Nabors Industries Ltd. (NBR) Q3 2015 Earnings Report, Transcript and Summary

Good morning, and welcome to the Nabors Industries Third Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Dennis Smith. Please go ahead.

Good morning, everyone. Thank you for joining Nabors' earnings teleconference to review our third quarter results. Today we will follow our customary format with Chairman, President and Chief Executive Officer Tony Petrello, and William Restrepo, our Chief Financial Officer, providing our perspectives on the quarter's results along with some insight into what we are seeing in our markets and how we expect Nabors to perform in these markets. In support of these remarks, we have posted some slides to our website, which you can access to follow along with the presentation if you desire. They are accessible in two ways. One, if you are participating by webcast, they are available as a download within the webcast. Alternatively, you can download the slides from within the Investor Relations section of nabors.com under the Events Calendar submenu, where you will find them listed in Supporting Materials under the conference call listing. Instructions for the replay are posted on the website. With us today in addition to Tony, myself and William are Laura Doerre, our General Counsel; Siggi Meissner, our Head of Global Drilling; and Chris Papouras, our President of Nabors Drilling Solutions. Since much of our commentary today will concern our expectations for the future, they may constitute forward-looking statements within the meaning of the Securities and Exchange Act of 1933 and the Securities Exchange Act of 1934. Such forward-looking statements are subject to certain risks and uncertainties, as disclosed by Nabors from time to time in its filings with the Securities and Exchange Commission. As a result of these factors, our actual results may differ materially from those indicated or implied by such forward-looking statements. Also during the call we may discuss certain non-GAAP financial measures such as adjusted EBITDA and adjusted income derived from operating activities or adjusted income. We have posted to the Investor Relations section of our website a reconciliation of these non-GAAP financial measures to the most recently comparable GAAP measures. Now I will turn the call over to Tony.

Good morning, everyone. Welcome to the call. We appreciate your participation as we review our results for the third quarter of 2015. As Denny mentioned, we have posted the accompanying presentation slides on our website. I will begin with a brief summary and then comment on our performance in the quarter. William will follow with a review of the quarter's financials. I will then wrap up and take some questions. The third quarter was challenging, particularly for the U.S. drilling industry. Nabors' results for the quarter demonstrate the value of our international operation in a difficult environment. In the U.S., our results declined along with industry activity of pricing. We also saw the impact of rig rates resetting to the current market. Margins were also impacted by a reduction in the number of rigs stacked on rate. Our international results were more resilient, both in rig years and in daily margin. Now I will provide a brief rundown of the quarter's results. Revenues of $847 million were down 2% sequentially. Worldwide rig activity declined to 242 rig years in the third quarter from 256 rig years in the previous quarter. Adjusted EBITDA totaled $248 million, down 14% sequentially. The primary driver of that decline was a 31% reduction in cash flow in our U.S. drilling operation. In light of the current market condition and our outlook, we impaired the value of several assets in the third quarter. The most significant of these was our investment in C&J Energy Services. William will discuss these items in more detail shortly. During the quarter we had several notable accomplishments. First, we completed the deployment of three previously announced high-specification rigs into Saudi Arabia. We built these rigs on time and on budget, and they are all drilling on multi-year contracts. Second, all six of the announced PACE-X rigs destined for Colombia are in country. During the third quarter, we began drilling operations with three of the six. The other three are starting up this quarter. We also deployed a new PACE-X rig to a customer in the South Texas market. Third, we took advantage of the favorable credit markets and secured a new $325 million term loan. The loan was intended to provide us with additional financial flexibility. The current interest rate is 1.175%, which is lower than the rate on our revolver. We intend to use the proceeds mainly to fund the debt maturity scheduled for next year. More immediately, we paid down a portion of our outstanding commercial paper. Finally, the equity market's recent volatility presented us with the opportunity to repurchase shares of Nabors. During the quarter we bought back 8.3 million shares. Next, I would like to share our view of the market, our strategies to manage in the current market and the near-term outlook. We saw two distinct phases to the third quarter. At the start of the quarter, WTI was approaching $60. Through the first couple weeks of August, optimism was building, at least among some customers. The Lower 48 land rig count increased by nearly 25 rigs during that time. From mid-August through the end of September, the rig count declined 71 rigs, or 9%. Nabors' market share held up during this time. Our rig count declined by 7%. That decline in market utilization, which has continued through last week, has led to additional declines in spot pricing. For the rigs that are continuing to work after existing contracts roll off, the downward reset in pricing is significant. You can see this impact in the decrease in our Lower 48 daily margin. As we look ahead in the near term, several factors will impact our Lower 48 results. First, commodity prices remain low. WTI is down to between $45 and $50. Natural gas remains below $3. Second, we expect that pricing environment will impact operator cash flows and their capital spending, especially as we approach the typically slower end of the year and the exhaustion of budgets. Third, going into 2016 we assume operator budgets will be set later rather than sooner. This delay could potentially create a further deceleration of drilling activity and the rig count. For the international segment, we foresee relative stability in both activity and pricing. However, international markets are not immune from the effects of weak commodity prices, especially in Latin America. We will continue to pursue additional opportunities to add rigs with long-term contracts at attractive returns. At this point, however, these opportunities are limited and concentrated in a few markets. With this backdrop, I will discuss the strategies we have adopted to navigate through this environment. First, we continue to aggressively and prudently pursue revenue opportunities. Our aim is to create an advantage in the market by increasing our service content while remaining competitive on pricing. Customers are responding positively to our additional service offerings. Second, we continue to rationalize our expense structure. The team has held direct field expenses in line with activity. Among our operating segments, staffing is down 29% since the fourth quarter of 2014. Segment revenue over that same period is down slightly more at 33%. In light of the activity decline since this summer, we have implemented another round of G&A reductions. As of the third quarter, the first round resulted in annualized savings of over $115 million versus the fourth quarter of 2014. For this next round, we are targeting an additional $30 million of annualized savings. We are also working with our vendors to further optimize our supply chain by an additional $100 million annually. Third, we remain dedicated to our stewardship of the company's capital. We are also committed to remain free cash flow positive. For 2015, we now expect capital spending for our current portfolio of businesses to finish below the $900 million threshold. Looking into 2016, our newbuild programs are scaling down. Along with rig activity, we should realize reductions in our maintenance capital spending as well. We are still developing our 2016 budget. We could see total CapEx below $700 million if necessary to maintain positive free cash flow. Fourth, our investment in new technology continues at prudent levels. We are in the advanced stages of development of innovative new rig designs. Our efforts to integrate downhole sensing with surface automation are also progressing. This downturn reinforces our vision, which is to fundamentally improve the drilling process and ultimately improve well productivity for our customers. Finally, we are committed to operational excellence. Our safety record continues to improve. We are again on track for another record safety year. We are achieving repeatable improvements in rig performance metrics such as move time. These achievements clearly benefit our rig hands, our customers and ultimately our company. Our performance in the field is also improving. Our PACE-X rig, which was designed for multi-well pad drilling, is now regularly completing pad-to-pad moves in less than three and a half days, and in some cases less than three days. This performance should increase the marketability of the X rig for smaller pad drilling programs. Now I will discuss the outlook. With commodity prices where they are, we believe U.S. drilling activity will continue to deteriorate into next year. Our visibility in this current market is limited. At the same time, U.S. oil production has begun to decline. That trend should eventually support higher commodity prices and ultimately increase oilfield activity. Before that increase occurs, operators will have to become convinced that higher cash flows are sustainable. That level of confidence is not yet evident among our customer base. Internationally, we see two scenarios unfolding. With few exceptions, our customers in countries with ample fiscal reserves are largely holding activity levels at a steady pace. This suggests status quo in those markets. The other scenario includes customers in geographies where fiscal stress exists or is emerging. Those customers are increasingly challenged to hold drilling activity at its current level and are likely to curtail activity. We continue to experience pricing pressure in most international markets. With that backdrop, I will now make a few comments regarding the outlook for our larger businesses. In the Lower 48, our rig count today stands at 82 rigs, including six rigs on rate. We exited the third quarter at 86 rigs total, including six rigs stacked on rate. Of the 86 rigs, 60 rigs were working on term contracts. For the fourth quarter, our rig count could average in the mid-70s and exit the quarter somewhat below that range. We also expect the fourth quarter average daily margin to decline by approximately $1,000 as the fleet increasingly reprices to current market. For our international segment, rig years totaled 121 in the third quarter. Given current trends in our outlook, we could drop by as many as five rigs in the fourth quarter. That incorporates the positive impact of the deployments in Saudi Arabia and Colombia. Our daily rig margin could contract by $1,000 to $1,500 per day. Several impactful projects are winding down, including Papua New Guinea and offshore Australia. We also expect some erosion in other markets. To summarize, several factors could further impact our results in the coming quarters. First, with the potentially weak finish to 2015 industry activity, our rig count and revenue are likely to deteriorate. Based on the number of well-to-well contracts and longer-term contract expirations, we are seeing average rig margins reset rapidly towards current spot market pricing. Second, the drilling market in Canada remains depressed along with commodity prices. An early start to the usual holiday-related pause in rig activity could challenge sequential growth in the Canadian market in the fourth quarter. Third, in our international segment, we still expect an improvement in full-year results over 2014. As we look ahead, we anticipate some deterioration on our rig count in the fourth quarter. Finally, we remain firmly committed to maintain breakeven or higher free cash flow. We will scale our cost structure to the size of our operations as warranted. We will remain extremely focused on initiatives to reduce overhead and optimize our supply chain. Our capital spending remains highly disciplined and scalable. These strategies should mitigate the effects of the current downturn and better position the company for an eventual upturn. This concludes my outlook comments. Before I turn the call over to William for his comments, I'll address a couple of other topics. First, the Big Foot platform floated out last spring. Subsequently, the platform's tendons experienced significant buoyancy issues. The platform was moved away from the intended location and it is now back in Corpus Christi. We still anticipate an extended delay before the rig commences drilling. Second, the recent term loan I mentioned earlier is another step in the active management of our debt structure. That structure benefits from investment-grade ratings and covenant terms attractive to our company. Currently, we have only one financial covenant in the entire debt schedule. That is a net debt to total capital metric which only applies to the revolver. The next maturity is $350 million of notes due in September 2016. With the proceeds from the term loan we recently did, we have effectively refinanced a large portion of those notes. Finally, long-term followers of Nabors know very well that the company was built on acquisitions. Specifically, Nabors has a good record of acquiring assets at attractive valuations. The current market conditions could once again bring such assets to market. Although we have evaluated several packages recently, we have not yet seen the fit or the valuations that make sense to us. I assure you, we look at everything, and we apply rigorous criteria in our evaluation process. We are committed to completing deals only if there's a clear expectation of value creation for Nabors' shareholders. This concludes my comments. William will now review the quarter's financial results in more detail and provide additional thoughts on the outlook.

Thank you, Tony, and thanks, everybody, for joining us today. Net income from continuing operations for the third quarter was a loss of $250.9 million, or $0.86 per diluted share. Excluding exceptional items essentially related to the current market downturn, the net loss from continuing operations was $44.9 million, or $0.14 per diluted share. Included in the above loss was our share of C&J's earnings with a one-quarter lag; in effect, a loss of $35.1 million dollars, or $0.12 per diluted share. Our core drilling business delivered a loss of $0.02 per diluted share. For purposes of this discussion, we excluded from our earnings the following items. First, the current industry environment resulted in several charges, mainly from asset impairments, sale of assets at a loss, severance costs, and currency exchange losses for a total of $250.9 million before tax, which translated into $225.1 million after taxes, or $0.79 per diluted share. Included in these charges is a $180.6 million impairment on the value of our C&J shares. Second, we recorded several one-time items related to income taxes that resulted in a $19.1 million benefit to our third quarter earnings, or $0.07 per diluted share. The largest of these items reflected a reduction in our forecast annual effective tax rate used for the allocation of income taxes between quarters. This required a favorable adjustment in the third quarter to the tax expense we recorded for the first half of the year. Moving on to our results, revenue for the quarter of $848 million decreased by $16 million, or 2% sequentially. Revenue in our international segment increased sequentially by 13%, primarily due to the full-quarter effect of the Saudi JV consolidation, partial payment for the newbuild rig we're selling to a customer in Kazakhstan, and improved operating results in Venezuela. Our revenue in the North American drilling market fell by 15%, driven primarily by the falling rig count and weaker pricing in the Lower 48. This decrease was exacerbated by seasonal factors in Alaska but partially offset by the seasonal uptick in Canada. Revenue for other rig services decreased by 27% as new rig building decelerated further and demand for Ryan's directional drilling services continued to trend down, albeit a couple of percentage points better than our drilling revenue reduction in the Lower 48 market. Consolidated operating income dropped sequentially by $62.5 million to $7.5 million. The current market conditions resulted in declines in operating income in all units with the exception of Canada and the U.S. offshore market. Operating income margins for the company of 0.9% fell by 720 basis points sequentially. Adjusted EBITDA held up better at $247.6 million for a margin of 29.2%, which represented a sequential reduction of $40.6 million and 420 basis points respectively. I will now cover the key performance metrics from the third quarter and then discuss two third quarter financial transactions. First, the U.S. drilling business. The quarterly average Baker Hughes land rig count declined by 43 rigs, or 5%. Our own Lower 48 rig years declined to 89, a 14% decrease. This reduction resulted mostly from the expiration of contracts for rigs previously stacked on rate, although our working rigs also decreased during the quarter. Daily gross margin in the Lower 48 decreased to $8,609 from $11,205 in Q2. However, the second quarter figure includes some level of lump sum early termination of revenue. If we adjust the second quarter daily margin for the full amount of early termination payments, the normalized daily margin for the second quarter was approximately $10,200 per day. The normalized sequential reduction of $1,600 per day was attributable to a reduction in average day rates and an increase in daily cost per rig driven by higher compensation per rig, as the rig count increase we expected in August did not materialize, and by an eight-week reduction of higher-margin rigs which were stacked on rate with minimal costs. Given the current environment, we anticipate a further reduction in drilling margins of up to $1,000 per day. While results in the Alaska business declined seasonally, we continue to run approximately two rigs more than last year. The U.S. offshore business did somewhat better than last quarter, essentially reflecting a construction-related payment. Utilization in the Lower 48 continues to vary significantly by rig type, with the highest utilization in our most capable rigs. At the end of the third quarter, 92% of our PACE-X rigs were on revenue. In Canada, the normal seasonal ramp was muted by the severe contraction in drilling overall. Adjusted EBITDA in this segment doubled sequentially to $7.5 million but operating income, although improved as compared to the breakup second quarter, closed at a loss of $4.1 million. In our international segment, third quarter rig count totaled 121.3 rig years, down from 127.1 rig years in the second quarter, translating into a 5% decrease, somewhat less than the decline we anticipated a quarter ago. Average daily cash margin in the international business widened by $1,350, principally reflecting the impact of new rig deployments and strong operational execution. We expect fourth quarter margin to decrease somewhat towards more normal levels. In our rig services segment, which consists of Canrig and the Ryan Directional business, operating income decreased by $8.8 million as drilling activity and the industry's newbuild deliveries both declined. The vast majority of the decline came from our Canrig business as deliveries for third-party top drives dropped by 90%. Despite the difficult operating environment in the U.S., we continue to focus on our initiatives to remain free cash flow neutral. First, we retain strict control over our capital spending. For 2015, we are still on track to invest approximately $900 million in our drilling-related businesses. For the third quarter, capital spending totaled $166 million, and year-to-date we have spent $648 million in our drilling businesses plus our corporate investment. Second, we're beginning another round of G&A expense reduction. From the fourth quarter of last year through the third quarter, our initial efforts resulted in a reduction in quarterly spending of just under $30 million on a comparable basis; that is, excluding the impact of the completion and production segment in the fourth quarter as well as the impact of severance costs and the acquisition of the Saudi JV during 2015. On an annualized basis, that savings amounts to approximately $115 million. We are now targeting another $30 million in annualized G&A savings on top of the amounts already realized. Third, the largest reduction activity has taken place in our Lower 48 operations. We are focused on aligning direct operating costs with activity levels. Since the end of December, we have reduced our Lower 48 staffing by 54%. Finally, we are fully engaged in a second round of discussions with our vendors as well as other internal initiatives which together target $120 million in CapEx and OpEx reductions over the 12-month period following August 2015. These efforts have already yielded a projected $22 million reduction in purchasing costs. Next I will detail two financial transactions that we have completed during the third quarter. Given favorable terms in the credit markets, just before the end of the quarter we entered into a $325 million term loan with a group of banks to provide us with additional financial flexibility. The term loan matures in two equal tranches of three years and five years. We intend to use the total availability provided by the term loan and our undrawn revolving credit facility to support investment opportunities that may present themselves and to retire over time some of our fixed-income debt instruments. In the interim, we have partially paid down our outstanding commercial paper. Also during the third quarter, we took advantage of volatility in the equity markets and repurchased 8.3 million shares of Nabors' common stock, approximately 3% of our shares, at an average price of $9.46. Looking forward in this near-term unfavorable U.S. environment, we will continue to remain focused on generating free cash flow through 2016. Although we cannot control the fundamentals in the markets for drilling rigs, we have multiple levers we can apply to stay free cash flow positive during 2016. We can reduce our CapEx by an incremental $250 million. We will continue to align our overhead to the new reality by implementing additional reductions before year-end. We'll continue to work with our vendors to further reduce our costs and we will remain vigilant on our activity levels to ensure we keep the direct costs in our rigs in line with the anticipated activity levels. With that, I will turn the call back to Tony for his concluding remarks.

Thank you, William. I want to conclude my remarks this morning by reiterating the four pillars that formed the foundation of our operational strategy. As this downturn progresses, we think they are increasingly critical. First, capitalize on the existing asset base. Nabors has a worldwide fleet of over 500 rigs. Our goal is to increase the returns on our existing assets. We are finding creative ways to use the equipment we already own. A prime example is our use of mass and substructures from idle high-horsepower rigs in the high-specification units we have built for the Middle East. Second, differentiate our service offering. We are adding additional services to our standard rig offering. These services clearly complement the rig itself, and in some cases we are replacing third parties. In addition, we are nearing completion of innovative new rig models and rig components. These developments should facilitate our vision of more intelligent drilling. Third, improve operational excellence. The metric I am most proud of is our safety record. With the improvement year-to-date, we are on the way to the safest year in the history of the company on the heels of the records achieved in the two previous years. Finally, enhance our financial flexibility. As mentioned earlier, we added a new term loan that allows us to effectively refinance the next maturity of debt. This is the latest in a series of steps we have taken over the past couple of years. We will focus on additional opportunities to increase the company's cash generation and meaningfully impact our financial flexibility. This concludes our remarks this morning. Thank you for the time. With that, I will take your questions.

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Byron Pope at Tudor, Pickering, Holt.

Good morning, guys.

Good morning.

Appreciate all the color. Really helpful. Tony, on the international side, you guys are pretty specific in terms of laying out how we should be thinking about Q4. Conceptually, as I think about sitting into 2016, what I heard from you, continued pricing pressure, maybe activity in some geomarkets continues to turn down. But I didn't hear anything that made me feel like we're looking at 2016 overall activity or revenues down dramatically for you guys, realizing it's a fairly limited visibility at this point. So I was just wondering if you could share your thoughts about international moving pieces as we head into 2016.

Sure. I think that's a pretty fair description of how we see it. And like we said, right now about a five-rig decline and some pressure on the day rate. And obviously international is a big basket of moving pieces. You got to understand that. So we got things moving in, things moving off. And obviously the big unknown is how long this oil pressure is going to stay with – particularly on the NOCs in these various countries. But as we sit here now, for the next six months we see that's kind of where the activity level should be right now.

Okay. And then just as a follow-up, I won't ask you to get into any details, but you did mention that you're all in advanced stages of new rig models and components, and just was wondering if you could give us a feel as to whether these are targeting more the North America unconventionals or international. I assume the answer might be both, but any incremental color there would be helpful.

Yeah. I think as you've seen from our last quarter on the X rig, we're trying to design rigs that are much more ubiquitous, applying to large opportunities. I think one of the advantages of the company and a strength is the fact that we operate in a diversified geographical market, and what we want to have is an asset base that could be optimized across the geographies. So that's going to be a key component of what we're trying to design in this new approach and that'll – so it will be something that applies to multiple markets.

Okay. Thank you, guys. Appreciate it.

Yes.

Your next question is from Marshall Adkins at Raymond James.

Good morning, Tony. You mentioned you're adding to your suite of services or trying to market more services around the rig. Can you give us some more detail on that? What exactly are you thinking or what services are you talking about?

Sure. As you know, within the Canrig operation, we already had some performance tools like ROCKit, which improves the drilling in the horizontal section of a well. We have a second product called REVIT, which is a product that improves for the operator stick slip. We have our new set of MWD tools which has downhole sensor information. And frankly, in the current market, except for the big boys, most of the GE tools don't have these sensors and we're going to be marketing the capability of additional control of the drilling process with these tools. That's what we're referring to, new control system. There's also some third-party services that are currently on a rig like BOP testing that we're providing, and there's some other third-party services that third parties provide today that we're also integrating back into our operation. So it's a suite of a bunch of things that are on a rig today, as well as some new things that we think are going to be performance enhancing.

Exactly. It's performance enhancing. That's really the big driver here, right?

Yeah. And we have what we refer to as the new group, as we said, Nabors Drilling Solutions is focused on bringing these to market now.

And along those lines, does that mean you're maybe in the running for Sperry, since a lot of those products would be similar, and/or with C&J and everything that's going on there with their balance sheet, is there a chance you're willing to put more money into that one looking down the road?

Well, acquisitions, I'll just refer back to my opening remarks which is we do look at everything. And as of now, we haven't seen something that meets the hurdles that we like. But I won't comment on any specific acquisition. But obviously the space is something that we're in right now in terms of directional. And in fact, I think we've previously talked about our – we have in development a rotary steerable tool which we think will be a real viable tool in the North American market and competitive with the best of the best that's out there. That's probably a year away from being fully commercial. So that's to me something that we do see the possibility of getting to our performance suite. In terms of C&J, I think we're still happy with the current structure and very happy with the response Josh is making to this incredibly difficult market. I think it's a testament to what they've done over there. And if you look today at the number of frac spreads they're working, I think he has as many frac spreads as anybody in the whole sector including Halliburton on the payroll right now and is doing better than some of the other big boys as well. And obviously there's a lot of stress and – but I think we're doing the right thing. I think we'll – what we'll look to do is to kind of optimize the best of what we both have. We'll try to – we haven't yet really scratched the surface on optimizing international stuff with him yet. But that's something on the game plan. We have drilled, though, at least one project in the U.S. jointly for an operator to see if there's some ways we can bring value to an operator. That's something that we may also put more energy into. But so far that's where we see things.

Thanks, Tony. Appreciate the color.

Sure.

The next question is from Angie Sedita at UBS.

Thanks. Good morning, guys.

Good morning.

Tony, could you give us a little further color on leading-edge day rates? You mentioned it briefly at the top of the call. But a little bit more color on what you're seeing for leading edge for both PACE-X and SDRs because there's not a lot of rigs thing renewed, but any color that you can share. And then it sounds by your comments, it does sound as if competition is becoming a little bit more heated versus the discipline we've seen earlier.

Sure. Do I really have to?

Sorry.

As I mentioned, pricing is down significantly. But to figure out what a real price is, there's so much variation between customers and their specific requirements that it's really hard to have a normalized price. Generally, I would say that the ultra-premium and 1500 horsepower and premium AC rigs in the high teens, and then the lesser, the 1000 horsepower class AC rigs in the mid-teens is kind of where the market is today. But that really doesn't take into account a lot of things because there's so many different configurations now of what goes in a basket. And frankly, our mission today is to try to add more content into the package to change the economics and create a better value proposition. But that's where we see things right now.

And then are you seeing sharper price declines for the day for the high-spec rigs or is it – previously it was SDR and has that moved now to the higher-spec rigs as far as the sharper declines?

In the ultra-high, what we refer to as the PACE-X style, we haven't seen further big pricing declines. But clearly there's pressure going on and as the whole market grows, that pressure I expect to increase. I expect the spreads to narrow, more like it happened in general in all rig markets. Even in the jack-ups you can see when utilization goes down, the ultra-spec and the lower-commodity rigs kind of move in a narrower spread. So I think there's that possibility as more rigs come off term in spot, unless there's some change in the underlying demand for drilling given where we are in the supply situation.

Okay. That's very helpful. And then I guess it's fair to assume that this pressure is going to continue as long as the rig count is under pressure, so throughout Q4 and into Q1.

Well, the only thing – I have no crystal ball compared to anybody else and there's so many [indiscernible] about people guessing where things are going to end up. I can give you a sense – I did a survey of 10 customers, and the 10 customers, which account for a large chunk of U.S. drilling. And of the 10 customers, only 2 of the 10 refer to any possibility of an uptick in rig count over the next six months. Six were flat and 2 were down and 3 of the 10 had some rigs on contract they were trying to farm out. So that gives you a sense where we think we are. And I think that's a sense of 10 of the real players in the marketplace.

Great. That's very helpful. I'll turn it over. Thanks, Tony.

Thank you.

The next question is from Sean Meakim at JPMorgan. Our next question is from Ole Slorer at Morgan Stanley. And I'm sorry for mispronouncing that.

No. That's very good actually. Thank you very much. So could you give us a little bit more color on what you actually see at the moment? I mean, everything is clearly very opaque. But based on what you last saw and see to the fourth quarter, you suggest your rig count down 15%. Am I understanding that correctly? And if so, is that in line with how you see the overall rig count down or do you think you're slightly better than your overall rig count because of contract backlog or other reasons?

Ole, no, I think we haven't said international will fall by 15%. It fell by 5% in the third quarter.

And five more rigs, we're saying, in the fourth quarter.

Yeah.

Sorry. I meant domestic Lower 48.

Okay. So I don't think we gave specific numbers, I guess, but we're going to expect to lose some more rigs in the fourth quarter.

Yeah.

I think you suggested mid-70s, right?

Mid-70s, yeah.

Is that 15% down?

We have 81 rigs today, so...

Yeah.

Okay, on average for the quarter. So does it mean that you believe you're doing better than the industry as a whole?

Not necessarily. I think certainly some of our competitors that have a higher proportion of contracted day rates, I think, are more sticky on their rig count than we've been because we have had more expirations of contracts. But compared to everybody else I think there we should be doing as well as everybody else.

And then I just want to...

We're also in line with market in terms of volume, and I think we're holding our own on day rates given the quality of the rigs that are – the majority of our rigs operating there are PACE-X's and those are higher-priced rigs. So in that sense, we're doing much better than the average.

Yeah. And the utilization on the PACE-X rigs are still close to 90%.

Have you repriced any PACE-X's lately? And can you give any kind of indication of the spread that the customer is willing to pay on recent data points?

Toeing the line is what you said.

Yeah, we have at the price indication that I said, which is in the near-20 number.

Okay. So that's still remarkably robust compared to the carnage that's going on in the mid-tier segment?

Yeah. I said that's the case. I would tell you also that – I mean one of the things I always want to emphasize on the PACE-X rig is it was designed for mostly pad moves. And as I said in my remarks, we originally thought those faulty pads, the rigs would stay there a long time. So it wasn't really designed for move-to-move pads, move-to-move between pads. And some of the competition has been marketing against us that they can move a rig faster pad to pad. But with some process changes we've now come up with, we have figured out how to move a PACE-X rig in three, three and a half days, which makes the rig very competitive on a move basis with the other alternatives. But when it's on a pad, there's no comparison for any rig in the marketplace today PACE-X outsells everybody on a pad. So that's part of the strategy right now, and that's one of the things we're selling to the customer.

And then the additional we see in certain areas we see more wells per pad.

Yeah.

Which enhances this content as well.

Yeah.

Yeah. Thanks for that. The second question on the Middle East, there's been some contract awards in Kuwait lately. There seems to be a pretty tight market at least on the supply side for the largest 3000 horsepower rigs. Can you give us a little bit of what you're seeing when it comes to Iraq, where the rig count has gone from 100 rigs to 40 rigs, or Kuwait and Saudi, Oman or other areas? There seems to be a little bit more of a robust outlook.

Yeah. Well, I think the outlook in those areas you talked to, mainly Oman, Kuwait and Saudi, in terms of gas, and Algeria as well, still can be a viable market. Iraq, for us, we're down to one rig...

And the plan is to move rig out. So in Iraq, I mean, we have only one rig at the moment. And we had – it's been our exit strategy for a while to get out of it. And then, Oman, we continue steady, it's just pricing pressure. And what other countries did you mention?

Kuwait.

Kuwait is one of the areas where we had a couple of tenders. And as you note, other people have been awarded. We had been awarded and we're trying to pick the ones with the high returns. I think that's really what we're saying. And there's more opportunities to come.

So are you able to reallocate existing idle assets to those contracts or are the rigs different?

So in Kuwait we relocated one rig from Bahrain into Kuwait. It's going to start in Q1. So it's not a newbuild and we have plans for the rigs that are coming off in other countries as well. They have spots potentially in other areas where they can fit.

Just finally, do see any light at the end of the tunnel in Iraq or is it a company-specific reason to take the rigs out or is it that you just that you take a very dim view on the entire market?

So I think first of all it's very dark and we don't see anything. And I think it has been very difficult to operate there for us. And I'm talking about Southern Iraq. So we basically decided to move out.

Yeah. You'll recall, I think we went in thinking we would have the best team there. We worked for Exxon and Shell and we partnered with Haliburton on a project, and we thought with that kind of team we can navigate Iraq. And I think it's fair to say everybody had their clock handed to them, and we've decided that that's not where we want to play. We are up in Kurdistan, which is a different environment. But in Southern Iraq it's just been a problem.

Okay. Well, thanks for that clarification and color, and I'll hand it back.

Thank you.

Thank you.

The next question is from Waqar Syed at Goldman Sachs.

Thank you for taking my question. Tony, you had decent share buyback in the quarter. Should we expect that to continue or this was kind of one time in the quarter that you initiated that?

Well, this is the second buyback we've done in a year. And as I've said before, we always try to figure out what the best use of our capital is. There was an element of opportunistic here. It's an interesting aspect to this particular buyback. If you look at the spread on the interest rate versus our dividend, we actually had a positive free cash flow on the trade, which is interesting given that we were borrowing at 117 basis points and the dividend is at 2.5%, 117 over LIBOR versus 2.5%, so we actually had a positive impact in cash flow. I think our main priority still has to be obviously in this kind of market to be careful about the balance sheet and our investment-grade rating. And in my dreams, I would like to buy back some of our debt and be able to do that at a discount, but that really hasn't occurred, that opportunity. But we will constantly reevaluate whether that opportunity against what our other uses of capital are, and you'll see we'll execute it. And what we do, you'll see the numbers. But right now, that's the way we see it. So that's the priorities.

Okay. And then on the additional services that you're offering on the drilling rig and that you plan to additionally provide in the future, is this just a domestic strategy or do you plan to offer such services in the international market as well?

International as well. Absolutely.

And are you offering any of those services right now internationally?

We're in discussions with a couple of NOCs right now. We have proposals in front of them right now.

Okay. Great. Thank you very much.

The next question is from Scott Gruber, Citigroup.

Yes. Good morning, gentlemen.

Good morning.

I may have missed this in the prepared remarks, but were there any early termination payments that benefited the international segment during the quarter?

No. Not this quarter, no.

Even better performance then. And William, you highlighted that the international rig count to be down as much as 4%. But given the mix shift, how do you think about the revenue trajectory in light of the activity decline?

Obviously there is a huge negative mix potential depending on which countries go down. There are high-performance rigs in certain countries. So for example the Southern Indonesia that was working for Papua New Guinea, excuse me – working for Exxon was very high-performance rigs which – we're looking for a home for those kind of rigs. We have two Saudi jackups that are subject to renewal that are going to come up and there's pricing risk on those renewals obviously in this market. So, yes, it depends which – so it's hard. That's why we've been trying to be very careful. I think we have the outside exposure here and it's very difficult to predict which country is this going to occur given the mix and the effects of mix.

The only thing we know is that in the fourth quarter we have full-quarter impact of Saudi deployments and some rigs we deployed in Columbia and those are reasonable contracts with good returns. We also have predicted or planned some reductions in other places that we feel are lower-margin than those particular contracts. However, as Tony pointed out, we do have some exposures in higher-margin-type activities and those contracts may either not be renewed or we may have some pricing movement on those as well. So at this point what we've been saying is that we expect the fourth quarter to be somewhat less and not as stable as we saw in the third quarter.

Net-net, it sounds like the revenue trajectory should be biased a little bit more negative than the activity, if activity is down 3%, 4%, revenue is doing a little bit worse on that. Is that fair?

We think activity and revenue should stay pretty close to each other and it's probably a 4%, like you said, reduction.

Okay. And then you walked through the outlook for the Middle East in response to Ole's question. Could you provide some color on the LatAm market? Should demand onshore stabilize there around the year exit point or is there risk for further deterioration across LatAm?

Yeah, I think it was in line with what Tony said that some of these NOCs are very stressed for funds and so I think the market is very challenged in Latin America.

I mean Colombia has been a bright spot for us.

Except Colombia.

Except for Colombia. Pemex in Mexico continues to be problematic, and Argentina there's a lot of stress going on there. There's not much going on in Ecuador. And Venezuela, we've been fortunate that our mix of customer base has changed away from PDVSA to the joint-venture companies, which accounts for the reference to the improvement there.

Well, the execution certainly has improved on the international fronts. So congrats.

Thank you. Thank you.

That's all for me.

Siggi, good job, mostly.

The next question is from Jud Bailey, Wells Fargo.

Thanks. Good morning. Question on margin per rig day in the Lower 48. Given your rig count is declining as you think probably into the first quarter. You're expecting about $1,000 a day of decline in 4Q. Help us think about early 2016. Do the declines in the margin per rig day start to soften as more of your rigs are under term contract? And I apologize, have you given any color on your term contract coverage for 4Q or for 2016 in the Lower 48?

Jud, I think, as we mentioned I think in the remarks, the third quarter was slightly penalized. I mean, the market gave us a bit of a pump fake. We thought we'd have 10 rigs more than we do today. And in fact the clients backed out. So we did adjust our direct costs pretty quickly after we realized those rigs would disappear. So in September we did see a little bit better margin per day than we saw at the average of the quarter. But some things are going to continue happening. We see more rigs are going to be rolling into lower day rates as contracts expire. More of our rigs stacked on rates, which tend to be a little bit more high-margin and, in fact, have a mix impact on the cost as well because those have very minimal costs. So those are going to be rolling off. So that's where the $1,000 per day are going to be coming from. You are right, though, that a lot of the steadier work and the more continuous work that we have now is composed by PACE-X's that are performing better than the average. So that helps temper a little bit the downtrend on our daily margins. As Tony mentioned, we think the impact could be as much as $1,000 per day. But again, it all depends on which rigs go down during the fourth quarter.

And just to clarify, though, for maybe digging up the first quarter of 2016, we should not expect a similar amount of decline. Maybe I would assume something maybe half that or so. Or how should we think about that?

I didn't get the question specifically. You said 2016? Oh, in the first quarter in 2016.

The first quarter of 2016, yeah.

Well, I think we could see a little bit more. Denny has always had his rule of thumb, daily margin. He says in a downturn at the bottom, we get to $7,000. Not there yet and we don't expect to be there in the fourth quarter. So is there possibility for more, for a further downturn? Yes, there is.

Okay. Thanks. And my follow-up is just to follow up on the international pricing environment. It sounds like spot rates or new contract opportunities, there's a lot of pricing pressure. Is there any discussion on another round of renegotiation of existing contracts? Is it that weak, or do you think what you have under contract is good for now?

I think what we have right now is good.

Okay. All right. Thank you.

The next question is from Robin Shoemaker at KeyBanc Capital Markets.

Thank you. I wanted to – did you mention in your comments that in the U.S. rig business that you've had a labor increase was in the third quarter or...

No. What we did say was that, in the third quarter, we did not cut as sharply early in the quarter as maybe we would have done because we had verbal requests from customers to provide incremental rigs. Now, as you all know, when the commodity price headed back down towards $40, those incremental requests disappeared. So in fact, we had a few extra heads per rig – a couple of extra heads per rig during the early part of the third quarter. That was corrected in September, though.

Okay. So it sounds like your kind of current run rate for the third quarter was like two-thirds term and one-thirds spot. You had 60 on term. Is that correct?

Yeah.

Yeah. So when we get closer to all-on spot or if we get to that point, is that where Denny's $7,000 a day margin kicks in or is that a negative impact?

Dennis, can you comment?

Well, it depends upon how long the duration is, right? Price always lags utilization, right? The last time it was two quarters later. So if the rig count continues to dribble down, you'll probably still going to see more pricing pressure. If it flattens out, the pricing will still probably overshoot it a little bit after a couple of quarters and then you really need a rising market to pull the prices back up.

Yeah. Okay. So you – but your percentage of rigs on spot, I mean, is just going to continually grow through next year. I think Jud asked a question is what is the average number of rigs on term. But you didn't answer it. Do you have that figure for 2016, I mean?

We do. We have – we think the – our exit is 20, 20 rigs on contract by year-end, 40 at the beginning of the year in 2016. Now that may change. At some point, clients may start wanting to get some term and that's always a discussion we can have down the road. But based on today's contracts, those are the numbers.

Robin, those are how many rigs are contracted through 2016 currently. So we're constantly signing new ones for a six-month term and things like that, so then we'll be able to do more than 20, but that's what's in force right now.

Okay. And some of those are the legacy contracts that were signed at the peak of the market I assume?

Yeah.

Okay.

Just about all of them probably.

Yeah. Right. Thank you.

Operator, I think we're bumping up against our hour here, so if we just take one more question, please.

Okay. The last question is from Kurt Hallead at RBC Capital Markets.

Hey. Hey, guys. Good morning. A couple of questions here. What is your outlook on Alaska and in Canada? Typically there's at least a seasonal uptick in Canada and this year probably going to be a lot more muted than it's been in the past. But if you could provide some perspectives on that, that would be great.

Should we have Joe Bruce do it? Joe, you on the call?

Yes. I would think that Q4 is probably muted. Similar to Q3, we are negotiating some contracts at this time that will lead through into Q1 but not a positive outlook at this point.

Yeah. And then follow-up on the cash flow, kind of getting back to cash flow neutral or whatever the terminology was. Is that more dominated by reduction in CapEx or increase – or reduction in net working capital? Can you give us a little more color on how you guys kind of see getting to that point?

So the way we see it, we try to keep a fairly generous cushion between our EBITDA and our CapEx to allow us to meet our other obligations like interest rates, dividends and taxes. So, yes, one of the levers has been CapEx and we're comfortable that we can control CapEx and the numbers we've given you through year-end. And we're also comfortable that we have another lever to pull their next year. And as Tony mentioned, we could see $700 million or even below $700 million CapEx next year. So that's part of the equation but it's not the only part. A big one of course has been the overhead, which I think we have cut around 30% of our SG&A; in terms of field support, those cuts have been even larger. So all the overhead in the organization has been compressed and we still have some room to work on that if need be. And then finally, we did address our supply chain with the consolidation of the company, the one drilling organization under Siggi. It has been much easier to implement all the supply chain initiatives that we have put in place. And that should give us another we expect $100 million-plus reduction in costs over the year to come. So there's a lot of levers. We're going to be very focused on making sure first that as the activity goes down, we do keep our direct costs in line. That's the first step. But all the other initiatives that are in place today are incremental to that. So we're comfortable that next year we won't require increasing our debt levels to fund our operations and our CapEx and so forth. And we also believe that if the environment is even worse than we envisage it today, and we think we're one of the more bearish companies out there, but even if it's worse than we envisage we are ready to take some more action if need be to avoid increasing our debt levels. And certainly we've done everything we can to avoid going to the capital markets in this environment. That's what the revolver extension and expansion was about. That's what the term loan was about. It's to make sure that whatever happens in this environment, even if it's twice as worse as we think it's going to be, we don't really have to go to the capital markets. But we are pretty self-sustaining throughout this downturn.

Thanks. That's great.

And the other thing that I'd add is on the working capital management, it's harder because we give the business units as EBITDA less their CapEx, working capital management. What we squeeze out of that is actually our benefit on top of that. So in other words the target of positive free cash flow is before what we're able to squeeze out on working capital management.

Okay, that's great, thank you.

Okay. Operator, that will wind up our call, if you could close out the call, please?

Certainly. The conference is now concluded. Thank you for attending today's presentation. And you may now disconnect.