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National Oilwell Varco, Inc. (NYSE:NOV)

Q2 2009 Earnings Call Transcript

July 28, 2009 10:00 am ET

Executives

Loren Singletary - VP, Global Accounts and IR

Pete Miller, Jr. - Chairman, President and CEO

Clay Williams - SVP and CFO

Analysts

Roger Read - Natixis Bleichroeder

Bill Herbert – Simmons & Company International

Jim Crandell – Barclays Capital

Joe Gibney – Capital One Southcoast

Collin Gerry – Raymond James

Geoff Kieburtz – Weeden & Co

Operator

Good morning ladies and gentlemen and welcome to the National Oilwell Varco second quarter 2009 earnings conference call. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please not that this conference is being recorded.

I will now turn the call over to Mr. Loren Singletary, Vice President Global Accounts and Investor Relations. Mr. Singletary, you may begin.

Loren Singletary

Thank you Christine and welcome everyone to the National Oilwell Varco second quarter 2009 earnings conference call. With me today are Pete Miller, Chairman, President, and CEO, and Clay Williams, Chief Financial Officer.

Before we begin this discussion of National Oilwell Varco's financial results for its second quarter ended June 30, 2009, please note that some of the statements we make during this call, may contain forecasts, projections, and estimates, including but not limited to comments about our outlook for the Company's business.

These are forward-looking statements within the meaning of the Federal Securities Laws, based on limited information as of today, which is subject to change. They are subject to risk and uncertainties and actual results may differ materially. No one should assume that these forward-looking statements remain valid later in the quarter or later in the year.

I refer you to the latest Form 10-K, National Oilwell Varco has on file with the Securities and Exchange Commission for a more detailed discussions of the major risk factors affecting our business. Further information regarding these, as well as supplemental, financial, and operating information maybe found within our press release, on our website at www.nov.com, or in our filings with the SEC.

Later on this call, Pete Clay and I will answer your questions. We ask that you limit your questions to two, in order to permit more participation. Now, I’ll turn it over to Pete for his comments.

Pete Miller, Jr.

Thanks Loren and good morning. As Loren said I’m Pete Miller CEO of National Oilwell Varco and welcome to our second-quarter 2009 earnings conference call. Earlier today, we announced earnings of $220 million or $0.53 a share on revenue of a little over $3 billion.

Included in this result are some unusual charges of approximately $224 million pretax or $0.37 per share. In a moment, Clay will discuss these charges in detail. Additionally, we announced new capital orders of $615 million, an increase over the $270 million announced in the first quarter.

Also, we announced discontinued orders of approximately $100 million to end the quarter with a solid backlog of $8.7 billion. We will also discuss this backlog in greater detail in just a moment. We continue to build on a strong balance sheet and position the company to withstand the current challenging times and prepare for the opportunities that the future will ultimately present.

In a moment I will come back and talk a little bit about the operations and give you a worldwide overview of what we are seeing. But at this point I would like to turn it over to Clay to provide more background on our quarter.

Clay Williams

Thanks Pete. As Pete mentioned National Oilwell Varco did earn $220 million or $0.53 per share on $3 billion in revenue in its second quarter ended June 30, 2009. Broadly, we saw excellent execution by our Rig Technology Group once again in the second quarter, posting sequentially higher margins on lower revenues.

However our second-quarter results both petroleum services and supplies, and distribution services declined due to falling rig counts stand increasingly fierce pricing pressure in North America, partly offset by relative strength and stability in certain of our international markets.

I would get into these market forces a little more in a moment, but first I would like to note that our second-quarter GAAP results do reflect a number of charges, which bear addressing.

First, we recognized $147 million pretax or $0.23 per share after-tax impairment charge on our carrying value of trade names acquired in our Grant Prideco acquisition, which we closed in April of last year. This is a non-cash charge, which arises from our retesting of all of our goodwill and intangible assets during the quarter in view of the deterioration in the rig count.

Second, we recognized $56 million in pretax charges related to acquisitions made in the quarter and the result of a voluntary retirement program offered to our long tenured employees. These total $0.09 per share after-tax. $10 million of the $56 million of this are transaction charges arising from legal due diligence and other costs associated with acquisitions that were previously capitalized under GAAP, but which now must be expensed under FAS141(NYSE:R).

The voluntary retirement program charge of $46 million of pretax is half in cash and half accrued retiree medical expenses and option expense. The voluntary retirement program was completed during the quarter and is expected to result in annual savings of approximately $33 million per year.

We have broken out the voluntary retirement program costs separately because it is a large discrete program in effect for a limited period only, which was a specifically approved by our Board of Directors.

We do not typically breakout other operating severance restructuring charges other than those specifically related to acquisitions, but I will tell you that these are about $10 million in the second quarter up from $7 million in the first quarter.

Third, we recognized $21 million in additional tax provisions related to our reconciliation of our tax return in Norway, which we filed during the second-quarter to our tax accrual. The tax is a result from gains on dollar-denominated non-monetary accounts recognizable for tax purposes when these are translated into kroner in our statutory accounts at the lower Kroner FX rates seen in late 2008.

This discrete item drove our tax rate from 32% to 37% in the second quarter, impacting it about by about $0.05 per share. We expect this rate to drop back into the 32% to 33% range for the remainder of the year and are hedging the exposure going forward. Excluding these three items, earnings were $376 million or $0.90 per share and operating income was $589 million or 19.6% of sales.

Consolidated revenues declined 14% sequentially and 13% year-over-year, and operating profit decremental average was 28% sequentially, and 44% year-over-year, excluding impairment, transaction, and retirement charges; and including a full-quarter contribution from Grant Prideco during the second quarter of 2008 on a pro forma combined basis.

Our rig technology backlog declined 10% sequentially to $8.7 billion, as we shipped $1,434 million out as revenue during Q2, booked $616 million in new orders, and canceled and removed $108 million from the backlog. We expect $2.5 billion of the backlog to flow out as revenue during the second half of 2009, up slightly from our last forecast.

$4.7 billion to flow during 2010 and $1.5 billion balance to flow out in 2011. Currently, 12% or $1 billion of our backlog are for land equipment and 80% or $7.7 billion are offshore. About 74% or $6.5 billion are major offshore new build projects and $1.2 billion are offshore replacement and upgrade equipment. Only 8% of the backlog is for the US with the rest going overseas.

The second-quarter backlog cancellation mostly pertains to a semisubmersible package destined for Brazil for which our customer was unable to secure financing. Concurrent with reliving this from our backlog we booked a $16 million gain from the down payment.

Total cancellation since the late 2008 downturn had been $235 million and total orders had been $1.7 billion. We encourage that some of our customers were beginning to say a little fall in the credit markets and our Q2 bookings include a drill ship package for Brazil that finally secured financing, partly with the help of government export finance agencies.

In particular trade finance assistance from Korea, Norway, China, and other countries are expected to play an increasingly important role in the financing needs of our customers, and we are encouraged to see steady, if somewhat slow progress on this front. Nevertheless, financing remains the single biggest obstacle between us and new orders.

With banks pushing for higher fees, higher interest rates, and higher levels of equity in new projects. Reluctance by majors and NOC’s to sign up long-term contracts make securing financing doubly challenging for drilling contractors these days, Brazil notwithstanding.

As of June 30, we estimate about 4% or $320 million of our backlog is at risk for cancellation. We continue to assist these troubled customers in their efforts to secure financing or make alternative arrangements to continue the projects. These alternative arrangements do not include reducing the price by the way.

Tax received on these projects totaled $115 million so far, far less than the amounts we have spent on these projects. Our order outlook for the remainder of the year is good, but has evolved into a distinctly hockey stick shaped. We expect orders from three main sources, first, 11 off the original 12 new built rigs launched by our letters of intent from Petrobras about a year ago are proceeding in the various stages of construction or financing.

Half a dozen of these new floaters continue to seek financing and remain unbroken by NOV or its competitors. At this point, we expect to book a portion of these late in the year. Second, NOV and its competitors have been working with Petrobras on specifications for another 28 rig equipment sets for floater new builds, it would like to have constructed in Brazil.

Our progress has been slow, Petrobras in both words and actions is clearly committed to securing more deepwater drilling assets to develop its massive Santos Basin discovery, and we remain optimistic that tenders will be issued before year-end.

Third, we are working with other established drillers on a variety of deepwater floater projects for other markets including West Africa, the Far East, and Arctic locations. All these potential deepwater prospects are in addition to land rig and jack up increase for the Middle East, Caspian, and Latin America, Platform upgrade opportunities in the North Sea, and wire line equipment worldwide.

We don't expect much in the way of orders from pressure pumping or drilling markets in North America for the foreseeable future, but have had a modest increase in pressure pumping increase in international locations. On the deepwater rig front favorable FX moments, lower steel prices, discounts we are offering, and rising price competition from increasingly hungry shipyards are cutting the oil-end price of rigs by 15% to 20%.

Nevertheless, outside of Brazil drillers are moving with far less urgency than was the case between 2006 and 2008, given the higher availability of shipyard slots, even as their fleets get another quarter older and another quarter rest year. As a reminder 74% of the worldwide jack up fleet and 61% of the worldwide floater fleet are more than 25 years old. Like a lot of baby boomers, these are approaching retirement.

In the meantime, execution by Rig Technology Group on a healthy current backlog book remains excellent. Installation and commissioning of new rigs continue extremely well with five offshore rigs delivered this quarter and 59 offshore rigs delivered so far this cycle, just shy of 10% of the fleet size when all these buildings started four years ago.

Our service businesses face far more challenging market conditions and we are severely impacted by price competition, particularly in North America, where rig counts fell 29% from Q1 in the US and Canada endured an unusually difficult breakup season, witnessing 47% year-over-year rig declines and 73% sequential rig declines.

Pricing dropped as much as 30% to 40% across many product lines in North America. International markets held up better with pricing down 5% to 20% as the rig count inched down about 4%, nevertheless our PS&S Group was able to post 9% sequential international gains, about half of which came from acquisitions.

International distribution sales dropped following a strong first-quarter artificial less sale into Latin America. Many of the consumables we sell through petroleum services and supplies and distribution services are down sharply, as our drilling contractor customers cannibalize idle equipment from stacked rigs rather than place purchased orders with us for new equipment, as slash-operating and capital expenditures in the face of low day rates.

Therefore current demand for these does not necessarily reflect actual worldwide consumption and demand should pick up concurrent with the recovery in the rig count. We do not see a meaningful recovery in North America this year, but are nevertheless convinced that steep shale gas decline gas decline curve and oil prices above $60 are likely to fuel at least a modest rebound in 2010, provided economic activity doesn't take another leg downward.

Cost-cutting efforts across the Company continue through the second quarter, but we are now able to offset sharp pricing declines. SG&A declined 10% sequentially despite three acquisitions flowing in for most of the quarter.

As we discussed last quarter, we are performing some heavy lifting during this downturn, driving in-source -- driving two in-source more through our internal plans to improve absorption, consolidating facilities where needed, pushing cellular manufacturing, and lean manufacturing techniques through our manufacturing locations and executing consolidation opportunities with recent acquisitions.

For example, our rig technology group has rolled out an initiative to speed order fulfillment by driving more standardized product configurations and improving process flow through its factories on items such as mud pumps and blowout preventers.

We also continued to evolve our manufacturing sources to higher productivity plants. All this can be disruptive to our operations, but is candidly easier and less risky to accomplish as business slows. We do not believe pricing pressures has stabilized, but we do expect cost cutting initiatives already enacted and underway will help stabilize margins in the third quarter.

Our acquisition team has been busy and we are pleased that NOV acquired three companies during the second quarter, including many manufacturers of wire line and flow line equipment, and a business to complement our solids control operations. We currently have a number of discussions underway with additional acquisition candidates and hope to close additional transactions later this year.

In a cyclical business like oilfield service as acquisitions are less risky during a down market, down when times of booming, I will stress again that NOV is exceptionally well-positioned and well-capitalized to execute investment opportunities during this downturn, with nearly $2.3 billion in cash, a $2 billion revolving line of credit, a book of business totaling nearly $9 billion, and an awful lot of experience at integrating acquired companies.

While 2009 will continue to be a challenging year, we have enormous confidence in the smart decisive leaders running our businesses and we are grateful for the tremendous job that they do.

Now let me turn to a segment operating results. Rig Technology posted revenues of $1,917 million in the second quarter, a decrease of 13% from the first quarter and flat with the prior year quarter. Operating profit was $536 million, yielding a record operating margin for the group with 28%, due in part to the gains on the canceled semi-submersible package.

Excluding this item, margins were 27.2% down slightly from Q1. Decremental leverage or flow-through was 25% from the first quarter, and 30% sequentially, excluding the cancellation gain. Revenue had a backlog of $1.4 billion, fell 15% sequentially, as both project revenues and discrete capital unit sales failed proportionately.

Aftermarket sales and services, which is about two-thirds offshore and one-third land, declined 3.6% sequentially and non-backlog capital sales were down 5.6% from the first quarter. Generally, our sense is that most drillers hit the brakes hard in the first quarter, reflectively stopping both new capital expenditures, and nonessential operating expenditures, and that these are slowly returning to more normal levels, during the second quarter.

This is admittedly anecdotal, and time will tell over coming quarters. In addition to Brazil, demand for equipment for the Middle East, IBM projects in Mexico, and upgrade products for North Sea platform cranes and winches remain steady to slightly improving and we are seeing rising interest for equipment for Iraq.

Interest in frac equipment for China picked up late in the quarter, after a nine-month long and wire line equipment demand has remained steady throughout. Instrumentation sales and rentals went down with North American rig count in the completion of a large sale into India in the first quarter.

We also secured a significant order on work over rigs for Russia during the second quarter, and are seeing great performance from the first of several new Drake rigs we had sold into the Marcellus shale and other markets. Looking into the third quarter, we expect to see roughly flat rig technology revenues at lower margins, due to the non-recurrence of the Q2 cancellation gain, and a modestly lower aftermarket mix.

The petroleum services and supply segment posted revenues of $913 million in the second quarter, down 10% from the first quarter of 2009 and down 27% from second quarter 2008. Operating profit was $96 million and operating margins dropped to 10.5%. Sequential leverage or flow-through was 67%.

Excluding the acquisition impact, petroleum services and supplies revenue declined 13% sequentially at 55% flow-through resulting in a more severe margin contraction than we had expected due to more pricing pressure than forecast in our base business.

Year-over-year the group saw revenues declined 27% at 60% decremental flow-throughs. Sales and rentals were downhole tools and bits, composite pipe, coil tubing -- and coil tubing saw large double-digit declines, while other products were down only modestly from the first quarter to the second.

Virtually, all products and services posted sequentially drops in North America, which declined a less than 50% of the groups mix during the second quarter in the aggregate. However, international sales increased in absolute terms by 10% sequentially, due to strength in Latin America and Europe.

Drill pipe sales were roughly flat sequentially, but margins improved on a better mix of premium high torque and lower cost. Sales of other expendable suffered from vigorous cannibalization of equipment by hungry drilling contractors off of their growing stacked rig fleets.

The seasonal break up in Canada when road bands go into effect that prohibit movement of heavy rigs during the spring fall, drove the rig count there down 73%, which led to 46%% lower sequential sales in Canada for the PS&S group. We expect only a modes recovery in Q3, led by Southeast Saskatchewan and rising interest in the mounting of Horn River Shales in BC.

Our forecast for petroleum services and supplies point to a modest third quarter decline in revenues. The slight seasonal recovery in Canada and increases in certain international markets will only partly offset lower drill pipe sales and further pricing declines.

Margins are expected to remain roughly flat. Distribution services generated $305 million in revenue in the second quarter, down 25% from the first quarter and down 28% from the second of last year. Operating profit was $10 million and margins were 3.3%, representing 15% decremental average from the first quarter, and 13% from the prior year quarter.

This group has achieved good success over the past few years increasing its international presence, which now accounts for 32% of its sales, but still derived [ph] 68% of its sales from North America, which softened considerably in the second quarter. Given this, we are pleased with the 3.3% margin this group was able to post in the second quarter, which was achieved through diligent attention to cost and efficiency and achieved in spite of 2% to 3% pricing concessions made across the United States.

Overall, North America declined 31%, but international sales fell 2%, down about 19% due to weakness in the Far East were a large rig up job was pushed out to Q3, and lower artificial list sales in Latin America. The group continues to modify its store network to expand coverage of the emerging Marcellus Haynesville in South Texas Eagle Ford shale plays, while also expanding its presence in Brazil, Mexico, and Central Asia.

Looking forward in the third quarter, we expect distribution services revenues to improve in the mid-single digit range at roughly flat margins as additional price pressure offsets normal volume metric operating leverage, which is historically run in the 10% range.

Turning back to National Oilwell Varco's consolidated second quarter income statement, overall revenues declined 14% and gross margins were down 80 basis points from the first quarter to the second.

SG&A declined $31 million sequentially, and overall operating profit declined 46% including impairment transaction retirement charges and declined 18%, excluding these. Equity income from our unconsolidated joint venture of Voest-Alpine declined $12 million, sequentially to $16 million and is expected to continue to fall down to about breakeven levels in Q3, due to lower OCTG pricing, and a scheduled mill shut down in August.

Other expense on our second quarter income statement was $38 million, which was $2 million higher than the first quarter. Contrary to my guidance last quarter, we again booked substantial foreign exchange charges totaling $29 million in Q2 from two primary sources, Norway and the UK.

In Norway, like last quarter, we reversed some over hedge positions related to large multi-year rig construction projects managed through our operations there. In the UK, we saw adverse movements in the pound sterling, which affected both our un-hedged operations there and our new acquisition.

As I have noted in the past given our extensive international operations will always have some level of foreign currency exchange volatility. Unallocated expense and eliminations on our supplemental schedule, which is pro forma for the Grant Prideco acquisition for all periods, were $53 million in the second quarter, down $22 million sequentially, and up $4 million year-over-year.

High second quarter legal and litigation expenses compared to both periods were offset by lower overhead and incentive compensation accruals in the second quarter. As I mentioned earlier, we expect that Q2 37% tax rate to drop back to the 32% to the 33% range for the remainder of the year.

Depreciation and amortization was a $122 million in the second quarter and CapEx was $64 million down $15 million sequentially. We expect 2009 capital expenditures to be in the $320 million range, down about 10% from our prior guidance. EBITDA was $689 million in the quarter, excluding transaction retirement and impairment charges down 17% sequentially.

Our June 30, 2009 balance sheet employed working capital, excluding cash and debt of $2.5 billion, up $270 million from the first quarter, due mostly to lower accrued taxes and payables and lower customer prepayments. Working capital on this basis equals 20.5% of annualized revenue, up 16% from the prior quarter. DSOs were up slightly as the $289 million decline in accounts receivable was more than offset by the $471 million sequential revenue decline.

Customer financing on projects in the form of prepayments and billings in excess of cost less cost in excess of billings was $2 billion at June 30 down $132 million from the prior quarter, due to lower customer prepaid accounts. Cash flow from operations for the second quarter was $414 million, and less second-quarter CapEx of $64 million yielded free cash flow for the quarter of $350 million.

At this point let me turn it back to Pete.

Pete Miller, Jr.

Thanks Clay. At this point I would like to make a few comments about our operations and then I will turn it back over to you guys for whatever questions you might have.

I think that the overriding theme is going to be cost containment and cost control. We clearly understand what is going on in the marketplace today, I mean, as Clay pointed out we know what is happening in North America, and I would caution everybody that while we think we are at the bottom, the bottom does not mean going up. You know, I think you could very well be looking at fishing along the bottom for a period of time.

I think the other thing that Clay pointed out is that pricing pressure remains. I think, we can mitigate the pricing pressure with the things we have done on cost containment, but I think that to believe the prices won’t go down any further is probably her shade not even [ph] at this point because that happens in this kind of environment.

I mean, I hate to throw out the I’ve been in the business for 30 years card, but I'm going to throw out the I've been in the business for 30 years card and whenever we think pricing has hit the bottom, it continues to defy and go down even further.

So, what we believe we are positioned well enough to take care of that. And there are some green shoots and I will talk about those green shoots in just a moment, but first I would just like to talk a little bit about what we're doing in our operations, you know in distribution, I think we continue to control our cost very well, but more importantly we for novel and new ways to do business.

I think, we're looking at our most creative and enlightened customers from finding out ways that we can help them really modify their logistics chain, while at the same time being able to teak out a profit on our own. We're also looking at our suppliers and vendors that we have and we are looking to develop more long-term relationships and programs that will actually withstand just the downturn like today, but even be quite beneficial for us when business does turnaround.

These guys are doing a great job of finding new ways to do business. And our petroleum serves us a supplies arena, it really again is about cost control, we're starting to see some raw material decreases, and I think as we go forward will be positive, but more importantly, we are really emphasizing the integration of our products.

You know, if you look at our downhole tools and ReedHycalog and our ability to be able to talk about the entire bottom hole assembly as opposed to just talking about discrete products. While we continue to sell those discrete products, where we are really pushing hard is the integrated products and really aftermarket support of that.

We are doing the same thing in our brand operations for solids control and our drip pipe operations between Grant Prideco and Tuboscope, we are offering more and more integrated services that allow our customers to get better control of their cost in the long run.

In our Rig Technology Business, it is really about executing the backlog that we currently have and I think as you saw the results for this quarter they are doing a very good job on that, but it is also about new products.

You know Clay mentioned the Drake Rig, the Drake Rig has had a very successful run up in the Marcellus, and we’re going to be building more of those. It really is a rig that has a worldwide application as you look at Shale Plays around the world. I will talk about this in just a second, but we are excited about our ability to do certain things.

I think also the other thing you will see out of the rig technology group will be an increase in the business of rig refurbishments and enhanced enhancements. We are already seeing discreet sales and pipe handling systems to go on rigs that don't have them.

In the North Sea you are seeing a lot of refurbishment's for some of the older rigs that are up there. So, we continue to see some very good business that's going to come out of that. Now let me just kind of look a little bit in the international arena and talk where we do see some green shoots.

As Clay mentioned in Russia, we sold some work over rigs this quarter, it is the first shale in their procreative time and I think, while I don't believe Russia is going to explore with business, I think over the next few years, you will see a steadily rising business and that seems to be substantiated by some of the other oil service companies that are doing business in there.

One area that is very exciting today of course is the Middle East. I think, we continue to see an improvement in our operations there. Just this morning, we took an order for a land rig in the Middle East for about $16 million. So, that is good way to start a conference call. I got that about 10 minutes before we cracked up.

So that is – and we are starting to see that. I think in places like Oman, Kuwait, Saudi, and UAE I would expect over the next couple of years for all of those to be very vibrant places. I think Iraq will ultimately awaken a little bit. Some of our customers have started moving equipment in there now.

We will be supporting that and it will be your equipment that is going in. So, we think, while it may not explode and I don't mean that in a bad way. It may not pop, as much as we might like initially, I think in the long-term that is going to be a great play.

In Mexico, as you have seen with many of the service companies you have the IPM's that are going on down there not only are they service companies there, but you will start to see some indigenous companies that would become involved in those IPM’s, as that happens we are positioned with both manufacturing and distribution and down hold tool support to be able to take care of that for a lot of folks.

I won't talk too much about Brazil. I am sure we will get some questions on that, but obviously that is an area I think for the entire oil field to be very excited about. I think the things that Petrobras and the other Brazilian companies have inline are going to be very positive as we go forward.

The North Sea, again, I mentioned that earlier, we are seeing some refurbishments there that I think are positive for our businesses and will continue to see some actions there. I think in the Norwegian Outer Continental shelf, it is a little bit further north and some of the other areas (inaudible) further south and you will probably see some improvement in operation there. So we are -- overall in the international arena, we feel pretty positive. And especially considering what you're seeing in North America.

And while we expect not much to happen in North America, you will probably see a rig count increase in the Canadian area just because of the time of the year, but I think to see any big bounce there is really too many variables that are out there, the primary one being what is going to happen to this general economic environment.

You know, we have had probably the coolest summer in almost ten years and without the economic improvement too, I think the demand for natural gas is going to be lacking for a period of time. To talk just is second on the backlog, Clay kind of pointed out what was in there.

I think one of the more interesting things to as we go forward, we will probably see a little bit more inclusion of things like FPSOs and well intervention vessels and we are still very, very optimistic on our opportunities to add to the backlog as we go through the remainder of the year.

On our acquisition philosophy right now, we have got a very strong balance sheet, and I think our philosophy is really (inaudible). We have to take a look at what is going to be out there and we have got the capability of being able to seize the moment, and if we do that one of the more interesting things is that you come out of a downturn it -- with the acquisitions that we are able to make it really gives us much greater acceleration of profitability and revenues as we go to the future.

So, overall a tough environment today, but I have to thank the people of this Company from the hard work, their dedication, their commitment to new products, and I think we are going to weather the storm, as well as anybody can possibly whether it.

So, at this point Christine, I would like to turn it back over to you for any questions that our listeners might have.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Your first question comes from Roger Read from Natixis Bleichroeder. Please go ahead.

Roger Read - Natixis Bleichroeder

Hi, good morning gentlemen.

Pete Miller, Jr.

Good morning Roger.

Clay Williams

Good morning.

Roger Read - Natixis Bleichroeder

I guess the Brazilian awards would be the most interesting thing to us, I mean we understand the story with the ones that are continuing to look for financing, but the sort of incremental 28 orders from Petrobras, give us an idea of exactly how involved, you know to the extent you can, you are in terms of negotiations with them financing opportunities, would that be strictly Brazilian built rigs or does this also include the greater rig owning public out there?

Clay Williams

Yeah Roger, obviously a lot of effort going into that and just to fill in the rest of the picture about this time last year, Petrobras started off by saying they needed 40 rigs and sooner after issued letters of intent for 12 and so these are sort of the incremental 28. And everything that Petrobras has said and done since that point is indicated that they are -- I think are very serious and committed to putting those rigs in place.

We have since then seen a big meltdown obviously in the credit markets, which has kind of gotten away a lot of peoples plan, but nevertheless have worked closely with that customer on developing technical specifications for those rigs.

Along the way, I think they have been under some pressure to build many perhaps most of these rigs in country in Brazil and I think that candidly has probably slowed us both down a little bit in terms of actually winning awards for these and are still wrestling with that issue, it is clear to us that they want a significant amount of work done in Brazil by the shipyards.

We as you know have a large operation in Brazil, we are close to 700 employees, but we don't manufacture and actually a lot of our drilling equipment there. We think that most of the in-country construction work that is going to be done, is going to be performed by the ship guards with regards to the holes, and so we are optimistic that tenders are going to start flowing later this year, and that hopefully some of these 28 drilling equipment packages show up in our backlog and that is certainly part of our booking plans and an important part of our achieving the $3 billion to $4 billion in orders that we think we are going to get this year.

Roger Read - Natixis Bleichroeder

Okay and then my unrelated follow-up, PS&S, obviously lot different pricing international versus North America, I know Pete you said it is tough to predict where pricing goes, but as you look in the international arena based on some of the things you talked about the IPM projects etcetera, you are under the impression that pricing is at least moderating its declines internationally, if not finding a bottom or that if let’s say oil stays in the level its been in may be we have seen all the pricing declines we will see there.

Pete Miller, Jr.

Yes, I think Roger that‘s a fair statement. I believe that we probably are moderating in the decline. The other thing is that we are also kind of catching up in the cross containment arena and so that the two kind of work together, so I am not sure that you will see it really a much of a decline in the actual margins that we see it. I think we are hopefully we will be pretty flattish at this point, but you will continue to see people put pressure on the pricing. I mean that pretty much goes without saying in this industry, but again when you first kind of go into a downturn, it takes you a little while to catch-up on the cost containment side. But once kind of catch-up in cost containment side, you can help to mitigate the issue. So I think we ought to be flattish on the margin side.

Clay Williams

Yes, that’s the fact that lot of the work done in international markets too are done on longer term contracts and so they would get less pricing on spot generally, so I think that’s helped to mitigate the pricing pressures here in this downturn.

Roger Read - Natixis Bleichroeder

Okay. Thank you.

Pete Miller, Jr.

Thanks, Roger.

Operator

The next question comes from Bill Herbert from Simmons & Company International. Please go ahead.

Bill Herbert – Simmons & Company International

Thanks. Good morning, guys.

Pete Miller, Jr.

Hey, Bill.

Clay Williams

Good morning.

Bill Herbert – Simmons & Company International

Hey, Pete, with regard to trying to get a grip on normalized orders, if you will, if there is such a thing in this environment, but as we are sort of kind of casketing here along the bottom as you referred to earlier, one drill ship package and then a series of additional opportunities and inbound orders yields call it something slightly north of $600 million. Is that how we should be thinking about normalized orders in this environment going forward? One big package coupled with the usual assortment of this, that and the other yields something along the lines of $600 million in orders per quarter.

Pete Miller, Jr.

I think first off, when you say normalized orders, I am just sitting here smiling because I am not sure I have ever figured out what normalized orders were, but as we take a look at this, Bill, and we kind of dissected internally. You know, if you look at this quarter, you had 600 plus with one fairly significant drill ship in there.

Bill Herbert – Simmons & Company International

Yes.

Pete Miller, Jr.

That leaves you with about a 350, and that 350 probably is a reasonable normalization given kind of where we are today. That 350 just includes a bunch of stock, new ranges, new top drives, new pipe-handling and presuming that stop is kind of a go forward type deal. And then you start adding in couple of land rigs here and there that are project oriented and then you start looking at what we believe are going to be some of the floaters in different things that are coming out. That really does kind of push you to a little bit different number, say, you have got the 350 plus, plus, plus and that’s really what we are kind of banking on as we go through the remainder of the year.

Bill Herbert – Simmons & Company International

Great. That’s helpful. Secondly, with regard to the order guidance of $3 billion to $4 billion, I am wondering it’s a better way to look at this as opposed to getting hung-up on $3 billion to $4 billion this year because so much is contingent upon timing, financing etcetera is really to think about Petrobras’ needs going forward and the fact that you guys seem to persistent thanking of that clearly is going to get done or have a higher level of confidence in doing so. And whether or not these orders manifests themselves within the next two quarters or the next three to four quarters, it doesn’t really matter ultimately the business is going to be there?

Pete Miller, Jr.

I, you know, Bill, I couldn’t have said it any better myself. I mean at the end of the day, we have to have an arbitrary cut off and we have talked about those a lot, and our backlog cuts off on 1st of July.

Bill Herbert – Simmons & Company International

Right.

Pete Miller, Jr.

And cut off in the 1st of October. And if an order comes in anytime after that, while we love it, we have to report the cut off date here sort of reporting a backlog every day, which quite frankly we are not going to do, its impossible when you take a look at the timing. We are making our best guess and we are hoping like as these things fall in, but I think that the way you put it is very well done. The fact of the matter is this stuff is going to get done. Petrobras has to have these rigs whether they order them in the next three months or the next six months, in the long term isn’t going to impact us that greatly as we forward into 2010 and 2011, but it will impact the future very well. So we are going to continue to try to give you guidance as best we can when the orders will come in, but rest assure they will come in and rest assure they will be there in the future whether or not they make it by the 1st of October or the 1st of November or the 1st of December, we are pushing hard to get that done, but the fact is they will come.

Bill Herbert – Simmons & Company International

Great. Thanks, guys.

Pete Miller, Jr.

Thanks, Bill.

Clay Williams

Thanks, Bill.

Operator

The next question comes from Jim Crandell from Barclays. Please go ahead.

Jim Crandell – Barclays Capital

Good morning, Pete and Clay.

Pete Miller, Jr.

Hey, Jim, how you are doing?

Jim Crandell – Barclays Capital

Great. My first question to go back to Brazil, it struck me that during the quarter that announced that they had gotten financing for two of their rigs in Brazil and then one other of those rigs changed ownership during the quarter. With those rigs in your backlog before this quarter took place or those still hanging out there?

Clay Williams

Yes, Jim, we are already quite deeper and talking about specific projects than either Pete or I are comfortable doing. So we have long tried to stay away from talking about specific projects and specific customers. I know it’s a big picture here and I appreciate your point that’s out is that there has been progress made on the financing front, a lot of hard work, it’s going into these things by these drilling contractors and our own people; good support efforts from the various trade export finance agencies around the world and so we are seeing some progress on that front. But we did as we mention win one large drill ship package in the quarter from one of those customers who was able to secure financing in Q2.

Jim Crandell – Barclays Capital

Okay. So those were general question, can you see deepwater new build orders the balance of this calendar year ex-Brazil and if so, do you think that they will more likely come from India or China, other NOCs or IOCs.

Pete Miller, Jr.

Jim, you will see somewhere. I mean I think that quarterly we all take about Brazil an awful lot because that’s kind of the yellow point of the room, but fact of the matter is that we are talking to other folks today about things like Arctic rigs, we are talking about rigs for the West African area for Southeast Asia and we continue to do that, and it’s a combination of folks that do that. We are talking to regular international drilling contractors, we are talking to IOC’s and we are talking to NOC’s, it really is kind of across the board, you are talking to different shipyards whether you are talking to shipyards in China or some of the bigger shipyards in Korea, we are talking to shipyards in the Middle East about some of these things. So it really is a little bit more than just the Brazilian operation. I know that, again, we talk about Brazil a lot but I think we pretty much have to, but the fact is that there is a lot of excitement in other areas that may be won’t manifest themselves in the next quarter, but they will certainly come across over the next six to 12 months.

Clay Williams

Yes, you know, everybody is kind of running into the same problem which rig had only roughly 70 rigs in the world that can hold 6,000 foot. These are very scarce resources and Petrobras with the Santos Basin discovery obviously has very large rig needs, but they are not the only ones, there is lot of frontier deepwater basins out there left to be explored and developed. And so that’s -- the fundamental driver here is very, very solid.

Jim Crandell – Barclays Capital

Okay. There were some reputable drilling contractors out with generation rigs being constructed that are available going forward and so your discussions with IOC’s relative to potential new rig orders, are they more specific in this looking for more specialized rigs or they or why would they want a new build versus if they could get one that’s coming on that’s currently available let’s say in the first half of 2012?

Pete Miller, Jr.

A lot of them what you see out there, Jim, is very much project specific. But also what you have is a lot of people, they want a rig designed exactly to their specifications and there they are going to go out and they are going to push hard to get it, but lot of it is very much project specific. It might need a couple of things there that some of the existing rigs don’t have. I think kind of points out something and I will talk about for a long time, a rig is not necessarily a rig. People have a tendency to look at the brick rig and the aggregate, and in fact the rig capabilities on lot of these rigs differ very, very greatly. Even on the -- when some says, while I have got a 6000 foot water depth rig, they are not all quite the same, so that’s why you continue to see the interest in these very, very discrete projects.

Jim Crandell – Barclays Capital

Okay. And one final question, Pete, if I could, to the expense that this globe charter design catches on with may be Novo [ph] and others in the customer base, how does that impact your potential for rig equipment orders on a per rig basis?

Pete Miller, Jr.

Well, I think, Jim, globe charters are rig that will put a lot of equipment on and we will be watching it very, very closely. I will tell you this, where -- we’ve been in the rig design business for a long time. We like what we offer our customers. I think the numbers pretty well indicate that our customers like what we offer our customers. There is always going to be new stuff out there and we watch it closely. We will participate with the best we can, but I don’t think it’s going to update the need for the type of rigs that we are building right now.

Jim Crandell – Barclays Capital

Okay. Thank you.

Operator

The next question comes from Joe Gibney from Capital One Southcoast. Please go ahead.

Joe Gibney – Capital One Southcoast

Thanks. Good morning.

Pete Miller, Jr.

Hi, Joe.

Clay Williams

Hi, Joe.

Joe Gibney – Capital One Southcoast

Just want to touch a little bit on the non-Petrobras side, your rig (inaudible) Pete you mentioned a little bit inherent strength there that 350 million figure, frame, top drives, can you comment a little bit what’s your incremental outlook on the jack up side assuming there are no jack up packages booked this quarter, but you referenced the age of jack up fleet moving into a reverb scenario, but can you just comment on incremental opportunities that you are seeing out there on the jack up side?

Clay Williams

Yes, that is correct, Joe. We didn’t have jack up packages booked in Q2 quite worth noting, I think every quarter up until this year, we’ve had jack up packages even though much of the billed book that’s been underway for the past few years remains un-contracted. Since the quarter closed, we have had a little movement on the jack up front and we have a couple of other folks we that are talking to, so its not that out there – with regards to jack ups.

Pete Miller, Jr.

And then Joe, I continue to believe that the jack up business is one that while it may be a little oversupply at a point in time, I think what you are going to see is a replacement and then the type of jack up rigs that people are demanding. You are saying that they are continuing to find work for a lot of the newer jack ups and we have been on the jack up retooling period for quite sometime, and that’s not up and this is going to die anytime soon. I think there is clearly going to be something in the future that will be positive for us.

Joe Gibney – Capital One Southcoast

Okay. And then in terms of your, on the (inaudible) side to walkup or some backlog revenues not out of backlog, Clay, you intimated there, you commented it maybe a little bit more softness on the aftermarket side or lower aftermarket mix sequentially. Broadly speaking, are we seeing some stabilization here in the sort of after market work over the next couple of quarters looking to 2010 and your strengths loosening in doing ancillary service work, is this sort of stabilizing? Do you see this bleeding a little bit further back half of the year?

Clay Williams

Yes, I think so Joe and I kind of referenced this in my comments, but our sense is that when we got into the first quarter, you saw plummeting day rates in just a lot of very dark outlook for the global economy broadly and slowing down of economic activity. A lot of our drilling contractor customers put out stock spending OpEx, stock spending CapEx and that affected both our order book for new capital equipment orders along with spare parts and services, and other things that we sell which show up on their P&L as operating expenditures. As we move through the quarter, we think we are starting to see little bit of improvement there even though our outlook calls for aftermarket to be down a little bit in Q3, it has stabilized. I think our Q1 number, I don’t call a precise number, but it was down in the order of 18% or 20%, and this quarter was down about another 4%. We have gone for another little slide in Q3, but we think that we are finding it although at the bottom here. We also know more so on the PS&S side, but this probably extends to rig as well that a lot of these customers are getting very interject about pulling equipment offer stag rigs and redeploying it on rigs that are working in order to avoid expenditures during the short run, and that works along as rig count didn’t go up. Once it starts to move up before those rigs can go back to work, those drilling contractors have to spend money to re-outfit them with spare parts and consumables. So we think that’s kind of entering into the freight here as well.

Joe Gibney – Capital One Southcoast

Okay, helpful. I appreciate it. I will turn it back.

Clay Williams

Okay. Thanks, Joe.

Pete Miller, Jr.

Thanks, Joe.

Operator

The next question comes from Collin Gerry from Raymond James. Please go ahead.

Collin Gerry – Raymond James

Hi, good morning guys.

Clay Williams

Hey, Collin.

Collin Gerry – Raymond James

Just kind of a bigger picture question, the latest REIT census, I think it showed about 3000 rigs in the US if my figures are correct, what’s your sense on what percent of those really don’t come back into the rig market when eventually the rig count does start moving up?

Pete Miller, Jr.

Well, you know, Collin, I did trouble with all my customers whatever I opine on this. So I would say this, I mean I think it’s pretty eminent out there today that the rigs that are continuing to work in the rig that the operators want or the best technological rigs. Take a look -- want are the, the highest rig counts and where they are going, and I think you will continue to see that the contractors are going to want to upgrade their rigs especially possibly can simply because that’s what the operator is demanding. We have always said that contractors don’t retire rigs operators do, and I think a lot of the rigs that are stacked out today won’t see the light of day again. Now, if one of my customers said, well, that’s wrong then I would agree with my customer. However, I kind of standby where I am right now. I think that it’s pretty clear that the industry wants credit rigs.

Clay Williams

Yes, Collin, I will approach the question from the other angle which is how many of those are new AC powered electronic control quick move rigs and we think that number is about 450 that have been added over this latest build cycle. There is probably another 350 may be 400 rigs that are new, but they are older designs and don’t really incorporate the modern technology that makes those new rigs so much more efficient.

Collin Gerry – Raymond James

Okay. That’s helpful. Another kind of bigger picture question, last quarter, we talked about a lot of projects being shave ready [ph], oils picked up here obviously. I guess do you get the sense of where the point where you start seeing a lot of the international work getting underway and I am thinking of it in the context, Schlumberger did a day were saying that its really going to hinge on where oil prices end the year and that 70 might be the right target to look at. I guess how do you see things plan out?

Pete Miller, Jr.

Well, I think that 70 would certainly be a right target. Here is the problem, Collin, I think that it’s not so much what the price is that are point in time. It’s what the expectation level is. And its not (inaudible) stocks, I mean you guys know a lot about how you pick stocks and its not about necessarily what’s you have in the last 20 minutes what you expect over the next year.

I think that the determination on project go forward is really somebody sit back and saying, okay, I am looking at the economy, I think we are seeing some green sheets, I think the economy is going to improve. If the economy improves Airgo, you are going to need more energy. Airgo, the price of oil will probably go up. I think that’s got to be the calculation that you make as oppose to whether or not oil is $70 sort of day. I mean oil was 70 bucks a month ago and we are in the 60s now and it goes back up to 70. Clearer to that, that’s positive for projects but I think it really has to be what is your expectation on the go-forward and if your expectation is that the economy isn’t going to improve with the oil prices are going to go up, you probably going to be hesitant to forward with things. So that’s kind of the way we see it and tell there is some more clarity on that. You won’t see people pull the trigger quite as rapidly as they have in the past.

Collin Gerry – Raymond James

Okay. That’s helpful. So it sounds like the underlying thing that might be stability in oil prices and the direction might be more independent then the spot, number where we are right now.

Pete Miller, Jr.

Absolutely. And if you could ever find stability in oil prices is a good job.

Collin Gerry – Raymond James

All right. Last question for me on the technology front, it’s been a while since we, we got a status update on Teleserve. Maybe give us what’s the latest development to there and where in the stages we are in developing that product.

Pete Miller, Jr.

Yes, technically, Teleserve continuous to perform very, very well. its was actually down just a shade in Q2 from Q1 like everything else in the old field, its in projects that it, if we are queued up to run that technology on. Move out to the right and running those some delays, but technical performance remains very, very strong for anything not aware. And teleserve is the proprietary wired drill pipe that is effectively offers broadband from the rig down to the bottom of the hole and kind of is a real step chanechu in terms of data communications, with what’s happened in whole and we are very, very excited about. We are pleased that the early adopters of this technology which includes a handful major ICOs and NOCs are coming for lot of repeat business. Since our order book reflects satisfied customers, coming back and deploying on new projects and so. We feel pretty good about the outlook for the business. We did announce few months ago, we entered into an agreement with Schlumberger on a joint venture, they are going to buy into ownership position and in Teleserve. And we have not yet closed it, but we do expect to close that sometime in the next few weeks.

Collin Gerry – Raymond James

Okay. Great. I will turn it back. Thanks guys.

Clay Williams

Thanks.

Pete Miller, Jr.

Thanks, Collin.

Operator

There is time for one last question. The final question comes from Geoff Kieburtz from Weeden. Please go ahead.

Geoff Kieburtz – Weeden & Co

Thanks very much. Pete, last quarter you said you thought that we would get $3 billion with orders this year with a little bit of luck. How would you characterize your opinion or probabilities on that outcome today?

Pete Miller, Jr.

Well, I think we are still there. I mean as Clay kind of pointed out in lot of this comments and I followed up on little bit later, Geoff, it’s more of a hockey stick but that’s to be expected. I think as you go into an environment like this, two years ago we were closing deals pretty quickly because everything was moved in so rapidly today. There is a lot more conversation on contracts, free pays, doubting the eyes and crossing the teas, and what might have come to flush and very quickly on the past has taken a little bit more time today. What are the things that’s nice for us is, we have great visibility into the market. We are talking to our customers, we know what’s the size project and what’s not. And the consequence of that is, we are pretty already. They are all real questions coming one of timing. How quickly can you get the deal closed as opposed to you have done in the past. So we are still optimistic about our projections on that Joe.

Geoff Kieburtz – Weeden & Co

Okay. So if you had given us a probability three months ago, your number today would be unchanged?

Pete Miller, Jr.

Ai, yes, absolutely.

Geoff Kieburtz – Weeden & Co

And you mentioned that the backlog we may see orders coming into the NOB backlog over the next few quarters that are not rigs. I think you mentioned FPSOs and some other stuff, how much of the current backlog is not rigs?

Pete Miller, Jr.

About three fourth of the backlog, Geoff, $6.5 billion are major new build rig projects. The remaining -- its actually relatively, I am not sure how to characterize it, because its not necessarily whole rigs, but it’s a lot of rig equipment. I think what you are driving towards this non-rig equipment?

Geoff Kieburtz – Weeden & Co

Correct.

Pete Miller, Jr.

And that’s little bit of a gassier but may be on the order of $0.5 billion or so.

Geoff Kieburtz – Weeden & Co

Okay. So it’s a very small number as a percentage right now.

Clay Williams

Right.

Pete Miller, Jr.

Right.

Geoff Kieburtz – Weeden & Co

Okay. And I guess just last question, so I just have the opportunity, how do you expect your pricing on new orders over the say the next 18 months or may be more importantly how do you expect margins on orders that you take in the next 18 months to compare with what you are producing today.

Pete Miller, Jr.

All Right. I would say that probably on the capital side, you are liable to see a little bit of movement, but I don’t think its going to be anything that. Clearly when you are doing capital equipment, it’s not like the PS&S or the distribution business. So I mean we are not going to build capital equipment for practice. If we are going to build that, we are going to be build it to make profit and almost all of the capital that we do Geoff is done through order. It’s not done through inventory, so if we take on an order we are going to make sure that the potential of making a decent margin. I mean that’s when we sell something, we sell it one time. It’s not some cost where we can rent it now for the next 10 years. So we while certainly there will be some pricing pressures, its nothing like your saying in some of the day to day type businesses.

Clay Williams

Yes. We are also as we mentioned on our prior comments, were using this opportunity to reduce our cost and to become more efficient, we have also been helped out by a stronger US dollar than where we saw the dollar to much of ’07 and ’08, so that gives him a little more latitude on that front too.

Geoff Kieburtz – Weeden & Co

Right. Great. Thanks very much.

Clay Williams

Thanks.

Pete Miller, Jr.

Okay. Thank you.

Operator

This concludes the Q&A portion of today’s conference. I will now turn it over to Peter Miller for additional comments.

Pete Miller, Jr.

Thanks, Christine and thank you all for listening in today and we look forward to talking to you at the end of the third quarter. Thank you very much.

Operator

A replay of today's conference is available by calling 888-843-8996 and enter the pass code 24794996. You may also access the webcast recording at www.nov.com. Thank you for participating in the National Oilwell Varco second quarter 2009 earnings conference call. This concludes today’s conference.

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Source: National Oilwell Varco, Inc. Q2 2009 Earnings Call Transcript
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