Nabors Industries Ltd. (NYSE:NBR) Q3 2023 Earnings Call Transcript

Nabors Industries Ltd. (NYSE:NBR) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Hello and welcome to the Q3 2023 Nabors Industries Limited Earnings Call. [Operator Instructions]. Please note today’s event is being recorded. I’ll now turn the conference over to William Conroy, Vice President of Investor Relations. Please go ahead, sir.

William Conroy: Good afternoon everyone. Thank you for joining Nabors’ third quarter 2023 earnings conference call. Today, we will follow our customary format with Tony Petrello, our Chairman, President, and Chief Executive Officer; and William Restrepo, our Chief Financial Officer, providing their perspectives on the quarter’s results, along with insights into our markets and how we expect Nabors to perform in these markets. In support of these remarks, a slide deck is available, both as a download within the webcast and in the Investor Relations section of nabors.com. Instructions for the replay of this call are posted on the website as well. With us today, in addition to Tony, William, and me, are other members of the senior management team.

Since much of our commentary today will include our forward expectations, they may constitute forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934. Such forward-looking statements are subject to certain risks and uncertainties as disclosed by Nabors from time-to-time in our filings with the Securities and Exchange Commission. As a result of these factors, our actual results may vary materially from those indicated or implied by such forward-looking statements. Also, during the call, we may discuss certain non-GAAP financial measures such as net debt, adjusted operating income, adjusted EBITDA, and adjusted free cash flow. All references to EBITDA made by either Tony or William during their presentations, whether qualified by the word adjusted or otherwise, mean adjusted EBITDA as that term is defined on our website and in our earnings release.

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Likewise, unless the context clearly indicates otherwise, references to cash flow mean adjusted free cash flow as that non-GAAP measure is defined in our earnings release. We have posted to the Investor Relations section of our website a reconciliation of these non-GAAP financial measures to the most recently comparable GAAP measures. With that, I will turn the call over to Tony to begin.

Tony Petrello: Good afternoon. Thank you for joining us, as we present our results and outlook. Activity in our major global markets was essentially in line with our expectations. Rig count in the lower 48 declined in the third quarter. It appears to have reached the bottom. Leading-edge pricing seems to have stabilized, lower drilling activity in the U.S. impacted results in our Nabors drilling solutions and rig technologies segments. The new bill of rigs in Saudi Arabia were a source of disappointment as reflected in our third quarter results. Specifically, the issues included delivery delays by our local supplier, field performance challenges with certain of the new build rate components, and higher startup costs, as we addressed these challenges.

The impact to EBITDA in the third quarter was approximately $5 million. We have now addressed the existing quality issues. We expect our supplier’s performance to improve rapidly as their local manufacturing experience increases. On the positive side, our lower 48 margins remain at historically high levels and international rig markets provide us with multiple opportunities at attractive pricing. For the third quarter adjusted EBITDA total $210 million. This result principally reflects the known decline in lower 48 drilling activity as well as the shortfalls in Saudi Arabia. Our global average rig count for the third quarter declined by eight rigs, all of which was attributable to the U.S. Our drilling solutions and Rig technology segments together accounted for 18% of total EBITDA.

This contribution is approximately double the proportion immediately pre-COVID. Next, let me make some comments on each of our five priorities. First, performance in the U.S., daily rig margins in our lower 40 operation were in line with our expectation. Pricing in this market reflects the reduction in industry utilization this year. Please note that our margin performance in the third quarter was higher than that of any quarter prior to 2023. Our reported lower 48 daily rig margin reflects the financial results of just our drilling rig. On top of that, Nabors Drilling Solutions portfolio generates significant additional margin. I’ll discuss this in more detail in a few moments. Now I’ll discuss our international drilling business. In the quarter, we stood up a new bill rig in Saudi Arabia and a rig in UAE.

These units are the first two of the 13 pending international startups that I detailed last quarter. Profitability improved substantially in several international markets, primarily in Latin America. Let me add a few more comments concerning the new bill program in Saudi Arabia. The fourth rig deployed in the third quarter. The fifth was also expected to start in the third quarter. Although construction of the rig has been completed, its start date has been pushed to the beginning of next year. The aforementioned supplier issues caused this delay. This timing mismatch between the capital outlays and the commencement of EBITDA had a negative impact on free cash flow in the quarter. The second tranche of five rigs is currently under construction in the kingdom.

We currently expect the first of this group to spud in the first quarter of next year. Two of the remaining four rigs should be deployed by the third quarter of 2024. The last two rigs of that tranche are expected to spud in the early 2025. Saudi Arabia recently awarded the third traunch of five new bills. We expect to deploy the first of these rigs around mid-year 2025. In general, the outlook for international business, including Saudi Arabia, remains quite positive. Coming out of the third quarter, we have 11 deployments expected through the end of 2024. Beyond these, we see improving prospects for additional rigs across the number of markets. These include Kuwait, Algeria, and Oma in the Middle East, and Argentina, and Columbia, and Latin America.

Next, let me discuss our technology and innovation. Growth in NDS’s international business actually accelerated in the third quarter. Managed pressure drilling and casing running drove this growth. NDS’s US business was impacted by reductions in overall rig activity. Third party revenue offset some of these reductions. Next, I will detail the value that NDS generates in the lower 48 market. The average daily margin in the lower 48 from our drilling and drilling solutions businesses combined was over $19,000 in the third quarter. Of that, NDS contributed approximately $3,400 per day. This significant incremental margin contribution comes with limited capital spending. Thanks to the low capital intensity of the NDS portfolio. The returns on capital are the highest in our company.

In the third quarter, penetration of NDS services held steady on Nabors rigs in the lower 48 at nearly seven per rig. Once again, we saw an increase in installations of our Smart Slides directional steering system and our smartNAV directional guidance software. Our volume of casing running jobs also grew sequentially. Our NDS portfolio remains robust. We have seen increasing interest both domestically and internationally in including for our software solutions on third-party rigs. Next, let me offer an update on our capital structure. Our free cash flow generation and debt reduction were challenged in the quarter. Most of the items impacting our liquidity were one-offs or resulted from shifts in expected timing between quarters. We are addressing the impact of the issues in Saudi Arabia that I mentioned in order to recapture our momentum.

The entire company remains focused on increasing free cash flow and reducing net debt. I can assure you these goals remain our top priorities. I’ll finish this part of the discussion, which remarks on sustainability and the energy transition. Our energy transition initiatives, as you know, focus on making a difference on Nabors own emissions profile and exporting solutions to other verticals. These technology solutions already contribute visible margins. The first of these is our power tap module. This unit connects rigs to the grid. At the end of September, we had 23 modules running more than 20% of those were on third-party rigs. We have commitments in hand to add two units in the fourth quarter. Notably, one of these is our first PowerTap unit incorporating a frequency converter for the international market.

This allows our rigs working in certain markets to tap into the local grid. We believe this is an industry first. In addition to the unit now deploying, we expect three more international deployments by early 2024. Second is the nanO2 diesel fuel additive, which improves engine performance and reduces emissions. We have treated more than 22 million gallons of diesel to date on both drilling rigs and pressure pumping units. In the third quarter alone, that increased by 10%. Quarterly revenue and EBITDA from our energy transition portfolio, once again, increased versus the prior quarter. We see a path to further growth across the client base, both on Nabors and third-party rigs, as well as in other verticals. Now, I will spend a few moments on the macro environment, notwithstanding the volatile environment as well as the decline in rig count in the quarter, commodity prices remain constructive for operator economics.

Compared to our last earnings conference call, oil prices are up more than $10 a barrel. We believe this oil price environment is very positive for international markets. We are still of the view that several large LNG projects along the Gulf Coast will support drilling activity for gas, especially in the Haynesville. These commodity prices form a favorable backdrop for operator economics. However, the combination of operator capital discipline and consolidation could temper the scale up in U.S. activity that we have normally seen at these higher prices. Recently, we have noted two announced mergers involving U.S. majors. These transactions indicate their confidence in the future of the U.S. hydrocarbon business. As I mentioned, given this backdrop, international prospects, particularly those driven by national oil companies, remain favorable.

Our balanced geographical portfolio positions us well to capture U.S. growth in 2024, and to capitalize on these international opportunities. Some overhanging risks nevertheless remain. These include sustained higher interest rates, if not additional increases by the Fed and looming geopolitical concerns across several geographies. Next, I’ll spend a few moments on the rig pricing environment. Our third quarter results for the lower 48 reflect stabilization of leading-edge market prices. As I have emphasized in the past, these current rates for our highest spec rigs exceed all of the pre ‘23 market highs. Our focus in the lower 48 market remains profitability while continuing to serve our valued customers. As such, we continue to demonstrate the worth of our technology portfolio with NDS.

As I mentioned, in the international market, we still have visibility to 11 additional rigs through 2024. This growth should provide substantial uplift potential. Given the commodity price backdrop, we believe there is room for additional unit additions in the Middle East and Latin America. As rig utilization across these markets improves, we expect rig pricing will increase further as well. Once again, we surveyed the largest lower 48 clients at the end of the third quarter. Our survey covers 17 operators, which will account for approximately 45% of the working rigs at the end of the quarter. The survey indicates this group will add about 6% to its rate count through early 2024. This increase is spread across nearly 50% of the surveyed operators.

We are encouraged by the distribution of this planned increase. With the expected international additions, we would increase our international rig count by 15% by the end of next year. Let me wrap up my remarks with the following. We expect our financial performance to improve materially in the fourth quarter as we remain committed to increasing cash flow, reducing that debt, and greater returns to our investors. Now let me turn the call over to William, who will discuss our financial results and guidance.

William Restrepo: Thank you, Tony, and good afternoon everyone. Our third quarter financial results reflected primarily the expected reduction in lower 48 activity with an associated leading-edge pricing decrease. As anticipated, our US offshore results fell as we completed planned annual maintenance and critical components for our largest rig. I will also point out that results in Saudi Arabia, despite their quarter and quarter activity increase, fell materially short from expectation. Results were mainly affected by the disappointing performance and quality assurance by the supplier of our new builds. Standard experienced delays in delivery and commissioning of their new build rigs, which cost them significant revenue and which we only partially anticipated.

These delays were compounded by unexpected downtime and newly delivered rig components by the same manufacturer. We are now forecasting additional loss margins in the fourth quarter from these issues. The drilling activity reduction in the lower 48 also impacted our NDS results more than we expected, driven by higher than anticipated rig count reductions in the general market. These affected our ability to increase penetration on third-party rigs. On the positive side, we continue to experience tailwinds in most international drilling rig markets, particularly in Latin America and throughout the eastern hemisphere. Revenue from operations for the third quarter at $734 million declined by $33 million or 4% as compared to the second quarter. Revenue for our US segment at $276 million fell by $38.4 million or 12%.

This decrease reflected an eight-rig sequential reduction in low 48 rig count. Revenue per day of $35,700 fell by $1,054 from the second quarter level. US offshore revenue was $6.5 million lower sequentially as our largest platform rig completed its planned angle maintenance for major components. In addition, a second rig was placed on standby rate by our customer through the end of the year. Our international segment reached $345 million at $7 million or 2% improvement over the prior quarter. This expansion was driven by an additional new build rig deployed in Saudi Arabia, as well as strong increases in Argentina and Mexico. These positive outcomes offset the end of contracts in Kuwait and Columbia. Nonetheless, the magnitude of the increase was disappointing due to the aforementioned delays and quality assurance issues on the new bills.

These issues cost China a total of $5 million in foregone revenue during the quarter. Nabors during solutions and Rig technologies were both affected by the reduction in U.S. rig count during the third quarter. The combined revenue impact for the two segments was approximately $6 million sequentially. Revenue in our drilling solutions segment declined by 5% to $72.8 million, reflecting the lower drilling activity in the lower 48 market. There were, however, a couple of bright spots to highlight. Despite the headwinds in the broad U.S. drilling rig market, NDS revenue continued to grow with third parties, compared to the second quarter, NDS increases us third party revenue by 8%. International revenue also continued to expand increasing by 8% sequentially.

Total adjusted EBITDA for the quarter was $210 million, $25 million lower than the second quarter at 10.6% decline. Nearly all of this decline was in the U.S. drilling segment, which reported EBITDA of $117.4 million down by $24.1 million or 17% sequentially. This was driven by the activity reductions in the lower 48 market. Lower 48 drilling rig EBITDA decreased by $18.2 million or 15.3% compared to the prior quarter. Average recount of 74 declined by 10%. Average daily rig margin of almost $15,900 was in line with expectation and represented a reduction of about $1,035 per day or 6%. Operating expenses were in line with the prior quarter. We believe leading edge prices as well as costs has stabilized. For the fourth quarter, we project our average daily rate gross margin between $15,000 and $15,200, driven by the repricing of renewals, as rigs roll to new contracts.

We’re targeting flat operating costs. During the third quarter, our rig count when it’s low as 70 rigs, and exited the quarter at 71. On a net basis, Alaska and the U.S. offshore businesses perform better than we anticipated. In the third quarter, the combined EBITDA of these two operations was $16.5 million, a decrease of $5.9 million. This reduction reflected planned downtime for the top drive upgrade and recertification on our M400 rig in the Gulf of Mexico. Combined EBITDA for Alaska and U.S. offshore should improve by $1.5 million in the fourth quarter with a full quarter of M400 operations, partly offset by planned maintenance on two rigs in Alaska. International EBITDA decreased by $2.2 million or 2.2% to $96.2 million. Average rig count and average daily gross margin were lighter than expected, largely driven by the new gold challenges in Saudi Arabia.

In addition to the material foregone revenue, we still had to absorb compensation on other costs on these non-performing rigs. For the quarter, average rig count remains at 77, average daily gross margin came in approximately at $15,800. The summit issues affected our international daily margin by about $700. We project international average rig count in the fourth quarter to increase by one to two rigs driven by redeployments in Latin America, and for average daily gross margins, we are targeting between $16,200 and $16,300. Drilling solutions posted adjusted EBITDA of $30.4 million in the third quarter down $2.3 million. This was primarily driven by the declining that Nabors lower 48 rig count. Although international and third-party revenue did well during the quarter, some of our third-party target clients reduced their activity, which cut our opportunities for additional expansion in this market segment.

We expect fourth quarter EBITDA for drilling solutions to increase by approximately 10% over the third quarter level as we continue to grow in international markets and add third party activity in the US. NDS gross margin per day for the lower 48 was $3,388. Our combined drilling rig and solutions daily gross margin close at $19,243. Rig technologies generated EBITDA of $7.2 million, a 12.7% increase versus the second quarter. This improvement was primarily driven by higher margin aftermarket sales and services, as well as higher penetration of our energy transition technologies. We expect rig technology EBITDA in the fourth quarter to expand by approximately 20%, reflecting expected yearend sales of rig components and additional increases in energy transition revenue.

Now turning to liquidity and cash generation. Free cash flow for the third quarter at just under breakeven fell below our target, mainly due to higher capital expenditures of $33 million, which reflected the accelerated timing of investments in Saudi Arabia and the US. This should result in lower than previously expected CapEx in the fourth quarter. In addition, our accounts receivable balance and other working capital items were some $40 million higher than we expected. In addition to this working capital impact lower EBITDA than plan negatively impacted free cash flow. In the fourth quarter, we expect overall CapEx to decrease significantly and the Q3 working capital impact to reverse itself. We expect free cash flow for the four-year 2023 of between $225 million and $250 million as compared to our previous expectation to generate between $300 million and $350 million.

The reduction includes $40 million of incremental CapEx during the second half. Our Algerian deployment has been moved up. We expect to spend approximately $20 million in CapEx before year end. In preparation for the four rig multi-year contract, we also decided to spend $10 million in purchasing a rented base in Argentina’s Vaca Muerta Basin. The opportunity to purchase this critical facility presented itself after unsuccessful attempts in previous years to lock in our major operation space for the long term. Finally, also SANAD new build CapEx in the third quarter was essentially an acceleration from the fourth quarter. We now expect about 10 million of 2024 CapEx to move into late 2023. Capital expenditures in the third quarter were $157 million, $4 million higher than per quarter.

This amount including investments for the SANAD newbuild program of $52 million. For the fourth quarter, we expect capital expenditures of approximately $95 million, including $35 million for SANAD newbuild. For the full year, we are targeting $520 million of which $190 million are per SANAD newbuild rigs. In conclusion, the third quarter EBITDA and free cash flow were unfavorably affected by one-off events, as well as items that shifted between quarters. Excluding these items, the underlying results for an international segment continue to progress and we expect further acceleration ahead. Just as importantly, the trends in the lower 48 proceeded as we had forecast, and I believe we have seen a bottom in rate count and pricing. We also anticipate that U.S. drilling, NDS, and Rig Tech will benefit from a meaningful uptick in activity in 2024 driven by an expected recovery in gas drilling.

Increased EBITDA in 2024 versus the prior year, as well as sustained capital discipline, should result in higher free cash flow next year than what we now forecast for full year 2023. We will continue to allocate this cash generation to debt reduction throughout 2024. With that, I will turn the call back to Tony for his concluding remarks.

Tony Petrello: Thank you, William. I will now conclude my remarks this afternoon. Notwithstanding challenging marketing conditions in the U.S., we expect a material improvement in our consolidate financial results for the fourth quarter. In the lower 48, we expect to grow our rig count this quarter from its current level. As we look to put rigs back to work, we remain committed to our pricing, discipline, and expense control. Our international segment has excellent visibility to significant growth through 2024 and beyond, and additional opportunities are already emerging across our major markets. The international portion of our NDS segment is also growing as those clients realize performance benefits from the NDS solutions portfolio.

In the U.S., we continue to focus on increasing penetration on our own rigs as well as on third-party units. We are encouraged by early signs of an acceleration in rig technologies, especially for capital equipment in the international markets. On top of that, we have high expectations for rig tech’s energy transition initiatives. We remain committed to our goals of free cash flow generation and net debt reduction. We expect to report improvements in both metrics this quarter. That concludes my remarks today. Thank you for your time and attention. With that, we will take your questions.

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Q&A Session

Operator: [Operator Instructions]. The first question comes from Derek Podhaizer with Barclays.

Derek Podhaizer: Just wanted to ask you about the 14 warm stack rigs you highlighted in the press release. You mentioned these things are ready to go. Just maybe give us a more color around your expectations on when those should be deployed, the cadence of deployment, maybe the customer type, the basin. Just help us with those 14 rigs as you look at them through 2024.

Tony Petrello: Sure. Well in terms of customer types, obviously we’ve seen a bit of a shift from the private to the public from where we were a year ago, and I think that shift is going to continue given other developments. In terms of basins right now, I think the most attractive right now is South Texas due to a combination of interest and rig availability. West Texas, there’s been some redeployments of existing equipment there and there’s no operator churn. But at the same time, we’re seeing slight increases. And based on our survey, we see a pickup in early 2024 with budgets reloading. East Texas and Northeast s we alluded to, that those are gas driven. And right now, we see some stability. In fact, we think pricing, which had been disconnected from oil is actually firming up that gap between oil and gas is actually narrowing.

So that’s another area. And then finally, North Dakota, as you get into winter, that activity’s going to be pushed into next year more. But there’s some recent stuff now, but then later in the year. So pretty much in each of those markets. Northeast, I’m not so sure where you see much in the northeast for us right now.

Derek Podhaizer: I guess how many of those 14 do you think you can add back by the end of 2024?

William Restrepo: It depends on customer demand, Derek. I mean, it’s a bit early to be hazarding that, but if the demand is there, we’ll be ready.

Derek Podhaizer: Just follow-up, just wanted to ask about the 2024 CapEx budget. Any help you can give us as far as color, maybe some bookends, how we should think about it between the US international, SANAD, technology, anything just to give us some preliminary guidelines here.

Tony Petrello: I think, SANAD will be similar to this year, maybe slightly higher. Because the suppliers going to get better and probably deliver those rigs, a little bit more reliably than they have in the past. We’ll have a significantly higher rig count. And as you know, the maintenance CapEx is directly correlated to the number of rigs. So that will go up. So those are the areas where we see, on the other hand, we won’t be buying a base in Argentina. And some of the things we have absorbed in places like the Algeria will not repeat. So, we will see, I would expect to see CapEx higher than this year, but we haven’t yet finalized our budget exercise. And as you know, CapEx is a competition between different geographies. So, we are shooting to have a number that’s going to be constructive in terms of free cash flow generation next year, but we we’re not ready yet to share that with our investors.

Operator: And the next question comes from Arun Jayaram with JP Morgan.

Arun Jayaram : Good afternoon. Tony, I just wanted to go through some of the call, the challenges you talked about in Saudi Arabia in the quarter. How has this impacted the future timing of the new build schedule? Is this going to be kind of compartmentalized to this year or does it have kind of a knock-on effect? And I know you gave us a bit of color around four startups next year and five beyond that?

Tony Petrello: Correct. Well, yeah. Let me give you some context first. First of all, the new build program vis-a-vis what neighbors normally does in countries, it’s kind of sui generous. Because as you know, in this particular operation, it’s unique because Aramco has committed over 10 years for us to build these, these 50 rigs. Five a year. But also, this was part of Vision 2030 and they wanted to source the manufacturing in local country and they award that sourcing contract to a joint venture between them and OV. So unlike where Nabors normally does stuff or our sales and controls at all, that’s different. And also, the fact was that JV called on had no infrastructure. So, they had to build a new facility, they have to get up to speed, they had no inventory, all that stuff.

And all that was occurring at the same time. The new build programs started to get underway. So, the only thing I tell you is, that we’re committed to follow Aramco’s wishes. I’m trying to make this work. We actually have a 30-year relationship with NLV [ph], so we respect them, but it’s hard and it’s — these are — this is actually a very big project and there’s a lot of strain in the system when this stuff happens. Aramco has very deliberate acceptance testing processes and procedures and what’s been going on these rigs is given — it’s all a startup operation from a manufacturing point of view, the acceptance for seizures are taken somewhere from two to three months just to go through acceptance testing, nevermind putting things that are coming up.

And then there’s issues of stock inventories for stuff that’s never been there in the country before and all those kinds of challenges. So that’s what’s stretching everything out and that’s what’s create great tension. But notwithstanding that, I think we’ve really had some great success this year in terms of getting these rigs on the payroll. And as we said, we have great visibility here right now, in terms of next year with the four more rigs next year and the beginning of the second crunch. So as William said, the fifth of the first crunch, it’s going to be pushed to the first quarter. Obviously, that rig, as we alluded to, is already built. But again, for all these problems, we have to make sure the base rigs are all working in the right way.

That’s the foundation here. So, it’s in everybody’s interest to make sure they’re all get to up to snuff the exact way and then it should become cookie cutter as you go forward. So that’s why the time is being spent here. And obviously that all drives extra costs, because if you have a rig and you’ve been crew planning for the rig and then the acceptance testing gets strung out, then we have all that crew, extra crew expense as well. So that’s what’s driving a lot of this extra expense here. So that’s a concept. And then the last thing I make is, two other good points here is we’ve also told you that the third tranche has also been announced, which is going to start in 2025. Again, that just shows Aramco is really getting behind this thing now and the fact that they’re announcing it so early when 2024 is not even yet delivered, the second tranche shows that their intent on pushing everybody to actually get the program going.

So here, so like I said, everybody’s motivated to get this work. I’m sure, our friends across the street feel the same way and we just want to make it work and get this cadence down. In terms of the numbers and impact, I think this is probably the least appreciated thing of what Nabors has today actually. These — the four rigs that have already been put on the payroll next year, combined with the four that are going to be added are going to be more than $40 million incremental EBITDA…

William Restrepo: $50 million to $60 million roughly actually to be precise.

Tony Petrello: Yes. Well, so anyway, the magnitude as you can see is very large and therefore that gives us great visibility. And when you add that to the 11 rigs that you know about in other markets, I think international is really poised for a really great upturn here. And we can talk a little bit more about that context. But hopefully, that answers your questions about Saudi Arabia. If you have any other ones, I’ll be happy to follow up question.