Dennis Smith - VP, Corporate Development & IR Anthony Petrello - Chairman, President & CEO William Restrepo - CFO

Kenneth Sill - SunTrust Robinson Humphrey James Wicklund - Crédit Suisse James Adkins - Raymond James & Associates Sean Meakim - JPMorgan Chase & Co. Byron Pope - Tudor, Pickering, Holt & Co. Thomas Moll - Stephens Inc. Marc Bianchi - Cowen and Company Michael Urban - Seaport Global Securities Bradley Handler - Jefferies

Good morning and welcome to the Nabors Second Quarter 2018 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Denny Smith, Vice President of Corporate Development. Please go ahead.

Good morning, everyone. Thank you for joining Nabors' Second Quarter 2018 Earnings Conference Call. 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 their perspectives on the quarter's results along with insights into our markets and how we expect Nabors to perform in these markets. In support of these remarks, a slide deck is available both as a download within the webcast and in the Investor Relations section of Nabors.com. Instructions for the replay of this call are posted on the website as well. With us today, in addition to Tony, William and myself, are Siggi Meissner, President of our Global Drilling organization; John Sanchez, our Chief Operating Officer for Canrig; and other members of senior management team. Since much of our commentary today will include our forward expectations, they may constitute forward-looking statements within the meaning of the Securities and Exchange Act of 1933 and 1934. Such forward-looking statements are subject to certain risks and uncertainties as disclosed by Nabors from time to time in our filings with the Securities and Exchange Commission. As a result of these factors, our actual results may differ materially from those indicated or implied by such forward-looking statements. Also, during the call, we may discuss certain non-GAAP financial measures such as adjusted operating income, EBITDA and adjusted EBITDA. All references to EBITDA made by either Tony or William during their presentations, whether qualified by the word adjusted or otherwise, mean adjusted EBITDA as that term is defined on our website and in the earnings release. 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 to begin.

Good morning, everyone. Welcome to the call. We appreciate your participation as we review our results for the second quarter of 2018 and our assessment of the market going forward. Our results took another significant step forward this quarter in terms of revenue and adjusted EBITDA led by the U.S. Drilling and Rig Technologies segments. The main drivers of the improvement included, first, the favorable oil price environment, which is conducive to growing drilling activity; second, the successful commencement on full day rate of our deepwater platform rig in the Gulf of Mexico. Third, a combination of higher pricing and additional revenue opportunities in the Lower 48. And fourth, better performance in our Rig Technologies segment. During the second quarter, we completed a significant equity financing. We also closed on the sale of three jackups in the Middle. Even without the impact of these transactions, we reduced net debt. The equity offerings strengthened our balance sheet. We paid down the revolver and then subsequently redeemed the remaining $303 million of our 9.25 notes. In our other drilling segments, activity declined modestly. This was due primarily to normal seasonality in Canada. In our International segment, financial performance was slightly better than we expected. The International rig count declined slightly as anticipated deployments in Latin America were later than planned. EBITDA in the Drilling Solutions segment was flat. Finally, Rig Technologies improved from the first quarter when it experienced delays in shipment of equipment, those items shipped during the second quarter. We believe the quarter's financial results and the success of our marketing activity demonstrate the value proposition of our advanced rig fleet and our expanded technology offering. At the same time, we have challenged our engineering team to develop capital-efficient rig upgrade solutions. The team has delivered. We are now better positioned to take advantage of the improving market with relatively minimal investment. I will discuss this success in more detail in my outlook comments. Now let me turn to this quarter's results. In the second quarter, Nabors generated adjusted EBITDA of $188 million on operating revenue of $762 million. This performance compares to $168 million and $734 million, respectively, in the first quarter. That's an 11% EBITDA increase on a 4% increase in revenue. This improvement was focused in the U.S. Drilling and Rig Technologies segments. In the U.S., results were driven by the startup of our deepwater platform rig in the Gulf of Mexico as well as higher daily revenue and margins in the Lower 48. Rig Tech benefited from both higher equipment shipments and aftermarket sales. The better performance of these segments more than offset seasonal reductions in Canada and Alaska. Nabors' worldwide rig activity declined due primarily to breakup in Canada. Globally, we continue to see a growing contracting interests and prospects for higher drilling activity from our clients. We already have additional rig contracts in hand in the U.S. and commitments for more. Outside of the U.S., we have rigs deploying in coming quarters. Tendering activity remains strong. Now let me drill down a bit further into each of the business segments. U.S. Drilling. First, let's turn to the U.S. segment. Adjusted EBITDA for the U.S. Drilling segment grew by 19% on a fractionally higher rig count. Daily margin for the U.S. segment grew 15% sequentially to nearly $9,400. At the beginning of the quarter, our MODS 400 platform rig commenced full operating day rate. The Lower 48 rig count was fractionally higher. Second quarter daily margin in the Lower 48 exceeded $7,400 even after a $310 a day increase in labor costs. The 7% sequential increase in margin resulted from higher average pricing, additional content and an improving mix. We signed contracts for 6 AC rigs with a large operator in the Permian. The term is 3 years. These rigs are currently idle. We have engineered an innovative upgrade design for these units. That design will bring them into the top tier of our fleet's performance. A portion of the $6 million to $8 million capital cost will be paid upfront by the customer, and we will utilize idle assets. Needless to say, the returns on this project meet our threshold. The first unit should deploy next month with the balance going into the field over the following 6 months. We have received an award for an additional 3 upgraded rigs also in the Permian. Those deployments should commence in the first half of next year. The term is 3 years. Again, the operator will contribute a portion of the upgrade CapEx. The expected returns on these fixed rigs also meet our threshold. In the second quarter, we exceeded our expectation, which was to increase our Lower 48 margin to the low 7,000s. Our previous daily margin target for the fourth quarter was $8,000. Given our progress and the market climate, we anticipate exiting the fourth quarter near $9,000. We currently have 106 rigs working in the Lower 48, about equal to the average for the second quarter. This total includes 2 SCR and 12 legacy AC rigs. Coming into 2018, we plan to upgrade 8 rigs. In the second quarter, 3 of these deployed on top of the first one in the first quarter. That leaves 4 remaining, which should deploy by the end of the year. In summary, we have line of sight to 14 idle AC rigs to return to work by the middle of next year as super-spec rigs. In addition to the rigs I have mentioned, we have 42 idle AC rigs, which are upgradable at a cost of $6 million to $8 million each. Next, I will share the results of the quarterly survey of our larger Lower 48 customers. These operators represent 1/3 of the Lower 48 land rig count. About half of these clients plan to add rigs. At this time, only one plans to drop rigs. From our customer survey, we would expect the industry-wide Lower 48 rig count to add 30 to 40 rigs through the end of the year. Last quarter, we expected 40 to 60 rigs to be added through the end of the year. Since that time, the rig count has grown by approximately 30 rigs. What does this mean for Nabors? We expect the incremental rigs to be accretive for our market share. We should capture a full quarter of the rate increases signed during the second quarter. Our highest tier rigs remain sold-out. In this quarter, approximately 40% of our smart rigs are scheduled to roll off contracts. We are taking those rigs to the leading-edge day rates. Our average contract duration in the Lower 48 is stretching out gradually. Clients are willing to discuss longer-term contracts. At this point, we do not believe it make sense to lock in current rates for a large portion of the fleet. About 25% of our Lower 48 working fleet is currently contracted on term beyond 6 months. We expect this percentage and the average duration of our contracts to progressively expand in the coming quarters. To sum up, adjusted EBITDA for the U.S. Drilling segment increased by 90% sequentially and exceeded our internal expectations. Our Lower 48 business has developed a real momentum. We have ongoing discussions with several operators for additional upgraded super-spec rigs. As such, we anticipate further improvement in the overall U.S. Drilling segment's results through the end of 2018. Now, let's turn to the International drilling segment. Net average rig count declined by two rigs from 95 to 93. The average margin declined by $270 per day. This margin decrement was smaller than our forecast on the previous call. The change of rig count was due to the delayed spud of 4 additional rigs in Latin America. Those rigs have already commenced operations and are on rate. Second quarter results also included 2 of the jackups in the Middle East through mid-June. The third unit was off rate in the shipyard during the quarter. This quarter, we should realize the full quarter impact of the rigs that returned to work in Colombia. That equates to about 2 rig years. We are in advanced discussions for an additional two rigs in Colombia. Over the coming quarters, we expect to put 2 offshore platform rigs back to work in Mexico as well as 4 rigs in Argentina and a rig each in Ecuador and Kazakhstan. Finally, one more standard rig from our partner should begin work later this year. Tendering activity remains robust in many of the international markets where we are currently active. Notwithstanding the strength of oil prices, the deployment of rig internationally can be subject to customer timing. Consistent with the views of the large service companies, we believe the macro environment is conducive to greater utilization. Ultimately, this activity should lead to higher pricing. Given the expected increase in rig count, we should recover the loss of the Saudi Arabia jackup earnings by year-end. Let's now turn to the Canadian Drilling segment. The second quarter normally marks the low point for rig count in Canada. Our rig count there declined by roughly half in the quarter to just over 10 rigs. Margins improved sequentially due to an improved fleet mix. The higher-spec rigs tend to continue working through the breakup. At this point in the third quarter, our rig count stands at 21. Our rig offering is gaining share in this competitive market. We expect to average more than 20 rigs in the third quarter. Typically, the fleet mix phenomena reverses from 2Q, and an increasing number lower-spec doubles are likely to work. Now to Drilling Solutions. Adjusted EBITDA in the second quarter of $14.8 million was marginally above the first quarter's results despite seasonality in Canada. Averaged across our working Lower 48 fleet, daily margins per rig increased slightly to $1,367. We still expect meaningful growth in adjusted EBITDA over the next 2 quarters. Our $100 million annual run rate target for the fourth quarter remains intact. In the Lower 48, we expect increases in activity and financial results across our product portfolio. This includes an increase in wellbore placement, growth from our Managed Pressure Drilling offering and an increase in tubular services. We have selectively increased pricing and reduced expenses. These actions should lead to meaningful improvements in margins in wellbore placement and tubular services. Our rotary steerable tool performed as expected in a follow-up test during the second quarter. We anticipate the first commercial deployment later this year. Altogether, we now run 5 or more NDS services on approximately 40% of our rigs in the Lower 48. Internationally, we completed our second directional drilling job in Saudi Arabia. The tubular services business, which we expanded with the Tesco acquisition, has a very broad geographic reach. Under the Nabors' organization, we see opportunities to expand this business. We remain confident in the international growth potential for the entire NDS portfolio. Turning to Rig Technologies. Results improved as the operation caught up with shipments that were delayed during the first quarter. Sales to external customers and in the aftermarket also grew. This performance indicates an improving rig equipment market. Along with broadly higher margins that reduced G&A spending, adjusted EBITDA swung back into the black in the second quarter. For this segment, prospective activity is supported by upgraded rig contracts in hand. We expect further improvement and results by the fourth quarter. This concludes my comments. William will now review the quarter's financial results and provide additional thoughts on the outlook.

Good morning. The net loss from continuing operations attributable to Nabors of $202 million represented a loss per share of $0.61. Results from the quarter included a loss on the net sale of the Middle East jackup rigs of $64 million or $0.20 per share after tax, and cost for strategic transactions of $6 million or $0.02 per share. The second quarter results compare to a loss of $144 million or $0.46 per share in the first quarter. Revenue from operations for the first quarter was $762 million, a 4% improvement compared to the first quarter. Revenue increased despite a moderate rig count decline in International and the seasonal headwinds in Canada and Alaska. U.S. Drilling revenue increased by 10% to $264 million, reflecting the contribution of a Deepwater platform rig on full operating day rate and higher day rates in the Lower 48. Average rig count for the U.S. Drilling segment at 112 was in line with the prior quarter. International revenue increased by 2.5% to $378 million, despite slightly lower rig count and the sale of the jackups. Over half of the revenue increase came from lower downtime days in Saudi Arabia, with the remainder from customer-reimbursed expenses with very limited margin. In Canada, revenue decreased by 45% to $17 million, driven by the seasonal spring breakup. The roughly 50% decrease in average working rigs was somewhat offset by a $1,900 increase in revenue per day, mainly the result of a better mix as our larger rigs stayed active. Drilling Solutions' revenue decreased 4.5% in the quarter to $60 million. The reorganization of our tubular services and related shifting of resources from losing or lower-return areas to more attractive markets drove most of this reduction. To a lesser degree, the lower rig count resulting from seasonality in several countries hurt our performance software sales. Rig Technologies revenue increased by 26% to $81 million. The improvement reflected higher external sales of rig equipment and better revenue from aftermarket services. The delayed Tesco shipments from the first quarter also drove the increase. Adjusted EBITDA grew for the fifth consecutive quarter to $188 million compared to $168 million in the first quarter. EBITDA has risen by 88% since the low watermark in the first quarter of 2017. U.S. Drilling increased by $14 million, driven by the Gulf of Mexico platform rig and a further improvement in Lower 48 margins. Lower 48 adjusted EBITDA rose by $6 million as daily margins increased by $450. Drilling margins for the Lower 48 were up from approximately $7,000 a day to slightly over $7,400, just beating the upper end of our expectations. The average contracted day rate for a fleet increased by $900, while changes to over time schedules and other compensation adjustments translated into a $300 increase in daily OpEx. We expect the upward margin trend to continue. Supporting this expectation, we anticipate market pricing to continue to firm and our rigs to reprice to the current levels. Also we now have additional upgrades deploying at the upper end of the market, which should further boost margins. And this time, we still believe the Lower 48 margins should reach or eclipse $8,000 a day in the fourth quarter of this year. International adjusted EBITDA declined by $1.4 million to $123 million in the second quarter, in line with the reduction in our rig count. This was a somewhat lower decline than we anticipated due to a 1-month delay in the sale of our Saudi jackups. Incremental revenue from the lower downtime of our Aramco land fleet was offset by higher operating costs in Saudi Arabia as well as by contract preparation costs for the 4 rigs added in Columbia. The international rig count declined by 1.5 rigs as multiple additions late in the quarter were offset by 1 rig that completed its contract. The sale of our 3 jackup rigs in early June, 2 of which were active with the other in dry dock, reduced our active rig count by just over half a rig in the second quarter. International margins were $16,349 per day as compared to $16,619 in the prior quarter, driven partially by the sale of our higher-margin Saudi jackups. These rigs contributed over $3 million of adjusted EBITDA to the second quarter results. Given the above, we expect international margins in the third quarter of just below $16,000 per day. Canada adjusted EBITDA declined to $5 million from the seasonal peak of more than $9 million in the first quarter. While rig count fell by 11 rigs to 10.2 in the quarter, daily margin at $6,662 increased as expected, with our most capable and self-sufficient rigs working through the breakup. We are encouraged to be running 21 rigs at this stage of the quarter, nearly double our rig count of a year ago. Drilling Solutions posted an adjusted EBITDA contribution of $14.8 million, in line with the first quarter despite the lower revenue. We expect a strong increase in our wellbore placement results in the third quarter, reflecting the large number of contracts added in July. We also anticipate a solid improvement in our tubular services in international markets. Finally, the seasonal rebound in Canada should drive higher performance software revenue. We believe the market is strong enough to support our $100 million annualized adjusted EBITDA target for this segment in the fourth quarter of 2018. The Rig Technologies segment representing Canrig and 2 technology development efforts reported adjusted EBITDA above breakeven for the second quarter as compared to a loss of nearly $9 million in the first quarter. The market for rig components and aftermarket sales appears to be improving somewhat as illustrated by our external sales. The third quarter should reach similar results to those of the second. Nonetheless, by the end of the year, we anticipate additional improvements in this segment's results. Now let me review our liquidity and cash generation. Net debt decreased by $681 million in the second quarter. The reduction was funded in large part by the equity offerings completed during the second quarter. The common and preferred share issues raised $581 million net of fees. In addition, with the closing on the sale of our jackups in June, we received about $82 million. As we had stated earlier, excluding these 2 nonoperational cash inflows, we reduced our net debt by almost $20 million during the quarter. CapEx for the second quarter was $128 million. We are targeting CapEx for 2018 of $500 million, excluding upgrade projects with customer pre-funding for the upgrade expense. Our net debt on June 30 was just below $3.2 billion as compared to just under $3.9 billion at the end of the first quarter. For the full year, we are targeting net debt in line with the end of 2017, excluding the impact of equity issues. With expanding U.S. margins and International activity, along with growth in Drilling Solutions and additional improvement in Rig Technologies, we expect to exit this year generating strong annualized cash flows. The coming years should bring substantial cash flow generation, which we plan to dedicate to debt reduction. Let me say explicitly that the improvement in balance sheet leverage will remain a top priority. With that, I will turn the call back to Tony for his concluding remarks.

Thank you, William. I will conclude my remarks this morning with the following summary. For the second half of the year, increasing free cash flow remains a top priority. We expect to achieve this with improved pricing, tighter control over expenses and capital discipline. Our U.S. Drilling business, particularly in the Lower 48, continues its strong upward trajectory. Market demand remains robust. Only one of our rigs works for an operator constrained by Permian takeaway limitations. Nabors' rig offering is clearly resonating among operators. With our supply of vital AC rigs, upgradable and minimum costs, we are well positioned to meet demand and grow our market position. In the international markets, tenders have begun converting to contracts. We see the excess supplier rigs of this market beginning to tighten as activity increases. If this trend continues, pricing should follow. In summary, I see reasons for optimism across all our segments. We remain committed to our vision to develop and deploy advanced technologies on high-performance rigs. I look forward to reporting our progress. That concludes our remarks this morning. Thank you for your time and attention. With that, we will take your questions.

[Operator Instructions]. And our first question comes from Ken Sill of SunTrust.

Outlook sounds great. Free cash flow positive is good. I was wondering if you could help us a little bit on the rig services side of thing. Q2 was kind of flattish. You're guiding to roughly $25 million of EBITDA by the end of the year. So for Q3, should we interpolate that result? Or is it going to be more back-end loaded as you develop -- deliver some of the 3D rotary steerable tools?

Okay. So with respect to the NDS, the growth for the past 6 quarters has been pretty deliberate each quarter. And this past quarter, I think we had some cost issues in motors in the directional side, and we actually spent some time redesigning our offering for wellbore replacement to have enhanced automation. On the tubular services side, as you know, in the U.S. market in particular, the conventional casing market is low margin and a lot of price takers. So what we did this quarter is we started pruning our portfolio, which is why you see some revenue down and the margins actually still preserved. So this quarter was kind of a retooling of the portfolio, and that's why we think now we're well poised to move forward. We actually, on our casing business, we've actually taken the tactical casing running tool and we figured out a way to automate it into the top drive directly, and we think we have a kind of nifty new product that will be -- the first test is happening this week with it, and we think it will be a great value proposition that we're going to roll out. So I think all the other performance products, et cetera, are on track. Canada, we had Canada with the cycle time. A lot of our performance products actually worked in Canada, which is why there was little bit of a hiccup there as well. So I would say that we're about to roll out these new rigs on services. And as I said, the target is still to test in the fourth quarter. Yes, we'll be a little more weighted to the fourth quarter, but we start seeing results this quarter as well.

So the impact in Canada -- this is William. The impact in Canada was about $1 million for performance software. At seasonal, it'll go back up in the third quarter. And the rest of the business, the segments, should grow in line with what we thought before.

And as a follow-up, how do you see uptake of this in international markets? It seems like U.S. is -- North America is going to lead. Are customers really hungry for this or looking for this kind of services in a lot of your international markets yet?

It's interesting. We actually think having now gotten under the hood with Tesco, we had some real upsides in the international marketplace. In Saudi today, we have a presence in the tubular services business. There are some other large players there, but we think with the kinds of things that I just mentioned that we're introducing in the Saudi market, as well as the rest of Middle East, that that's a market where we actually can get an expansion. And it will be meaningful because, obviously, the margins in that kind of market are much more significant. There, of course, the value proposition -- selling the value proposition when you get international oil companies is difficult because of the supply chain methodology. And we have to be more innovative in our marketing. That's kind of the stuff that we're focusing on now. But that's a real priority, to push this. In Argentina and Colombia as well, there are some indications that operators there are also interested in this as well. So yes, I think international should be a way that's growing here for NDS.

Our next question comes from Jim Wicklund of Crédit Suisse.

It is nice to see your debt-to-cap down to 51% and no covenant issues on the horizon. I think that was a great deleveraging step. There's obviously more that needs to be done. Have you guys given some thought or can you give us some guidance around your thinking about how you, over the next couple of years, continue this effort?

Well, first is, obviously, the main concept around here is extract more juice from the existing orange. In other words, we have a portfolio here that I think is really -- has great potential, and we just got to extract more from that. That's why William's referenced to free cash flow and discipline matters a lot. So I think there's a lot of to be squeezed out of this, so that's our first priority to do that. Other than that, I think obviously, there's -- we're going to constantly look at the portfolio to see if there's other opportunities to monetize either idle assets or things that were not really core to business. But right now, I think we have a good cash if we execute what's in front of us to actually start generating free cash flow in 2019 and 2020.

And this year, this year was all about not digging ourselves deeper into a hole. So basically, maintaining our net debt excluding the equity offerings, and we're still on track for that part of the plan. And then 2019 and 2020 is when we expect to generate significant amounts of cash that we'll allocate to debt reduction. In fact, we think the fourth quarter itself will be very strong in terms of cash flow generation.

Excellent. Excellent. Okay. My follow-on kind of follows on from that, as it's supposed to, and that is in the International market. You sold your 3 Saudi jackups, which is a good thing. You're talking about if you have anything else that's noncore to sell. But after several years of waiting, we're starting to see a pick-up in the international markets. Ex Saudi, what do you see for growth internationally? And do you have enough idle capacity in International to meet your expectations of that increase in activity again, ex Saudi?

Sure. Well, if you look away from Saudi today, we see opportunities in South America, namely Argentina, Mexico and Colombia. As you know, we entered 4 rigs in Colombia. We signed 2 in Mexico, 1 in Argentina. We have 1 in Kazakhstan and 1 in Ecuador, and we're starting up two rigs in Russia. So when you look at the -- what's in front of us here, I think International in the third quarter, we're going to lose about 1.5 jackup years for our Saudi jackups, but we're going to gain 3 Columbia rig years because the 4 rigs did start in the last quarter, part of the change in rig years that we didn't get as much in the quarter as we'd like to. But that means this quarter, we got 3-full-year rig years of incremental Columbia rigs in that. Half of -- well, there's a new rig going in Ecuador and two rigs in Russia, so that's probably about a four-rig year incremental in the third quarter. In the fourth quarter, we have two rigs for Argentina and a rig for Aramco, two Mexico platform rigs, a rig for Russia and two Columbia, which is 8 to 9 rigs starting in that quarter and what that add to average rig years will depend on customer schedules. As you know, it's targeted for the quarter, but how much we get on the payroll will depend on that. So we have clear visibility, too, in International to another 12 rig years this year with what's in hand. And you can see from those jurisdictions, it's not just Saudi, there's other places. And I think that's typical of what's going on. Algeria, of course, is another one that we're not counting on yet, but obviously it's very tough for us as well given our position there. And that's also plus the Canrig on the manufacturing side, since a large portion of the marketing in Algeria is Canrig top drives. So we think that could be recertification work, things could pick up there as well, as well as request for additional top drives.

Our next question comes from Marshall Adkins of Raymond James.

Tony, you mentioned that your latest survey has another 30, 40 rigs being added to the rest of this year. And I would tell you consensus from most investors that I've spoken with is that we're going to see meaningful falloff in the Permian, maybe as much as 75 rigs. And so overall, U.S. rig count is going to suffer modestly. So this is a very differentiated opinion. Obviously, I assume you're closer to the customer than most of my people -- investors I talked to. Give us more color on these rigs. Or are we going to see a decline in the Permian? Or is Permian going to stay flat, and you add in Eagle Ford and other areas? Can you just help us understand where it's going?

Okay. Sure. I hate to be the guy in the outlier here. So that's the reason why we did the surveys. Because this information of the company comes from the customers, and that's what the customers told us. Now I think it runs a little counter to the major concern regarding the differentials in West Texas. So that led us to go back, and we just did this past 48 hours. So we went back to the top 20 operators in the Permian and we asked them specifically about their limitation for pipeline access. And while our risk ratio may not be perfect, it suggested only 2 of the top 20 operators have any takeaway concerns in the Permian. Only two of the top 20 operators, which is kind of interesting. Neither those two, by the way, affect Nabors' position to Permian, which is also interesting when you look at our customer base. When we checked the other Nabor-specific customers in Permian, we reviewed our exposure with respect to them, and only one of our rigs in the Permian is working for a customer which may have takeaway constraints and there's ongoing discussions with that rig. And as you surmised and based on our discussions, we do recognize that where there are reactions to differentials, you could see rigs moving between basins depending on customer preference. So all that says to us that we don't see, at least in the core client base there, a dramatic downside impact to the overall rig count. Now it well could be the numbers you're citing with respect to the mid-size guys to the smaller guys that don't benefit from this pipeline access thing or subject to it that they're more subject to the volatility, and that's what will impact it. But at least with Nabors, that's the story.

That's great news and then I appreciate that color. As opposed to Jim, I'm going to do unrelated follow-up. National Oilwell Varco announced a big contract for new rig additions in the Saudi. They didn't mention who that was with, but I assume it's going in the oils JV. Can you comment at all on that?

Yes, the idea is that there will be newbuilds and a portion of those newbuilds will go to NOV.

And that's a big time, it's like a lot of rigs are going into Saudi.

That's right. And all those rigs are Nabors' SANAD rigs and, therefore, one of the things that people don't appreciate from Nabors International is those 50 rigs are Nabors' SANAD rigs that have very good economics because they're -- the rig orders cannot be ordered until those contracts are issued by Aramco to SANAD. And the economics of those contracts are all defined up ahead of time. And those should start some time in 2020 when things are up to speed, and that's at a rate of 5 incremental new rigs a year for SANAD, which is our joint venture company. So that's kind of deliberate, planned upside over the next 5 -- over the next 10 years for the joint venture company. So that's a huge anchor for our operation that no one's, frankly, appreciated so far. And keep in mind, they're 6-year contracts and 4-year extensions, yes. So you'd think...

Yes, that was not -- go ahead.

Go ahead. No, that's -- so I would say that's probably the underappreciated story, which what our position really is there.

Well, that was my point. Because it seems like that is an underappreciated component of not just your story, but probably the overall energy story in general. This thing probably has a lot more legs and longer life than certainly the stock market is giving you credit for.

Our next question comes from Sean Meakim of JPMorgan.

So I appreciate the commentary and some of the feedback we've gotten here on International. And I think in the prepared comments you talked about maybe hitting just kind of below $16,000 a day on cash margins. Can you ever give us a sense of is that a number where you're able to call a bottom on that margin profile? And just yes or no, kind of how you see the puts and takes of that margin progression beyond the next quarters out?

Sure. I'll let William answer that, yes.

So Sean, what we're seeing is a little bit of a race between some of the things that have happened like some pricing movement that we've seen in the international markets plus the sale of the jackups and the impact of that that's going to be offset by the incremental volume and some of the high-impact rigs that are coming in later in the year. So we think to that we'll be somewhere below $16,000, pretty -- hopefully pretty close to $16,000 in the third quarter. Depending on the timing of the deployment of the new rigs, we could see a number lower than that in the fourth quarter. But I would expect that to be the bottom for the year and going forward as well.

Okay. Because it seems like second half timing is little bit uncertain, but being able to call a bottom there would certainly be -- would be welcome. Okay.

Yes, but that would be first to margin, obviously. But as I mentioned, the activity numbers are going up 4 rig years, then there's 8 rigs. Depending on when they start in the fourth quarter, at least 2 of which are platform rigs in Mexico, which are super high-margin numbers. So depending on exactly when that starts, that would affect what the calculation is. But the other important part is the number of rig years in total going up, which should...

Yes, more than -- which should more than ameliorate any margin degradation. So the concept is to make up with additional rig years the lower margin. That's what we're trying to do. And the goal is to position ourselves for a good, strong 2019.

Got it. That's very helpful. And in the U.S., in Lower 48 specifically, just curious if you can talk about the incremental demand on the customer side for opportunities for you to trade rate for upfront capital to accelerate your upgrade process. So the most recent plan you announced wasn't like accretive and a smart move given the balance sheet. Can you talk about incremental opportunities here of that type in Lower 48?

Well, that's been -- that's one of the things that we've been pressing with operators, and we think we have a very good value proposition to do that. These rigs, they're getting a chance to -- as delivered are really going to be equal to the best of what our competitors have out in the marketplace. They're going to be super competitive in terms of fracking capacity, movability and all kinds of stuff like that. So we've been fortunate so far that a bunch of operators saw the value of doing that, and that's something we're continuing to press on. And while see it's a logical approach, obviously nobody likes putting more money upfront. And there's always pushback, but that's something we've been doing. And we've been doing, as you know, in the international marketplace for many years doing that. So we just kind of moved that model into the U.S. And there are more discussions along those lines going on right now. So in summary, we like to see long-term pre-funding participation and payback of the investment well within the life of the contracts.

Got it. That's all very helpful. Makes a lot of sense.

Yes, the only thing I'd add here is that I don't think people have appreciated as well the fact that we actually have 35 of these rigs that can be upgraded in the range we talked about, which, up until now, people obviously think what our real [indiscernible]. And that doesn't include additional rigs that -- at higher numbers that we don't even talk about that we could have. Other people are doing renovations in the mid -- high mid-teens and that number we would have a bunch of other rigs, but were not focused on that. We are focused on the things that are kind of the no-brainer stuff right now. But in terms of like firepower in the portfolio, there's a bunch more firepower.

Our next question comes from Byron Pope of Tudor, Pickering, Holt.

Tony, you've partially answered the question I just had, but it might -- which was it's an economic no-brainer just given the $6 million to $8 million upgrade cost to do these upgrades when you can get super-spec leading-edge day rates. And so maybe you could just expand a little bit more on the upgrades, the nature of the upgrades that you're making to the PACE-F rigs and the PACE-M550s to take them to the highest spec part of the market. And then that relative to the customer desire for newbuilds, is that a function of being able to get access to the super-spec rig sooner? Or how do you think about that based on what you're hearing from customers?

Yes. I think, obviously, because the masts and subs are actually built, that obviously shortens the time to get access. And both the F rigs and M550s, which are 1,000-horsepower version today, both are AC ready. So the upgrade, for example, on the M550 will be AC. It'll have a so-called side saddle for moving the top drive. It's upgraded as well to the [indiscernible] top drive. It gets racking capacity of 25,000 feet of racking capacity. And so -- and it...

5.5-inch pipe.

5.5-inch pipe and mud pumps, 1,600-horsepower mud pumps. So they have all the bells and whistles. And that rig is a very fast-moving rig. If you go back, remember, 10 -- it was almost 10 years ago, when the market first went to AC, we focused on the Cotton Valley and the gas. And these rigs, the M1000s were designed to be -- to do those laterals. And actually, they can do laterals up to like 17,000, 18,000 feet. What happened with the shales -- when the shales came and that play went away, then they became idle. And -- but the rigs were known to be the fastest-moving rigs in that category. And now we figured out a way to upgrade that 1,000-horsepower capability to 1,500 horsepower without really major structural changes. So that was the nifty thing the guys came up to do. So we actually can short-circuit the whole process. And the other -- all the other upgrades are -- will be automatic in terms of the Rigtelligent control system, all that stuff as well. So it really has all the best of the best on it.

Our next question comes from Tommy Moll of Stephens.

So just to follow up on the upgrade opportunities within your U.S. fleet. I think you mentioned earlier, you've got 42 idle AC rigs that you could upgrade in the $6 million to $8 million range. Are those primarily the M550s that you're talking about?

Yes, sir.

Okay. And then just stepping to...

We also have some 7 F rigs as well left that haven't been committed already for international work or for upgrades in the U.S. Those are 1,500-horsepower rigs, and the rest are 1,000 horsepower.

Okay. And then just stepping back to the industry level here in the Lower 48 with leading-edge terms having moved up or rather day rates having moved up to the mid-20s in the last quarter. It's been interesting to see a few things happen. We've seen some M&A activity amongst smaller players. We've seen some of your public peers digging deeper into the fleet for bigger-ticket upgrades with longer contract terms. You just mentioned you've had a customer provide some upfront capital for some upgrades. So on the one hand, you're seeing signs of a very tight market and good momentum in terms of the leading-edge rates. But on the other hand, it seems like there are still a fair number of idle and upgradable rigs left, I mean we talked about the 42 you have. Others have mentioned significant numbers of those as well. So how do we reconcile those 2 data points? Do we have enough capacity? Do you feel like to keep pace with the upgrade demand with rate with day rates in the mid-20s? Or do you think we may end up moving higher and potentially even get closer to newbuild territory?

Well, I think there are still about 200 rigs arguably that are upgrade candidates. I think all upgrades are not equal. As you can see from other people that have announced upgrades, now their costs -- some of their costs are almost double the $8 million number I'm mentioning. So -- and some people are going free cash flow negative to support those upgrades, which will also put some caps on how fast things can move. So I would say, therefore, yes, there's a path. And that pool of assets really is a hurdle that needs to be addressed before you can get into newbuild territory. But given the way things are going, it seems like there's continued pressure to move to super-spec category and to do things economically. If you can do things economically, that will continue the drawdown on that 200 number. But I don't see any time soon us yet getting to the point where we're going to get substantially newbuilds. Newbuilds will take day rates, I would say, in the mid- to high 20s to justify, and I don't think we're there yet. With significant term contracts backing them up, at least these people are going to be rational, that's what's going to require.

And another thing we haven't seen is people upgrading the rigs and spec there and generally trying to get some contractual support for them. So the market has been disciplined in general in terms of the upgrades as well. One thing that Tony pointed out is that our upgrades cost between $6 million to $8 million, and that's because we are the most vertically integrated company -- drilling company in terms of rig manufacturing. So we estimate that our $6 million to $8 million means $10 million to $12 million by some of our peers who have to go outside to buy some of those components.

Our next question comes from Marc Bianchi of Cowen.

William, I want to go back to a comment you made about net debt expectations for the year. I think you said that net debt exiting the year would be flat from the exit of 2017, excluding the equity issuance. Is that correct?

That's right.

Okay. That would imply, if I did my math right here, pretty modest cash generation in the back half of the year. I suspect that you guys have some increasing capital program for these 6 rigs in the U.S. But could you kind of talk through what we should expect in terms of net debt in the third quarter? And then it sounds like maybe that improves in the fourth?

So that imply -- you're right, Marc, that implies about $100 million worth of cash and ration in the back half of the year to get us back to where we started, ex the impact of the equity issues. So basically, yes, the third quarter is when we have the heavy interest payments. So we would -- we are targeting close to breakeven in the third quarter. And then in the fourth quarter, we're targeting a materially positive number.

Okay. And then the CapEx, I don't think you've changed, it's still $500 million. What does that look like in 2019 given what you guys see right now with the opportunities internationally, developing -- you mentioned the 42 upgrades in the U.S. potential, but a lot of that might be customer funded. Could you talk through may be some ranges there for '19?

We've demonstrated that we can live within $500 million to $600 million in CapEx, and the company does pretty well. I know there's a lot of tension, obviously, with the market expanding and more opportunities that are attractive going forward. But I think the new reality over the last couple -- next couple of years where we plan to allocate most of our cash generation towards debt reduction means that we're going to be working to keep our CapEx in that range, in the $500 million to $600 million range over the next couple of years.

Andrea, this is Tony. We're getting closer to our 1-hour time limit, so why don't we take one more question and then wrap up the call, please.

Our next question comes from Mike Urban of Seaport Global.

Sorry to waste the question. I was going to ask about the upgrades, but you guys covered that in a lot of details. That's all for me.

Okay. Thank you.

Our next question then is from Brad Handler of Jefferies.

You guys are good sports, appreciate it. Maybe just a couple of quick unrelated questions. In terms of your -- the demand you're seeing in the U.S., I guess it's for the upgraded rigs. Are -- do you know if these customers are adding to their rigs? Or are they displacing presumably lower-quality? Are they high-grading here or are they adding rigs?

The ones I mentioned are all additive, they're all incremental, which is also interesting.

That is interesting, okay.

The nine rigs I talked to, the 6 and 3, are all additives, which is interesting. So that's why I'm saying, I don't know whether we're an outlier or what, but it's kind of interesting. By the way, [indiscernible] our survey covers about 1/3 of the wells drilled in the -- the customers have about 1/3 of the wells drilled, so that extrapolation is from that subset of clients and admittedly could be skewed towards a higher-quality customer set. So those 30 to 40 rig increase take away the grain of salt.

Understood. Understood. No, no, I appreciate that the people you're interviewing, the companies you're interviewing -- you're serving. Okay, I promised an unrelated second question, I guess, so as it relates to the international tenders and your constraints, right, because there is this push and pull of growth opportunity versus managing your cash flow. I guess, I don't know if it is a great example, maybe you can speak to it if it's illustrated. So like we're just coming off of this Kuwait tender, I guess, which is probably just stating for many years in some fashion. It seems as though you guys tried to be selective, tried to get a certain rate of return perhaps and didn't win as a result. And maybe you can speak to that example a little. And should we anticipate that there is a lot of that, that there's -- much of a tendering out there requires a rig that you don't have or would require a newbuild capital? And it helps us think a little bit about how you're evaluating how to pursue those types of opportunities.

So those rigs were a mixture of both oil rigs and gas rigs. And obviously, the gas rigs, the 3000-horsepower gas rigs, it's interesting stuff, those are the rigs that today do not exist in anybody's fleet. So when you're computing for those rigs, you're basically talking about replacement dollars. And as William mentioned, I mean, we're interested in doing those work, and we're not -- we don't feel we're capital restrained to do the opportunity. But if we're going to do a replacement dollar bid or close to it, even -- given that Nabors had some advantages we think with the extra equipment that other people don't have, we want to make sure the returns are there. And thus far, the people, the actual players there that we -- we're very, very aggressive in terms of payouts back into numbers the payouts -- for, excuse me, kind of payout number, your number that we were willing to do for those contracts. And so right now, at least on the first pass, we decided to take a pass and see what the market -- how much gets absorbed, how much capacity. Is it drawn out on other countries as well, and we'll see what happens on the next round. But that's on a close situation, that's going to be an iterative process there.

And the second constraint was the unwillingness of the client to contribute significantly to the build cost. That is another constraint that we face. And there are ways to go around it and find partners to -- companies to partner with us and pre-fund some of that investment, but that certainly is a constraint. Those rigs cost about $60 million a pop. So we're not very enthusiastic about going into a tender without any pre-funding on CapEx of that size today.

Sure. How much of an outlier was that? Was that bid or do you see that type of newbuild requirement coming elsewhere, or alternatively -- go ahead.

What I'd say is that the spread between the lowest bidder and most the rest of the pack was almost 30 -- more than 35%, 40% lower. So it was dramatic. It was absolutely huge. And that's all I can say right now. But it was -- and that -- so in other words, we weren't alone in terms of our approach, but the lowest bidder was really low.

Very aggressive, right. Right, right, right. But we hear about opportunities elsewhere in Middle East, North Africa. Help us think about how much rig requires sort of newbuild assets like that versus things that you can look to use your own equipment, maybe it requires a little bit of upgrade, but basically existing -- your existing fleet.

No. I mean, we still have a bunch of -- several dozen rigs that with a -- or a fraction of that number still -- all -- every international tender because everything in operation specifically requires capital. So -- but numbers between $10 million and $20 million incremental capital or less...

Or less, $4 million or $5-ish million.

Or $4 million or $5 million.

Like Algeria was $3 million maximum.

Yes. Algeria, $2 million to $3 million maximum. It depends on the market. But yes, Kuwait and Saudi Arabia are particular markets where they have very heavy specifications, a very specific specification that make it basically a requirement to build a new rig. But that's not generally the case in international markets. Most of our rigs move well, even the higher-spec ones move well between markets, in the other international markets.

You mean 104 goes to Kazakhstan.

Yes, 104, which was in...

In Kurdistan.

In Kurdistan, it's moving to Kazakhstan, as an example. That's going to go with a long-term contract. It's a super-spec rig, basically international version of a super-spec rig, and that'll start up in 2019. That's a long-term contract for a major operator.

Ladies and gentlemen, that will wrap up our call for today. Thank you for participating. If we didn't answer your question or didn't get to you, feel free to contact us by phone or e-mail. Andrea, you want to close up the call, please?

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