FMC Technologies, Inc. Q1 2009 Earnings Call Transcript

May. 4.09 | About: FMC Technologies, (FTI)

FMC Technologies, Inc. (NYSE:FTI)

Q1 2008 Earnings Call

April 30, 2009 9:00 am ET

Executives

Rob Cherry - Director of IR

Peter Kinnear - President, Chairman, and CEO

Bill Schumann - CFO

John Gremp - EVP, Energy Systems

Bob Potter - SVP, Energy Processing and Surface Wellhead

Analysts

Bill Herbert - Simmons and Company

Ole Slorer - Morgan Stanley

Rob Mackenzie - FBR Capital Markets

Collin Gerry - Raymond James

Dan Pickering - Tudor Pickering Holt

Brad Handler - Credit Suisse

Kurt Hallead - RBC Capital Markets

Kevin Simpson - Miller Tabak

Stephen Gengaro - Jefferies & Co.

Geoff Kieburtz - Weeden & Co.

Michael LaMotte - JPMorgan

Operator

Good morning and welcome to FMC Technologies First Quarter 2009 Earnings Release Teleconference. (Operator Instructions). In the event of technical difficulties during this call, we will post updates at www.fmctechnologies.com/earnings. Thank you.

Your host is Rob Cherry, Director of Investor Relations. Mr. Cherry, you may begin your conference.

Rob Cherry

Good morning and welcome to FMC Technologies first quarter 2009 earnings conference call. Our press release and financial statements issued yesterday can be found on our website.

During our call, we will reference earnings from continuing operations, which excludes the results from the FoodTech and Airport Systems businesses that were spun off to shareholders in the form of a stock dividend on July 31, 2008. Historical results have been revised to reflect those operations as discontinued.

I would like to caution you with respect to any forward-looking statements made during this call. Although these forward-looking statements are based on our current views and assumptions regarding future events, future business conditions, and the outlook for us based on currently available information.

These forward looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed in or implied by these statements.

I refer you to our disclosures regarding risk factors in our annual report and our other SEC filings.

I will now turn the call over to Peter Kinnear, FMC Technologies Chairman, President and CEO.

Peter Kinnear

Good morning. Welcome to our first quarter 2009 conference call. On the call with me today are Bill Schumann, our CFO; John Gremp, who heads our Energy Systems; and Bob Potter, who runs our Energy Processing and Surface Wellhead businesses.

I will give you some highlights of our first quarter results, and then Bill will provide you with additional details on our financial performance and an outlook for the rest of the year. We will then open up the call for your questions.

First, let me say we started the year recently well given the headwinds in both our industry and the global economy.

Our first quarter diluted earnings per share from continuing operations was $0.56. This was increase of 8% from the first quarter of 2008.

Just to remind you, we reported $0.62 in the first quarter of 2008, but this included $0.10 for the FoodTech and Airport businesses that we divested.

Our first quarter operating profit for the company was $133 million, equal to the first quarter of 2008. Energy Production operating profit was up 10% from the prior year quarter on the strength of our subsea business. The Energy Production operating margin in the first quarter was 12%, as compared to 11.5% for the full year of 2008.

We had solid revenue in subsea for the quarter, up 2% from the first quarter of last year. Our first quarter subsea inbound was just under $500 million. Orders were supported by options exercised on existing projects, new subsea manifolds, installation services, feed studies and a few new trees.

We entered the quarter with Energy Production backlog at $3.1 billion, including $2.7 billion in subsea. This substantial backlog should help support our expectations for subsea revenue in 2009.

The bigger question continues to be the subsea order rate in the second half of 2009 for delivery in 2010 and beyond. Some large projects like Kizomba, Jack/St. Malo, Goliat, and Jubilee are moving forward.

There is also substantial Petrobras frame agreements on the immediate horizon. However, other projects have been subject to more delays than normal given the current commodity price uncertainty.

On the upside we are seeing significant interest in subsea tieback projects. These projects involve subsea trees that are tied back to existing offshore production facilities. They are typically highly attractive for operators to do and they can be done with short-lead times and fast paybacks.

Additionally, they require less capital expenditures. Since the incumbent tree suppliers frequently selected to provide the trees for these subsea tiebacks, and given our large installed base, we think we have a very good chance to capture these opportunities.

Also on a positive note, Petrobras is aggressively pursuing their deepwater, pre-salt discoveries. Recent announcements include tenders for 28 additional new build, deepwater rigs and 240 offshore vessels.

We are very well positioned in Brazil with over 1,000 employees all focused on subsea. Our opportunities in Brazil and elsewhere go far beyond just subsea trees and include subsea manifolds, riser, tooling packages, subsea processing, and installation services.

In general, we continue to see results on our technology investments and our strategy to develop broad subsea product portfolio. Our second and third Light Well Intervention Systems are now going into service, so we will have three fully operational systems for the second half of this year. We are also pursuing new Light Well Intervention opportunities with several other oil companies including Shell, Total, and Petrobras.

In our other businesses, we continue to face market risks, particularly in our fluid control business, where our revenue is significantly driven by North American pressure pumping activity.

Surface wellhead will be impacted by lower North American rig activity, but much less so than fluid control due to our strong international position, which accounts for about 70% of our surface wellhead revenue.

As you may recall last quarter, we expected that the US land rig count would average between 1,100 and 1,300 for the year. The decline has actually been more significant than we anticipated, and with the US rig count now around 900, we now think the US land rig count for the year will average between 1,000 and 1,100. As a result, we are taking measures to mitigate the impact to our businesses.

Returning to our first quarter results, we had solid revenue and profit performance with subsea revenue up over the last prior year quarter. The end result for the quarter was an 8% increase in diluted earnings per share going from $0.52 to $0.56.

Now, let me turn it over to Bill Schumann, who will provide you with some further details on the quarter and our earnings outlook for the year. Bill?

Bill Schumann

Thanks, Peter. Let's review the continuing operations for the quarter. Energy Production sales were $872 million, up 2% over the prior year quarter, primarily due to the growth of subsea, which also increased 2% in the quarter. The subsea growth was based on the execution of our strong backlog position.

Surface wellhead revenue was flat compared with the prior year quarter. As you may recall, our surface wellhead business is 30% North American and 70% international.

The North American business was down, but it was offset by international growth. We do expect weakness in North America, however, as the year progresses.

Energy Production generated EBIT of $104.4 million in the quarter, up 10% from the prior year quarter due to higher margin and volume. As Peter mentioned, operating profit for Energy Production was 12% in the quarter.

Inbound orders in Energy Production were $614 million in the first quarter, including subsea orders of $481 million. Backlog was $3.1 billion, including subsea backlog of $2.7 billion.

The Energy Production orders in the quarter benefited from a positive impact of $53 million from backlog translation, as both the Norwegian Krone and the Brazilian Real appreciated slightly against the dollar over the quarter.

Energy Processing sales were $101 million, down 11% from the prior year quarter and down 21% sequentially. The segment EBIT of $28.5 million was down 27% from the prior year quarter.

The deterioration in the North America land drilling and pressure pumping activity in the quarter was more significant than we had anticipated. This had an immediate impact on our fluid control business.

Fluid control experienced a sales decline of over 20% from the fourth quarter of 2008. This, in turn, contributed to the segment's operating profit margin decline of almost 200 basis points from the previous quarter.

Inbound orders and backlog for Energy Processing were down sequentially, decreasing 12% and 11% respectively. The order softening came from fluid control, measurements solutions and loading systems. Given its exposure to the weakening North America pressure pumping market, fluid control was impacted the most.

Now, for the corporate items; corporate expense in the quarter was $6.8 million, down $2.3 million sequentially. The decrease was, in part, the result of lower professional service expenses. We still expect corporate expense to be in the range of $8 million to $9 million per quarter on an ongoing basis.

Other expense net of $25 million increased slightly from the prior year quarter. The total was higher than expected primarily due to accelerated stock-based compensation expenses and foreign exchange losses, which together amounted for $13 million or about $0.06 per share impact on our EPS.

We do not expect either item to reoccur in the remaining quarters this year. Accordingly, we expect other expense net to average about $11 million per quarter for the remainder of the year.

The tax rate for continuing operations in the first quarter was 28%, which was lower than expected due to the country mix of sales and profits.

Our net debt at the end of the first quarter was $82 million, comprised of $412 million of cash and $494 million of debt. Net interest rose from the previous quarter due to a higher average debt level.

We averaged 127.8 million diluted shares outstanding in the first quarter. During the quarter, we spent $43.5 million to repurchase 1.5 million shares of common stock. We now have 8.1 million shares remaining in our board authorized stock repurchase program.

We spent $25 million during the quarter for capital additions. We still expect CapEx for the full year to be around $120 million.

As we look forward into the remainder of 2009, we believe we are going to benefit from having our $2.7 billion in subsea backlog. The majority of our 2009 sales will be from this backlog. However, we still require some new subsea orders that we can execute this year to reach our expected revenue targets.

Our surface wellhead and fluid control businesses, which are the most exposed to North American activity, could continue to face revenue declines if the activity levels stay at the current level or deteriorate further.

The operating profit decline in these businesses could exceed the revenue decline. Our focus in these businesses continues to be on managing them accordingly.

Our infrastructure-related businesses, loading systems, measurement and material handling continue to have the same outlook as we provided last quarter, down 10% to 15% at the top line and down 15% to 20% on the bottom line. Although I should mention they performed better than that in the first quarter.

So, in summary, despite various market challenges, we had a solid quarter. Our operational results met our expectations. At the corporate line, we had higher other expenses net that were partially offset by lower taxes.

As a result, our first quarter earnings of $0.56 were up 8% compared to a year ago quarter. Given the significant deterioration of the North American activity, we are narrowing our 2009 diluted EPS guidance to $2.40 to $2.50 per share.

Operator, you may now open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Bill Herbert with Simmons and Company.

Bill Herbert - Simmons and Company

Peter, I was wondering if you could give us an update with regard to the timing of the looming, I guess, Petrobras tender for the standard trees and manifolds?

Peter Kinnear

That's a good question, Bill. There has been numerous delays from Petrobras and the issues around the percent local content that they're going to require the local suppliers to provide on that contract.

There has been much debate around that within Petrobras and the government. The current outlook, I think, is the tenders are going to be submitted around May the 11th, but that slipped two or three times already. That's the current target.

Then we would anticipate probably some review period both to confirm the technical submissions of all the competitors and then commercial review. So, even if they're submitted May the 11th, there may be some lag before they're actually awarded.

Bill Herbert - Simmons and Company

Is it still your understanding that these anticipated composition of the tender is going to be anywhere from 200 to 300 trees, three tranches encompassing about three to four years of their needs?

Peter Kinnear

Yes, that's correct. There's also a tender for manifolds and there's two tranches for manifolds.

Bill Herbert - Simmons and Company

And there are 14 of those, right?

Peter Kinnear

Yes. I guess 10 to 14. There's a range on those also.

Bill Herbert - Simmons and Company

And secondly, you were self-effacing with regard to the key unknown as the timing and magnitude of subsea tree orders as the year unfolds. A couple which I guess have been talked about being on the front burner in terms of being awarded, projects such as Exxon, Kizomba satellite, Tullow, Jubilee, Chevron, Jack. Can you give us an update with regard to when you expect those to be ordered, I mean awarded?

Peter Kinnear

We would think some time a couple of them may go in the second quarter. I would say Jack/St. Malo is probably a little bit further out in terms of their review process and selection of vendors and all that sort of stuff.

Bill Herbert - Simmons and Company

Do you hazard a guess as to whether subsea tree awards this year will be lower or flat with last year?

Peter Kinnear

That's a good question. It depends. The Petrobras award is a big number. They're going to be awarded to the suppliers, but they're probably going to be called off in certain time periods.

So, if you count that in or out, I mean if you count Petrobras, say you're not going to count the trees so they're actually physically called off. Our anticipation in the 2009 outlook would be certainly lower than our prior estimates.

Bill Herbert - Simmons and Company

We were awarded 430 something trees last year.

Peter Kinnear

That's correct.

Bill Herbert - Simmons and Company

Do you think it's at least 400 this year or lower?

Peter Kinnear

It's hard to say on the timing. We would anticipate somewhere in the 400 range. Certainly, it could be lower.

Operator

Your next question comes from the line of Ole Slorer with Morgan Stanley.

Ole Slorer - Morgan Stanley

What occurred help me a little bit on the guidance. You narrowed the range at the high end a little bit. Is this still little bit just looking at what moved since you made your last guidance? It's still a very, very solid number, but is it only North America or are there kind of other moving parts, like currency or something else that also kind of compensates? How has this outlook changed in your view since last time?

Bill Schumann

Ole, this is Bill. It's primarily the North American activity level. Our previous guidance was 240 to 260 and that was based on about an average land US rig count of between 1,100 and 1,300. We now think it's going to be around 1,000. That could be optimistic.

I think we had 1,275 average in the first quarter and we're sitting at about 900 right now, but based on that decline from say the top range of 1,300 down to 1,000, we've lowered the top end of our guidance from 260 to 250. So, our range now is 240 to 250 and the majority of that change is associated with the North American oil field activity.

Ole Slorer - Morgan Stanley

It's a very tight range there, Bill. Do you have that type of confidence, visibility at this point?

Bill Schumann

Well, the subsea area gives us a fair a nice solid base to look at to base it off of. There are, of course, a lot of moving parts in this, but it's kind of where we think the year is going to come out at this point.

Ole Slorer - Morgan Stanley

On the currency side a little bit of a debate in the fourth quarter number, can you tell us a little bit about how that shakes out this quarter?

Bill Schumann

Well, currency impacts us in a lot of ways, but unfortunately in the first quarter we had some nonfunctional currency balance sheet items that caused almost the entire $7.3 million loss in the quarter. We don't expect to have those kinds of exposures in the future and don't expect to record any losses on that line in the future, although it is volatile quarter-to-quarter.

The bigger impact, however, that really you can't see from the income statement is the impact of the change in currency on our sales and profits. If foreign exchange rates in the first quarter of 2009 had been at the same level they were in the first quarter 2008, our sales would have been $178 million higher and our EBIT would have been $12 million or almost $0.06 per share higher.

Operator

Your next question comes from the line of Rob Mackenzie with FBR Capital Markets.

Rob Mackenzie - FBR Capital Markets

Follow-up question for you guys here on and maybe I missed it with your guidance, Peter. Where do you anticipate the rig count bottoming vis-à-vis your Weco/Chiksan outlook for this year?

Peter Kinnear

I'm going to say we lowered and Bill just commented a little bit about that, but we lowered our outlook for the full year average. In terms of a bottom, that's hard to predict. Obviously, we're down to 900 right now and we would anticipate the deceleration would start to slow and I think the early report on the Smith rig count was only down eight or 10 this last week. So, it could go down to 600, 700, certainly, but when that happens, obviously we would anticipate the prices start to react and you get some uplift in the rig count.

Rob Mackenzie - FBR Capital Markets

Of your expectation for a predictable subsea this year, how much of that would you say is already in backlog and/or expected call offs from frame agreements?

Peter Kinnear

I think Bill commented. Let me say on the top line revenue our outlook, we said before we anticipated being in and around a level that we achieved last year. We still need some orders. We got some good orders in the first quarter and we still need a few more good orders in the second quarter to then turn that into revenue and profit for the balance of the year.

I think, just to remind you, we do percent completion accounting so that when we receive an order and we start working on it, we start recognizing revenue and profit fairly quickly. So, we anticipate that we'll make our outlook for the year.

Rob Mackenzie - FBR Capital Markets

And then can you help us understand how you're thinking about the non-fluid control portions of process systems reacting this year? Can you give us some help on how we should think about modeling that?

Bob Potter

Rob, this is Bob Potter. Basically, our infrastructure business, as Bill alluded to earlier, are going to be down, consistent with our prior estimates. I think it was 10% to 15% at the top line and 15% to 20% at the earnings line.

Again, we did better than that in the first quarter. We still see some positive things out there in the L&G environment for our loading systems business, still seeing quite a few opportunities in measurement for the big fiscal metering system. So, we think those estimates are still valid.

Rob Mackenzie - FBR Capital Markets

And then finally, on the question of pricing and pushback from your customers, what are you seeing particularly for projects that are yet to be awarded in terms of pricing pressure, potential margin pressure going forward on these stuff you're bidding on now or expect to be bidding on later this year?.

Peter Kinnear

I think the whole industry, the oil companies are pushing back on all the services they buy. We're being very aggressive and we're pushing back on our raw material suppliers and vendors for concessions.

We hope that process we can be more efficient and more economic and offer an attractive price to our customers in terms of. We don't anticipate significant deterioration on our margin percentages, but obviously we may have to offer a more competitive price that's based on our internal efficiencies and our vendor giving us better raw material prices.

Operator

Your next question comes from the line of Collin Gerry with Raymond James.

Collin Gerry - Raymond James

I just wanted to follow up on that last question. In regard, on the pricing side, if you look to the prices on your raw materials, how long does any sort of gain in efficiency there take to work through the income statement? Are raw material costs coming down? Should we see that in the next quarter or the next three quarters?

Peter Kinnear

Well, they're coming down. Our large subsea projects, we go out to bid every time for raw materials. So, we've seen efficiency and things pass through based on lower scrap prices that are basis for the [thing get set the forgers by]. So, that's going through the system and we've seen those benefits. So, we're more cost efficient from that standpoint.

We have done some things internally in terms of reconfiguring our product manufacturing and have consolidated components to lower cost sources and we're doing that. All discretionary spending as you can appreciate has been stopped.

We have headcount freezes in a lot of our businesses. We've taken some businesses. Obviously, we had to downsize significantly, particularly the ones focused on North America. So like every oil service company, we're reacting to the market situation and doing things fairly aggressively.

Collin Gerry - Raymond James

And just taking your comments from earlier, it sounds like the net of that, your margins should stay on percentage basis in the same range where they are right now as we work through 2009.

Peter Kinnear

We'll have some businesses that will be particularly, the ones focused on just take North American pressure pumping. Obviously, those ones we may have to make some adjustment on price and our pricing strategies there. But the other ones we're pretty comfortable about.

Collin Gerry - Raymond James

And then just last question. On the inbound orders, did you give us in terms of dollars and numbers of trees on the subsea side?

Peter Kinnear

No, we didn't, but I can do that. For the quarter, we had $481 million of subsea inbound and it was highly a mix as I commented. The primary thing was options exercise and existing contracts and those were various different customers Statoil, Anadarko, BP, Shell and Total. And we had a number of changes in things that happened and options exercised in the quarter.

We went up a subsea manifold for Petrobras called P55 in the quarter. Then, we had significant and you can appreciate every quarter, we have installation services and related things in the after market for subsea.

And also in the quarter, we had a favorable adjustment of about $60 million from translation for subsea. The number of actual trees was fairly low as I counted. At this point, we have only recorded three new trees in the quarter. So, if you look on a per tree basis, we're $160 million per tree.

Collin Gerry - Raymond James

I guess just a follow-up on that. The outlook for the next few quarters, do you see existing options and similar opportunity for that? How are the frame agreements running? Are those customers still kind of booking call offs?

Peter Kinnear

I think we would anticipate that. This first quarter, obviously, was low in the tree count, but, as we've told you before and talked about, we have a strategy just not to focus on trees. We focus on everything on the seabed that we can possibly do in terms of expanding our scope. This quarter is an indication of what happens. We've got a lot of options that oil companies choose and change and modify. That's normal in our business.

Operator

Your next question comes from Dan Pickering with Tudor Pickering Holt.

Dan Pickering - Tudor Pickering Holt

Coming back to the subsea business for a second, if we think about that $3 billion kind of revenue estimate I understand we need to win a couple more orders here for the rest of the year. But I guess, Bill, as we look at the scheduling of deliveries in subsea for the remainder of the year, it's going to be pretty ratable over the remainder. Is it back-end loaded? I'm just looking for kind of any lumpiness in the business there.

Bill Schumann

You wouldn't think that subsea business would be seasonal, but after looking at a first quarter that is down, after the fourth quarter for four years now we're beginning to think it is seasonal. So, the first quarter for whatever reason tends to be lower in terms of revenue recognition and profit recognition than the rest of the year. But other than that, we really can't give you any guidance that Q3 is going to be higher than Q4 or vice versa at this point.

Dan Pickering - Tudor Pickering Holt

But it does sound like Q2 should be higher than Q1 just given that seasonality?

Bill Schumann

Given the seasonality, we would think it would be. We think part of it is the fact that we recognize most of our sales on percent of completion and that's based on the costs that we incur. We think that our suppliers tend to ship us more equipment in the final quarter of the year to make their year.

Consequently, we record a little bit higher revenue in the fourth quarter, and as a result of that, they don't have much to ship to us in the first quarter. But that's kind of supposition. Empirically, though, the fourth quarter is the highest and the first quarter is the lowest.

Dan Pickering - Tudor Pickering Holt

And then as you look at the mix of business in the rest of the year, it sounds like it's going to be softer and subsea should pick up from the current levels. Generally, what is that mix effect going to do from a margin perspective? Are we growing margin because subsea is higher? Are we losing some margin because surface is higher?

Bill Schumann

If we look I guess what we're saying is subsea will probably be higher relative to the rest of the company during that time, and that actually could drive margins on sales down. I haven't looked at the total margin on sales for the company I have to admit that going forward.

Dan Pickering - Tudor Pickering Holt

But generally, more subsea is going to translate to slightly lower margins?

Bill Schumann

Right. Relative to the first quarter.

Dan Pickering - Tudor Pickering Holt

One last clarification. When you talked about Energy Processing, you talked about I think you said something like your operating profit declines might be more than your revenue decline. Is that on a percentage basis or a dollar basis? I'm just trying to clarify that comment.

Bill Schumann

Well, let me make one, apparently I misstated the sales in Energy Processing. I think I said it was $101 million in the quarter and it was $181 million in the quarter. But, yes, I think if we take fluid control, for instance, we anticipate it will be down similar to the rig count in the US and our bottom line operating margins are going to be down more than that just because we haven't been able to take out as much cost as the top line has declined.

Dan Pickering - Tudor Pickering Holt

Okay. So if rig count is down 20%, operating profit will be down more than 20%?

Bill Schumann

Exactly.

Dan Pickering - Tudor Pickering Holt

Okay. I just wanted to clarify. Thank you.

Operator

Your next question comes from the line of Brad Handler with Credit Suisse.

Brad Handler - Credit Suisse

May I please stay with the fluid control? I think you guys have characterized in the past that as a capital equipment business, it tends to be sort of a bit at the end of the whip, so to speak. So, as there's an effort by customers to stop ordering when times are down and then, of course, they find themselves a little short and you guys catch it on the rebound, I guess is what I'm trying to get at.

Any signs of that sort of behavior in Q1 or rather the fall actually might have happened a little bit more quickly than you expected given that historical behavior? Do you see what I'm reaching for? Any help there.

Bob Potter

Basically what we saw happen in Q1 was CapEx come to a very quick halt virtually across all the pressure pumping companies. We think that in large measure results from the fact that they idled more equipment, as a result of the lower rig count and resulting activity. And for us when they idle equipment almost always they'll start through a cannibalization process taking our Chiksan/Weco products off of idle pressure pumping equipment and putting it on their active gear.

So, that in large part was probably more impactful than what we thought given the severity of the decline in Q1. We still do see a fairly high level of field activity, though, in terms of repair and the equipment, that's still working is requiring lots of resource and a fair amount of product to keep their iron working.

Brad Handler - Credit Suisse

Okay. Thank you, Bob. I appreciate that and if we can just stick with it. So, if you go as you go forward as more equipment is idled, obviously the impact is felt there. There's that much more effort for cannibalization.

You made some comments about the rig count, I'm trying to calibrate that relative to if that's the way we should think about it or if it really is more severe because as you say the pressure pumpers just basically stop ordering absolutely to the extent possible. It would be a lot worse than the rig count decline, I guess?

Bob Potter

I don't actually think so because, again, keep in mind, what equipment is still working is in a very frac intensive environment, particularly as it relates to unconventional gas and shale plays. We've got some new areas that are coming on likes Haynesville that are in their infancy right now.

For all intents and purposes, we're seeing a lot of equipment moving to that area. Northeast British Columbia after road restrictions come off should pick up quite nicely. So, it's still a frac intensive environment and it gets a little decoupled from what you read into rig count because of the amount of multistage fracing they're doing and the impact that has on our equipment.

So, I don't expect the rate of decline in fluid control to exceed the rig count, if you will, because of that phenomenon with multistage frac.

Brad Handler - Credit Suisse

And just a very quick follow-up, Bill. The tax rate going forward with continued pressure on the North American earnings side might it stay kind of in the high 20's for the year?

Bill Schumann

Yes. Unless there's some other transactions, we would expect it to stay in that range.

Operator

Your next question comes from the line of Kurt Hallead with RBC Capital Markets.

Kurt Hallead - RBC Capital Markets

Sorry to beat the fluid control thing into the ground here. What percent of processing revenue is fluid control?

Peter Kinnear

Hang on just a second. We're going to give you a number here.

Kurt Hallead - RBC Capital Markets

Just a general range is fine.

Peter Kinnear

It's roughly a third.

Kurt Hallead - RBC Capital Markets

And of that, how much of that is North America?

Peter Kinnear

We're about 55% North America.

Kurt Hallead - RBC Capital Markets

That's helpful. And then on the subsea backlog $2.7 billion, you said a majority would roll through this year. Does that mean like $2 billion of the $2.7 billion or is it higher or lower than that?

Bill Schumann

Kurt, at the beginning of the year, we said $2 billion would come out of our backlog and roll through revenues, so that meant we needed to kind of book and bill $1 billion to get to our targets. We've kind of rolled that forward, so maybe we need to take $1.5 billion out of the current backlog to get to our numbers. Something like that. Does that help?

Kurt Hallead - RBC Capital Markets

Yes. Is that the same thing as saying that you've got $1.5 billion in your current backlog that's going to roll through '09? Or are you saying that $1.5 billion would include some stuff that you have to take in?

Bill Schumann

No, $1.5 billion that we've got in backlog will roll into sales in 2009.

Kurt Hallead - RBC Capital Markets

And then coming into the year, you guys identified some elements of risk as it related to the current environment and potential delays on project awards as customers assess their situation. Has there been any shifts in tone, maybe more to the positive? Have things stabilized? Are they getting any worse? Can you give us some qualitative commentary on what you're hearing from the customers?

Peter Kinnear

I can answer, Kurt. I would say when oil prices got down into the 30s, there was a lot of uncertainty in our customer base. Now, it's back somewhat stabilized around 50. Our impression with oil company customers that somewhere between 50 and 60, they could make, assuming they got some cost efficiencies from the industry, they could make those projects work in terms of subsea applications.

So, I think now that oil prices have been around that range, I think oil companies are going back and starting to saying, okay, what do we need to put? What do we need to do? And you can appreciate the depletion of their wells. They've got to reinvest, otherwise they're a declining asset.

I was in Brazil a couple weeks ago and they told me I thought their wells had about a 6% to 8% decline rate and their senior E&P guy said the wells in Brazil decline at a 10% per year. So, at some point, they have to come back and reinvest. So, we also think the opportunities and tiebacks into the existing fields is going to be something.

They have rig commitments coming. What are they going to do with the rig? They're probably going to focus on development to get cash flow. They're not going to necessarily do exploration.

So, when they go to use the rig, they can either fund a brand, new project or they can go back into an existing field and drill some quick wells. We stock a lot of standard equipment for our customers and we can deliver pretty quick on that sort of stuff.

Kurt Hallead - RBC Capital Markets

And a lot of important focus there on Petrobras and Brazil. What about outside of Brazil?

Peter Kinnear

I think all oil companies pretty much are thinking that way. The ones that we have our frame agreements and long-term agreements with. They're starting to say we're going to have a rig available and we've got to decide what we're going to do with this rig. To us, it will be positive.

Kurt Hallead - RBC Capital Markets

And Bill, can you give us some general guidelines on what you guys are thinking on cost savings?

Bill Schumann

Cost savings?

Kurt Hallead - RBC Capital Markets

As it relates to fluid control and the decline in that business. You talked about some ways to mitigate some of the softness. So, I just kind of assumed it would be some sort of cost savings program you're going to undertake.

Bill Schumann

Let me ask Bob. He's got the statistics on it.

Bob Potter

We've taken about 27% of our employee base out so far. And that's somewhat misleading in that we've taken more a greater percentage out of our production environment, closer to 40% in fact, as we've increased our field personnel because of the level of activity we still see in that arena. So, Peter talked earlier about the hiring freeze. We've done that. Obviously all the discretionary spending and capital spending we've delayed or deferred.

At the same time, it's important to remember that we are also investing in places like Haynesville, Boulder City in our case to be specific and then Fort Nelson to support British Columbia. So, we've got a little tension in that while we're trying to take cost out, at the same time trying to capture the opportunities that are available to us.

Kurt Hallead - RBC Capital Markets

Is there any way to translate those numbers you gave us into dollar terms in terms of benefit as the year goes on?

Bob Potter

I guess about the best thing I can tell you is that we're trying to maintain our margins because I mean I just gave you kind of the spending other than our raw material and we've got all those factors going on. So, we're trying to do the things we can do to mitigate the impact on our margin. I can't give you a specific number.

Operator

Your next question comes from the line of Kevin Simpson with Miller Tabak.

Kevin Simpson - Miller Tabak

I just wanted to get a couple quick clarifications, I guess. Peter, are you saying that at $50ish oil that we can see a fairly healthy kind of uptake of satellite type of orders? And if so, would that be an '09 phenomenon that you're seeing interest already or would that become more 2010?

Peter Kinnear

Well, I think we see a lot of interest in the tiebacks and I think we could certainly see some inbound in that sector that application of subsea technology in '09. That would have some, obviously, revenue recognition for us in '09 and flow into '10.

So, we think the oil companies they added I think 12 deepwater rigs in '08 and there's another 20ish coming out in '09. Somebody's going to have to put the rigs to do something. They're heavily focused on deep water. So, we think all that is going to still keep our outlook for subsea fairly strong.

Kevin Simpson - Miller Tabak

On the major projects, we've seen a consistent slip to the right. Are there any of the larger, I guess it seems to me listening to Chevron, the Jack/St. Malo in their kind of feed stage now that we might not see that at all this year.

I guess these large complicated projects that have like large separation components in them like that one or CLOV. Do you think there's risk that they just don't go forward until the economy has gotten a lot better and/or at least stopped going down and there's a little bit more comfort? Or do you think that they can still move forward?

Peter Kinnear

Kevin, I think the answer depends by operator. You saw ExxonMobile. They didn't blink an eye. They're spending more money this year than they did last year. On Chevron, Jack/St. Malo in particular, Chevron has spent three years of drilling, assessing the reservoir. They've had a full team in place and they're going full steam ahead, too. We would anticipate that that project on the subsea side to certainly be awarded in 2009.

Kevin Simpson - Miller Tabak

And then I guess last. On the surface side, maybe for Bob, are you reducing headcount and manufacturing the same way that you are maybe not as severely for Weco, but directionally the same? Or are you getting some protection from the larger overseas component there?

Bob Potter

Well, we have taken some actions in North America. We've reduced our headcount in North America 17%. We are getting some cover from our international operations, though, that are still growing. And quite honestly, our North American surface business didn't decline in Q1 anywhere near where the rig count did in part because of the new revenue sources I talked about Haynesville.

We're active there now. Northeast British Columbia will continue to be active for us; Marcellus. So, there's some opportunities that really result in some strong frac revenue for us that's been driving our business for the last 18 to 24 months, but we are taking directionally the same actions and it's 17% in Q1.

Operator

Your next question comes from the line of Stephen Gengaro with Jefferies and Co.

Stephen Gengaro - Jefferies & Co.

Two follow-ups really. The first, going back to Brazil. Have you seen any impact of the local content issues as far as improving your competitive position?

Peter Kinnear

That's a good question. We've been in Brazil for 45 years and have localized our manufacturing execution to a very high level. We have to go outside for resources and the material is in the specialized forging area. We go to US or European sources, and sometimes for electronics, we do subsea control manufacturing and that sort of thing in Brazil. And so, sometimes electronics we have to go outside of Brazil. So, it's a good balance.

I think we would view ourselves as probably having the ability to provide the highest local content and the other competitors may have some difficulty. There's quite severe penalties on these contracts, if you don't make, they're going to be audited, you're going to be audited for your local content and there's penalties that are going to be applied if you don't meet the local content.

So, they're serious about trying to get a system that benefits Brazil as they execute this kind of mini boom down there in terms of the oil service sectors.

Stephen Gengaro - Jefferies & Co.

And then the other question was around the subsea trees. I'm not sure if you mentioned this earlier, but has there been any progress on sort of the second wave of trees for the pre-salt?

Peter Kinnear

John can talk about that.

John Gremp

I wouldn't necessarily say progress, but the plan is still the pre-salt trees would be bid at the end of this year and that hasn't changed that we know of. So, they're still looking at the end of this year a bid for pre-salt trees.

Operator

Your next question comes from the line of Geoff Kieburtz with Weeden & Co.

Geoff Kieburtz - Weeden & Co.

Bob, I'm going to have to ask you to go back on your headcount reduction numbers because you gave us several numbers 27% and 17%. Could you just go back over and clarify for us what those numbers are pertaining to?

Bob Potter

Fluid control was 27%. We've had 27% headcount reduction since our peak and surface wellhead in North America has had a 17% headcount reduction since its peak. And the peaks were like Q3 last year.

Geoff Kieburtz - Weeden & Co.

Okay. And that 27% headcount reduction in fluid control is a global number.

Bob Potter

Yes, it is.

Geoff Kieburtz - Weeden & Co.

Okay. But I'm assuming concentrated in North America, right?

Bob Potter

Absolutely.

Geoff Kieburtz - Weeden & Co.

And is the fluid control and surface businesses the only two where you've had headcount reductions across the company?

Peter Kinnear

I can answer that. You can appreciate, Geoff, when we got into, we saw the downturn coming. We were very quick to put headcount freezes across the board. So as we've had attrition, we have not replaced those people.

And like most service companies, we operated with a buffer of maybe 5% to 10% contract employees in our businesses. So, those have been not totally eliminated, but certainly reduced in terms of the magnitude.

Geoff Kieburtz - Weeden & Co.

And in the first quarter, were you realizing any of the benefits of those headcount reductions or are those benefits that should start to materialize more noticeably in the current and subsequent quarters?

Bill Schumann

Geoff, because of the severance cost implications of those reductions, we probably didn't realize much, if any. In fact, we probably had a negative impact in the first quarter. So, we should see it in the second quarter.

Geoff Kieburtz - Weeden & Co.

Are you willing to give us some idea of kind of what the magnitude of severance cost impact in the first quarter was?

Bill Schumann

It's somewhere between $1 million and $2 million. I don't have the exact number.

Geoff Kieburtz - Weeden & Co.

That's fair enough. You've tightened your guidance and talked about it being based on now a kind of 1,000 to 1,100 average rig count in the US I'm assuming?

Bill Schumann

Right. That's our US land rig count estimate.

Geoff Kieburtz - Weeden & Co.

Not to cut it too finely, but if the rig count were to average below 1,000 for this year, would that threaten the low end of your guidance?

Bill Schumann

Well, we've got a lot of moving parts. It could, but that's an average, remember, and we averaged, I think, 1,275 in the first quarter.

Geoff Kieburtz - Weeden & Co.

I understand. And then in terms of the map you walked through, Bill, on the subsea business, I maybe didn't get the numbers exactly right, but you still expect at the beginning of the year $2 billion of revenue coming out of backlog and another $1 billion coming out of orders that you would take in the course of 2009, right?

Bill Schumann

Right.

Geoff Kieburtz - Weeden & Co.

And you booked $700 million of revenue in subsea for the first quarter?

Bill Schumann

And we rolled off between $500 million and $600 million of backlog in the first quarter to achieve that $700 million.

Geoff Kieburtz - Weeden & Co.

Okay. So, you've got $1.5 billion more to come out of backlog and about $800 million to come from new orders?

Bill Schumann

Yes.

Geoff Kieburtz - Weeden & Co.

And Peter your comment about increasing interest in the tieback market. Is that the principal area where you expect to see that $800 million of unbooked orders coming from?

Peter Kinnear

Well, I mean that would be one element of it. Certainly, we anticipate other projects or scope changes in our existing backlog that could fill that void like we had in the first quarter. We had a lot of options in terms of scope that oil companies decided on and from six or seven different projects that represented quite good inbound for us.

Geoff Kieburtz - Weeden & Co.

To the extent that the tieback market is a significant contributor to that unbooked order requirement, would that have a positive or negative effect on margins in the subsea business?

Peter Kinnear

Typically, our tiebacks we've already sunk the engineering costs on the design because it's pre-existing design. And so, in general it should be a little bit better.

Operator

Your next question comes from the line of Michael LaMotte with JPMorgan.

Michael LaMotte - JPMorgan

Most of my questions have been answered, but two quick ones hopefully. One, I was hoping you could comment on just the M&A environment, particularly possibly in the process segment?

Peter Kinnear

In general, obviously, there may be more opportunities in this market. It depends on the particular financial outlook of any company. The specifics in processing we have a wide range of businesses in that sector and we're always looking at opportunities to see what might make sense. We have an active business development team that's reviewing potential opportunities that are a good fit.

And just like in the fourth quarter, we felt that Schilling Robotics was a good fit for us in the subsea arena. In Bob's sector and businesses, we have a few identified targets that we're looking at. Acquisitions are tricky things to do and take some time to develop and execute.

Michael LaMotte - JPMorgan

Can you maybe compare the market versus six or nine months ago? I just think of that space as you've got a lot of unconsolidated markets, a lot of private companies. I would imagine leverage would be an issue for a lot of your competitors in those various sub segments. This might be, actually, a pretty target rich environment for you all right now.

Peter Kinnear

You get into the price expectations that nine months ago I was worth X million and I'm still worth X Million. So, I think you'll have to

Michael LaMotte - JPMorgan

We need a little more pain.

Peter Kinnear

Yes, we need a little more pain.

Michael LaMotte - JPMorgan

Okay. Last one for me is just on talking to operators particularly about pre-salt Brazil, one of the technology hurdles that there really seems to be consensus on is the subsea boosting and power systems. Can you all maybe address where you are in those areas and what you see as potential developments coming down the line?

Peter Kinnear

That's a good question. The seabed activities around separation and processing and pumping, we've seen a very good expansion of the interest worldwide. As you know, we were awarded five subsea processing projects, so we have positioned ourselves as a very strong player in that sector. Shell has a specific project in Brazil called BC-10 that we're executing that has a separation and boosting and pumping.

Petrobras has; in addition to the pre-salt activities, they have a lot of material fields. Their fields are producing a lot of water and so water cut is an issue for them. The StatoilHydro Tordis solution dealt with water cuts, so we have a very good solution there. We would see Brazil as a maturing and probably a pretty good active area for subsea separation and boosting in the future.

Michael LaMotte - JPMorgan

Would you describe your, I guess, strength in terms of differentiation on the boosting side as being separation oriented, because it does seem to me that subsea power systems are actually an area that operators are focusing on, too?

Peter Kinnear

I think there's the whole spectrum. When we designed the system, we have a good technology base for the power requirements on the seabed. You can appreciate like on pass floor, we have three very large subsea separation units that have significant multiphase pump applications. We're the turnkey contractor and we have to deal with all the power requirements on the seabed and do all that engineering work and system layout. So, we're very familiar with that technology and what we need to do there.

Operator

There are no further questions at this time. I will now turn the call over to Mr. Cherry for closing remarks.

Rob Cherry

Thank you, Operator. This concludes our first quarter conference call. A replay of our call will be available today on our website beginning at approximately 2:00 PM. Eastern time. If you have any further questions, please feel free to contact me. Thank you for joining us. Operator, you may end the call.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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