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Weatherford International Ltd. (NYSE:WFT)

Q1 2009 Earnings Call

April 20, 2009 10:30 am ET

Executives

Bernard Duroc-Danner – Chairman, President, Chief Executive Officer

Andrew Becnel – Chief Financial Officer

Analysts

Michael LaMotte – J.P. Morgan

James Crandell – Barclays Capital

Ole Slorer – Morgan Stanley

William Herbert – Simmons & Company

Robert Mackenzie – Fbr Capital Markets

Michael Urban – Deutsche Bank

Mark Brown – Pritchard Capital

Dan Pickering – Tudor Pickering

Operator

Welcome to the first quarter 2009 Weatherford International earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today's call, Mr. Bernard Duroc-Danner, Chairman, President and Chief Executive Officer.

Bernard Duroc-Danner

Good morning. We'll do as we normally do. Andy and I will read prepared comments and then we'll take Q&A. Andy, why don't you get started.

Andrew Becnel

Good morning. For our first quarter of 2009, we report fully diluted earnings of $0.27 per share. This performance excludes $13 million of cost incurred in connection with our ongoing government investigations and $12 million for severance charges incurred mainly due to North American head count productions.

Compared to our record Q4 performance, earnings per share declined $0.26 with a $0.21 decline in North American and a $0.05 internationally. Below the line items were flat in the aggregate as our interest expense was offset by a sequentially lower tax rate, 15.5% and lower FX losses. We still incurred $10 million of FX losses in the quarter.

Operating performance; company wide revenue declined $378 million sequentially or 14% with North America retreating $340 million and international operations down $38 million or 3%. This matches the sequential international decline experienced last year.

Seasonal declines and product sales reduced international revenue by $26 million while the continued strengthening of the U.S. dollar handicapped growth by another $26 million. Absent these factors, international revenue was up $14 million or 1% on a 6% decline in rig count ex Russia and China.

Consolidated EBIT before corporate R&D was $424 million, down $212 million sequentially with operating margins at 18.8%. North America was responsible for the brunt of the decline as expected, with a margin deterioration slightly over 1,000 basis points. International margins proved far more resilient to pricing and volume pressures, giving way to Q4 levels by 210 basis points.

Compared to Q1 '08, company wide revenue increased $60 million or 3% despite a 19% decline in global rig count. International growth of $313 million or 28% was largely offset by a $253 million pull back in North America. This international growth was against a 2% decline in rig count.

On a constant currency basis, international revenue was up 38% as exchange rate deltas reduced the top line by$110 million. Over the same period, global EBIT before corporate R&D declined 25% with deterioration in North America more than offsetting a 10% improvement internationally.

I'll now go through the international performance by region. North America, 37% of total revenue. Revenue was down $340 million or 29% sequentially on a 28% decline in rig count. Pricing and volume impacts were severe with pricing concessions estimated at an average of 20% across all product lines. None escaped the bludgeoning.

Canadian activity hit a 17 year low in March with 432 wells drilled, a level not seen since 1992. At the same time, well completions were down 6% compared to Q1 '08. EBIT was $123 million, down $173 million sequentially with margins at 14.7%. Detrimentals were 51%.

We have aggressively reduced our cost structure in North America with annualized savings of $250 million completed and another $90 million being implemented in Q2. Of the $340 million in total, $110 relates to fixed costs and represents a 10% improvement in our fixed cost structure in North America.

These improvements entailed the closure of eight facilities to date with nine additional facilities planned in the next 90 days, redundancy of 225 overhead employees as well as a $35 million reduction in costs outside of wages. We view these fixed cost reductions as permanent and necessary, a reflection of the reality of the reservoirs our customers will pursue in North America for the foreseeable future.

Middle East, North Africa and Asia packed 26% of total revenue. Revenue declined $94 million or 14% sequentially against a 4% decrease in rig count. One third of this decrease reflects the seasonal rhythm of customer's product based spending patterns. Reduced rig counts in Saudi Arabia, Egypt, India and Australia as well as project delays and ramp ups depressed volumes.

EBIT was $134 down $29 million on detrimentals of 31%. Margins were 23%, down 120 basis points sequentially.

Year on year, revenues increased $60 million or 12%. On a constant currency basis, revenue would have been up 16%. EBIT was up $13 million with incrementals of 22%.

Latin America, 21% of total revenue. Revenue increased $80 million or 21% sequentially against a 6% decrease in rig count. Strong performances in Mexico and Brazil were partially offset by macro driven weakness in Venezuela, Argentina and Columbia.

EBIT was $92 million, up $3 million sequentially. Strong incremental performances in Mexico and Brazil were weighted down by hefty detrimentals outside these countries. As a result, margins were 19.7%, down 320 basis points sequentially.

Year on year revenue increased $232 million or 98%. EBIT was up $32 million or 53% with incrementals of 14%.

Europe, CIS, West Africa, 16% of total revenue. Revenue declined $24 million or 6% sequentially against a 12% decrease in rig count. Excluding the impact of foreign currency, revenue would have been nearly flat.

The United Kingdom, Romania and Russia showed activity reductions as expected. EBIT was $75 million, down $13 million. Margins were 20.3%, down 210 basis points. Detrimentals were 55%. Year on year revenue increased $21 million or 6% and $87 million or 25% excluding FX impacts. EBIT was down $18 million on pricing declines and lower absorption.

Cash and capital; cash flow, during Q1 we generated EBITDA of $537 million with G&A running at $201 million. Operating working capital, A/R plus inventory, less A/P provided $44 million of cash. After taking into account changes in operating working capital and deducting for interest and tax expense, operating cash flow was $454 million for the quarter.

Capital expenditures were $558 million for the quarter net of lost in whole revenue. For the full year of '09, we anticipate capital expenditures of approximately $1.4 billion. This level reflects our prognosis for H209 and full year 2010 as well as our aggressive build out of tools incorporation recently commercialized technologies.

As of March 31, our ratio of net debt to net capitalization stood at 41.8% with total net debt at $6 billion. Cash balances totaled $162 million at quarter end. As of March 31, we have more than $2 billion of liquidity in the form of cash on hand plus untapped borrowing capacity under our committed lending facilities.

I have the following updates for you on 2009 non operational items and housekeeping. Corporate expense is $140 million, R&D expense $210 million, net interest expense remains at $400 million, capital expenditures $1.4 billion, G&A $900 million and tax rate, 15.5% for the year. This is reduced from our prior guidance as a result of adjustments to regional forecasts and incremental tax planning.

I'll now hand the call over the Bernard who will cover operational outlook.

Bernard Duroc-Danner

Q1 was a difficult quarter. It is more constructive on each two '09 and 2010. The outlook includes magnitude and speed of market declines to date to what we perceive as early crafting in a number of important markets, three, planned indications in other markets, and four early evidence of accelerating reservoir decline rates.

We'll address Q1 and then move on to our outlook. With respect to Q1, we saw seven moving parts; collapse in North American activity, volume and price, collapse of Russia and Continental European activity, volume and price. In both cases the word collapse is correctly calibrated.

Three very weak U.K. and North Sea, Caspian, Saudi Arabia, Australia and Latin America ex Brazil and Mexico included pull backs for somewhere between 10% and 20%. Weak pockets in the Middle East, North Africa, Egypt, Oman, Indian and Asia Pacific adding up to pull backs of 10%. A few markets were mercifully flat; Norway, part of Persian Gulf, West Africa and Brazil.

Across the board integrative project mobilization was slowed down or altogether delayed until second half of '09 or first half of 2010. Finally, Mexico bucked the trend for idiosyncratic reasons.

Markets moved at different rates of decline, but they shared varying degrees of the same factors; one, seasonality. Traditionally Q1 sees a drop in international business driven by weather and customer buying patterns through product sales. There's a powerful factor in the Eastern Hemisphere and this Q1 was no exception.

Two, aggressive action. IOC has inflected NOE's hammered volume and price and they did so early and hard. A large number of industry projects onshore and offshore are cancelled, cut back in size or forestalled.

Thirdly, and different from aggressive action, plan paralysis. On the back of the October/December events of the financial markets and other subsets of our client base was unusually hesitant of setting a definite course of action for '09. This [inaudible] into voluntary decisions being returned to March of Q1.

Activity was suspended which is another way of saying suppressed and new markets were not expected to show significant weakness, China, Malaysia are good examples.

Although volume declines were wide spread throughout the international markets above and beyond what recounts show, pricing movements were less homogeneous. In the course of the quarter we renegotiated pricing with our largest IOC clients and a few NOC's. The balance in the quarter, the Eastern Hemisphere realized pricing declines of low single digits and Latin American expected of mid single digits.

Taking stock of how we fared in this environment, international revenues were down 3%, margins down 210 basis points, although I would only focus on a sequential comments, note year on year international revenues were up 28%, Eastern Hemisphere was up 9% and Latin America was up 98%. Adjusting for foreign exchange movement, our year on year international growth rate would have been up 38% with EH up 19% and Latin America up 108%.

Sequentially, EH top line is down 11% and margins were down 150 basis points. While 3% of the 11% top line decline was traditional product sales decrease, the balance or 8% was a result of a combination of declines in pricing and volume. Volume losses were held back vis a vis the market by apparent share gains in a few erratic markets.

Most of the margin erosion was the effect of price and cost. Cost structure almost matched declines one for one on a percentage basis yielding the quarter's 150 basis point lower margin. Integrative projects didn't help in the quarter. They incrementally impacted both revenues and margins as clients imposed delays, and in one case scale backs, pushing the projects into H2 '09 and H1 '10.

Latin America's top line was up 21% and margins were down 320 basis points. We had severe detrimentals in Argentina, Venezuela and a few other smaller markets due to a combination of sharply lower price and volume. Mexico and Brazil by contrast had healthy volume increases and solid incrementals.

North America was a fast moving target. Top line was down 29% and margins eroded by over 1,000 basis points. The volume and price erosion was brutal. Variable and fixed costs have been driven down as fast as we can make it happen.

After this review of Q1, why is it we feel more construction on H2 '09 and for 2010? For one, we feel the fast and hard pull back in the international markets is healthy. We feel it will be behind us quickly. There's no doubt that Q2 and Q3 will see continued volume and pricing erosion, but we believe on average, international market volume, pricing and margins will trough soon. Our best guess will be in Q3 at latest.

Some of the worst hit international markets have already troughed; Russia, North Sea, Central Europe, Latin America ex Mexico, in our judgment have troughed. The other international markets should be reasonably well behaved. The Middle East and South Africa will show strength in North Africa, particularly Algeria and a few select Persian Gulf markets.

Asia will experience further volume and pricing declines in secondary markets but not much and not long. India and China will be constructive for the balance of the year. In Latin America, Brazil will be steady to strong for the balance of the year while Mexico will gradually grow as we ramp up new contracts throughout the year both onshore and offshore.

Summarizing the points above, Eastern Hemisphere will become gradually more constructive between now and year end. When the full year '09 is counted, we expect Weatherford's Eastern Hemisphere top line to achieve double digit growth year on year. We expect Weatherford top line in Latin America to show quantum growth year on year.

Finally, in North America NAM will be manageable but we anticipate a NAM trough of around 800 rigs in the U.S. and 75 rigs in Canada, give and take. You should also expect EBIT margins to bottom out during Q2 and to recovery gradually from there.

Product lines; I'll take you through the quality performance of our ten service product lines. Our product lines are ranked in size from largest to smallest. Drilling services, just under $318 million, artificial lifts, $353 million while construction $246 million, completion systems $241 million, integrated drilling $235 million, drilling tools $210 million, re-entry fishing $151 million, chemicals and stimulation, $145 million, wire line $143 million and pipeline $53 million.

After nine negative score cards, completion was the least bad product line with a near flat performance. Only one product line made a positive score card, that's integrated drilling. Integrated drilling represents about 10% of the company's revenues at this time.

As of right now we hold 12 confirmed integrated project contracts in eight countries. We are operating seven but not at full throttle yet on the seven. The other five are delayed until the second half of '09 and the first half of 2010. When all 12 projects are operating, we'll be running on integrated assignments of approximately 40 strings in Eastern Hemisphere and 40 strings in Latin America. These numbers will change though as the year progresses.

Acquisitions, we spent $31 million in cash primarily on two acquisitions. The most important was the Work Control Pressure Drilling Software Technology we view as strategic to both that product line and Weatherford as a whole. Control pressure drilling is another way of controlling underbalance.

Forward views, as mentioned above we expect NAM to reach its nadir by mid year. We do not know when NAM will recover from its volume trough. We believe though that even with our volume recovery, margins in NAM will be improving in Q3, even more so in Q4.

Credit, lower variables and fixed costs; reductions in fixed costs are particularly important as they are designed to be structural and permanent.

On the international side, in last quarter's conference call our comments were, and I'm quoting, "We expect double digit growth in our international business." We can confirm this with a higher degree of certainty. It strikes us also that H2 '09 will set the stage of 2010 as a year of healthy double digit growth in out international segments both in Eastern Hemisphere and Latin America.

Direction, no real change from three months ago except for some tweaking of the numbers and we're planning on an '09 CapEx or $1.4 billion or $200 million higher, predominantly on infrastructure and equipment that will benefit 2010 and 2011. Over 85% of the CapEx is for the international regions.

We're monitoring CapEx commitments carefully. We can adjust expenditures down or up with 120 day response time as required by the economic environment.

In closing, three thoughts to summarize our operating focus. We see more opportunities to permanently reduce our cost structure in NAM. This is a good time to improve operational processes and services in the international market and notwithstanding the upward revision to CapEx, we think cash flow from operations will be $500 million or higher.

With that, I will turn the call back to the operator for the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael LaMotte – J.P. Morgan.

Michael LaMotte – J.P. Morgan

Quick question on Latin America. Revenue looked a little light to me relative to the degree of activity. Is that just offsets from Argentina and Venezuela?

Andrew Becnel

Yes.

Michael LaMotte – J.P. Morgan

And $200 million in incremental CapEx Bernard, can you comment more specifically on where that's going either by parts and services or geography?

Bernard Duroc-Danner

It's going to North Africa and Asia Pac so I would say about 75% of the $200 million is going there. The balance is other areas of the Eastern Hemisphere.

Michael LaMotte – J.P. Morgan

And the catalyst being Q1 contract wins?

Bernard Duroc-Danner

Yes.

Michael LaMotte – J.P. Morgan

Can you comment on the status of the rotary steerable tool and the introduction for this year?

Bernard Duroc-Danner

Actually following the original CapEx we had had a large allocation for the RSS and some of the other directional tools and will allow us to introduce it. That's proceeding as scheduled. I think most of the early market penetration will be in Q3.

Operator

Your next question comes from James Crandell – Barclays Capital.

James Crandell – Barclays Capital

Andy can you comment on the, give more detail on the fixed costs rate down in North America, to what extent is it service locations, manufacturing facilities and then also how much further you see margins going down in North America in the second quarter.

Andrew Becnel

On the fixed cost side it's not just really mainly service facilities, not so much, it's very light on the manufacturing side where we've been able to load shift if you will across various plants just based on total delivery cost that we can get out of each facility and obviously we have a global footprint on the manufacturing side.

In terms of margins, I would expect at this point, don't know, but given the impact of a decline in Canada which is more of a very seasonal thing as opposed to continued activity declines, exacerbating it a bit this quarter will be additional pull back that we see probably in the U.S.

I would expect something on the order of 500 basis points of additional decline from Q1 to Q2 and from there I see us building back up on the margin side with 200 to 300 basis points each quarter and subsequently margin expansion in each of Q3 and Q4.

James Crandell – Barclays Capital

Bernard, certainly Russia has dropped precipitously here in the last six months. What makes you confident that Russian activity has bottomed and will turn up over the rest of the year?

Bernard Duroc-Danner

I think first, it's what we hear from our clients. Our clients are saying that the level of pull back went too far and there will be a correction going the other way through the balance of the year. Second, an observation which is indeed the decisions that were made by much of our client base in the USSR was to the extreme.

In a way, the decline in activity and the pull back on budgetary operations was more sudden, more vertical and more extreme than what you see in North America and partly I think it really has to do with a real fear in October, November, December in that particular market of no liquidity at all. And so in essence, no liquidity, I think one tends to go to extreme decisions.

But at this point there's a realization that the extreme decisions may not be necessary so you're coming to more of a mid point that's more reasonable. Still down a lot, especially to where we were in '08, but not as quite as dramatically as we were in late Q4 and Q1.

Then the last aspect of the equation as best I can tell and this is just anecdotes. Anecdotes should be viewed as such and you can't generalize from it, but they are what they are. There's enough anecdotes of significant volume declines in oil reservoirs that also from a current perspective is something that one wants to rest by whatever means one can use.

And one of the means is obviously a greater number of work orders, greater expenditures on production and greater expenditures on drilling, not exploration and development, but on drilling. So some of all three which as of about a month ago made us believe that the European market, the Central European markets have been as bad as the FSU market, and also I think this is what I would describe as surprised at some of the markets in Latin America.

Obviously not Mexico and Brazil, they fall into a different category, but the other markets in Latin America also are not quite as perfectly but they fall into the same category as markets perhaps reacted too sharply, too fast and we may be experiencing now a bottoming out and if not a bit of a recovery, at least no deterioration.

James Crandell – Barclays Capital

Do you think that given the sharper flow here in the first quarter in some of those markets that Eastern Hemisphere revenues as a whole would increase in Q2 over Q1?

Andrew Becnel

It's always hard to tell from one quarter to the other. The answer is yes.

Bernard Duroc-Danner

Certainly Q3 and Q4 but then also in Q2, the answer is most likely yes.

James Crandell – Barclays Capital

Can you comment on the operational and financial performance of Chicontepec to date versus what you expected going in?

Bernard Duroc-Danner

I'll just say I think it's good or better than we expected when we went into it, and of course we had some exogenous help in so far as the number of input costs were lower than when we got into it, and also with time operational efficiencies come to bear simply because we've been running a large operation, running it successfully.

We've learned a lot along the way, and as the operation grows, we'll see better economies of scale. All of that comes to bear.

Andrew Becnel

The drilling results for March were fantastic and it's clear that we've continued to progress along the learning curve and we're not giving up. We think that there's still more efficiency to be squeezed out of it. The increase in scale due to the addition of the new contract and some expansion of the scope of what we're currently working on also helps on the financial side.

So we're very pleased net net.

Bernard Duroc-Danner

And a closing comment, every well is different. Not all wells call for the same number of days to drill the well. But if you look at the performance on a per well basis, the number of days drilled, you find that for similar shaped wells, we've done increasingly well month on month on month, and in the end, the only thing that matters is how fast you can drill those wells and we seem to be doing very well on that score card.

Operator

Your next question comes from Ole Slorer – Morgan Stanley.

Ole Slorer – Morgan Stanley

Just following up on the international side again you mentioned revenues may be up sequentially. Can you talk a little bit also about margins and the key drivers of margin. The scale is your own cost structure, pricing on contracts whether its been renegotiated pricing or whether it is pricing that you might benefit from this year that might roll over to another price level for next year relative to what you mentioned on the paralysis and to what extent you might have had contracts but rig activity work over, things grind to a halt and you get sort of killed both ways and helped the other way on the process relative to the cost structure.

Bernard Duroc-Danner

It's a complicated question. I have so many different variables. Of course, the ones that are most advertised is the fact that there has been, this is not new, a push led by IOC, very local about it and also by some IOC, pushing down pricing and some of the percentages one reads are ones that make the headlines but our impression is they are mostly applied to different classes of services on the off shore rigs.

But nonetheless it's been a major push by IOC's and a lot of that has been negotiated already. But there's the perception that it only applies to new contracts. Well traditionally that's correct. In an environment where there is extreme economic stress and we are in an environment of extreme economic stress, about as extreme that anybody on this call has probably ever seen, the negotiations tend to apply to everything, and of course there's some give and take.

In other words, if you have a contract which is good for another year or two years and you're asked to give a concession, which contractually you don't have to, you're in a different position than if you just want some more business volume and you're expected to take it at a lower price.

So negotiations have been held pretty much on the entire book of business. Much of it was done in December, January, February and March. There's still some more going on now, but our perception is that much of the price negotiation, much, not all, but much of the price negotiation will be finished, completed by the end of the second quarter in the international markets.

There are always exceptions. Remember all of you listening on this call, there's how many countries are we operating in? How many countries do we call our market? About 100. So obviously there's always exceptions. But by and large, by the end of the second quarter much of what is being renegotiated will be completed.

Already a lot has been done. We've a very good idea of where it needs, so that is a factor. The other factor of course is the cost side. The input prices, I've alluded to it in the case of Chicontepec, the prices are down. You know what the input prices are; it's steel, its oil, its people.

The variable costs, we have found are, we found in Q1, it was a very distressed quarter for us. We have found that its feasible to bring variable costs down in very short order almost by the exact same amount as expenses decline, pricing. That's pretty good before you even take a hit on fixed costs that allows you to minimize the price effect on margins. Certainly you see it in the Eastern Hemisphere.

But second factor is cost. I think I'm quite red blooded about what we can do in terms of speed of variable cost reduction and some fixed cost reduction. There's a third aspect, which is we have quite a bit of equipment which is sort of somewhere between coming out of the yard and being on location. We've had some delays in mobilization.

Some of it is our fault, but for the most part it is simply clients of our putting the brakes on when they want the project started. As you can appreciate, that doesn't help margins. That also is something is something which is a moving target. I suspect that much of that goes away in Q3 and Q4 and Q1 and Q2 of next year. In fact, all of it goes away. So you have the reverse effect which is positive because it brings quite a bit of volume. That is the third effect.

And then of course there is the other effect that you are alluding to which is that while you can't measure it by rig counts. Rig counts don't measure activity very well because many of the countries are not being measured properly. Example, FSU and China. But another segment to the business is not measured by rig counts properly, is work over's and production.

Those were unusually depressed in Q1, no doubt. You can take a look at other people who are in the same realm we're in, meaning artificial lifts; many you'll find the results are not very good in Q1. This has everything to do with budgetary authority being withheld. Well, that I think all things being equal is likely to catch up in the balance of the year and that carries normally very good margins.

So you put all that in one bag, I think it is what's going to happen to margins? In the EH we really don't know is the answer except the movement is not going to be a big number. We may very well have margins about around where we are right now, up or down a few basis points between this quarter and the balance of the year and not move very much.

If you take a very pessimistic view and think that some of the mitigating factors I've described are not as potent as we think they might be, I think the most you'll see in the EH in terms of margin erosion between now and the end of the year is something on the order of 200 basis points tops. So I really in view of the 200, I can't give you any more precision than that because I don't know.

In Latin America, you have the build up of Chicontepec, etc. in Mexico which is one factor, and then the fact that I think the rest of Latin America does in our judgment enough off from its trough. So that one again you can draw your own conclusions as to what's going to happen to margins there, but then again, I think that you should not expect anything bad at all. Quite the contrary.

When you add the two pieces, the whole environment on the margin side, we're not over optimistic at all. That's very realistic. It's easy to be negative. It's be a bit harder to be positive, so we're not doing this simply to buck the trend. It simply strikes us that volume and margin will rise. There is no apparent reason why we would expect a situation to be worse. Quite the contrary, we expect the situation in the second half of the year to be gradually get more constructive.

Ole Slorer – Morgan Stanley

If I had to take everything you've said, and I tried do so some on the back of an envelope, it strikes me that we could actually see margins both in North America and International troughing in the second quarter and that the quarter might be a little weak than expected but that the full year number must be something that at this point you feel very confident about.

Bernard Duroc-Danner

For all we know, and we're just telling you what we know without holding anything back or moving it up or down, that's pretty much how we feel.

Ole Slorer – Morgan Stanley

It's steeper in the second quarter and then a rebound.

Bernard Duroc-Danner

The second quarter we'll see. I do think that NAM will trough in third quarter. I think that's not a controversial statement. I don't see how margins do any worse than actually detract from taking half the year off, with the cost catching up with the price curve. The international margins will be up in Q2, make no bones about it, but they will be much stronger in Q3, Q4.

But international margins will either, if they decline they'll either decline in Q2 or Q3, but that's it. I'm not even sure that they will. It's too many factors. Any kind of sort of simplistic, ah well, the IOC will reduce price, that's why margins go down. It's true, but it's not enough. You can't draw that conclusion. It is not enough of an analysis.

I think that in terms of volume up international markets at least for us, two, three, four. The margins may very well be flat; if they are down I would suspect they would trough in two or three. That's my best guess.

Ole Slorer – Morgan Stanley

So in other words, volumes coming back.

Bernard Duroc-Danner

That's an elegant way to put it, yes.

Operator

Your next question comes from William Herbert – Simmons & Company.

William Herbert – Simmons & Company

I think it's pretty straightforward how you get the double digit growth in Latin America in 2010. Walk us through the bridge for the double digit growth in Eastern Hemisphere for next year.

Bernard Duroc-Danner

It is easy in Latin America isn't it? Eastern Hemisphere is harder. It comes essentially from Middle East and North Africa. The premise is predominantly that FSU and European Markets and West African markets don't deteriorate any further, I think is correct.

I think if anything, they do a little bit better and then I think there is on the horizon for us volume that we expect to get through Middle East, South Africa and also Asia, which let me pause here for a second. Much of the delta comes from essentially four countries and often smaller places of course, up and down, four countries.

I'd rather not tell you the countries for competitive reasons, but the two countries that are in the Middle East and North Africa and one in Asia and one in the other parts of the Eastern Hemisphere. Of those four and we shall see because there are many, many things that ought to be concluded in terms of studying or in terms of mobilizing by the end of the second quarter.

The four secure enough volume and even being reasonably conservative with assumptions and everything else that I think it would make our assessments come true.

William Herbert – Simmons & Company

I would presume, it's not exactly at state secret that one of those would be Algeria given the huge ramp in the budget?

Bernard Duroc-Danner

Yes.

William Herbert – Simmons & Company

And with regard to Russia, can you bring up us to date with regard to the project?

Bernard Duroc-Danner

Now you've two out of four. You've got the first rig spouting as we speak. The second rig is on location and is being prepared. When I say rig, I'm talking about strings now, but the second rig is on location, different location I might add, and is being readied to spout. One would presume that it would spout before the end of the second quarter.

And you've got two others that are being mobilized, meaning they are in transportation to Orenburg as we speak and presumably they will arrive on location before the end of the second quarter, meaning they should be spouting in the second quarter, in Q2 and Q3. There's another four behind which have to be, you get into delays there.

You have to be authorized to mobilize and hopefully for those four, the other four will be authorized to be mobilized sometime soon and then that progresses.

William Herbert – Simmons & Company

And we're still envisioning $600 million over five years.

Bernard Duroc-Danner

That's correct. It runs about $120 million or so per annum.

William Herbert – Simmons & Company

Latin America revenue in the quarter, how much was Mexico?

Andrew Becnel

Let's just leave it that it's a substantial share of the business at this point in light that it's likely to become a lot more significant share of Latin America as the year progresses.

William Herbert – Simmons & Company

We spent $558 million in CapEx in the quarter, and we're going to $1.4 billion for the year. Walk me through how we generate $500 million in free cash flow.

Andrew Becnel

Let's do it the simple way. If you look at on a net income basis, you're somewhere between $600 million and $650 million if you want to use that number. It seems to be where people are and it's not unreasonable.

And depreciation of $900 million, give you $1.5 billion to $1.55 billion, less the $1.4 billion CapEx and we see $350 million coming out of working capital, we're about $50 million so we're better on that thus far. With a bit of improvement thus far on the receivable side, not on inventory due to on the product side we've had a decent build there in preparation for chunks of business that are still good, and we'll see the inventory levels improve as we move through the year.

Operator

Your next question comes from Robert Mackenzie – Fbr Capital Markets.

Robert Mackenzie – Fbr Capital Markets

I want to get some perspective comments out of you with over capacity and pretty much everything be it manufacturing, directional drilling tools and what not in the U.S. and other markets, how do you see that over capacity affecting not just the U.S. market but global markets and how long does that weigh on pricing everywhere? I know it's a very broad question, but one of my concerns is the over capacity due to huge reductions in activities is going to affect not just the U.S. but everywhere. Can you give me some color on that?

Bernard Duroc-Danner

Certainly things like, you put your finger on one which I think is affected which is directional. To the extent that the overcapacity in directional equipment, because of the demise of NAM is in the hands of the companies that have also large infrastructure internationally where they can move it.

It doesn't mean that every single directional company in NAM is going to move it with equipment overseas. No, because they don't have the infrastructure. But the four companies that have large shares of directional in North America can indeed move that equipment in the international markets. That means the glut of equipment is spreading around the world in that particular class of service.

That's absolutely true. Are the tools in North America usable around the world? Not always, but often, so that is a very legitimate concern and all things being equal, it will tend to depress the pricing in directional for as long as NAM is down or for as long as the tools takes to be assimilated.

But that doesn't apply to every single class of service simply because of their services where the equipment is not movable or where simply the people who control the equipment don't have an infrastructure overseas. All this applies across the board to everything at all.

And be mindful also that the few pockets of great strength in the international market that will also absorb quite a bit of that equipment. Think Mexico, think pockets of the Middle East, just to name two.

Robert Mackenzie – Fbr Capital Markets

Can you also calibrate your comments for manufacture items such as bits etc.?

Bernard Duroc-Danner

We don't really get involved in bits. In completion tools and liner hangers, it's not really for example which would be our equivalent, not equivalent to bits, but manufactured items, it's much less of an issue because you bring manufacturing down. I think all of our peers are bringing it down hard. Volumes are being put out at or below market requirements. Inventories get liquidated rather quickly and you're done.

The tools are consumables and they're entirely different than tools that are service tools, like directional. It is much longer for them to be absorbed. Therein lies the difference. That's why I tend to agree with your point. I do not feel quite the same about lift or completion. I can't speak to bits because we are not in it, or tubular.

Tubulars have the same issue, but you bring manufacturing levels down which is one of the reasons why people have a fair amount of manufacturing like us have strained economics when you bring the levels down, but once you bring them down, you put out less than the market requires, utilize inventory. It's no fun, but of course when the market turns, it's that much better. The service items, like directional rigs is another example, is a much harder thing to absorb.

Robert Mackenzie – Fbr Capital Markets

How much of the material cost deflation, i.e. steel prices and everything else did you recognize in the first quarter and how much more do you expect to see in the second and third quarters this year?

Bernard Duroc-Danner

With the way inventories are moving, you've started benefiting from it really in the last month of the first quarter, so I think you could say one third of Q1 was helped, and I think all of Q2 will be helped.

Operator

Your next question comes from Michael Urban – Deutsche Bank.

Michael Urban – Deutsche Bank

Going back to the question on the Eastern Hemisphere growth, certainly some of those projects are already under way. How much confidence do you have in those numbers given your conversation with clients? In other words, you've spoken to delays and integrated projects, how much of the growth that you're counting on in the Eastern Hemisphere is already underway versus we think and we hope the contract begins as planned but there could be a risk of pushing it back further.

Bernard Duroc-Danner

Part of me would like to say that what we're engaged in is not a balance in nuclear physics where we have a molecule too many, so one has to take it with a grain of salt. Having said that, we try to provide you the best guidance we can. We don't try to simply put out things that are either too high or too low and hope to get there. No, we really try to give you the best information we have. If it was any different, we would tell you.

When we look at the volume of things, and we've had a lot of delays. We have some scale backs, some things that were supposed to be confirmed have not been confirmed. I could go down the list. We have a very, very long list of disappointments, and not a surprise, they started in October and it's been a rough five months. It's not a surprise to anyone.

But if we look at where we are and what we still have left which is definitely confirmed, add the numbers and it strikes us that although Latin America is not controversial because of the very large scale development in Mexico that we benefit from, Eastern Hemisphere should when the full year is counted, should show as we said double digit growth year on year. It if it doesn't we'll be disappointed. If it does, we'll be happy. But it's the way it looks right now.

Michael Urban – Deutsche Bank

Shifting back to North America, you've done a great job in recent years of picking up share, especially in some of your newer product lines. I realize it's difficult to make any judgments based on one quarter given the seasonality that you have with Canada, but you did lose a little bit more on the top line of the rig count after a number of years doing better in rig count, where do you feel like you are in your share positions? Is that somewhat anomalous on a one quarter basis? Give us a sense of where you're headed.

Andrew Becnel

It's something that we're tracking obviously as we've become very customer focused by customer as opposed to by product lines in terms of our sales efforts in North America. But the market was down 28%. Don't forget about pricing in that and what we gave up in pricing in essence, a little bit less than what we gave up in pricing, we make up for in share improvement.

So if I look at about half of the market decline was regained due to share improvements, things like lift, and I could name others but I don't really want to get into all the details, but on balance we probably gave up about 15% in pricing for the quarter.

So weigh that against the results. 15% down in price, 20% decline in volumes and you think about the delta there is what you did on share.

Operator

Your next question comes from Mark Brown – Pritchard Capital.

Mark Brown – Pritchard Capital

One question regarding the inventory of wells that have been drilled and not completed pertaining to North America, do you have a sense of how many wells there are that would fit that description?

Bernard Duroc-Danner

I'm afraid I don't. It's a good question though and I could understand what you're after but I don't and I don't know that Andy does either. Unfortunately, we can't help you.

Mark Brown – Pritchard Capital

Another question on tax rate. I think you said 15.5% guidance. If you could give any color for why that was lower than previously?

Andrew Becnel

If you look at distribution of earnings by our geographic segment, and the different rates both statutory rates versus effective rates that we've been able to achieve and incremental tax planning that we undertook during the quarter in connection with our move to Geneva, all of those helped and obviously we feel a lot more confident about putting our thumb on exactly where we'll be by the end of the year in terms of earnings given the prognosis that Bernard just went through, and so I feel a lot more confident in that rate than where we were heading into Q1.

Mark Brown – Pritchard Capital

In terms of your potential M&A activity going forward, you mentioned two that you did in the past quarter and about $2 billion worth of liquidity available, is that something that you're actively canvassing the market to do going forward?

Bernard Duroc-Danner

We always are but we always are not meaning it depends what there is. The things that we're interested in are not that many and they're typically not available. So it depends when things cross our screen or cross our desk that fit that category of assets we think would benefit Weatherford, and there may be nothing. We're quite agnostic otherwise on the timing.

Let me rephrase it. It's less things are cheap now, let's buy them in our case. It's more an issue of things we really are interested in. Very, very few. Either they're available or they're not. And obviously if they're not, it's academic. If they are, we try to make things happen. It's more that really than things are cheap.

I would remind you that the things that are cheap and are plentiful are in North America, and we're not particularly interested in adding North American assets to our basket.

Operator

Your next question comes from Dan Pickering – Tudor Pickering.

Dan Pickering – Tudor Pickering

Coming back to the IPM projects for just a second, could you give us a snapshot of what the rough percentage of your revenues or your dollar revenues came from IPM in the quarter and then if this ramps as you suggest, where would our exit rate for this year or number for next year be in terms of IPM?

Bernard Duroc-Danner

Right now it's around 10%. I'm not sure it captures all of the dollars that go to those projects, so I'll tell you what I think I know. Again, a lot of the dollars stay within the product lines even though they are sold through projects, so we don't do a very good job necessarily of accounting for it. I'll stick at 10%. That's a number which I can support, but I think it's a bit higher than that.

I think by year end we'll be around 15% on the same basis meaning also understating, also to the same degree from the revenues that might be hiding in the product lines. I don't want to change the methodology. Otherwise, I'm not going to compare anything that's comparable.

So we go from 10% to 15% by year end. That's pretty safe.

Dan Pickering – Tudor Pickering

Is that 10% to 15% of total company or the international revenue?

Bernard Duroc-Danner

Total company. It's 10% of total company today, probably a little bit understated. We go to 15% of total company by year end, probably understated to the same degree.

Dan Pickering – Tudor Pickering

I assume that given some project delays etc., you probably have some carrying costs?

Andrew Becnel

Yes we do. I was trying in my long David answer on the margin thing which probably the longest answer I've given on any conference call, God help me, what I was trying to convey is that part of the moving parts have to do precisely with negative margins experienced by having those holding costs, and they presumably go away when you start getting active. But I wish we'd gotten active before. Unfortunately, you can't go against the will of your clients.

Dan Pickering – Tudor Pickering

Are those costs do you think tens of millions, twenties of millions?

Bernard Duroc-Danner

Between $10 million and $20 million a quarter.

Dan Pickering – Tudor Pickering

If we look at the U.S. margin discussion, I guess I was struck by the fact that just doing the simple math that you talked us through that sort of implies that Q4 exit rates are very close to the numbers we saw here in Q1, maybe even above. Does that math work?

Andrew Becnel

Close, a little bit shy, but close. You're in the ball park.

Dan Pickering – Tudor Pickering

And then if as you think through that process, how much of that is cost driven versus activity recovery?

Andrew Becnel

I'm not assuming any recovery off of 800 to 900 rigs.

Dan Pickering – Tudor Pickering

So that is going to be an ongoing flow through of your cost reduction efforts.

Bernard Duroc-Danner

Yes, we fully expect about a six month lag to get, the variable costs come about three months after perfectly if you do a good job. Fixed costs come about six months after, again if you do it very well.

Dan Pickering – Tudor Pickering

So the $340 million number that you talked about, $256 million and another $80 million that you're doing here in the second quarter, we view those as actual cash. That's not just avoidance of cost of goods sold. That's actual cash cost reduction.

Andrew Becnel

Actual cash cost reduction is correct. And it was $110 million on the fixed cost side and the balance on the variable, and something I didn't comment on, but we have preliminarily tagged another $100 million on the fixed cost side that we're going after. It will depend on whether we can achieve it is going to depend on how long this downturn lasts.

Dan Pickering – Tudor Pickering

And that will be a 2010 impact potentially?

Dan Pickering – Tudor Pickering

The incremental capital that you've added to the budget, is that all international?

Bernard Duroc-Danner

Yes, I said 85% of the overall CapEx. The 85% will be non NAM. The $200 million incremental, is 100% international, but 85% of the overall $1.4 billion, but 100% of the incremental $200 million from 1.2% to 1.4% is international. It will predominantly be NAP.

Dan Pickering – Tudor Pickering

So it looks like given cost reductions in North America, your international growth projects, it would seem to me like 2010 is clearly an up earnings year for you. It may not be for the industry, but it looks like it is an up earnings year for you guys. Does my math roughly work here?

Bernard Duroc-Danner

That is correct. That is what we're trying to communicate. That is correct.

Which concludes our conference call. Thank you very much.

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Source: Weatherford International Ltd. Q1 2009 Earnings Call Transcript
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