Good day, ladies and gentlemen, welcome to the Halliburton third quarter 2012 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, instructions will follow at that time. If anyone should require operator assistance, please press star then the zero key on your touchtone telephone. As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Kelly Youngblood. Sir, you may begin.
Thank you. Good morning, welcome to the Halliburton third quarter 2012 conference call. Today's call is being webcast, a replay will be available on Halliburton's website for seven days. The press release announcing the third quarter results is also available on the Halliburton website. Joining me today are Dave Lesar, CEO; Mark McCollum, CFO; Tim Probert, President, Strategy and Corporate Development. Jeff Miller, our new COO, will not be a speaker today, will be a key participant on future calls and investor events going forward. I would like to remind our audience that some of today's comments may include forward-looking statements reflecting Halliburton's views about future events and their potential impact on performance. These matters involve risks and uncertainties that could impact operations and financial results and 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 31, 2011, Form 10-Q for the quarter ended June 30, 2012, recent current reports on Form 8-K. Our comments include non-GAAP financial measures. Reconciliation to the most directly comparable GAAP financial measures is included in the press release announcing the third quarter results, which as I have mentioned, can be found on our website. During the quarter, we recorded a $48 million charge, which amounts to $30 million after tax or $0.03 per diluted share related to an earn-out adjustment due to significantly better than expected performance of our global oilfield services artificial lift acquisition. These charges are reflected in our North America and Latin America Completion and Production segment results.
We recorded a $20 million gain, which amounts to $13 million after tax or $0.01 per diluted share related to a recent patent infringement settlement that is reflected in our Corporate and Other Expense. Our third quarter 2011 results included an asset impairment charge of $25 million or $19 million after tax in our Europe, Africa, CIS region. We will be excluding the impact of these items on our financial results. For better comparability when discussing year-over-year rig activity, we will be excluding Iraq, as certain historical data is not available. We will welcome questions after we complete our prepared remarks. We ask that you please limit yourself to one question and one related follow-up to allow more time for others who have questions. I'll turn the call over to Dave.
Thank you, Kelly, and good morning to everyone. Let me begin with a summary of our overall results for the quarter. Total revenue of $7.1 billion was down 2% sequentially, driven by a 5% reduction in our North America revenues. Our international revenue was up 2% this quarter compared to a 2% rig count decline as a result of solid sequential growth in our Latin America, Middle East, and Asia regions, where both had revenue records. Our Drilling and Evaluation division also posted record revenue in the quarter. From a product service line perspective, we had record revenues this quarter for Boots & Coots, Wireline and Perforating, Consulting and Project Management, and Baroid, which also had a record quarter from operating income. Operating income of $982 million decreased 18% sequentially, primarily due to pricing pressures and guar costs in our North America production enhancement business.
International operating income was up 5%. We are very pleased with the continued strengthening of our market position in key international geographies and product lines where we envision continued growth in the coming years. We believe our strategy is playing out as planned, as evidenced by solid activity improvements this quarter in key geographies such as Mexico, Brazil, Russia, Malaysia, and Australia. We continue to be very optimistic about our Latin America business, where we posted another excellent quarter. Revenue was up 8% sequentially, despite a 5% drop in the rig count. Operating income increased 12% sequentially, led by solid performance in Mexico and Brazil. We saw a significant ramp-up in unconventional activity across all of Latin America during the quarter as we won new work with IOCs and independents in Brazil, Colombia, and Argentina, where we recently completed the country's first microseismic analysis.
In Mexico, we continue to introduce new unconventional completions techniques for horizontal wells. Looking ahead to the fourth quarter, we expect margins for Latin America to continue to expand, aided by the end-of-year software sales. Our Eastern Hemisphere revenues grew 19% and operating income almost 70% compared to the third quarter of last year, relative to a rig count growth of only 5%. We continue to see steady margin improvement and are optimistic about activity levels expanding in the fourth quarter and into the coming year. Overall, for the Eastern Hemisphere margins, we expect to exit the year with margins in the mid to upper teens and anticipate continued year-over-year margin improvement as we go into 2013. In the Middle East and Asia, revenue and operating income increased 3% and 9% respectively compared to the second quarter.
The improvement was driven by strong activity this quarter in Malaysia and Australia, along with improved results in Iraq. During the quarter, Halliburton provided integrated drilling and completion services for horizontal shale gas wells in both China and Australia. In Saudi Arabia, we deployed the StimStar Arabian Gulf, Halliburton's latest stimulation vessel, providing state-of-the-art services for the Saudi market. Europe Africa CIS had a slight decline in revenue and operating income compared to the previous quarter. Increased profitability in Russia and Libya was more than offset by activity delays resulting from election time shutdowns in Angola, strikes in Norway, and reduced activity across continental Europe. Compared to the third quarter of last year, we achieved double-digit revenue growth in this region, and operating income grew 66% as we addressed underperforming markets.
We are optimistic about the continued improvement in this region, as we are currently pursuing price increases on a number of our contracts. Our deepwater growth strategy remains on track. In the third quarter, we successfully executed our first complete well testing and subsea job in West Africa and expanded operations in East Africa with the addition of drilling fluid services on an exploration well for a large independent offshore Kenya. Overall, our outlook for the international markets has not changed. We continue to be faced with a series of macroeconomic headwinds, the European debt crisis, lower GDP expectations in China and Brazil, and renewed tensions in the Middle East. Despite these factors, there is a tightness in global oil supply today, and natural gas is expected to be the single largest component of future energy demand growth.
We remain very optimistic about the outlook for international services activity and our ability to outperform in that market. We expect that fourth quarter margins will exit in the mid to upper teens, and 2013 will improve upon that year-over-year. Going forward, we believe margin expansion internationally will come from four key areas. Volume increases as we ramp up on our recent wins and new projects, continued improvement in those markets where we have made strategic investments, the introduction of new technology, and increased pricing and cost recovery on certain contracts. Let's turn to North America. Our North America revenues were down 5% compared to the prior quarter as a result of the lower U.S. land rig count, contract renewals that result in lower stimulation pricing, and activity disruptions associated with Hurricane Isaac.
The U.S. land rig count declined sequentially by 68 rigs or approximately 4% as operators continued to decrease their gas-directed activity. The oil-directed rig count was up 44 or 3% this quarter as customers continued to shift their budgets toward basins with better economics. This increase was insufficient to offset the 18% reduction in gas rig count. In Canada, the rebound in rig activity from the spring breakup was significantly less than industry expectations. Compared to third quarter 2011 levels, Canada's rig count was down 116 or 26%, and we expect activity levels to remain subdued into the fourth quarter. Across the North American market, we have seen customers curtail spending compared to the first half of the year and believe they will continue to decrease activities to operate within their capital budgets for the remainder of 2012.
Couple this with expectations that our customers will take significantly more holiday downtime than prior years, this could have an even more than normal negative impact on the rig count as we approach year-end. Our North American operating income was down 30% sequentially, driven by guar cost inflation and pricing pressures in hydraulic fracturing. We continue to work through our higher-priced guar inventory, and we expect our guar costs in the fourth quarter to be similar to this quarter, but we have made no additional purchases of guar. We expect a reduction in guar costs as we take deliveries of new lower-cost inventory, which we believe will translate into a tailwind to our PE margins in 2013. We have also seen increased pricing pressures in the oil and liquids markets as we renew existing stimulation contracts and win new work.
The continued migration of hydraulic horsepower into the oil basins has resulted in these areas being an especially crowded place for stimulation equipment today, with the natural outcome being overcapacity and pricing pressure. We expect this pricing pressure to persist through early 2013 as we renew our existing contracts. In response to giving fracturing price concessions, we have negotiated pull-through of additional product lines. Several smaller stimulation companies have recently reported losses or break-even levels of profitability. This has historically been a good indicator that the market is close to or at the bottom of spot pricing deterioration. We remain focused on maintaining our leadership position in North America. Our stimulation fleet remains highly utilized today as we negotiate fracture contract renewals, and we've been able to increase our percentage of 24-hour crews.
Many of our competitors simply do not have the infrastructure in place to meaningfully grow their 24-hour operations. This provides us with a unique opportunity to maintain superior asset utilization. Despite the 4% sequential decline in U.S. rig count, North American D&E revenue held relatively flat sequentially, while our operating income grew 5%. Going forward, the successful company will be the one who can help lower our customers' cost per BOE for drilling and completing unconventional wells. This is going to require three capabilities: an efficient pumping fleet, which we clearly have, especially as we expand our Frac of the Future footprint. 2, better well engineering and fracture design to drill more efficient wells to only fracture the most productive zones. 3, fluid systems that maximize reservoir response. To address the second item, we have recently released the industry's most advanced software model called Noesis.
To address the third item, we have developed PermStim. Tim will discuss them more in a few minutes. Turning to the Gulf of Mexico, although there was some impact from Hurricane Isaac, the timing of certain projects was the primary driver of profitability this quarter. We are optimistic about the work that we have secured for new deepwater rigs arriving in the Gulf and expect that this will translate into higher market share relative to our historical levels. We are also optimistic about anticipated fourth quarter activity and believe we are well-positioned to continue with strong growth in the Gulf in 2013. To summarize North America, we expect the next couple of quarters to be pretty bumpy.
While we have an understanding of the price impact of our contract renewals, there remains significant uncertainty around customer activity levels throughout the fourth quarter, both in terms of rig programs and extended holiday downtime. Activity may be further impacted by the muted recovery in Canada, by typical weather-related delays, and by customers' decisions to drill but not complete wells. At this point, we believe the downside pressure to the fourth quarter outweigh any upside, and we will take the necessary steps to adjust our operations. Now, we've been running our people and equipment flat out for the past several years. If this short-term drop in activity happens, we will not chase the lower price transactional work to keep our crews busy or to gain market share. This is something we traditionally would have done.
We will instead stack our equipment and reduce labor costs by working with our employees to minimize the temporary impact of these disruptions. The reason we are taking a different approach this time is because we believe these issues are transitory, and we do not want to take the risk of lowering the pricing baseline for a problem that we will expect to go away in a couple of quarters or to have our customers believe that such pricing would be the new normal going forward. I'm confident that our North American management team is up to this challenge. We're forecasting modest rig growth in oil for 2013, assuming that commodity prices continue to support that. To return to the utilization levels we saw in 2010 and 2011, the industry will require some degree of recovery in the natural gas market.
We continue to be very confident in the long-term fundamentals of our business and our growth strategy going forward. We will continue to focus on maintaining our leadership position in North America, continuing to strengthen our international margins, and grow our market share in deepwater and in global unconventionals and underserved international markets. Let me turn it over to Mark for a few minutes.
Thanks, David. Good morning, everyone. Our revenue in the third quarter was $7.1 billion, down 2% sequentially from the second quarter. Total operating income for the third quarter was $982 million, down 18% sequentially after normalizing for the acquisition-related charge and litigation settlement gain this quarter. North America revenue and operating income decreased 5% and 30% respectively compared to the previous quarter, with margins coming in slightly above 15%. As Dave mentioned, the lower U.S. land rig count, hydraulic fracturing pricing pressure, and guar cost inflation were the most significant drivers, combined with lower customer activity and the impact of Hurricane Isaac. Canada had sequential improvement, the rebound from spring breakup was significantly less than we've seen historically.
In North America, we typically expect to see a drop in activity and margins due to holiday downtime and winter seasonality as we move from the third quarter to the fourth quarter. This year, we're anticipating this sequential decline will be exacerbated by widespread activity reductions across the U.S. land market as a number of our customers work to maintain spending levels within their 2012 budgets. These activity reductions, along with the additional pricing pressure related to contract renewals, will most likely result in lower revenues and incrementally lower margins in the fourth quarter. For international, we expect the usual sequential improvement in the fourth quarter driven by Landmark software sales, increased Completion Tools deliveries, and end-of-year equipment sales. Typically, international revenues have increased on a percentage basis by low single digits from the third quarter to the fourth quarter, carrying higher margins as a result of these year-end activities.
We would expect to see a sequential decline in international revenues and margins in the first quarter of 2013 as these activities subside, coupled with weather-related seasonality. Looking at our third quarter results sequentially by division, Completion and Production revenue and operating income decreased 4% and 30% respectively. North America stimulation pricing pressure and guar cost issues drove the lower profitability, but were partially offset by stronger results in our Middle East-Asia region. On a geographic basis, Completion and Production North America revenue and operating income were down sequentially by 6% and 39% respectively, as increased activity in Canada was offset by the transitory U.S. land headwinds already discussed. The Gulf of Mexico was also down sequentially due to the timing of Completion Tools sales in certain projects, as well as the impact of Hurricane Isaac.
We're optimistic about higher activity and margins in the Gulf in the fourth quarter and going into next year. In Latin America, Completion and Production posted a 10% sequential increase in revenue due to improved activity across most product lines in Mexico and higher Completion Tools sales in Brazil. Operating income decreased due to lower overall profitability in Argentina and Venezuela and reduced cementing activity in Brazil and Colombia. In Europe, Africa, CIS, Completion and Production revenue decreased by 5% and operating income decreased by 7%. Higher activity in Russia and increased Boots & Coots activity in the North Sea were offset by depressed North Sea activity and Completion Tools cementing and lower stimulation vessel activity. Activity declines in Angola across most product lines contributed to the sequential decline. In Middle East-Asia, Completion and Production revenue and operating income increased by 4% and 8% respectively.
The growth was driven primarily by strong stimulation activity in Australia, strong Completion Tools sales in Malaysia, growth in all product lines in China, and increased cementing activity in India. Partially offsetting this growth were declines in Completion Tools sales in Indonesia and Brunei and lower Boots & Coots activity in Saudi Arabia. In our Drilling and Evaluation division, revenue and operating income increased 2% and 9% respectively, led by higher software and consulting services in Latin America and increased activity in the Middle East-Asia region, where we had strong sequential growth in Malaysia and Saudi Arabia and improved profitability in Iraq. In North America, Drilling and Evaluation revenue remained relatively flat while operating income increased 5%, primarily due to higher drilling activity in Canada and improved Wireline and Perforating profitability in U.S. land.
Drilling and Evaluation's Latin America revenue and operating income increased 7% and 26% respectively due to improved activity in Mexico and increased software sales across the region. Brazil had higher Wireline and testing activity contributing to this growth. Partially offsetting these increases were reduced profitability in Colombia and lower testing and subsea activity in Mexico. In the Europe, Africa, CIS region, Drilling and Evaluation revenue and operating income both came in basically flat with the previous quarter. Improved drilling fluids activity in Norway and Russia, increased Wireline profitability in Libya, and higher activity in software sales in Angola were offset by lower directional drilling activity in Nigeria and the Caspian, along with reduced Wireline activity across continental Europe. Finally, Drilling and Evaluation's Middle East-Asia revenue and operating income increased by 2% and 10%, respectively.
Malaysia had strong results during the quarter in our directional drilling, Wireline and Perforating and testing and subsea product lines. Also contributing to the growth this quarter was increased Wireline and Perforating and directional drilling activity in Saudi Arabia and China, along with better performance in Iraq. Partially offsetting this growth was lower testing and subsea sales in China. Our corporate and other expense was $87 million this quarter, excluding the patent litigation settlement gain, and includes cost for our continued investment in various strategic initiatives. The expenses related to these initiatives during the quarter totaled approximately $32 million, slightly more than Q2, but less than we were expecting for the third quarter. We anticipate the quarterly impact for these investments will increase in the fourth quarter to approximately $0.03 per share after tax.
In total, combined with those initiative costs, we anticipate that corporate expenses will range between $100 million-$105 million during the fourth quarter of 2012. Our effective tax rate, including the non-recurring adjustments mentioned earlier, was 30.5% for the third quarter, which is significantly less than previously anticipated. We currently expect the full year 2012 effective tax rate will be approximately 32%, which is again, lower than past guidance. As mentioned last quarter, one of the key strategic initiatives that we've been focused on is a realignment of our international operations to better position us for improved delivery of our products and services to our international customers, closer alignment to our international supply base, more efficient use of our technology, and an overall reduction in cost.
Going forward, we expect to see an increase in our international earnings and a related reduction of our effective tax rate in future years. Specifically looking ahead to 2013, we expect to see a 200- to 300-basis point improvement in our effective tax rate as compared to the current full year 2012 rate. We now anticipate that our capital expenditures for the full year will be approximately $3.4 billion-$3.5 billion. We'll be presenting our 2013 capital expenditure plan to our board of directors at the end of the year, and we'll provide formal guidance on next year's capital plan during our fourth quarter call. However, our current expectation is that our overall capital budget will be lower in 2013 than 2012. We currently intend to direct less capital toward the North America pressure pumping market. Our North American horsepower build will be aimed toward fleet replacement.
The displaced equipment will be retired from the market, and the emphasis will be on the rollout of the Q10 pump and other ancillary equipment designed to advance our Frac of the Future goals. Now I'll turn it over to Tim.
Thanks, Mark, and good morning, everyone. I'm going to provide a bit more color on Dave's comments regarding factors impacting our return to prior activity levels and normalized margins in North America. First, the impact of guar. As discussed previously, the rising cost of guar resulted in a headwind of approximately 600 basis points in our North America business in the third quarter. The current crop is anticipated to be 25%-50% larger than last year. We foresee a significant improvement in guar costs in 2013 and a restorative tailwind to margins, notwithstanding the fourth quarter activity challenges Dave described earlier. We've seen rapid adoption of PermStim, one of the game-changing technologies Dave mentioned, which is our high-performance guar replacement.
PermStim not only provides an economic alternative to guar, but also provides a vastly improved post-frac cleanup, enabling better flow rates and production when compared with guar systems. On the same Williston pad, for example, production was 20% higher 150 days post-frac, compared with a similar well fracked with a guar-based fluid system. In terms of economics, PermStim is highly competitive with guar at current prices and we believe will offer us a compelling alternative in the event of future guar cost escalation. The second key factor is customer spending. Our customers have reined in their spending in the back half of the year, resulting in a decline of 172 rigs since the beginning of the year. Spending reductions have been more concentrated in large cap public companies since the end of the second quarter.
As Dave discussed, this group of customers are indicating to us a return to historical levels of activity in the first quarter as 2013 budgets get underway. Thirdly, a more favorable balance in the terms of horsepower supply and demand. Some industry horsepower has been parked. Indications are that horsepower additions have slowed dramatically. We retired two fleets in the second quarter and a third this quarter. We anticipate further fleet retirements in the fourth quarter. As Mark mentioned, any incremental horsepower builds will be directed towards fleet replacement and focused on our Q10 pumps, which are designed to more efficiently handle continuous pumping operations associated with horizontal activity. Q10s have demonstrated an ability to pump twice as many stages as existing pumps before requiring regular maintenance on a spread that requires 25% less horsepower on location.
They're a core component for us of our Frac of the Future. Finally, in a flat rig count environment, we believe that continued drilling efficiency gains and a rise in integration will be key components of improving North America margins. This suggests to us that excelling at delivering integrated completion services will increasingly become a differentiator in work selection. Earlier this month at the SPE annual conference, we introduced our industry-changing family of software called Noesis. Designed to improve reservoir knowledge and stimulation characteristics, Noesis is the industry's first comprehensive and ground-up solution to the challenge of modeling fracture behavior in complex unconventional reservoirs. This enables our customers to add a further layer of science to the fracture completion portfolio. We're now able to design and forward-model fracture completions using three-dimensional propagation methodologies, which provide previously unavailable insight on fracture planes and the extent of reservoir contact.
The Noesis suite gives us unparalleled subsurface visualization and design capabilities. Paired with our industry-leading well site delivery
We believe we're uniquely positioned to provide improved knowledge of the reservoir and its stimulation characteristics to our customers with the singular goal of making better wells. While the extent of the North America cycle in 2013 is uncertain, we believe our Frac of the Future initiatives will continue to provide cost benefits and that Noesis will enable us to materially improve our service intensity. Coupled with moderating horsepower capacity, supportive commodity prices, and a guar cost tailwind to our operations, we see these as supportive factors in our goal to return to normalized margins over the course of 2013. Dave?
Thank you, Tim. Let me just quickly summarize. We're very proud of our third quarter international results. We continue to gain market share in key markets and expect our Eastern Hemisphere margins to be in the upper teens as we exit the year, and are optimistic about continued improvement in 2013. In North America, we will not chase the transactional market as we would typically have done, but will instead idle our equipment. Overall, we remain very laser-focused on providing industry-leading returns. We will reduce capital spending as we go into 2013. Our strategy remains intact. We'll focus on maintaining our leadership position in North America, continuing to strengthen international margins, and grow our market share in deep water, unconventionals, and underserved international markets. Let's open it up for questions at this point.
Thank you. Ladies and gentlemen, if you do have a question at this time, please press star then the one key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. As a reminder, ladies and gentlemen, please limit yourself to one question and one follow-up. Our first question comes from Brad Handler of Jefferies & Company. Your line is now open.
Thanks. Good morning, guys.
Brad.
I guess in light of going first, let me try to just make sure I understand some of what you're trying to guide us to. First, maybe a clarification of what you consider to be normalized margins in the U.S. If we're working towards that, how would you think about 2013 evolving? I recognize, of course, in that there are elements to the revenue side you don't see, but if you could clarify the normalized margin comment, that would be helpful.
Well, without trying to give specific guidance as to when this might happen, because that's not what we're doing. We continue to hold that we think normalized margins are in the mid-20s. As we look at the business historically and sort of a balanced market, balanced cost structure, those mid-20s margins seem to be appropriate to us, and that's what we're targeting internally to drive our business toward.
Okay. Makes sense. The follow-up in the same vein, maybe it's a bit more fourth quarter focused. You all helped us in saying, okay, traditionally, internationally now, you see a modest, what'd you say, low single-digit revenue increase. I actually thought it might have been higher traditionally, then some margin increase. Are you suggesting that from what you can see, the fourth quarter of 2012 would be a traditional year? In other words, that's what you're encouraging us to think about for the fourth quarter in non-North America. Are there some elements that change that?
Well, no. I think the way that we're looking at it right now, and based on our forecast, we're seeing it as a fairly traditional year, maybe with a slight bias to the lower end. Obviously, some of the macro headwinds that Dave discussed continue to be out there. We're watching them very carefully. There seem to be more headwinds than tailwinds in the broad market itself. But as our business is performing, and particularly with regard to the share gains that we've had and as some of those contracts come in, we think that those things coupled together will allow us to post a revenue gain that's in line with what we have traditionally seen. Does that make sense?
It does.
In other words, that the broad market may not be up, but with regard to our revenues, because of our share gains, we think that it will look fairly typical.
Understand. Okay. That's very helpful. Thanks, guys.
Thank you. Our next question comes from James Wicklund of Credit Suisse. Your line is now open.
Good morning, gentlemen.
Morning, Jim.
A question. I understand that CapEx being down in 2013 because the current overcapacity in U.S. pressure pumping. You make comments about unconventional work in China and Australia and of course, the big deepwater projects that you've won and that you're chasing. Is CapEx going to continue to be a high number? Are we going to have to continue to invest in this market at levels close to what we've seen this year? Do we have enough capacity for the international shale boom and the deepwater boom?
Part of the reason we didn't give specific guidance, Jim, is because it's something that we're still working on. You've got to have input from our customers as to what not only the amount, but the timing of their capital spending will be. I think the other sort of data point to always consider is that we don't build speculative capital. As we address our capital budget for next year, I think it is fair to assume that there are going to be capital being placed in international markets around unconventionals, around some of the deepwater markets too. For us to be able to satisfy what our customers are doing on the share wins that we've got and on the projects that they will be doing. As Dave said, we are focused like lasers on returns right now.
We're going to be trying to drive that as carefully as we possibly can. We do continue to be encouraged about the pace of development in international and deepwater and unconventionals. The industry as a whole is undercapitalized. I think it's fair to say, particularly around unconventionals, we're undercapitalized, and we're going to continue to be working to try to make sure that we have assets on the ground to do that work on a real-time basis.
Okay. Thank you for this. The second follow-up, if I could. The international strategic initiative that you talk about, better delivery of technology, closer to supply bases. Can you give us a more layman's term as to what it is you're doing to accomplish this? What the $32 million this quarter was actually spent on so we can better understand what that is?
There are several different initiatives, Jim, that we're working on. One is we've been completing a fairly significant manufacturing plant in Singapore for our Completion Tools product service line. Our Completion Tools product service line management now reside in Singapore. We're operating that business internationally. It also, because of the way that we procure, has required some system changes to back that up.
Secondarily, we still are continuing to work on a project we internally call Battle Red, that is associated with our Frac of the Future initiative, that really is designed to look at our back-office operations, the order-to-cash process, the use of mobility, mobile technologies in the field itself to allow our business development, our operations people to be better connected, to move our paper flows more, to expedite that flow so that we can bill faster, be more responsive to customer changes when work moves as it always does. That's a fairly significant rollout that requires some changes to SAP, some reorientation of our business support centers. That change will probably be kind of full fruition in the middle part of next year, but it's something that we're spending some ongoing cost around.
We're pretty excited about the opportunities that it will hold to reduce our working capital in terms of day sales outstanding and to allow us to improve our service quality as we work with customers. The final step really is around other changes that we see as, particularly our Drilling and Evaluation business, orients to be more international. We are taking steps with our legal entity organization, other things, to be able to expedite that work. A lot of that relates to moving IP and other things offshore that allow us to better utilize that in some of our foreign jurisdictions.
Mark, that's very helpful. Thank you very much.
Sure.
Thank you. Our next question comes from James West of Barclays. Your line is now open.
Hey, good morning, gentlemen.
Hey, James.
If I could shift back to North America quickly here. Tim, you went into some detail, but I want to make sure I caught everything correctly. In your discussions with your customer base, who admittedly is being very disciplined right now and living within their stated 2012 CapEx budgets. As you talk to them about 2013, it sounds like they all plan to get back to where they were kind of starting 2012, which is 175 rigs or so higher. Am I correct in that assumption? Is that what your customers are kind of implying to you at this point?
I think a couple of points, James. I think number 1, I think the rate of drilling efficiency in the second half of the year probably exceeded expectations. As a result of that, we've seen essentially this construct of many companies essentially running out of budget as we glide in towards the end of the year. I think as Dave mentioned as well, the combination of that fact plus it's real easy to take a little extra time around holiday periods as we've seen in past cycles. That clearly is contributing to the slowdown. I think the indications we're getting clearly is that we will see that increase as we get into 2013. I don't think we're naive enough to think that it happens in the first week of January.
Sure.
It won't. It'll be a staged event as we go through the first quarter. That's the best view that we have at the moment.
Okay. Just a follow-up specifically to pressure pumping and kind of the pricing dynamics today. Is market pricing, understanding that you are still rolling over to kind of your new pricing on your contracts, which is still, I believe, at a premium to the market price. Is the market price still going down at this point, or have we started to stabilize?
I think that's very basin specific. When you sort of break things out a little bit, if you just kind of look at, say, the Permian, the Eagle Ford, and the Bakken together, those three basins now represent about 50% of the total rig count in the U.S. You look at the Marcellus, the Barnett, and the Haynesville, they're only about 10% of the total rig count today and down about 50% since the beginning of the year. You can see where the greatest pressures come from that. It's not to say that any basin is immune right now, but basin by basin, there are different pressures. Dry gas, the rig count declines have stabilized there, in fact. Wet gas is still coming down. If you look at the wet gas, dry gas, and liquids, the former are the most impacted.
I think I would say that we're starting to see some signs of a bottom. As Dave mentioned, the best sign that you ever see is when you see people, smaller firms operating at EBITDA breakeven. We've certainly seen some indications of that. That usually is the best indicator the pricing is starting to stabilize.
Okay.
I think you'll gather more information on that over the coming week or so in terms.
Sure
Of whether or not that thesis continues from last quarter to this quarter.
Okay, got it. Thanks, Tim.
Thank you. Our next question comes from Waqar Syed of Goldman Sachs. Your line is now open.
Thank you very much, good morning.
Hello.
Hi. I just wanted to shift from rig count more to a well count level. As you mentioned that rigs are becoming more efficient, maybe it's probably more useful to be focusing on well count now. As you focus on that, on the horizontal well count, how do you see that progressing in the first half of next year, versus the second half of this year?
Well, when we sort of look at the overall sort of rig contracting picture, clearly there are a lot of the mechanical and SCR rigs that are getting sort of dropped and put on the sidelines. The efficiency gains have been quite substantial during the course of this year, both not just in terms of drilling times, but also in terms of move times as well. That obviously contributes to, as you mentioned, a higher well count. We've also seen, I think, an increase in the wells in inventory. Dave touched on that a little bit earlier. It's a little hard to triangulate exactly what the picture looks like at this moment. I don't see any change in next year in terms of the drive towards drilling efficiency. I think the biggest gains have probably been realized.
We're a very innovative industry, we'll keep pushing to reduce days to depth. As we get back into next year, I think we kind of start where we left off, then we'll continue to see incremental gains from there, though arguably not quite as significant as we saw this year.
Secondly, on service intensity, do you see service intensity still increasing or has it now become kind of leveled off or even falling as we look forward into 2013?
Yeah, I think we do see service intensity increasing. As we've said a couple of times, the first battle here has been all around surface efficiency. I feel that as a company, we've got that well positioned, and from the example I was giving you regarding our new pumping systems, some significant benefits there, not just in terms of operating costs, but in terms of capital deployment too, which is very important to us. The next innings really is all about subsurface efficiency. It's about making better wells. We've been in a scramble as an industry to get work done for a couple of years. Now it's about applying the science to the subsurface, making better wells, and becoming a lot more efficient, not just in the oily basins, but in the gassy basins, too.
Just to follow up on that, I think though, as we look ahead, we're not trying to build our plan just around service intensity growth and sort of relying on that. As Dave said, we think that the ultimate differentiator is going to be those guys that can be the lowest cost service provider. We're very keenly focused on reducing our footprint, our operating cost, bringing down our internal costs so that ultimately our realization on a per stage and/or per well goes up regardless of what happens on the service intensity side.
To that point, that Frac of the Future, where are you in that implementation phase, and when do we start to see the benefits of the lower cost?
Well, we're in the rollout phase today. Obviously we have a large existing fleet, so we have to implement enough Frac of the Future fleets to ensure that we sort of impact the overall balance. We'll start to see some impacts during 2013. The bulk of the impacts, though, probably will be more felt in 2014.
We do have some Frac of the Future fleets that are out there operating, the early results are quite dramatically good.
Quite good. We're very pleased.
Thank you. Our next question comes from David Anderson of JPMorgan. Your line is now open.
Thank you. We've been hearing a lot of talk about E&Ps using up their 2012 CapEx budgets. I guess on the one hand, I guess there's a first for everything, but it's pretty unusual considering these guys are cash flow driven and WTI is above 90. I'm just wondering, it seems to me like a lot of the weaker activity levels is really about them looking to drive down cost through lower service pricing. Along the same lines, Dave, you just made a pretty big change there in your strategy saying you're not going to be seeking full utilization anymore.
Should I be reading this or should we be reading this as basically you guys drawing a line in the sand saying, "This is as far as we're going to go on pricing, and we're not going to devalue our services anymore compared to the one-dimensional players"?
Yeah. I guess that's a great way to summarize it, Dave. As I indicated, one of the lessons we learned coming out of the last dip is that chasing the transactional market essentially sets the lowest common denominator for pricing. It's that point that you have to then battle uphill on getting price increases out of. Our view is that that is a relatively transitory market for us to chase into given the percentage of 24-hour crews we have. Therefore, we are not going to chase into it this time. We're not going to lower our prices to get that work, therefore, giving us a higher baseline to move forward when some of these other issues get out of the way.
Yes, that is a strategy change and one that ultimately, I think will be successful and is just a lesson that we learned from the past.
You talked about transitory weakness in North America, and it's going to last only a few quarters. What are some of the signs or at least what are some of the drivers that you're looking for? I kind of count looking at kind of three or four things. We talked about pressure pumping fleet attrition. You've talked about kind of some of the laying down, do you need to see industry attrition levels higher? Is it improvement in natural gas rig count? Is it E&P cost coming down, or is it kind of these emerging basins absorbing capacity? What do you think are kind of the couple of the key drivers or at least a couple of the signs that you're pointing towards that are going to be transitory?
David, remember that about 80%-85% of our fleet is contracted. The key thing that we're looking for is customer budgets and an announcement that they're getting back to work. As we think about this transitory issue, we're talking about in the Q4, they use up their budget, and they're basically taking time off to coast into the end of the year. The key thing we'll be looking for is, when are they going to be starting back up, and when could we get our crews back to work? That takes up the vast majority of the issue around what we're looking for. The second thing, obviously, will be then watching the rig count overall and as it begins to leak up. As you commented, I think that it's not the commodity price. The commodity price environment, particularly on the oil side, has been supportive.
We've seen it on an absolute basis, a 6% reduction in the U.S. land rig count since the end of June, in spite of that. That's why this feels so transitory and really budget related. Going into next year, many of the contract rollovers customers have all suggested, at least in their initial indications, that they're going to be doing more work, they'll be running more rigs and asking for more equipment on our side. We feel, on a long-term basis, pretty good about what 2013 may hold.
When do you start having those conversations? Is that kind of a December conversation for January? Is that how we think about it?
They're happening now.
They're happening right now.
Great. Thank you.
Thank you. Our next question comes from Kurt Hallead of RBC Capital Markets. Your line is now open.
Hey, good morning.
Hi, Kurt.
Good morning, Kurt.
Great. It's a great rundown. Appreciate that incremental color. Question I would have, you guys indicated here that you're able to maybe offset some of the reduction in frack activity by pulling through other services. That seems like a very familiar refrain from other downturns that typically tend to be transitory. Can you talk a little bit about what kind of product lines you're able to pull through? And whether or not that pull through on a go-forward basis is going to be a substantial factor in helping you get back to that normalized margin, or is that normalized margin, once again, coming back to what you said earlier, is it primarily just frack utilization? Can you just give us some color around that?
Yeah. I think the first comment there probably, Kurt, is around pricing in general. I think just to sort of clarify a little bit, the pricing issues that we have today primarily around stimulation. You saw the D&E results. They were good for North America, improvement in margins on the Q. I think as we've touched on, clearly anything that directly touches frack may have a little more pressure than those things that don't touch frack. I think the first point is that there is a real opportunity to pull through elements which do not today have significant pricing pressure. I think that's point number one. With respect to the pull-through, obviously, any time that you renegotiate, you're looking for some opportunity to improve your longer-term position. You've heard it from us before.
It's something that we tend to focus on. Those product lines typically would be around completions, would be around wireline, would be around coil, just to give a few examples of areas where we would really sort of push to try and improve the pull-through.
Okay.
Let me just add to, Kurt, thinking about the normalized margins. As we think about our North America margins, or at least our U.S. margins right now, they're not as far off as I think that the average margin indicates. We've described that guar is about 600 basis points of margin impact on us. When you eliminate that, if that comes back to us substantially, we're back above 20%. We also think that we probably lost a little under 100 basis points of margin this quarter just on activity and mix as a result of the declining rig count over the course of the quarter. It doesn't take that much movement for us to sort of begin to threaten those normalized margins as we've talked about them with some repair in the market.
Right. I was wondering, Dave, if you can give us an update on how you think things are progressing in Iraq and what you think the outlook is in general for Saudi and Iraq heading out into 2013.
Well, I think first with Saudi, I think it's a good news story. We like our position there. We've had additional rigs added to our South Ghawar project. That one is going very, very well. Manifa, the rig count is up on that project. As I indicated, we've just added a stimulation vessel into their market
We have been assigned a geographic area in Saudi to try to demonstrate that we can make unconventionals work there in some of their tight gas areas. That market is very good for us right now and potentially even better as we go into the next couple of years. Iraq is certainly, for us, a lot better than it was last year, where we were struggling with some contracts. We are getting through those at this point in time, and as I indicated and Mark indicated, the financial results are better. It is still a very difficult market to operate in, and the size of the projects and the contract structure basically creates a bidding frenzy around them, which means that everybody is bidding those things fairly thinly. We've got good infrastructure on the ground. We're committed to that marketplace.
We just have to work our way through some of the contracts that we did have some issues with. We're very optimistic about that market also.
Thank you. Our next question comes from Bill Herbert of Simmons & Company. Your line is now open.
Thanks. Good morning.
Bill.
Mark, could you just review with us exactly how the mechanics of the guar cost recovery work? I understand the fact that you guys are churning through some high-cost inventory, haven't necessarily been able to pass that through. On a guar cost markdown with regard to the raw material cost input into the job, would the client expect to receive some of that? Or because they didn't have to pay for it in the first place, you get to keep it? How does that work mechanically?
Yeah. Essentially, guar is our cost, right? It's an input cost into the work that we do. As our guys have been in the market bidding, we know that we have a higher average cost of guar. They have substantially tried to ignore that, so that they remain competitive.
Got it.
As a result of that, to the extent that our inflation is above the market, we've just taken that straight on the chin.
Okay.
As we look ahead, with the crop yield being 20%-50% higher next year, we're already beginning to see current pricing of guar in the market beginning to fall. The success of the PermStim rollout and what it's been able to achieve for customers and then the demand that we're seeing in terms of its growth.
We feel like that we'll not only be able to get ourselves back to as we normally would on a supply chain side, to be at the most favored nations price that's out there in the market, but also probably have some ability to value price the PermStim offering going into next year as we get more and better results from its use.
On the lower cost guar is what I'm getting to contractually with your customers.
Is that there's no roll-through element.
Yeah.
Yeah. Got it.
Let me try to give you an example. Our stimulation pricing is generally on a per stage basis.
Got it.
Let's say we charge $100 for it's obviously a lot more than that, but let's use $100 as an example, of which, let's say $50 of that 100 is materials that are consumed. That includes our guar cost today. As Tim says, about 600 basis points is in that. What we would expect is our $50 of material to go down to $44 of material or whatever the math would work out. Therefore, the customer doesn't see the increase as it came through and won't see the decline as it goes out.
That makes sense. Then with regard to, again, timing this, we would expect to see the headwind become a tailwind when? Q2 of next year?
Well, our hope is that we're going to be really working through a lot of our inventories, getting it down to normalized levels toward the end of this year or early next. The variable in this is to what extent activity falters in Q4. We know fairly closely what our usage is and where that's going. Then also how much PermStim. PermStim's been growing significantly, and as a substitute product, that can also cause some of the guar inventory to leak over into Q1 if we don't use it. Having done that, we think that really, we're going to start new purchases of the new crop year at the end of the year, and that will begin to influence the average cost in our inventories quite dramatically.
Hopefully, by the time we get out of Q1, no matter what happens, we'll have this guar issue behind us, and be back to market levels.
Okay.
Sam, we're out of time. Can you go ahead and close the call, please?
Certainly. Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.