e10vq
Table of Contents

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
 
Form 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended September 30, 2006
 
Commission file number: 001-32657
 
 
 
 
 
Nabors Industries Ltd.
 
Incorporated in Bermuda
Mintflower Place
8 Par-La-Ville Road
Hamilton, HM08
Bermuda
(441) 292-1510
 
98-0363970
(I.R.S. Employer Identification No.)
 
 
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer þ     Accelerated Filer o     Non-accelerated Filer o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
The number of common shares, par value $.001 per share, outstanding as of October 26, 2006 was 299,173,034. In addition, our subsidiary, Nabors Exchangeco (Canada) Inc., has 173,588 exchangeable shares outstanding as of October 26, 2006 that are exchangeable for Nabors common shares on a one-for-one basis, and have essentially identical rights as Nabors Industries Ltd. common shares, including but not limited to voting rights and the right to receive dividends, if any.
 


 

 
NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
INDEX
 
                 
        Page No.
 
    PART I FINANCIAL INFORMATION    
  Financial Statements (Unaudited)    
    Consolidated Balance Sheets as of September 30, 2006 and December 31, 2005   2
    Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2006 and 2005   3
    Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2006 and 2005   4
    Consolidated Statements of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2006 and 2005   5
    Notes to Consolidated Financial Statements   7
    Report of Independent Registered Public Accounting Firm   34
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   35
  Quantitative and Qualitative Disclosures About Market Risk   51
  Controls and Procedures   51
             
    PART II OTHER INFORMATION    
  Legal Proceedings   52
  Risk Factors   52
  Unregistered Sales of Equity Securities and Use of Proceeds   53
  Exhibits   53
  54
 Awareness Letter of Independent Accountants
 Certification of Chairman and CEO pursuant to Section 302
 Certification of VP and CFO pursuant to Section 302
 Certification of Chairman and CEO, VP and CFO pursuant to Section 906


Table of Contents

 
PART I FINANCIAL INFORMATION
 
Item 1.   Financial Statements
 
NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
                 
    September 30,
    December 31,
 
    2006     2005  
(In thousands, except per share amounts)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 360,206     $ 565,001  
Short-term investments
    913,216       858,524  
Accounts receivable, net
    1,098,818       822,104  
Inventory
    98,769       51,292  
Deferred income taxes
    204,140       199,196  
Other current assets
    115,514       121,191  
                 
Total current assets
    2,790,663       2,617,308  
Long-term investments
    491,404       222,802  
Property, plant and equipment, net
    4,975,081       3,886,924  
Goodwill, net
    369,978       341,939  
Other long-term assets
    301,702       161,434  
                 
Total assets
  $ 8,928,828     $ 7,230,407  
                 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
               
Current portion of long-term debt
  $     $ 767,912  
Trade accounts payable
    417,026       336,589  
Accrued liabilities
    289,067       224,336  
Income taxes payable
    41,081       23,619  
                 
Total current liabilities
    747,174       1,352,456  
Long-term debt
    4,003,545       1,251,751  
Other long-term liabilities
    174,361       151,415  
Deferred income taxes
    720,616       716,645  
                 
Total liabilities
    5,645,696       3,472,267  
                 
Commitments and contingencies (Note 8) 
               
Shareholders’ equity:
               
Common shares, par value $.001 per share:
               
Authorized common shares 800,000; issued 299,143 and 315,393, respectively
    298       315  
Capital in excess of par value
    1,587,376       1,590,968  
Unearned compensation
          (15,649 )
Accumulated other comprehensive income
    232,429       192,980  
Retained earnings
    2,235,583       1,989,526  
Less treasury shares, at cost, 22,240 common shares
    (772,554 )      
                 
Total shareholders’ equity
    3,283,132       3,758,140  
                 
Total liabilities and shareholders’ equity
  $ 8,928,828     $ 7,230,407  
                 
 
The accompanying notes are an integral part of these consolidated financial statements.


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2006     2005     2006     2005  
(In thousands, except per share amounts)  
 
Revenues and other income:
                               
Operating revenues
  $ 1,244,478     $ 893,254     $ 3,526,404     $ 2,442,319  
Earnings from unconsolidated affiliates
    5,706       91       19,475       7,298  
Investment income
    37,155       27,178       67,753       54,544  
                                 
Total revenues and other income
    1,287,339       920,523       3,613,632       2,504,161  
                                 
Costs and other deductions:
                               
Direct costs
    670,326       500,552       1,879,169       1,429,762  
General and administrative expenses
    93,769       65,879       270,396       184,325  
Depreciation and amortization
    97,556       73,673       266,891       212,843  
Depletion
    7,731       11,349       28,661       35,045  
Interest expense
    13,735       11,195       33,958       33,265  
Losses (Gains) on sales of long-lived assets, impairment charges and other expense (income), net
    4,284       15,684       12,529       23,778  
                                 
Total costs and other deductions
    887,401       678,332       2,491,604       1,919,018  
                                 
Income before income taxes
    399,938       242,191       1,122,028       585,143  
                                 
Income tax expense:
                               
Current
    20,377       10,153       140,351       24,271  
Deferred
    86,810       53,181       198,730       122,796  
                                 
Total income tax expense
    107,187       63,334       339,081       147,067  
                                 
Net income
  $ 292,751     $ 178,857     $ 782,947     $ 438,076  
                                 
Earnings per share:
                               
Basic
  $ 1.05     $ .57     $ 2.65     $ 1.41  
Diluted
  $ 1.02     $ .55     $ 2.57     $ 1.36  
Weighted-average number of common shares outstanding:
                               
Basic
    277,553       314,419       294,987       311,210  
                                 
Diluted
    286,544       323,700       305,066       321,228  
                                 
 
The accompanying notes are an integral part of these consolidated financial statements.


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
                 
    Nine Months Ended September 30,  
    2006     2005  
(In thousands)  
 
Cash flows from operating activities:
               
Net income
  $ 782,947     $ 438,076  
Adjustments to net income:
               
Depreciation and amortization
    266,891       212,843  
Depletion
    28,661       35,045  
Deferred income tax expense
    198,730       122,796  
Deferred financing costs amortization
    4,168       3,661  
Pension liability amortization
    315       360  
Discount amortization on long-term debt
    3,370       15,500  
Amortization of loss on hedges
    416       113  
Losses on long-lived assets, net
    10,394       11,542  
Gains on investments, net
    (26,421 )     (23,452 )
Gains (losses) on derivative instruments
    (850 )     (708 )
Share based compensation
    22,601       3,354  
Foreign currency transaction (gains) losses
    556       970  
Equity in earnings from unconsolidated affiliates, net of dividends
    (17,041 )     (4,798 )
Increase (decrease) from changes in:
               
Accounts receivable
    (254,403 )     (188,619 )
Inventory
    (46,047 )     (13,043 )
Other current assets
    (26,720 )     (39,508 )
Other long-term assets
    (52,922 )     4,575  
Trade accounts payable and accrued liabilities
    107,081       68,422  
Income taxes payable
    12,634       10,700  
Other long-term liabilities
    25,179       7,545  
                 
Net cash provided by operating activities
    1,039,539       665,374  
                 
Cash flows from investing activities:
               
Purchases of investments
    (1,087,987 )     (454,625 )
Sales and maturities of investments
    799,713       468,271  
Cash paid for acquisitions of businesses, net
    (46,510 )     (46,201 )
Investment in affiliates
    (2,433 )      
Capital expenditures
    (1,344,682 )     (577,844 )
Proceeds from sales of assets and insurance claims
    10,322       19,989  
                 
Net cash used for investing activities
    (1,671,577 )     (590,410 )
                 
Cash flows from financing activities:
               
Proceeds from sale of warrants
    421,162        
Purchase of exchangeable note hedge
    (583,550 )      
(Decrease) increase in cash overdrafts
    (15,845 )     3,857  
Proceeds from long-term debt
    2,750,000        
Reduction of long-term debt
    (769,789 )     (424 )
Debt issuance costs
    (27,972 )      
Proceeds from issuance of common shares
    21,925       186,717  
Repurchase of common shares
    (1,373,334 )     (80,572 )
Tax benefit related to the exercise of stock options
    4,315        
                 
Net cash provided by financing activities
    426,912       109,578  
                 
Effect of exchange rate changes on cash and cash equivalents
    331       6,317  
                 
Net (decrease) increase in cash and cash equivalents
    (204,795 )     190,859  
Cash and cash equivalents, beginning of period
    565,001       384,709  
                 
Cash and cash equivalents, end of period
  $ 360,206     $ 575,568  
                 
 
The accompanying notes are an integral part of these consolidated financial statements.


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS’ EQUITY
(Unaudited)
 
                                                                                 
                      Accumulated Other Comprehensive
                   
                            Income (Loss)                    
                            Unrealized
                               
                            Gains
                               
    Common Shares     Capital in
          (Losses) on
    Cumulative
                      Total Share-
 
          Par
    Excess of
    Unearned
    Marketable
    Translation
          Retained
    Treasury
    holders’
 
    Shares     Value     Par Value     Compensation     Securities     Adjustment     Other     Earnings     Shares     Equity  
(In thousands)  
 
Balances, December 31, 2005
    315,393     $ 315     $ 1,590,968     $ (15,649 )   $ 18,865     $ 178,109     $ (3,994 )   $ 1,989,526     $     $ 3,758,140  
                                                                                 
Comprehensive Income:
                                                                               
Net income
                                                            782,947               782,947  
Translation adjustment
                                            31,528                               31,528  
Unrealized gains on marketable securities, net of income taxes of $749
                                    10,099                                       10,099  
Less: reclassification adjustment for (gains) losses included in net income, net of income tax benefit of $24
                                    (2,489 )                                     (2,489 )
Pension liability amortization, net of income taxes of $117
                                                    198                       198  
Amortization of loss on cash flow hedges
                                                    113                       113  
                                                                                 
Total comprehensive income
                            7,610       31,528       311       782,947             822,396  
                                                                                 
Adoption of SFAS 123-R
                    (15,649 )     15,649                                                
Issuance of common shares for stock options exercised
    1,033       1       21,924                                                       21,925  
Nabors Exchangeco shares exchanged
    43                                                                        
Purchase of call options
                    (583,550 )                                                     (583,550 )
Sale of warrants
                    421,162                                                       421,162  
Tax benefit from the purchase of call options
                    215,914                                                       215,914  
Repurchase and retirement of common shares
    (17,935 )     (18 )     (90,449 )                                     (536,890 )             (627,357 )
Repurchase of 22,240 treasury shares
                                                                    (772,554 )     (772,554 )
Tax effect of exercised stock option deductions
                    4,455                                                       4,455  
Grants of restricted stock awards
    649                                                                        
Forfeitures of restricted stock awards
    (40 )                                                                      
Stock based compensation
                    22,601                                                       22,601  
                                                                                 
Subtotal
    (16,250 )     (17 )     (3,592 )     15,649                         (536,890 )     (772,554 )     (1,297,404 )
                                                                                 
Balances, September 30, 2006
    299,143     $ 298     $ 1,587,376     $     $ 26,475     $ 209,637     $ (3,683 )   $ 2,235,583     $ (772,554 )   $ 3,283,132  
                                                                                 
 
The accompanying notes are an integral part of these consolidated financial statements.


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS’ EQUITY (Continued)
(Unaudited)
 
                                                                         
                      Accumulated Other Comprehensive
             
                            Income (Loss)              
                            Unrealized
                         
                            Gains
                         
    Common Shares     Capital in
          (Losses) on
    Cumulative
                Total
 
          Par
    Excess of
    Unearned
    Marketable
    Translation
          Retained
    Shareholders’
 
    Shares     Value     Par Value     Compensation     Securities     Adjustment     Other     Earnings     Equity  
(In thousands)  
 
Balances, December 31, 2004
    299,722     $ 300     $ 1,358,224     $     $ 271     $ 151,520     $ (3,562 )   $ 1,422,640     $ 2,929,393  
                                                                         
Comprehensive income:
                                                                       
Net income
                                                            438,076       438,076  
Translation adjustment
                                            27,457                       27,457  
Unrealized gains on marketable securities, net of income taxes of $995
                                    36,232                               36,232  
Less: reclassification adjustment for gains included in net income, net of income taxes of $367
                                    (8,249 )                             (8,249 )
Pension liability amortization, net of income taxes of $133
                                                    227               227  
Amortization of loss on cash flow hedges
                                                    113               113  
                                                                         
Total comprehensive income
                            27,983       27,457       340       438,076       493,856  
                                                                         
Issuance of common shares for stock options exercised
    18,022       18       186,699                                               186,717  
Nabors Exchangeco shares exchanged
    76                                                                
Repurchase of common shares
    (3,000 )     (2 )     (14,761 )                                     (65,809 )     (80,572 )
Tax effect of exercised stock option deductions
                    33,404                                               33,404  
Grants of restricted stock awards
    654               21,163       (21,163 )                                      
Forfeitures of Restricted shares
    (18 )             (463 )     463                                        
Amortization of unearned compensation
                            3,354                                       3,354  
                                                                         
Subtotal
    15,734       16       226,042       (17,346 )                       (65,809 )     142,903  
                                                                         
Balances, September 30, 2005
    315,456     $ 316     $ 1,584,266     $ (17,346 )   $ 28,254     $ 178,977     $ (3,222 )   $ 1,794,907     $ 3,566,152  
                                                                         
 
The accompanying notes are an integral part of these consolidated financial statements.


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Note 1   Nature of Operations
 
Nabors is the largest land drilling contractor in the world, with approximately 600 land drilling rigs. We conduct oil, gas and geothermal land drilling operations in the U.S. Lower 48 states, Alaska, Canada, South and Central America, the Middle East, the Far East and Africa. We are also one of the largest land well-servicing and workover contractors in the United States and Canada. We own approximately 590 land workover and well-servicing rigs in the United States, primarily in the southwestern and western United States, and approximately 215 land workover and well-servicing rigs in Canada. Nabors is a leading provider of offshore platform workover and drilling rigs, and owns 46 platform, 19 jack-up units and five barge rigs in the United States and multiple international markets. These rigs provide well-servicing, workover and drilling services. We have a 50% ownership interest in a joint venture in Saudi Arabia, which owns 18 rigs. We also offer a wide range of ancillary well-site services, including engineering, transportation, construction, maintenance, well logging, directional drilling, rig instrumentation, data collection and other support services in selected domestic and international markets. We time charter a fleet of 29 marine transportation and supply vessels, which provide transportation of drilling materials, supplies and crews for offshore operations. During the first quarter of 2006 we began to offer logistics services for onshore drilling and well-servicing operations in Canada using helicopters and fixed-winged aircraft purchased from Airborne Energy Solutions Ltd. on January 3, 2006 (Note 4). We manufacture and lease or sell top drives for a broad range of drilling applications, directional drilling systems, rig instrumentation and data collection equipment, pipeline handling equipment and rig reporting software. We also have made selective investments in oil and gas exploration, development and production activities.
 
The majority of our business is conducted through our various Contract Drilling operating segments, which include our drilling, workover and well-servicing operations, on land and offshore. Our oil and gas exploration, development and production operations are included in a category labeled Oil and Gas for segment reporting purposes. Our operating segments engaged in marine transportation and supply services, drilling technology and top drive manufacturing, directional drilling, rig instrumentation and software, and construction and logistics operations are aggregated in a category labeled Other Operating Segments for segment reporting purposes.
 
As used in this Report, the “Company,” “we,” “us,” “our” and “Nabors” means Nabors Industries Ltd. and, where the context requires, includes our subsidiaries.
 
Note 2   Summary of Significant Accounting Policies
 
Interim Financial Information
 
The unaudited consolidated financial statements of Nabors are prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Certain reclassifications have been made to the prior period to conform to the current period presentation, with no effect on our consolidated financial position, results of operations or cash flows. Pursuant to the rules and regulations of the U.S. Securities and Exchange Commission, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been omitted. Therefore, these financial statements should be read along with our Annual Report on Form 10-K for the year ended December 31, 2005. In our management’s opinion, the consolidated financial statements contain all adjustments necessary to present fairly our financial position as of September 30, 2006 and the results of our operations for the three and nine months ended September 30, 2006 and 2005, and our cash flows for the nine months ended September 30, 2006 and 2005, in accordance with GAAP. Interim results for the three and nine months ended September 30, 2006 may not be indicative of results that will be realized for the full year ending December 31, 2006.
 
On December 13, 2005, our Board of Directors approved a two-for-one stock split of our common shares to be effectuated in the form of a stock dividend. The stock dividend was distributed on April 17, 2006 to shareholders of record on March 31, 2006 (see Note 7). All common share, per share, stock option and restricted stock amounts


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

included in the accompanying Consolidated Financial Statements and related notes have been restated to reflect the effect of the stock split.
 
Our independent registered public accounting firm has performed a review of, and issued a report on, these consolidated interim financial statements in accordance with standards established by the Public Company Accounting Oversight Board. Pursuant to Rule 436(c) under the Securities Act of 1933, this report should not be considered a part of any registration statement prepared or certified within the meanings of Sections 7 and 11 of the Securities Act.
 
Principles of Consolidation
 
Our consolidated financial statements include the accounts of Nabors, all majority-owned subsidiaries, and all non-majority owned subsidiaries required to be consolidated under Financial Accounting Standards Board (FASB) Interpretation No. 46R, which are not material to our financial position, results of operations or cash flows. All significant intercompany accounts and transactions are eliminated in consolidation.
 
Investments in operating entities where we have the ability to exert significant influence, but where we do not control their operating and financial policies, are accounted for using the equity method. Our share of the net income of these entities is recorded as Earnings from unconsolidated affiliates in our consolidated statements of income, and our investment in these entities is carried as a single amount in our consolidated balance sheets. Investments in net assets of unconsolidated affiliates accounted for using the equity method totaled $91.2 million and $71.2 million as of September 30, 2006 and December 31, 2005, respectively, and are included in other long-term assets in our consolidated balance sheets. Similarly, investments in certain offshore funds classified as non-marketable are accounted for using the equity method of accounting based on our ownership interest in each fund. Our share of the gains and losses of these funds is recorded in investment income in our consolidated statements of income and our investments in these funds are included in long-term investments in our consolidated balance sheets.
 
Recent Accounting Pronouncements
 
In June 2006 the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes,” which prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. Under FIN 48, the financial statements will reflect expected future tax consequences of such positions presuming the taxing authorities’ full knowledge of the position and all relevant facts, but without considering time values. FIN 48 is likely to cause greater volatility in income statements as more items are recognized discretely within income tax expense. Application of FIN 48 is required in financial statements effective for periods beginning after December 15, 2006. FIN 48 revises disclosure requirements and will require an annual tabular roll-forward of unrecognized tax benefits. We expect to adopt FIN 48 beginning January 1, 2007. We are currently evaluating the impact that this interpretation may have on our consolidated financial statements. Any adjustment required as a result of the adoption of FIN 48 will be recorded to retained earnings.
 
In September 2006 the FASB issued SFAS No. 157, “Fair Value Measurements.” This statement establishes a framework for measuring fair value within generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The provisions of SFAS 157 should be applied prospectively as of the beginning of the fiscal year in which SFAS 157 is initially applied, except in limited circumstances. We expect to adopt SFAS 157 beginning January 1, 2008. We are currently evaluating the impact that this interpretation may have on our consolidated financial statements.
 
In September 2006 the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Nos. 87, 88, 106 and 132(R).” This statement requires companies to recognize a net liability or asset to report the funded status of their defined benefit pension and other


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

postretirement benefit plans in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS 158 is required to be applied in financial statements effected for periods ending after December 15, 2006. We will adopt SFAS 158 as of December 31, 2006. We do not believe that the adoption of SFAS 158 will have a material impact on our financial position, results of operations or cash flows.
 
Note 3   Share-Based Compensation
 
The Company has several stock-based employee compensation plans, which are more fully described in Note 9 in the Company’s 2005 Annual Report on Form 10-K. Prior to January 1, 2006, we accounted for awards granted under those plans following the recognition and measurement principles of Accounting Principles Bulletin (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” (APB 25) and related interpretations. Under APB 25, no compensation expense was reflected in net income for the Company’s stock options, as all options granted under those plans had an exercise price equal to the market value of the underlying common shares on the date of grant. The pro forma effects on income for stock options were instead disclosed in a footnote to the financial statements. Compensation expense was recorded in the income statement for restricted stock grants over the vesting period of the award.
 
Effective January 1, 2006, we adopted the fair value recognition provisions of FASB Statement of Financial Accounting Standard No. 123(R), “Share-Based Payments,” (SFAS 123-R), using the modified prospective application method. Under this transition method, the Company will record compensation expense for all stock option awards granted after the date of adoption and for the unvested portion of previously granted stock option awards that remain outstanding at the date of adoption. The amount of compensation cost recognized was based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123. Results for prior periods have not been restated.
 
As a result of adopting SFAS 123-R on January 1, 2006, Nabors’ income before income taxes and net income for the three months ended September 30, 2006 were $4.2 million and $3.3 million lower, respectively and $14.0 million and $10.8 million lower for the nine months ended September 30, 2006, respectively, than if we had continued to account for share-based compensation under APB 25. Basic and diluted earnings per share for the three months ended September 30, 2006 would have been $1.07 and $1.03, respectively and $2.69 and $2.60, respectively, for the nine months ended September 30, 2006, if we had continued to account for share-based compensation under APB 25, compared to reported basic and diluted earnings per share of $1.05 and $1.02, respectively, for the three months ended September 30, 2006 and $2.65 and $2.57, respectively, for the nine months ended September 30, 2006.
 
Compensation expense related to awards of restricted stock was recognized before the adoption of SFAS 123-R. Compensation expense for restricted stock totaled $3.2 million and $1.5 million for the three months ended September 30, 2006 and 2005, respectively, and $8.6 million and $3.4 million for the nine months ended September 30, 2006 and 2005, respectively, and is included in direct costs and general and administrative expenses in our consolidated statements of income. Total stock-based compensation expense, which includes both stock options and restricted stock totaled $7.5 million and $22.6 million for the three and nine months ended September 30, 2006, respectively. Stock-based compensation expense has been allocated to our various operating segments (Note 11).
 
Prior to adoption of SFAS 123-R, Nabors presented all tax benefits of deductions resulting from the exercise of options as operating cash flows in the Consolidated Statements of Cash Flows. SFAS 123-R requires the cash flows resulting from tax deductions in excess of the compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. The actual tax benefit realized from options exercised during the nine months ended September 30, 2006 was $4.3 million.


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Under the provisions of SFAS 123-R, the recognition of unearned compensation, a contra-equity account representing the amount of unrecognized restricted stock compensation expense, is no longer required. Therefore, in the first quarter of 2006 the Unearned Compensation amount that was included in our December 31, 2005 consolidated balance sheet in the amount of $15.6 million was reduced to zero with a corresponding decrease to Capital in Excess of Par Value.
 
Prior Period Pro Forma Presentation
 
Under the modified prospective application method, results for prior periods have not been restated to reflect the effects of implementing SFAS 123-R. The following pro forma information, as required by SFAS No. 148 “Accounting for Stock-Based Compensation — an Amendment to FAS 123,” is presented for comparative purposes and illustrates the effect on our net income and earnings per share as if we had applied the provisions of SFAS 123-R beginning on January 1, 2005:
 
                 
    Three Months Ended
    Nine Months Ended
 
    September 30, 2005     September 30, 2005  
(In thousands, except per share amounts)  
 
Net income, as reported
  $ 178,857     $ 438,076  
Add: Stock-based compensation expense, relating to restricted stock awards, included in reported net income, net of related tax effects
    1,128       2,275  
Deduct: Total stock-based employee compensation expense determined under the fair value method for all awards, net of related tax effects
    (9,225 )     (31,314 )
                 
Pro forma net income-basic
    170,760       409,037  
Add: Interest expense on assumed conversion of our zero coupon convertible/exchangeable senior debentures/notes, net of tax
           
                 
Adjusted pro forma net income-diluted
  $ 170,760     $ 409,037  
                 
Earnings per share:
               
Basic-as reported
  $ .57     $ 1.41  
Basic-pro forma
  $ .54     $ 1.31  
Diluted-as reported
  $ .55     $ 1.36  
Diluted-pro forma
  $ .53     $ 1.27  
 
Stock Option Plans
 
Stock option awards under the Company’s various stock-based employee compensation plans are granted at prices equal to the fair market value of the shares on the date of the grant. Options granted under the plan generally vest in varying periodic installments after one year. In the case of certain key executives, options granted under the plans may vest immediately on the grant date. Options granted under the plan expire ten years from the date of grant.
 
The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model that uses the assumptions for the risk-free interest rate, volatility, dividend yield and the expected term of the options. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for a period equal to the expected term of the option. Expected volatilities are based on implied volatilities from traded options on the Nabors’ common shares, historical volatility of Nabors’ common shares, and other factors. We do not assume any dividend yield, as the Company does not pay dividends. We use historical data to estimate the expected term of the options and employee terminations within the option-pricing model; separate groups of employees that have


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

similar historical exercise behavior are considered separately for valuation purposes. The expected term of the options represents the period of time that the options granted are expected to be outstanding.
 
We also consider an estimated forfeiture rate when determining the fair value of each award, and we only recognize compensation cost for those shares that are expected to vest, on a straight-line basis over the requisite service period of the award, which is generally the vesting term of three to four years. The forfeiture rate is based on historical experience. Estimated forfeitures will be adjusted to reflect actual forfeitures in future periods.
 
There were no stock options granted, and as a result, no fair value determinations were made during the nine months ended September 30, 2006. Stock option transactions under the Company’s various stock-based employee compensation plans during the nine months ended September 30, 2006, is presented below:
 
                                 
                Weighted
       
                Average
       
          Weighted
    Remaining
    Aggregate
 
          Average
    Contractual
    Intrinsic
 
Options
  Shares     Exercise Price     Term     Value  
(In thousands, except exercise price)  
 
Options outstanding as of December 31, 2005
    38,559     $ 21.87                  
Granted
        $                  
Exercised
    (1,033 )   $ 21.22                  
Forfeited
    (135 )   $ 22.70                  
                                 
Options outstanding as of September 30, 2006
    37,391     $ 21.88       5.2 years     $ 320,167  
                                 
Options exercisable as of September 30, 2006
    34,322     $ 21.85       5.0 years     $ 297,173  
                                 
 
The total intrinsic value of options exercised during the nine months ended September 30, 2006 and 2005 was $15.5 million and $330.3 million, respectively.
 
As of September 30, 2006, there was $11.7 million of total future compensation cost related to nonvested options. That cost is expected to be recognized over a weighted-average period of less than one year. We expect substantially all of the nonvested options to vest.
 
Restricted Stock and Restricted Stock Units
 
Our stock compensation plans allow grants of restricted stock. Restricted stock is issued on the grant date, but is restricted as to transferability. Restricted stock vests in varying periodic installments ranging up to 3 to 4 years.
 
A summary of our restricted stock as of September 30, 2006, and the changes during the nine months then ended is presented below:
 
                 
          Weighted
 
          Average
 
          Grant-Date
 
Restricted Stock
  Outstanding     Fair Value  
(In thousands, except fair values)  
 
Nonvested as of December 31, 2005
    710     $ 28.78  
Granted
    762     $ 32.41  
Vested
    (141 )   $ 28.71  
Forfeited
    (48 )   $ 29.89  
                 
Nonvested as of September 30, 2006
    1,283     $ 30.91  
                 
 
The fair value of restricted stock vested during the nine months ended September 30, 2006 is $4.8 million. There was not any restricted stock that vested during the nine months ended September 30, 2005.


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

As of September 30, 2006, there is $30.3 million of unrecognized compensation expense related to nonvested restricted stock awards. That cost is expected to be recognized over a weighted-average period of 1.3 years.
 
Note 4   Acquisitions
 
On January 3, 2006, we completed an acquisition of 1183011 Alberta Ltd., a wholly-owned subsidiary of Airborne Energy Solutions Ltd., through the purchase of all common shares outstanding for cash for a total purchase price of Cdn. $41.7 million (U.S. $35.8 million). In addition, we assumed debt, net of working capital, totaling approximately Cdn. $10.0 million (U.S. $8.6 million). Nabors Blue Sky Ltd. (formerly 1183011 Alberta Ltd.) owns 42 helicopters and fixed-wing aircraft and owns and operates a fleet of heliportable well-service equipment. The purchase price has been allocated based on preliminary estimates of the fair value of assets acquired and liabilities assumed as of the acquisition date and resulted in goodwill of approximately U.S. $18.8 million. The purchase price allocation is subject to adjustment as additional information becomes available and will be finalized by December 31, 2006.
 
On May 31, 2006, we completed an acquisition of Pragma Drilling Equipment Ltd.’s business, which manufactures catwalks, iron roughnecks and other related oilfield equipment, through an asset purchase consisting primarily of intellectual property for a total purchase price of Cdn. $36.4 million (U.S. $33.0 million). Additional cash purchase consideration, up to a maximum of Cdn. $12 million (U.S. $10.8 million), will be due if certain specified financial performance targets are achieved over a one-year period commencing on June 30, 2006. The purchase price has been allocated based on preliminary estimates of the fair market value of assets acquired and liabilities assumed as of the acquisition date and resulted in goodwill of approximately U.S. $2.0 million. The purchase price allocation is subject to adjustments as additional information becomes available and will be finalized by December 31, 2006. Any contingent consideration payable in the future will be recorded as goodwill.
 
On September 21, 2006, we entered into a Letter of Intent to acquire the Moncla Companies for an undisclosed amount. Moncla owns six barge rigs, 50 workover and well-servicing rigs, 13 truck-mounted swabbing and testing units, rental equipment, various auxiliary equipment and real estate. Moncla’s headquarters, central training and maintenance facility and principal operations are located in Lafayette, Louisiana with extended operating yards located in Mississippi and Southeast Texas. The transaction is expected to be completed during 2006.
 
Note 5   Debt
 
On May 23, 2006, Nabors Industries, Inc. (“Nabors Delaware”), our wholly-owned subsidiary, completed a private placement of $2.5 billion aggregate principal amount of 0.94% senior exchangeable notes due 2011 that are fully and unconditionally guaranteed by us. On June 8, 2006, the initial purchasers exercised their option to purchase an additional $250 million of the 0.94% senior exchangeable notes due 2011, increasing the aggregate issuance of such notes to $2.75 billion. Nabors Delaware sold the notes to the initial purchasers in reliance on the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended. The notes were reoffered by the initial purchasers of the notes to qualified institutional buyers under Rule 144A of the Securities Act. Nabors and Nabors Delaware filed a registration statement on Form S-3 pursuant to the Securities Act with respect to resale of the notes and shares received in exchange for the notes on August 21, 2006. The notes bear interest at a rate of 0.94% per year payable semiannually on May 15 and November 15 of each year, beginning on November 15, 2006. Debt issuance costs of $28.3 million were capitalized in connection with the issuance of the notes in other long-term assets in our consolidated balance sheet and are being amortized through May 2011.
 
The notes are exchangeable into cash and, if applicable, Nabors’ common shares based on an exchange rate of the equivalent value of 21.8221 Nabors’ common shares per $1,000 principal amount of notes (which is equal to an initial exchange price of approximately $45.83 per share), subject to adjustment during the 30 calendar days ending at the close of business on the business day immediately preceding the maturity date and prior thereto only under the following circumstances: (1) during any calendar quarter (and only during such calendar quarter), if the closing price of Nabors’ common shares for at least 20 trading days in the 30 consecutive trading days ending on the last


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

trading day of the immediately preceding calendar quarter is more than 130% of the applicable exchange rate; (2) during the five business day period after any ten consecutive trading day period in which the trading price per note for each day of that period was less than 95% of the product of the closing sale price of Nabors’ common shares and the exchange rate of the note; and (3) upon the occurrence of specified corporate transactions set forth in the indenture.
 
The notes are unsecured and are effectively junior in right of payment to any of Nabors Delaware’s future secured debt. The notes will rank equally with any of Nabors Delaware’s other existing and future unsubordinated debt and will be senior in right of payment to any of Nabors Delaware’s future subordinated debt. Our guarantee of the note is unsecured and ranks equal in right of payments to all of our unsecured and unsubordinated indebtedness from time to time outstanding. Holders of the notes, who exchange their notes in connection with a change in control, as defined in the indenture, may be entitled to a make-whole premium in the form of an increase in the exchange rate. Additionally, in the event of a change in control, the holders of the notes may require Nabors Delaware to purchase all or a portion of their notes at a purchase price equal to 100% of the principal amount of notes, plus accrued and unpaid interest, if any. Upon exchange of the notes, a holder will receive for each note exchanged an amount in cash equal to the lesser of (i) $1,000 or (ii) the exchange value, determined in the manner set forth in the indenture. In addition, if the exchange value exceeds $1,000 on the exchange date, a holder will also receive a number of Nabors’ common shares for the exchange value in excess of $1,000 equal to such excess divided by the exchange price.
 
In connection with the sale of the notes, Nabors Delaware entered into exchangeable note hedge transactions with respect to our common shares. The call options are designed to cover, subject to customary anti-dilution adjustments, the net number of our common shares that would be deliverable to exchanging noteholders in the event of an exchange of the notes. Nabors Delaware paid an aggregate amount of approximately $583.6 million of the proceeds from the sale of the notes to acquire the call options.
 
Nabors also entered into separate warrant transactions at the time of the sale of the notes whereby we sold warrants which give the holders the right to acquire approximately 60.0 million of our common shares at a strike price of $54.64 per share. On exercise of the warrants, we have the option to deliver cash or our common shares equal to the difference between the then market price and strike price. All of the warrants will be exercisable and will expire on August 15, 2011. We received aggregate proceeds of approximately $421.2 million from the sale of the warrants and used $353.4 million of the proceeds to purchase 10.0 million of Nabors’ common shares.
 
The purchased call options and sold warrants are separate contracts entered into by Nabors and Nabors Delaware with two financial institutions, and are not part of the terms of the notes and will not affect the holders’ rights under the notes. The purchased call options are expected to offset the potential dilution upon exchange of the notes in the event that the market value per share of our common shares at the time of exercise is greater than the strike price of the purchased call options, which corresponds to the initial exchange price of the notes and is simultaneously subject to certain customary adjustments. The warrants will effectively increase the exchange price of the notes to $54.64 per share of our common shares, from the perspective of Nabors, representing a 55% premium based on the last reported bid price of $35.25 per share on May 17, 2006. In accordance with Emerging Issues Task Force Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed To and Potentially Settled In, a Company’s Own Stock” and SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” we recorded the exchangeable note hedge and warrants in capital in excess of par value as of the transaction date, and will not recognize subsequent changes in fair value. We also recognized a deferred tax asset of $215.9 million in the second quarter of 2006 for the effect of the future tax benefits related to the exchangeable note hedge.
 
We intend to use the remaining proceeds of the offering for general corporate purposes, which may include capital expenditures, acquisitions, retirement of other indebtedness and additional repurchases of Nabors’ common shares.


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

On May 23, 2006, Nabors International Management Ltd. (“NIML”), a direct wholly-owned subsidiary of Nabors borrowed from affiliates of the initial purchasers $650 million pursuant to a 90-day senior unsecured loan. The proceeds of the loan were used to purchase 18.4 million of Nabors’ common shares, which are held in treasury. The unsecured loan was paid in full on June 30, 2006.
 
On February 6, 2006, we redeemed 93% of our $1.2 billion zero coupon senior convertible debentures due 2021 for a total redemption price of $769.8 million; an amount equal to the issue price of $679.9 million plus accrued original issue discount of $89.9 million to the date of repurchase. We treat the redemption price, including accrued original discount, on our convertible debt instruments as a financing activity for purposes of reporting cash flows in our consolidated statements of cash flows. The principal amount of these debentures outstanding subsequent to this redemption totaled $57.0 million. The original principal amount of these debentures upon issuance was $1.381 billion, of which $180.8 million had been redeemed prior to 2005.
 
Note 6   Income Taxes
 
Our effective income tax rate was 26.8% and 30.2% during the three and nine months ended September 30, 2006, respectively, compared to 26.2% and 25.1% during the three and nine months prior year periods. The increase in our effective income tax rate resulted from a higher proportion of our taxable income being generated in the U.S. during the three and nine months ended September 30, 2006 compared to the prior year periods. Income generated in the U.S. is generally taxed at a higher rate than in international jurisdictions in which we operate. Additionally, during the three months ended June 30, 2006, we recorded a $36.2 million current tax expense relating to the redemption of common shares held by a foreign parent of a U.S. based Nabors’ subsidiary. This income tax expense was partially offset by an approximate $20.5 million deferred tax benefit recorded as a result of changes in Canadian laws that incrementally reduce statutory tax rates for both federal and provincial taxes over the next four years.
 
Note 7   Common Shares
 
During the nine months ended September 30, 2006, we repurchased 40.2 million of our common shares in the open market for $1.4 billion. We retired 17.9 million shares during the nine months ended September 30, 2006 and held 22.2 million of these shares in treasury. During the nine months ended September 30, 2005, we repurchased and retired 3.0 million of our common shares in the open market for $80.6 million.
 
On December 13, 2005, our Board of Directors approved a two-for-one stock split of our common shares to be effectuated in the form of a stock dividend. The stock split was subject to the approval by our shareholders of a proposal to amend our Amended and Restated Bye-Laws to increase the authorized share capital of Nabors by the creation of additional common shares. This proposal was approved by our shareholders in a Special Meeting of Shareholders on March 30, 2006. The stock dividend was distributed on April 17, 2006 to shareholders of record on March 31, 2006. For all balance sheets presented, capital in excess of par value was reduced by $.2 million and common shares were increased by $.2 million.
 
Note 8   Commitments and Contingencies
 
Commitments
 
Employment Contracts
 
Nabors’ Chairman and Chief Executive Officer, Eugene M. Isenberg, and its Deputy Chairman, President and Chief Operating Officer, Anthony G. Petrello, have employment agreements which were amended and restated effective October 1, 1996 and which currently are due to expire on September 30, 2010.
 
Mr. Isenberg’s employment agreement was originally negotiated with a creditors committee in 1987 in connection with the reorganization proceedings of Anglo Energy, Inc., which subsequently changed its name to


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Nabors. These contractual arrangements subsequently were approved by the various constituencies in those reorganization proceedings, including equity and debt holders, and confirmed by the United States Bankruptcy Court.
 
Mr. Petrello’s employment agreement was first entered into effective October 1, 1991. Mr. Petrello’s employment agreement was agreed upon as part of arm’s length negotiations with the Board before he joined Nabors in October 1991, and was reviewed and approved by the Compensation Committee of the Board and the full Board of Directors at that time.
 
The employment agreements for Messrs. Isenberg and Petrello were amended in 1994 and 1996. These amendments were approved by the Compensation Committee of the Board and the full Board of Directors at that time.
 
The employment agreements provide for an initial term of five years with an evergreen provision which automatically extended the agreement for an additional one-year term on each anniversary date, unless Nabors provided notice to the contrary ten days prior to such anniversary. The Board of Directors in March 2006 exercised its election to fix the expiration date of the employment agreements for Messrs. Isenberg and Petrello, and accordingly, these agreements will expire at the end of their current term at September 30, 2010.
 
In addition to a base salary, the employment agreements provide for annual cash bonuses in an amount equal to 6% and 2%, for Messrs. Isenberg and Petrello, respectively, of Nabors’ net cash flow (as defined in the respective employment agreements) in excess of 15% of the average shareholders’ equity for each fiscal year. (Mr. Isenberg’s cash bonus formula originally was set at 10% in excess of a 10% return on shareholders’ equity and he has voluntarily reduced it over time to its 6% in excess of 15% level.) Mr. Petrello’s bonus is subject to a minimum of $700,000 per year. In 15 of the last 16 years, Mr. Isenberg has agreed voluntarily to accept a lower annual cash bonus (i.e., an amount lower than the amount provided for under his employment agreement) in light of his overall compensation package. Mr. Petrello has agreed voluntarily to accept a lower annual cash bonus (i.e., an amount lower than the amount provided for under his employment agreement) in light of his overall compensation package in 13 of the last 15 years. For 2005, the annual cash bonuses for Messrs. Isenberg and Petrello pursuant to the formula described in their employment agreements were $41.2 million and $13.7 million, respectively; but in light of their overall compensation package (including significant stock option grants and restricted stock awards), they agreed to accept cash bonuses in the amounts of $3 million and $1.5 million, respectively.
 
Mr. Isenberg voluntarily agreed to amend his employment agreement in March 2006 (the “2006 Amendment”). Under the 2006 Amendment, Mr. Isenberg agreed to reduce the annual cash bonus to an amount equal to 3% of Nabors’ net cash flow (as defined in his employment agreement) in excess of 15% of the average shareholders’ equity for 2006. For 2007 through the expiration date of the employment agreement, the annual cash bonus will return to 6% of Nabors’ net cash flow in excess of 15% of the average shareholders’ equity for each fiscal year.
 
Messrs. Isenberg and Petrello also are eligible for awards under Nabors’ equity plans and may participate in annual long-term incentive programs and pension and welfare plans, on the same basis as other executives; and may receive special bonuses from time to time as determined by the Board.
 
Termination in the event of death, disability, or termination without cause.   In the event that either Mr. Isenberg’s or Mr. Petrello’s employment agreement is terminated (i) upon death or disability (as defined in the respective employment agreements), (ii) by Nabors prior to the expiration date of the employment agreement for any reason other than for Cause (as defined in the respective employment agreements) or (iii) by either individual for Constructive Termination Without Cause (as defined in the respective employment agreements), each would be entitled to receive within 30 days of the triggering event (a) all base salary which would have been payable through the expiration date of the contract or three times his then current base salary, whichever is greater; plus (b) the greater of (i) all annual cash bonuses which would have been payable through the expiration date; (ii) three times the highest bonus (including the imputed value of grants of stock awards and stock options), paid during the last three fiscal years prior to termination; or (iii) three times the highest annual cash bonus payable for each of the three


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

previous fiscal years prior to termination, regardless of whether the amount was paid. In computing any amount due under (b)(i) and (iii) above, the calculation is made without regard to the 2006 Amendment reducing Mr. Isenberg’s bonus percentage as described above. If, by way of example, these provisions had applied at September 30, 2006, Mr. Isenberg would have been entitled to a payment of approximately $203 million, subject to a “true-up” equal to the amount of cash bonus he would have earned under the formula during the remaining term of the agreement, based upon actual results, but would not be less than approximately $203 million. Similarly, with respect to Mr. Petrello, had these provisions applied at September 30, 2006, Mr. Petrello would have been entitled to a payment of approximately $103 million, subject to a “true-up” equal to the amount of cash bonus he would have earned under the formula during the remaining term of the agreement, based upon actual results, but would not be less than approximately $103 million. These payment amounts are based on historical data and are not intended to be estimates of future payments required under the agreements. Depending upon future operating results, the true-up could result in the payment of amounts which are significantly higher. In addition, the affected individual is entitled to receive (a) any unvested restricted stock outstanding, which shall immediately and fully vest; (b) any unvested outstanding stock options, which shall immediately and fully vest; (c) any amounts earned, accrued or owing to the executive but not yet paid (including executive benefits, life insurance, disability benefits and reimbursement of expenses and perquisites), which shall be continued through the later of the expiration date or three years after the termination date; (d) continued participation in medical, dental and life insurance coverage until the executive receives equivalent benefits or coverage through a subsequent employer or until the death of the executive or his spouse, whichever is later; and (e) any other or additional benefits in accordance with applicable plans and programs of Nabors. For Mr. Isenberg, as of September 30, 2006, the value of unvested restricted stock was approximately $9.9 million and the value of in-the-money unvested stock options was approximately $4.3 million. For Mr. Petrello, as of September 30, 2006, the value of unvested restricted stock was approximately $5.0 million and the value of in-the-money unvested stock options was approximately $2.2 million. Estimates of the cash value of Nabors’ obligations to Messrs. Isenberg and Petrello under (c), (d) and (e) above are included in the payment amounts above.
 
The Board of Directors in March 2006 exercised its election to fix the expiration date of the employment agreements for Messrs. Isenberg and Petrello. Messrs. Isenberg and Petrello have informed the Board of Directors that they have reserved their rights under their employment agreements with respect to the notice setting the expiration dates of their employment agreements, including whether such notice could trigger an acceleration of certain payments pursuant to their employment agreements.
 
Termination in the event of a Change in Control.   In the event that Messrs. Isenberg’s or Petrello’s termination of employment is related to a Change in Control (as defined in their respective employment agreements), they would be entitled to receive a cash amount equal to the greater of (a) one dollar less than the amount that would constitute an “excess parachute payment” as defined in Section 280G of the Internal Revenue Code, or (b) the cash amount that would be due in the event of a termination without cause, as described above. If, by way of example, there was a change of control event that applied on September 30, 2006, then the payments to Messrs. Isenberg and Petrello would be approximately $203 million and $103 million, respectively. These payment amounts are based on historical data and are not intended to be estimates of future payments required under the agreements. Depending upon future operating results, the true-up could result in the payment of amounts which are significantly higher. In addition, they would receive (a) any unvested restricted stock outstanding, which shall immediately and fully vest; (b) any unvested outstanding stock options, which shall immediately and fully vest; (c) any amounts earned, accrued or owing to the executive but not yet paid (including executive benefits, life insurance, disability benefits and reimbursement of expenses and perquisites), which shall be continued through the later of the expiration date or three years after the termination date; (d) continued participation in medical, dental and life insurance coverage until the executive receives equivalent benefits or coverage through a subsequent employer or until the death of the executive or his spouse, whichever is later; and (e) any other or additional benefits in accordance with applicable plans and programs of Nabors. For Mr. Isenberg, as of September 30, 2006, the value of unvested restricted stock was approximately $9.9 million and the value of in-the-money unvested stock options


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

was approximately $4.3 million. For Mr. Petrello, as of September 30, 2006, the value of unvested restricted stock was approximately $5.0 million and the value of in-the-money unvested stock options was approximately $2.2 million. The cash value of Nabors’ obligations to Messrs. Isenberg and Petrello under (c), (d) and (e) above are included in the payment amounts above. Also, they would receive additional stock options immediately exercisable for five years to acquire a number of shares of common stock equal to the highest number of options granted during any fiscal year in the previous three fiscal years, at an option exercise price equal to the average closing price during the 20 trading days prior to the event which resulted in the change of control. If, by way of example, there was a change of control event that applied at September 30, 2006, Mr. Isenberg would have received 3,366,666 options valued at approximately $36 million and Mr. Petrello would have received 1,683,332 options valued at approximately $18 million, in each case based upon a Black Scholes analysis. Finally, in the event that an excise tax was applicable, they would receive a gross-up payment to make them whole with respect to any excise taxes imposed by Section 4999 of the Internal Revenue Code. With respect to the preceding sentence, by way of example, if there was a change of control event that applied on September 30, 2006, and assuming that the excise tax were applicable to the transaction, then the additional payments to Messrs. Isenberg and Petrello for the gross-up would be up to approximately $89 million and $48 million, respectively.
 
Other Obligations.  In addition to salary and bonus, each of Messrs. Isenberg and Petrello receive group life insurance at an amount at least equal to three times their respective base salaries, various split-dollar life insurance policies, reimbursement of expenses, various perquisites and a personal umbrella insurance policy in the amount of $5 million. Premiums payable under the split dollar life insurance policies were suspended as a result of the adoption of the Sarbanes — Oxley Act of 2002.
 
New Joint Venture
 
On September 22, 2006, we entered into an agreement with First Reserve Corporation to form a new joint venture, NFR Energy LLC, to invest in oil and gas exploitation opportunities worldwide. First Reserve Corporation is a private equity firm specializing in the energy industry. Each party initially will hold an equal interest in the new entity and has committed to fund its proportionate share of $1.0 billion in equity. NFR Energy LLC will pursue development and exploration projects with both existing customers of ours and with other operators in a variety of forms including operated and non-operated working interests, joint ventures, farm-outs and acquisitions. NFR Energy LLC has not commenced operations and has not received funding as of September 30, 2006 by either party.
 
Contingencies
 
Income Tax Contingencies
 
We are subject to income taxes in both the United States and numerous foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We are regularly under audit by tax authorities. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different than that which is reflected in historical income tax provisions and accruals. Based on the results of an audit or litigation, a material effect on our financial position, income tax provision, net income, or cash flows in the period or periods for which that determination is made could result.
 
It is possible that future changes to tax laws (including tax treaties) could have an impact on our ability to realize the tax savings recorded to date as well as future tax savings as a result of our corporate reorganization, depending on any responsive action taken by us.
 
On May 31, 2006, Nabors International Finance Inc. (“NIFI”), a wholly-owned U.S. subsidiary of Nabors, received from the U.S. Internal Revenue Service (the “IRS”) two Notices of Proposed Adjustment (“NOPA”) in connection with an audit of NIFI for tax years 2002 and 2003. One NOPA proposes to deny a deduction of


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

$85.1 million in interest expense in our 2002 tax year relating to intercompany indebtedness incurred in connection with our inversion transaction in June 2002 whereby we were reorganized as a Bermuda company. The second NOPA proposes to deny a deduction of $207.6 million in the same item of interest expense in our 2003 tax year. On August 9, 2006, NIFI received a Revenue Agent Report, asserting the adjustments relating to the two NOPAs referred to above. On September 18, 2006, NIFI filed a protest with the IRS related to the two adjustments and we intend to contest the IRS position vigorously. We previously had obtained advice from our tax advisors that the deduction of such amounts was appropriate and more recently that the position of the IRS lacks merit. In 2003 the Company paid off approximately one-half of the intercompany indebtedness incurred in connection with the inversion. We currently have not booked any reserves for such proposed adjustments.
 
On September 14, 2006, Nabors Drilling International Ltd. (NDIL), a wholly-owned Bermuda subsidiary of Nabors, received a Notice of Assessment (the “Notice”) from the Mexican Servicio de Administracion Tributaria (the “SAT”) in connection with the audit of NDIL’s Mexican branch for tax year 2003. The Notice proposes to deny a depreciation expense deduction that relates to drilling rigs operating in Mexico in 2003, as well as a deduction for payments made to an affiliated company for the provision of labor services in Mexico. The amount assessed by the SAT is approximately $19.8 million (including interest and penalties). Nabors and its tax advisors previously concluded that the deduction of said amounts was appropriate and more recently that the position of the SAT lacks merit. Nabors has not booked any reserves for the adjustments proposed by the SAT. NDIL’s Mexican branch took similar deductions for depreciation and labor expenses in 2004, 2005 and 2006. It is likely that the SAT will propose the disallowance of these deductions upon audit of NDIL’s Mexican branch’s 2004, 2005 and 2006 tax years.
 
Self-Insurance Accruals
 
We are self-insured for certain losses relating to workers’ compensation, employers’ liability, general liability, automobile liability and property damage. Effective April 1, 2006, with our insurance renewal, certain changes have been made to our insurance coverage increasing our self-insured retentions. Our domestic workers’ compensation program continues to be subject to a $1.0 million per occurrence deductible. Employers’ liability and Jones Act cases are subject to a $2.0 million deductible. Automobile liability continues at a $.5 million deductible. We are assuming an additional $3.0 million corridor deductible for domestic workers’ compensation claims. General liability claims continue to be subject to a $5.0 million deductible. However, as a result of insurance market conditions following hurricanes Katrina and Rita, we are now subject to higher deductibles for removal of wreckage and debris and collision liability claims depending on the insured value of the individual rigs.
 
In addition, we are subject to a $1.0 million deductible for all land rigs except for those located in Alaska, and a $5.0 million deductible for all our Alaska and offshore rigs with the exception of the Pool Arabia rig, which is subject to a $2.5 million deductible. This applies to all kinds of risks of physical damage except for named windstorms in the U.S. Gulf of Mexico. The deductible for named windstorms in the U.S. Gulf of Mexico is $25.0 million per occurrence. Also, the maximum coverage for named windstorms in the U.S. Gulf of Mexico is $50.0 million in this policy year.
 
Litigation
 
Nabors and its subsidiaries are defendants or otherwise involved in a number of lawsuits in the ordinary course of business. We estimate the range of our liability related to pending litigation when we believe the amount and range of loss can be estimated. We record our best estimate of a loss when the loss is considered probable. When a liability is probable and there is a range of estimated loss with no best estimate in the range, we record the minimum estimated liability related to the lawsuits or claims. As additional information becomes available, we assess the potential liability related to our pending litigation and claims and revise our estimates. Due to uncertainties related to the resolution of lawsuits and claims, the ultimate outcome may differ from our estimates. In the opinion of management and based on liability accruals provided, our ultimate exposure with respect to these pending lawsuits


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

and claims is not expected to have a material adverse effect on our consolidated financial position or cash flows, although they could have a material adverse effect on our results of operations for a particular reporting period.
 
During the quarter ended June 30, 2006, we settled a lawsuit involving wage and hour claims relating primarily to meal periods and travel time of current and former rig-based employees in our California well-servicing business. Those claims were heard by an arbitrator during the fourth quarter of 2005. On February 6, 2006, we received an interim award against us in the amount of $25.6 million (plus attorney’s fees and costs), which was accrued for in our consolidated statements of income for the year ended December 31, 2005. As a result of subsequent proceedings and the settlement, the final award was $24.3 million, which was paid during May 2006.
 
Additionally, on December 22, 2005, we received a grand jury subpoena from the United States Attorney’s Office in Anchorage, Alaska, seeking documents and information relating to an alleged spill, discharge, overflow or cleanup of drilling mud or sludge involving one of our rigs during March 2003. We are cooperating with the authorities in this matter.
 
Guarantees
 
We enter into various agreements and obligations providing financial or performance assurance to third parties. Certain of these agreements serve as guarantees, including standby letters of credit issued on behalf of insurance carriers in conjunction with our workers’ compensation insurance program and other financial surety instruments such as bonds. We have also guaranteed payment of contingent consideration in conjunction with a minor acquisition completed during the first quarter of 2005 and in conjunction with the acquisition of Pragma Drilling Equipment Ltd., completed in May of 2006, which are both based on future operating results of those businesses. In addition, we have provided indemnifications to certain third parties which serve as guarantees. These guarantees include indemnification provided by Nabors to our stock transfer agent and our insurance carriers. We are not able to estimate the potential future maximum payments that might be due under our indemnification guarantees.
 
Management believes the likelihood that we would be required to perform or otherwise incur any material losses associated with any of these guarantees is remote. The following table summarizes the total maximum amount of financial and performance guarantees issued by Nabors:
 
                                         
    Maximum Amount  
    Remainder
                         
    of 2006     2007     2008     Thereafter     Total  
(In thousands)  
 
Financial standby letters of credit and other financial surety instruments
  $ 273     $ 102,112     $ 1,195     $ 125     $ 103,705  
Contingent consideration in acquisition
          11,596       850       2,550       14,996  
                                         
Total
  $ 273     $ 113,708     $ 2,045     $ 2,675     $ 118,701  
                                         


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 9   Earnings Per Share
 
A reconciliation of the numerators and denominators of the basic and diluted earnings per share computations is as follows:
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2006     2005     2006     2005  
(In thousands, except per share amounts)        
 
Net income (numerator):
                               
Net income — basic
  $ 292,751     $ 178,857     $ 782,947     $ 438,076  
Add interest expense on assumed conversion of our zero coupon convertible/exchangeable senior debentures/notes, net of tax:
                               
$2.75 billion due 2011(1)
                       
$82 million due 2021(2)
                       
$700 million due 2023(3)
                       
                                 
Adjusted net income — diluted
  $ 292,751     $ 178,857     $ 782,947     $ 438,076  
                                 
Earnings per share:
                               
Basic
  $ 1.05     $ .57     $ 2.65     $ 1.41  
Diluted
  $ 1.02     $ .55     $ 2.57     $ 1.36  
Shares (denominator):
                               
Weighted-average number of shares outstanding-basic(4)
    277,553       314,419       294,987       311,210  
Net effect of dilutive stock options, warrants and restricted stock awards based on the treasury stock method
    8,991       9,281       9,893       10,018  
Assumed conversion of our zero coupon convertible/exchangeable senior debentures/notes:
                               
$2.75 billion due 2011(1)
                       
$82 million due 2021(2)
                       
$700 million due 2023(3)
                186        
                                 
Weighted-average number of shares outstanding-diluted
    286,544       323,700       305,066       321,228  
                                 
 
 
(1) Diluted earnings per share for the three and nine months ended September 30, 2006 do not include any incremental shares issuable upon the exchange of the $2.75 billion 0.94% senior exchangeable notes. The number of shares that we would be required to issue upon exchange consists of only the incremental shares that would be issued above the principal amount of the notes, as we are required to pay cash up to the principal amount of the notes exchanged. We would only issue an incremental number of shares upon exchange of these notes, and such shares are only included in the calculation of the weighted-average number of shares outstanding in our diluted earnings per share calculation, when the price of our shares exceeds $45.83 on the last trading day of the quarter, which did not occur during the three and nine months ended September 30, 2006. The $2.75 billion notes were issued during the quarter ended June 30, 2006 and had no effect on prior period’s earnings per share calculation.
 
(2) Diluted earnings per share for the three and nine months ended September 30, 2006 excludes approximately 1.2 million potentially dilutive shares initially issuable upon the conversion of the $82 million zero coupon


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

convertible senior debentures. Diluted earnings per share for the three and nine months ended September 30, 2005 excludes approximately 17.0 million potentially dilutive shares initially issuable upon the conversion of these debentures. Such shares did not impact our calculation of dilutive earnings per share for those quarters, as we are required to pay cash up to the principal amount of any debentures converted. We would only issue an incremental number of shares upon conversion of these debentures, and such shares would only be included in the calculation of the weighted-average number of shares outstanding in our diluted earnings per share calculation if the price of our shares exceeded approximately $49.
 
(3) Diluted earnings per share for the three months ended September 30, 2006 and 2005 and the nine months ended September 30, 2005 do not include any incremental shares issuable upon the exchange of the $700 million zero coupon senior exchangeable notes. The number of shares that we would be required to issue upon exchange consists of only the incremental shares that would be issued above the principal amount of the notes, as we are required to pay cash up to the principal amount of the notes exchanged. We would only issue an incremental number of shares upon exchange of these notes, and such shares are only included in the calculation of the weighted-average number of shares outstanding in our diluted earnings per share calculation, when the price of our shares exceeds $35.05 on the last trading day of the quarter. This was the case for the quarter ended March 31, 2006 and is therefore included in the weighted-average number of shares outstanding in our diluted earnings per share calculation for the nine months ended September 30, 2006.
 
(4) Includes the following weighted-average number of common shares of Nabors and weighted-average number of exchangeable shares of Nabors Exchangeco (Canada) Inc., an indirectly wholly-owned Canadian subsidiary of Nabors, respectively: 277.4 million and .2 million shares for the three months ended September 30, 2006; 314.0 million and .4 million shares for the three months ended September 30, 2005; 294.8 million and .2 million shares for the nine months ended September 30, 2006; and 310.8 million and .4 million shares for the nine months ended September 30, 2005. The exchangeable shares of Nabors Exchangeco are exchangeable for Nabors common shares on a one-for-one basis, and have essentially identical rights as Nabors Industries Ltd. common shares, including but not limited to voting rights and the right to receive dividends, if any.
 
For all periods presented, the computation of diluted earnings per share excludes outstanding stock options and warrants with exercise prices greater than the average market price of Nabors’ common shares, because the inclusion of such options and warrants would be anti-dilutive. The number of options and warrants that were excluded from diluted earnings per share that would potentially dilute earnings per share in the future were 4,327,513 and 2,443,254 shares during the three and nine months ended September 30, 2006 and 2,250 and 1,014,422 shares during the three and nine months ended September 30, 2005. In any period during which the average market price of Nabors’ common shares exceeds the exercise prices of these stock options and warrants, such stock options and warrants will be included in our diluted earnings per share computation using the treasury stock method of accounting. Restricted stock will similarly be included in our diluted earnings per share computation using the treasury stock method of accounting in any period where the amount of restricted stock exceeds the number of shares assumed repurchased in those periods based upon future unearned compensation.


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 10   Supplemental Balance Sheet Information
 
Accrued liabilities include the following:
 
                 
    September 30,
    December 31,
 
    2006     2005  
(In thousands)        
 
Accrued compensation
  $ 117,940     $ 88,071  
Deferred revenue
    70,676       19,542  
Workers’ compensation liabilities
    37,458       37,458  
Interest payable
    12,462       9,728  
Litigation reserves
    4,583       30,182  
Other accrued liabilities
    45,948       39,355  
                 
    $ 289,067     $ 224,336  
                 
 
Our cash and cash equivalents, short-term and long-term investments consist of the following:
 
                 
    September 30,
    December 31,
 
    2006     2005  
(In thousands)        
 
Cash and cash equivalents
  $ 360,206     $ 565,001  
Short-term investments
    913,216       858,524  
Long-term investments
    491,404       222,802  
                 
Total
  $ 1,764,826     $ 1,646,327  
                 
 
As of September 30, 2006 and December 31, 2005, our short-term investments consist entirely of investments in available-for-sale marketable debt and equity securities while our long-term investments consist entirely of investments in non-marketable securities. Non-marketable securities consist of asset-backed securities and mortgage-backed securities, global structured asset securitizations, whole loan mortgages and participations in whole loans and whole loan mortgages. These investments are classified as non-marketable, because they do not have published fair values.


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 11   Segment Information
 
The following tables set forth certain financial information with respect to our reportable segments:
 
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2006     2005     2006     2005  
(In thousands)        
 
Operating revenues and Earnings from unconsolidated affiliates:
                               
Contract Drilling:(1)
                               
U.S. Lower 48 Land Drilling
  $ 498,173     $ 355,172     $ 1,393,310     $ 914,862  
U.S. Land Well-servicing
    188,650       130,265       518,224       355,154  
U.S. Offshore
    56,219       42,115       162,299       125,312  
Alaska
    24,098       18,159       75,816       64,882  
Canada
    167,705       126,643       514,849       366,500  
International
    195,445       143,355       511,487       402,553  
                                 
Subtotal Contract Drilling(2)
    1,130,290       815,709       3,175,985       2,229,263  
Oil and Gas(3)
    9,268       16,354       48,808       46,871  
Other Operating Segments(4)(5)
    154,463       86,458       459,759       244,368  
Other reconciling items(6)
    (43,837 )     (25,176 )     (138,673 )     (70,885 )
                                 
Total
  $ 1,250,184     $ 893,345     $ 3,545,879     $ 2,449,617  
                                 
Adjusted income (loss) derived from operating activities:(7)
                               
Contract Drilling:
                               
U.S. Lower 48 Land Drilling
  $ 219,485     $ 135,295     $ 611,912     $ 310,567  
U.S. Land Well-servicing
    54,495       29,297       148,000       75,126  
U.S. Offshore
    17,492       12,883       51,613       32,392  
Alaska
    2,123       3,612       9,749       13,743  
Canada
    42,549       28,709       145,524       74,947  
International
    58,145       38,630       146,142       100,955  
                                 
Subtotal Contract Drilling
    394,289       248,426       1,112,940       607,730  
Oil and Gas
    (5,101 )     3,998       7,751       7,741  
Other Operating Segments
    20,882       6,862       59,918       19,493  
                                 
Total segment adjusted income derived from operating activities
    410,070       259,286       1,180,609       634,964  
Other reconciling items(8)
    (29,268 )     (17,394 )     (79,847 )     (47,322 )
Interest expense
    (13,735 )     (11,195 )     (33,958 )     (33,265 )
Investment income
    37,155       27,178       67,753       54,544  
(Losses) Gains on sales of long-lived assets, impairment charges and other income (expense), net
    (4,284 )     (15,684 )     (12,529 )     (23,778 )
                                 
Income before income taxes
  $ 399,938     $ 242,191     $ 1,122,028     $ 585,143  
                                 
 


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

                 
    September 30,
    December 31,
 
    2006     2005  
(In thousands)        
 
Total assets:
               
Contract Drilling:
               
U.S. Lower 48 Land Drilling
  $ 2,054,179     $ 1,513,618  
U.S. Land Well-servicing
    546,840       389,002  
U.S. Offshore
    422,899       366,354  
Alaska
    214,554       202,315  
Canada
    1,072,350       1,109,627  
International
    1,808,405       1,436,234  
                 
Subtotal Contract Drilling(9)
    6,119,227       5,017,150  
Oil and Gas
    244,059       127,834  
Other Operating Segments(10)
    639,300       387,422  
Other reconciling items(8)
    1,926,242       1,698,001  
                 
Total assets
  $ 8,928,828     $ 7,230,407  
                 
 
 
(1) These segments include our drilling, workover and well-servicing operations, on land and offshore.
 
(2) Includes Earnings (losses), net from unconsolidated affiliates, accounted for by the equity method, of $1.1 million and $(1.1) million for the three months ended September 30, 2006 and 2005, respectively, and $5.9 million and $.7 million for the nine months ended September 30, 2006 and 2005, respectively.
 
(3) Represents our oil and gas exploration, development and production operations.
 
(4) Includes our marine transportation and supply services, drilling technology and top drive manufacturing, directional drilling, rig instrumentation and software, and construction and logistics operations.
 
(5) Includes Earnings (losses), net from unconsolidated affiliates, accounted for by the equity method, of $4.6 million and $1.2 million for the three months ended September 30, 2006 and 2005, respectively, and $13.6 million and $6.6 million for the nine months ended September 30, 2006 and 2005, respectively.
 
(6) Represents the elimination of inter-segment transactions.
 
(7) Adjusted income (loss) derived from operating activities is computed by: subtracting direct costs, general and administrative expenses, and depreciation and amortization, and depletion expense from Operating revenues and then adding Earnings from unconsolidated affiliates. Such amounts should not be used as a substitute to those amounts reported under GAAP. However, management evaluates the performance of our business units and the consolidated company based on several criteria, including adjusted income (loss) derived from operating activities, because it believes that this financial measure is an accurate reflection of the ongoing profitability of our company. A reconciliation of this non-GAAP measure to income before income taxes, which is a GAAP measure, is provided within the table above.
 
(8) Represents the elimination of inter-segment transactions and unallocated corporate expenses and assets.
 
(9) Includes $41.8 million and $35.3 million of investments in unconsolidated affiliates accounted for by the equity method as of September 30, 2006 and December 31, 2005, respectively.
 
(10) Includes $49.4 million and $35.9 million of investments in unconsolidated affiliates accounted for by the equity method as of September 30, 2006 and December 31, 2005, respectively.

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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 12   Condensed Consolidating Financial Information
 
Nabors has fully and unconditionally guaranteed all of the issued public debt securities of Nabors Delaware, and Nabors and Nabors Delaware have fully and unconditionally guaranteed the $225 million 4.875% senior notes due 2009 issued by Nabors Holdings 1, ULC, our indirect subsidiary.
 
The following condensed consolidating financial information is included so that separate financial statements of Nabors Delaware and Nabors Holdings are not required to be filed with the U.S. Securities and Exchange Commission. The condensed consolidating financial statements present investments in both consolidated and unconsolidated affiliates using the equity method of accounting.
 
The following condensed consolidating financial information presents: condensed consolidating balance sheets as of September 30, 2006 and December 31, 2005, statements of income for each of the three and nine month periods ended September 30, 2006 and 2005, and the consolidating statements of cash flows for the nine month periods ended September 30, 2006 and 2005 of (a) Nabors, parent/guarantor, (b) Nabors Delaware, issuer of public debt securities guaranteed by Nabors and guarantor of the $225 million 4.875% senior notes issued by Nabors Holdings, (c) Nabors Holdings, issuer of the $225 million 4.875% senior notes, (d) the non-guarantor subsidiaries, (e) consolidating adjustments necessary to consolidate Nabors and its subsidiaries and (f) Nabors on a consolidated basis.


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Condensed Consolidating Balance Sheets
 
                                                 
    September 30, 2006  
          Nabors
          Other
             
    Nabors
    Delaware
    Nabors
    Subsidiaries
             
    (Parent/
    (Issuer/
    Holdings
    (Non-
    Consolidating
    Consolidated
 
    Guarantor)     Guarantor)     (Issuer)     Guarantors)     Adjustments     Total  
(In thousands)        
 
ASSETS
Current assets:
                                               
Cash and cash equivalents
  $ 14,102     $ 37,024     $ 11     $ 309,069     $     $ 360,206  
Short-term investments
                      913,216             913,216  
Accounts receivable, net
                      1,098,818             1,098,818  
Inventory
                      98,769             98,769  
Deferred income taxes
                      204,140             204,140  
Other current assets
    162       1,110       376       113,866             115,514  
                                                 
Total current assets
    14,264       38,134       387       2,737,878             2,790,663  
Long-term investments
                      491,404             491,404  
Property, plant and equipment, net
                      4,975,081             4,975,081  
Goodwill, net
                      369,978             369,978  
Intercompany receivables
    284,791       1,043,626             19,944       (1,348,361 )      
Investments in affiliates
    2,988,413       3,621,237       283,133       1,195,157       (7,996,739 )     91,201  
Other long-term assets
          250,518       677       175,220       (215,914 )     210,501  
                                                 
Total assets
  $ 3,287,468     $ 4,953,515     $ 284,197     $ 9,964,662     $ (9,561,014 )   $ 8,928,828  
                                                 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
                                               
Current portion of long- term debt
  $     $     $     $     $     $  
Trade accounts payable
    22       84             416,920             417,026  
Accrued liabilities
    4,314       11,300       1,409       272,044             289,067  
Income taxes payable
          17,890       1,848       21,343             41,081  
                                                 
Total current liabilities
    4,336       29,274       3,257       710,307             747,174  
Long-term debt
          3,779,316       224,229                   4,003,545  
Other long-term liabilities
                      174,361             174,361  
Deferred income taxes
          32,600       4       903,926       (215,914 )     720,616  
Intercompany payable
                3,428       1,344,933       (1,348,361 )      
                                                 
Total liabilities
    4,336       3,841,190       230,918       3,133,527       (1,564,275 )     5,645,696  
                                                 
Shareholders’ equity
    3,283,132       1,112,325       53,279       6,831,135       (7,996,739 )     3,283,132  
                                                 
Total liabilities and shareholders’ equity
  $ 3,287,468     $ 4,953,515     $ 284,197     $ 9,964,662     $ (9,561,014 )   $ 8,928,828  
                                                 


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

                                                 
    December 31, 2005  
          Nabors
          Other
             
    Nabors
    Delaware
    Nabors
    Subsidiaries
             
    (Parent/
    (Issuer/
    Holdings
    (Non-
    Consolidating
    Consolidated
 
    Guarantor)     Guarantor)     (Issuer)     Guarantors)     Adjustments     Total  
(In thousands)        
 
ASSETS
Current assets:
                                               
Cash and cash equivalents
  $ 527     $ 14     $ 11     $ 564,449     $     $ 565,001  
Short-term investments
                      858,524             858,524  
Accounts receivable, net
                      822,104             822,104  
Inventory
                      51,292             51,292  
Deferred income taxes
                      199,196             199,196  
Other current assets
    163       959       376       119,693             121,191  
                                                 
Total current assets
    690       973       387       2,615,258             2,617,308  
Long-term investments
                      222,802             222,802  
Property, plant and equipment, net
                      3,886,924             3,886,924  
Goodwill, net
                      341,939             341,939  
Intercompany receivables
    545,099       766,079             522       (1,311,700 )      
Investments in affiliates
    3,212,605       2,539,283       270,461       1,544,222       (7,495,407 )     71,164  
Other long-term assets
          10,295       826       79,149             90,270  
                                                 
Total assets
  $ 3,758,394     $ 3,316,630     $ 271,674     $ 8,690,816     $ (8,807,107 )   $ 7,230,407  
                                                 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
                                               
Current portion of long-term debt
  $     $ 767,912     $     $     $     $ 767,912  
Trade accounts payable
          23             336,566             336,589  
Accrued liabilities
    254       5,582       4,151       214,349             224,336  
Income taxes payable
          6,696       1,380       15,543             23,619  
                                                 
Total current liabilities
    254       780,213       5,531       566,458             1,352,456  
Long-term debt
          1,027,721       224,030                   1,251,751  
Other long-term liabilities
                      151,415             151,415  
Deferred income taxes
          26,246             690,399             716,645  
Intercompany payable
                2,534       1,309,166       (1,311,700 )      
                                                 
Total liabilities
    254       1,834,180       232,095       2,717,438       (1,311,700 )     3,472,267  
                                                 
Shareholders’ equity
    3,758,140       1,482,450       39,579       5,973,378       (7,495,407 )     3,758,140  
                                                 
Total liabilities and shareholders’ equity
  $ 3,758,394     $ 3,316,630     $ 271,674     $ 8,690,816     $ (8,807,107 )   $ 7,230,407  
                                                 


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Condensed Consolidating Statements of Income
 
                                                 
    Three Months Ended September 30, 2006  
          Nabors
          Other
             
    Nabors
    Delaware
    Nabors
    Subsidiaries
             
    (Parent/
    (Issuer/
    Holdings
    (Non-
    Consolidating
    Consolidated
 
    Guarantor)     Guarantor)     (Issuer)     Guarantors)     Adjustments     Total  
(In thousands)        
 
Revenues and other income:
                                               
Operating revenues
  $     $     $     $ 1,244,478     $     $ 1,244,478  
Earnings from unconsolidated affiliates
                      5,706             5,706  
Earnings from consolidated affiliates
    296,520       218,849       3,683       224,104       (743,156 )      
Investment income
    68       683             36,404             37,155  
Intercompany interest income
    1,019       17,289                   (18,308 )      
                                                 
Total revenues and other income
    297,607       236,821       3,683       1,510,692       (761,464 )     1,287,339  
                                                 
Costs and other deductions:
                                               
Direct costs
                      670,326             670,326  
General and administrative expenses
    4,417       67             89,538       (253 )     93,769  
Depreciation and amortization
          150             97,406             97,556  
Depletion
                      7,731             7,731  
Interest expense
          12,727       2,860       (1,852 )           13,735  
Intercompany interest expense
    439                   17,869       (18,308 )      
Losses (gains) on sales of long-lived assets, impairment charges and other expense (income), net
          809             3,222       253       4,284  
                                                 
Total costs and other deductions
    4,856       13,753       2,860       884,240       (18,308 )     887,401  
                                                 
Income before income taxes
    292,751       223,068       823       626,452       (743,156 )     399,938  
                                                 
Income tax expense
          1,561       263       105,363             107,187  
                                                 
Net income
  $ 292,751     $ 221,507     $ 560     $ 521,089     $ (743,156 )   $ 292,751  
                                                 


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Table of Contents

 
NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

                                                 
    Three Months Ended September 30, 2005  
          Nabors
          Other
             
    Nabors
    Delaware
    Nabors
    Subsidiaries
             
    (Parent/
    (Issuer/
    Holdings
    (Non-
    Consolidating
    Consolidated
 
    Guarantor)     Guarantor)     (Issuer)     Guarantors)     Adjustments     Total  
(In thousands)        
 
Revenues and other income:
                                               
Operating revenues
  $     $     $     $ 893,254     $     $ 893,254  
Earnings from unconsolidated affiliates
                      91             91  
Earnings from consolidated affiliates
    173,114       95,535       3,683       101,980       (374,312 )      
Investment income
    6,430             7       20,741             27,178  
Intercompany interest income
    1,008       18,587                   (19,595 )      
                                                 
Total revenues and other income
    180,552       114,122       3,690       1,016,066       (393,907 )     920,523  
                                                 
Costs and other deductions:
                                               
Direct costs
                      500,552             500,552  
General and administrative expenses
    1,666       216       3       64,075       (81 )     65,879  
Depreciation and amortization
          150             73,523             73,673  
Depletion
                      11,349             11,349  
Interest expense
          9,470       2,860       (1,135 )           11,195  
Intercompany interest expense
                      19,595       (19,595 )      
Losses (gains) on sales of long-lived assets, impairment charges and other expense (income), net
          (865 )           16,468       81       15,684  
                                                 
Total costs and other deductions
    1,666       8,971       2,863       684,427       (19,595 )     678,332  
                                                 
Income before income taxes
    178,886       105,151       827       331,639       (374,312 )     242,191  
                                                 
Income tax expense
    29       3,558       281       59,466             63,334  
                                                 
Net income
  $ 178,857     $ 101,593     $ 546     $ 272,173     $ (374,312 )   $ 178,857  
                                                 


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Table of Contents

 
NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

                                                 
    Nine Months Ended September 30, 2006  
          Nabors
          Other
             
    Nabors
    Delaware
    Nabors
    Subsidiaries
             
    (Parent/
    (Issuer/
    Holdings
    (Non-
    Consolidating
    Consolidated
 
    Guarantor)     Guarantor)     (Issuer)     Guarantors)     Adjustments     Total  
(In thousands)        
 
Revenues and other income:
                                               
Operating revenues
  $     $     $     $ 3,526,404     $     $ 3,526,404  
Earnings from unconsolidated affiliates
                      19,475             19,475  
Earnings from consolidated affiliates
    793,828       631,400       12,672       659,203       (2,097,103 )      
Investment income
    179       10,343             57,231             67,753  
Intercompany interest income
    3,003       48,669                   (51,672 )      
                                                 
Total revenues and other income
    797,010       690,412       12,672       4,262,313       (2,148,775 )     3,613,632  
                                                 
Costs and other deductions:
                                               
Direct costs
                      1,879,169             1,879,169  
General and administrative expenses
    12,966       146       2       257,625       (343 )     270,396  
Depreciation and amortization
          450             266,441             266,891  
Depletion
                      28,661             28,661  
Interest expense
          27,776       8,580       (2,398 )           33,958  
Intercompany interest expense
    1,097                   50,575       (51,672 )      
Losses (gains) on sales of long-lived assets, impairment charges and other expense (income), net
          (832 )           13,018       343       12,529  
                                                 
Total costs and other deductions
    14,063       27,540       8,582       2,493,091       (51,672 )     2,491,604  
                                                 
Income before income taxes
    782,947       662,872       4,090       1,769,222       (2,097,103 )     1,122,028  
                                                 
Income tax expense
          11,645       1,359       326,077             339,081  
                                                 
Net income
  $ 782,947     $ 651,227     $ 2,731     $ 1,443,145     $ (2,097,103 )   $ 782,947  
                                                 


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

                                                 
    Nine Months Ended September 30, 2005  
          Nabors
          Other
             
    Nabors
    Delaware
    Nabors
    Subsidiaries
             
    (Parent/
    (Issuer/
    Holdings
    (Non-
    Consolidating
    Consolidated
 
    Guarantor)     Guarantor)     (Issuer)     Guarantors)     Adjustments     Total  
(In thousands)        
 
Revenues and other income:
                                               
Operating revenues
  $     $     $     $ 2,442,319     $     $ 2,442,319  
Earnings from unconsolidated affiliates
                      7,298             7,298  
Earnings from consolidated affiliates
    428,864       241,314       11,803       259,366       (941,347 )      
Investment income
    12,013             7       42,524             54,544  
Intercompany interest income
    2,992       55,788                   (58,780 )      
                                                 
Total revenues and other income
    443,869       297,102       11,810       2,751,507       (1,000,127 )     2,504,161  
                                                 
Costs and other deductions:
                                               
Direct costs
                      1,429,762             1,429,762  
General and administrative expenses
    5,385       1,316       6       178,495       (877 )     184,325  
Depreciation and amortization
          450             212,393             212,843  
Depletion
                      35,045             35,045  
Interest expense
          27,498       8,580       (2,813 )           33,265  
Intercompany interest expense
                      58,780       (58,780 )      
Losses (gains) on sales of long-lived assets, impairment charges and other expense (income), net
    344       (708 )           23,265       877       23,778  
                                                 
Total costs and other deductions
    5,729       28,556       8,586       1,934,927       (58,780 )     1,919,018  
                                                 
Income before income taxes
    438,140       268,546       3,224       816,580       (941,347 )     585,143  
                                                 
Income tax expense
    64       10,076       1,096       135,831             147,067  
                                                 
Net income
  $ 438,076     $ 258,470     $ 2,128     $ 680,749     $ (941,347 )   $ 438,076  
                                                 


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Condensed Consolidating Statements of Cash Flows
 
                                                 
    Nine Months Ended September 30, 2006  
          Nabors
          Other
             
    Nabors
    Delaware
    Nabors
    Subsidiaries
             
    (Parent/
    (Issuer/
    Holdings
    (Non-
    Consolidating
    Consolidated
 
    Guarantor)     Guarantor)     (Issuer)     Guarantors)     Adjustments     Total  
(In thousands)        
 
Net cash (used for) provided by operating activities
  $ 1,175,772     $ (155,865 )   $ (10,968 )   $ 2,872,939     $ (2,842,339 )   $ 1,039,539  
                                                 
Cash flows from investing activities:
                                               
Purchases of investments
                      (1,087,987 )           (1,087,987 )
Sales and maturities of investments
                      799,713             799,713  
Cash paid for investments in consolidated affiliates
    (977,927 )     (487,275 )           (1,189,056 )     2,654,258        
Proceeds from sale of affiliate’s stock
                      1,800,000       (1,800,000 )      
Investment in affiliates
                      (2,433 )           (2,433 )
Cash paid for acquisitions of businesses, net
                      (46,510 )           (46,510 )
Capital expenditures
                      (1,344,682 )           (1,344,682 )
Proceeds from sales of assets and insurance claims
                      10,322             10,322  
                                                 
Net cash provided by (used for) investing activities
    (977,927 )     (487,275 )           (1,060,633 )     854,258       (1,671,577 )
                                                 
Cash flows from financing activities:
                                               
(Decrease) increase in cash overdrafts
                      (15,845 )           (15,845 )
Proceeds from sale of warrants
    421,162                               421,162  
Purchase of exchangeable note hedge
          (583,550 )                       (583,550 )
Proceeds from long-term debt
          2,750,000                         2,750,000  
Reduction of long-term debt
          (769,789 )                       (769,789 )
Proceeds from issuance of common shares
    21,925                               21,925  
Debt issuance costs
          (27,972 )                       (27,972 )
Proceeds from parent contributions
          1,178,088       10,968       1,465,202       (2,654,258 )      
Repurchase of common shares
    (627,357 )                 (2,545,977 )     1,800,000       (1,373,334 )
Tax benefit related to the exercise of stock options
          4,315                         4,315  
Cash dividends paid
          (1,870,942 )           (971,397 )     2,842,339        
                                                 
Net cash provided by (used for) financing activities
    (184,270 )     680,150       10,968       (2,068,017 )     1,988,081       426,912  
                                                 
Effect of exchange rate changes on cash and cash equivalents
                      331             331  
                                                 
Net (decrease) increase in cash and cash equivalents
    13,575       37,010             (255,380 )           (204,795 )
Cash and cash equivalents, beginning of period
    527       14       11       564,449             565,001  
                                                 
Cash and cash equivalents, end of period
  $ 14,102     $ 37,024     $ 11     $ 309,069     $     $ 360,206  
                                                 


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NABORS INDUSTRIES LTD. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

                                                 
    Nine Months Ended September 30, 2005  
          Nabors
          Other
             
    Nabors
    Delaware
    Nabors
    Subsidiaries
             
    (Parent/
    (Issuer/
    Holdings
    (Non-
    Consolidating
    Consolidated
 
    Guarantor)     Guarantor)     (Issuer)     Guarantors)     Adjustments     Total  
(In thousands)        
 
Net cash (used for) provided by operating activities
  $ 134,753     $ 61,358     $ (10,975 )   $ 541,456     $ (61,218 )   $ 665,374  
                                                 
Cash flows from investing activities:
                                               
Purchases of investments
    (117,623 )                 (337,002 )           (454,625 )
Sales and maturities of investments
    73,112                   395,159             468,271  
Cash paid for investments in consolidated affiliates
    (85,386 )     (10,968 )           (10,968 )     107,322        
Cash paid for acquisitions of businesses, net
                      (46,201 )           (46,201 )
Capital expenditures
                      (577,844 )           (577,844 )
Proceeds from sales of assets and insurance claims
                      19,989             19,989  
                                                 
Net cash provided by (used for) investing activities
    (129,897 )     (10,968 )           (556,867 )     107,322       (590,410 )
                                                 
Cash flows from financing activities:
                                               
Increase in cash overdrafts
                      3,857             3,857  
Reduction of long-term borrowings
                      (424 )           (424 )
Proceeds from issuance of common shares
    8,374                   178,343             186,717  
Repurchase of common shares
    (80,572 )                             (80,572 )
Proceeds from parent contributions
                10,968       96,354       (107,322 )      
Cash dividends paid
          (50,250 )           (10,968 )     61,218        
                                                 
Net cash provided by (used for) financing activities
    (72,198 )     (50,250 )     10,968       267,162       (46,104 )     109,578  
                                                 
Effect of exchange rate changes on cash and cash equivalents
                      6,317             6,317  
                                                 
Net (decrease) increase in cash and cash equivalents
    (67,342 )     140       (7 )     258,068             190,859  
Cash and cash equivalents, beginning of period
    67,584             18       317,107             384,709  
                                                 
Cash and cash equivalents, end of period
  $ 242     $ 140     $ 11     $ 575,175     $     $ 575,568  
                                                 


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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Shareholders
of Nabors Industries Ltd.:
 
We have reviewed the accompanying consolidated balance sheet of Nabors Industries Ltd. and its subsidiaries as of September 30, 2006, and the related consolidated statements of income for each of the three-month and nine-month periods ended September 30, 2006 and 2005, and the consolidated statements of cash flows and of changes in shareholders’ equity for the nine-month periods ended September 30, 2006 and 2005. This interim financial information is the responsibility of the Company’s management.
 
We conducted our review in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
 
Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated interim financial information for it to be in conformity with accounting principles generally accepted in the United States of America.
 
We previously audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet as of December 31, 2005, and the related consolidated statements of income, of cash flows, and of changes in shareholders’ equity for the year then ended, management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005 and the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005; and in our report dated March 16, 2006, we expressed unqualified opinions thereon. The consolidated financial statements and management’s assessment of the effectiveness of internal control over financial reporting referred to above are not presented herein. In our opinion, the information set forth in the accompanying consolidated balance sheet information as of December 31, 2005, is fairly stated in all material respects in relation to the consolidated balance sheet from which it has been derived.
 
/s/ PRICEWATERHOUSECOOPERS LLP
 
Houston, Texas
November 1, 2006


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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Forward-looking Statements
 
We often discuss expectations regarding our future markets, demand for our products and services, and our performance in our annual and quarterly reports, press releases, and other written and oral statements. Statements that relate to matters that are not historical facts are “forward-looking statements” within the meaning of the safe harbor provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act. These “forward-looking statements” are based on an analysis of currently available competitive, financial and economic data and our operating plans. They are inherently uncertain and investors should recognize that events and actual results could turn out to be significantly different from our expectations. By way of illustration, when used in this document, words such as “anticipate,” “believe,” “expect,” “plan,” “intend,” “estimate,” “project,” “will,” “should,” “could,” “may,” “predict” and similar expressions are intended to identify forward-looking statements.
 
You should consider the following key factors when evaluating these forward-looking statements:
 
  •  fluctuations in worldwide prices of and demand for natural gas and oil;
 
  •  fluctuations in levels of natural gas and oil exploration and development activities;
 
  •  fluctuations in the demand for our services;
 
  •  the existence of competitors, technological changes and developments in the oilfield services industry;
 
  •  the existence of operating risks inherent in the oilfield services industry;
 
  •  the existence of regulatory and legislative uncertainties;
 
  •  the possibility of changes in tax laws;
 
  •  the possibility of political instability, war or acts of terrorism in any of the countries in which we do business; and
 
  •  general economic conditions.
 
The above description of risks and uncertainties is by no means all-inclusive, but is designed to highlight what we believe are important factors to consider. For a more detailed description of risk factors, please refer to our Annual Report on Form 10-K for the year ended December 31, 2005 filed with the Securities and Exchange Commission under Part 1, Item 1A, “Risk Factors.”
 
Unless the context requires otherwise, references in this Quarterly Report on Form 10-Q to the “Company,” “we,” “us,” “our,” or “Nabors” means Nabors Industries Ltd. and, where the context requires, includes our subsidiaries.
 
Management Overview
 
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to help the reader understand the results of our operations and our financial condition. This information is provided as a supplement to, and should be read in conjunction with our consolidated financial statements and the accompanying notes to our consolidated financial statements.
 
Nabors is the largest land drilling contractor in the world. We conduct oil, gas and geothermal land drilling operations in the U.S. Lower 48 states, Alaska, Canada, South and Central America, the Middle East, the Far East and Africa. Nabors also is one of the largest land well-servicing and workover contractors in the United States and Canada and is a leading provider of offshore platform workover and drilling rigs in the United States and multiple international markets. To further supplement and complement our primary business, we offer a wide range of ancillary well-site services, including engineering, transportation, construction, maintenance, well logging, directional drilling, rig instrumentation, data collection and other support services, in selected domestic and international markets. During the first quarter of 2006, we began to offer logistics services for onshore drilling and well-servicing operations in Canada using helicopter and fixed-winged aircraft purchased from Airborne Energy


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Solutions Ltd. on January 3, 2006 (see Note 4 to our accompanying consolidated financial statements). We have also made selective investments in oil and gas exploration, development and production activities.
 
The majority of our business is conducted through our various Contract Drilling operating segments, which include our drilling, workover and well-servicing operations, on land and offshore. Our oil and gas exploration, development and production operations are included in a category labeled Oil and Gas for segment reporting purposes. Our operating segments engaged in marine transportation and supply services, drilling technology and top drive manufacturing, directional drilling, rig instrumentation and software, and construction and logistics operations are aggregated in a category labeled Other Operating Segments for segment reporting purposes.
 
Our businesses depend, to a large degree, on the level of spending by oil and gas companies for exploration, development and production activities. Therefore, a sustained increase or decrease in the price of natural gas or oil, which could have a material impact on exploration, development and production activities, could also materially affect our financial position, results of operations and cash flows.
 
Natural gas prices are the primary driver of our U.S. Lower 48 Land Drilling, Canadian and U.S. Offshore (Gulf of Mexico) operations, while oil prices are the primary driver of our Alaskan, International and U.S. Land Well-servicing operations. The Henry Hub natural gas spot price (per Bloomberg) averaged $8.05 per million cubic feet (mcf) during the period from October 1, 2005 through September 30, 2006, up from $7.41 per mcf average during the period from October 1, 2004 through September 30, 2005. West Texas intermediate spot oil prices (per Bloomberg) averaged $66.11 per barrel during the period from October 1, 2005 through September 30, 2006, up from a $53.69 per barrel average during the period from October 1, 2004 through September 30, 2005.
 
Operating revenues and Earnings from unconsolidated affiliates for the three months ended September 30, 2006 totaled $1.3 billion, representing an increase of $356.8 million, or 40% as compared to the three months ended September 30, 2005 and $3.5 billion for the nine months ended September 30, 2006, representing an increase of $1.1 billion, or 45% as compared to the nine months ended September 30, 2005. Adjusted income derived from operating activities and net income for the three months ended September 30, 2006 totaled $380.8 million and $292.8 million, ($1.02 per diluted share), respectively, representing increases of 57% and 64%, respectively, compared to the three months ended September 30, 2005. Adjusted income derived from operating activities and net income for the nine months ended September 30, 2006 totaled $1.1 billion and $782.9 million ($2.57 per diluted share), respectively, representing increases of 87% and 79% respectively, compared to the nine months ended September 30, 2005.
 
The increase in our operating results during the three and nine months ended September 30, 2006 resulted from higher revenues realized by essentially all of our operating segments. Revenues increased as a result of higher average dayrates and activity levels during the three and nine months ended September 30, 2006 compared to the prior year periods. This increase in average dayrates and activity reflects an increase in demand for our services in these markets during the three and nine months ended September 30, 2006, which resulted from strong capital spending by our customers as supply challenges persist and cash flows remain adequate and confidence in the long-term outlook of higher price levels for natural gas and oil regardless of short-term price volatility. These increases were accomplished in light of delivery slippage on new rigs for both drilling and workover rigs, and a larger than expected impact from our customers’ deferral of work in the Gulf of Mexico during the hurricane season.
 
Our operating results for 2006 are expected to increase from levels realized during 2005 as a result of:
 
  •  Our current expectation of the continuation of historically high commodity prices during 2006 and the related impact on drilling and well-servicing activity, dayrates for drilling services and hourly well-servicing rates, and
 
  •  Our current expectation of the impact on our overall level of drilling and well-servicing activity resulting from new or substantially new rigs to be added as part of our expanded capital program and planned reactivations of and enhancements to existing rigs.
 
The expansion of our rig fleet through our expanded capital program is expected to most significantly impact the results of our U.S. Lower 48 Land Drilling, U.S. Land Well-servicing, Canadian and International operations. For our existing rigs, we expect the largest increase in drilling activity and dayrates to exist in our U.S. Lower


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48 Land Drilling operations as a result of strong demand for drilling services in that market driven by the sustained level of higher natural gas prices. We also expect strong demand for our drilling and well-servicing services across a number of our other markets, resulting from higher commodity prices, to improve our results of operations from existing rigs for our U.S. Land Well-servicing, Canadian, International and U.S. Offshore operations. Canadian drilling activity is subject to substantial levels of seasonality, as activity levels typically peak in the first quarter, decline substantially in the second quarter, and then generally increase over the last half of the year. We expect that the improvement in our International operations will also be driven by multiple rig contract re-pricings, which should begin to impact our results in the second half of 2006. We expect that the improvement in our U.S. Offshore operations will also be driven by a continuing improvement in the utilization of and pricing for our workover jack-up rigs. We expect results from our operations in Alaska to be substantially unchanged during 2006 when compared to 2005, as the improvement in demand for drilling services as a result of increases in commodity prices have just started to be demonstrated in this market during the latter half of 2006.
 
During the second quarter of 2006, our wholly-owned subsidiary, Nabors Delaware, placed $2.75 billion in five-year exchangeable notes with a 0.94% coupon interest rate and an original exchange premium of 30%. In order to offset the potential dilution to our shares, Nabors Delaware entered into a series of hedge transactions which effectively increased the exchange premium to 55%. In the hedge transactions, Nabors Delaware purchased call options which will cover the net shares of our common shares that would be deliverable to the note-holders upon exchange of the notes. In order to partially offset the cost of the purchased call options (but which also limits the anti-dilutive effect of the call options), we sold warrants to acquire approximately 60.0 million of our common shares at a strike price of $54.64. The net cost of these hedge transactions was approximately $162.4 million. These costs were accounted for as a reduction to shareholders’ equity. A portion of the proceeds from the notes were also used to repurchase approximately 28.5 million shares of our common stock for approximately $1.0 billion, which further reduced shareholders’ equity. These decreases to equity as a result of these transactions were partially offset by a $215.9 million increase to equity related to a deferred tax asset representing the tax benefits of the cost of the purchased call option, which was also accounted for through shareholders’ equity. We expect these transactions to be accretive to our results by roughly $.26 per share in 2006 and $.56 per share in 2007. After the consummation of this transaction, we had approximately $2.0 billion in cash and investments, which we believe puts us in an excellent position to capitalize on future opportunities.


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The following table sets forth certain information with respect to our reportable segments and rig activity:
 
                                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
                Increase
                Increase
 
    2006     2005     (Decrease)     2006     2005     (Decrease)  
(In thousands, except percentages and rig activity)                                            
 
Reportable segments:
                                                               
Operating revenues and Earnings from unconsolidated affiliates:
                                                               
Contract Drilling: (1) 
                                                               
U.S. Lower 48 Land Drilling
  $ 498,173     $ 355,172     $ 143,001       40 %   $ 1,393,310     $ 914,862     $ 478,448       52 %
U.S. Land Well-servicing
    188,650       130,265       58,385       45 %     518,224       355,154       163,070       46 %
U.S. Offshore
    56,219       42,115       14,104       33 %     162,299       125,312       36,987       30 %
Alaska
    24,098       18,159       5,939       33 %     75,816       64,882       10,934       17 %
Canada
    167,705       126,643       41,062       32 %     514,849       366,500       148,349       40 %
International
    195,445       143,355       52,090       36 %     511,487       402,553       108,934       27 %
                                                                 
Subtotal Contract Drilling (2)
    1,130,290       815,709       314,581       39 %     3,175,985       2,229,263       946,722       42 %
Oil and Gas (3)
    9,268       16,354       (7,086 )     (43 )%     48,808       46,871       1,937       4 %
Other Operating Segments (4)(5)
    154,463       86,458       68,005       79 %     459,759       244,368       215,391       88 %
Other reconciling items (6)
    (43,837 )     (25,176 )     (18,661 )     (74 )%     (138,673 )     (70,885 )     (67,788 )     (96 )%
                                                                 
Total
  $ 1,250,184     $ 893,345     $ 356,839       40 %   $ 3,545,879     $ 2,449,617     $ 1,096,262       45 %
                                                                 
Adjusted income (loss) derived from operating activities: (7)
                                                               
Contract Drilling:
                                                               
U.S. Lower 48 Land Drilling
  $ 219,485     $ 135,295     $ 84,190       62 %   $ 611,912     $ 310,567     $ 301,345       97 %
U.S. Land Well-servicing
    54,495       29,297       25,198       86 %     148,000       75,126       72,874       97 %
U.S. Offshore
    17,492       12,883       4,609       36 %     51,613       32,392       19,221       59 %
Alaska
    2,123       3,612       (1,489 )     (41 )%     9,749       13,743       (3,994 )     (29 )%
Canada
    42,549       28,709       13,840       48 %     145,524       74,947       70,577       94 %
International
    58,145       38,630       19,515       51 %     146,142       100,955       45,187       45 %
                                                                 
Subtotal Contract Drilling
    394,289       248,426       145,863       59 %     1,112,940       607,730       505,210       83 %
Oil and Gas
    (5,101 )     3,998       (9,099 )     (228 )%     7,751       7,741       10       0 %
Other Operating Segments
    20,882       6,862       14,020       204 %     59,918       19,493       40,425       207 %
Other reconciling items (8)
    (29,268 )     (17,394 )     (11,874 )     (68 )%     (79,847 )     (47,322 )     (32,525 )     (69 )%
                                                                 
Total
    380,802       241,892       138,910       57 %     1,100,762       587,642       513,120       87 %
Interest expense
    (13,735 )     (11,195 )     (2,540 )     (23 )%     (33,958 )     (33,265 )     (693 )     (2 )%
Investment income
    37,155       27,178       9,977       37 %     67,753       54,544       13,209       24 %
Gains (losses) on sales of
                                                               
long-lived assets, impairment charges and other income (expense), net
    (4,284 )     (15,684 )     11,400       73 %     (12,529 )     (23,778 )     11,249       47 %
                                                                 
Income before income taxes
  $ 399,938     $ 242,191     $ 157,747       65 %   $ 1,122,028     $ 585,143     $ 536,885       92 %
                                                                 
 


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    Three Months Ended September 30,     Nine Months Ended September 30,  
    2006     2005     Increase     2006     2005     Increase  
 
Rig activity:
                                                               
Rig years: (9) 
                                                               
U.S. Lower 48 Land Drilling
    257.3       244.2       13.1       5 %     255.3       232.0       23.3       10 %
U.S. Offshore
    16.0       15.7       0.3       2 %     16.3       16.2       0.1       1 %
Alaska
    9.3       6.5       2.8       43 %     8.1       6.7       1.4       21 %
Canada
    52.9       54.7       (1.8 )     (3 )%     54.6       49.0       5.6       11 %
International (10)
    100.8       84.8       16.0       19 %     93.5       81.1       12.4       15 %
                                                                 
Total rig years
    436.3       405.9       30.4       7 %     427.8       385.0       42.8       11 %
                                                                 
Rig hours: (11)
                                                               
U.S. Land Well-servicing
    322,445       313,677       8,768       3 %     953,174       919,006       34,168       4 %
Canada Well-servicing
    91,047       89,329       1,718       2 %     273,919       263,962       9,957       4 %
                                                                 
Total rig hours
    413,492       403,006       10,486       3 %     1,227,093       1,182,968       44,125       4 %
                                                                 
 
 
(1) These segments include our drilling, workover and well-servicing operations, on land and offshore.
 
(2) Includes Earnings (losses), net from unconsolidated affiliates, accounted for by the equity method, of $1.1 million and $(1.1) million for the three months ended September 30, 2006 and 2005, respectively, and $5.9 million and $.7 million for the nine months ended September 30, 2006 and 2005, respectively.
 
(3) Represents our oil and gas exploration, development and production operations.
 
(4) Includes our marine transportation and supply services, drilling technology and top drive manufacturing, directional drilling, rig instrumentation and software, and construction and logistics operations.
 
(5) Includes Earnings (losses), net from unconsolidated affiliates, accounted for by the equity method, of $4.6 million and $1.2 million for the three months ended September 30, 2006 and 2005, respectively, and $13.6 million and $6.6 million for the nine months ended September 30, 2006 and 2005, respectively.
 
(6) Represents the elimination of inter-segment transactions.
 
(7) Adjusted income (loss) derived from operating activities is computed by: subtracting direct costs, general and administrative expenses, and depreciation and amortization, and depletion expense from Operating revenues and then adding Earnings from unconsolidated affiliates. Such amounts should not be used as a substitute to those amounts reported under accounting principles generally accepted in the United States of America (GAAP). However, management evaluates the performance of our business units and the consolidated company based on several criteria, including adjusted income (loss) derived from operating activities, because it believes that this financial measure is an accurate reflection of the ongoing profitability of our company. A reconciliation of this non-GAAP measure to income before income taxes, which is a GAAP measure, is provided within the table above.
 
(8) Represents the elimination of inter-segment transactions and unallocated corporate expenses.
 
(9) Excludes well-servicing rigs, which are measured in rig hours. Includes our equivalent percentage ownership of rigs owned by unconsolidated affiliates. Rig years represent a measure of the number of equivalent rigs operating during a given period. For example, one rig operating 182.5 days during a 365-day period represents 0.5 rig years.
 
(10) International rig years include our equivalent percentage ownership of rigs owned by unconsolidated affiliates which totaled 4.0 years during the three months ended September 30, 2006 and 2005, respectively, and 4.0 years and 3.9 years during the nine months ended September 30, 2006 and 2005, respectively.
 
(11) Rig hours represents the number of hours that our well-servicing rig fleet operated during the period.

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Segment Results of Operations
 
Contract Drilling
 
Our Contract Drilling operating segments contain one or more of the following operations: drilling, workover and well-servicing, on land and offshore.
 
U.S. Lower 48 Land Drilling.  The results of operations for this reportable segment are as follows:
 
                                                                 
                      Nine Months Ended
             
    Three Months Ended September 30,                 September 30,              
    2006     2005     Increase     2006     2005     Increase  
(Dollars in thousands)        
 
Operating revenues and Earnings from unconsolidated affiliates
  $ 498,173     $ 355,172     $ 143,001       40 %   $ 1,393,310     $ 914,862     $ 478,448       52 %
Adjusted income derived from operating activities
  $ 219,485     $ 135,295     $ 84,190       62 %   $ 611,912     $ 310,567     $ 301,345       97 %
Rig years
    257.3       244.2       13.1       5 %     255.3       232.0       23.3       10 %
 
The increase in operating results during the three and nine months ended September 30, 2006 primarily resulted from an increase in average dayrates and in drilling activity, which were driven by higher natural gas prices. The increase in drilling activity is reflected in the increase in rig years during the three and nine months ended September 30, 2006 compared to the prior year periods.
 
U.S. Land Well-servicing.  The results of operations for this reportable segment are as follows:
 
                                                                 
    Three Months Ended September 30,                 Nine Months Ended September 30,              
    2006     2005     Increase     2006     2005     Increase  
(Dollars in thousands)        
 
Operating revenues and Earnings from unconsolidated affiliates
  $ 188,650     $ 130,265     $ 58,385       45 %   $ 518,224     $ 355,154     $ 163,070       46 %
Adjusted income derived from operating activities
  $ 54,495     $ 29,297     $ 25,198       86 %   $ 148,000     $ 75,126     $ 72,874       97 %
Rig hours
    322,445       313,677       8,768       3 %     953,174       919,006       34,168       4 %
 
The increase in operating results during the three and nine months ended September 30, 2006 primarily resulted from an increase in average dayrates and from higher well-servicing hours compared to the prior year periods. This increase in dayrates and well servicing activity resulted from higher customer demand for our services in a number of markets in which we operate, which was driven by a sustained level of higher oil prices.
 
U.S. Offshore.  The results of operations for this reportable segment are as follows:
 
                                                                 
    Three Months Ended September 30,                 Nine Months Ended September 30,              
    2006     2005     Increase     2006     2005     Increase  
(Dollars in thousands)        
 
Operating revenues and Earnings from unconsolidated affiliates
  $ 56,219     $ 42,115     $ 14,104       33 %   $ 162,299     $ 125,312     $ 36,987       30 %
Adjusted income derived from operating activities
  $ 17,492     $ 12,883     $ 4,609       36 %   $ 51,613     $ 32,392     $ 19,221       59 %
Rig years
    16.0       15.7       0.3       2 %     16.3       16.2       0.1       1 %
 
The increase in operating results during the three and nine months ended September 30, 2006 primarily resulted from an increase in dayrates for our entire rig fleet as compared to the prior year periods, due to higher customer demand for our services stemming from higher natural gas prices.


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Alaska.  The results of operations for this reportable segment are as follows:
 
                                                                 
    Three Months Ended September 30,                 Nine Months Ended September 30,              
    2006     2005     Increase/(Decrease)     2006     2005     Increase/(Decrease)  
(Dollars in thousands)        
 
Operating revenues and Earnings from unconsolidated affiliates
  $ 24,098     $ 18,159     $ 5,939       33 %   $ 75,816     $ 64,882     $ 10,934       17 %
Adjusted income derived from operating activities
  $ 2,123     $ 3,612     $ (1,489 )     (41 )%   $ 9,749     $ 13,743     $ (3,994 )     (29 )%
Rig years
    9.3       6.5       2.8       43 %     8.1       6.7       1.4       21 %
 
The increase in operating revenues and earnings from unconsolidated affiliates during the three and nine months ended September 30, 2006 is primarily due to increases in average dayrates and drilling activity levels as compared to prior year periods. The decrease in overall operating results during the three and nine months ended September 30, 2006 as compared to prior year periods relate to increased labor and repairs and maintenance costs.
 
Canada.  The results of operations for this reportable segment are as follows:
 
                                                                 
    Three Months Ended September 30,                 Nine Months Ended September 30,              
    2006     2005     Increase/(Decrease)     2006     2005     Increase  
(Dollars in thousands)        
 
Operating revenues and Earnings from unconsolidated affiliates
  $ 167,705     $ 126,643     $ 41,062       32 %   $ 514,849     $ 366,500     $ 148,349       40 %
Adjusted income derived from operating activities
  $ 42,549     $ 28,709     $ 13,840       48 %   $ 145,524     $ 74,947     $ 70,577       94 %
Rig years
    52.9       54.7       (1.8 )     (3 )%     54.6       49.0       5.6       11 %
Rig hours
    91,047       89,329       1,718       2 %     273,919       263,962       9,957       4 %
 
The increase in operating results during the three months ended September 30, 2006 over the prior year period primarily resulted from increases in average dayrates and hourly rates, as well as foreign exchange increases due to the strengthening of the Canadian dollar against the U.S. dollar. These increases were partially offset by a decline in drilling activity due to lower demand stemming from lower natural gas prices during the three months ended September 30, 2006. The increase in operating results during the nine months ended September 30, 2006 primarily resulted from an overall increase in drilling and well-servicing activity and an increase in average dayrates and hourly rates for drilling and well-servicing operations compared to the prior year periods. These increases were driven by increased natural gas prices, which resulted in improved demand for our services in this market. Further increases in operating results in the nine month period were due to foreign exchange increases as a result of the Canadian dollar strengthening against the U.S. dollar during these periods.
 
International.  The results of operations for this reportable segment are as follows: