Nabors Industries (NBR) Anthony G. Petrello on Q2 2016 Results - Earnings Call Transcript

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Nabors Industries Ltd. (NYSE:NBR)

Q2 2016 Earnings Call

August 03, 2016 11:00 am ET

Executives

Dennis A. Smith - Director-Investor Relations

Anthony G. Petrello - Chairman, President & Chief Executive Officer

William J. Restrepo - Chief Financial Officer

Analysts

Angie M. Sedita - UBS Securities LLC

K. Blake Hancock - Scotia Howard Weil

Sean C. Meakim - JPMorgan Securities LLC

James Wicklund - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Waqar Syed - Goldman Sachs & Co.

Marc Bianchi - Cowen & Co. LLC

Daniel J. Boyd - BMO Capital Markets (United States)

Operator

Good morning, and welcome to the Nabors Second Quarter 2016 Earnings Results Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded.

I would now like to turn the conference over to Denny Smith. Please go ahead.

Dennis A. Smith - Director-Investor Relations

Good morning, everyone. And thank you for joining Nabors' earnings teleconference to review our second quarter 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 results, along with insights into our markets and how we expect Nabors to perform in these markets.

In support of these remarks, we have posted some slides to our website which you can access to follow along with the presentation if you desire. They are accessible in two ways. One, if you're 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 as Supporting Materials under the conference call listing. Instructions for the replay are posted on the website.

With us today in addition to Tony, William and myself are Chris Papouras, our President of Nabors Drilling Solutions; John Sanchez, our Chief Operating Officer for Canrig; and Laura Doerre, our General Counsel, and some of our other members of our senior management team.

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 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, adjusted EBITDA, operating income loss and free cash flow. We have posted to the Investor Relations section of our website a reconciliation of these non-GAAP financial measures to the most recently comparable GAAP measures.

Now I will turn the call over to Tony.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Good morning, everyone. Welcome to the call. We appreciate your participation as we review our results for the second quarter of 2016. I will begin with a brief summary and then comment on our performance. William will follow with a review of the quarter's financials. I will then wrap up and take some questions.

The second quarter marked a turning point in customer sentiment. Despite the recent drop in commodity prices, our customers remain more positive than they were as the year began. Two main factors that drove second quarter sentiment include, first, the price of WCI crude, which during the second quarter increased by $10 a barrel; and second, the Baker Hughes land rig count, which declined to 374 rigs in May before increasing to 397 rigs by quarter end and further to 440 rigs last week.

We believe our U.S customers have reached their targeted spending levels during the second quarter. Activity in this market has begun to increase. Some operators are following through on drilling plans made earlier in the year. Others have decided that current economics justifies drilling. In our International segment, the rig count declined in the second quarter. We expect declines in activity in the third quarter and fourth quarter, leading to a bottom at approximately year end. Keep in mind that while the international cycle typically lags the U.S., it is also usually less volatile as a whole.

In the second quarter we generated adjusted EBITDA of $166 million; revenue was $572 million. Despite deteriorating global markets, net debt decreased by nearly $140 million year-to-date. This is mainly attributable to strict control over operating expenses and capital spending. Results in the Lower 48 drilling business declined versus the first quarter. That decrease was mainly due to the quarterly reduction in our rig count from 54 rigs to 44 rigs. We realized nominal lump sum early termination revenue on two of our rigs. Our rig count was basically flat through the early part of May. The rig count moved up gradually through the end of the quarter as we put rigs back to work.

Financial results in our International segment increased slightly. Primarily this was due to early termination of a rig in Asia and a negotiated resolution related to standby revenue. Nabors' total revenues for the quarter were down 4% sequentially. Worldwide rig activity declined to 159 rigs in the second quarter from 188 rigs in the first quarter. The rig year drop was spread across the Lower 48, International and Canadian operations.

Adjusted EBITDA was up 2% sequentially. We booked lump sum early termination revenue on a total of three rigs. In this environment we are aggressively collecting all potential sources of EBITDA. We were successful in this effort with a couple of offshore rigs in the second quarter. Excluding these items, adjusted EBITDA declined across all of our reporting segments.

Next, I will update you on several noteworthy developments since our last conference call. First, we reached agreement with our customer for the MODS 400 rig. This is the rig that was destined for a deepwater TLP in the Gulf of Mexico. The agreement includes a five-year initial term with a drop dead date of April 15, 2018 to commence full rate. The rig is going to work for an important customer. We look forward to starting operations.

Given the magnitude of the investor in the project and the state of the offshore market, the conclusion of this agreement is a significant milestone. Second, we signed a contract for the first M800 rig and it is now mobilizing to West Texas. Customers continue to express strong interest in this rig. For pads with up to four wells, we believe it is the highest-performance rig available today.

Given the indications we see thus far from customers, we have authorized building another three units. With the rig components we have already in hand, the incremental cash spend to complete these three units is less than half of the full cost.

Third, we signed a contract for our new-build PACE-X rig with a key customer in the Lower 48 under a term contract. The rig deployed to West Texas after the end of the quarter. The customer also opted for several additional services on this rig.

Fourth, we began mobilizing new-build rigs to the North Slope on a five-year contract and to Kazakhstan on a six-year contract. These projects are impactful, on time and on budget. We expect both will go on rate around the end of the third quarter. These contracts illustrate the benefit of a global drilling franchise, which Nabors has uniquely developed.

Finally, our second quarter results reflect continued focus on stringent cost control resulting in an 8% sequential decline in SG&A spending.

Now I will share our view of the market, our strategies to managing the current market and the near-term outlook. As you will recall from our last conference call, based on survey data from customers, we expected the North American customer base to reach its targeted activity levels at approximately mid-year. With the benefit of hindsight, it was a bit earlier than we anticipated. Our own Lower 48 rig count and the broader industry counts bottomed during the second quarter. Since then, it has been a slow climb upwards.

In the International markets, spending cuts have resulted in lower rig activity levels. The largest sequential decline in our activity took place in Colombia and Russia. We experienced minor declines in several other countries as well. With this backdrop, let me next share our view of the future. We assume operators will react cautiously to the current environment, particularly in light of the recent drop in oil prices. Balance sheets are still in need of repair. And capital availability remains questionable. Although there have been early signals indicating the global oil market is moving back into balance, high inventory levels persist and large-scale activity increases are unlikely for the balance of 2016.

I will now discuss our outlook. While directionally there is positive sentiment, we continue to lack full clarity regarding the rate of utilization increase and the timing of pricing increases. We note the recent oil price pull back. That drop makes it difficult for operators to get clear traction on cash flow improvements now, making it harder to increase activity in the next two quarters.

As you know, we survey our customers' sentiment each quarter. Last quarter we told you that six planned to reduce rigs by the end of the year, two planned to add and the remaining 12 were flat. It turned out for that operator group the results were about in line. Eight reduced rig activity, four were up and eight were flat. Anecdotally, customer interest has increased the past several weeks. We again surveyed the larger Lower 48 customers following quarter end, when oil prices were higher. These represent approximately 30% of the total rig count. Of those, about two-thirds have planned to add rigs by the end of the year, only one has indicated a reduction by year-end and the balance is flat.

This positive shift indicates an improvement in sentiment among our customers versus the survey we conducted a quarter ago. Directionally, as I noted, there is a clear shift in positive sentiment. However, given the past week's pull back in oil prices, we remain cautious. In the Lower 48, our rig count currently stands at 49 rigs, including 7 rigs stacked on rate.

We exited the second quarter at 48 rigs in total, including 7 stacked on rate. Of the 48 at the end of the quarter, 33 rigs were working on term contracts. For the third quarter, we expect a modest increase from the second quarter exit rate. We also expect the third quarter average daily rig margin to approach the $5,500 level.

In International markets, customers remain challenged by the current environment, most notably in Latin America. Their reaction by and large has been to reduce drilling activity. In light of the upward move in oil prices during the second quarter, some of their concern has abated. In certain markets in the Middle East, tendering activity is already increasing.

For our International segment rig years totaled 101 in the second quarter. Given current trends and our outlook, adjusted EBITDA could decline somewhat modestly in the third quarter. As in the second quarter, we will continue to focus on sweeping up sources of miscellaneous EBITDA opportunities we have available.

We anticipate realizing catch-up revenue in the third quarter. This is included in our adjusted EBITDA outlook. As for our rig count, the most significant expected reduction in rigs is concentrated in Mexico, where we do not currently have any rigs working. We expect our reported daily margin to decline again modestly in the third quarter by around 5%.

To summarize, several factors could further impact our results in the coming quarters. First, U.S. customers appear to have reached their targeted spending levels during the second quarter. The tempo of rig releases has slowed significantly. The tepid pace of rig additions more than offsets the releases, so rig counts are generally rising. Our customers' plans to add rigs are still determined by commodity prices. At this point, our outlook for the U.S. market remains cautiously optimistic.

Second, in our International segment we expect activity to decline further in both the third and fourth quarters. In turn, we expect sequential declines in adjusted EBITDA in both quarters, more significantly in the fourth quarter.

Third, the Canadian market remains very weak. We expect third quarter activity to increase sequentially but from a low base number in the second quarter. This downturn is approaching its second anniversary.

As I previously highlighted, Lower 48 rig counts have begun to move higher. While we are encouraged by the apparent turn, we are certain our customers' plans depends on commodity prices. The recent retreat in WTI reinforces our outlook for a modest recovery for the balance of 2016 and potential acceleration thereafter if commodity markets rebalance.

In the U.S., the increase in our rig count has been across basins in a number of our AC rig models. Ultimately we believe demand will be strongest for high-performance, pad-optimal rigs in lower-cost basins.

For our International business, we expect customers to reach their targeted spending levels by approximately year-end. Some are already planning their activity for next year. As is the case for the U.S., plans are predicated upon commodity prices. Based on tendering activity and indications from customers, we expect increases in their activity after the first of the year. Having said that, I want to note that we have tried in these calls to be very transparent to utilization and price movements in the International portfolio.

By its nature, the international market is not a monolith. However, it is also clear that by its nature it does not have the immediate highs and lows that we see in North America. During this past cycle, while the U.S. rig count plummeted 80% from its high, the International rig counts are up to only 33%. Accordingly, the effect on companies like ours has also dampened. This is a core, long-term benefit we believe due to the strength and resilience of our operations and the soundness of our business model. It sets us apart from others in our space.

This concludes my outlook comments. Before I turn the call over to William for his comments, I would like to address some other topics.

First, C&J Energy Services. As you know, C&J commenced a voluntary reorganization in July. The equity rate of the company has been substantially impaired and existing common shareholders will likely be wiped out. Second, Nabors' balance sheet and liquidity. I mentioned earlier the company reduced net debt year-to-date by more than $140 million. We continue to target net-debt neutral or better performance for the full year.

Third, the market is validating our initiatives in rig technology and complementary services. We now have the first signed contract for the M800 rig. Customer interest is building for this new rig. We have committed to finishing an additional three units by year-end for a total of six rigs.

The M800 is the second stage in our current technology development initiative. We are developing further stages now, and we expect more announcements in the next two quarters or three quarters. At the same time, our penetration of rigs with our complementary services continues to increase. We are now running three or more services on over two-thirds of our Lower 48 rigs.

We are planning an Analyst Day for mid-November. We will be sending out a save-the-date notice soon. In addition to a comprehensive financial review, we intend to elaborate on our vision of the future rig market requirements, both domestically and internationally. That will include detailed presentations on pad-optimal rig features.

We also plan site visits revealing the cutting edge features of our M800 rig, our rig automation and downhole integration achievements, our new rig operating system software and our case histories that demonstrate the performance-enhancing accomplishments. This concludes my comments. William will now review the quarter's financial results in more detail and provide additional thoughts on the outlook.

William J. Restrepo - Chief Financial Officer

Thank you, Tony, and thanks, everybody, for joining us today. Second quarter net income from continuing operations attributable to Nabors was a loss of $183.7 million, or $0.65 per share. Excluding impairments and losses related to disposed businesses and assets, net income from continuing operations was a $72.1 million loss, or $0.26 per share. The comparable loss for the first quarter was $80.1 million, or $0.29 per share.

Excluded from the above second quarter losses were charges of $95.8 million after-tax, or $0.34 per share, for a portion of C&J's earnings as well as impairments and costs related to our remaining investment in that company. Also excluded were $15.8 million after-tax, or $0.05 per share, related to the impairment in the value of certain assets we have agreed to sell as well as the write-down of a receivable from a previously sold business.

Revenue from operations for the second quarter of $571.6 million decreased by $26 million, or 4% sequentially. While our international business was relatively stable, our drilling activity eroded further in North America and our Rig Services business declined even more.

U.S. drilling fell by 5.6% to $140.3 million, driven by a 10-rig drop in the Lower 48 and the seasonal reduction in Alaska. These decreases were offset by the resolution of negotiations on the contract for a MODS 400 rig in the Gulf of Mexico, which resulted in recognition of additional revenue totaling $40.9 million.

In addition, early-termination revenue accounted for $4.2 million, roughly in line with the prior quarter. International revenue was flat at $401 million despite a nine-rig reduction during the quarter. The second quarter benefited from early-termination revenue of $10 million in Kazakhstan and $9 million in non-recurring revenue from the conclusion of standby revenue negotiations in Angola.

Rig Services suffered more than our other segments, as demand for rig components was severely muted and a 25% rig reduction for the market affected both volume and pricing for our other drilling services. Rig Services revenue fell by 27% to $39.2 million with both Canrig and Nabors Drilling Solutions dropping at a similar rate.

Finally, Canada revenue fell by 62%, reflecting a 66% drop in rig count during the seasonal breakup period. Despite lower revenue, adjusted operating income was essentially flat at a loss of $53.4 million. However, the second quarter operating income included $29.7 million of one-time operational gains while the first quarter only had $3.6 million. These items had an estimated favorable impact on our net income of $24.1 million, or $0.09 per share.

Adjusted EBITDA for the quarter of $165.5 million increased sequentially by $3.5 million. The previously-mentioned one-time operational items in the second quarter accounted for $35.2 million as compared to $3.6 million in the first quarter.

International EBITDA of $150.6 million improved by $2.3 million, primarily due to the extra Angola revenue and the Kazakhstan early-termination payments, partly offset by a nine-rig reduction during the quarter. U.S. drilling EBITDA of $52.9 million improved by $1.6 million despite sharp drops in land rigs as the $12 million impact of the MODS 400 more than offset the decreased volume.

Canada EBITDA was still slightly positive but fell by $1.8 million on an eight-rig decrease. Rig Services had a material decline with both Canrig and Nabors Drilling Solutions contributing. EBITDA for these businesses with their heavy U.S. concentration decreased by $9 million to negative $10.4 million.

Let me turn to the key performance metrics from the second quarter. First, the U.S. drilling business. The quarterly average Baker Hughes U.S. land rig count declined by 128 rigs, or 25% from the prior quarter. Our own Lower 48 average rigs declined to 44 rigs for the same period, an 18% decrease. Daily gross margin in the Lower 48 increased to approximately $7,900 from $7,400 in Q1. However, both quarters include early-termination revenue of approximately $1,000 per day in the second quarter and over $700 per day in the first quarter. Adjusting for these categories, the comparable daily margin was approximately $6,900 in the second quarter versus $6,700 in the first quarter.

Utilization in the Lower 48 continues to vary significantly by rig type, with the highest utilization in our most capable pad-optimized rigs. At the end of the first quarter, 62% of our PACE-X rigs were on revenue, the highest utilization rate for any of our rig categories.

In our international segment, second quarter rig count averaged 101.2 rig years, down from 110.5 rig years in the first quarter. The drop was comprised entirely of drilling rigs and was slightly less than the decline we anticipated on our first quarter earnings conference call. Average daily cash margin in the international business increased by almost $1,700 to $18,172. All of the increase resulted from the one-time favorable items in Angola and Kazakhstan.

Our low-contribution work-over rigs are still vulnerable but remained working during the quarter. The mix of rigs remained relatively constant which, combined with the 8% rig reduction, trimmed a bit our normalized daily margin.

In terms of cash generation, as anticipated we remained free cash flow positive during the second quarter. Our net debt, defined as total debt less cash and short-term investment, fell by $121 million. As a result, we ended the quarter with the entire $2.25 billion capacity undrawn on our revolving credit facility. The strong cash generation resulted partly from our continued efforts to align our operational cost structure to the falling rig counts, as highlighted by stable daily drilling margins.

We also continued to focus on segment and corporate SG&A. In fact, our total SG&A spending fell by $6 million versus the first quarter. This run rate reduction already exceeds our target to cut 2016 SG&A by $20 million versus the fourth quarter's annualized run rate.

Finally, CapEx for the second quarter totaled $63 million, somewhat below our expected run rate for the year. For all of 2016, we expect CapEx in the range of $450 million. Looking to the future, although we have experienced some recent improvement in rig count in the Lower 48 and expect additional moderate increases during the remainder of the year, given oil price uncertainty we believe the environment will remain challenging. Because of expected low drilling rig utilization, material day rate increases in North America remain unlikely through the end of 2016. International industry rig count should continue to fall during the second half. Nabors Drilling Solutions will at best hold steady given the still anemic rig count in the U.S.

And finally, our sales of rig components are not expected to improve as rig building has essentially vanished. Our current rig count in the Lower 48 at 49 rigs, including seven rigs stacked on rate, is up slightly from the exit rate of the first quarter. We expect the third quarter will average just under 50 rigs.

We also expect a seasonal increase in Canada and a seasonal decrease in the Gulf of Mexico. Nonetheless, for the MODS 400 we expect to benefit from recurring revenue of approximately $5.5 million per quarter and EBITDA of $3.3 million per quarter. Finally, in our international market we expect a minor reduction in drilling rig activity coupled with additional cost action on our operating expenses to match our lower activity level.

Despite these cost reductions, without the second quarter favorable items noted earlier, we anticipate our international margin to fall below $18,000 per day. Recent events on our customer interactions would indicate an improving environment and also bolster our belief that we are much closer to a sustainable material recovery in activity across the globe.

However, some uncertainty about the price of oil still remains. So we remain focused on liquidity. This means we will continue to target positive free cash flow for the year and a stable net debt balance. Achieving this objective will require continuous strong discipline on all of our costs and our capital expenditures.

With that, I will turn the call back to Tony for his concluding remarks.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Thank you, William. I want to conclude my remarks this morning with the following summary. The Lower 48 market appears to have bottomed in the second quarter. In the international business, we expect the pace of rig count declines to abate after the year-end. I want to note two things. One, we expect rig economics, especially in the U.S., to continue to decline through year-end. Current spot day rates are materially lower than those in our term contracts.

Second, both the recovery today and any prospective recovery are highly dependent on oil prices. Recently, WTI has been back in the low $40s. This recent dip in oil prices has tempered our own enthusiasm. In the face of this market, we continue to pursue our technology initiatives, most notably the M800 rig, and there is more in the pipeline.

At the same time, we continue to find ways to streamline our organization and to optimize our cost structure. The goal is to emerge from the downturn as the performance driller of choice. As always, I look forward to updating you on our progress.

That concludes my remarks this morning. Thank you for your time and attention. With that, I will take your questions.

Question-and-Answer Session

Operator

The first question is from Angie Sedita at UBS.

Angie M. Sedita - UBS Securities LLC

Good morning, guys.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Good morning.

William J. Restrepo - Chief Financial Officer

Good morning.

Angie M. Sedita - UBS Securities LLC

Well, congratulations on the term contract for the M800 in this market, so it's certainly impressive. So maybe you can give us a little color there on the length of term for that contract and anything that you're willing to say on rate. Is it closer to leading edge or modestly better?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Well, in terms of term, it's in the one-year to two-year category on term, and rate, yes, it's above what you understand as spot, upper teens, plus additional services. So that's the concept.

Angie M. Sedita - UBS Securities LLC

Okay, okay. And that's three services on that rig or more?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

There is going to be a bunch of services on the rig, yeah.

Angie M. Sedita - UBS Securities LLC

Okay. And then when you think about your entire fleet, right, clearly the rig of choice here is the 1,500 horsepower, 7,500 psi circulating systems and the 750,000 pounds of mass. I know that's in your M800 fleet. Can you talk about your rest of your fleet, how many other rigs have those capabilities and how many could be upgraded to that capability?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Okay. So the X rig that we announced, Angie, as you know two years ago was all designed with the prospect that we saw the market moving to optimized pad drilling. So the entire technology of the X platform rig was key to this structure. So for example the X rig was designed with three platforms – with three mud pumps in its base case constructive with all the high-pressured pumping – piping already done. When we start rolling it out, at the beginning the operators didn't want to have the third mud pump, so we didn't put third mud pump into all of them but it's already configured for the third mud pump.

The other interesting point is the racking capacity on the X rig is also 25,000 full racking capacity, which also goes to pad optimizing. The next point is when you think about pad-optimized, as people start getting experience with these pumps, they're also going to realize you may need a fourth engine, and we've actually had some operators come to us about a fourth engine.

The difficulty for the existing rigs out there in the marketplace, conventional 8T (31:09) rigs, is their engine housings are all designed for three engine houses. We specifically designed the fourth – the X rig with more than that because we had international experience where we've tried to be, as I said earlier, we intend the original design make it as ubiquitous as possible. So the X rig is actually wired to handle four engines.

So our expectation is as the market matures and the customers understand that they need the stuff, we're going to drop those additional components in and by March next year we'll have probably over 90 rigs that I think are unparalleled. They'll have 7,500 pumps – 7,500 horsepower liners, I'm saying, that the three pumps and the fourth engines.

Angie M. Sedita - UBS Securities LLC

Okay. Okay. Very, very helpful. And then maybe one quick final one on the international market, are you seeing any – you mentioned, number one, that you think that we'll see some increasing spending in Latin America next year, and maybe you could talk a little bit about that. And then second is thoughts on price concession recovery in the Middle East and the potential timing of that?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Sure. Well, as you know from the last conference call we expressed some concern about what was going on in the Middle East with pricing and we also, to be conservative, we also signaled maybe there's some additional (32:31) risk in Saudi in particular. And as you can see from the announcement, those rigs didn't come down and we're working hard at keeping those rigs busy in the marketplace. Generally I think the biggest activities in terms of location would be Middle East and Asia. That ranges from the countries such as Kuwait, obviously, everyone knows about Kuwait. The Kuwait tenders have been – it's like the longest berth out there. It's been going on for 18 months and we are still waiting for the tender but it's a very sizeable tender that everybody in the industry knows about.

Algeria, there's incremental rigs; India, Kurdistan, Oman, UAE and maybe Russia. So all those markets we see some activity at least in terms of tendering and discussions right now for next year. In Latin America I think Mexico – I think one of the reasons why our numbers are – we're seeing some decline in the third quarter and fourth quarter is Mexico is actually maybe going to zero rigs right now. But we think there is some discussions going on that signal maybe that's going to about to turn like the first quarter of next year as well. So that's the way I see it right now.

Angie M. Sedita - UBS Securities LLC

Okay. Great. Thanks. I'll turn it over.

Operator

The next question is from Blake Hancock at Howard Weil.

K. Blake Hancock - Scotia Howard Weil

Thanks. Good morning, guys.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Good morning.

K. Blake Hancock - Scotia Howard Weil

Tony, maybe back on the three new M800s, the one that's contracted and the two more that it sounds like you are looking to sign. Can you maybe talk about are those rigs maybe replacing some of your own or are they taking market share? Just trying to understand what the dynamics are there. And then are those also with new customers or just what dynamic's driving the new build or is this maybe a legacy AC rig since we have plenty of those stacked in the market today?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Right. Well, first of all, those rigs are not replacing our own, they are actually expanding our market and our footprint. The X rig, as we said before, was designed for pad optimal – as a pad-optimal rig and the consequence that when we signed the X rig we thought that the market was going to go to multi-well pads, pads consisting of more than four wells per pad, as we thought that's the way the operator would find the economics most attractive. That's what was built. It was not built as a fast-moving 1,500 horsepower rig. The M800 builds on that and now the M800 has most of the features the X rig has; it also can be a fast-moving rig.

So for wells with – for pads with less than four wells or six wells on a pad, the M800 is the rig of choice. I think it has a lot of advantages compared to all the other existing AC rigs in the sense that it has more racking capacity, it has the three pumps, it has the four engines, it has a (35:23) and actually it can move in – we're targeting two days for that rig. So we think that the M800 is actually going to expand the marketplace for us, not have a (35:32). And the idea is to get it to customers, particularly in areas where it's been the bastion of our – some of our other players in the market, in the industry, that's the whole thinking.

K. Blake Hancock - Scotia Howard Weil

That's great. I appreciate it. And then internationally, like you said the rigs didn't come off in 2Q like we had expected and you mentioned maybe a modest decline here in 3Q with 4Q looking it sounds like a bit worse. Can you maybe just talk about what's taking place here, where are the rigs coming out of and help us understand the margin progression at least over the back half of this year?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Right. So I think, as you look into the next quarter, the amount of decline in rigs, and we are looking at most a couple rigs, and I think we signaled that in terms of mix the rig is working a drop in rates from our average this quarter maybe another 4% or 5%. So the total – that would indicate what the total would be. I think there is also – we also signaled in the comments that we are really being very aggressive about figuring out where are all the money is put on the table and trying to collect some.

So we also expect and have some offset build declines. So when you put it all together in the third quarter we think the sort of EBITDA internationally is a risk of about say 3% to 4% just to give you some rig sensing here. And the fourth quarter maybe another 5% kind of risk. And the declines – there is no single area where there's a lot of declines. It's a bunch of miscellaneous stuff. It's everything from – as I said the largest one I think is Mexico.

And Mexico totally goes off down to zero effect. There is Angola will go off, Kurdistan has something, Iraq has something. I mean it's just a bunch of miscellaneous stuff. But our core market of Saudi, for example, we don't really see at this point. We think we're going to try to do our best to hold the position. And let's say it's at risk, it's not a risk, everything is at risk when you talk about oil prices today, but I think that gives you some sense. So it's pretty stability here.

So the other point is to make is that, having said that about the fourth quarter, then what you have is in the end of the fourth quarter, the Kurdistan rig goes on payroll and that's going to be a very additive right into international, so then starts propping things up as we see immediately in the first quarter.

The other point I'd make is, when you look at the contracts that we've announced today there is basically three contracts and this is not excepting international is the point I would like to make here because when people think of Nabors or they think of the marketplace, they always focus on the Lower 48. The three contracts we've announced today, which is the contract with the M400, the rig in Kazakhstan and the coil tubing rig in Alaska, which are three different markets, not in the Lower 48. They're all five-year contracts and the collective EBITDA contribution each year for those three contracts is in excess of $75 million. Okay? And that really shows you what Nabors is about.

So that's what's going on here. And obviously any single market goes up and down, et cetera, but in this environment to end up in three different markets with that kind of thing now in the pipeline, that's where they're trying to allocate capital.

K. Blake Hancock - Scotia Howard Weil

That's great. Thanks, guys. I'll turn it back.

Operator

The next question is from Sean Meakim at JPMorgan.

Sean C. Meakim - JPMorgan Securities LLC

Hey, good morning.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Good morning.

Sean C. Meakim - JPMorgan Securities LLC

So I think I heard you right that you're expecting contracted rigs to be up sequentially in the third quarter, so perhaps that M800 helps a little bit, but I think that implies that you're adding contracts. If that's the case, could you give us a little more detail what those could look like, maybe term lengths, rates, any of them are bids versus being negotiated? Just trying to get a sense of the mix of some of that activity that you're adding the third quarter.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Right. Right now I would say the bulk of it is very short term, and you just get rigs back into the marketplace and customers normally start thinking of ramping up. And as we sit here now, as mentioned in our comments, we think we'll exit the quarter an average of 50 rigs, and hopefully the exit rate will be modestly above the rate we are seeing which is at 46 rigs – 49 rigs working. So yeah, that's the strategy right now.

We're not really going long on stuff other than some of the new-builds that we talked about. And we're just – we're more on the shorter end of the curve right now.

Sean C. Meakim - JPMorgan Securities LLC

Okay. That's helpful. And then just maybe circle back to the contracts that you announced today, and you talked about this is where we want to be allocating capital. Can you give us maybe a sense of, we talked a bit perhaps a little bit internationally, but just where do the other kind of opportunity sets that are out there, and is there kind of a return hurdle rate or some of the different ways in which you're trying to rank order some of your deployment of capital into some of these opportunities?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Right. Well, the first thing is with respect to the three ones that we announced today, the payback is less than four years on those projects. And some of them actually pay back substantially better than that, so that's point one. And that kind of hurdle rate we've consistently used at Nabors and we try to look for opportunities where that makes sense. I think the other point though is in the U.S., where we are building rigs right now in a market that obviously the pricing does not lag into term contracts and cover those contracts. Our thinking there is that there is a technology shift going on and we want to be at the table with that. We think we have some better mousetraps in process right now.

And we want to get them in front of the customer and build that position. And the other point I'd like to make is, all this technology we're talking about, this has been part of a two-year campaign in terms of building a platform. And so one of the things that we're thinking when we do this is that a lot of the features, especially operating systems and performance tools that are going into the new rigs, is all being paid for and being retrofitted on our existing rigs.

So we get kind of a double benefit there. And the last thing of course is as we add these new rigs and we retrofit them with these extra packages, we also expand the capability of our performance services – scope of services which we think also has attractive returns at the margin compared to other opportunities.

So that's the thinking here. So it's not just in a quest to just build a bunch of rigs into a market that doesn't have term contracts. It's actually position us as well as taking advantage of improving our existing legacy assets and existing new assets like the X rig that's out there with merely supercharging them with technology. That's what we're trying to do. And it's up to us to now in the marketplace to show the customer that that can deliver.

And in that point, since you gave me a chance, I'll just mention that there is a rig in exporting, it sits in the Permian this past week that we drilled for an operator and we have all our services. In addition to the rig, we had the full rig, and we're told – I'm sure people know what all the records are there out there, but we're told it could be a basin record where from takeoff point to the end of the curve we did it in 6.75 drilling hours and 12 tons in eight (43:20) hours.

William J. Restrepo - Chief Financial Officer

(43:21)

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Yeah. And that includes our directional drilling as well as ordinary performance tools on the rigs. So we have had operators calling around saying how the hell we did it. But that's the concept here.

Sean C. Meakim - JPMorgan Securities LLC

Thank you very much for that detail. I guess to wrap up that point, one thing that would be helpful is if you could just remind us going from say just a rig day rate to adding in all the potential services, what does that delta look like on a day rate basis?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Well, on the – without wellbore placement, it's a couple thousand. With wellbore placement, it could be anywhere from $8,000 to $10,000 more.

Sean C. Meakim - JPMorgan Securities LLC

Wow, okay. Great. Thank you for all that.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Yeah.

Operator

The next question is from Jim Wicklund at Credit Suisse.

James Wicklund - Credit Suisse Securities (USA) LLC (Broker)

Good morning, guys.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Good morning.

James Wicklund - Credit Suisse Securities (USA) LLC (Broker)

There is no question that the packaging or bundling of services, as you note is a coming trend and is very beneficial. If I could though, just what is the current leading edge – now that we actually I guess have a spot market – what is the spot market for a PACE-X or equivalent rig in the market today?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

I would say mid to upper teens.

James Wicklund - Credit Suisse Securities (USA) LLC (Broker)

Upper teens?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Mid to upper teens. Mid to upper teens.

James Wicklund - Credit Suisse Securities (USA) LLC (Broker)

Mid to upper teens. Okay, okay. Because we had heard, I guess Pioneer had talked about getting rigs at $14,000 a day in the Permian, and so we were just trying to triangulate that. I appreciate it. And Tony, I was...

William J. Restrepo - Chief Financial Officer

That's per month.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Not much. It was per month.

James Wicklund - Credit Suisse Securities (USA) LLC (Broker)

Okay. I was a bit surprised to see Nabors and Riverstone vie for the C&J business in the courts, after the sale of your C&P business was the crowning achievement of your strategic plan. Can you talk about the rationale for what you're doing there?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

I can't talk much about it other than to say, like I said, I think at this point the company has filed for bankruptcy, and the lenders have a pretty large number of lenders behind the restructuring plan. I think our thinking has always been that if there is an opportunity that we could deploy capital and maximize the investment we had in C&J with our superior return for ourselves, if there's that path to do that, we would pursue it. And obviously, if we're doing it with a partner like Riverstone who has got, I would say, has become the premier energy company in this space right now on private equity, that we would only do it to make money and – so that's the only thing I can comment on right now.

James Wicklund - Credit Suisse Securities (USA) LLC (Broker)

And clearly it seems that most people in the market think that completions at least early will do better than land drilling early. You make the point of how much more efficient we've made the rigs, and unfortunately you guys don't capture all the value created in day rate. Do you agree with that attitude, and is pressure pumping something that, other than what you're doing with Riverstone, is pressure pumping something that, and given the right circumstance, Nabors would find attractive going forward into the next cycle?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

I would say, number one, we made the decision to get out of that business, and we're not looking to kind of roll up the pressure pumping business. Number two, we've heard all that commentary, and we understand how the attractiveness in terms of what people are saying, and we've heard with great interest what Schlumberger and Halliburton have said. But we're also keenly aware that this equipment is running at overtime, and the capitalization rate on the equipment is super high. And I'm not sure of actually the capital is really good return in terms of what's happening. And sure, when you adjust for capital expense that it's the panacea that everyone's talking about.

So I'm not in that business, but that's my own $0.02. So there is other parts in the C&J thing like the work-over side that I think have better risk-reward attributes actually. And as I've said many times I really believe in the work over – if you believe in the shale space the work-over has a pretty good future in terms of built-in demand. But on the pressure pumping I think there should be an opportunity for smart people to make money that are innovative and can come up with a better mousetrap. As you mentioned, the rig guys – the completion guys have not done completions what the rig guys have done to rigs in terms of efficiency, when you actually look at it. So there appears to be room for somebody to do that. But right now that's not our – that's not where we're at.

James Wicklund - Credit Suisse Securities (USA) LLC (Broker)

Very helpful, Tony. Thank you very much.

Operator

The next question is from Waqar Syed at Goldman Sachs.

Waqar Syed - Goldman Sachs & Co.

Thank you for taking my question. Tony, you mentioned that you're providing additional services on the drilling rigs. Could you describe what those are, number one? And number two, when do we start to see the impact of those services on the profitability of the Rig Services business?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Okay. Well, they range from everything what you've heard about before, obviously one of the core ones is ROCKIT, which is the performance part that we use when you drill all these horizontal sections. There is only one competing product out there, and I think it's really a second-rate product and it (48:57) for the marketplace. We have another product called REVIT which is a stick slip mitigation, which has been extremely helpful and could account for the case study I just referred to a little bit. We're doing BOP testing, we're doing chokes.

We've also started with some customers running casing running with a new casing running tool that we're testing. And so those are the kinds of things that we're talking about in addition to what we're replacing, which would be our directional tools, which by the way are not the conventional directional tools but these tools we are offering have add-on capabilities that are competitive with what the big boys use offshore. They do downhole torque, downhole weight on bit. They do azimuthal gamma, which is something that in the market it's not really interesting yet. We all saw the (49:47) module as well.

So there is a lot of stuff in the pipeline. You're not seeing the numbers yet, but obviously we're building out the organization and that, coupled with the manufacturing part of the business being pretty bleak right now. So it's not showing, but we are starting to get these things out there. Obviously we're competing with everybody and their brother and the margins are razor thin right now.

But our goal is to get these on the rigs and prove the value of it and show how on the integrated package we cannot – we're not just looking to bundle. We want to redefine how these services are done. I'm not really interested in just bundling because bundling just means the guy's going to buy three things and he wants a discount. What I want to do is change the way we actually do things for the customer and give them a better product and a better service, so that's our goal here. So we're in the early stages of it, and I hope over the next couple of quarters you can start to see some momentum behind it in the numbers.

Waqar Syed - Goldman Sachs & Co.

And to that point, in terms of providing a better service to the customer, you were looking into integrating the – basically the data from the downhole assembly, bottom-hole assembly, with the systems on the rig. Where are you in that? Have you made progress in that? Do you have prototypes now in the field?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Yes we do, we do. In fact we, hopefully when you're here by November we're going to show you a bunch of stuff that's real and actually out there. But yes, we do have prototypes in the field, and we actually have a whole remote operations center here now that's running this stuff and we're just, as I say, we're trying to commercialize right now. But yes, we have working versions of things right now.

Dennis A. Smith - Director-Investor Relations

So what Tony is referring to, an Analyst Day, which is going to be held in November.

Waqar Syed - Goldman Sachs & Co.

Sure, I already have you guys on the calendar, so looking forward to that.

Dennis A. Smith - Director-Investor Relations

Thank you.

Waqar Syed - Goldman Sachs & Co.

Thank you, sir.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Thank you.

Operator

Your next question is from Marc Bianchi at Cowen.

Marc Bianchi - Cowen & Co. LLC

Thank you. Maybe just a point of clarification for the international comments that you provided, and thanks for such detailed guidance. Is the sort of 4% to 5% margin decline, or I guess 3% to 4% EBITDA decline, and then another 5% in the fourth quarter, is that off the $150 million that you reported in the second quarter?

William J. Restrepo - Chief Financial Officer

Yes.

Marc Bianchi - Cowen & Co. LLC

It is? Okay.

William J. Restrepo - Chief Financial Officer

Yes.

Marc Bianchi - Cowen & Co. LLC

Okay, and then if I kind of carry that through I end up with something in the sort of mid-to-high $130s million by the fourth quarter. Just wondering if we excluded all of the recoveries that you're sort of chasing right now in terms of any kind of repayment that might be out there, where would that number be? Really what I'm trying to do here is get a base line for starting 2017 for your continuing business.

William J. Restrepo - Chief Financial Officer

Well, so some of those recoveries, most of those recoveries that would be one time would be in the third quarter, I think. But some of those recoveries are recurring, right. Those are recoveries of pricing that we've given in the past and things of that nature.

Marc Bianchi - Cowen & Co. LLC

Okay, so then something in the high $130s million is really what we would be expecting as you enter 2017.

William J. Restrepo - Chief Financial Officer

Yes, yes.

Marc Bianchi - Cowen & Co. LLC

Okay. And then, to the comment about the $75 million of kind of recurring business that you signed up here, how much of that is going into the international business as we enter 2017?

Anthony G. Petrello - Chairman, President & Chief Executive Officer

I don't want to be break it down right now, because there are three notable contracts and it will become clear but right now I'd rather not...

Marc Bianchi - Cowen & Co. LLC

Okay.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Because there's three high-profile contracts and you guys are smart enough and you are going to start to try and pick apart the actual contracts and who did what to whom. So we don't want that to happen. So to be honest with you we thought we – whether it's five years or at least five years, one is actually a little bit longer, or at least five years, and as I said the EBITDA is, between all three of them, is a minimum of $75 million.

Marc Bianchi - Cowen & Co. LLC

Excellent. Okay. Thank you. I'll turn it back.

Dennis A. Smith - Director-Investor Relations

Maybe we've got about five minutes left. Let's just take one more call, please.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Yeah, just to be clear, so when I'm talking about these three contracts, I am talking about the M400 rig, the rig in Kazakhstan and the coil tubing rig in Alaska. All of which, obviously the Kazakhstan rig starts by the end of the fourth quarter, should be on payroll in the first quarter, the Alaska rig starts...

William J. Restrepo - Chief Financial Officer

October 1 – late September.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Late September next year and in the press release we indicated when the M400, what the drop dead date is. So you know for sure when that thing gets on payroll, the M400. It depends on what Chevron is doing in terms of planning whether it can get out on the platform earlier.

William J. Restrepo - Chief Financial Officer

Alaska this year.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

Alaska...

William J. Restrepo - Chief Financial Officer

End of September.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

The end of September this year, I'm sorry. Yeah, I misspoke. So you've got two of the three go on, basically be up and running by the first quarter of 2017.

Dennis A. Smith - Director-Investor Relations

Amy, go ahead with the last question, please.

Operator

The last question is from Dan Boyd at BMO Capital Markets.

Daniel J. Boyd - BMO Capital Markets (United States)

Hi, thanks for squeezing me. One of my questions is more of an accounting question, just on where are you going to recognize the services revenue above and beyond the daily rig rate? And then the other one is from a risk management perspective. Are you protected if there is downside related to say a lower fee service such as BOP testing?

William J. Restrepo - Chief Financial Officer

So the accounting it will go into the Rig Services category.

Anthony G. Petrello - Chairman, President & Chief Executive Officer

So it doesn't – we're not getting into the margin on the rigs currently, we're not doing that. We're keeping it as a separate infrastructure. So it's kind of a separate line as part of the Rig Services. That's the first thing. Then on the second thing, it depends on the type of service. I mean for example ROCKIT, REVit, the amount of downtime associated with that in terms of the – it's really nothing in terms of the rig. The BOP testing, there's not really a substantial risk. When people are drilling sometimes there is a linkage between your downtime on the rig versus your downtime when your – with the tools that you're using, and that's all part of where things are in the marketplace at a certain time. But we don't really see a huge risk increase, risk exposure from these particular services that we're talking about at all.

Daniel J. Boyd - BMO Capital Markets (United States)

Okay. Great. Thank you.

Dennis A. Smith - Director-Investor Relations

Ladies and gentlemen, that will wrap up our call for today. And if we didn't get to your questions or you want to follow up with anything, just feel free to contact us either by phone with William or myself or by e-mail. Amy, if you want to go ahead and close up the call, please.

Operator

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

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