Nabors Industries Ltd. (NBR) Q4 2016 Earnings Report, Transcript and Summary

Good morning, and welcome to the Nabors Fourth Quarter 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, and thank you for joining Nabors' earnings teleconference to review our fourth quarter and full year results. Today we will follow our customary format with Tony Petrello, our Chairman, President and Chief Executive Officer; and William Restrepo, our Chief Financial Officer, providing 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 going forward in these markets. In support of these remarks, we have posted some slides to our Web site, 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 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 Web site as well. With us today in addition to Tony, William and myself are Siggi Meissner, President of Global Drilling; Chris Papouras, our President of Nabors Drilling Solutions; John Sanchez, our Chief Operating Officer of Canrig, and other members of our senior management team. 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 operating income, EBITDA and adjusted EBITDA, operating income loss and free cash flow. We have posted to the Investor Relations Section of our Web site a reconciliation of these non-GAAP financial measures to the most recently comparable GAAP measures. I will now turn the call over to Tony for his prepared remarks.

Good morning everyone. Welcome to the call. We appreciate your participation as we review our results for the fourth quarter of 2016. First, I would like to discuss how Nabors is executing on our vision to be the global driller of choice. William will follow with a review of our financial results. I will then wrap up, and we will take your questions. In November, we rolled out our 2020 vision at our analysts' day in Houston. In it we unveiled some exciting new technology. We also detailed our plan to generate growing levels of free cash flow, and dramatically improve returns on capital. While we are a long way from reaching our 2020 goals, we have already achieved several key milestones in the last few months. We are currently on track to meet these ambitious targets with continued focus and execution. First, we have achieved 100% utilization on our industry-leading SmartRigs. These rigs targeted primarily at Lower 48 market go beyond super-spec pad off capabilities. By leveraging the Rigtelligent [ph] operating system they can deliver more efficient, more consistent results for our clients through the benefits of automation. Next, we have made great progress in our Nabors Drilling Solutions division. The fourth quarter set new high watermarks for customer penetration across multiple product lines. Customer acceptance of our technology solutions is increasing every day. I'll share a couple of examples of that later in the call. Finally, we signed one groundbreaking joint venture agreement. Our joint venture with Saudi Aramco will result in a best-in-class drilling company in the region. That joint venture is a robust platform for long-term growth in one of our most important markets. The foundation for its growth prospects is a highly capable national workforce which will also grow over time. The joint venture will benefit in the coming years as Saudi Aramco transitions much of its current spending to in-country suppliers. This milestone highlights our unique international business. It further positions us to succeed across multiple market scenarios even in the case of volatility of the U.S. market. To summarize, 2016 was a tough year financially as it was throughout the oil patch. But during this challenging year we managed to continue providing positive free cash flow, and we also executed several major strategic game changers. Though we had to make many difficult choices over the last two years, we did not walk away from our crucial long-term R&D initiatives. We introduced new technology to the oilfield. Both the Lower 48 and international markets validated our technology direction, and we built the framework for future profitable growth in the years ahead. Now, let's turn to our financial results. In the fourth quarter, Nabors generated adjusted EBITDA of $146 million on revenue of $539 million. This performance compares to $149 million and $520 million respectively in the third quarter. This marks the first quarter that revenue has increased in two-and-a-half years. Our fourth quarter results reflect an acceleration of the rig activation trend which we saw beginning in the second quarter. For the full quarter, our average rig count in the Lower 48 increased sequentially by 29% compared to 13% in the third quarter. More significantly, our average working capital highest spec PACE-X and PACE M800 rigs increased by 41%, with both rig types reaching full utilization, this outperformance indicates operator preference for the most capable and automated rigs currently in the market, a trend that continues today. Our Lower 48 customers increased their activity levels in the fourth quarter, benefiting from growing confidence after the OPEC production cut announcement. We believe this increase reflects relatively stable commodity prices, continued efficiency gains both in service companies and EMPs at a favorable cost structure. It is important to note however that while current margins are still well short of desirable returns, the trajectory for the highest spec rates is positive. We believe Nabors is best positioned to exploit this trend. Over 80% of our current working Lower 48 rigs are priced at spot rates of relatively short durations. We expect to have another 32 upgraded rigs ready to go to work over the next few quarters. In our International segment the net rig count declined by approximately five rigs in the fourth quarter. The largest impact was attributable to Algeria, along with less significant declines spread across several markets. However, several rigs are starting up in the very near term in most of these same countries. We commenced operations of our second Kazakhstan new build rig in early January. We expect one of the off-shore platform rigs start soon in Mexico. Additionally, in the late fourth quarter we resumed operations on three rigs in Columbia, with one more expected there this month. All of this bolsters our conviction that the International segment has bottomed, and should exhibit growth in 2017. Each market has its own unique demand drivers. We are capitalizing our recovery in the hardest hit region of Latin America even while other regions continue to stabilize. The pace of recovery on land appears to be proceeding modestly in the first half, driven primarily by Latin America. Tendering activity points to a potentially more robust uptick in the second-half activity in the Middle East, North Africa, and Eurasia. Now turning to our segment results, let's start with U.S. drilling. Financial results for the U.S. drilling segment improved as Lower 48 activity increased. In the Lower 48 the drilling business grew versus the third quarter. The increased rig count more than offset the erosion in average margin. Our quarterly rig count improved to 64 average rigs working from 50 in the third quarter. As anticipated, reported daily gross margin declined from 6,238 in the third quarter to 5,349 in the fourth. This decline was primarily due to new contracts signed at spot rates below the average day rate for our fleet. We finished the quarter at 75 rigs on revenue in the Lower 48, which has increased to 86 today. Financial results in our International segment decreased modestly on an apples to apples basis given favorable non-recurring revenue in the third quarter. This decrease was primarily due to a net five-rig decrease in activity, along with an unusually large number of discreet maintenance projects in Saudi Arabia during the quarter. Reported daily margin in our International segment decreased by approximately $1,400 a day, which is about the level we expect a quarter ago. Canada rebounded seasonally in activity at an average rig count only slightly below the fourth quarter of 2015, but that continued to improve in the first quarter. Nabors total revenues for the quarter were up 4% sequentially. Worldwide rig activity increased to 177 average rigs on revenue in the fourth quarter from 164 rigs in the third quarter. The activity increase was principally in the Lower 48 and Canada, more than offsetting modest declines internationally. Consolidated adjusted EBITDA declined just 2% sequentially. It is worth highlighting that adjusted EBITDA in our rig services segment, which includes Canrig and Nabors Drilling Solutions contributed positive adjusted EBITDA in the fourth quarter for the first time in 2016. We are encouraged by the positive trajectory here, and by customer adoption of many of the new technologies highlighted at our recent analyst day. Next, I will update you on several noteworthy developments since our last conference call. Our comprehensive rig enhancing program in the Lower 48 is proceeding smoothly. When the program is completed we will have a fleet of 100 of the highest tier 1,500 horsepower AC rigs, all outfitted for the most demanding customer requirements today and in the future. As of today, we have converted 11 tier 1 rigs to SmartRigs, and completed six new PACE M800 rigs, bringing the total of Lower 48 SmartRigs to 61. We expect to complete our goal of 100 SmartRigs delivered in our contract by the end of this year. We continue to schedule our upgrade program around the higher-than-expected demand for several of the rigs in our upgrade backlog. Next, we contracted the remaining two of our initial tranche of six new build PACE M800 rigs prior to their completion in the yard. As of today, all six of these rigs are operating in the field across various geographies. Startup of these rigs has been quite smooth. They have enjoyed success with some of the most respective majors and large independents. The positive feedback and ongoing demand we have seen validates our strategy to keep improving our product offerings even in the middle of the downturn. Our focus on innovation does not stop at the rig itself. At our Analyst Day, we outlined our expectation that Nabors' Drilling infusion to reach $200 million to $250 million of EBITDA by the year 2020. We committed to providing more transparency and insight into our progress which starts today. Our performance product installations increased by 25% from third quarter with 26% of all installations on third-party rigs. Directional drilling jobs nearly doubled and have increased further this quarter. We are currently operating over 20 directional jobs. Other services also showed strong improvement quarter-over-quarter with BOP testing and choke rentals also doubling. While NDS margins remain constrained, we see some pricing traction emerging in subsequent quarters as the rig count marches higher. The Q4 annualized run-rate adjusted EBITDA for NDS was $10 billion. We expect that the 2017 full-year EBITDA for this business will be a multiple of that number with continued quarterly progression. We also recently announced the signing of an MoU with Weatherford. Our objective is to accelerate the achievement of our NDS financial goals and the adoption of our drilling solutions offering. The agreement validates our vision of the SmartRigs. The rig is an essential platform to provide a wide range of value-added integrated drilling services. These services are currently offered by ourselves and by third-parties with separate equipment and personnel. Leveraging our MPD-ready SmartRigs, our performance software and automated wellbore placement system enables us to provide Weatherford's best-in-class capabilities to clients. It provides Nabors with immediate access to Weatherford's MPD technology, LWD and multiple sizes of rotary steerable tools and expertise. This ready access to MPD hardware, software and proven rotary steerable tools, significantly accelerates the timeline for meaningful revenue generation for these services. I believe this alliance will help us accelerate the creation of a new integrated filling model for delivering a drilled well to our customers. Concurrently, we will continue development of our own proprietary rotary steerable tool. We expect our tool to become the low cost solution for Lower 48 drilling. Negotiations to formalize this alliance are currently proceeding. We expect them to conclude by the time in our next call. Turning to international rig deployments, the first of two new rigs deployed into Kazakhstan operated successfully throughout the fourth quarter. The second rig went on in early January and we expect essentially a full quarter's contribution from it, in the first quarter. I will now discuss our outlook. While rig demand ultimately depends on commodity prices, operators in Lower 48 rigs at a rapid pace. We have visibility towards this trend continuing for at least the first quarter. The global oil market appears to be moving back into balance with the recent OPEC production cuts, even at a time of seasonally low global demand. We expect Lower 48 demand to keep pace with our upgrade schedule. In the U.S. customer interest has increased steadily across all major basins. We again surveyed the larger Lower 48 customers following at the beginning of the year. These represent over 25% of the total rig count in Lower 48. Of those almost 60% have plans to add rigs between now and June 30, none indicated a reduction. More tellingly the confidence indicator of our customers is evident in our continued increase in market share during the quarter. We have seven pending deployments in this quarter already under contract. In addition, we are in advanced discussion on several others though we're actively trying not to contract too far in advance of deployment given upward day rate trends. As of yesterday, our rig count in Lower 48, currently stands at 86 rigs including three SCR rigs and two rigs stacked on rate. We exited the fourth quarter at 75 rigs in total including stacked on rate. For the first quarter, we expect Lower 48 margins to decline, before this decline to be more than offset on an EBITDA basis by an increase in average rig count. We expect sequential activity growth to slightly exceed that of the fourth quarter on an average rig count basis from the 5,350 average daily margin reported in the fourth quarter, we expect the decline to roughly $4,000. In international markets, some customers remain challenged by the current environment. Although we are now seeing activity increases in Latin America. In Colombia the rigs that re-commenced work late in the fourth quarter will have an impact on first quarter average rig count. Additionally, these rigs in Colombia have had their contract day rates restored. In the Eastern hemisphere, we see some variation by customer. Our rig count in Algeria declined with the exploration of some contracts as in our Russian rig count. Our second new Kazakhstan rig commenced operations in early January. We have commitments to put rigs back to work in Algeria, along with Kuwait and Russia. Although we have seen some deferrals, we are processing notable tenders across several markets and anticipating more. In Saudi Arabia, we expect formation of the JVNC at the end of the second quarter. At this point, we intent to consolidate the JVs results, which will result in the addition of rigs, contributed by our partner upon formation, we are honored to have received this Vote of Confidence vote of confidence from Saudi Aramco the world's largest oil and gas operator. We also expect that new bills contracted through this entity will provide upside to our allied state forecast. For our international segment, average rigs working total 92 in the fourth quarter. Given current trends and our outlook, adjusted EBITDA of $128 million should represent the trough for this down cycle. We expect the international rig recovery will likely be slower and more enduring than the Lower 48, although at much higher daily margins. To summarize, several factors could impact our results in the coming quarters. First, U.S. customers are adding rigs at a rapid clip that has exceeded most observers' previous forecast and quite frankly including ours. We will likely need to see a move about $55 a barrel of WTI, just to stay at the current pace of rig additions, beyond the first quarter. However, we remain confident that current trends along with the rebalancing of the oil market are sufficient to take in, our upgrade and limited new built plant for 2017. Rig costs make up just 10% plus or minus of the overall well costs including completions. Given this, the day rate inflection, we have seen to-date does not have a significant impact on the cross threshold for a well. But our costs for reactivating rigs, including moves, hiring, and training crew, as well as rebuilding inventories, impacted fourth quarter results. We expect these costs will likely impact the first quarter, as we put more rigs back to work. Second, our international segment encompasses a number of different dynamics that vary by region and between NOCs and IOCs. We expect our rig count to move gradually higher in the first half and have some visibility to a more meaningful inflection in the second half of the year, without sending tender activity. As is the case for the U.S., expanded customer plans are propagated upon commodity prices and the lower course of this market has afforded them. The unique value for international franchise and the growth opportunities it generates sets Nabors apart from peers, who depend more heavily on the U.S. Third, while the Canadian market has rallied seasonally to a much larger degree than last year, margins remained compressed. We expect first quarter activity to increase seasonally from 13 to 20 rig average. Finally, our backlog of Canrig's nearly doubled during the fourth quarter to the highest level of 2016. This backlog is split roughly evenly between Nabors and third-party customers. With the turning of the rigs cycle and the return of rigs deeper into STACK, Canrig's customers must recertify and can no longer cannibalize older equipment. Equipment and systems manufacturing has been especially hard hit by the downturn and we expect that this increased backlog will lead to a return to positive EBITDA at some point in 2017. This concludes my outlook comments. Before I turn the call over to William for his comments, I would like to reiterate that cash generation and capital discipline remain top priorities and primary areas of focus. While, William will provide detail, I would like to note, how pleased I'm with the success of our two recent unsecured debt and convertible offerings. These provide us with extensive liquidity extended term and lower cash interest going forward. I am especially proud of the convertible deal, which priced at an interest rate of just three quarters of a point and an effective premium of 75%. We believe that the yields at which all of our bonds are currently trading are a much more accurate real-time indicator of our financial strength than our current credit ratings. This concludes my comments. William will now review the quarter's financial results in more detail and provide additional thoughts on the outlook.

Good morning and thanks for joining us today. Our fourth quarter performance was driven by several market related factors. Essentially, a continuation of what we've seen in the third quarter. First, a strong sustained recovery in the U.S. Lower 48 with material spot pricing improvements, they are still below the average day rate for a fleet; two, a brisk rebound in Canada at an even faster pace than in the U.S. three, as anticipated a modest reduction in our international rig count into the fourth quarter; finally, increasing market penetration of Nabors Drilling Solutions, with not only sequential revenue improvement, but also an increase over prior year level in the phase of a lower rig count. Now to our financial results, fourth quarter net income from continuing operations was a loss of $331 million or $1.17 per share as compared to a loss of $99 million or $0.35 per share during the third quarter. The fourth quarter loss included $245 million net after tax changers, primarily from asset impairments and other charges related to the strategic initiative. Excluding those charges, the fourth quarter loss was $86 million or $0.30 per share. Revenue from operations for the fourth quarter was $539 million as compared to $520 million in the prior quarter, a nearly 4% improvement, increases of $33 million in U.S. drilling, $6.5 million in Canada, and $4.7 million in rig services more than offset of $20 million decline in international. The U.S. drilling revenue increased by 28% to $149 million, reflecting 29% higher rig count in the Lower 48, along with the full quarter from our CDR-3 rig and generally high revenue in Alaska. The Lower 48 revenues increased by 24%. As the rig count increase was partially mitigated by a $700 reduction in revenue per day. This reduction was driven by the large number of new contract and renewal signed at average spot rates that are somewhat below the average day rate for fleet. International revenue was $343 million, down 5.6%. The fourth benefitted from demobilization revenue of $7 million as compared to $12 million of favorable items in the third quarter related to Mexico and Yemen. Excluding those one-time items, international revenue fell on a sequential basis from the idling of the rigs in Algeria and Russia. These declines more than offset gains in Colombia. Also of note in the fourth quarter was loss revenue in Saudi, as we face an abnormally high number of equipment and re-certifications during the quarter. We expect to finalize this maintenance exercise during the first quarter of 2017. Canada revenue increased by 62% to $16.9 million driven partially by the normal seasonal increase in rig count, but also by a strong turn of the cycle which has also improved pricing. While the Canadian rig count improved sequentially by 51%. Our revenue per day was $973 higher. Rig services revenue continued higher in the fourth quarter, reaching $63.7 million or for an 8% sequential increase. Although Canada rig grew by 3%, this segment benefited primarily from growing customer demand for our NDS product and services. NDS revenue reached $17.6 million, yielding 25% growth. Our reported operating income improved slightly to a loss of $70.2 million from a loss of $72 million in the third quarter. The fourth included approximately $4 million in demobilization margin as compared to $12 million of one-time operational gains in the third. Adjusted EBITDA for the quarter was $146 million as compared to $148.7 million in the second quarter. The previously mentioned exceptional operational items provided a net benefit of $8 million in the third quarter over the fourth. The sequential reduction in EBITDA was driven by a $20 million decrease in international, largely offset by increases of $12 million in U.S. drilling, $5.2 million in rig services and $2.5 million in Canada. The drop off in international reflected the lower one-time items mentioned before, as well as the lower average rig count and the Saudi lost revenue. U.S. drilling improvement came from higher rig count, despite a material daily margin reduction and from the strong result in Alaska. Rig services benefited primarily from a healthy progression in Nabors Drilling Solutions. NDS adjusted EBITDA reached $2.3 million for the fourth quarter or 13% EBITDA margins compared to negative EBITDA in the prior quarter. SG&A which includes our research and engineering expenses was $61 million for the quarter, down $3 million sequentially. For the full year, our SG&A reached $261 million as compared to $326 million in 2015, a 20% reduction. Although we will continue to focus on optimizing our overhead expenditures during 2017 we expect our first quarter compensation to increase somewhat in line salary increases after freezing their level since our last raise, since the beginning of 2014. In addition, burden raise for compensation normally increased on January 1, to account for the reset of payroll taxes target bonuses and 401(k) match. Financial results for the quarter included $237 million in after-tax charges, primarily reflecting losses from fixed asset impairments, demobilization of vital equipment and yard closures. Majority of these charges are $161 million derived from our 1,000 horsepower AC rigs many of which were built around a decade ago. We also retired certain of our Lower 48 SCR rigs, resulting in a $60 million after-tax charge. However we have not written off these asset classes entirely, as we see continued customer demand for both of them across numerous basins. As of yesterday, we had nine 1,000 horsepower AC rigs and 3 SCR rigs working in the Lower 48. Let me turn to the main drilling rate business metrics from the fourth quarter. First the U.S. drilling business, our Lower 48 average rig count increased to 64 for the quarter a 29% increase over the prior quarter. Our rig count stood at 75 at the end of the fourth quarter, as compared to 53 at the end of third quarter and to 86 rigs as of yesterday. While the Permian has been the strongest region, our increases in rigs have been widely based geographically, and have reflected our customer's preference for the highest spec rigs currently available. Both are PACE-X and PACE M800 rigs, as well as our upgraded rigs are currently 100% utilized. We expect to have a 100 high spec rates available and working before the end of 2017. Drilling margins for the Lower 48 fell by $900 per day to 5,350. The reduction reflected a 700 per day reduction in revenue per day and a 200 per day increase in daily operational expenses. However, compensation costs were exceptionally low at year-end as we reduced our fourth quarter burden rates to match year-to-date costs. We expect compensation per day to increase during the first quarter as we reach that burden certain rates. Also, as we continue to bring our rigs backup, we have and we will continue to experience increased costs of rig moves. Early compensation before revenue starts and incremental maintenance cost including the buildup of spares inventories and rigs. Although we have managed this process well, the geographically and even pace of growth will result in progressively higher rig moved costs as we move out to some areas of lower utilization to faster growing basins. In our international segment, fourth quarter rig count averaged 92 down from 97 in the third quarter. The reduction was primarily in Algeria and Russia, while two rigs went back to work in the fourth quarter in Colombia. We believe our rig count has bottomed in the fourth quarter, although we expect to drop several work over rigs in Argentina with essentially zero margin. We also expect to see growth in Latin America, Kazakhstan Russia and Kuwait as well as in Algeria. Daily margin for international decreased from 18,400 in the third quarter to approximately 17,000 in the fourth. Gross margin on a material demobilization was offset by down time related to the maintenance project in Saudi Arabia. During the first quarter, as we conclude this maintenance program, we should see a similar level of downtime. Now let me make a few comments on our liquidity and cash generation. First our financial transactions, last November, we closed a tranche of $600 million, senior unsecured debt of 5.5%, six-year senior notes maturing at the end of 2023. The notes are in an initial step in restructuring of debt maturity profile, the proceeds were used to repay earlier maturing debt. The opportunistic transaction took advantage of a favorable market window. The coupon compares very favorably to our historical cost of debt. In January, we executed on a $575 million convertible bond with a coupon of 0.75%. This seven-year note carries an exchange premium of 40%, which equates to a future stock price of $25.16. Simultaneously, we entered cap call transactions to protect against dilution up to a 75% exchange premium or a $31.45 stock price. As was the case with the senior note, this transaction was opportunistic, we waited for an ideal market window of high convertible demand and executed at a time when our share price was just under its more recent highs. The robust demand, we received from investors coupled with the strong performance we've seen for both securities in the market, since they began trading, indicates confidence in Nabors as an investment-grade entity. These two transactions helped us materially push out $1.1 billion in debt maturities. CapEx for the fourth quarter was $151 million and $422 million for the full year, significantly below our initial $500 million annual target. For 2017, we expect CapEx in the range of $550 million. Our maintenance CapEx will increase in line with a significantly higher rig count in the U.S. and Canada. We will also complete our SmartRigs upgrade program and seven new builds in the pipeline, for which the majority of these components have been purchased in 2014 before the start of the downturn. The earlier than expected rebound in Canada will be addressed with low costs upgrades in 2017, as compared to essentially no CapEx in the prior year. Finally, the rapid market penetration of our NDS product line should require us to add more equipment than initially anticipated. Despite increased working capital requirements, as a result of higher revenue, we ended the fourth quarter with net debt of $3.3 billion, essentially flat with the prior quarter. And our $2.25 billion revolver was fully available at the end of the year. For the full year, in addition to over $50 million distributed in dividend, to pay in premiums and debt buyback and to incurring bond issue fees, we reduced net debt by about a $100 million. In fact, we kept the commitment we made to our investors of remaining free cash flow neutral to positive. Looking to the future, the rig count trajectory in the Lower 48 has led to some level of pricing traction for high-spec rig and assuming oil prices stay around $55 or higher, we would expect additional increases for at least the first of the year. Our latest contracts for high-spec rigs have been signed at $18,500 to $19,000 per day. Again absent a negative oil price, we expect to average roughly 80 to 85 rigs on revenue in the first quarter, with an upward slope throughout the period. As a reminder, we had 86 rigs on revenue in the Lower 48 as of yesterday. Average margins have expected to deteriorate to $4,000 per day range as our average revenue per day falls in the first quarter versus the fourth. We also expect the reset of the compensation burden to cost us $300 per day and rig move and startup cost to account for another $300 to $400 million a day on a fleet wide basis. Our international rig count should have bottom in the fourth quarter and is currently beginning a gradual recovery. With a slight increase in activity and margins in the $17,000 range, we would anticipate our international adjusted EBITDA to improve in the first quarter by no more than 5%. Assuming the weather helps and March rig count remains constructive in Canada, we expect average rig count at close to 20 rigs for the quarter with margins similar to those in the Lower 48. Alaska should fall significantly as rig count has already dropped by one rig and more could follow, U.S. offshore will likely decline somewhat with a one rig reduction in activity that occurred in late fourth quarter and no prospects for near-term recovery. And finally, rig services should continue to improve primarily from continued growth in Narbors Drilling Solutions as these services continue to benefit from a higher rig count and better market penetration, particularly in well bore replacement and performance software. 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 with the following summary. The Lower 48 market has increased dramatically in recent quarters, and our highest spec SmartRigs have reached full 100% utilization. In the international business, we expect our rig count to increase gradually in the first half of the year and begin accelerating higher by mid-year. I also want to note two things. First, we expect average rig margins in the Lower 48 to trough in the first half of 2017. On the average, current spot rates now moving higher remain lower than the average day rate of our fleet. Additionally, the upfront cash required to crew up and bring rigs back to service presents us with the headwind. Nonetheless, it is important to continue placing our rigs into the market while staying short on duration. This preserves our ability to increase prices in the near future as utilization warrants. Second, we're dedicated to providing more value per dollar to our customers even while day rates increase. Our new rig systems and equipment provide higher rates of penetration, enhanced resource recovery and perhaps most importantly increase performance consistency. Despite the discussion of shale drilling, transitioning to a manufacturing process over the last few years, there is still tremendous variation in performance across many aspects of the drilling operation. Our aim is to reduce this variance to then top decile of current performance across all operations and make shell shale drilling a truly predictable, consistent manufacturing process, while we maintain our focus on the execution in this early recovery. We also want to reflect on the lessons of 2016. Our extreme focus on cash generation let us to take many difficult steps, whilst also maintains our financial strength of liquidity. One step we did not take was to shutdown our R&D program for the benefit of short-term cash flow. Rig flow automation and downhole integration are essential to the future of the industry. Drilling contractors who embrace and concurs these challenges, we believe can add tremendous value to their customers and break our legacy per trade by some technology providers. We believe the SmartRig paired with our NDS technology is the key platform to provide the safest, most efficient, most cost effective drilling solutions to our customers. The accomplishments of 2016 and the further initiatives we have underway give us confidence to be on the right pay towards achieving this vision. As always, I look forward to updating you on our continued progress going forward. This concludes my remarks this morning. Thank you for your time and attention. With that, I will take your questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Chase Mulvehill at Wolfe Research.

Hey, good morning.

Good morning.

Good morning, Tony. So I guess, I'll start on international. Could we talk about cash margins a little bit, I think if I heard you right, $17,000 a day is kind of what you expected for cash margins in the first quarter. Could we talk about -- can you confirm that. And then what do you see cash margins as we kind of go into 2Q into the back-half of the year?

I think cash margins, yes, definitely would be above where they were in the fourth quarter. There's a mix in the rig count, in the first quarter it's going to be roughly the same average rig count as in the fourth quarter. We mentioned that we had rigs coming down -- we have rigs coming up this quarter. There's a couple of workover rigs that William alluded to that's coming down, but the mix of change in rigs is actually going to improve. So I think the net is expected is about two-and-a-half to three increase if drilling rigs in the out rig count for first quarter. So, the mix changes, and I think also the margin will improve.

Okay, all right, that's helpful. And then so for the Argentina work over rigs how many of those go down?

Two or three.

Two or three, okay, and you have a total of 12 if I remember correctly, is that right?

That's correct.

Okay, all right. Last one, and then I'll turn it back over. Could you talk about how you're thinking about M&A and acquisitions in this market?

I think they're difficult. I think -- we've looked at a number of other companies, and most of the transactions out there frankly are not accretive in terms of asset acquisitions to where we want to go with our asset quality. And therefore it's hard to justify paying especially for public company deals a premium price to something when the assets you're acquiring are actually less or the price is more than replacement cost. So given our intention of having rigs that really comprises new platform, which we call the SmartRig, it's hard to see what deals can work. But obviously deals that bring synergies or customers, we're always looking at every possibility there. On the other hand, I think the third piece of acquisition opportunity is in things that would fold into the NDS portfolio of services. And we're open to that.

Okay, that's helpful. I'll turn it back over. Thanks, Tony.

Okay, let me just add one further comment. I think it was inspired by your write-up actually. It concerns our press release reading the rate of pricing of the commitments, the new builds. I think the press release said nine out of 10 committed new builds were in the low 20s. I think it's more accurate to say the average rate of those nine were in the low 20s. Two of that group were agreed in 2016 when the market was meaningful for less than 20,000. So I just wanted to clarify that.

Okay, thanks.

Yes.

The next question is from Sean Meakim of JPMorgan.

Hi, good morning.

Good morning.

So we have another step-down in the first quarter for U.S. margins transitioning costs go from negative mix on the day rates. I think you noted in the prepared comments first-half had marked the bottom for margins. Just was curious how confident you could be in a 1Q bottom or another way to put it I guess is, how much risk do you think there is at this point for another material step-down in 2Q or you know, are the two fairly, in your model today fairly similar?

So basically, I mean, it is pretty certain that we'll see a reduction in the first quarter of course. Basically, we have been signing contracts at the end of last year, and early this year in the -- all the way between the $17,000 and $19,000 range, and our average day rate is higher than that. So obviously we expect to see some reduction in average revenue per day in the first quarter, which I'd quantify as roughly $700 per day. We think there're some positive impacts going forward in terms of costs as we utilize the structure a little bit more efficiently when adding rigs. However, in the near-term that's more than offset by bringing in new rigs. Sometimes those rigs need to be moved from certain areas to other areas, and we have to build up the spares inventory, and the rigs, and so forth. So we think that those impacts will hit us in the first quarter, and that's why I brought up those items. I think in the second quarter the erosion in our day rates will be much mitigated. I don't see a huge impact in the second quarter. If anything we will see potentially some improvement. So that's why we think in the second -- we will have troughed in the first quarter. And in the second we expect stable to increasing, improving margins.

Got it, that's helpful. Thank you for clarifying that, William.

Yes, the only thing I would add to his comments is about two-thirds of our rigs are on terms less than six months. So as the market moves to the higher rates we have an opportunity obviously to push them up you know, just with the market. But two-thirds of the portfolio today is less than six months which was literally structured for this environment.

Few of them…

Yes, and many of them are also well-to-well, so that gives us a further opportunity.

Got it. Okay, thank you. And I guess that leads to the next question on the day rates. So the data points you gave us, sounds like leading edge for super-spec you could call like 18.5 to 19, and then you've done some new builds, let's call it in the low 20s roughly. Just curious if you're seeing any significant variance by basin, the customer mix these days in terms of kind of the small folks versus the larger integrated or large independent. Just trying to get a better sense of the mix of what you're seeing out there in terms of what's driving changes in day rates?

Yes, well first of all, just in terms of the driver of that 70, obviously is seeing the biggest change is in the Permian, and South Texas, East Texas, and Mid-con. And interestingly we're now starting to see East Texas and North Dakota as places for incremental activity. I'd make a few comments here, the first one is you're correct about the rates. I think it's also the case that our new SmartRigs should command close to the same numbers of new builds because the SmartRigs are going to be the leading edge rig. And there's really no difference between a SmartRig and a new build today that are being outfitted. And so the way I would describe it in terms of those new builds, I think a rig today that's being -- will go to work in June or so, you're looking at above 20,000 -- 20,000 or above as opposed to the number you're talking about. Rigs today, we are actually obviously said -- prior discussion so there is not so much talk make some sense there. In terms of the delta, I think it's the case of the Mid-con. The Mid-con rates are actually a little higher, and North Dakota is a little higher. Then South Texas, and actually EMEA a little higher than West Texas, so that's where I'd describe it.

That makes sense. Yes, thanks guys, I appreciate it.

The next question is from Marshall Adkins at Raymond James.

Hi guys, thank you all for the helpful comments starting out. Clearly your market share gains in the past even two months have been much faster than the overall markets improving. Is it just because you have more the super-spec rigs available or are there other things playing into that, such as your SmartRig or packaging with the NDS, or something that we can't see from the outside that's driving your utilization up a lot faster than the rest of the industry.

That's a great question. Actually, I'd say it's a multi-pronged answer, Marshall. The first is, I think it's becoming clear that our rig design technology is second to no one. And we actually believe we're setting the pace for the agenda. We've actually had dialogue with customers and uniformly we've been receiving praise for the technology initiatives in terms of rigs that they are drilling. So that's the first point. The second point is I think our crews, we did an excellent job retaining our best crews during the downturn, and they're the nucleus of rigs to work. Even in the downturn we had another record safety year this year for example. And all the exclusives are coming back. I think the customers have complete confidence in Nabors, in the upturn here, in the sense that the nucleus of these rigs are these best-in-class people we left, and they're forming the center of the new crews manning these rigs going up. The third thing I would say is the KPI information, which relates to the information in the new system that you alluded to that we have today. I think our KPIs and information about rig performance that we're making available to operators is unparalleled. I think it's part of our initiative. I'm not hiding the ball, and being proactive on attacking areas of improvement. And we're gaining a lot of momentum in that regard of just building a culture of performance. And that, I think, is really embraced by the operators. And we're telling them things that they really didn't know about, invisible downtime, where it's coming from, et cetera. And that's part of our new systems on the SmartRigs. And then finally I would say the customer attitude about Nabors, I think there is hopefully a mind shift going around Nabors is more of a solutions provider for looking to support customer base that can take advantage of the full range of NDS services I would bring to the table and U.S. as a value-added partner, solution partner as opposed to a commodity rig provider. I think all of those things are combined to make a different proposition that would have been historically. So, it is a multi product strategy, Marshall.

Okay. Well, obvious follow-up for that, you all did, I thought heck of a job in your Analyst Day, showing this -- your version of the rig of the future, we are starting to call it, where do you see the competitive landscape for the type of thing you are doing? Is anyone else who have been close to you in terms of providing that? I just want to understand where the competition stands.

Well, I would assume NOV is out there doing something with upgrading their ideal rig and trying to take their technology and put it into a land rig. I think there is no question that technology that factor is going to exist in this sort of place. We're repackaging it to be cost effective on land. I think it's the key. And I think one of the differentiation of Nabors' strategy is this SmartRig platform that we are creating will be able to be the rig of the future. Each one of these far rigs was designed, as I mentioned at the Analyst Day four years ago with the view that there is the last stage of the last mile completed, the less mile would be -- with the four automations. And so, the rig is also up to accommodate that. So, instantly when we make this available in scale, we would be able to roll it out, and I think no one else has that, and these are our leading service company. It's also high rig of future. Once they design they have to build them, they have to build a hundred of them. Whereas today, we have a hundred rigs and we can just retrofit and the time to market is going to be a lot shorter. So, at that point of view, I think we are in a unique space. I think from a technology point of view, I think we have all the ingredients, and as you saw at Analyst Day we had the prototype of the eye-racker, we are shaking it down, we are actually making some changes to it. We will start in the second half with getting some customer responses of it. And like we said our goal is by the end of the year to really be commercial with this prospectus scale. And on the NDS services side, that aspect of it, again, I don't -- as far as we know, there is not other people thinking about it the way we think about it, I think frankly, the score now for everyone whether this is causing to putting the NDS service in the rig make sense. I think some of our competitors don't believe in it at the strategy, and they don't think operators will be open to it, or it's too hard, et cetera. So, it truly will come to us to make sure the strategy works and to prove it up. I think I am encouraged by the fourth quarter numbers, as you heard, you know, NDS is gaining traction and in terms of penetration on the rigs, we are making progress there. So, we got to make sure we pushed the numbers, and that's what the mission is.

Thank you.

Thank you.

Hey, maybe given the time here, we were a little longer on our prepared remarks than usual. Let's just take one more question and then we will wrap up.

Okay. Our last question is from Blake Hancock of Howard Weil.

Thanks. Good morning, guys.

Good morning.

Tony, last quarter you talked about international EBITDA of at least 500 million, and clearly that seems achievable here given the commentary for 1Q. I wanted to see you would go as far as talk about full year, do you think you can be flat to up with what you did in 2016, let's call it you know, 575 million, does that seem ballpark-ish or achievable given the second half ramp you are discussing?

Yes, I don't want to limb here, but we've noted the comments by other people in the international market space that things are going to be actually down. In our view, right now, if things continue to where we see them, we actually think we will meet that and we will be up.

That's great. I appreciate it. And then also, going back to kind of the daily commentary on the new bills, and what we are seeing in the low $20,000 a day, is it any of that attributable to NDS in that, or is that purely just a rate of the rig?

Well, that's an important point you are making, I'm waiting for that, but the NDS -- that excludes NDS, so rig service is lined up with P&L that we are talking about. So, yes, those numbers aren't in there at all as compared to some of our competitors in their rig day rate, they are good revenue, that sound break stuff and other stuff, or that's separated out. So, it's add-on. It's that $10 million that we said in the fourth -- of run rate in the fourth quarter for EBITDA, NDS in the fourth quarter, and that by the way is after SG&A. So that's all per rig margin, not in our day rate, absolutely.

That's great. I appreciate it, guys.

Thank you.

Amy, that will conclude our call today. Thank you, ladies and gentlemen for participating. I apologize for the short Q&A session. If you have any further questions, just give us a call or send your emails. Thank you very much.

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