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.

Arun Jayaram: Great. Thanks for the clarification. Appreciate it.

Clay Williams: You bet.

Operator: Thank you. And one moment as we move on to our next question. And our next question is going to come from the line of Stephen Gengaro with Stifel. Your line is open. Please go ahead.

Stephen Gengaro: Thanks and good morning everybody.

Clay Williams: Hey, Stephen.

Stephen Gengaro: Two for me. I think I’d start, Clay, you mentioned in your prepared remarks, you kind of alluded to new build being a long way off. And I was just curious kind of what your take is on the potential for new build deepwater rigs over time? And maybe as part of that, any sense for kind of what’s in sort of the idle bucket that still any idea for the number of rigs which could realistically come back to the market before we see something like that?

Clay Williams: With respect to reactivating rigs, I’m going to stay focused on offshore, Stephen, I think that’s the context of your question. We’re kind of getting to the bottom of the barrel, frankly, on rig reactivations, new construction projects that were suspended through the past decade that have been restarted and so those opportunities are becoming less and less. And with respect to those individual opportunities, as Jose pointed out, kind of rig by rig, it’s taking a lot more money and capital to get those rigs back into the fleet and serviceable because they’ve been stacked longer. And so the revenue opportunity per rig has been going up for NOV as we start reactivating more rigs. Moving to new builds, it’s getting to be an interesting time.

I do think we’re ways off from compelling new build economics, and that would require day rates to take another leg up and probably a substantial leg up from where they are today. And I would add, there’s additional headwinds in addition to returns, which are, one, Asian shipyards kind of got burned out of the last super cycle and ended up with projects that weren’t completed and customers that went bankrupt. Two, so they’re going to be a little more hesitant to take these demand higher margins. Two, they’re pretty busy with the rising book of business for FPSOs, LNG vessels, wind turbine installation vessels and other things. I think banks are probably a little hesitant to lend into this. But I guess what I would underscore is that’s not necessarily unique for prior up cycles where the industry faced expensive capital and difficulties with capital.

And eventually, what happens is as these assets are fully utilized and very expensive, it’s the oil companies that really need assets to prosecute their development aspirations. And they are the ones that jump into the scene and start prompting either start-ups or incumbents to start thinking about adding capacity, and I would love to tell you when that will happen, but going to beg off. I don’t know when. It’s not next quarter, it’s not next year. But I think if history is a guide, it’s sort of — it’s not if but when. And so that’s just the way the cycles kind of play out here in our space.

Stephen Gengaro: Great. Thanks for the color. And then my follow-up, I know you want to look too far ahead of the fourth quarter. But when we think in next year, we think of maybe a modest rebound in U.S. land and kind of what seems to be this consensus from at least the large service companies around double-digit international growth. In that context, how do you think your revenue performance? You mentioned the outperformance on the top line relative to them over the last couple of years. Just curious your take on that.

Clay Williams: We feel pretty good. Again, quarter-by-quarter, we’re getting more E&P companies interested in the technologies that we can bring. And as we all know, they’re at the top of the food chain here in the oilfield and certainly getting busier in offshore and in international markets. And I think as an organization, we’ve gotten a lot closer to national oil companies to IOCs and they’re liking what they’re seeing. So I think next year we’ll be good. We’re actually in the middle of our annual planning process now and some — to not wrap numbers around that, but I think the outlook for 2024 top line growth continues to be very strong.

Stephen Gengaro: Great. Thank you.

Operator: Thank you. And one moment of our next question. And our next question is going to come from the line of Marc Bianchi with TD Cowen. Your line is open. Please go ahead.

Marc Bianchi: Hey, thank you. I’m curious about the new segmentation and how you expect that to drive better results. How are you going to define success there? And are there any targets that you’d be willing to share with us?

Clay Williams: Yes, it’s a good question, Marc. First, for us, success is always financial, right? We’re a public company and very focused on returns on capital, margin efficiency and the like. The reason for the move is the role of our segments here at NOV have always been to coordinate the cooperation between our business units, our product lines, to enable them to use shared services within our organization and lots of examples of that. But for instance, Wellbore Technologies that segment was able to coalesce a lot of manufacturing activities across multiple business units several years ago to drive efficiencies. And when you go from three segments to two segments, we’re kind of rearranging some business units within that, and I think it’s going to give us opportunities for even greater operation across product lines and business units and avail ourselves of more benefits from shared services and the like.

So we’re believe that’s going to contribute to more efficient operations in the future. It’s part of our $75 million cost reduction annual cost reduction program that we talked about last quarter and I think ultimately, this is going to make us better. But the right measurement is going to be financial.

Marc Bianchi: Okay. Jose, you had talked about healthy free cash flow in the fourth quarter and very strong in 2024. Can you put some — maybe put some brackets around that or help us understand what – what that translates to in dollars, maybe on a conversion of EBITDA, or however you want to talk about it?

Jose Bayardo: Sure, Marc. So yes, we were intentionally vague on that this time around because obviously, we’ve been struggling a little bit from a free cash flow perspective this year for both good and bad reasons. When I say good reasons is that, one, the business has had better top line growth than we anticipated coming into the year. Particularly from international and offshore markets, which have longer cycle times and our — the downside of it is consuming more cash tied up in AR and inventory. The other piece that’s both good news and bad news relates to our challenges with inventory. The good news is that the supply chain has continued to get better and better. Vendors are accelerating deliveries to us. Bad news is obviously the impact that it has on our inventory growth and the cash consumed by that.

But as I said in our prepared remarks, inventory, we believe, peaked in August and has started trending down, and that will help support healthy free cash flow going forward. And so look, if you look at our current working capital metrics, and we’ll start with the one simple high-level one, which is working capital as a percentage of revenue run rate. finished the quarter at about 33%. If you just sort of look back to where we’ve been historically in the not too distant past, we were down to 25%. But let’s not get overly ambitious. We’ll call it, if we get back to 27.5%, that immediately frees up $480 million in cash. So last quarter, I think I said we should see at least a 50% conversion of EBITDA to free cash flow next year. I still think that is easily achievable.

Obviously, the free cash flow breakeven for Q4, I think, is a bit ambitious at this point. It’s not completely out of the question. Look, if you go back to 2019, we had, in the fourth quarter of 2019, we had $473 million in cash flow from operations. If you assume we did the same thing there, we fall about $50 million short on sort of that target. But realistically, I think we’ll probably have best estimate free cash flow in the fourth quarter, somewhere between $100 million and $300 million. But as we’ve seen and frankly, as some of the big three service companies have talked about in their conference calls, pinning down free cash flow in one quarter is a pretty difficult thing to do, highly dependent on the timing of customer payments and other things that come along.

But at the end of the day, we’re in it for the long term. And long term, we think we’re right on the cusp of shifting over to generating extremely healthy free cash flow going forward.

Marc Bianchi: That’s great. I appreciate it. It’s tough to call. So thanks very much for all the commentary on it.

Jose Bayardo: Thanks, Marc.

Operator: Thank you. Our next question comes from the line of Kurt Hallead with Benchmark. Your line is open. Please go ahead.

Kurt Hallead: Hey, good morning.

Clay Williams: Good morning, Kurt.

Kurt Hallead: So Clay, I’m really curious, right, as the cycle evolves and you kind of outlined the historical dynamics of what your customers tend to do, how they behave and kind of what drives your decision making and then how it has a positive impact on your businesses, right? But you guys have like a number of different product lines across a lot of different areas. And I’m just kind of curious, as this cycle evolves, what is the thing that gets your organization most excited? Like for example, in the prior cycle was like a new top drive and along those lines, right? So, what are the two or three product lines that you think are really going to be difference makers.

Clay Williams: It’s a great question. I think edge computing condition-based monitoring, control systems, the whole digital space. We’ve come out with so many new products there, and we’re seeing really good traction and specific application of those digital products with our wired drill pipe hardware, Kurt, coupled with managed pressure drilling, I really think we’re pioneering a whole new way of drilling that 10 years from now, 20 years from now, let’s say, you’re going to see on most rigs. And the customers a great stable customer base in the North Sea, putting us to work with really good results, seven or eight customers there. We’ve got four customers in the Middle East running — getting ready to run trial programs, super excited about that.

Our products that reduce emissions, including cuttings waste management technologies, a lot of interest in the Eastern Hemisphere as operators tighten their cuttings disposal requirements and reduce the oil on cuttings that they’re willing to tolerate. And so that requires a lot of NOV technology. We’ve got new automation products that are couple of dozen customers are looking at. And the first version of that is running for an offshore driller in Brazil. The first land version of that is going to be operating very soon as well. Just across the board, we put a lot of really creative thought and ingenuity and innovation into our product portfolio really kind of outside the whole capital build — and that’s what’s been driving the topline growth for the past two and a half years, and I’m super excited about all that.

Also excited about the old — the good old rig iron that we make and the new versions of that like e-frac and so that — but across the board, the level of creativity and innovation in this organization just amazes me every day. And we’ve got real solutions for our customers to make their operations more efficient, safer and lower emissions. And I think that’s what’s going to drive NOV’s fortunes. While the capital equipment dynamic remains, as I’ve mentioned in my remarks, more optionality at this point. But on the whole, we’re looking forward to the next few years.

Kurt Hallead: That’s great. So, one other thing — all right. So, I guess one thing I’m very curious about and you kind of referenced this concept about offshore drillers potentially being willing to activate rigs without contracts. Is that your sense of how history may repeat, or are you getting indications from your discussion that’s actually going to happen?

Clay Williams: No, I would say, not yet. We’re not seeing that just yet. But our point was longer term contracts and as the market moves towards — E&Ps are starting to realize, hey, rigs are in short supply here, I better sign-up contracts that run a little bit longer than I previously could, which is in contrast to — there’s a bunch of rigs out there that’s oversupplied. I’m just going to go well-to-well, which was — has dominated the prior decade. We think could change their thinking. But right now, everybody is very capital disciplined and understandably so, coming out of the last 10 years and all the financial challenges we’ve all been through. But again, if history is a guide over time, and shortages of equipment and high margins that are earned by the people that own that equipment can change that thinking.

Jose Bayardo: And Kurt, I’d add that we’re not seeing that take place. there are conversations where customers are getting a little bit further ahead in terms of planning and preparing and starting to do small things around the edges to get ready to go sooner rather than later.

Kurt Hallead: Got you. Look, if I may squeeze one more in because you’ve referenced it earlier about how do you gauge success on restructuring and so on, right? So maybe we can talk about it in this context. What type of incremental margin would you then equate to success? In the past, you’ve given some updates on incremental margins for your different business segments on a through-cycle basis. So maybe we can throw that out there, and say what are the incremental margins that you would want to see achieved in these new segments to say, hey, we’re successful.

Jose Bayardo: Yeah. So Kurt, good question, tough question. But really, outside of what we’ve really accomplished with Wellbore Technologies here to date in the cycle. We, obviously, haven’t been extremely satisfied with the incremental margins that we’ve delivered. So part of this restructuring, part of the cost-out program, part of the doubling down our efforts to make sure that we’re extremely disciplined in knowing what type of opportunities that we’re going to have to drive price higher revolves around trying to drive those incremental margins higher. And so I think the same through the cycle, incremental margins apply, same things that we’ve always talked about, as we’ve also always talked about different points in the cycle, they can be above other parts of the cycle, they can be below.

And so as I mentioned to date, some of those have been below over the last couple of years, and our aim here is to accelerate getting them to be above the average expected through-cycle incremental margin.

Kurt Hallead: That’s good, really good. Really appreciate that. Thanks.

Jose Bayardo: Thanks Kurt.

Operator: Thank you. And one moment for our next question. And our next question comes from the line of Ati Modak with Goldman Sachs. Your line is open. Please go ahead.

Ati Modak: Hi, good morning team. Just to follow-up on some of the questions from — before on free cash flow, maybe any color you can provide on the cadence because it sounds like the conversion is improving. But should we still see impact of working capital seasonality to start the year, next year? And then what metrics are you looking at to inform your capital allocation strategy?

Jose Bayardo: Yeah. So from a free cash flow standpoint, yes, we’ll continue to have seasonality with Q1 typically being a more challenging cash flow quarter, but then we expect it to improve throughout the course of 2024. And I’m sorry, I didn’t catch the second part of the question.

Clay Williams: Capital allocation. Was that your question, Ati?

Ati Modak: Yeah.

Clay Williams: Yeah. What I would say is we — with stronger free cash flow in 2024, I’m hoping — well, that should open up opportunities to return more capital to shareholders. We have, I think, a pretty strong track record here, having returned almost $5 billion since 2014 through both share backs — share buybacks and dividends as well as continuing to move forward on our organic growth opportunities. And as we always do, we’re going to keep an eye on M&A opportunities. But I think looking forward into 2024 really focused on allocating between those three areas.

Ati Modak: That’s great. And then curious if you’re seeing any conversations around new build frac fleets at all, particularly given the strength in pricing in pressure pumping has been very strong this year despite activity declines. Anything that you could share there? What could that mean for NOV?

Jose Bayardo: Yes, we are having inquiries around new frac fleets, a lot of that. I mean, as you know, the frac fleet has a lot of churn in it because it’s so consumptive of equipment. And as the industry has moved to greater frac intensity that equipment is being run harder. And so yes, we’ve had a number of conversations underway with customers around new frac fleets. What I would tell you is that the interest in electric fleets continues to grow, in particular, we noted this quarter some orders for some pumpers and e-frac equipment. And so I think more and more E&P companies are requiring that are preferring frac fleets, because they have lower emissions as well as the pressure pumpers learning, they have lower cost of ownership. And so that’s a good opportunity, I think, for again, NOV’s technology to play a key role going forward.

Ati Modak: Thank you. I appreciate the answers.

Jose Bayardo: You bet. Thank you.

Operator: Thank you. And this does conclude our question-and-answer session. And I would like to hand the conference back over to Mr. Clay Williams for his closing remarks.

Clay Williams: Thank you, Michelle, and thank you all for joining us this morning. We look forward to discussing our fourth quarter and year-end results with you in February. Hope you have a very nice day.

Operator: This concludes today’s conference call. Thank you for participating. You may now disconnect.