Cameron International Management Discusses Q3 2013 Results - Earnings Call Transcript

Oct.24.13 | About: Cameron International (CAM)

Cameron International (NYSE:CAM)

Q3 2013 Earnings Call

October 24, 2013 9:30 am ET

Executives

Jeffrey G. Altamari - Vice President of Investor Relations

Jack B. Moore - Chairman of the Board, Chief Executive Officer and President

Charles M. Sledge - Chief Financial Officer and Senior Vice President

Analysts

Jeffrey Spittel - Clarkson Capital Markets, Research Division

James Knowlton Wicklund - Crédit Suisse AG, Research Division

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Edward Muztafago - Societe Generale Cross Asset Research

Douglas L. Becker - BofA Merrill Lynch, Research Division

James C. West - Barclays Capital, Research Division

Ole H. Slorer - Morgan Stanley, Research Division

Brad Handler - Jefferies LLC, Research Division

J. Marshall Adkins - Raymond James & Associates, Inc., Research Division

Robin E. Shoemaker - Citigroup Inc, Research Division

William A. Herbert - Simmons & Company International, Research Division

Jeff Tillery - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

Michael K. LaMotte - Guggenheim Securities, LLC, Research Division

Operator

Greetings, ladies and gentlemen, and welcome to the Cameron Third Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Jeff Altamari, Vice President, Investor Relations, for Cameron. Thank you. Mr. Altamari, you may now begin.

Jeffrey G. Altamari

Good morning, and welcome to the Cameron Third Quarter Earnings Call. Thank you for joining us today. This morning, we'll hear from Jack Moore, Chairman, President and Chief Executive Officer of Cameron; and Chuck Sledge, Senior Vice President and Chief Financial Officer. Jack and Chuck will offer commentary on the results for the quarter. We will then open the line for your questions.

In accordance with the Safe Harbor provisions of the securities laws, we caution you that some of the statements made on this call may be forward-looking in nature and, as such, are subject to various factors not under the control of the company. For a more complete description of these factors and the related risks and uncertainties, please refer to Cameron's annual report on Form 10-K, the company's most recent Form 10-Q and the recent earnings news release.

I will now turn the meeting over to Jack.

Jack B. Moore

Thank you, Jeff. As you've seen, Cameron reported $0.81 in earnings for the quarter net of special items. Revenues totaled $2.5 billion in the quarter, up 13% from year ago levels. Total orders in Q3 were just above $3 billion, up 32% from last year. Q3 orders were driven by OneSubsea, which totaled $1.1 billion in the quarter. Cameron's total backlog now stands at $11.2 billion, up 47% from year ago levels.

Now let me cover some highlights from our operating segments, starting with OneSubsea. Orders in Q1 totaled $1.1 billion, as I've said. Year-to-date, OneSubsea orders stand at $2.8 billion, eclipsing the previous record of $2.7 billion for all of 2008. Q1 orders were highlighted by the order of 2 larger subsea projects from Chevron versus Rosebank in the North Sea and the second was the second phase of the Jack/St. Malo project in the Gulf of Mexico. And subsequent to this quarter's close, we were advised of the award from Total for their subsea dual pumping stations for their mobile project at Northwest Africa, one of the largest systems we have ever booked.

Subsea boosting has proven to be a huge value creator for our customers and a clear differentiator for OneSubsea to leverage as a leader in subsea systems. We have sold 85 subsea pumping units since Framo launched this technology and these units have logged close to 2 million hours in subsea operations and have formed the basis of the very reliable and robust subsea processing system foundation.

The combination of Cameron and Schlumberger's capabilities in deepwaters has generated a host of new product development opportunities that we will be making significant investments into in 2014, all of which are focused on advancing our stated goal of maximizing customers' reservoir recovery for the life of their fields.

As for the outlook for subsea, we continue to track a healthy list of projects and have a number of engaged customers that understand the unique capabilities of this joint venture, which allows us to build upon what already is a record orders year for OneSubsea.

Drilling Systems segment had orders totaling about $635 million in the quarter. Orders for new equipment continued at a solid pace as we put 2 deepwater stacks in a number of projects for land systems in the Middle East. Orders for jack-up BOPs were strong in Q3 as well with 5 new stacks being ordered.

Our aftermarket business had another strong quarter with orders totaling $230 million and is on a record pace for 2013. Year-to-date aftermarket orders have totaled $700 million, slightly below the record $740 million for all of -- in 2012.

Inquiries for new equipment for both jack-up and floaters remained high. Coupled with aftermarket services, we expect a strong finish in Q4, making 2013 our second largest year ever.

Backlog with Drilling now stands at a record $4 billion.

Revenues totaled $500 million in the quarter and included the delivery of first of a series of a harsh environment jack-up rig packages that utilizes our Sense technology. Total revenues have increased 25% versus last year and that's the good news. Bad news is we are spending a lot more than when should to get it out the door. A number of initiatives to improve our margins have not happened in the time frame we've planned and delays with capacity expansions in our plants and suppliers have been a big contributor to the higher costs. While our actions to address these issues are well underway, we continue to see an impact from these higher costs in Q4.

Surface Systems continues to be a great story. Orders totaled $450 million in Q3, essentially flat with last year's level. Year-to-date, our Surface Systems orders are up 30 -- 29% versus year ago levels. While we were seeing substantial growth in our North American markets, our most significant year-over-year growth has been in the Middle East where orders have grown by over 60%.

And our outlook for continued growth is very positive. Our investments in the U.S. shales continue to open new opportunities to grow share and we have a number of targeted projects in the Middle East, North Sea and Canada that will have a long development cycle providing for another strong quarter for Surface Systems orders in Q4 and a healthy order flow for years to come.

Revenues topped $500 million in Q3, a 20% growth over year ago levels.

Our Valves & Measurements orders totaled $500 million in Q3, which were down 5% sequentially. Revenues came in just over $500 million, up 10% sequentially. Engineered Valve orders that are targeted for both pipeline and midstream projects are the main reason and are down 15% from year ago levels. While the majority of this customer -- is customer-driven delays, we have seen -- it will impact V&M's performance in Q4 given the shorter cycle nature of this market. We have also seen a shift in project awards across most every major market that will create a shortfall in orders for Engineered Valves in 2013, but we expect to see this translate in a more robust order environment in 2014.

On a positive note, our distributed valve bookings were up 20% versus year ago levels, but all of this is a result of the focus on the shales in the U.S. and growth in our Middle East distribution center.

Our Process & Compression orders came in at $343 million in Q3, up 12% sequentially and flat versus last year. Revenues totaled $357 million in the quarter, up 10% from year ago levels, but up 15% sequentially.

Process Systems orders topped just over $200 million with the majority of the orders from our FPO -- from FPSO projects offshore Brazil. And we continue to track a number of projects that we anticipate result in record orders for Process Systems in 2013, the majority of these opportunities being outside the U.S. and involve our embedded MEG and CO2 separation technology. Compression orders of $140 million were slightly below year ago levels and most all of this is a result of slow activity in China.

I want to make a few comments before I turn it over to Chuck. As most of you know, I'm an optimist by nature and see the numbers opportunities that our platforms have created to drive sustainable growth for Cameron for years to come. But I'll also not be honest with you if I didn't tell you on this call that I did not -- that myself and our management team are not pleased that we have guided earnings expectations down throughout this year. We have been challenged in our Drilling Systems business unit with the costs associated with ensuring that we execute on record backlog and we've also underestimated the impact of timing of orders would have on our future quarterly revenues that we have seen in our V&M businesses impacting Q4. While our updated guidance for Q4 reflects the impact of these realities, it does not excuse us from the actions we must take to address these challenges. We're addressing the cost structure in V&M to deal with the drop in volume and the pace to improve Drilling Systems capacity to perform is my personal top priority.

I will close with one reminder: 2013 will be a record year for Cameron in terms of orders, revenues, earnings and we expect to finish with a record backlog. We have wonderful platforms to build upon and the expectation for profitable growth is not lost with this team.

Chuck?

Charles M. Sledge

Thanks, Jack. This morning we reported earnings of $0.78 per share on a GAAP basis. These results included $0.01 per share of minority interest, which is primarily related to our OneSubsea joint venture, as well as $13.9 million of other cost, pretax, of which $6.9 million relates to the formation of OneSubsea.

Revenues for the quarter were up 9.1% sequentially. Revenues were off our expectations due primarily to V&M segment. Delays in international project bookings and both delays and pricing pressure in our North American midstream book-and-bill business negatively impacted revenues for the quarter. This will also hurt our fourth quarter results, which I will cover in more detail later.

DPS grew 14% sequentially with all 3 product lines growing. OneSubsea increased the most with the Framo business now being reporting Cameron's results for the first time. V&M was a surprise for the quarter with revenues actually falling 6% sequentially. EBITDA margins were flat sequentially. An increase in PCS margins were offset by a decline in V&M margins. Unfortunately, the impact of this pricing pressure I mentioned earlier will continue in our V&M segment into the fourth quarter.

Our tax rate for the quarter was 22.4%.

A quick word on minority interest for the third quarter. The $0.01 per share was lower than our guidance due to a shift in OneSubsea earnings from the third to fourth quarter, as well as integration costs being recorded in the amounts reported.

On a year-on-year cash generation, it has improved with $206 million of cash flow from operations being generated on a year-to-date basis versus $138 million last year.

Now turning to our financial policy for Cameron. Our intent is to use our balance sheet flexibility to grow the company, whether it be by growing working capital, CapEx or acquisition. We're also targeting to return our free cash flow and other proceeds, such as those received in conjunction with the formation of OneSubsea, to our shareholders. We believe this is the right balance between the growth opportunities we see in front of us and the need to consistently return our cash -- will return cash to shareholders.

Under this policy, we've repurchased 7.7 million shares during the quarter. As a result, we have returned the full after-tax proceeds received in connection with the formation of OneSubsea, as well as the majority of our 2012 free cash flow to our shareholders. In addition, our board authorized an additional $1 billion share repurchase program.

Turning to our fourth quarter outlook. We have tempered our fourth quarter outlook from our previous forecast due to 2 main factors: First, we've seen a movement to the right in our V&M international project business; and delays and pricing pressure in our North American midstream businesses. These 2 items will cause revenue growth in this segment to be below our previous estimates. You should think about a 5% to 10% sequential improvement in revenue versus our mid- to upper teens previous forecast. This will also serve to mute this segment's margin performance in Q4 to something closer to Q3's level. Secondly, as Jack mentioned, our drilling product line will experience cost overruns in executing its record backlog. Our supply chain is stretched to keep up with record demands and we are going to incur expediting costs to meet our customer need dates. We have taken steps to address this in terms of people and capacity investments, but our progress is slower than we had expected. This will cause our DPS margins to expand at a slower pace than previously anticipated. We now expect DPS margins to expand 100 basis points from third quarter levels.

Interest expense will increase to $26 million in Q4, G&A should stay flat with third quarter's level and corporate expenses should increase to approximately $65 million.

Minority interest should approximate $0.07 to $0.10 per share, reflecting a robust forecast for OneSubsea earnings in Q4.

Now for a few comments on '14. I want to point out that we are not through our budget process nor have we seen how the fourth quarter short-cycle bookings hold up. There are a few things that investors should think about in terms of revenue for '14. Our subsea bookings in the second quarter of this year were light, as everyone saw. This will have the effect of dampening revenue in the back half of '14. Additionally, V&M has experienced international project booking delays and midstream issues that Jack has spoke about. As a result, our V&M backlog is now below year ago levels. As such, we do not see top line growth in V&M for '14.

These 2 factors will weigh on Cameron's 2014's revenue growth. We see total revenue approaching $11 billion for '14. In addition, our robust OneSubsea R&D program Jack discussed earlier will further moderate our EBITDA margin growth in '14.

As is our practice, we will provide a detailed view on '14 during our fourth quarter conference call.

Jeff, let's open it up for questions.

Jeffrey G. Altamari

Rob, please open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from the line of Jeff Spittel with Clarkson Capital Markets.

Jeffrey Spittel - Clarkson Capital Markets, Research Division

Maybe if we could start with -- and I appreciate the comments on 2014. Let's say we print something at the midpoint of the range for the fourth quarter. The seasonality has been pretty pronounced in the first quarter over the last couple of years. Is there any reason to believe it's any different as you kind of head into Q1?

Jack B. Moore

No. Q1 will be seasonally impacted like it has in the past.

Jeffrey Spittel - Clarkson Capital Markets, Research Division

Okay. And then with regard to the subsea backlog, is what you've scheduled to ship in 2014 pretty consistent with the run rate of where DPS margins right now? Or is it still a little bit dilutive?

Charles M. Sledge

I'm not sure I understand the question. Could you maybe phrase a little differently?

Jeffrey Spittel - Clarkson Capital Markets, Research Division

With the subsea stuff that's supposed to come out of the backlog and convert to revenue next year, is that at a similar margin to where DPS margins are today or is that a little bit light versus DPS margins today?

Charles M. Sledge

Subsea, obviously, is lower than DPS' aggregate margins. I think, the rate you see, absent the R&D program we talked about in subsea, the margins are good. The margins will be good in '14. But again, you've got to factor in an R&D program that wasn't there in the past.

Operator

Our next question is from the line of Jim Wicklund with Credit Suisse.

James Knowlton Wicklund - Crédit Suisse AG, Research Division

How much visibility or advanced visibility do you have in V&M? I thought that was a fairly well-tracking business?

Jack B. Moore

Jim, it is. Let me kind of give you 2 primary segments that drive the V&M platforms: one is the Engineered Valve business, which is predominantly project driven. So pipelines, infrastructure, both midstream and even some of petrochem drives that LNG infrastructure. The other is more of a short-cycle businesses that is really focused on North America. And a lot of that, not only through distributed, but even some of that through the smaller, let's say, 2- to 12-inch-sized ball valve range. We have been impacted in both of those markets. We have continued to see projects pushed to the right. And really customers are saying -- they're not canceled. It's just that we're not executing on them in the time frame we thought. So really, the visibility is there. It's just the timing of when they're happening is not. And some of it is really a result of the infrastructure downstream that isn't been built out yet to support pipeline infrastructure, even some of the midstream things. But robust outlook. It's just the timing.

Charles M. Sledge

Okay, Jim, it's Chuck, I just want to point out that V&M's backlog has been below year ago levels now for a few quarters. And so clearly, we've seen it. We thought that some of the shorter-cycle would pick up to offset and it just hasn't happened.

James Knowlton Wicklund - Crédit Suisse AG, Research Division

And we know that order rates drive a lot and so if I can segue a slowdown in Engineered Valves and international projects, do you think that the current consensus outlook for tree orders next year is too high? Or does that need to come down as well, not just for you but for the industry?

Jack B. Moore

Yes. Let me segue on our view of the tree market. This year is going to be off-the-chart good in terms of subsea tree awards. I think that the chapter -- most of those chapters have already been written. Next year, we'll see tree awards not repeat 2013 levels predominantly because of Brazil. So if you take Brazil out of the equation, that's probably 30% of this year's awards, we still see a lot of opportunities. But in total, probably not as big as what you saw in '13. Still a decent year. But I don't segue the timing of the subsea trees relative to the valve project.

James Knowlton Wicklund - Crédit Suisse AG, Research Division

You don't think they'll be connected to the delay? Okay, okay. And my follow-up question is, is the stock buyback is great. It's fabulous. Why don't you guys do a Dutch auction and do this all at once, lever up, lower your cost of capital, make everybody happy and don't try and shoot against the hedge funds and everybody else in the open market?

Jack B. Moore

Thanks, Jim, we'll take that into consideration.

Operator

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

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Just wanted to circle back around the comments about the increase in R&D. Can you give us some general sense on how we should be thinking about that, maybe on a percent of revenue basis and maybe in terms of absolute dollar? And can you also segue that into what kind of margin impact in basis points do you think that might have on your -- on the outlook?

Jack B. Moore

Unfortunately, Kurt, we're not through our budgeting process, so I'd hate to preempt kind of our senior-level review process, i.e., our board. So it is -- so I can't give you the numbers. But I can tell you it will have an impact on DPS margins next year and it will lower them.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Okay. Follow-up question. As we've heard so far, the order intake for trees skewed a little bit here in 2013 by Brazil. So if you x Brazil out for '13 and you look at '14 versus '13, what kind of growth, if any, would you be looking at for tree count right now?

Jack B. Moore

Well, if you say we're going to come out of '13 with 600-ish trees, I mean, what are we, year-to-date, 540? So if you just say there's another 50 trees to be booked in the fourth quarter, which is probably not unreasonable, and 30% of that is Petrobras, that's a big number. So can the rest of the market equate to 350, 400 trees next year? I think it can. Now it depends on the timing of projects. You got Block 32, which is big. You got [indiscernible], which is big. You got a couple of big projects for E&I. You got -- again, you've got some Petrobras work but not on the scale at what it was last year. So it always gets back to the timing of when these big projects are awarded. There are some large tree projects that are supposed to be booked in '14. But we'll know when we get there.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Okay. And then addressing some other questions that have come up, given some of the margin dynamics that are playing not just for your company, but for others. There seems to be a perception in the marketplace that pricing may not be as robust as indicated. Could you give us some indication as the kind of pricing improvement that you've seen over the course of the past, say, 12 to 18 months versus the prior period?

Jack B. Moore

Well, in what segment of our business?

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Let's focus on subsea and if you want to talk about some other segments, that's great.

Jack B. Moore

Well, let me tell you, I think, the subsea market's been fairly well behaved. I think, everyone has got healthy backlogs. I think when you look at the margins we've all historically executed on, we're not happy with them. I think that hopefully got everyone's mind right around getting paid for the risk and the work we do. So I haven't-- we haven't seen a shift in behavior. You can probably pick 1 or 2 projects and handicap them. But overall, I think everyone has a healthy backlog. I think everyone has a long view of this business and I think a much better understanding of the risks and the costs associated with execution. So let's hope that behavior stays there. In our shorter-cycle business, such as Chuck mentioned on some of our valve businesses and -- we're seeing pricing pressure. As things moderate, as activity levels kind of, in certain markets, have flatlined and not grown at the pace we've seen over the last 3 years, we've seen pricing pressure come back into it. But that also -- the way we deal with that is we have to get more efficient and we have to continue to work with our supply chain to get our costs down. In certain businesses, we've been able to do that; in others, we've not done as good a job in that area as we need to.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Okay. Then let me just wrap up here. So what kind of share count you'll be thinking about for fourth quarter? And then any general sense -- I guess, that'd be our baseline for '14. But what are you thinking about for share count in fourth quarter?

Charles M. Sledge

Kurt, all I can tell you is we ended the third quarter at 238 million, so it's obviously going to be driven by how many shares we buy back during the fourth quarter and just not comfortable giving a prediction on that.

Operator

Our next question comes from the line of Ed Muztafago with Societe Generale.

Edward Muztafago - Societe Generale Cross Asset Research

Just wondering if you could talk a little bit about the realization of margin initiatives. I mean, this is a theme now that we sort of seem to be hearing across-the-board, that people aren't able to realize these efforts as quickly as they anticipated. Can you talk about both to whether you see this as a broader industry issue and whether this may ultimately, at some point, lead to another push higher in pricing to try and offset some of the margin issues?

Jack B. Moore

Yes, let me just specifically talk about one part of our business, which happens to consist of our largest backlog and that's Drilling. Now I can't speak for others in our space other than I know that we're all challenged with some of the same issues and that's capacity and supply chain. When you look at our Drilling business, it has grown substantially quicker than we had planned and envisioned. We've thrown a lot of capital at it. As you guys know, we've spent a lot of money over the last 2 years building out our capacity. The challenge, it hasn't happen quick enough. It hasn't happened as quick as we thought it would and we're all disappointed with that and I know you guys are as well. A lot of this is within our control in terms of managing those costs. When you're spending a lot of money expediting things through your own system: air freighting; lots of overtime; spending premiums with suppliers to get things built that you should be building yourself, it all adds to the margin dilemma. Has it affected everyone else in our space? I think, to some degree, we're all challenged with what's going on in our market and competing for some of that supply chain space. But our mission and our challenge has been to invest back into our business, to take these challenges on internally. We've been slower than we should have been at it. We haven't done it quick enough. We've got a lot of focus on it. So it's within our control to fix. It's just going to take us longer than we thought.

Edward Muztafago - Societe Generale Cross Asset Research

Okay, that's good. I guess, maybe a little bit of commentary on sort of V&M and the project slippage issue. I mean, I know it's a little too early to give any indication for 2014 in terms of margins, but presumably, the projects are there. You need the cost structure where it is to meet the projects. Can you maybe talk a little bit as to how you see that impacting margins going forward? I mean, do we need to see projects stop slipping for margins to move higher?

Charles M. Sledge

Yes, a couple of things. You saw margin performance in the first half of V&M versus what you saw in the third quarter and we've guided to in the fourth. So I think it's going to be difficult for the next year to replicate the first half margin performance of V&M. That's just kind of unfortunately the way the cards have played out. Longer term, meaning post-'14, because some of the projects do take a little while to get turned into revenue, yes. That business, as we've always said, should be between 21% and 23% EBITDA. So I think on the longer term, structurally, the margin is intact, but I do not believe we will replicate the first half margin in '14 that V&M showed in '13.

Edward Muztafago - Societe Generale Cross Asset Research

Okay. So certainly no margin expansion from here then?

Charles M. Sledge

Correct. I think that's probably a safe assumption.

Operator

Our next question comes from the line of Doug Becker with Bank of America.

Douglas L. Becker - BofA Merrill Lynch, Research Division

Just turning to OneSubsea. Just want to get the latest thoughts on winning integrated offering is likely and what that might entail?

Jack B. Moore

I'd say stay tuned. We've got a lot of -- I'd tell you, there's a lot of interest. We have a great partner that's got some wonderful bandwidth. So and as I've said, when we created OneSubsea, to go out with a complete package was going to take some time. Going out with the complete capability to go in and take on a development where we can really go in and provide dual boosting and the intervention technologies and the things that are really going to drive the incremental value around reservoir optimization. Those are going to take some time. But I will tell you there are small steps we can take in between and the team is doing a wonderful job of identifying those. We talked about the R&D initiative. I mean, as we put this thing together, these guys have spent a lot more than what they're asking for, trust me. But we can't even moderate some of that. But pedal to the metal, we've got a great platform to exploit and a great partner that's committed with us. And this is a long-term view of where we see the deepwater opportunities and how we see OneSubsea to differentiate itself versus anyone else in that space. So we'll get to -- we're getting a lot of support from customers and haven't -- I think a lot of great conversations around where we can help them perform better than they have in the past.

Douglas L. Becker - BofA Merrill Lynch, Research Division

Would something in integrated offering by late 2014 be a reasonable assumption at this point?

Jack B. Moore

I would just say, stay tuned on that. We've got a lot of opportunities. But the prediction of timing is something that I wouldn't want to make.

Douglas L. Becker - BofA Merrill Lynch, Research Division

Understood. Maybe switching more to just Block 32 in Angola. Obviously, very large project out there. Looks like you might have some additional work coming in, in Angola next year as well. But just your thoughts on that project, in particular, given its size?

Jack B. Moore

Well, it is a big project. And anything that big that involves multiple partners, I think, everyone who's been working with Total, looking at the scope of this project for well over a year, probably longer in some respects, it's a big opportunity for whoever is going to provide the equipment and services. But it is a challenging environment in Angola. I think we've all executed projects there and know the risk. We just hope that everyone takes that into consideration as we look at this opportunity as it comes to potential closure.

Douglas L. Becker - BofA Merrill Lynch, Research Division

And then just one last one, I guess, for Chuck. Appreciate that the budgeting process is still ongoing. The approaching $11 billion of revenue, just doing some quick math, that would call into question being able to earn $4 in EPS in 2014. Is that a fair statement?

Charles M. Sledge

Yes, I'm just not prepared to answer that. We don't have all the pieces yet. But we've laid out what you got to think about.

Operator

Our next question is coming from the line of James West of Barclays.

James C. West - Barclays Capital, Research Division

I just had one question, but Doug picked it up there in his last part of the Q&A.

Operator

Our next question is from the line of Ole Slorer with Morgan Stanley.

Ole H. Slorer - Morgan Stanley, Research Division

Just a quick question on the $500 million of R&D. What exactly is it that you are targeting with that kind of spend? And how much are you spending within V&M division on R&M -- sorry, R&D right now? Are you spending nothing and this a $500 million increase? Or is there some run rate there already?

Charles M. Sledge

Yes. First of all, we didn't say $500 million. So I'm not where -- sure where that number...

Ole H. Slorer - Morgan Stanley, Research Division

Sorry. Yes, maybe it's not been confirmed.

Charles M. Sledge

So anyway, yes, the place where we're increasing R&D is OneSubsea. We've kind of indicated that on past interactions with our investors that we have to invest in that business to change the game. That's the whole focus of it. However, if you look at the opportunities in deepwater where we now have a lot more horsepower to focus initiatives. Dual boosting with the Framo platform and some of the other things we have brought in with our MARS technology. You got intervention technology, which, clearly, if you're going to approach a life-of-field approach, this is something that we want to exploit and Schlumberger have some great technology. We just got to make sure that we have the right focus on how to MAR-enize that and touch that deepwater infrastructure. And again, high pressure, high temperature, this is going to be continuing to evolve. We're getting a lot of support to evolve this technology. As you think about the opportunities, there's a lot of them. We got to be very focused on what we do and understand what value we're driving with that and how it differentiates Cameron and OneSubsea's platform going forward. And that's really where the focus is going to be. We're going to be aggressive with this. That's why we're kind of telling you guys now we're going to spend a lot more money on R&D in 2014 than we have in the past because it's the opportunity is there for us to do it. So that's the focus.

Ole H. Slorer - Morgan Stanley, Research Division

And any of these R&D programs kind of cost-funded by any of your customers? Or is it all going to be something that you will have to pay for yourself and hopefully...

Jack B. Moore

We have one that's wonderful, it's called Wet Gas Compression, that is with a customer that's kind of up in that northern part of the North Sea. And that is a wonderful project that we both, together, will invest our own money in. But having a partner that is committed to take it and put it through its paces is a -- in a fairly quick order to get this one over the line, we're going to juice it up. Absolutely.

Ole H. Slorer - Morgan Stanley, Research Division

Yes. And when it comes to the boosting contract you just got and congrats on that, would that be sort of in the neighborhood of $300 million? Or what type of size would that be?

Jack B. Moore

Look, we haven't reported the number and that's at the request of the customer. So we'll leave it at that. But it's substantially, to us, and it's the second largest we've ever done. So it's important.

Ole H. Slorer - Morgan Stanley, Research Division

Yes. I mean, clearly a lot of focus on a flattish tree market into next year, kind of adjusting for the longer lead time on a Brazilian work. So the -- so what -- how important could the boosting market be for you in terms of -- or even if you could break into processing and how close are you to that? I think the shifting...

Jack B. Moore

Yes. Ole, it's a good question and one where, I think, our teams in the past have been focused on kind of greenfield opportunities and not brownfield opportunities. And we got a lot of horsepower now around how we think about exploiting the subsea processing space. And with the advent of having reservoir capabilities embedded in this organization, the monitoring and the ability to get subsea with other equipment that Cameron brings to it, the Framo technology is all of a sudden looking a lot more applicable in some of the brownfield application. So we're going to create some of our own business as a result of this. So flattish tree markets in 2014 may not equate to us being handicapped that much relative to the opportunities. We see, with subsea processing, last -- I think last quarter I talked about $1 billion view of what the opportunities are out there for the next 18 months. I still -- that's still what we see. Timing is always going to be something we can't predict. But going out and creating opportunities with what we have created with OneSubsea is going to be a lot of fun and it's going to be something that we have a lot of value that we can talk about.

Ole H. Slorer - Morgan Stanley, Research Division

And just finally, on margins. Is it fair -- how much of the margin shortfall relative to what you had expected comes from the Drilling division versus the OneSubsea division?

Charles M. Sledge

Actually, the OneSubsea division didn't have a shortfall in margin.

Ole H. Slorer - Morgan Stanley, Research Division

So the $0.06 to $0.07 for the final quarter -- or $0.07 to $0.10, sorry, suggests a pretty robust profitability, right?

Charles M. Sledge

Yes, I think it does. And just remember that some of the decline also -- a good portion of the declines is coming out of V&M. Remember what we said about V&M.

Ole H. Slorer - Morgan Stanley, Research Division

Yes, yes, yes. So finally, on V&M, how should we think about normalized margins, if there ever is such a thing, call it the current business environment; gets no better, gets no worse, but through internal measures and execution, some of the airfreighting and other stuff that normalizes, what would you say that at normalized EBIT margin is, if you can define it however you want to?

Jack B. Moore

Yes, in terms of the V&M, again, I don't see us in '14 replicating the first half margin performance. So you've got definitely a different margin that's in third quarter and fourth quarter. And I think somewhere around there is about right.

Ole H. Slorer - Morgan Stanley, Research Division

And what about DPS?

Jack B. Moore

I'm sorry?

Ole H. Slorer - Morgan Stanley, Research Division

And what about the Drilling & Productions Systems? What would the normalized margin be there?

Jack B. Moore

Again, you've got this R&D running through it, so kind of hard to pin that down till we firm up -- till we pin that number down. We'll give you more guidance at the year-end call.

Operator

Our next question is from the line of Brad Handler with Jefferies.

Brad Handler - Jefferies LLC, Research Division

If I could, I guess, stick with margins as well, but please just talking about the fourth quarter just so I understand some of the moving pieces. In the Drilling side, the improvement in margin that you're looking for, is that a function of having addressed some of the issues? Or having a little bit less third-party outsourcing of components? Or a little less expediting costs? What's actually driving the improvement in your outlook sequentially?

Jack B. Moore

At DPS, it's surface and subsea, the margin improvement.

Brad Handler - Jefferies LLC, Research Division

Okay. More volumes flowing through in both of those, I gather?

Jack B. Moore

Better -- well, a little more volume. But it's just better margins that are being realized in backlog. And the noise in the number is coming out of Drilling.

Brad Handler - Jefferies LLC, Research Division

Got you. So the drilling challenge is as acute as it has been the last -- well, this quarter, so it doesn't change that quickly and so that's the same, the problem remains the same?

Jack B. Moore

Not as quick as we'd like.

Brad Handler - Jefferies LLC, Research Division

Sure, sure. How -- you've mentioned the initiatives and I guess, your frustration that, that hasn't been implemented. But maybe you can tell us a little bit more about them and when that starts to -- whether it's your plans or your hopes, but when that starts to help?

Jack B. Moore

Well, I think, as I've said, we are -- we have an organization that's totally focused on deliveries. In this business, it is everything to our customers. So we're close to $600 million in revenue run rate, we'll be higher in the fourth quarter relative to that given the $4 billion of backlog. We've got to keep the pedal to the metal. But we probably are 70% complete with what we thought we would be relative to capacity additions. We started over a year ago and if you think back in the fourth quarter of '12, we had huge bookings. And it was one of those kind of holy crap moments. We got to get after it even more than we were. So as you think of the capacity additions we're bringing on and its infrastructure and people doing critical things around getting these pieces of equipment and stacks built, some of this equipment, remember, is about as big as a Suburban. So it's not for the faint of heart in terms of what unique capabilities we have to have in order to get this equipment handled and built. So a lot of momentum, not fast enough. We're going to feel it through the fourth quarter. I think we're going to feel it through the first part of next year. We'll make a lot of progress in between time. But it -- I think the reality is, is we still got a lot of work to do. And we're -- we haven't done what we said we're going to do and I am -- we are totally focused on making sure we get through this.

Brad Handler - Jefferies LLC, Research Division

Okay, I appreciate that additional color. If I ask similar sort of line of questioning about V&M and again, just in terms of the fourth quarter, I guess there are cost initiatives in place, you mentioned, there are pricing pressure. But on that -- on a higher revenue base, the mix is if the margins hopefully stay about the same?

Jack B. Moore

Yes, it's an interesting contrast. V&M is a volume miss, which creates negative flow-through that we have to deal with the overhead in plants and some SG&A issues. So we have to rationalize some of the cost structure in both factories in other parts of our business to deal with lower volumes. Drilling, it's not a volume issue, it's a manufacturing cost issue. So there are 2 different aspects that we are taking. Someone said, well, let's just take all the -- some of the drilling components and throw them over into the V&M plants. And building ball valves versus -- that are the size of a trunk of a Suburban versus the size of a Suburban is a different angle. And I'll tell you the other thing that's kind of added to the drilling challenge. The 7 stacks, a lot more complex than 5 and 6 cavity stacks -- I mean, 7 cavity stacks. Hard piping, new diverter and riser tool designs, which are accommodating the new rotary table, the larger rotary table designs that are coming out with the new builds. Third-party inspections, guys -- post-Macondo, we got a lot of third-party ABS, DMV, they are all over our business. So all of this adds to, again, to the complexity. You kind of cook that in with us being late on getting our capacity put in place. It's resulted in what we're seeing. And we know what to do and we're focused on it. We just to get it done.

Operator

Our next question is from the line of Marshall Adkins with Raymond James.

J. Marshall Adkins - Raymond James & Associates, Inc., Research Division

Just a big picture question to start out with. On V&M, intuitively, thank God, we're putting in a hell lot more infrastructure, more pipelines, more petrochem, more everything. And when I hear you describe the business, like that ought to be a great business. Is it because that stuff is just getting started and this is more of a '15 business? Or is somebody else capturing that? Or am I just missing something totally from a macro perspective?

Charles M. Sledge

Yes, Marshall, it's Chuck. From a macro perspective, it is a great business. But you can only lay so much pipe at a time. And so people bought a lot of valves. Now they're laying the pipe. As soon as they get that done, they're going to buy a bunch more valves, okay, to put the next phase of construction. So everybody is covered up in installation and construction. And they order those valves earlier. And so what you're seeing here is just a temporary pause. It's creating a little downdraft. But we fully expect that to change. But it's going to create a downdraft in our financials for just a little bit of time here. This isn't a structural issue or the fact that there's not the activity levels. It's just -- it's timing and it creates a little -- given the nature of that business and its high profit level, it just gives us a little indigestion for a short period of time.

Jack B. Moore

Marshall, I mean, you're asking the same questions we ask. We have other data points within our business that kind of collaborate what we're seeing with the timing, some of it going on in our Compression & Process -- onshore process businesses. Tons of opportunities on the radar. We're just -- the timing has surprised us a little bit. I think if you look in '14, we're going to see a pretty healthy bookings opportunity. Problem is it's just late and it's not going to translate into the revenue opportunities that we expected in the back half and some of that will impact us in '14. But I mean, the opportunities with the infrastructure, rewiring all of America, it is -- it's huge and we clearly are seeing it. It's just the timing of when it happens.

J. Marshall Adkins - Raymond James & Associates, Inc., Research Division

So think about this as a slow and steady grow -- or slow being slower than subsea, but a steady grower '15, '16 time frame.

Jack B. Moore

Yes. And I think we'll see more episodic events. We have key alliances with about half a dozen majors. And we have good visibility of the pipeline of their projects. We've worked with them early in the process. And they just deferred some of them. I mean, look at Gorgon 2. That's probably a good example of as our customers are executing on the prior projects, they get a little bit indigestion in terms of the timing. And it just kind of creates a chain of delays that have caught up with us in this particular business. It'll be good. It's just going to be a little more episodic.

J. Marshall Adkins - Raymond James & Associates, Inc., Research Division

I'm going to resist my impulse to ask you another question about '14 margins and shift to CAMSHALE. That's a been a rock star business for you all. Obviously, a lot of focus on that business in the industry. How is that going? And you taking share in that business, does that continue to do well?

Jack B. Moore

It had been a rock star for us. If you look at the margins, what impresses me is the guys have been able to continue to improve them. That, Marshall, is a function of our investments that we've made early. I mean, that's a great example of where we are early movers in that business and it really paid off. And let me tell you the other big factor for us there that differentiates is the performance. And we've put a lot of infrastructure in place to support it. So it's not just building equipment, but you got to have the infrastructure to repair it and get it back down in the field to make sure it performs every time. And a lot of our customers now are focusing on making sure they get their cost efficiencies on locations. That's where our performance is making a big difference. And the reason we're able to penetrate some shares because we can walk into a customer and say, our downtime with our kit is less than 1% and measured against what you're getting now. It's a huge selling point for us. And we're going to continue to exploit it. We just have to continue to put the resources there to back it up and we're up big time year-over-year in the U.S. shales with our Surface Systems kit. So we're still playing a little bit of catch-up with the resources there, too.

Charles M. Sledge

Yes, we're up actually, Jack. We're up 20% year ago levels in that business, in that region in a fairly flat market.

Operator

Our next question comes from line of Robin Shoemaker with Citigroup.

Robin E. Shoemaker - Citigroup Inc, Research Division

I wanted to frame the question about delivery scheduling just a little bit different way, perhaps, oversimplified. But when you book a order in DPS, you commit to a certain delivery date. And I suppose sometimes you realize after the fact that, that's going to be pretty tough to achieve that delivery date. And then -- or that it's coming, coming pretty quick, and you may not have all the resources in place. And then perhaps another situation is where the customer asks you if you can expedite or deliver that equipment perhaps sooner than the contract stipulates and you agree to do that. I just wonder kind of what is more often the case that causes these costs to escalate around the expedited delivery?

Jack B. Moore

Yes. Let me specifically talk about Drilling, Robin. Here's a couple of examples that hit us. Our customers order a stack, there's a delivery date and then they want to make a change to it. For example, they want to go fully Inconel lined on all the critical aspects of it or they want to go from couplings to hard piping. We estimate -- we've got a delivery date and their ship delivery date is not changing, okay? So we go through a process of estimating the time and effort involved. Sometimes we get that right, sometimes we get that wrong. And it starts a spiral of you've got to do a lot more work in the same amount of time frame. That is the typical norm. And then because we're delivering so many of them, once one kind of causes you a little bit of trouble, you've got a knock-on effect. And on the other 14, you've got to get out for the year. And so it just causes time. It takes a lot of time to get it through the system and clear all that.

Robin E. Shoemaker - Citigroup Inc, Research Division

So is part of this solution requiring more for like these change orders from the customer or...

Jack B. Moore

Yes, that's part of it, that's part of it. But we've also got to do a bigger job or recognizing the impact of that change.

Robin E. Shoemaker - Citigroup Inc, Research Division

Okay, understood. Just one other question for me. On the deepwater drilling equipment market, both BOPs and non-BOP drilling equipment that you sell for the deepwater drillship market, how is that going currently? Or how did it go in the third quarter? And what's your outlook for that part of the...

Jack B. Moore

Well, we booked 2 stacks in the third quarter. And I would say our outlook continues to be positive. What you're seeing is just upgrades in next-generation fleets or getting a premium -- they're getting the premium looks. And I think as you see the new stacks -- the new drillships and floaters populate the market, I think they're going to come in the premium pricing and I think they're going to command a lot more attention. And I think you'll continue to see our customers upgrade and evolve their fleet to be more competitive with the new norm. So that's a positive for us and a positive for those who we compete with. The other thing that's very positive for all of this is the aftermarket. Don't forget that all of this equipment needs tender, loving care for many, many years to come. And a lot of our focus is really going to be geared to making sure we do that.

Operator

Our next question comes from the line of Bill Herbert with Simmons.

William A. Herbert - Simmons & Company International, Research Division

I'll be quick here, hopefully. DPS margins, I know you aren't prepared to give us an exact number. But can you give us directionally what you think they'll be in 2014?

Charles M. Sledge

Bill, no. Not until we kind of nail down the -- kind of the R&D program we've talked about. But clearly, that's going to have a significant impact on DPS margins, that one program. So again...

William A. Herbert - Simmons & Company International, Research Division

Do you think that it's -- well, do you think, at this stage, taking that into account and given what you know today because you know a lot more than we do, okay, are margins in '14 flat, up or down versus '13?

Charles M. Sledge

I do know a lot more than you, but I don't know enough at this point is the only problem. So when you go segment-by-segment, I think Drilling will probably do better, okay, year-on-year. I think Surface will do better year-over-year margin. I think the core Subsea will do better year-over-year on margin, but it's going to be way down by a large R&D investment that I don't have total clarity on, whether it pulls it down or not.

William A. Herbert - Simmons & Company International, Research Division

Okay. So stay tuned on that front. And with regard to top line, Chuck, for '14, I think you guys have been inferring pretty strongly here for a while with reason that we were not going to have -- we were not going to repeat the same level of revenue growth '14 -- in '14 versus what we did in '13 for the DPS. Can you give us a sense as to what pipeline rate of expansion will be for DPS for '14? A range is perfectly fine.

Charles M. Sledge

Yes, I think, Bill, you can back into it by what we said about V&M and think of PCS up a bit.

William A. Herbert - Simmons & Company International, Research Division

No, no, no. I'm saying DPS.

Charles M. Sledge

I know, but I'm asking you to back into it by the data points we've given you. It is what I am asking you to do.

William A. Herbert - Simmons & Company International, Research Division

Okay. Well, I will go back and look at it. If that's the case, why not just give us a number, Chuck, I mean, if would be a recommendation. And finally, for PCS in the fourth quarter, I did not hear you, you may have given it. What is the revenue guidance for Q4?

Charles M. Sledge

For PCS, hold on here 1 second. PCS will be up in revenue, probably around -- actually from third quarter levels up quite a bit. So I'd probably say something closer, the $400 million range.

Operator

Our next question is from the line of Jeff Tillery with Tudor, Pickering.

Jeff Tillery - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

I'll be quick as well. We can understand the discussion around kind of digestion and transitory issues. But I think the big picture question people are wrestling with is this will be the fourth year in a row where revenue growth outpaces earnings growth. As you think about the business plan over the next 15-or-so months, what are those risks that are out there that we need to pay most acute attention to in terms of the robust order environment turning into profit growth?

Jack B. Moore

Well, I think if you think of '14, if you take what we are supposed to be doing in '13, this is -- you'll see a market difference in terms of how we can deliver incremental revenue -- I mean, incremental profits on the incremental revenue. Some of it is getting our capacity squared away and getting it in place. I clearly feel that when we get through well into the first part of Q -- '14, Q1, Q2, we'll have a lot of these issues relative to what we're dealing with behind us. What we do know is that the backlog margin in our OneSubsea business and in our Surface Systems businesses and in our Drilling Systems businesses, are going to be better going forward. So those all will weigh into the results we'll see. Same with PCS in terms of the Process businesses that we're seeing. So the margin in backlog and the quality of it is going to be there. What we have to make sure we do is make sure our capacity is aligned to support it and make sure we don't overspend in getting this stuff through the finish line. And we got a lot of attention on that right now. So that's the focus.

Charles M. Sledge

Yes, Jeff, and if I can add something. Kind of as you think about it, if we're growing the top line in that 15% to 20% range, it's -- the phenomenon that you just referred to is going to happen. You're just going to incur a lot of costs because you're having to throw costs at things in order to get them out of the door. You moderate the growth to something lower than that, then you start seeing the inverse happen where we can focus on true efficiencies and the true wringing out of costs that could flip that phenomenon you just referred to. So I think that's how you got to think about Cameron. When we're in the hyper growth mode, it's just difficult because we are having to do things in an inefficient way to get stuff out the door. But as growth moderates, profit definitely rise because we can -- we focus -- we can focus better and you can lean things out and you're more proactive and in front of the ball than behind the ball.

Jeff Tillery - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

And then just one more question on the Subsea business. The R&D investment, does that not start in the fourth quarter? I mean, so we see a big margin rebound in the fourth quarter because it's not yet -- and part of it because it's not yet burdened by that R&D level, is that correct?

Charles M. Sledge

It's not burdened to the same extent it's going to be clearly because -- yes. Some of it in the fourth quarter, but the big impact is going to be next year.

Operator

Our next question will be coming from the line of Michael LaMotte with Guggenheim.

Michael K. LaMotte - Guggenheim Securities, LLC, Research Division

Chuck, if I can come back to OneSubsea and minority interest. We go from $0.01 here in the third quarter to $0.07 to $0.10 in the fourth. We've got R&D weighing on the number as we look into 2014. Can you just give us a sense as to what kind of volatility we can expect? I mean, that's a pretty big margin swing from Q3 to Q4 and just trying to get a sense as to whether that will be steady or volatile in 2014.

Charles M. Sledge

Quarterly, it will be volatile. Remember, subsea is a lumpy business. Subsea is a very lumpy business in terms of revenue. So the minority interest by quarter, you cannot flatline if you're trying to get it within a tight band. We'll try to give you guys our view of it, kind of how it will fall out during the quarters. But even then, a big tree that's got a lot of revenue will either ship in a quarter or won't ship and that will cause volatility in that number quarter-to-quarter.

Michael K. LaMotte - Guggenheim Securities, LLC, Research Division

Okay. Is -- which of Q3 or Q4 is sort of a better -- if we were to annualize them, which would look better? Somewhere in the middle?

Charles M. Sledge

Yes, probably somewhere closer to the middle.

Michael K. LaMotte - Guggenheim Securities, LLC, Research Division

Okay. And then, Jack, in your introduction comments, you've made notion of the delays related to capacity expansion and suppliers and all of the discussion, thus far, has really been focused on bottlenecks in the manufacturing and problems that come up in trying to get all these volume out the door. If I think about front-end supply chain and back-end even commissioning, what are the issues there? And are they being addressed and what are you doing to address them?

Jack B. Moore

Yes, a lot of it on the supply chain, especially around the Drilling side, is just the complexity of equipment we are building. Not just any supplier can handle the size of the equipment that we need, whether it's HBM, BTO capacity, some of the welding capacity. So as we get constrained internally, we go external. That external supply chain is stretched because there's only so many people that have the ability to do this. So their lead times go up, their costs go up. Our challenge has always been to bring as much of the critical mass as we can control internally. Obviously, not 100% of it, but enough of it to where we can affect costs and deliveries more specifically. But in this time where we have record backlog and we are focused on deliveries to no end, we have spent more in this arena than we had planned. So that external supply chain is something that we are -- we have not developed as fast and it has not been as responsive as we had planned it to be. And part of our challenge has been to bring some of that back and to control it ourselves. Takes a little longer to do that because you've got to make some additional investment.

Michael K. LaMotte - Guggenheim Securities, LLC, Research Division

Okay. And then in terms of that investment, any preliminary guidance on CapEx for next year?

Jack B. Moore

I think what we've been saying, absent one-off things that could occur, that we've been kind of guiding people to a 5% level.

Operator

At this time, I will turn the floor back to management for closing comments.

Jeffrey G. Altamari

Thank you, Rob. This concludes our third quarter earnings call. And thank you, all, for joining us this morning.

Operator

Thank you. You may now disconnect your lines at this time. Thank you for your participation.

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