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Weatherford International (NYSE:WFT)

Q2 2009 Earnings Call

July 20, 2009 10:30 am ET

Executives

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

Andrew Becnel – Chief Financial Officer

Analysts

James Crandell – Barclays Capital

Ole Slorer – Morgan Stanley

William Herbert – Simmons & Company

Michael LaMotte – J.P. Morgan

Dan Pickering – Tudor Pickering

Kurt Hallead – RBC Capital Markets

Michael Urban – Deutsche Bank

Geoff Kieburtz – Weeden & Co.

Dan Boyd – Goldman Sachs

Operator

Welcome to the second 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. Please proceed.

Bernard Duroc-Danner

Thank you very much. Good morning everyone. Andy why don’t you get started with your comments.

Andrew Becnel

Good morning. For our second quarter of 2009, we report fully diluted earnings of $0.10 per share before non-recurring items. This performance excludes $18 million of after-tax costs incurred in connection with our ongoing government investigations and $10 million of after-tax charges for severance and facility closures.

At $0.10 earnings per share are down 63% sequentially and are down 77% year-over-year. Of the 17% sequential drop, we saw a $0.15 decline in North America, a $0.03 decline out of international operations and $0.01 improvement below the line due to a lower tax rate for the year as a result of lower North American operating income.

This was a difficult quarter for Weatherford. During Q2 our operations experienced what we believe will be the trough quarterly for 2009 and 2010 financial performance. The combination of historical record lows in Canadian activity and greater than anticipated pricing declines in both the U.S. and Canada produced North American EBITDA margins in the low teens.

From an activity viewpoint, the U.S. market performed much as expected with a 30% decline in average rig count. However, Canadian activity levels were significantly worse than expected. While we anticipated a normal seasonal turn in Canada following more than two years of steady activity declines, actual activity levels were far worse. Canadian rig count was down 73% compared to Q1 and down 46% versus Q2 2008.

Rig utilization hit 11% and operating days were down 50% compared to the same quarter last year. At these levels it is nonsensical to think about covering one’s fixed cost structure on matter how lean the operation may be. In contrast, international revenue was up slightly despite a 5% decline in rig count X Russia and upper single digit pricing declines.

Pricing impacted margins as did increased overhead allocations due to the shift in geographic mix away from North America. Volume and share gains helped to ameliorate this impact as international margins retreated 210 basis points in line with guidance provided on the Q1 call. Our financial results aren’t at odds with performance in the field during the quarter. Field leaders seamlessly prepared for launch of two new projects in China and Russia.

We also added six strings to our operations in Central Mexico where we will add more than a dozen strings during the second half of the year based on contracts in hand. In North America, operations leaders continued an aggressive carve down of our internal cost structure and we expect our financial performance to reflect this success in the coming quarters.

Also in North America our new technologies continue to gain traction. In the Haynesville Shale we successfully ran RSS jobs in high temperature applications north of 300 degrees Fahrenheit and completed our first-ever pump down perforating operation allowing perforating on wire line and horizontal and highly deviated wells without using drill pipe.

In the deep water Gulf, we continued to achieve successful runs of our new sonic technology as well as executing newly one rotary steerable and LWD jobs. In addition, we completed our first off-shore floating application of managed pressure drilling with constant bottom hole pressure. We also ran our first commercial job on land for our compact dipole sonic tool in the U.S.

On a consolidated basis, sequential revenue receded $261 million or 12%. North America produced the entire sequential decline. International revenue was up slightly and accounted for 71% of our company wide revenue. Meaningful growth in Africa, Saudi Arabia, Kuwait, Yemen, Oman, China and Mexico were offset in part by declines in Egypt, Libya, Romania and Venezuela.

Compared to the year-ago quarter company-wide revenue was down 11% against a 35% decline in rig count. North America dropped 44% while international was up 17% on a 9% decline in rig count.

Through the first half of 2009 international revenue was up 22%. Latin America was up 84% on a 5% rig count decrease and the Eastern Hemisphere is up 5% on a 6% decrease in rig count.

Consolidated EBIT before corporate and R&D declined $153 million sequentially with operating margins at 13.6%, down 520 basis points from Q1. North America precipitated most of this fall with EBIT basically break even while international margins at 19.1% slid 210 basis points as expected. Year-to-date international margins were down 400 basis points to 20.2%.

Financial performance within our core geographic regions was as follows: North America 29% of total revenue. Revenue fell $266 million or 32% sequentially on a 39% decline in rig count. Revenues down 44% compared to Q2 2008 versus a 50% decline in rig count. Year-to-date revenue is down 33% with rig count down 37%.

EBIT was a loss of $1 million, down $124 million sequentially. Canadian activity was approximately 30% worse than anticipated with a rig count bottoming around 60 rigs. Less than 800 wells were leased in Canada during the quarter representing a 52% decrease from Q2 2008. Pricing in both U.S. and Canada continued to take a beating. The regional management team continued on the path of aggressive cost control.

Through the first half of this year, North America trimmed $475 million annualized from its cost structure, $150 million of which was fixed costs representing a 13% improvement year-to-date. In addition, we have reduced headcount by more than 3,000 and have closed more than 20 facilities. We are not done. We will continue to identify and execute improvements to our cost structure including our infrastructure throughout the remainder of 2009 and 2010. Well construction, completions and fishing and re-entry weathered this storm the best albeit all still declined at the top line.

Middle East, North Africa, Asia Pac was 30% of total revenue. For the first time in our history this was our top ranked revenue region in terms of size. You should expect to see this region at the top of the revenue hierarchy for Weatherford for some time to come with Latin America giving it a run for its money.

Revenue increased $11 million or 2% sequentially against a 2% decrease in rig count. Strong performances in Saudi, Iraq, Oman, Kuwait, India, Pakistan, Yemen and China were partially offset by weakness in Egypt and Libya. Revenue is up $37 million or 7% compared to Q2 2008 and is up $97 million or 9% on a year-to-date basis. EBIT was $124 million, down $10 million sequentially and margins were 20.8%, down 220 basis points. Year-to-date incrementals were 7%.

Under balance drilling, wire line, well construction, artificial lift and completion systems were among the top performers. Latin America was 23% of total revenue. Revenue was essentially flat at $466 million. The declines in Venezuela, Argentina and Colombia were offset by strong sequential growth in Mexico and Brazil. Venezuela and Colombia were particularly severe with a 20% plus decline sequentially. On average, we operated 33 strings in Mexico during Q2, up six strings from Q1. During the second half of 2009 we will step up to 48 strings. Revenue is up $194 million or 72% compared to Q2 2008 and is up 84% year-to-date 2009 versus year-to-date 2008.

EBIT was $86 million, down $6 million sequentially with margins down 130 basis points. Improvements in Mexico were more than offset by headwinds in Venezuela and Argentina. Artificial lift, stimulation in chemicals and integrated drilling stood out as the top sequential performers.

Europe, FSU, West Africa was 18% of total revenue. Revenue declined $4 million sequentially against a 14% decrease in rig count. While Russia appears to have troughed in March, the market lingered near the bottom for the quarter. Central Europe declines were on par with those of Venezuela and Colombia. Revenue was down $25 million or 6% compared to Q2 2008 and was down $3 million or 1% year-to-date 2009 on year-to-date 2008.

EBIT at $63 million was down $12 million sequentially. Margins were 17.2%, down 310 basis points with sales, mix and pricing declines being the main culprits. Drilling services, stimulation and chemicals and integrated drilling were the strongest performers from a product line perspective.

Cash flow. During Q2 we generated EBITDA of $398 million with G&A running at $214 million. Operating working capital, AR plus inventory less AP, provided $37 million of cash. After deducting interest expense and taxes, operating cash flow was $333 million for the quarter. We still remain focused on achieving $500 million of free cash flow in 2009 and are on track to do so.

Capital expenditures were $368 million for the quarter net of lost and hold revenue. For the whole year we still anticipate CapEx of approximately $1.4 billion. This level reflects our prognosis for H209 and full-year 2010 as well as our continued build out of tools incorporating recently commercialized technologies.

As of quarter end our ratio of net debt to net capitalization stood at 42% with total net debt at $6.3 billion. Cash balances totaled $204 million at quarter end.

I have the following updates for you on 2009 non-operational items. Corporate expense was $160 million. R&D expense $195 million. Net interest expense $380 million. Tax rate, full year effective rate between 12-13%, again due to the sharp decline in anticipated operating income in North America.

Share count you should expect average share count to be 729 million during Q3 and 737 million during Q4 with the increase attributable to the TNK acquisition.

I will now hand the call over to Bernard.

Bernard Duroc-Danner

Thank you. Q2 was all about North America. NAM’s results were punitive where the NAM performance was brutal. By contrast, our international segment held its ground well, edging modest gains in revenues. Pricing declines brought about levels of margin erosion consistent with our expectations.

Q2 had six moving parts; collapse of NAM, volume and price. Overall NAM market volumes dropped close to 39%. U.S was very weak and Canada was much worse. Canadian market almost closed down. At its low point only 63 rigs were working. Canada averaged 89 rigs for the quarter. This is 10% below ’99 levels. [inaudible] EBIT Q2 beat Canada’s historical low of 101 rigs in ’99.

For Weatherford’s legacy, heavy weighting in that market was severely affected. Two, our operations loss closer, 32% revenues and quarter-over-quarter our pricing erosion average best we can tell was 14%. We showed [a century] break in EBIT or a 1,470 basis point decline in margin. Some continued share gains helped in the U.S. and overall cost cuts mitigated further margin deterioration but not enough or soon enough. The inevitable lag between NAM’s fast eroding price and volume and the concurrent lowering of fixed and variable costs.

In Africa markets were soft but obviously much better behaved. Overall, market volume dropped sequentially by 5% and we incurred the full impact in the quarter of international pricing declines negotiated on the [Cagney] triggered in Q4 and Q1. Our realized pricing eroded overall by about 6% during the quarter. In this environment our international revenues were up very modestly, but up nonetheless. Our EBIT margins declined by 210 basis points which is what we had anticipated. All in all, a decent performance.

A contrary 11% increase in our international business volume more than offset market and pricing declines. Of particular note, drilling services, well construction, integrated drilling, stimulation and lift measurably gained share.

Activity and performance varied depending on the geographic segment. Performance deteriorated in descending order of impact by region in Venezuela, Argentina, Colombia, Central Europe, Russia, Indonesia, Malaysia and Australia. In some instances nothing more than Q1’s trough impacting the full quarter with Russia being a good example. In other instances the conditions and performance deteriorated further from Q1’s exit levels and Venezuela would be a good example.

We showed relative strength in Mexico, Brazil and the Middle East. In all three cases building a backlog. Integrated party mobilizations were in progress in China, Oman, Ethiopia, Iraq and Russia while the rate of activity in Mexico ramped up throughout the quarter.

By year end we expect to add in operations more than a dozen strings in Mexico and at least 10 strings in the Eastern Hemisphere on integrated projects. Q2’s mobilization performance was seamless.

Clearly Q2 was a very difficult quarter in NAM and horrifically so in Canada. Looking out, NAM remains strained. By contrast, the international environment is stabilized. We constructed internationally in the second half of 2009 and 2010. We feel this way even more so than the last conference call. The pull back international markets during the first half of the year has been quick and complete. This puts us in a relatively healthy spot. Pricing moves appear to be behind us. With a few exceptions we believe the international markets and our own financial performance there troughed in Q2.

In Latin America, Brazil will be steady to strong for the balance of the year while Mexico will continue to grow as we ramp up new contracts throughout the year. Argentina and Colombia will stabilize. Venezuela is still vulnerable to further curtailments but it is for us from very reduced scales. We lost close to half of our business in Venezuela over the past few quarters.

In the EH, look to Middle East and North Africa for strength. Look to Asia and Russia for some recovery. When the full year 2009 is counted we expect Weatherford’s EH top line to achieve double digit growth. We expect Weatherford’s top line in Latin America to show quantum growth year-over-year. NAM should not deteriorate further which is partially the reflection of Canada having seen seasonal and cyclical lows that are not sustainable. Activity has to increase.

As for the U.S., the market tone strikes us as weak but stabilizing, leaving the way for an end in pricing and volume erosion. Curtailment of excess equipment together with growing instances of negative EBITDA margins in some segments leads one to believe that a point of equilibrium is near. Much like in the case of international, we believe Q2 will be the trough in NAM market conditions and financial performance.

Pipelines, I will take you through the quarterly performance of our ten service pipelines. I will go straight to the conclusion. Out of eight negative scoreboards, well construction was the best rather than the least bad pipeline with a near flat performance. Only two pipelines managed a positive scoreboard; integrated drilling and pipelines. Integrated drilling represents about 12% of the company’s revenues. As of right now we hold 12 concerned integrated project contracts. We are operating eight but [not the four] as of yet. The other four will get started up in the second half of the year and the first half of 2010.

The amount we will be operating we will be running integrated assignments of approximately 80 strings in EH and Latin America. These numbers will change as the year progresses. Acquisitions, we spent $68 million primarily on two acquisitions. The most important was buying the balance of the control pressure drilling software technology in the U.S. strategic for both our product line and Weatherford as a whole.

As a follow-up on the acquisition of TNK-BP’s OFS subsidiary, we have just cleared the Russian government’s antitrust process and we expect to close OFS within 30 days.

Forward views. As mentioned above, we believe NAM has reached its trough. We don’t have a particularly strong view as to the timing of volume recovery. We believe, though, that even without volume recovery margins in NAM will improve in Q3 and Q4 though progress will be gradual. Credit, low variable and fixed costs for that. Reduction in fixed costs are particularly important as they are designed to be structural and permanent.

In the last quarter’s conference call our comments were, “we expected 2009 double digit growth in our international business.” We have confirmed this with a high degree of certainty. It strikes us also that second half 2009 will set the stage for 2010 as a year of particularly strong growth in our international segments both Eastern Hemisphere and Latin America. The rate of growth 2009 to 2010 may rival what we experienced 2007 to 2008 moving Weatherford back on its long-term international growth goals.

Direction. No real change from three months ago. We are planning on CapEx of $1.4 billion predominately on infrastructure and equipment that will benefit 2010 and 2011 and over 85% of the CapEx will be for international regions.

In closing, two thoughts to summarize our operating focus. We see more opportunities to permanently reduce our cost structure in NAM and we will execute on these. Two, we are focusing with the same intensity on delivering strong operating performance to our international clients. Operating performance is the [inaudible] backbone of our planned growth.

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

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of James Crandell – Barclays Capital.

James Crandell – Barclays Capital

Can you talk about the trend in international margins from here? I thought you said the pricing may have bottomed and/or the pricing moves are behind you and maybe if you could comment on what you think is the trend in margins over the next few quarters internationally?

Bernard Duroc-Danner

It is a complicated issue because we have so many different markets and so many different contracts. We do the best job we can to measure analytically where pricing has occurred, why it has occurred and what is the timing for any kind of other pricing changes. Because of that analysis, which is about as real-time as you could have, we have come to the conclusion there is about more than 2/3 of our business or maybe 70% of our business in international markets which has been in one way or another, either mechanically or by negotiation or simply new business re-priced and the remaining 30-35% of our business is not likely to be repriced in 2009 and therefore by the time it gets repriced we think the positions may be different. So it strikes us that by and large the pricing effect on the international markets, with a few exceptions…there are always exceptions, is behind us.

That is statement one. Two, in general I think the market is red hot. Not at all. The tone is decent in the international markets. The tone is better which is also an environment which is less conducive to major pricing concessions. So between the analytical work and the tone, we are reasonably confident that pricing changes at least insofar as Weatherford is concerned, are behind us.

James Crandell – Barclays Capital

My second question has to do with the domestic market. I think it is no surprise that stimulation prices have collapsed but the magnitude of the drops in wire line and directional I’m sure were a big reason behind your poor results in North America. Can you comment on the weakness of that and are these 40-60% average price declines you have seen since the peak of the market the new reality of the market going forward?

Bernard Duroc-Danner

I think that my observation and I will also ask Andy to share his thoughts. My observation is that it seems that in North America there is no place to hide. Pricing was under severe pressure just about everywhere I can think about. To that degree, I think product lines like artificial lift, for example, had less pricing. Completion had less pricing. Anything that was drilling related was heavily pressured by clients. Andy you might want to add to that.

Andrew Becnel

I agree. I think our clients have gotten incredibly good over time at managing supply chain. They are doing a very good job of it with respect to the service industry today. We did see significant pricing declines quarter-over-quarter in places like directional and wire line. Not at the 60% level you are mentioning, but certainly in the 35-45% level in certain instances. Make no mistake about it, obviously with the focus on the unconventional there is not a heck of a lot of wire line activity going on there. If you look at the shift of rig count. On the directional side there is plenty of equipment out there and some of the conventional work doesn’t require incredibly sophisticated tools on the rotary steer or LWD side. So there is plenty of equipment out there and pricing certainly hit us.

Obviously we have fantastic legacy businesses in Canada in both directional and wire line and again when you start hitting around 60 rigs there is not a lot of drilling going on. Your price [tanker].

James Crandell – Barclays Capital

In Iraq, how quickly do you think the government work ramps up not just the contracts from FOC and Nissan but perhaps other companies and those two companies how quickly does their overall level of contracting ramp up? How about discrete awards coming from IOC’s outside of the normal bidding process?

Bernard Duroc-Danner

It is going to be hard to say. It is hard to say. You have a need for almost boundless link activity in that country to make up for really almost 40 years of non-activity. So that is one thing. There is evidence of declining production in some of those reservoirs and declining bottom hole pressures in some of those reservoirs so there is an urgent need. On the other hand, you have got a combination of a difficult political situation meaning that anything international is unpopular in the country and at the same time a very slow, best described as opaque decision making by the government. I am not being very helpful in terms of the timing except to say that there are a lot of initiatives underway both domestically and special negotiations outside of major tenders but I am afraid I can’t give you a date or even a sense of timing of when these things are going to be officially granted or officially become business for any one of the large service companies be it us or any of our peers. You have to take it; I’m afraid, month by month in that country.

James Crandell – Barclays Capital

Pertaining to Iraq, does it seem to you that because of the political security concerns that maybe the logistical concerns about Iraq that even the IOC’s that the business is likely to be awarded in some kind of IPM or modified bundled service approach versus picking and choosing best in class technology?

Bernard Duroc-Danner

I’m not so sure that security is as much the issue as the absence of infrastructure. One of the reasons why you don’t have much bundle or integrated anything in North America where it is possible to have it is because you have massive infrastructure. You have in fact too much infrastructure in North America. Iraq would be exactly the opposite. You have no infrastructure or you have antiquated infrastructure so as a consequence it is sort of hard to pick and choose your ten favorite vendors and put them together to do a program be it a production or drilling program. It is very difficult to do it that way. So you almost have no choice but to work with a small number of service contractors who either will be responsible for infrastructure or have infrastructure.

I think it is much more that than security. Security is another issue but I think whether it is with ten vendors or one vendor I think it is manageable either way. Equally difficult to manage is the infrastructure.

Operator

The next question comes from Ole Slorer – Morgan Stanley.

Ole Slorer – Morgan Stanley

I you gave us the numbers from your common trade but just in terms of understanding the magnitude of the drag from Canada, could you give us a little bit more color so we can kind of understand the U.S. margins?

Bernard Duroc-Danner

Whatever color you get on Canada is going to be dark. Because we don’t break it out that makes that a little bit more difficult. By way of demonstration, say that as a percentage of revenue Canada went from Q1 to Q2 cut in half. This is not a riddle I am giving you but it is giving you an idea. North America was not cut in half as a percent of revenues. Canada, within North America was cut in half.

Look, Canada will have its day and in the meantime one has to live with one’s legacy. Not that long ago Canada represented 25% of whatever was on the top line. It doesn’t represent 25% of our top line and it hasn’t in a very long time. It is only because NAM is down altogether to being 29% of Weatherford. Notwithstanding that, our legacy is one which still to a degree quite dependent when it comes to North America, the ups and downs of Canada. More so than our peers. At times it helps us. At times it hurts us. In this quarter it hurt us.

Ole Slorer – Morgan Stanley

If we back that out using some basic assumptions on fixed costs that are sticky, would it be fair to assume the U.S. margins were sort of mid single digits? Something like that?

Bernard Duroc-Danner

Yes that is correct. You are more right than wrong. You are in the right direction.

Ole Slorer – Morgan Stanley

So with Canada at least normalizing going into the third and fourth quarter would you expect that middle single digit margin level could be sustainable for North America as a whole?

Bernard Duroc-Danner

Yes. Put another way, I don’t expect Canada to be a good market any time soon. I don’t think it is going to fall off the map either. In Q3 and Q4, it will be better than Q2 simply because it cannot be as bad as Q2. It is not possible. Therefore, the negative numbers coming out of Canada in combination of that with the fact we are not sitting on our hands will mean that all things being equal North American margins will be up not by the U.S. but by simply Canada turning. So yes you should expect to see there is a decent probability that you will see margins in North America that are positive in Q3 and Q4 and along the lines of what you suggested.

Ole Slorer – Morgan Stanley

And the U.S. pressures there are they on a weaker note and how does it look?

Bernard Duroc-Danner

No, I don’t think the U.S. exited the quarter on a weaker note. Quite the contrary. I think the U.S. had a hard time in April and May. Canada had a hard time for the whole quarter.

Ole Slorer – Morgan Stanley

With the oil rig count bouncing back quite sharply and you having artificial lift and other oil related areas are these showing some signs of life at the moment?

Bernard Duroc-Danner

Yes they are. Of course they are not a large percentage of the U.S. but yes they are.

Ole Slorer – Morgan Stanley

I’m just trying to find some linearity. Finally, on [inaudible] could you give us some type of operational update there in terms of something that could help us gauge how efficient you have become or how much more there is to improve?

Bernard Duroc-Danner

What would you like to know?

Ole Slorer – Morgan Stanley

Cycle time on comparable wells with six months ago? Anything that could give us some kind of sense of…

Bernard Duroc-Danner

I will throw a number out and immediately it might be an over simplification but I think the drilling times have gone down by about 20%. That is one number. The second number is that you are not in full blown operation yet. You won’t be until year end. Year end you will have at least in today’s operational environment all the strings operating that you intend to keep operating.

Ole Slorer – Morgan Stanley

Clearly this is going to be a benchmark I would assume for what you are trying to do in other parts of the world?

Bernard Duroc-Danner

I genuinely hope so insofar as nothing is perfect but the quality of the operation is as good as probably anything I have seen. It has come a long way in terms of infrastructure, mobilization and efficacy in drilling. So I will let our performance speak for us. Both financial and also at the bit in that particular market. So, we will see where Q3 and Q4 numbers come out for Latin America but Latin America will now have to put up with declining, at least for us in Venezuela to the degree we saw in Q2. I can comment on that as well if you want because there are specific things to Weatherford which are not necessarily the same for everyone else.

Ole Slorer – Morgan Stanley

Please do.

Bernard Duroc-Danner

When we acquired Precision they had a large rig presence in Venezuela. That rig presence was not in a bundle of integrated assignments at all. They were just behaving like rigs. Nothing wrong with that. Although we are very interested in rigs as a step in a drilling string more so than in isolation. In the present environment and for reasons I think many of you will understand we are anxious to keep very large amounts of equipment in Venezuela to a degree and probability they remain active is very low. So we are over the course of the quarter we brought down the number of rigs running there from 7 down to 2 to date. Five pieces of equipment are either exiting the country or have exited the country already. If you do your math that has an enormously depressing effect on the top line of that particular country.

At the same time it reduces our exposure both in terms of margin and also in terms of receivables in that country. I don’t think that phenomenon as described exactly can be duplicated in Q3 and Q4 because this is a region we don’t have exposure anymore.

Ole Slorer – Morgan Stanley

In terms of this magnifying the impact, as a rule of thumb is $30 million of annualized revenue per string a good measure?

Bernard Duroc-Danner

No, just rigs. When you talk about integrated projects on strings typically we look at $40 million as a conservative number. If you move towards the east it ends up being more like $50-60 million depending on the contract. The West is more $40 million.

Ole Slorer – Morgan Stanley

So, going from 50 to 80 is 30 times 40. Should that be the increase in the run rate between now and the end of the year?

Bernard Duroc-Danner

That’s correct.

Operator

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

William Herbert – Simmons & Company

Back to the road map for non-North American margins if I heard you correctly you expressed that pricing as painful as it has been has basically from your standpoint largely unfolded and is behind you. Most of the damage has been done. I know it is difficult to be precise but with regard to the margin impact going forward in non-North America when do you expect the trough roughly to manifest itself and what magnitude of margin erosion, if any, do we have on the international front in aggregate relative to the second quarter margins?

Bernard Duroc-Danner

It is very hard to know because you have mix issues also and as projects turn on you don’t have any more of carrying the burden with nothing to show for it. You have a lot of that going on too. So you have really three things in play; pricing, mix and also end of start ups. I would say there is a bit [nast] over here on that particular issue. The bitter [nast] is that Andrew believes that we could have 100 basis point decline in Q3 and then from that point on either contract or rising in Q4. I actually believe that in Q3, first I believe we can’t tell because we have done as much analytical work as you can and we are reaching the limit to what we can measure and based on what I see I believe that we will not have 100 basis point decline in Q3. We will be flat or something like that or maybe better. Better is immaterial here. I should say flat to 100 basis point decline in Q3. He and I both agree that in Q4 it is flat to up.

William Herbert – Simmons & Company

Would you agree with the comment that if you have above average IOC exposure that you probably have more pricing mischief in front of you on a relative basis relative to those who have more NOC exposure on a relative basis?

Bernard Duroc-Danner

Undoubtedly. That actually is far less controversial than whether we are going to have improvement in margin in Q3 or up to 100 basis point decline which again I think there are limits to what we can tell. That, on the contrary, is black and white.

William Herbert – Simmons & Company

Shifting gears, with regard to TNK I was struck by the fact that the capital investment or capital spending profile is not going to change all that materially given that we have embraced TNK in Q3 so accordingly can you provide us with a roadmap as to the level of incremental capital investment you foresee as a result of having acquired TNK?

Andrew Becnel

I think most of it is not going to hit or be spent until 2010. There is a small amount of maintenance CapEx that will go with those rigs during the four months or so that we own them in 2009. Going forward you should expect the run rate on CapEx just solely with respect to the business acquired to be something between $75-100 million a year. Don’t forget with respect to the pull through we are looking for additional services expect another $100-150 million of investment into that business during 2010.

William Herbert – Simmons & Company

Also, any particular change with regard to the guidance provided earlier on the free cash flow front?

Andrew Becnel

No.

William Herbert – Simmons & Company

So we still expect $500 million for the year?

Andrew Becnel

Correct.

William Herbert – Simmons & Company

So that would imply a heavy harvesting in the second half correct?

Andrew Becnel

Yes on the working capital side.

Operator

The next question comes from Michael LaMotte – J.P. Morgan.

Michael LaMotte – J.P. Morgan

If I could follow-up on comments on Venezuela going from seven to two rigs, could you elaborate on what has happened in Colombia and Argentina as well? Certainly if I look at the quarter-to-quarter revenue and operating profit of your major competitor that reported today it was consistent with yours but they clearly don’t have the Mexico business or the Mexico ramp. So I just kind of what to understand what is happening perhaps on a competitive dynamic or line of business dynamic or even just your decision to downsize in Venezuela.

Bernard Duroc-Danner

I think the Venezuela loan on the top line side sort of absorbed all of the Mexico increase. It is almost a one for one. It wasn’t planned as such. These are two coincidental events. With respect to Argentina and Colombia it is not dramatic. In both cases, and I’m looking at the numbers right now, you are looking on the one hand an erosion of roughly $5 million on the one hand and about $10 million on the other from one quarter to the next. $15 million decline in those two if I read the numbers correctly. That is about right.

So it could be less than that. $25 million between the two of them. Some of the other smaller markets did reasonably well. But if you set aside Argentina and Colombia which is just a market for us at least in that particular quarter didn’t do very well and maybe does better next quarter the key event has been a pull down in Venezuela which was essentially mocked up by continued scale up in Mexico. That is about all we can say about Latin America.

Michael LaMotte – J.P. Morgan

But we should think about, at the true rig level, Venezuela really shouldn’t be hurting you in Q3 and Q4?

Bernard Duroc-Danner

No. An interesting example, the thing about rigs that is useful is it is easy to talk about them and it is easy to measure. But aside from rigs there has been a scale down in general in Venezuela. We like that market. We like Venezuela very much. It is a core market. It is a market that will come back. It is just a market where it is very difficult to have a large scale operation without having the risk of having very large receivable exposure.

Andrew Becnel

We take full responsibly for we delayed and held back shipments of product. A lot of our business in Venezuela is product. We held it back during the quarter just because of questions on payment and some specifics in some contractual terms. I think that was the right thing to do from a business perspective albeit pinches in these little 90 day windows we tend to focus on.

Michael LaMotte – J.P. Morgan

If I could ask on the exit and restructuring charges, at some point the non-recurring becomes recurring. We are looking at six quarters now and some $100 million. When do you see all this stuff wrapping up?

Andrew Becnel

I wish I could tell you. It is not something with respect to the timing of the investigation or the substance of it…it is not something I should be commenting on. In terms of the details in public. It goes without saying, I think in our experience if we were to just look at a statistical spread of how long these investigations tend to last it tends to be quite a long time. It has been two years now. We obviously hope and look forward to getting that wrapped up and resolved as quickly as we can. We are not the ones in control of the schedule.

Bernard Duroc-Danner

In general, the investigation has been done as thoroughly as you can humanly carry out an investigation which is a good thing. So that is one thing. What is thorough takes time. The other thing is philosophically I think typically processes of government take time.

Michael LaMotte – J.P. Morgan

Has the change in administration slowed things down?

Bernard Duroc-Danner

Not discernibly. I think this takes the time it takes. The fact it is thorough means it takes maybe more time but I think that is actually a good thing. We are very anxious for it to be brought to an end. We are hopeful that we made progress but then again we are not in control of this.

Operator

The next question comes from Dan Pickering – Tudor Pickering.

Dan Pickering – Tudor Pickering

You talked about international revenue growth in 2010 of something like 2007/2008. I just want to make sure I understand. My model shows that as a roughly 30% number. Is that the ballpark you are trying to get?

Bernard Duroc-Danner

I don’t expect people to; One, believe me to pay us [for it]. I fully understand that. At the same time, I have got to tell you what we see. What we see with respect to Weatherford is that we have had a very long season period over the past three quarters with a decline in some of our business. At the same time we made progress in other very important markets. It looks when you line up the numbers that it will be a little bit of a catch up year. That is my best observation. Again I don’t expect that people will believe me at face value or two, give us credit for it but I am trying to give you what I see. If I saw it different I would tell you.

Dan Pickering – Tudor Pickering

I want to make sure that I understand what is included as you are talking about things. I assume that BP-TNK is part of that?

Bernard Duroc-Danner

Yes it is. I don’t think that is the main driver but yes it is.

Dan Pickering – Tudor Pickering

I know there are some fairly significant numbers out there in the marketplace regarding Iraq. We have heard $1 billion in Iraq for 2010. We have also heard Mexico at $2-2.5 billion. In your 30% number are Iraq and Mexico at that size?

Bernard Duroc-Danner

No, I say no in the sense that at this stage we are in July so we have another six months to go. What we have done is we looked at the high/low what is likely in the international markets in terms of going through our P&L. Not just business but in terms of being able to execute on it. There is a difference which is the lag of mobilization, etc. When you look at the high/low what is likely in 2010 it looks strong. That is where the comment comes from. Now, on the high side you have a lot of things you described and based on others too. On the low side you have less of it. Even on the low side I think it is a strong number and that is what we are reporting. I don’t think I want to be more analytical than that at this stage.

Dan Pickering – Tudor Pickering

The 30% number year-over-year similar to 2007/2008, that is the low side or the middle case? I’m not sure I heard you.

Bernard Duroc-Danner

Because I didn’t say whether it was.

Dan Pickering – Tudor Pickering

I think you said low side and I just want to confirm.

Bernard Duroc-Danner

I think that is actually more on the low side than on the high side. I really don’t want…that is not what I want to say now but since you made me say it so be it.

Dan Pickering – Tudor Pickering

Coming back to North America, $150 million in fixed cost reductions discussed here during this call. Did we see all $40 million-ish of that this quarter or will there be more of that next quarter?

Bernard Duroc-Danner

There will be a benefit next quarter. We saw some this quarter but the benefit next quarter for sure.

Dan Pickering – Tudor Pickering

We dropped quarter-to-quarter in North America profit dropped $124 million. Was Canada half that? More than half that? Again, just trying to dial in to the magnitude of the Canadian impact.

Andrew Becnel

No, Canada is not half of that.

Dan Pickering – Tudor Pickering

So a big chunk of it coming from North American business.

Andrew Becnel

Yes.

Operator

The next question comes from Kurt Hallead – RBC Capital Markets.

Kurt Hallead – RBC Capital Markets

Sort of a dovetail to Dan’s question, focused a little bit more on 2009 than maybe 2010. You talked about double digit Eastern Hemisphere growth in 2009 versus 2008. Year-to-date so far has been 5%. Just want to try to gauge is that double digit primarily going to be off the TNK-BP acquisition and if not could you just give us some color on how we go from a 5% year-over-year to a double digit? Project awards or otherwise some things you might be able to help us with?

Bernard Duroc-Danner

I think TNK will add what, more than $100 million worth of top line between now and the balance of the year. So about four months or so maybe a bit more. It could be $125 million. I don’t exactly know. It is a little bit the same exercise in 2010 with more granularity which is that you have got a number of different service businesses cropping up. You have increases in volumes in service businesses that are already ongoing. You have delivery of products. Then you have got a number of different forecasts. I don’t know that we will be double digit or not for sure. We may be a bit better than industry. 10% maybe a bit less. I don’t know but it seems that double digits is about right for EH but it is not one big project that sort of saves the day. It is a multitude of little businesses that are either catching up, delivering or ramping up or stepping up. It is a lot of little streams. It is not a big river.

For 2010 there are a number of big rivers that are making the numbers bigger but between now and year end no it is a lot of small things. I couldn’t begin to give you the details.

Kurt Hallead – RBC Capital Markets

In your commentary you referenced integrated drilling and integrated project management. Can you help us understand the difference between the two?

Bernard Duroc-Danner

Well, you have got at one end of the spectrum one of our peers describes as bundled which is when you have separate contracts with a client but they are on the same field and the client fully expects to have you coordinate and harmonize the different parts and services when you execute. That would be the case in Russia. At the other end of the spectrum you have got contracts that cover operations for an entire phase of a field development in some cases up to 20 years or 25 years and you have got contracts that are defined in chunks of five years and those chunks of five years cover every single aspect of what is being done. You are responsible fully as if you were the EP company taking the reservoir risk for all of the operation. That would be on the opposite spectrum that would be the case in Oman.

Semantically really the latter could be called integrated project management. The former you could call it anything you want to but it is the same sort of rationale except contractually a little bit different.

Andrew Becnel

What you see reported on integrated drilling as a product line in terms of revenue number really encompasses rigs, well site supervisors, coordination, revenues associated with those items. Whereas when we talk about IPM which is not a product line in terms of what we separate out that has to do with the type of contract that is under place and the various revenue from each of the various products and services is allocated to each of those products and services as they are performed on the project.

Does that help?

Operator

The next question comes from Michael Urban – Deutsche Bank.

Michael Urban – Deutsche Bank

I wanted to come back to Russia a little bit. You talked about the strategy there a little bit at the time of the acquisition. I am just wondering if you could expand on that as you close the acquisition what are you going to be trying to do there? What is the scope of opportunities in Russia with the new platform?

Bernard Duroc-Danner

The first thing we are going to try to do is we are going to try to integrate the organizations together. Have people move together at the overhead level, learn how both organizations work and also learn how both operations where they are operating and how they work in various locations. So you have integrations that go on, actually has already gone on in an arm’s length basis, but now as soon as we close it will go on as one organization. In terms of the market and how to try to harvest it, you will remember the various engines we intend to use. One is one that we don’t drive; it drives us which is the level of market activity. The level of market activity in Russia should be volume a little better in the second half of the year and in 2010 if only because it was so bad in Q4, Q1 and Q2. Two, we intend to use the tremendous infrastructure and footprint of TNK OFS in order to try to sell some of the drilling parts and services that relate to the various fields that the rigs work on, not on an integrated manner, that is way premature, but simply concurrently with drilling activity with the rig business selling, directional selling and construction and so forth. Not even in a bundled way. Simply as a pull through of the rigs acting as a distribution system.

That is the second important engine. The third one is the operations at TNK have for all its life only worked with TNK. It started working for some other clients late in the process the past two years but never represented more than 5-10% of business. So the idea is to be able to take the TNK operation and make it into a service provider for [Rosnieff] and for [inaudible] and so forth and so on. Why would we be successful in doing it? It is a very fine operation in terms of drilling efficacy I don’t think there is a better one in Russia. We also have a lot of equipment which I think can be deployed in the market which has not been deployed on the market.

The flip of it, it is hard to have people who never had to sell for a living to learn how to sell. We only have one client you don’t have to sell you just coordinate with that client. So you have got obviously a lot of work to do. Those are the engines that will provide a return on our investment on our time. We are acutely aware of it and so is the organization. I think you have to give us 2-3 quarters of seeing how well it is doing. At a minimum though the operation will be carried by the Russian market by simple fact that it is a very, very good drilling operation. So without us doing very much of anything it should earn a living. The question is can we do more than earn a living. Can we provide an outside return for it and that implies pull through on the one hand and second gaining share with other clients outside of TNK.

Michael Urban – Deutsche Bank

So by maybe the middle of next year it would be reasonable to have this thing integrated and start to be able to pull through some services and expand the customer base?

Bernard Duroc-Danner

Very much so. Very much so. That is exactly our timing actually.

Operator

The next question comes from Geoff Kieburtz – Weeden & Co.

Geoff Kieburtz – Weeden & Co.

Coming back on a couple of topics that have been touched on, focusing just on the U.S. what do you see going on in terms of pricing trends today? Are you seeing pricing eroding in the U.S. through the quarter or has that stabilized?

Bernard Duroc-Danner

I think it has stabilized, at least in our case, it really has.

Geoff Kieburtz – Weeden & Co.

That is pretty much across all your product lines?

Bernard Duroc-Danner

Yes there are a few exceptions here and there but I think statistically for your purposes I don’t see any further erosion from where we were in Q3.

Andrew Becnel

Average pricing will be lower in Q3 in the U.S. but up a little bit in pricing and volume up a bit in Canada. From a revenue perspective I would expect something flattish with I don’t think any up tick on the volume side in the United States but there are other points of view that could be just as good as that one. I also think U.S. revenue probably down a touch and Canada just recovering, going from 90 rigs to 200 and change.

Geoff Kieburtz – Weeden & Co.

You mentioned you see other opportunities or fixed cost reduction in North America. Could you just remind us a couple of things; what are you sizing your infrastructure in North America to address in terms of activity? You talked about permanent reductions here so I am assuming that you are talking about having a pretty long term view as to what kind of level of activity you are prepared to address.

Bernard Duroc-Danner

When you look at the size of our operation in the United States, you have to ask yourself do I need this amount of infrastructure to serve the market as it was in 2008? Meaning, can you organize your infrastructure in a manner where you can reasonably, without being overly simplistic, harvest the volume that you may get back one day just as efficiently but without carrying as large of a fixed cost structure as you presently are. So the exercise is really one of productivity which is trying to organize what we are carrying in terms of support costs and physical infrastructure but organize in such a manner that you can still harvest the market as it was in 2007/2008 but not have to have the number of facilities and the number of support functions and the differentiation of one support function to the other that you have historically. The notion that you have to be very, very large an organization and be everywhere or else you can’t harvest an up side in the market I think is a notion that should be challenged. Certainly in our case.

I think it is not easy. You have to be careful how you make your decisions but it is incumbent upon us to look very hard at other ways in which we can pull some fixed costs out of the organization permanently without abandoning the up side in the North American market. North America being a very high [beta] market you will have some upside eventually.

Geoff Kieburtz – Weeden & Co.

So you have said a couple of times in the past that you were sizing the North American fixed cost base to be I think profitable at an 800 rig count but you don’t see that as being inconsistent with being able to service the kind of activity…

Bernard Duroc-Danner

That is precisely what we are trying to do. It is not easy. It is not a one quarter process. It is not linear and so forth and so on. We don’t model it that easily. That is precisely what we are trying to do.

Geoff Kieburtz – Weeden & Co.

On the international pricing, I missed the first question. I think you addressed it. With the rolling over of pricing and the signing of new contracts, I’m not quite clear why you don’t see some sort of a slide in the average pricing outside of North America at least for another several quarters.

Bernard Duroc-Danner

Our analysis, this is the first question I answered, our own analysis we have already either renegotiated contracts, have new contracts or some contracts have mechanical clauses that all three categories have already been done. You may have in Q3 sort of the full three months of particular pricing declines. That is sort of the debate of whether it is flat or the 100 basis point decline in margins in Q3. You have the issue of mix and the end of start up costs. You have about 30% or 1/3 of our business internationally, best that we can tell, that has not been re-priced materially but those particular contracts do not come for renewal for quite some time. Let’s say some time in 2010 at which point the market environment may or may not be conducive to price reductions then. So we are pretty much done on the other 2/3 or 70% of our existing business internationally, on pricing negotiations. By way of example, look at the [inaudible] contract. There isn’t any pricing negotiation to be done there. You are set until these contracts run their term.

That is just an example so that you understand that falls in the 30% to 1/3 of our business which is not going to be impacted. They may be at low prices to begin with, mind you, but they are not going to be impacted. The rest is pretty much done. Mechanically it could depress margins in Q3 but more simply because the three months or a month or two months of pricing, that is debatable. Insofar as we are concerned, we don’t see any other deterioration in pricing in our P&L internationally with the exception of Q3 possibly some. The arithmetic average of existing pricing declines.

Geoff Kieburtz – Weeden & Co.

One quick question on the TNK acquisition. Not to hang you up on an off the cuff comment, but $100 million of revenue at TNK for the last four months of this year would I think kind of back into a 50% lower revenue base than what they had in 2008 if I remember correctly. Is that kind of the ballpark?

Bernard Duroc-Danner

They were running, estimated running in 2009 at $450 million revenue for the whole year. So take four months as the third. 450 divided by 1/3 is more than 100. It is 150 roughly. 125-150. Four months.

Geoff Kieburtz – Weeden & Co.

So that is still a good estimate for 2009?

Bernard Duroc-Danner

Yes, I think for modeling purposes it is about as good as you can get.

Geoff Kieburtz – Weeden & Co.

Your outlook for that business, just the straight TNK what you are buying, in 2010?

Bernard Duroc-Danner

Well I think we haven’t changed at all what we though originally which is the business itself will be anywhere from 650 to a higher number. I don’t want to tell you more than that.

Operator

The next question comes from Dan Boyd – Goldman Sachs.

Dan Boyd – Goldman Sachs

A question for Andy on Canada. You mentioned that you had expectations for 200 and change in terms of number of rigs for next quarter. Is that enough for you to break even there?

Andrew Becnel

Yes.

Dan Boyd – Goldman Sachs

So then if things are flat in North America, as you are expecting, we should see margins of 4.5% next quarter would be our expectation?

Andrew Becnel

I think that is a fair estimate. It might be a little bit better than that but let’s see.

Dan Boyd – Goldman Sachs

On Latin America, I think we have talked before that you would be at a $2 billion annual run rate just from Mexico by the fourth quarter. That is $500 million. Can you give us an update there? Then with Brazil, also similarly ramping up we should be north of $700 million in the fourth quarter in Latin America?

Andrew Becnel

Yes, I think it will comfortably be north of 600 in Q4 out of Latin America. I think that $2 billion is still a good run rate coming out of Mexico leading into 2010.

Bernard Duroc-Danner

Nothing has changed in Latin America in terms of how we look at it.

Dan Boyd – Goldman Sachs

And margins from here and Latin America with that type of ramp up in revenue, Venezuela not being much of an impact, we should see improvements in margins in Latin America?

Andrew Becnel

Yes, taking out any type of sequential impact for any further deterioration in other markets, margin should be steady here and then improving through the course of the year.

Operator

At this time I would like to turn the call back over to Mr. Duroc-Danner for closing remarks.

Bernard Duroc-Danner

No closing remarks. Thank you very much for your time and we will take additional questions off line. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect.

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Source: Weatherford International Q2 2009 Earnings Call Transcript
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