Nabors Industries Ltd. (NBR) Q3 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Nabors Industries Third Quarter 2012 Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Wednesday, October 24, 2012. I would now like to turn the conference over to Mr. Dennis Smith, Director of Corporate Development. Please go ahead, sir.

Good morning, everyone, and thank you for joining our second quarter (sic) [third quarter] earnings conference call. Our format today will be to have Tony Petrello, our Chairman and Chief Executive Officer, provide you with our perspective on the quarter's results and give you some insight into how we see our business in the next few quarters and over the longer term as well. In support of his remarks, we posted some slides to our website as we customarily do, which you can access and follow along, if you desire. They're available in 2 ways. If you’re on the webcast, they should be available through the webcast on the Web for Thomson's webcast. Alternatively, you can download them from our Nabors website, nabors.com under Investor Relations, then under the submenu, Events Calendar, and you'll find them listed as Supporting Materials under the conference call listing. In addition to Tony and myself today are Laura Doerre, our General Counsel; Clark Wood, our Principal Accounting Officer; and all of the heads of our various business. Since our remarks today will concern our expectation of the future, they are subject to numerous risk factors as elaborated upon in our 10-K and other filings. These comments constitute forward-looking statements within the meaning of the Securities and Exchange Act of 1933. Such forward-looking statements are subject to certain risk and uncertainties as disclosed by Nabors from time to time as filings with the SEC, and as a result of these factors, our results may vary from what we expect. Please refer to those filings for further details of the risk factors. Now I'll turn the call over to Tony to get started.

Good morning, everyone. Thank you for participating this morning. As Dennis said, we have posted to the Nabors website a series of slides about our business. During the course of my remarks, I'll refer to the slides by slide number. I won't refer to all of them, but the slide presentation tracks the comments. First, I'd like to start with some macro comments. I would like to give you an update as to how we see the current market environment, particularly in North America. In sum, we did not see anything positive over the past quarter to change our previously spoken of outlook. We remain very cautious and conservative over the near term. As you may recall on our earnings call last February, we expected a flattening to modestly declining U.S. land rig count in the second half, a moderation in the number of new build contract awards, and the further deterioration of the spot market for pressure pumping. In reality, the first quarter drop in gas prices, coupled with declining NGL prices and volatile crude prices in the second and third quarter, caused conditions to worsen. These forces eroded our customers cash flows and reduced their spending. In addition, it appears that the operators overspent their 2012 budgets in the first half of the year, further impacting their expenditures in the second half of the year. The upper section of Slide #4 shows the Baker Hughes U.S. land rig count over the recent cycles, and the lower section from its peak in November to last week. Since the peak in November, we have seen a decline of 201 U.S. land rigs, 123 of which have occurred since the beginning of the third quarter. That's much more than what I thought previously. We expect a decline -- continued decline in…

Camille, we're ready for the Q&A session, please.

[Operator Instructions] Our first question is from the line of Jim Crandell with Dahlman Rose. James D. Crandell - Dahlman Rose & Company, LLC, Research Division: Tony, how long these 9 new PACE-X rigs that you are coming out with, how long are the contracts that you've signed? And how did the day rates compare with the contracts for AC drive rigs you signed on term contracts here in the last cycle?

Yes. Well, first of all, all the contracts are -- the 3 we just signed are all 3-year contracts, and the 6 before were 3-year contracts. So and I think that's a testament to, in the market we're talking about, the perceived value of this new platform. And in terms of day rates, they're consistent with our allocation of capital objectives, because one of the things we've spoken about is the fact that we're letting capital seek the best opportunities, and that's what these will do so. And they are loaded with all the stuff that you've talked about, AC top drives, the latest in terms of the integration of some directional tools that Canrig has, the substructure is kind of unique in the way it's going to be moved. It's kind of unique. And we're kind of excited about it, and we hope to have all of you on the call to be able to see one shortly. James D. Crandell - Dahlman Rose & Company, LLC, Research Division: Okay. My other question, Tony, of your -- in pressure pumping, of your spreads that are still on longer-term contracts, how many of those are still on what you would call above market day rate contracts?

I think all of them. James D. Crandell - Dahlman Rose & Company, LLC, Research Division: All of them?

Yes. James D. Crandell - Dahlman Rose & Company, LLC, Research Division: And when did those come -- and when did those come off contract?

At various point through...

At various points of 2013 all the way until early 2014.

Yes, through the various points of 2013 and some even into 2014. And yes -- now having said that, on the rates, the customer does have the opportunity to scale back numbers of stages. So there's always this issue of rate versus utilization. And the customers, as I mentioned, one of their responses to those is to scale back some of the utilization. And with all customers, we view the contracts as a means to satisfy mutual end, and we're always willing to talk with them about other ways to optimize the whole thing, and we've looked at things like that. And we'll continue to do that to make it all work for everybody so. James D. Crandell - Dahlman Rose & Company, LLC, Research Division: Okay, good. And one more quick one, Tony. I think most people or most observers of the industry expect a decline here through year end. And then there seems to be 2 different point of views. One is that we'll see a typical seasonal decline in the early months of the year and go down further. The other is, it's a new year and companies are on next year's budget, next year's cash flow and because they had been overspending early in the year that we could see an increase in activity and sort of right out-of-the-box in January into February. And that seems -- I don't want to put words into your mouth, but that seems to be your view at this point?

Well, I'll let Joe -- Joe has just had some just recent conversations, but in terms of this quarter, I do see a further decline given where the budgets are, given the holidays and a whole bunch of other things. Whether that's a 50, 60 rig further decline order of magnitude, I do see another decline this quarter. And in terms of the pickup in January, Joe, anecdotally, he can give some ideas about what he's hearing.

Jim, we -- I met with the president of a large major independent public company. He indicated last year or this year, they ramped up from 41 to 82, capital was spent inefficiently. Just money wasn't being spent well, they pulled back. Pulled back to 50 and they intend to right after the first of the year go back up to 60 rigs. 60 with quality contractors. Now will that be all 60 in the first week? The answer is no. But they're going to ramp up so they can spend the money efficiently, plus their own pad offers [ph]. So we hear a lot of this. We're already seeing tenders, requests for numbers today, starting mid to late fourth quarter. So there's a lot of opportunity we think coming in the first quarter. So we think the money that's been spent, they call it inefficiency. We call it drilling efficiency has allowed them to spend their budget very early, the public companies are having a reload. They have production targets. They've got to meet those production targets. To do that, they have to put the rigs back to work. So no, we're optimistic about next year, but it'll be a gradual increase.

Our next question is from the line of Marshall Adkins with Raymond James. J. Marshall Adkins - Raymond James & Associates, Inc., Research Division: Oh, I remember when it used to be easy to model you all. So let me get this thing straight. We've got... so we got contract cancellations up, but your total number of contracts are also up. You're leading edge rates, the number of rigs active are down, but margins are up, which is totally absolutely abnormal, so we need help here. Help us at least in the Lower 48 land stuff understand where you think margins are going to go when you add up the new contracts, the shift in mix to the higher priced stuff? Help us understand where costs are going and I guess finally, leading-edge rates, I mean, I know there's a lot of parts to that, but the answer I'm ultimately trying to get to is, kind of where should we model daily margins going the next few quarters?

Let me just -- I know that the guys -- because there's a lot here in this topic. But let me say that one of the things is, there's always the macro point on each one of these things. But as we encounter each specific situation, our guys are always trying to create the best value. And so part of the -- part of the margin increase you see, for example, in the third quarter compared to second quarter, and as we mentioned, there was this termination and when you back out the portion of the termination that's due to future periods, there's still a healthy increase. That healthy increase is really due to 2 things. One is the base change in the mix, because we have new rigs that have higher rates coming on to the payroll, that's new AC rigs and some old stuff dropping off. And then frankly, even with respect to termination payments, in connection with those terminations, sometimes we figure out ways working with an operator to make 1 and 1 equal 3. And sometimes the extra 1 falls to the bottom line. So there's some of that at work as well. So I appreciate your dilemma, if that's kind of hard stuff to model. But I think I just want to emphasize, it reflects our culture here of trying to really optimize value. So with that, as an introduction, I let Denny add any more color to the specifics of what your question is.

I think Tony put it very well. We spent dozens of hours sorting this out, because there's a lot of elements to it, and there's dozens of elements. But satisfied ourselves that legitimately the numbers we published are right. There are, just as Tony said, there's some 1 and 1 made 3 this quarter, where our guys were -- got lucky. We kept some good deals, cut the rights, put the rig back to work, got terminated and they had some successes in some of those. But it's all in the third quarter. Going forward, as Tony alluded to, a lot of it's mix. And what you had was a spike in rates at the leading edge that's now come in. And rigs that are rolling over, particularly a lot of them that went down in the third quarter, are rolling over at substantially low prices. And one small element of why we lost so much rigs relative to others, other than the many things we articulated is, we may be -- we've had to get more aggressive with net pricing reductions in certain markets where prices are down a lot. So I expect fourth quarter margins are going to be down $1,000, $1,200, $1,500 a day, something in that range, probably. It's a little bit of a reversal of that. It's all the rigs that you've seen gone down roll over. So that's where I would suggest you model. Longer term, they migrate up from mix because there's more and more new rigs deployed. As Tony mentioned and Joe, the X rig has got enough features. We haven't had to back off stuff at all, and we're getting our capital returns at our targets and still getting good long-term contracts, contrary to some of the other rigs that are coming to the market. So I think margins will be down in the fourth quarter, probably about the same in the first quarter and migrate up from there.

And the only thing I'd add, Marshall, is that, I mean, one of the consequences of the terminations is that there are -- we now have a number of AC rigs out there that are obviously at good leading edge rigs and the numbers you're seeing are numbers without all of them working. So I think the guys have some work ahead of them to get them working in all the right places, at the rates that make sense, and that's the mission so. J. Marshall Adkins - Raymond James & Associates, Inc., Research Division: Awesome. That's exactly what I needed. The follow-up, same thing on the pressure pumping. Your margins, at least relative to what I thought, they'd be a little more stout. Are those going to hold up or should we model those dropping off a little bit here in the next quarter or 2?

They're probably coming in a little bit, and this stuff where everybody's pushing us back to minimum. Some of that on some big contracts that just happened recently late in the quarter. So that impact would be felt going forward. And the spot market just continues to be pretty slack, plus we stacked the crew.

I mean one of the major participants in their call talked about their changed position about following this market. I think our philosophy on this has not really been different than our philosophy has been on the rig side for the past 20 years. And we, as I said earlier in the year, we're not going to run equipment to make negative cash to keep things going. And so our mission is, we have these spot crews out there, and we want to create value for the customer. We want to do a good job, but we don't want to lose money. And so we'll try to be as fast as we can and try to show differentiation of value, and that's the game. But we idled 5, and we just idled 1 more, and we're going to keep that balance. So that's the way we're approaching it.

Our next question is from the line of Scott Gruber with Sanford Bernstein & Co. Scott Gruber - Sanford C. Bernstein & Co., LLC., Research Division: Tony, you sidestepped the rig question on the new build the first time, so I'll try it from a different angle. Given the rate secured, are you still looking at double-digit returns?

Oh, yes, absolutely. Yes. It's still within the kind of payout number that we have always aspired to. Scott Gruber - Sanford C. Bernstein & Co., LLC., Research Division: And what's the all-in cost on a PACE-X unit today?

We're not giving those numbers out. Scott Gruber - Sanford C. Bernstein & Co., LLC., Research Division: Okay. And then when I look at...

That is one of the advantages of the key components. That we have control over the manufacture of the key components. In this rate, the VFD, the top drive, the walking system, the drillers cabin, is all something we control. Not necessary something that every piece of it that Canrig builds, it's something we control, and that we can add value to. And one of the values of adding is obviously on the cost side. But also more importantly, and just getting the kind of integration that we think that the evolving generations are going to require. And that's really a mission of ours here to -- and that's actually the thinking behind consolidating our engineering to put more effort into that. But that's all, and that's all still being mindful of the overall objective, which is the allocation of capital and achieving the kind of return that everyone's aware of. Scott Gruber - Sanford C. Bernstein & Co., LLC., Research Division: And if you had to ballpark it, what percent of the total cost of the unit is supplied by Canrig today?

40%. Scott Gruber - Sanford C. Bernstein & Co., LLC., Research Division: Okay. And then if I look at your market share, the market share of your large public peers, in the third quarter, there was a rather consistent loss within Lower 48 despite more aggressive new build programs. You highlighted the contract role issue for you. I'm just curious, is there an element here where smaller drillers are cutting pricing more aggressively to maintain utilization on their fleets?

Yes.

Yes?

Yes.

I think there's 2 things. First, for the reason you said, the percentage, the real percentage of what was going on is obscured by the terminations. But yes, there's no question in this market there's been aggressive price cutting. And frankly, we have to do a better job of getting the stuff that's been terminated back to work quickly. And to regain -- I mean, the good thing about terminations is -- consistent with what we've all told you is, this shows that when we say we have term contracts that are real, when they're terminated, we get the cash flow, and it's in the bank. I think the follow-up now is, we still have good rigs, and we got to get them back to work now following those terminations. And that is definitely on the table. But you correctly pointed out, there's 2 things. It's not only those guys, but it is also other people that maybe had new builds in the pipeline or some other rigs that came off contract as well and everyone's sort of heading to the same areas where they know the work is. It's no secret that pressures in both the Eagle Ford area and North Dakota have become much higher the past 4 or 5 months given what's happened in terms of rigs coming loose. And so it's not just the small drillers, but it's those other people that may have thought that they had a home, that are looking for a home now, and they're affecting the pricing. Scott Gruber - Sanford C. Bernstein & Co., LLC., Research Division: So does that suggest that we need to see activity positively inflect and start to grow again before we see rates stabilize or is a stable activity sufficient?

No, I think the -- again, I think in the next 6 months, as Tony just said, there's equipment in broad areas in the U.S. that is down. We've mentioned like 200 rigs total. We think the upside in the rig count next year is going to be in AC rigs. So we think the opportunity to -- you have to put the rigs back in. Rigs coming off term, as Tony mentioned, are coming off. Now we're doing back into the market as we rollover price threshold. We're going to get back into the first quarter, we think we'll see a ramp-up in activity starting sometime in the first quarter when we do. And so when we look at contracts now on the existing AC assets, customers are asking for -- now what they're saying -- just talking about terms for me, we're looking not, let's say, 15% of the customer base. So we say, well, we don't want to go past a 6 month term or we'll do a mix, because we got caught this time with a lot of rigs rolling off term. So we're looking at 6-month term, it gets rigs back into the market, but also it doesn't put you in a position on pricing that you take and you can't take the upside in the marketplace. So we think that's the proper strategy to getting back in. We do think there's a comeback in the marketplace next year for the AC rigs.

So our hope is that whatever increase we see throughout first quarter, utilization will kind of arrest pricing declines. But it's yet to be seen.

Our final question is from the line of Brad Handler with Jefferies & Company. Brad Handler - Jefferies & Company, Inc., Research Division: Maybe I could ask a question keying on your enthusiasm about both the PACE-X and the AC rig demand, generally. How do you best position for that? Obviously, contracted opportunities are ideal, but are you willing to, given the success of PACE or your optimism about the success of PACE, are you willing to put some capital upfront to have availability there? Are you willing also to put some moving systems to convert more rigs to have moving systems on a speculative basis, just to try to capture your perception of how the market is shifting?

I have -- to answer your question -- this is Joe. I have currently ordered 10 moving systems. We placed those last month on spec. I believe 3 to 4 of those have already been taken on contracts. We currently have 3 to 4 spec rigs still in the mix, which we think there's a great opportunity for contracts on those. We have bought long lead-ons, so we can consolidate quickly and build incremental rigs. We're making the investment. We're not going to miss the market this time by not making that investment.

Yes. I think that, again, one of the reasons why we're taking this approach with the new X -- I think in my remarks you might have heard, how it's being designed to be something that maybe not just works in the U.S. but elsewhere, and Joe mentioned a couple of additional rigs don't have contracts. One of the benefits we have is the long lead components. That's really the part of the thing you got to get in the hopper. So with Canrig, we can do that and reserve those slots and without a lot of risk here of engaging in so-called spec building or spec commitments, get these components lined up and those components could be either used for U.S.A., used for International, used variety [ph] or even third parties, potentially. And so one of the reasons, one of the thinking behind this is, that's part and parcel of the strategy here. Brad Handler - Jefferies & Company, Inc., Research Division: Interesting. Makes sense. I suppose there's probably a certain minimum level of manufacturing designed around efficiency as well, right?

Exactly, yes. Exactly. Brad Handler - Jefferies & Company, Inc., Research Division: Sure, makes sense. If I could sneak in an unrelated follow-up, and I recognize that the premise for a lot of the corporate consolidation is probably as much about revenue efficiency and revenue opportunity as anything else. But can you ballpark for us some of the cost savings relative to consolidating that engineering and technical staff, for example, and some of the corporate consolidations in the United States business?

I'm just not ready to do that, but you can -- I mean, we do have some internal numbers that I'm actually ratcheting up on the guys. But it's a priority to make that number meaningful and making it visible. As I mentioned, the visibility given the dwarfing of what's happening on the gross margin level is hard to make that visible. But I can tell you we have numbers, and we're driving as best we can.

But in the corporate side, like you specifically talked about in engineering, it's more on harmonizing our old efforts and concentrating the resources, people and technology where it's needed the most, instead of having individual pools of resources. So it's more of an efficiency driven issue. Brad Handler - Jefferies & Company, Inc., Research Division: Sure. That makes sense. And maybe since you're going to lock this call up, maybe I could sneak in one more, if you don't mind. I'm getting a little confused about the concept of Alaska's seasonality, and that's probably -- that may just be my own.

Yes, it's basically the reduction in work in the legacy fields because of the progressivity of the tax. Now it's much, much more exploration-focused in the winter season. That's the bottom line of it. If we get some tax changes as the industry seems to be optimistic about, the operators have already promised a restoration some activity in the legacy fields. So that will level things out a little more. Brad Handler - Jefferies & Company, Inc., Research Division: Okay, that helps. How much -- what's a realistic kind of ballpark for Q1 activity levels then and how much does that falloff in Q2, normally?

I think you can look at the same profile last year and it's probably pretty close to that -- or this year. Brad Handler - Jefferies & Company, Inc., Research Division: The first half of the year and that path [ph], okay.

Yes, the quarter-by-quarter progression should be pretty much in line with this year.

Camille, that wraps up our call. If you want to wrap it up for us, please?

Thank you, sir. Ladies and gentlemen, this concludes the Nabors Industries Third Quarter 2012 Earnings Conference Call. Thank you for your participation. You may now disconnect.