Patterson-UTI Energy Inc 2026 Q3 Earnings Call

Good morning, and welcome to Patterson-UTI's earnings conference call to discuss our third quarter 2026 results. With me today are Andy Hendricks, President and Chief Executive Officer, and Andy Smith, Chief Financial Officer. As a reminder, statements that are made in this conference call that refer to the company's or management's plans, intentions, targets, beliefs, expectations, or predictions for the future are considered forward-looking statements. These forward-looking statements are subject to risks and uncertainties as disclosed in the company's SEC filings, which could cause the company's actual results to differ materially. The company takes no obligation to publicly update or revise any forward-looking statements. The statements made in this conference call include non-GAAP financial measures. The required reconciliation to GAAP financial measures are included on our website at patenergy.com and in the company's press release issued prior to this conference call.

I will now turn the call over to Andy Hendricks, Patterson-UTI's Chief Executive Officer.

Thank you, Mike, and welcome to our third quarter earnings conference call. The recovery in U.S. onshore activity gained momentum during the third quarter, with activity levels increasing significantly compared to earlier in the year. Against this backdrop, our businesses performed very well, supported by strong field-level execution and investments in technology and premium assets that continue to improve pricing and further strengthen the quality of our customer portfolio. At the same time, we generated strong free cash flow and maintained our solid balance sheet. Looking ahead, we believe Patterson-UTI is well-positioned to benefit as the cycle continues to improve. Customer demand for advanced technology is strengthening while constrained access to capital is limiting the ability or even the willingness of some of our competitors to invest. These dynamics are creating attractive opportunities across our core businesses.

We will continue to pursue those opportunities with discipline, deploying capital only where we see compelling returns and the potential to deepen long-term customer relationships. Our capital allocation priorities remain clear. Target investments that improve our long-term return on capital and our free cash flow per share, preserve the strength and flexibility of our balance sheet, and return capital to shareholders through dividends and share repurchases, and if appropriate, reduce debt. The macro outlook for U.S. onshore drilling and completions has improved dramatically. Overall, we see a healthy outlook into 2027 across our core oilfield services and products markets, particularly for premium equipment and technologies that improve efficiency, reliability, and overall well economics. To date, the increase in U.S. onshore drilling activity has been led by private E&Ps, which is typical in the early stages of a recovery.

As we approach 2027, however, our conversations with larger public operators are gaining momentum. These customers are increasingly focused on premium technology, including advanced digital, automation, and AI capabilities across our drilling rigs and frac fleets, larger rig structures designed for longer laterals and deeper wells, and equipment capable of using natural gas as a fuel. This is the market scenario we anticipated when we increased our CapEx budget earlier this year. Importantly, the performance gap between the industry's highest quality assets and the older, less efficient equipment continues to widen. As activity improves, we expect customers to increasingly prioritize technologies that lower total well cost, enhance operational performance, and reduce fuel costs by using more natural gas. We believe this trend creates an increasingly favorable backdrop for Patterson-UTI. For the fourth quarter, we expect industry activity to remain relatively steady compared with third quarter levels.

As we move into 2027, as customer budgets reset and considering contracts we already have in place, we anticipate another step up in demand, with 2027 forward oil prices meaningfully higher than what our customers used to budget for 2026. Overall, we expect oil-directed activity to strengthen further into 2027. Based on the demand signals we see today, we believe public operators are likely to account for a significant share of the next round of rig additions. On the natural gas side, the commodity backdrop has been more fluid, although activity across our businesses has remained stable. Our position in the Northeast continues to be steady, consistent with the historical characteristics of that market. In the Haynesville, our activity has also remained stable despite greater volatility in the broader basin.

While the overall trajectory of natural gas-directed activity remains less certain, customer demand is shifting toward the same advanced technologies we are seeing gain traction in the oil basins. As a result, we believe our activity is likely to increase even if aggregate demand across the natural gas basins remains relatively unchanged. Over the long term, we continue to expect activity in natural gas basins to increase as global natural gas demand continues to grow. Turning to drilling services, activity strengthened during the quarter and pricing continued to improve. Average rates have increased from the low $30,000 per day range earlier this year to the mid $30,000 per day range, with leading-edge day rates well above the average. Demand has been particularly strong for rigs emerging from our upgrade program, with structurally enhanced rigs securing day rates several thousand dollars above our company average.

Importantly, demand for these upgraded rigs is highest among larger public and private operators. Several customers have indicated that they expect these rigs to remain integral to their drilling programs for multiple years, reinforcing our confidence in the durability of the opportunity. by quarter end, our rig count was up 16 rigs, or 18%, from the April trough. Since activity bottomed, reactivation costs have averaged approximately $1 million per rig, excluding any incremental upgrades required to meet customer specifications. We have a limited number of low-cost rig reactivations remaining before seeing a material increase in our incremental capital and upgrade costs, at which point additional reactivations would require significantly higher pricing to meet our return threshold.

Beyond these limited remaining reactivations, we currently expect growth to come primarily from higher pricing, stronger contract terms, and longer durations, and a greater focus on strategic customer programs rather than just further rig additions. Based on current demand, we could reach that level of U.S. activity in early 2027. Internationally, we are seeing a growing pipeline of opportunities for our drilling rigs. The opportunities in Argentina are tangible and could develop in the near term. Given the attractive contract terms, we may choose to deploy a portion of our remaining Tier 1 rig fleet into that market. For Venezuela, we have sold rigs and components for 10 AC electric high-spec rigs from the U.S., as well as multiple other rigs from our operations in Colombia. These rigs are actually of higher capacity than was originally used to drill the horizontal wells in the country when I lived there.

We may also supply additional equipment to Venezuela. Turning to completion services, third quarter results improved sequentially, driven by a mid-single-digit increase in pricing from the second quarter. Our completions team continues to work with many of the industry's leading operators who appreciate the value that we bring to their operations, reflecting the quality of our assets, the value of our digital investments, and our commitment to delivering what we believe is the market's premier completion services offering. Results improved despite elevated non-productive time across several fleets, as portions of the completion supply chain tightened late in the quarter. In South Texas, industry-wide sand constraints during much of September resulted in substantial downtime for several fleets, while trucking availability in the Permian periodically limited sand deliveries to location. We believe both issues were temporary, and our operations have returned to full efficiency thus far in the fourth quarter.

Looking ahead, the medium-term supply and demand outlook for the completions market is becoming increasingly constructive. The U.S. shale industry has added more than 50 drilling rigs since activity trough this past spring, and current completion activity does not yet reflect the incremental demand those additions are expected to generate. At the same time, higher diesel prices are materially increasing the operating costs of legacy diesel-powered equipment, which we estimate still represents around 20% of the U.S. completion industry horsepower in operation today. These diesel-powered assets were only marginally competitive before the recent increase in diesel prices, and even with the improved completion pricing for some equipment, are increasingly uneconomic to maintain. In short, we expect completion demand to move higher over the next several quarters as available industry horsepower likely declines through the accelerating retirement of older diesel assets.

The replacement requirements are further challenged by extended equipment lead times. In our view, the direct drive systems represent the best new technology available, but lead times now exceed one year because these systems are produced on manufacturing lines that also support behind-the-meter power equipment for burning 100% natural gas. These dynamics create an attractive outlook for equipment capable of operating on natural gas. By year-end, nearly 90% of our active horsepower will be powered at least in part by natural gas. As we expect the quality of our fleets to improve further in 2027, as natural gas-powered horsepower becomes a constraint on the industry's ability to meet completion demand, we believe we are well positioned to benefit from the changing competitive landscape.

While this backdrop could present attractive investment opportunities that expand our position in the completions business over the next several years, our near-term focus remains on restoring segment returns to acceptable levels before committing capital to address the emerging undersupply. From the past several years through this spring, pricing in our completions business declined by approximately 30%. We have since recovered roughly one-third of that decline, but pricing must move higher before we reconsider our investment strategy for the business. For 2027, we expect to continue replacing anticipated diesel equipment retirements with new Emerald 100% natural gas-powered direct drive assets while keeping our overall capacity relatively steady. Turning to drilling products. Third quarter results improved substantially from the second quarter. Revenue increased 21%, while we also saw significant margin expansion. The segment delivered its highest quarterly revenue and adjusted gross profit since we completed the acquisition of Ulterra in 2023.