NOV Inc. (NYSE:NOV) Q3 2023 Earnings Call Transcript

NOV Inc. (NYSE:NOV) Q3 2023 Earnings Call Transcript October 27, 2023

Operator: Good day, ladies and gentlemen, and welcome to the NOV Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session, and instructions will follow at that time. As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference, Mr. Blake McCarthy, Vice President of Corporate Development and Investor Relations. Sir, you may begin.

Blake McCarthy: Welcome, everyone, to NOV’s Third Quarter 2023 Earnings Conference Call. With me today are Clay Williams, our Chairman, President and CEO; and Jose Bayardo, our Senior Vice President and CFO. Before we begin, I would like to remind you that some of today’s comments are forward-looking statements within the meaning of the federal securities laws. They involve risks and uncertainty, and actual results may differ materially. No one should assume these forward-looking statements remain valid later in the quarter or later in the year. For a more detailed discussion of the major risk factors affecting our business, please refer to our latest forms 10-K and 10-Q filed with the Securities and Exchange Commission. Our comments also include non-GAAP measures.

A technician in a jumpsuit working on a pumping system in an oil and gas well.

Reconciliations to the nearest corresponding GAAP measures are in our earnings release available on our website. On a U.S. GAAP basis for the third quarter of 2023, NOV reported revenues of $2.19 billion and net income of $114 million or $0.29 per fully diluted share. Our use of the term EBITDA throughout this morning’s call corresponds with the term adjusted EBITDA as defined in our earnings release. Later in the call, we will host a question-and-answer session. Please limit yourself to one question and one follow-up to permit more participation. Now, let me turn the call over to Clay.

Clay Williams: Thank you, Blake. NOV’s third quarter revenues of $2.185 billion were up 4% sequentially and up 16% compared to the third quarter of 2022. The company posted fully diluted earnings of $0.29 per share for the third quarter, up $0.21 year-over-year and EBITDA was $267 million. Both sequential and year-over-year EBITDA leverage was 24%, driving consolidated margins up 50 basis points sequentially and 190 basis points year-over-year to 12.2% in the third quarter. NOV’s extensive offshore business drove results. Consolidated sales destined for offshore markets increased 10% sequentially and roughly 40% year-over-year, lifting our offshore mix to 46%. All three segments posted higher offshore revenue sequentially with Completion & Production Solutions and Rig Technologies, both posting solid double-digit growth.

Our strong franchises in oil and gas as well as offshore wind carried today. Following a decade of underinvestment, which saw North American shale crowd out spending in offshore and international land drilling, we are pleased to see growing momentum in several offshore basins around the world in addition to international land, underpinned by LNG and constructive commodity prices, global offshore FIDs look to be in the range of $140 billion in 2023, up 60% from the average of the preceding eight years and 2024 looks to be even stronger. Offshore service capacity continues to tighten broadly, driving improved economics for us and our customers. Leading-edge day rates for high-spec drillships are barreling towards $500,000 a day, and jack-up rates are rising as well.

Importantly, we are hearing of operators looking to lock up rigs for longer terms, which we hope will give our customers greater confidence to pull the trigger on capital projects that will drive future NOV orders. Although, we are a long way from offshore rig new builds, we are intrigued by inquiries we’ve received related to three Eastern Hemisphere national oil companies considering potential new build jackups and a new build floater. In the meantime, our Rig Technologies segment is benefiting from strong demand for aftermarket spares and reactivations as offshore rigs continue to mobilize. Rig Technologies aftermarket increased 10% sequentially and 46% year-over-year. Completion & Production Solutions saw bookings rise 18% and posted a book-to-bill of 114%, led by our Subsea XL Systems and Process and Flow Technologies business unit selling kit into offshore developments.

Rig Technologies capital equipment bookings for the offshore were up 14% sequentially, but overall bookings fell $44 million following Q2 strong demand for land equipment. Our consolidated revenues into international land drilling programs increased 3% with Wellbore Technologies leading the way, posting double-digit sequential gains coming from Africa, Asia Pacific and the Middle East. Consolidated international and offshore sales gains were partially offset by sequentially lower revenues in North American land markets down about 2% sequentially. Low gas prices and lower levels of US drilling softened demand for drilling equipment orders but caps benefited from some large e-frac equipment orders in the third quarter for the US. It’s been an interesting time.

We’ve navigated a decade of significant global underinvestment in oil and gas everywhere, except North American shale, which was responsible for 80% of global oil supply growth over the past 10 years. And during the last few years of this journey, we’ve been pummeled by inflationary gales and a supply chain tsunami. In response we’ve cut costs everywhere except new technology development. We push prices to try to keep up with inflation, which has been challenging. Nevertheless, I’m very, very pleased with the reception our new products are getting. As the oil field goes back to work, our customers are benefiting from NOV’s new solutions that are driving better performance, better safety and lower emissions. They like what they are seeing in demand is building notwithstanding their pledges of capital austerity and lack of animal spirits.

Let me take a few minutes to address revenues, margins and cash flow. First, with respect to revenue, NOV’s performance has been strong. Specifically NOV’s top line growth rate since our low point in the first quarter of 2021 has been at a rate of about 25% annual growth, 6% higher than the big three average through the same period. This has been driven by new bids and new drilling motors, new composite pipe designs, new digital products, including new wired drill pipe high-speed connections to the bottom of the hole. New edge computing products and new control systems and new automation tools, all of which drive performance for our customers. Thus far, NOV’s sales outperformance has been accomplished without a meaningful capital equipment recovery.

It has been achieved through resetting our activity-driven product and service portfolio to offer what we knew all along our customers would eventually need. Oilfield down cycles all end in well, up cycles. In the end of every down cycle and the beginning of the next up cycle, scarred by their near-death experience as oilfield service survivors generally suffer from chronic PTSD. They elsewhere never to spend $1 of capital they don’t have to ever again and never ever to stretch for rector bedsheets ever again, 1992 and 1999 today. In a lot of ways, following periods of underinvestment solemn pledges of capital discipline kind of marked the opening ceremony for an up cycle. As an up-cycle gains momentum and activity rises the challenge oilfield service companies face is less financial fidelity and related to the laws of physics.

The oil and gas industry consumes highly specialized fit-for-purpose equipment voraciously, putting a bit 5 miles into the earth to hit a precise target devours expensive pipe and rigs. As demand rises and equipment is consumed, prices rise to ration its availability, leading to outsized margins and returns for oilfield service participants who own scarce equipment. When E&P companies face these equipment shortages, they actively sponsor additions to fleets through profitable longer-term contracts to both incumbents and start-ups. And as the up cycle progresses, well, you know the rest of the story. Now, perhaps this time will be different, but we shall see. The second thing I’d like to talk about are our margins. While our margins continue to improve, they still remain below levels we need to generate adequate returns.

Thus, we are focused on pulling the levers we can control, namely price and cost structure. We announced that we intend to further streamline our overhead by going from three segments to two segments; Energy Equipment and Energy Products and Services starting January 1st. This is part of the $75 million cost reduction program we disclosed last quarter and is designed to make our business more efficient while capitalizing on the new technologies, we are bringing to the marketplace. We will be providing historical pro forma financials for your models next quarter. As we continue to reduce costs, we are also intent on putting better quality and higher-margin orders into our backlog. We’ve been very intentional about price, risk, and commercial terms on large tenders, particularly in the offshore and international markets.

Predictably, this has led to missing some project awards on price and terms. But having been stung by inflation, we are sticking with our disciplined approach of price leadership and quarter-by-quarter, we see our competitive positioning improving as end customers come to appreciate execution, reliability, and technology more and more. We’re confident in our strategy because we have good visibility on a growing pipeline of tenders, plus we are carrying solid and stable backlogs, $3 billion for rig, which has had a book-to-bill of 102% through the last year and $1.6 billion for Completion & Production Solutions, which has posted a book-to-bill of 106% through the past year. And as I mentioned earlier, we’ve been able to post significant revenue growth since 2021, up 75% on the strength of the rest of our portfolio, our noncapital equipment products.

Our expectation is that as the up-cycle emerges, these new businesses to lay blossoming capital equipment demand at higher margins will translate to overall higher margins and returns for NOV on a consolidated basis. Said another way, our quick turn transactional businesses have enabled NOV to post strong revenue growth, while our later cycle equipment businesses represent additional optionality to a future up cycle. Finally, free cash flow during the quarter improved $114 million sequentially, but remains negative at $34 million. As we discussed on last quarter’s call, the healing of the global supply chain has led to an acceleration of raw material and component deliveries for our businesses and net working capital remained at an elevated 33% of annualized revenue during the quarter as a result.

This trend is expected to begin reversing during the fourth quarter as our product shipments continue to catch up to the supply chain, which will improve our cash flow sequentially. Looking ahead to next year, the normalization of supply chains and working capital intensity should enable NOV to generate meaningfully positive cash flow and position us to begin returning more capital to our shareholders. So, to summarize, one, NOV’s new products and technology are amazing and are fueling strong revenue gains for the company without much assistance from our later cycle capital equipment businesses. Two, if history is a guide, these capital equipment businesses will begin to grow and then grow sharply as an up cycle matures, but for now remain mostly optionality.

Three, margins have been pressured by extraordinary supply chain disruptions and inflation, but progress in these areas has lifted margins steadily from breakeven to 12.2% in two and a half years. And four, after cresting in the third quarter, we expect working capital to decline in the fourth quarter to begin to drive strong positive free cash flow through 2024 and beyond. Years of underinvestment in the oilfield, combined with operator demands for better reliability in the field and improving cash flow for our customer base should drive our oilfield service customers to more normalized levels of maintenance spending and reinvestment in their asset bases. More efficient manufacturing operations and a fully healed supply chain, together with a higher margin backlog converting into revenue will drive better incremental margins.

All these things will contribute to improving financial results for NOV, as we work to provide the global energy industry with the technologies and customer service for which NOV is so well known. Before I turn it over to Jose for more detail, I want to thank the NOV employees listening today for all your hard work and diligence to take such great care of our customers as well as each other. Two of the best examples that I can think of are Kirk Shelton and Isaac Joseph, who I have enjoyed working with for many, many years. Many thanks to both of you guys, and I wish you all the best. Jose?

Jose Bayardo: Thank you, Clay. NOV’s consolidated revenue totaled $2.185 billion in the third quarter, an increase of 4% sequentially and 16% compared to the third quarter of 2022. Revenue from international markets grew 11% sequentially, offsetting a 6% decline in revenue from North America. EBITDA For the third quarter totaled $267 million, or 12.2% of sales, representing an incremental flow-through of 24% sequentially. We’re in the early phases of our $75 million cost savings plan and realized modest savings during the third quarter. As we noted last quarter, we expect the majority will be captured in 2024, helped by the additional restructuring efforts Clay discussed. We generated $40 million in cash flow from operations with working capital continuing to be a use of cash.

As anticipated, receivable days increased slightly with the shift in our business towards international markets. Inventory also increased, as vendors have continued to debottleneck their operations and make deliveries earlier than originally planned. However, we believe our inventory build crested in August. The timing of these deliveries also contributed towards the $82 million sequential drop in accounts payables, which further impacted cash flow in the third quarter. We expect working capital metrics to improve from here, leading to healthy free cash flow in the fourth quarter and setting up a very strong free cash flow year in 2024. Our Wellbore Technologies segment generated $799 million of revenue during the third quarter, a decrease of $5 million or less than 1% compared to the second quarter and an increase of 8% compared to the third quarter of 2022.

Improving international activity and market share gains have offset lower drilling activity in the U.S. Despite the slight sequential decline in revenue, EBITDA grew slightly to $166 million, or 20.8% of revenue. Our ReedHycalog drill bit business posted sequential revenue growth in the mid single digits, driven by continued growth in the Middle East, a strong recovery from the spring breakup in Canada and continued market share gains in the U.S. Despite U.S. drilling activity levels that have declined 16% since the fourth quarter of 2022, ReedHycalog has increased its revenues in the U.S. for three straight quarters. Our new cutter technologies continue to deliver better drilling performance and record bit runs, driving market share gains while commanding premium pricing.

Our downhole tools business reported revenue growth in the low single digits with strong incremental margins. The strong seasonal recovery in Canada and continued gains in the Middle East and Latin America more than offset bottoming activity in the U.S. Despite the unit posting a slight sequential decline in overall U.S. results, revenue from our drilling motors business in the U.S. grew 3% sequentially against a 10% decline in drilling activity. Record runs and strong performance from new products is fueling demand for our drilling motors, which has continued to exceed supply with operators increasingly preferring our Series 55 motors along with premium power sections a combination that delivers stronger drilling performance in some of the most challenging drilling environments.

Our Wellsite Services business reported low single-digit revenue growth with strong incremental margins. The improved results were driven by growing demand for solid control and managed pressure drilling services and equipment in the Middle East and offshore markets, which more than offset softer demand in the US and Latin America. New product offerings like our iNOVaTHERM solid waste control units and our growing suite of new MPD technology have positioned this business particularly well in light of climbing international and offshore activity. Our Grant Prideco drill pipe business posted a double-digit drop in revenue with outsized EBITDA decrementals after a very strong recovery in the second quarter. Over the course of the year, we have seen our mix shift from North America to international land and offshore markets.

We expect this internationally oriented revenue mix to continue into the fourth quarter. However, based on customer inquiries, the outlook for orders in the US may improve sooner than we’d normally expect, likely reflecting expectations for higher levels of drilling activity in 2024. Our Tuboscope business unit posted a slight sequential increase in revenue, achieving its 12th straight quarter with top line growth. Strong demand in the Eastern Hemisphere offset softer activity in the US and Latin America. The unit realized stronger demand for pipe coating services and our TK liner products across the Eastern Hemisphere, where activity remains strong, while lower drilling activity in the US and higher industry inventory levels of OCTG reduced demand for inspection services at steel mills and outside processors.

Our M/D Totco business results in the third quarter were flat with its record results in the second quarter. Revenues from drilling surface data decreased sequentially due to lower drilling activity in the US and strong Q2 sales of capital equipment in the for East that did not repeat, partially offset by higher activity in the Middle East and Canada. Lower revenue from drilling surface data were offset by another strong increase in revenue from our eVolve wired drill pipe drilling optimization services. During the quarter, we helped a major operator in the North Sea who shave more than 30 days from its drilling plan for a well on the Norwegian continental shelf by utilizing our wired drill pipe optimization and visualization tools, which are starting to see significant interest in the Middle East.

We estimate the significant improvement in drilling efficiencies saved our North Sea customer more than $15 million, substantially improving its wells economics. For the fourth quarter, we expect continued strength in international and offshore markets will more than offset bottoming US land activity, resulting in revenue for our Wellbore Technologies segment increasing 46% and accompanied by incremental margins in the low to mid-20% range. Our Completion & Production Solutions segment generated revenues of $760 million, in the third quarter of 2023, an increase of 1% compared to the second quarter and an increase of 12% compared to the third quarter of 2022. EBITDA for the third quarter was $67 million or 8.8% of sales, down $2 million from the second quarter and up $11 million from the third quarter of 2022.

While our CAPS segment’s results were essentially flat sequentially and drilling and completion activities remain subdued in North America. Positive momentum in international and offshore markets helped us drive an 18% increase in orders to $530 million, resulting in a book-to-bill of 114%. Backlog at the end of the third quarter totaled $1.626 billion. We’ve remained disciplined on what projects we take and continue to insist on driving pricing higher, resulting in the addition of margin-accretive projects into our backlog, which will result in higher margins for the segment as we move into 2024. Our Process and Flow Technologies business unit posted a low teens sequential increase in revenue with solid EBITDA flow-through, led by accelerating progress on new higher-margin projects in our Wellstream Processing operations.

We continue to pursue a large pipeline of potential offshore projects for our Wellstream and APL businesses. While some operators remain cautious, others are moving projects forward. We’re seeing a sufficient number of quality opportunities advance that are allowing us to remain extremely disciplined with our pricing to drive better margins in our backlog while still posting a book-to-bill near 100% in the third quarter. Our Subsea flexible pipe business posted results that were effectively in line with the second quarter but orders more than doubled sequentially, achieving the unit’s highest order intake since 2015. While it has taken some time for customers to recalibrate their expectations and the unit is still working through lower margin backlog, our disciplined approach related to which projects we’re willing to take and at what price is beginning to pay off.

Our efforts along with growing demand from Brazil, West Africa, Australia and the North Sea are allowing us to book projects that have much healthier margins and more favorable milestone payment terms than those booked over the last several years. Our XL Systems conductor pipe connections business posted a low single-digit sequential decrease in the third quarter after a robust increase in revenue during the second quarter. Orders remained strong and book-to-bill was over 100% for the fifth straight quarter led by demand from West Africa and the North Sea. In addition to the unit success in its core offshore market, the business continues to see growing opportunities in geothermal markets and recently completed the first sale of its new XCalibur gas-tight threaded connector to a geothermal customer in California.

Our Fiber Glass Systems business posted a low single-digit increase in revenues during the third quarter. Solid growth in oil and gas markets, led by the Middle East more than offset slightly softer demand from industrial and fuel handling markets. The outlook for this unit remains bright with growing demand for new corrosion-proof composite pipe products from international oil and gas markets. We also continue to see meaningful opportunities to supply our new flame and smoke resistant composite DUCs for semiconductor manufacturing plants and to support the lithium mining and processing space. Our Intervention & Stimulation Equipment business realized a double-digit sequential decrease in revenue largely due to lower deliveries of pressure pumping equipment, partially offset by higher shipments of process and wireline equipment.

While drilling and completion-related activity in the US continued to soften during the quarter, order intake remains solid with the business unit posting a greater than 100% book-to-bill underpinned by demand for our new eFrac products. Demand from international and offshore markets remain solid and customers in North America remain focused on replacing and upgrading their asset base with more operationally and energy-efficient equipment. During the quarter, we booked orders for 25,000 hydraulic horsepower of eFrac equipment in three of our Power Pod systems that enable hybrid fleets. Where eFrac equipment works alongside conventional assets, making it easy for customers to begin capitalizing on the efficiencies of our eFrac technology as they replace their conventional pumping units over time.

Despite the perception that there is much excess completion equipment in North America, demand remains steady from technology-driven customers as evidenced by the eFrac order. Demand from technology forward customers is not limited to pressure pumping, but also applies to wireline and coiled tubing equipment. In the third quarter, we sold four of our iMaxx wireline units and two high-spec coiled tubing spreads that are fully equipped with our latest controls and utilize our new digital MAX Completions platform to deliver process, machine and control data to provide superior service at the wellhead. NOV’s technology leadership is second to none, which is also reflected in our team being selected by a major IOC to engineer the industry’s first 20,000 psi pressure control equipment, for use in completion and intervention services in the Gulf of Mexico.

For our Completion & Production Solutions segment, we expect continued improvements in offshore markets will more than offset bottoming activity in North America, resulting in sequential revenue growth of between 2% to 4% in the fourth quarter. Additionally, a better mix of higher-margin business and cost savings should result in a 100 to 300 basis point improvement in EBITDA margin which should reach into the double-digits for the first time in three years. Our Rig Technologies segment generated revenues of $686 million in the third quarter, an increase of $80 million or 13% sequentially. The strong growth was driven primarily by an increase in deliveries of capital equipment packages, greater progress in projects and an increase in sales of aftermarket parts and services.

Adjusted EBITDA increased $29 million to $100 million or 14.6% of revenue. The strong incremental leverage of 36% was driven by a more favorable sales mix with improved output from our aftermarket operations as well as progress on cost reductions. New orders totaled $178 million, and we also received a $145 million inflationary price adjustment related to the new rigs for Saudi Arabia, resulting in a total of $323 million added to our backlog. When netted against Q3 shipments of $248 million, the segment’s backlog increased by $75 million sequentially to $2.968 billion. The bulk of the segment’s capital equipment orders were to upgrade or replace various rig components for offshore and land rigs. We also saw increasing demand in robotics technology due to its ability to enhance well site safety and improved drill floor efficiencies.

While orders for rig capital equipment remained muted, we’re growing increasingly optimistic that continue to improve, driving additional demand for capital equipment sales. Our aftermarket business delivered strong results in the third quarter, up 10% sequentially and up 46% year-over-year. The sequential growth was driven by a 12% increase in spare part sales. Accelerated deliveries from our vendors allowed us to ramp our throughput and begin chipping away at our backlog of orders. While total inventory increased, we were able to ship a large amount of spare part packages and assemblies that were awaiting missing components which was reflected in a 25% sequential reduction in the segment’s work in process inventory. We expect our shipments will continue to grow during the fourth quarter and combined with lower deliveries from our vendors, should drive both improved profitability and cash flow.

Beyond the fourth quarter, the outlook for our aftermarket business, which now comprises 56% of Rig Technologies mix is strong. Customers are digging deeper into their stacks for rig reactivations active rig fleet is aging, driving larger opportunities for our aftermarket operations. We’re seeing this play out in our backlog of reactivation, upgrade, and recertification projects. Executing projects with the scope of less than $2 million in the first quarter, we had $199 million in active projects with an average cost of $9 million. In the second quarter, total value of projects and execution increased to $316 million with an average price of $11 million. And in the third quarter, the total increased to $404 million with an average price of $14 million.

We expect the combination of a growing number of actively working offshore rigs and continued reactivations will continue to support a healthy environment for our aftermarket business. I next want to take a moment to highlight the importance of the duration of contracts between our offshore drilling contractor customers and their E&P operating company customers. Over the recent past, we’ve seen our offshore drilling contractor customers reset and repair balance sheets, supported by rapidly improving day rates. To-date, any rig reactivation, or upgrade has been supported by operator contracts that provide mobilization fees, higher day rates and duration sufficient to reach a payback on the meaningful investments required to get that rigs back to work.

However, despite all the contracts that have been announced over the past two years, most of the fleet remained on short well-to-well contracts, and it wasn’t until recently that the average duration of contract for the active drillship fleet exceeded one year in length. In fact, average duration of high-spec drillship contracts signed from 2015 to 2022 was about eight months. Today is pushing well beyond the year. Similarly, semi jackups are also seeing meaningful extensions of average term. This is important because it drives drilling contractors investment decisions on capital expenditures. We believe that with extending visibility of healthy cash flow backed by contracts across the offshore drilling fleet contractors will become more willing to buy upgraded equipment and reactivate rigs without contracts in order to improve their competitive positioning for upcoming tenders in which they can secure work over longer time horizons.

We’re already beginning to see signs of this taking place. In the jackup market, the slight demand dynamic within the high-spec asset class continues to tighten with leading-edge high-spec day rates now eclipsing $170,000 a day, a level above which new builds become possible. While we don’t anticipate any of the established drilling contractors to place orders anytime soon, as Clay referenced, three NOCs have made serious inquiries into current newbuild pricing, shipyard availability and construction timing. In the offshore wind market, the impact of higher interest rates and cost inflation is challenging the economics of certain high-profile projects. Therefore, it was not surprising that wind installation best contractors deferred tenders during the quarter.

Despite the recent challenges, there is still a projected shortfall in vessel capacity needed for projects that have been sanctioned, which is driving constructive conversations with multiple contractors. While we did not book a new wind installation vessel during the quarter, we did receive an order for an offshore cable vessel equipment package from a European contractor who will use their new vessel to install critical infrastructure for offshore wind development. We believe this award supports the view that the buildout of offshore wind will continue to advance once expectations on project economics or reset. Looking forward for our Rig Technologies segment, we believe steadily improving market conditions and manufacturing throughput will drive improved financial results for the segment.

For the fourth quarter, we expect revenue to increase between 1% to 3% with EBITDA flow-through in the low to mid-30% range. For consolidated company results, we believe building momentum in numerous of markets, including rising exploration activity, along with continued growth in the Middle East will more than offset soft North American land activity, enabling EBITDA to reach the $300 million range with much improved cash flow in the fourth quarter. With that, we’ll open the call to questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] And our first question is going to come from the line of James Rollyson with Raymond James. Your line is open. Please go ahead.

James Rollyson: Good morning gentlemen. Thanks for all the detail as usual. Clay, both you and Jose, kind of called out something you’ve been talking about which is on the flexible side, one of your competitors yesterday talked about receiving large orders here recently. And obviously, I think part of your strategy, as you’ve talked about, is tied not just to that business, but in general to watching the industry order uptake, watching what’s going on with capacity in certain markets and obviously kind of waiting it out to enhance your margins over time? And kind of just curious your view on how that’s playing out. And you also mentioned lower margin backlog that gets replaced with some of these higher-margin orders and going forward. Just kind of curious how that also plays out in terms of timing of margin improvement as you think about it.

Clay Williams: Jim, I’m going to address that sort of more broadly than just flexibles, but the pattern that we see within our Completion & Production Solutions backlog. About two-thirds of that backlog are longer-term sorts of contracts sort of 18 months on average to turn and in the past have had levels of inflation protection baked in and so forth and contracts and flexibles and other project-driven sorts of work that we do are characterized that way. What we experienced through the pandemic downturn and the disruptions that we faced is the inflation, you never can protect everything. And so we ran into some — a lot of margin pressure, frankly. And so what we’re trying to do is those contracts signed in 2020 and 2021, burn off quarter-by-quarter is replace that with higher margin work and that’s sort of the strategy that I think both Jose and I laid out in our prepared remarks.

And I think we’re moving into a period as the offshore, in particular, gets back to work, rising FIDs, we’re all seeing higher demand across the space. I think that can be a good tailwind for the next couple of years is high-grading our work high grading our work to be higher margin as a result of that strategy.

James Rollyson: Makes perfect sense. And then just as a follow-up on the North American side, obviously, that’s been a bit of a headwind here in the last couple of quarters, and it seems like we’re in the bottoming process here yet. Interestingly, you still — in some areas like the newer technology side on the eFracs and what have you are picking up orders. But curious how you think that plays out as the market likely starts to recover through at least next year?

Clay Williams: Yes. Good question. I think third quarter and as we move into the fourth quarter, recovery hasn’t been quite what we — or our customers had hoped for North America. But when I look into 2024 as E&Ps reset their budgets as I think as drillers get more visibility into natural gas supply-demand dynamics given that the United States is increasing its LNG export capacity in 2025 and another 6.5 Bcf per day. I think that’s going to prompt a little more drilling plus hopefully, a continued constructive oil price once the dust settles on these mergers announced for North America. I hope that’s a better backdrop for more drilling in 2024. I know we have a lot of customers that kind of see it that way. And we’re all sort of pulling for that to play out as we get into 2024.

James Rollyson: Great. Thanks. And look forward to the improvement in free cash flow.

Clay Williams: Good. Thank you, Jim. We do too.

Operator: Thank you. And one moment as we move on to our next question. Our next question is going to come from the line of Arun Jayaram with JPMorgan Securities. Your line is open. Please go ahead.

Arun Jayaram: Yes, good morning. Clay, you highlighted a 5% sequential increase in capital equipment orders, yet the Rig Tech book-to-bill is a bit below 1%, clearly, aftermarket is driving that. But I was wondering, if you could help us just think about the mix of aftermarket as we get into next year, I think Jose mentioned 56% of Rig Tech now aftermarket and just maybe the margin implications from that.

Clay Williams: I think this is going to be a good tailwind as well. We’re kind of seeing the supply chain logjam clear itself this year. We’re now getting, as we talked about on prior calls, room castings and forgings and parts that we need that’s moving through our systems now. That was a good tailwind that lifted rig aftermarket 10% sequentially and lifted at 46% year-over-year. I think we’re going to continue to make progress in that area. And that will be a really good thing for rigs margins. With respect to capital equipment, again, kind of echoing what I said earlier, we’re remaining disciplined on pricing. But as we all know, our customers are remaining very disciplined on their CapEx expenditures as well. We’re hopeful that begins to turn.

And inevitably, we know our customers are going to have to reinvest in their rig fleets and rig will gain a benefit from that. Plus, we’re kind of watching the wind turbine installation vessel demand picture here closely, softened a bit the last six months. I think our last vessel order was in Q1 but the good news is we continue to be engaged in — in some conversations with our customers here for markets outside the United States. And so — but to sum it all up, I do think you hit on the right theme, aftermarket growth here in the next few quarters is really going to drive rig results.

Arun Jayaram: Okay. And just maybe just a question. We listened to Nabor’s call yesterday. And they mentioned about some teething issues with the Saudi Arabian newbuild program, maybe pushing some deliveries a little bit. Can you just give us an update on what’s going on there and just thoughts on any impact to you as we think about next year into 2025 and up?

Clay Williams: I’ll be honest with you, Arun. I was actually puzzled by their comments, and also look back at their second quarter and first quarter comments where they said that, the rigs are performing very, very well. And last quarter, Q2, 90 days earlier, they noted we were delivering milestones on time. What I would tell you is I’m very, very pleased and proud of the execution our joint venture in Saudi Arabia has been doing. We’ve got a joint venture there with Aramco. We built a wonderful facility. It’s in a remote location, and we’re waiting for the grid to catch up to us and actually been running off a generator power for the last two years. But in spite of that, the first four rigs that we built were all delivered on time in accordance with our contract, rig number five was manufactured on time in August.

Our customer came out and witnessed our endurance test, which is part of the factory acceptance testing that we do with all of our rigs anywhere in the world and signed off on it on August 30. And so the rig has been available to pick up since August 31. Unfortunately, here we are 60 days later, and they had not yet picked it up. So I don’t quite know what’s going on there. But just want to emphasize that our team there has done a terrific job delivering on time, on budget, and I’m very proud of the great work that they have all done.