3 months ago or 2.5 months ago, end of the Q4? 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. And so 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 2. I think that the bouncing around, but generally to the downside of commodity prices has caused our IOC customers to again relook at projects. I mean, 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. So 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.
And we've been on the conservative side and that really hasn't changed. I mean, the bottom line is, we're going to participate in that market when it bounces back with the market share we have or more, but 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,
David, I appreciate that. And I would assume that all the pressure pumping companies have talked about getting somewhere in the neighborhood of a 25% price improvement since the beginning of the year. Is that along the magnitude that Halliburton has seen as well?
Yes, I think that's a good ballpark number.
Okay. Thanks for the call, David. Okay.
Our next question is from Angie Sedita of UBS. Your line is open.
Thanks. Good morning. Hi, Dave. Thanks. I agree.
We really appreciate the call and Jim has spot on and that is to be expected given the surge of rig count in Q1. So Q1 and Q2 both are expected 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 twenty 18 and any thoughts on where we could be on North American margins as we exit 2017?
I think Angie, if 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 investment. And so to some extent, it's a bet on the direction of the rig count. But 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. But 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.
Fair enough. And then 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? And then have you seen any change in E and P behavior given where oil prices have recently slipped through?
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. And so, 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 Jud 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. But just to make sure we're on the same everyone's on the same page, just how do you think about normalized margins, and when you
is 20% plus.
Okay, that's helpful. Thanks. And then my follow-up question is, if 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 Q2.
Is it unrealistic to think that the 2nd quarter revenue growth should materially exceed Q1, if we're thinking about the cadence of reactivations correctly?
Yes. It's a good point, Jud, in that, obviously, we have brought some equipment back that is actually working and generating revenues, but 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. And 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. But I suspect that you 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 costs. And I think to go back, as I 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 the 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. And so just 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 percent growth in 1Q?
I'll let Jeff answer that one.
Yes. No, that's right. As we as you described it, our rig count continues to move and we continue to bring equipment out there, clearly, we would expect the 2nd quarter revenues to exceed the first.
Yes. I guess one way to think about is, if you get a 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, but we have not moved into completion mode on them. And so that would come 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 bokar saith 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, look, our equipment is spoken for. I mean, the equipment that we're bringing out, we're bringing out and placing in a position to earn obviously higher margins. And so very thoughtful about where that equipment goes. It has a plan. It's not sitting on the sidelines.
And so that should be incrementally improving our margins.
And has the pricing been set on that? And I just wanted to also understand how in these new contracts, you're trying to protect yourself from further escalation in input costs.
Yes. I mean right now, we are being being very careful in terms of what we sign up. And 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. So as we see escalation in input costs and other things, so maintaining flexibility as we go into the market right now.
So would you have would the cost of any further escalation in sand prices, let's say, in the second or third quarter, would that be a pass through for these the new equipment that's coming in? Or who or protected there?
Yes. 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 becomes evident in the market what the price of Sandd is doing, we'll have ways to manage that prospectively with customers.
Okay. And then 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?
Yes. Well, Carr, I mean, if I go back, I guess, to the summer of last year, I talked about 900 And 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 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. So this is what we expected to see.
Thank you. Our next question is from Sean Meakim of JPMorgan. Your line is open.
Thanks. Good 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?
Yes. I mean, I think they see the same market that we do. And 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 business around service quality and making better wells and I feel comfortable that that absolutely wins over the long term.
Okay. Fair enough. And then 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, perhaps some additional spending on equipment, etcetera? And then how you're thinking about at this point of cycle deploying capital towards M and A versus
kind of what you have line
of sight with your existing fleet in North America?
Yes, I'll go back to what Dave said. I mean these are sort of decisions we make based on what we see at midyear. Right now, we haven't changed our guidance around CapEx and what we need to spend there. And then on the M and A front, we've been pretty clear in terms of our focus has been around M and A around lift, more organic around chemicals. And that view my view of that hasn't changed.
So if we see a particular technology or things that make sense to incorporate into our business, we'll move on those. But beyond that, we are sort of viewing the production space the way we always have.
So we're going to wrap up here, but I just want to make one last comment. Part of the reason we want to do this 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 Q1 call here coming up in April. I 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, because 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. And so 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.