Nabors Industries' (NBR) CEO Tony Petrello on Q2 2014 Results - Earnings Call Transcript

Jul.23.14 | About: Nabors Industries (NBR)

Nabors Industries Ltd (NYSE:NBR)

Q2 2014 Earnings Conference Call

July 23, 2014 11:00 AM ET

Executives

Dennis Smith - Director of Corporate Development

Tony Petrello - Chairman, President and Chief Executive Officer

William Restrepo - Chief Financial Officer

Laura Doerre - General Counsel

Clark Wood - Chief Accounting Officer

Ronnie Witherspoon - Executive Vice President, U.S. Completion Services

Joe Hudson – President, U.S. Drilling

Analysts

Doug Becker - Bank of America Merrill Lynch

Jim Rollyson - Raymond James

Waqar Syed - Goldman Sachs

Jim Crandell - Cowen & Company

Jim Wicklund - Credit Suisse

Brad Handler - Jefferies

John Daniel - Simmons & Company

Operator

Hello and welcome to the Nabors Second Quarter 2014 Earnings Teleconference. At the request of Nabors this conference is being recorded for instant replay purposes. Following today’s presentation, we will conduct a question-and-answer session. All participants will be in listen-only mode today. (Operator Instructions). I would now like to turn the conference over to Mr. Dennis Smith, Director of Corporate Development. Sir, you may begin.

Dennis Smith

Good morning everyone, and thank you for joining Nabors’ earnings teleconference. 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 perspective on the quarter’s results along with some insight into the trends we’re seeing in our markets and how we expect Nabors to benefit from these trends. 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 so desire.

They are accessible in two ways. If you are participating via webcast, they’re 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 as supporting materials under the conference call listing. With us today, in addition to Tony, William, and myself, are Laura Doerre, our General Counsel; Clark Wood, our Chief Accounting Officer and the heads of other various operating units.

Since much of our commentary today will concern our expectations of the future. They may constitute forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934. Such forward-looking statements are subject to certain risks and uncertainties as disclosed by Nabors from time to time in 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.

Finally I would like to point out that a recording of this call will be available by telephone beginning at 2 PM Eastern Time today until 9 AM Eastern Time on September 22nd. You can access the call by calling 1877-344-7529 in the United States and 412-317-0088 outside of the U.S. The replay conference number is 100-48-528. I will repeat that it’s 100-48-528.

Now, I will turn the call over to Tony to begin.

Tony Petrello

Good morning and welcome to the Nabors Industries conference call to review results for the second quarter of 2014. Thank you for participating this morning. As Denny mentioned, we have posted the quarterly presentation slides on nabors.com. I will begin with my opening remarks, William will then follow with discussion of financial results for the second quarter and then I will wrap-up to take some questions.

Yesterday, we announced our results for the second quarter. Our EPS from continuing operations totaled $0.21. The quarter’s results included several items related to businesses in the process of being disposed which nets to a loss of approximately $0.03 a share. Before we detail our financial results and the outlook, I think it would be timely to share some of our strategic imperatives.

First, as we previously announced, during the second quarter, we signed an agreement to combine our completion of production services businesses with C&J Energy Services. This agreement marks the combination of our strategic review process. This combination creates an oilfield service provider with critical mass in multiple service lines across many geographic regions. At the same time, the new company will have significant growth opportunities. We are also entering into a global strategic alliance with C&J to accelerate its entry into international markets.

Nabors retains more than half of the equity ownership in the new company. This retained equity position should allow us to benefit from the upside we see emerging in these businesses. Nabors will also receive over $900 million in cash which will enhance our financial flexibility. Second, with the future of our completion of production businesses now spelled out by the agreement with C&J, Nabors will sharpen our focus on the global drilling business. I would like to share with you what this means to Nabors.

First, we view the rig as a key mechanism to apply the expertise that ultimately enhances well productivity. We are working both on the surface and in the well to develop and deploy technology that increases the efficiency and the precision of the drilling process while automating manual processes. Second, to facilitate those improvements on the rig, we have recently combined multiple rig engineering organizations into a single streamline group. We expect several benefits in this structure including a lower capital cost for new rigs, quicker time to market for new rig designs and greater component commonality across our rig types.

Third, once the transaction with C&J closes, we will concentrate virtually all of Nabors human and financial capital on our drilling and related businesses. We are on target to double our newbuild rig production schedule for the U.S. land market by the end of 2014. Our aim is to bolster Nabors position as the preeminent land driller in the global industry. We believe we have the resources, the focus and the momentum to improve that position.

Third and finally the transaction will further enhance our financial flexibility. You’ve already seen us take significant steps in that direction. We’ve emphasized adherence to a disciplined process to review capital projects and we have steadily reduced net debt and we have reduced the cost of our remaining debt.

Now let me turn to a business review while we speak to our results. In the aggregate, we were very pleased with the results. Across the board, our drilling businesses delivered strong performance throughout the quarter. The completions business rebounded from the operating loss in Q1, however its profitability was restrained by the tight industry supply of propane and adverse weather in the first half of the quarter.

We are encouraged that the quarter saw a record for stage count. Year-over-year, our stage count was up 45%. Compared to the first quarter, the sequential revenue improvement was roughly split between volume and pricing. We believe increasing utilization and pricing are leading to better profitability in the near future. Our second quarter earnings were driven primarily by a strong performance in our U.S. Lower 48 business, higher utilization and the initial realization of pricing in the completion services segment and continued progression in the international drilling segment.

Our rig services which consists mainly of Canrig, eclipsed its first quarter performance which at that time was its best performance in over a year. Results in the segment benefited from both strong revenue and margins especially for third-party equipment and were aided by a restrained level of product development expenses. I will discuss these factors as well as our outlook in a few moments.

Let me turn to a few recent highlights. Before, we get into the details for each operation, I would like to highlight the quarter’s notable operational accomplishments. First, during the quarter we entered into agreements for eight PACE-X rigs to be deployed later in 2014. We are now seeing the benefit of building rigs at a steady pace rather than starting to build only after signing a contract. The X-rig’s excellent field performance is driving strong customer interest and we are looking forward to fulfilling the market’s growing demand for them.

Second, we completed deployment number two of 11 previously announced newbuild rigs into Saudi Arabia on time and on budget. We anticipate deploying the remaining nine rigs of the substantial newbuild program during the remainder of 2014. The full impact of all 11 rigs should be evident beginning in 2015. Additionally, our jackup rig 660 resumes its operations of full-day rate during the second quarter, slightly ahead of schedule and also on budget.

Third, we completed the start up of the final rig of the six previously announced upgrade rigs in Argentina. The Saudi Arabia and Argentina projects are examples of Nabors ability to execute very large, complicated capital projects in drilling markets across the globe. Finally, during the quarter, we completed the sale of four of our Gulf of Mexico rigs including three barge rigs and a jackup. We also signed an agreement for the sale of our North Slope E&P acreage. All together, we expect cash proceeds from these sales to approach $100 million. More importantly, these transactions mark additional milestones as we sharpened our focus back on the global drilling business.

Let me now turn to our outlook. Nearly every element of the business continues to be positive in the near to intermediate term. I will start with U.S. Lower 48 market where we identified several positive trends. First, as I mentioned, we see a high level of customer interest in our PACE-X rig. We deployed the first X-rig in early 2013 and field performance has been outstanding. We rolled out four X-rigs in the second quarter. We now have 25 in the field, working in all major shale plays in the U.S. Our 26 X-rig is scheduled to go out this week. Our plans call for eight additional X-rig deployments during 2014, all of which already have contracts.

Second, the market for higher performance AC rigs continues to improve. Industry utilization for such rigs including our fleet is quite high. As operators realized the value of our advance rigs to deliver improved total well cost, we are realizing broad rate increases across major basins. We are also seeing substantial improvement in leading edge rates for AC rigs and our legacy fleet although utilization of our legacy rigs remains challenged.

Third, the trend toward high density drilling pads continues to march onward. We think this trend is partially responsible for the strong customer interest in our X-rig which is the premier rig available today for drilling large well arrays out of single pad. For our international business, the near-term outlook is driven by two main factors. First, continued deployment of the new and substantially upgraded rig awards we announced last year and second, improving pricing momentum as existing contract roll forward.

We expect the balance of the newbuild land rigs for Aramco to deploy by the end of the year. With all of our Argentine awards now deployed, we should realize a full quarter impact beginning this quarter. Our largest jackup rig 660 came back on rate during the second quarter. And we expect the four quarters contribution from that rig in the third quarter. As well four of the renewals in Saudi Arabia which we signed last year, commenced a new contracts in the second quarter and the balance start the new contracts by the end of the year.

As you look beyond our current backlog, the market upturn we previously identified remains intact. We see opportunities for additional meaningful rig awards in the Middle East and Latin America. We are pursuing those awards aggressively. At the same time, we continue our disciplined approach to returns on capital which mark our recent contract awards. A couple of items partially offset these positive factors.

As we called out last quarter, the market for land rigs in Mexico has softened as a result of reduced activity and more aggressive competition. We see limited prospects for those rigs to return to work until the New Year. In India, we are marketing the two platform workover rigs which came off contract. We currently have two iackups which are offering in the Middle East. Rig 655 also came into the yard for repairs, so it remains under contract during the yard visit which we expect to last about a month. Rig 240 which went into the yard during the second quarter for repairs, was released by the customer and we expect it to return to work during 2014. We are taking advantage of the current yard state of completed special survey ahead of its due date early next year.

The Alaska rig market remains highly prospective. We are on track to add slightly more than a full rig year in 2014 versus 2013 and potentially two more rig years in 2015. Discussions with customers for large projects in Alaska are continuing. Those talks are for projects which will potentially require significant capital investments but which we believe also will generate returns on capital consistent with our capital allocation criteria.

Within our U.S. offshore operations, we have begun to rationalize the Gulf of Mexico jackup and barge fleets and we’re looking at alternatives for the remaining rigs. We are committed to the platform market where our utilization is firm. We anticipate that the rig supporting the Bigfoot project will mobilize very late this year and come out full operating day rate late in 2015.

In our Canadian drilling operation, we are already seeing the seasonal increase in activity. While we expect higher utilization than a year ago, our margins remain challenged in that market. We are seeing reasonably healthy activity in the liquids rich basins and the early phase of the drilling ramp to support LNG.

Within our rig services business, backlog at Canrig continues to build both the third-party and Nabors internal business. Canrig’s backlog now to sits at an all-time record since bottoming in the second quarter of last year, total backlog is up 250%. With the current backlog composition, we expect a slight shift in Canrig’s business mix between third-parties and internal needs. We also anticipate an investment in necessary resources to support the expected ramp up in production and lot of its growing backlog.

In the Completion Services business, the second quarter rebound in the financial performance of this sector from the first quarter level is encouraging. While we’re not yet satisfied with this operating performance, we’re optimistic for improvement throughout 2014. We began implementing price increases in most basins during the second quarter, so the full effect of those should be evident in the third quarter.

The challenge in this business currently is the availability of propane. We have taken steps to improve our supplies of propane which should improve our utilization further. For our Production Services business, we expect rig and trucking hours to increase seasonally. While the business remains solid, so far this year we have seen less acceleration than we anticipated. For the rest of the year, we would not expect better performance than normal seasonality would indicate.

I will conclude this outlook with our near-term expectations. Several specific factors will impact our results in the third quarter. First, we anticipate booking $30 million in early termination revenue in the Lower 48 business in the third quarter. This amount is the second half of the larger early termination payment we announced almost a year ago. Second, we expect a normal seasonal uptick in the Canada and Alaska markets, while the U.S. offshore business should decline as we enter hurricane season.

Third, two of the smaller jackups in the Arabian Gulf will spend time off day rate. We have a high expectation for rig 240 to return to work this year and rig 655 should go back on day rate this quarter. In the Lower 48 drilling business, we expect higher quarterly rig years as we add additional PACE-X rigs. Those rigs should have a positive impact on margins as should the day rate increases we’re realizing elsewhere in the fleet.

In the International segment, we expect stable rig years with an improving mix of newbuild deployments and renewals to push daily margins higher. Demand in completion services and pressure pumping in particular is quite strong and the market is tight enough to support price increases. We’re currently running 19 frac crews out of the total 24. Our utilization is constrained by the limited availability of propane though we anticipate improvements in supply chain, will enable us to pump a full calendar through the end of the year.

Now, I will turn the call to William who will detail our financial results.

William Restrepo

Thank you, Tony, and good morning, everyone. Net income from continuing operations was $66 million or $0.21 per diluted share compared to $28 million or $0.08 per share in the second quarter of 2013 and $49 million or $0.16 in the first quarter of 2014. The above earnings per share included certain charges in the second quarter related to assets and businesses that we divested during the quarter or that we are in the process of divesting, as well as tax benefits related to filing our 2013 returns in foreign jurisdictions. Excluding net charges, earnings per share for the quarter was $0.24.

The sequential increase excluding these net charges was principally driven by the following five after-tax items. First, a $0.09 per share improvement in completion services driven mainly by higher utilization, increased pricing and reduced cost for consumables. Second, a $0.06 per share improvement in Lower 48 drilling due to incremental rig years and wider daily margins. Third, a $0.01 combined improvement due to higher results in Canrig and Ryan. Fourth, a $0.01 reduction in income taxes and finally offsetting the above, an $0.08 per share decline in the Canada and Alaska drilling businesses driven by the normal seasonal breakup conditions.

Gains on sales of financial assets in the quarter of $4.9 million essentially offset equivalent currency losses in various operating locations.

Operating revenue and earnings from unconsolidated affiliates of 1.6 billion, increased 2% sequentially and 11% year-on-year with all our major segments contributing to the sequential growth with the exception of Canada drilling which experienced its usual sever seasonal downturn. Completion and production services led the way. Revenue of $535 million grew by 32 million or 6% sequentially and a sharp rebound in fracturing. U.S. drilling revenue of 533 million, increased by 22 million or 4% sequentially, reflecting the strengthening market in the Lower 48, while international revenue of $391 million improved by 15 million or 4% as additional rigs were deployed in Saudi and Argentina.

Other rig services of a 162 million, grew by $18 million or 13% sequentially, primarily due to Canrig internal and third-party sales. On the negative side, Canada drilling revenue of 55 million fell by 51%. Total operating income of $133 million, increased 22% sequentially and 49% year-on-year, again with all segments contributing sequentially with the exception of Canada.

Total operating margin was 8.3%, a sequential improvement of 140 basis points. U.S. drilling operating income of 90 million, increased 26% sequentially. Operating margin was 16.9%, a sequential increase of 270 basis points, driven by a strong performance in the Lower 48. U.S. offshore operating income and margins were stable while Alaska margins fell by 210 basis points and seasonal weakness. The Lower 48 had an operating margin of 15.9% and a sequential increase of 410 basis points, which reflected a higher number of active rigs as well as increasing revenue per rig from higher pricing with all rig categories improving.

Average active rigs were 199 and 11 rig or 6% sequential increase. The growth was evenly split between our legacy fleet and our AC rigs. Today we have 202 rigs on revenue including the one on stand-by rate. Our AC rig count stands at 148, utilization of our AC rigs in the second quarter was 94% and utilization for pad capable AC rigs was even higher at 96%. During the second quarter, contracts on 34 of our rigs expired, 14 of those received extensions for new terms averaging 7.3 months at rates that are up meaningfully.

The remaining rigs converted to well-to-well operations where they can benefit from the rising spot rates. For the third quarter, we have 26 rig contracts expiring. As we look across basins, demand in pricing is currently strongest in the Permian followed by the Eagle Ford. Our northern markets remain stable. Daily drilling margin for rig for the Lower 48 was $10,031 an improvement of $608 or 6%. Virtually, all of rig categories in the Lower 48 delivered increases in drilling margins as compared to the first quarter.

At the end of the second quarter a 117 of our rigs were working under term contracts and 82 were on the spot market. As we deploy additional PACE-X rigs, our rig mix improves which will progressively contribute to higher daily revenue and margins. International operating income of $50.6 million, increased 5% sequentially. Operating margin was 12.8%, essentially in line with the first quarter. Operating income increased sharply in Saudi, as two more rigs were deployed and in Argentina as all of our recently contracted rigs started drilling operations.

Additionally rig 660 went back on day rate during the quarter after concluding its stay in the shipyard. These increases were partially offset by lower revenue in Venezuela and weakness in Mexico’s land market. As we had already anticipated in our prior call, two of the platform rigs in India were released during the quarter as was our small kackup in the Arabian Gulf. The quarter’s results illustrate the level of execution that has characterized this business recently and that we expect to accelerate during the second half of the year. Canada drilling operating income of 0.2 million, fell by $24.9 million sequentially, reflecting the normal seasonal breakup.

As compared to the same quarter of 2013, operating margins declined by 560 basis points, driven by a weaker market environment with lower pricing. Also compared to the prior year, despite four more active rigs, some of our longer duration contracts have rolled to lower market rates and heavy tele doubles have replaced triples in some projects. Rig services operating income of 9.1 million, increased 4% sequentially despite incurring certain drilling project costs and experiencing a 3.4 million loss in the soon to be divested Alaska construction business.

Canrig and Ryan contributed with healthy operating income increases during the quarter. Demand for rig equipment and drilling optimization services increased as well as improving demand for directional drilling services. Operating income for completion of production services of $29.3 million, increased 32.4 million sequentially. Operating margin of 5.5% increased 610 basis points sequentially driven by completion services with an increase of 15 percentage points to essentially breakeven.

This improvement reflected the rebound in our fracturing operations from the harsh weather conditions in the first quarter. We’re all starting to benefit from price increases and targeted cost reductions. Utilization improved significantly as our stage count increased sequentially by over 10%. At this point we have filled the frac calendar through the end of the year.

We also implemented price increases in most of our operating regions and expect those to be fully realized during the third quarter. Even though operations were hampered by inclement weather that impacted operations into May and propane shortages that impacted our work flow. At this point, 15 of our pressure pumping fleets are working on 24 hour schedules, another three are on 12 hour schedules.

And additional spread is currently being retrofitted with dual fuel capability and we’re currently refurbishing our remaining idle equipment so it can work on high pumping intensity wells and provide relief horsepower for the existing crews. Reductions in chemical and guar costs are starting to contribute and should be more evident beginning in the current quarter.

Operating income for production services in the U.S. of $31.2 million, increased 9.3% sequentially. U.S. production services operating margins were 13%, an increase of 110 basis points. Canada production services fell by 3.4 million as a result of the spring breakup. This compares favorably to the 6.3 million seasonal decline in 2013.

In terms of outlook, I would like to provide some metrics that maybe useful for financial modeling purposes. As a result of gearing up our PACE-X newbuild program and with expectations of further international rig awards, we anticipate 2014 capital spending of roughly $1.8 billion. Capital spending in the quarter was 458 million. We estimate full year depreciation and amortization of approximately $1.2 billion. We should assume our full year effective income tax rate of 17% to 20% for 2014. So, our ultimo geographic mix of income could cause that to vary somewhat.

In conclusion, we have started to see the impact of the market trends we have anticipated. We also continue to work and leverage profitability improvement initiatives across business lines, specifically aim at realizing the full value for our services while we reduce purchase costs and have experienced some improvements already from these projects.

Our efforts are paying off and we expect continued progress throughout the year. And that wraps up my review of our second quarter results and now I’ll turn the call back to Tony for his concluding remarks.

Tony Petrello

Thank you, William. Let me summarize our views and priorities. First, the global drilling market continues to improve. We believe the fastest growing segment of the market is for high-spec drilling which is our focus. We are already seeing the benefits of this environment in our earnings stream and we believe there is more to come. Second, we have taken significant steps recently to reposition our portfolio of businesses while we strengthen our operational execution and improve our financial strength.

Having taken those steps Nabors is poised to grow in both the U.S. and international drilling markets. Third, we have reported steady progress at pruning non-core assets streamlining operations and improving our financial flexibility. While those initiatives continue, we’re now taking a more intensive look at the operational efficiency of our business segments.

We fully expect to identify and realize additional meaningful reductions in our cost structure by the end of this year. Last quarter, our outlook called for earnings to improve as the year progressed, as of this call that view is fully intact. As we look out further, we see growing opportunities set within our core drilling business. We’ve positioned the company to capitalize on those opportunities and we look forward to reporting our progress.

Thank you for your time this morning. With that I’ll take your questions. Operator, please open the line.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions). Our first question comes from Doug Becker of Bank of America Merrill Lynch. Please go ahead.

Doug Becker - Bank of America Merrill Lynch

I guess I have lot to cover but Tony you mentioned the availability of propane to pump, you now have enough to pump a full schedule where you mentioned that the frac calendar was full through year end. Does this mean for the 19 crews or for the 24 crews and what does this mean for profitability given that same cost seem to be rising?

Tony Petrello

Let Ronnie answer those questions.

Ronnie Witherspoon

Yes, so I think the full calendar, let me get through the 19 crews and 24 crews as far as utilization. Right now every piece of our horsepower is being utilized with the exception of one crew that is being retrofitted for dual fuel and the other crew is being refurbished. All the remaining, logically you this there is two more crew remaining. Those two crews have basically been built in to extend the size of large crews that have to be large enough to meet job requirements given by our customer demand. So, when we say that the calendar is full throughout the year that’s our entire food of horsepower outside of the one that’s being refurnished and one that’s the duel fuel that will be deployed in the first part of the Q4.

Doug Becker - Bank of America Merrill Lynch

And so just to clarify on that front, just kind of simplistically we’re thinking 19 crews let’s say currently, we should be going to 22 as we think about 3Q and 4Q.

Tony Petrello

Doug, what’s happened is the concentration of horsepower for crew has shifted, there are some other crews who can nail that in, so the average horsepower were higher than it was, effectively that’s correct, Doug.

Doug Becker - Bank of America Merrill Lynch

And just anything on the cost inflation?

Tony Petrello

Repeat the question, Doug.

Doug Becker - Bank of America Merrill Lynch

Just anything on the cost inflation of sand?

Tony Petrello

Yes, I think right now again all market indicators look solid. As far as our biggest challenge is right now it’s more along the logistics side and I think that’s going to continue to plague us because I think we’re going to see the high activity levels. And our team has done a great job with providing alternatives with our clients if we have shortages in sand or are hampered by certain logistic efforts and our clients have received this well. However, it does cause scheduling changes and you got to flip the job here and flip the job there. All of this leads to circumstances that could cause you to have exposure and some increased flat time. Outside of that, we don’t see anything out of the ordinary.

Doug Becker - Bank of America Merrill Lynch

Okay. And then may be just one on Lower 48 land drilling, daily margins increased by $600 or so let’s say 200 of that was a seasonal because of the payroll taxes that we see in the first quarter, so a net of 400. Is it reasonable to see this number accelerating as we go into 3Q and 4Q given the profitability improvements and just higher pricing?

Tony Petrello

Well, of that increase, I would say most of it was revenue increase and going into next two quarters, I think we’re going to see a steady increase but whether it’s at that pace or not I can’t tell you right now, it depends on all those overhead.

Ronnie Witherspoon

Most of the increase was due to revenue.

Doug Becker - Bank of America Merrill Lynch

Okay. Fair enough.

Operator

Our next question comes from Jim Rollyson of Raymond James.

Jim Rollyson - Raymond James

Good morning everyone. Tony, just following up on Doug’s line of question on the completion side, when you think about having a full schedule finally for the back half of the year and the pricing increases you alluded to. How do you think about the margin progression, I mean you had obviously first quarter hit with weather and contract rollovers and all kinds of stuff. Second quarter back more or less to breakeven. Is that going to the low or mid single-digits as you go through the back half of the year when you get pricing going and utilization up?

Tony Petrello

So, let me answer the question this way, obviously Q1 was a disappointment and Q2 the way it’s worked out is I think it shows steady progress. We are nowhere near where we want to be and I think as we march the Q3 and Q4, we still have a lot of initiatives, Ronnie talked about the propane side, also on other chemicals we have some initiatives to low our cost of sales there and pushing the pricing across the board. So, one metric I would say to you is if you actually look, I think William you can confirm this, if you look at our incremental revenue, second quarter versus first quarter in terms of top to the bottom line it was almost 68%. So, that’s obviously at the margin but that gives you an idea of where we are at and we just got to keep working on these factors as we march forward and I think we will get there by the fourth quarter.

Ronnie Witherspoon

We are not close to where we want to be, obviously there is a lot of hard work ahead of us but we expect to be there by year end.

Jim Rollyson - Raymond James

Okay, that’s helpful. And then as a follow-up, Tony on the international side, I think you said overall about flattish rig years in 3Q versus 2Q, but obviously you got some ups and downs of moving parts in various rigs. Two questions around that, one, where does that total rig year number go over the next three or four quarters when you get all of these rigs that are in different places right now into effect either with contracts or hopeful contracts? Would be first question and how do we think about international margins given that you will have the rig 660 in the fourth quarter and 3Q and you will have the six Argentina rigs in for fourth quarter and I imagine those are higher margin contracts and so the margins get skewed towards improving operating margins in the back of the year?

Tony Petrello

Sure. Okay, so first with respect to I think there will be a steady progression of change in the international rig count. It’s going to a modest number but the steady run as we march toward the end of the year. Just to give you an example of Saudi rigs flow in, we had one in the first quarter, one in the second quarter. We have two in third quarter and seven in the fourth quarter of those newbuilds. The other factor that you guys think about in terms of margin expansion for existing rigs is the rollovers of contracts, we have already alluded to the fact the Saudi rigs have been rolling over, will roll over. So, I think it’s those two factors that also contribute to the margin expansion. So, that’s where it will come from.

Jim Rollyson - Raymond James

Any sense of how much margin expansion might be from what you see with your contracts right now?

Tony Petrello

It is definitely more and I don’t want to put a number on but it’s definitely more.

Jim Rollyson - Raymond James

Fair enough. Thanks guys.

Operator

Our next question comes from Waqar Syed of Goldman Sachs.

Waqar Syed - Goldman Sachs

Thank you very much. Tony, could you talk about what’s your capacity to build PACE-X on an annual basis and can that increase?

Tony Petrello

Yes, so here is the story. Right now we’ve been doing about, we have about two a month. You should also understand Nabors as a whole is also doing another two. So, we’re actually building about four month right now. Canrig in terms of its components, certain components like top drives, it actually has capability to turning out about 15 a month. So, what we’re in process of doing is increasing our capacity for X-rigs to go to a run rate of about, go to a pace let’s say of around four by January of this year. And I think we’ll get there but as much as the increase in capacity, I am also spending time as we alluded to in our remarks, in improving the efficiency of the building process. And one of our missions now is to focus on optimizing what we have and extract more which you can try to lower the overall capital across these things as we move to a more repeatable model.

Waqar Syed - Goldman Sachs

Okay. And could you tell us what’s your current active rig count in the U.S. Lower 48 and where you expect it to average maybe in the third and fourth quarters?

Tony Petrello

I think it’s 203 today, I think it went up since the release and I think there will be a steady progression in the next two quarters.

Waqar Syed - Goldman Sachs

Okay. And then could you also talk about the industry’s ability to deliver rigs on an annual basis, what do you think that number is?

Tony Petrello

I think around a 100 to 150 something like that range.

Waqar Syed - Goldman Sachs

And would that be like a global number for a kind of high-spec tier 1 type of rig or is that just deliver into the Lower 48?

Tony Petrello

I think it’s more to just Lower 48. I think there’s still more rigs that can be delivered internationally and probably will be.

Waqar Syed - Goldman Sachs

Okay, good, that’s very helpful. And is that all limited by the number of top drives that the industry can deliver or is there some other limiting factor?

Tony Petrello

Well, I think there’s a limiting factor in terms of, there’s whole set of supply chain challenges now, BOPs, engines and all. I think unless you are in the mode that we are in, you’re going to have, there are some challenges out there. So nothing that is a show stopper but I think there are challenges and as this market continues along this way, those challenges could get exacerbated. I think one thing you should be aware of with the internal manufacturer capacity that we have is I think we’re in a unique position to modulate the whole thing and optimize it because as you know the draw works, the top drive and the catwalks are things that we are selling to third-parties.

And so we have the ability to sort of ramp up and if decided we don’t want to, we will supply those to the other people in the sector. So, I think we’re proceeding with a plan to ramp up here but I think on the other hand we also have alternatives to turnaround if the market isn’t there to support it.

Waqar Syed - Goldman Sachs

Okay. And were I to kind of order a top drive today from Canrig, what’s kind of the waiting time?

Tony Petrello

About six months.

Waqar Syed - Goldman Sachs

Okay. And just one final question, one of your Canadian competitors has signed kind of agreement with Schlumberger. How does that change the competitive landscape and does that force Nabors others or your peers to do something similar or what’s the strategy against that agreement?

Tony Petrello

I have looked at the agreement, I am not sure it meaningfully moves anything but I think from Nabors point of view, we’re interested in doing anything that will create value for our customers and that’s our strategy and that includes an alliance with somebody to make that happen. We’re open to it but right now we think the greatest value to our customers particularly in North America is producing the best rig for pad drilling and I think we have it. And you are going to see it augment with other things around that rig to improve overall performance during the next couple of quarters and that’s our strategy.

Operator

Our next question comes from Jim Crandell of Cowen.

Jim Crandell - Cowen

Hey Tony, I want to follow-up just on that last statement that you made about your strategy is to provide the best rig for pad drilling and there would be some enhancements coming up. Are you at the point now where you can make judgments on the performance of PACE-X versus other AC drive rigs and are those coming out very favorable for the PACE-X?

Tony Petrello

I think the first thing I am pleased to report is that we just did a site survey, visiting some customers particularly in South Texas where we’ve had other strong competitors. And one company man has operated two of our leading competitors’ rigs, has anecdotally said to us that the PACE-X is leaving other rigs into dust and we’re trying to convert that to tangible data. I think one of things that people don’t focus on when we talk about the pad drilling is yes, we’re XY but we are also 360 and so PACE-X moves on a 360 basis and when you think about moving from well to well, it’s not just the time moving well-to-well, I think one of things that is probably going to be more tapped as potential is notion of batch drilling.

And the batch drilling with a PACE-X rig has unique advantage because of its racking capacity. You never have to lay down pipe. So, the opportunity to be really productive as you move from well-to-well on a PACE-X rig is really quite sizable. And those are things that operators are beginning to understand and figure out ways to make it even more useful. And so, with all this anecdotal stuff coming in now, now we are going to look at the PACE-X and we will look and see what to be enhanced and what’s working well et cetera. And as I said we are also be looking at how we can build it more cost effectively.

Jim Crandell - Cowen

Thank you. So, initially you were selling the rig based on these enhanced number of features that PACE-X rigs have doing. We are just saying as you move beyond now from just where you have the features where customers are still selecting you based on performance of the rig itself from a field.

Tony Petrello

Correct, correct.

Jim Crandell - Cowen

So, as you look at the demand for PACE-X rigs in the U.S. Tony, as the primary newbuild orders coming to from repeat orders from existing customers, are you seeing quite a broadening out in the numbers of companies who are ordering new PACE-X rigs?

Tony Petrello

Actually, I will let Joe speak to but I think we have some new people come back into the fold, so I think as people become more aware of the rig, it’s actually becoming a crawling card for us and it will have the effect of broadening out our client base and particularly with some of the larger independent expanding those relationships.

Joe Hudson

Jim, the recent contracts, eight rig contracts for five different operators in four different basins.

Jim Crandell - Cowen

Interesting. And my last question, Tony or Siggi, as you look at the international business and the international demand for the rig. Is there a significant demand or will be for the fast moving rig up and rig down benefits that the PACE-X has and over the next two to three years, if the answer to that is yes as I suspected is in many regions, what do you think the percentage of the rigs that could go outside of North America could be over the next two to three years of just the PACE-X?

Tony Petrello

A PACE-X style rig I think is going to have some applicability internationally. Clearly in Argentina we are sending down some F rigs right now for pad drilling. PACE-X rig would an ideal rig and one of the other strategies here, as part of the common engineering group I've alluded to is the fact the X-rig is being especially with Siggi now running to entire engineering group, the X-rig will be set up in a way to be A national. In other words its components will be set up so the rig can move between U.S. and Canada or Canada and international markets. So, we definitely see that potential out there for the X-type rig to gain traction.

Operator

The next question is from Jim Wicklund of Credit Suisse.

Jim Wicklund - Credit Suisse

Good morning guys. Tony, you are talking about increased pricing in C&P across the U.S. is that because you were priced lower than competitors before or are we seeing that much of a broad-based improvement in completion and production services pricing in the U.S.?

Joe Hudson

All we can say is that, all market indicators look solid right now and I think if you look at the type of job requirements they have expanded in scope, it requires more horsepower, so we have seen the tightness that’s evolved across now pretty much the entire U.S. and so we are seeing pricing opportunities. And we’re able to move pricing towards the second quarter and as Tony and William alluded to earlier we will be able to realize some of that in the third quarter going forward but right now what we are doing is really trying to get some of these costs pass-through based on the logistical challenges we are having and some of the interruptions we are having there pass-through in a timely manner to our client. But even with that said, the overall fundamentals of the market seem to be leading us to even further increased pricing above those cost pass-through.

Jim Wicklund - Credit Suisse

Okay and on land rigs in the U.S. we had assumed that this year you see $1500 maybe as much as $2,000 worth of day rate improvement from January through December this year. Listening to you guys over the next four to 18 months and I know we never know but over the next 18 months that would appear to be tame, is that right?

Tony Petrello

You said it. You said it exactly.

Jim Wicklund - Credit Suisse

Well, I mean I know that independence is coming public and they are talking about signing three year contracts above 30. Are you guys seeing anything close to that or like to that even if you are not getting, are we seeing it in the market?

Tony Petrello

So, independence is saying they are signing what?

Jim Wicklund - Credit Suisse

They are talking about day rates over $30 on contracted rigs, I was just wondering if they see it and then everybody is going to eventually see it and I just wondered if you guys.

Tony Petrello

With add-ons and things like that I mean you got to really very normalize the rates but something could go above 30 in today’s market, something could go above 30 but depend on what the add-ons are. So, that’s clearly not the norm though right now it’s not we’re at and I think as what we are seeing as we roll over existing 80 rigs into new contracts, we’re getting meaningfully increased numbers and day rate improvement. And we think that environment is here for a while now.

Jim Wicklund - Credit Suisse

I know nobody ever likes to give real hard numbers or anything but can you give us some idea of what a normal or the average PACE rig day rate is today?

Tony Petrello

I mean we’re negotiating contracts right now with lot of people, I can just tell you they are really attractive numbers and operators are looking at the value proposition and they’re willing to pay up for it but it is above where the market has been, that’s what I can tell you.

Jim Wicklund - Credit Suisse

I’ll take that. And if I could, one last one, Saudi Arabia that clearly has been everybody’s big growth engine. You’ll have a lot more rigs there. I am trying to get an idea if we’re trying to model this, how much more meaningfully above current average is the new rigs going into the Saudi market might be?

Tony Petrello

The new rigs are rolling over at substantial increases in day rates, I mean very substantial increases in day rates.

Joe Hudson

I think very substantial.

Tony Petrello

What we have said in the past is that the margins in international contracts that we signed recently are two and a half times or so higher than your average U.S. rate, that’s what we have said.

Operator

Our next question is from Brad Handler of Jefferies.

Brad Handler - Jefferies

I’d like to try to hit on a couple of topics that haven’t gotten as much coverage in the Q&A. On production, can you put into perspective what happened in California in the quarter and what weight that may or may not have on the second half of the year?

Tony Petrello

There is no question that there is a major operator out there and maybe not but just one that looks at. They constantly have allocation of capital issues and the question is at what point you want to spend more of your dollars in drilling new wells versus spending money on working over existing wells. I think what’s happened there has been a shift recently by at least one main participant to more towards the new wells than the existing wells. And that has some precautions for certain people, certainly one of our big competitors.

It has had effect on us but probably not to the same extent and those kind of allocation of capital issues go back and forth. And I think as we get towards the end of the year, we may see that revisited but that’s as much far as I can put on for you.

Brad Handler - Jefferies

Okay, that’s helpful, maybe just a follow-up on that topic. So, it sounds like your strategy, your approach would be stay the course in terms of keeping assets in place and then sort of let’s see how that demand evolves into ‘15?

Tony Petrello

I think that’s exactly right.

Brad Handler - Jefferies

Okay, that’s helpful. And then turning to, I guess turning to G&A expense which has been, you have identified that you’re going refocus on your cost base in general terms. But I am wondering maybe as we look into ‘15 and you’ve given your C&P businesses off. What kind of percentage of revenue might we be able to see on a G&A basis? What’s the normalized number or target for you?

Tony Petrello

The one thing I would ask you to do is first off the public documents you can run numbers but look if you breakdown the component of our portfolio by line of work and then you apply the SG&A percentage for us by component that you do with the blended average compared to best in class or top three for any of our competitors, you are going to see that the blended average is right there with everybody else. So, one reason for the high percentage is because the mix of business is as we change now, as I alluded to actually change, we have the chance to optimize our own structure for obviously a much more streamline operation. And I think cost numbers we had there and that is going to be a priority. First priority was to get the mix of businesses, get the portfolio right. Next priority is now we have that direction established and try to basically extract more and do it with less.

And as I said with respect to the capital side of that equation we already have some visibility and we think when you’re spending the kind of capital we’re going to be spending, 5% decrease in capital cost is a really meaningful number to the bottom-line. So, we see this really in that area very clearly in that side. By the first quarter of next year, we should be making meaningful reductions there.

Brad Handler - Jefferies

Got it but just to be clear, I mean I understand your perception of your mix of business today but there is no reason why as you streamline then you wouldn’t think you’d be able to mirror your leading peers G&A proportions, that’s what I hear you saying, right?

Tony Petrello

Yes, so in fact what I am telling you is today we do. If you do the calculation you can find that we do and that’s just but I think there’s two factors. One it gets masked by the composition of our business and number two I think some of the good effort we’ve done for example in NCPS we’ve taken out more than $30 million of cost in the overheads in NCPS during this downturn in the past 18 months but it hasn’t really shown up as the meaningful to the bottom-line number. So, it sound like I have been waiting to get something done before focusing on this. We actually have had a lot of initiatives there, it’s just that the good efforts have been overshadowed by bigger factors but I do see the opportunity to bring more to the table in this arena.

Dennis Smith

Sorry to add that, since we’re getting close to our termination time, we will be able to just take one more question and then if anybody has remaining questions feel free to give us a call at the office.

Operator

Great, thank you. Our final question is from John Daniel of Simmons. Please go ahead.

John Daniel - Simmons

Thank you for squeezing me in, just two from me. You mentioned the intent to double the manufacturing capacity which I believe takes you to a cadence of about four rigs per months, one is that correct? And then two, is there enough demand or visibility for 2015 that you think that that cadence could last all year and then if so what’s the split between U.S. versus international deliveries, just a guess?

Tony Petrello

Well I think as we said we already have four for Nabors, so I think we are going to move at least another two for U.S. that would be at a rate of four starting in January. And right now our planning is to be prepared to have pretty close to that kind of run rate, three to four for 2015 right now, depending on how we see things develop for the remainder of this year but we will be in the capacity to do that of the three or four for the U.S. alone by the end of this year.

John Daniel - Simmons

Okay, all right. And then just a housekeeping one, you mentioned that you’ve got a 117, the rigs that are under term contract today, can you tell us what the average was in Q2?

Tony Petrello

If you heard that John, Joe said it was roughly 48% of the rig count was termed out the average for the quarter, probably about the same number I would guess.

John Daniel - Simmons

Okay. Thank you. And then just the last one, the frac fleet that’s been refurbished, when that process is complete and the fleet is redeployed, will you then recycle another fleet to come in for the refurb process?

Tony Petrello

Again this is the way the business has evolved and change. We’ll continue to have, continues to evolving refurb program just so we can keep up with horsepower, because we don’t have the ability and we’re trying to maximize pump hours per day, every calendar day of the month. So, we don’t have the ability to shut down for five or six, seven maintenance day as we did historically in the past. So, with the paradigm shift and the onset of the shales, we’re making sure that we have that rotational refurb program, so we can keep up our maintenance and make sure that we can continue to keep the service quality of our fleets across for our clients.

Operator

This concludes our question-and-answer session. I’d like to turn the conference back over to management for any closing remarks.

Dennis Smith

As I said thank you for participating today and if we didn’t get your questions, feel free to give us call at the office and we will be happy be to accommodate you. Thanks again for participating.

Operator

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

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