Schlumberger Limited CEO Discusses Q1 2014 Results - Earnings Call Transcript

Apr.17.14 | About: Schlumberger Limited (SLB)

Schlumberger Limited (NYSE:SLB)

Q1 2014 Earnings Conference Call

April 17, 2013 08:00 AM ET

Executives

Simon Farrant - VP of IR

Simon Ayat - CFO

Paal Kibsgaard - CEO

Analyst

David Anderson - JPMorgan

James West - Barclays Capital

Ole Slorer - Morgan Stanley

Kurt Hallead - RBC Capital Markets

Bill Herbert - Simmons & Company

Jim Wicklund - Credit Suisse

Jim Crandell - Cowen Securities

Waqar Syed - Goldman Sachs & Co.

Bill Sanchez - Howard Weil

Scott Gruber - Sanford Bernstein

Michael LaMotte - Guggenheim

Jeff Tillery - Tudor, Pickering, Holt

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Schlumberger Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. (Operator Instructions). As a reminder this conference is being recorded.

I would now like to turn the conference over to your host Vice President of Investor Relations, Mr. Simon Farrant. Please go ahead.

Simon Farrant

Thank you, Greg. Good morning and welcome to the Schlumberger Limited first quarter 2014 results conference call. Today’s call is being hosted from Abu Dhabi, where Schlumberger Limited board meeting took place earlier today. Joining us on the call are Paal Kibsgaard, Chief Executive Officer and Simon Ayat, Chief Financial Officer. Our prepared comments will be provided by Simon and Paal. Simon will first review the financial results then Paal will discuss the operational and technical highlights.

However, before we begin with the opening remarks, I’d like to remind participants that some of the information in today’s call may include forward-looking statements as well as non-GAAP financial measures. A detailed disclaimer and other important information are included in the FAQ document, which is available on our website or upon request. We welcome your questions after the prepared statements.

Now, I will turn the call over to Simon.

Simon Ayat

Thank you, Simon. Ladies and gentlemen, thank you for participating in this conference call. First quarter earnings per share from continuing operations, excluding charges and credits was $1.21. This is $0.14 lower sequentially but $0.24 higher when compared to the same quarter last year. As a reminder, during the second quarter of last year, we wind down our operations in Iran and classified the results of the business as a discontinued operation and all the prior period amounts have restated.

Oilfield Services first quarter revenue of $11.2 billion decreased 5.6% sequentially, while the pre-tax operating margins declined 18 basis points. Approximately half of the $667 million sequential revenue decrease was a result of the absence of the year end surge in the product software and multi-client sales that we experienced last quarter.

The remainder of the decrease was largely attributable to the seasonal weather related slowdowns that typically experience in Q1. These factors also accounted for the sequential decline in margins. Given the significant impact that these seasonal factors had on our sequential performance, my comments will focus on year-on-year changes unless otherwise noted.

Oilfield Services revenue increase 6.3% year-on-year, while pre-tax operating margins grew by 248 basis points. Highlight by product group were as follows. Reservoir characterization revenue of $2.9 billion increased 1.8% while margins grew by 129 basis points to 27.3%. These increases were -- are primarily attributable to a very strong performance in wire line on improved offshore exploration activity.

Drilling group revenue of $4.3 billion increased 6.6% and margin improved by 249 basis points to 20.3%. These improvements were due to increased technology integration and robust drilling measurement and M-I SWACO activities in the Middle East and Asia.

Production group of $4.1 billion increased 9.5%, while margin grew by 313 basis points to 17.9%. This growth was driven primarily by a very strong performance by well services in North America land despite the severe weather.

Now turning to Schlumberger as a whole, the effective tax rate excluding charges and the credits was 22.6% in the first quarter compared to 22.3% in the previous quarter. We generated $1.6 billion of cash flow from operations. Net debt increased $610 million during the quarter to $5.1 billion, reflecting the consumption of working capital that we typically experienced during Q1. Driven by the annual payments associated which increased compensation.

At 18% of last 12 month revenue, working capital was lower in both absolute terms as well as percentage against the same quarter of last year. Additionally, we spent $899 on our stock buyback program during Q1. We repurchased almost 10 million shares at an average price of $90.31 during the quarter. As you know, back in July of last year, our vote approved new $10 billion share repurchase program. To-date we have repurchased $2.6 billion of shares under this program.

During the quarter we spent $864 million on CapEx. We generated $688 million of free cash flow compared to $127 million in the same period last year. As it relates to full-year 2014, CapEx is still expected to be approximately $3.8 billion as compared to the $3.9 billion we spent in 2013.

And now I will turn the conference call over to Paal.

Paal Kibsgaard

Thank you, Simon. In spite of severe winter weather impacting activity in our Russia, China, and North America land operations, our first quarter results were solid and fully in line with our expectations. Sequentially revenue dipped from the fourth quarter as a result of seasonal slowdown in activity and lower product and multi-client seismic sales, but grew year over year by just north of 6% while pretax operating income increased by 21% to yield an incremental margin of 60%.

The driving force behind these results is further market share gains on the back of growing new technology sales and expanding integration related activity as well as a relentless focus on operational excellence and efficiency. In terms of revenue progression by customer group, our year-over-year growth was driven by the NOCs and the independents which now represent more than 70% of our revenue, while overall activity for the IOCs was more or less flat.

In the first quarter we generated close to $700 million of free cash flow which is an improvement of almost $550 million compared to the same quarter last year. Based on the growing strength of our free cash flow, we have decided to accelerate our current $10 billion stock buyback program announced in July of last year with the aim of completing the program in two and half years versus the original target of five years.

This does not change how we intent to use our cash where the priority continues to be reinvestment in the business to drive growth while we remain opportunistic when it comes to M&A and also plan to renew dividend levels each year. The acceleration of the buyback program is more a reflection of the confidence we have in our business performance and outlook and a signal of our commitment to return excess cash to our shareholders.

Our international business continued to perform well in the first quarter. The seasonal impact of weather and lower product sales resulted in a sequential drop in revenue of 8%. However pre-tax operating margins were resilient at 22.8%, down only 73 basis points from the fourth quarter. Compared to the first quarter of last year, revenue was up 5% on the back of strong growth in the Middle East and Asia while pretax operating margins expanded by 286 basis points driven by new technology sales and strong focus on cost and resource management.

In terms of pricing, the international market remains highly competitive and we have not seeing any signs of a general pricing inflection. However our latest technology and our best in class service quality continued to carry a premium which together with the growth in integration related activity is reflected in our revenue rated pricing indicator which is up compared to the first quarter of last year.

The improvement in effective pricing together with our ongoing transformation programs focused on reliability and efficiency puts us in a very competitive position in the international markets which we are using to drive both market share gains and to expand our margins.

In Latin America, revenue was down 12% sequentially while operating margins were essentially flat at 21.1%. Compared to the same quarter last year revenue was down 8% however pretax operating income was flat due to proactive cost and resource management and also supported by our broad and diverse contract base in the region.

The year over year reduction in revenue was predominantly driven by Brazil, where both activity and pricing were significantly down compared to last year. Still, introduction of new technology and swift actions to right size the resource base in the country has enabled us to minimize the negative financial impact from the lower activity.

In Mexico, revenue was also down compared to the first quarter of last year, driven by lower budget spend from Pemex, both on land and offshore. The Pemex, mega tender process was concluded during the quarter and we have signed contracts worth $1.9 billion, which represents nearly half of the awarded work scope covering all the major projects in the South and North regions. The resource mobilization for the additional project is ongoing and will be concluded during the second and third quarter as we gradually ramp up the activity.

In Argentina, year-over-year growth was strong driven by rig-based activity in the Vaca Muerta shale where we are also actively engaging with a number of customers on sub-surface studies and on projects to improve drilling and completion efficiency. In Venezuela, activity was also up year-over-year and we continue to work closely with PdVSA to help them grow production and improve operational efficiency.

And in Ecuador we posted strong growth compared to the first quarter of last year, as we continue to progress on the Shushufindi SPM project where we again set the new production record during the quarter.

We also secured a right to negotiate for two additional blocks of fields in the country in the latest production in [indiscernible] that took place in the first quarter and these commercial discussions have already started.

In the Middle East and Asia, revenue decreased 3% sequentially while operating margins were essentially flat at 26.3%. On a year over year basis, revenue increased 19% and margins were up by 349 basis points. In the Middle East, year over year growth was again driven by Saudi Arabia where we continue to move in resources to keep pace with the additional growth we are taking on, and also by the United Arab Emirates where activity is at a record high.

In Southern Iraq, activity was down significantly compared to the same quarter last year as contract awards are delayed due to ongoing discussions between the IOCs and the governments. Based on this as well as the upcoming elections, we do not expect any significant recovery in activity in Southern Iraq in the coming quarters, and we are therefore already taking actions to right size our resource base. Activity in Northern Iraq on the other hand was solid in the first quarter and we expect strong growth there in 2014 leaving full year revenue for the country flat with 2013 and the operating margins approaching the average of the region.

Southeast Asia posted strong first quarter results driven by high deepwater activity throughout the region, solid SPM performance in Malaysia and very good drilling performance in our IPM project in Queensland, Australia. In China we continue to ramp up activity on our tight gas SPM project with Yanchang Petroleum in the Ordos basin and we are operating a total of 12 rigs at the end of the first quarter.

In Europe, C.I.S. and Africa, revenue was down 11% sequentially and operating margins were down by 220 basis points. However compared to the same quarter last year when the majority of the [formal] (ph) activity was still included in our ECA numbers, revenue grew by 1% and margins were up by 253 basis points. The year over year revenue growth in the region was also negatively impacted by severe winter weather in Russia as well as the weakening of the ruble that took place during the quarter. Still, the underlying activity both offshore and on land in Russia remains firm for the year. There were also several positive activity signs in parts of Europe and Africa that helped offset the first quarter headwinds in Russia.

In Norway we posted solid year over year growth driven by market share gains for our drilling services and we expect to see further growth in the second quarter as the seismic season starts and wherever this year will have particular focus on the [balance sheet] (ph). We have also been awarded a five year integrated well construction contract by the Norske for exploration and drilling activity where we will play an integral part of both the planning and execution process. And in West Africa we also posted strong year over year growth driven by both exploration and development work in several of the Gulf of Guinea countries and we still expect strong growth in 2014 in the region in particular from Angola, Gabon and Chad.

In North America we posted a strong quarter with revenue up 1% sequentially while margins were down 107 basis points to 18.5% driven by pricing pressure and severe winter weather on land as well as drilling delays in the Gulf of Mexico. Compared to the same quarter last year, revenue grew 12% while margins were down 53 basis points.

On land, we posted strong year over year growth in revenue driven by market share gains and new technology uptick in pressure pumping as well as solid growth in our artificial lift business where we continue to expand our market position in the rod lift market. Our margins on land were impacted by lower pricing in pressure pumping as we rolled over several key contracts at the end of last year and we also choose to incur additional sand transportation and fuel costs during the periods of severe winter weather to avoid any disruption to our customers’ operations.

In the Gulf of Mexico, deepwater drilling activity was down compared to the first quarter of last year due to a series of operational delays, longer completion times and more work over activity and this impacted several of our product lines. However, the situation is expected to normalize again in the second quarter and the outlook for deepwater drilling activity in the Gulf of Mexico remains strong for the full year.

Turning to technology, in 2013, we saw further growth in the rate of high impact commercializations from our RNE organization. This, together with significant improvements and the out of box performance of our new products had a clear impact on our financial results as presented in last month’s Howard Weil conference in New Orleans. In 2014 we expect this trend to continue with a wide range of new technologies scheduled for introduction to the market at the rates that will even surpass 2013. We will showcase a number of these new technologies in our investor events that will take place June 24th and 25th in New York.

In addition to the latest technologies from reservoir characterization and drilling, we will present a range of new production related technologies including a revolutionary intelligent completion system, our latest multistage completion technology and new fracturing fluid innovation and we will give you an update on our North American land artificial lift business where we see strong growth potential for both ESP and rod pump sales sales. Together with these technology presentations we will review progress on our ongoing transformation programs and also provide an updated financial outlook for the coming three year period.

Moving on to the macro picture, the global economic data has been mixed so far this year, with the US suffering an unusually half winter, China showing some signs of slowdown, although still projected to grow along 7.5% in 2014 and the situation in Ukraine adding a new risk to the outlook. However, the fundamentals of the global recovery remain intact, as the above factors are likely to only have a temporary impact.

In contrast to this, the oil markets have been significantly tighter than anticipated, as strong demand trends in OECD and in the Middle East together with continuing supply disruptions in various regions have left to lower spare capacity figures and pushed OECD stocks down to the largest deviation from historical averages since 2003.

The North American supply search continues to be just enough to equal the world's growing demand, while all other growth regions, including Iraq, Brazil and the Caspian are struggling to meet their production targets. This should continue to support oil prices around $100 a barrel and therefore encourage oil directed investments in both the North American and International markets.

U.S. natural gas demand reached a new all-time record in Q1, due to the severe winter weather pushing prices to a six year high. However, U.S. supply trends remain strong on the back of the Marcellus and as the weather normalizes over the springs and summer months we expect the North American market to return to a balanced supply demand situation from natural gas.

International gas markets remain relatively tight largely driven by Chinese demand which continues to grow at double digit rates while European gas demand has eased in the past months on a mild winter. Based on these markets conditions, we continue to expect well related EMP spend to grow by more than 6% in 2014, with spend growth relatively balanced between North America and the international markets. We further expect our year-over-year growth in 2014 to be driven by the NOC’s and the independents.

After several years of strong growth, our revenue IOCs has dropped over the past two quarters and was in Q1 flat compared to the same quarter last year. However, the first quarter should be the low point for IOC revenue this year, as our latest activity outlook indicates sequential revenue growth from this customer group in the coming quarters and with full year revenue expected to be flat with 2013.

Equally important to the level EMP spend and the way we translate this into revenue it’s our ability to convert the top line growth into profits. While we plan to deliver a solid incremental margin on the challenging market conditions in North America, we see potential for higher levels in our international business as demonstrated by our first quarter year-over-year incremental margins of 86%.

We are not likely to maintain these levels to our 2014, but our international incremental margin potential should offer strong support to our earnings growth in the coming year. Furthermore, our broad geographical footprints, our balanced technology portfolio and our agile organization provides us with insulation from market downsides as recently seen in Latin America and allows us to swiftly capitalize on market opportunities, whether in North America or anywhere else in the growth.

We therefore remain positive and optimistic with respect to the 2014 outlook as we continue to aim for solid double digit growth in earnings per share, fueled by a combination of topline growth, margin expansion and the acceleration of our current stock buyback program.

That concludes my remarks, we will now open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). First question comes from the line of David Anderson from JPMorgan. Please go ahead.

David Anderson - JPMorgan

Thanks. Good morning, Paal. I was wondering if you could expand a bit on your comments with the IOC’s, so 30% business it looks kind of flat, obviously we have seen a lot of headlines of the IOCs cutting CapEx, I was wondering if you could put that into context first a little bit? Can you help us understand how you see it's progressing, is it simply a function of day rates and when day rates come down, the projects start moving ahead. I was just wondering if you can help us how you see that kind of progressing throughout the year.

Paal Kibsgaard

Okay. So let me first start one thing, so I said that the IOCs are now making up well below 30%. So it has dropped over the past couple of quarters. So we have already seen a reduction in their spend. And what we’re saying is that, it’s already flat now year-over-year, the forecast we have from the value, geomarkets and a roll-up indicates our progression in the next couple of quarters and we see the full year basically being flat year-over-year.

Now what’s driving that, as we said before, we believe that the primary focus of the CapEx cuts from the IOCs will be on projects that are heavy on infrastructure and probably less so on well rated CapEx, although we have seen some impact on this as well.

David Anderson - JPMorgan

Okay, so if I think about kind of the exploration spend side of that, I guess that’s the part that I wonder the most about. It seems like that might be a little bit more at risk than say, the development CapEx. Can you talk about that from that standpoint, and how that could impact the WesternGeco, because obviously you guys have more exploration risk, so just kind of help us, kind of quantify. Is that a risk for you going forward this year or are you seeing, are you feeling pretty good about that exploration spend even with these kind of chatter-bumpy cuts out there?

Paal Kibsgaard

We haven’t really changed our view on exploration spend or the seismic spends since the January call. We still expect to see growth in exploration spend in 2014. It’s going to be lower than 2013, and within the exploration spend, we see flattening or flat seismic spend and the growth is going to come through well related spend, through appraisal and exploration type of drilling. So we haven’t really changed the view on either exploration or seismic from the January call. That was already factored into the plan.

Operator

Your next question comes from the line of James West from Barclays; please go ahead.

James West - Barclays Capital

Why don’t you just step into North America for a second, clearly the rig count trends have been a little bit better than I think most people anticipated early in the year. How do you see the progress for your business in North America going forward? Is it more that you’re going to gain margin and share from technology or do you actually see some pricing power developing?

Paal Kibsgaard

Well, if you look at Q1 first of all, in terms of our performance we saw very strong year-over-year growth as I said, with revenue of 12%. And this is a combination of market share gains and new technology uptake. And we continue to gain share and pressure pumping. And this is on the back of efficiency gains and new technology uptake. And we added another two fleets in Q1 from our idle asset program.

Now in terms of activity outlook for North America, on land we expect solid activity growth in U.S. land in 2014. We see this being led by South and West Texas. And in addition to the number of wells, we also see supported by again efficiency gains and further uptake of new technology.

In terms of Canada, the breakup is going to have the normal impact on Q2 and we see Canada slightly up compared to 2013.

And Gulf of Mexico, again Q1 was slow for us because of lower deepwater drilling activity. We see this coming back in Q2 and onwards; so a strong outlook again for Gulf of Mexico.

James West - Barclays Capital

Okay, so you do it in the Gulf, but this was I think a little or so deepwater rigs scattered into the Gulf from the second half of this year, you do see all those rigs coming and going to work and see the big uptake in the second half of this year.

Paal Kibsgaard

Yes, we do. And also the number of rigs in Q1 wasn’t really the problem. They -- we regenerate less revenue, although we have completion work there, the amount of revenue per day in completion mode versus full drilling mode is obviously a significant relapse. So it was not a rig count issue, it was an activity type of issue in Q1.

Operator

Your next question comes from the line of Ole Slorer from Morgan Stanley; please go ahead.

Ole Slorer - Morgan Stanley

Paal, I’m just taking one step back at the -- and I want to just have you clarify a little bit a high level question. You mentioned that the oil markets are tighter than one's anticipated. I know you don’t like talking about client production or anything like that, but once you made a statement I feel like I can ask you to elaborate a little bit more on that. I think consensus have probably been more divided on where oil prices are going and this year, and next year are meant to be the big sort of surge in production [indiscernible] that actually highlighted Brazil, Iraq, Caspian and of course North America. So what is that you see here that you don’t think the other -- or that’s positive to make that statement?

Paal Kibsgaard

Ole I think if you want to build a very kind of bullish case on production, I am sure you can do that. It’s just that if you go back and look at the previous years, there is always an element of project delays and production disruption. And what we said in January is that we expect there to be a normal dose of that in 2014. And so far this year we have seen that, so the market is still relatively tight. Obviously these stocks are down. OpEx spare capacity is down. And there is nothing dramatic in it other than that all the things aren’t lining up as maybe the bull case was at the beginning of the year for production.

Ole Slorer - Morgan Stanley

Will you tie that to what you see at the customer level of increased project delays now with IOCs being more capital disciplined, or taking a step back here having to borrow for their dividends? Is this something that you think is permanently delayed? How have you changed your view on it, say 2017, let’s say longer term supply growth as a function of what’s going on at a CapEx level at the moment?

Paal Kibsgaard

I think what’s going to happen at least over the next couple of years is that the IOCs will focus more of their spend where they can drill wells and generate production from existing infrastructure or from infrastructure that costs less. So huge infrastructure projects, I would expect to be kind of lower in frequency. And some of them might be postponed as we have already seen. While the focus, again is going to be on generating production which generates cash. So the ability to do that at the lowest possible investment, I think is going to be the focus, which is still good for us.

Ole Slorer - Morgan Stanley

So does that mean that you’re more than positive on the areas like the North Sea, let’s say metro areas, Gulf of Mexico than what you will be on frontier exploration like Arctic, Russia or [indiscernible]?

Paal Kibsgaard

Well I think for the frontier areas, you will still see exploration I think there is still a push towards delineating and trying to assess what these frontiers contain. So I think although there is lower growth in exploration this year I still think there is going to be lot of interest to try to assess what kind of potential these areas have. Now how the economics of the project was stack up and when development starts, that will I think is going to be a function of what they find and what the economics look like. But I still think there will be a push towards doing exploration in frontier areas, yes.

Ole Slorer - Morgan Stanley

And finally back to the U.S. again you have the very impressive growth, you highlight that this was market share gains through new technology. Could you kind of help us understand a little bit now how much was market share gains on your technology and how much did the underlying market grow by in your view?

Paal Kibsgaard

Well, if you look at the overall rig counts, it was up about 4.5% year over year and I would say partly offsetting that growth also was inefficiencies due to the weather. So a fair bit of this I think for us is market share as well as new technology. So I am not going to give you a detailed number which I am sure you know. But I am quite pleased with how we are continuing to progress in particular, in the pressure pumping market. We added about four fleets in Q3, one fleet in Q4 and another two fleets in the first quarter of this year. And this is all at descent incremental margins, so we are pleased with how we are progressing.

Ole Slorer - Morgan Stanley

Anything on the technology side you can share or do you want to wait to do it?

Paal Kibsgaard

Well, I already said a lot more about them what we normally do, so I think that’s going to be it.

Ole Slorer - Morgan Stanley

Okay. Thanks a lot.

Paal Kibsgaard

Thanks.

Operator

Your next question comes from the line of Kurt Hallead from RBC Capital Markets. Please go ahead.

Kurt Hallead - RBC Capital Markets

Thank you. Good afternoon, Paal where you are, good morning where we are. I have a follow up question, you addressed a lot of the concerns that investors have had with respect to the outlook on IOC spend and so on in great detail, so thanks for that. Question I would have would be, how do you risk assess from this point forward, right. You put out your targets, you kind of took a look at what’s going on with the offshore elements, it looks like the offshore rig market is still kind of on a slide downward. So from this point forward Paal, if you were to look at the offshore market, how would you risk assess it from here. What do you is the biggest driver? Is it more, what’s the risk on activities really what I’m trying to ask you from your standpoint. Is it Brazil; is it outside of Brazil, where -- how do you see that dynamic spinning up?

Paal Kibsgaard

Well if you focus in on deepwater where I think the biggest discussion has been, this is where the biggest projects are and this is where the biggest discussion are on rig rates all right. We looked at this in detail and if you look at the deepwater market, it’s really two separate stories, you have Brazil and you have the rest of the world. In 2013, Brazil represented around 30% of the global deepwater drilling activity and in Q1 of 2014 Brazil was 20% down in activity while the rest of the world was up 3%. Now for the full year of 2014, we expect Brazil to be down more than 20% versus last year, while the rest of the world we see as being up high single digits. And as we previously indicated in January, the growth in the rest of the world deepwater is going to be driven by sub-Sahara Africa and Gulf of Mexico, so really no change to that. And we also see descent growth in both exploration as well as development for deepwater.

Kurt Hallead - RBC Capital Markets

And then if you take that information Paal, when you roll that up into your outlook from a total international revenue growth standpoint, how should we think about that, is that kind of mid-single digit or double digit still double digit growth, how would you look at the international revenue dynamic for the year?

Paal Kibsgaard

Well if you look at the activity outlook or revenue outlook for us in the international markets, again we see well rated CapEx spend growing north of 6% and it’s going to again be driven by both land and offshore. There are a few offsetting factors versus what we said in January, so if you quickly go through those, we do see solid growth in deepwater drilling activity excluding Brazil. In Latin America specifically, we now see this as being flat driven by lower revenue in particular in Brazil but also to a certain extent in Mexico. In Europe and Africa, we are still showing good growth and basically in line with the previous outlook.

In Russia, the activity outlook is unchanged but the revenue will potentially be lower due to the currently weaker ruble, so what’s going to happen with the ruble as the year progresses we’ll have to see, but if it stays where it is now then revenue is going to be somewhat lower than what we initially expected while activity is the same. Now Middle East and Asia is stronger than we initially expected and that’s driven by several countries in the Middle East as well as Australia. So that’s kind of how we see overall international.

Kurt Hallead - RBC Capital Markets

Great. And then one last follow up, one of the key drivers for the margin performance and earnings performance over the last couple of years has been this internal dynamic for technology and excellence and execution and everything else. As you look out at the North American market going forward, you’ve now established firm leadership versus your peer group. Do you expect the excellence and execution program in technology if your peer group were to grow margins by 100 or 200 basis points, is that’s something that you think you can keep pace with or exceed given the dynamics in play right now.

Paal Kibsgaard

Well, like you say we've outperformed our competitors in terms of both topline growth in margin evolution [indiscernible] since like mid-2012. So at this stage I am quite pleased with our position both on land and offshore in North America. So we expect to maintain our margin leadership and at the same time grow faster in revenues. So if our competitors can grow by 100 and 200 basis points, I don’t see why we cannot do the same or exceed it.

Operator

Your next question comes from the line of Bill Herbert from Simmons & Company. Please go ahead.

Bill Herbert - Simmons & Company

Thanks. Good morning. Paal so at a recent industry gathering, you offered some interesting commentary about industry challenges and you referenced the fact that E&P CapEx over the last 10 years have grown by 400% or as oil production was only 15%. And you mentioned the fact, that in the E&P value chain, the oil companies were the ultimate integrators of all the technical work associated with finding hydrocarbons and the collective oil services, community was accountable for not delivering on required performance progress. And you also mentioned that the required improvement was not going to come from yet another round of procurement driven price reductions across the E&P value chain. So along those lines, as the industry is in introspective mood with where the IOCs and deepwater [indices] (ph) in terms of getting their deepwater cost and alignment, apart from the mix shift from infrastructure to well CapEx, what structural reforms are clients contemplating, implementing and the discussions you’re having with your clients along those lines?

Paal Kibsgaard

Well, I think if you look at the short term actions they are taking today, they are looking at bringing the deepwater rig rates down. I mean, if you look at what’s happened on deepwater day rates over the past three, four, five years they have increased significantly and they have been completed disconnected from the other deepwater oilfield services, right. So today the rig rental makes up around 50% of the deepwater well cost, so customers have really been looking for the opportunity to get the rig rental rates down and the opportunity is here in form of the high number of new arrivals, all contract expiring and a significant reduction activity in Brazil. So I think this is the opportunity. In the short term they are trying to get some relief on cost.

Now my comments in terms of a procurement driven exercise across the industry, is more focused in on, we need to basically drive off the technical performance as an industry, whether that is process efficiency or reliability of the projects that we execute. So what some of my customers are doing is they are, they are approaching us a lot more than in the past in terms of doing fully integrated projects, where we are a lot more engaged in the upfront planning and the sign of the work. And where we have a more performance based contracts in terms of how we execute the work as well. So these are some of the short terms actions that they are taking. And I think beyond that I think the service industry needs to take responsibility in terms of finding way of transforming themselves to drive both their internal efficiencies and their technical performance versus the customers that is how we can create more value and support our customers.

Bill Herbert - Simmons & Company

Okay. And secondly, coming out of the last quarter, you offered some helpful, I guess, parameters for the first quarter earnings possibilities. Do you have just a high level broad commentary with regard to what we should be focused on with regard to second quarter earnings possibilities?

Paal Kibsgaard

Well, if you look at Q2, we should see seasonal recovery in Russia and China and also less weather impact in U.S. land. Now this is going to be partially offset by the normal spring break up in Canada which has already started. And beyond this we are expecting steady growth in the underlying business as per the other discussions we’ve had so far today. So our aim for the second quarter is to bring Q2 EPS back to the level of Q4 of last year. That is for us a good target.

Operator

Your next question comes from the line of Jim Wicklund from Credit Suisse. Please go ahead.

Jim Wicklund - Credit Suisse

Good morning. And Bill Herbert, thank you for asking the question. And all thank you for the answer on the integrated projects. Let me carry that on, you mentioned several times in the press release about integrated projects, their accretion to margins. Can you talk about performance related contracts and what those returns look like relative to the rest of your business?

Paal Kibsgaard

Well, in general, Jim, the performance based contracts are accreted to our margins. So we take on performance based contracts where we have a pretty good handle on the environment that we operate in. We have a very good handle on how our customers are operating and are interfacing and supporting our operations. And also what kind of controls we have to drive performance. So I would say in general our performance based contracts and a lot of them are within the drilling group, if you take away the production incentive contracts, they are generally accretive to our margins and if you look at the drilling group margin evolution over the past two, three years, you see a very steady improvement from the time we took over Smith in back in 2010.

Jim Wicklund - Credit Suisse

Okay. Thank you for that. My follow-up question is, your self-help efforts, your transformational efforts internally, those mean a lot and they’re structural and they last for a long time. Which markets do you see those efforts having the biggest impact in over the next two to three years?

Paal Kibsgaard

Well, I think they will have impacts globally. We piloted some of these things in North America when we did the initial restructuring of North America land back in when we started in 2010 and that’s being some of the basis for our improvements in North America over the past three-four years. But what we are doing is now starting to pilot in small scale in various other parts of the world and this is going to take several years before we get fully implemented. But at the end of the day, the transformation programs that I’ve been talking about publicly over the past year, will impact all parts of the company, both geographically and in terms of technology.

Jim Wicklund - Credit Suisse

Okay. And if I could, when we look at the globe of the world, what area, what region do you think has the best upside to margins over the next two to three years?

Paal Kibsgaard

It’s difficult to think, but I would say that -- as I said in my prepared remarks, if you look at incremental margins, we are going to focus in on driving incremental margins throughout our business. With some of the, I would say challenges in particularly in North America land with that we’ve been facing on pricing, it is still more difficult to drive very high incremental margins in North America although we are going to try, but the overall international markets I still think has a significant incremental margin potential and as I also mentioned, year over year Q1 we had 86% incremental margins in international.

Operator

Your next question comes from the line of Jim Crandell from Cowen. Please go ahead.

Jim Crandell - Cowen Securities

Thank you. Paal, if well based CapEx is up 6% globally, is that an environment that you can grow your revenues in double digits?

Paal Kibsgaard

It’s a difficult question to answer. I mean is it possible? Yes. Are we going to get to double digits? I can’t really say and I wouldn’t commit to it. But the fact that we have the potential of growing our revenues higher than the 6% is I think is very clear.

Jim Crandell - Cowen Securities

Okay. Second question Paal is getting back to North American pricing for today’s technology, not newer technology, but is the 6% increase in well based CapEx in the U.S. in 2014 sufficient to drive pricing anywhere in the U.S. in any product lines for again today’s technology?

Paal Kibsgaard

I think overall I don’t think 6% is going to be sufficient to have a wide spread price increase in commodity type of technologies. Now you might have small pockets where there is a surge of activity and there is insufficient capacity to deliver. You might have situations where new technologies are introduced or where efficiencies are stepped up, where you can drive your effective pricing. But at this stage I would say that we are expecting North America land pricing overall, we are hoping it’s going to flatten from where it is now, that’s going to be the forecast I would say that we have going forward and then we are looking on top of that to drive up our effective pricing through a new technology introduction and by driving efficiency of our operations.

Jim Crandell - Cowen Securities

Okay, good answer. And then last question, Paal you talked about Brazil, what is the risk in your opinion of continued slides in activity in Brazil throughout this year and even into 2015? It seems like every rig that’s coming off contract they’re releasing.

Paal Kibsgaard

Yes, so as already said, I think Brazil activity, Brazil revenue for us this year is going to be significantly down versus 2013, it’s a combination of both activity as you say as well as the pricing on the new contracts that we took on during 2013. So there is no surprise that Brazil revenue is going to be down significantly and that’s already factored into these discussions and the outlook that I’ve been giving today.

Operator

Your next question comes from the line of Waqar Syed from Goldman Sachs. Please go ahead.

Waqar Syed - Goldman Sachs & Co.

Thank you. Paal, you mentioned before China there was some weakness in the quarter. Where do you see the outlook? Is this temporary and then what’s going on there for the year and beyond?

Paal Kibsgaard

Well, we still expect solid growth in China in 2014. It’s going to be a bit lower than 2013 partly due to some of these budget reductions that we have seen from the NOCs. But our focus in the China land market is very much on penetrating it further and if you look at our overall penetration of that market it is still very low. So, we aren’t immediately impacted significantly by these budget reductions. We are seeing significantly high demand for our new technology, for our technical expertise and also for project management. So that’s why we are still quite optimistic about China. And growth is going to be driven by land both in terms of conventional type gas and shale gas, and offshore is also going to continue to be solid. So I would say solid growth in 2014, a bit lower than 2013.

Waqar Syed - Goldman Sachs & Co.

And then in the Middle East it seems to be pretty active area, as you mentioned. Is there a way to quantify what kind of revenue growth could be possible from the Middle Eastern areas, Saudi Arabia, UAE, Kuwait, that area?

Paal Kibsgaard

It is vague. Yes, and we have done it. But I’m not going to share the outlook with you in great detail, other than we see it -- we saw it as a major growth driver for 2014 and it has confirmed its potential and it might even be slightly up in April versus where we thought it would be in January.

Waqar Syed - Goldman Sachs & Co.

So could it be in the upper teens growth rate there or mid teen growth rates, in that kind of range?

Paal Kibsgaard

I’m not going to give you a number. You can look at the Q1 year-over-year number which was pretty solid.

Operator

Your next question comes from the line of Bill Sanchez from Howard Weil; please go ahead.

Bill Sanchez - Howard Weil

Thanks, good morning. Paal, I found your comments on the southern Iraq interesting. I know Iraq had been one of the five countries I think you had outlined previously as kind of the highest growth markets for you. Has there been any change in terms of your thought on Iraq in general here in how the proceeds for Schlumberger, as going forward and maybe just on a year-over-year basis?

Paal Kibsgaard

Yes, for 2014 the main change has been that the activity in the south is going to be down. And this is mainly driven by ongoing discussions between the IOCs and the Ministry. There are things that they need to sort out and agree upon before they will move forward and award some of these lump-sum turnkey contracts that are pending. So until that happens, there isn’t going to be a lot of work awarded in the south. And with the upcoming elections, we don’t think that that situation and these bids are going to be awarded in the next couple of quarters. We think that is probably a late year event before it happens.

So that’s why activity in Southern Iraq for this year is going to be down. Now offsetting this is very strong activity growth in Northern Iraq. And here we have an excellent market position. It’s a lot focused on high-end exploration and we are able to offset the reduced activity in revenue in the South with growth in the North. So that 2014 Iraq revenue is going to be flat year-over-year and the margins are also now quickly approaching the average for the region. So overall, it’s somewhat downgrading of the growth in Iraq, but both margins and as well as the offsetting factor of the North is positive.

Bill Sanchez - Howard Weil

My follow-up would be, I know you said sometime, talking about the topline expectations in Latin America and the headwinds in Brazil. Your commentary on Mexico, I think is least as we start to think about the exiting 2014 on a year-over-year basis seemed more positive. Just thoughts there in terms of when you perhaps see year-over-year growth in Mexico or I guess number one, my follow-up to it will be just on the margins in Latin America. You’ve done a pretty good job of holding those relatively flat. Perhaps I missed it, but I don’t think I heard any thoughts on the kind of margin growth we should expect that to move forward here in Latin America or just is relatively flat a good expectation?

Paal Kibsgaard

Yes, I think overall for Latin America, I think flat is a good word. I think we see overall revenue to be flattish this year. And we are going to work very hard on maintaining our margins around the levels that we had in 2013. So far this year that's worked out well. And we will continue to focus in on that.

So, obviously a significant negative on Brazil which we already talked about. Mexico is more of a positive story. But in the short-term here what we see is a lot more budget discipline from Pemex; and also a little bit more hesitance towards spend as this ongoing reform proceeds. But as you know, we had some significant wins in the mega tenders, where we have gained significant shares and we will be ramping up activity in Q2 and into H2. So we expect to be exiting Mexico this year on a pretty good note and that will be a good driver for us in 2015.

Operator

Your next question comes from the line of Scott Gruber from Bernstein; please go ahead.

Scott Gruber - Sanford Bernstein

Paal, can you talk about your strategy in North American and rod lift? You see a path to transform legacy products through technology development or is there any interest in the space largely based on a view of end-market growth?

Paal Kibsgaard

Yes, so we are interested in North America land artificial lift markets, and we have followed it for some time. There is clearly significant growth potential there. It’s a huge market. There are hundreds of thousands of wells that installed rod lifts and we see a significant opportunity to apply more science and technology into this markets and also to help drive production and cost per barrel. So, if you want to be part of transforming a market which obviously are ultimate goal this year, and transforming it to the benefit of our customers, we are firm believers that you have to play in it; you cannot change it from the side lines. So while we have a growing ESP business in the North America land for the, shale liquid wells, we also believe that we need to have a complete offering and what we are looking to do now is to combine our ESP offering with these rod lift companies that we have both over the recent quarters. And then ultimately provide a life of well lift solution to our customer base. And that could be ESP for part of the life and it could be a rod pump for the other part of the life. So we are working on this and we will give a further off take on this business both I would say further strategy as well as technology in our June investor event.

Scott Gruber - Sanford Bernstein

Great. In an unrelated follow-up in Russia, Rosneft appears to be taking a new strategy toward contracting rigs. Have you noticed a change in how they cooperate with the service companies? Are they starting to push back on pricing for any of your services?

Paal Kibsgaard

As far as I know, we haven’t had any recent discussions with Rosneft on pricing beyond what is normal for our services. Exactly what Rosneft do in terms of oil contracting rigs, I don’t have any further comments to what their strategy is, no.

Operator

Your next question comes from the line of Michael LaMotte from Guggenheim. Please go ahead.

Michael LaMotte - Guggenheim

Thanks. Most of my questions have been answered. But, Paal I wanted to ask you about Saxon and sort of more strategically Schlumberger in the last few years has been moving away from the more asset intensive segments with the sale of rigs in Russia, and obviously the spark business model in U.S. pumping. Can you -- is something changing with respect to that strategy or was this just an acquisition or consolidation of opportunity?

Paal Kibsgaard

No you’re right. I mean, we continue to focus on return on capital employed and to be, would say capital efficient as we go forward. So there is no change in the strategy here, but let me just give you a little bit of the rationale for why we are acquiring Saxon. So land rigs has always been a key part of our integration platform for well construction.

Now in the past, and what led to the set-up of Saxon where we have basically sold them the rigs, we sold the rigs to Eurasia in Russia as well is that our priority in the past have been basically to have access to rigs from a trusted provider. It’s more a capacity issue that we’ve been focusing in, in the past. What we are doing now is that we are evolving this view to also seeing the land rig as a critical element of how we drive drilling performance. So what we planned to do at this stage now and Saxon is generally focused on the international market where we have basically all of our integration related business. We plan to invest in optimizing rig design and rig operations by combining Saxon’s rig engineering and rig management capabilities with our existing drilling expertise from both IPM and the drilling group. So there are some third party rigs within the Saxon fleet today, it’s quite a few and we will continue to support them, and if there are opportunity to do third party rentals, we will continue to do. But we are predominately buying Saxon because we want to have our own rig provider that we can help, help us drive the performance of our integration business for well construction.

Michael LaMotte - Guggenheim

Very interesting. Thank you. On Venezuela, I know that PdVSA has been working with IOCs and [indiscernible] to try to work with terms and get activity higher to raise production. Can you may be talk about what you see happening in that market over the next year, do you think there will be success there and the 2015 could be a much bigger year in Venezuela potentially?

Paal Kibsgaard

Well, for us Venezuela today is actually quite good. Activity in Q1 was solid. It was up more than 20% year over year and as you say, we have a close working relationship with PdVSA and as we put our payment agreement with them in place, payments are regular and they are according to plan. So we are in reasonably good shape there.

So looking forward for this year, we see continued increase in the rig counts. And these addition of rigs are mainly focused in on the [indiscernible] and we continue to ramp up our resources and expertise in the country, right. We have a number of projects with PdVSA where we are working with them to drive operational efficiency and obviously to help them drive up production. So we see Venezuela for 2014 to be one of the positives in Latin America.

Operator

And your final question today comes from the line of Jeff Tillery from Tudor, Pickering, Holt. Please go ahead.

Jeff Tillery - Tudor, Pickering, Holt

Wondering, if you -- you guys have introduced a couple of [leasebacks] (ph) to the U.S. frac market from your stat capacity. I wondered if you could just talk us through how you are thinking about further efficiency gains in your frac fleet here in the U.S. as well as the ability to for the market to absorb incremental capacity for new well this year?

Paal Kibsgaard

Well, I think the overall activity in terms of new wells and in terms of frac stages is going to be up in 2014. And whether we will add more capacity into this, I think is going to be a function of the pricing and the incremental margins we will get on the addition of fleets that we put in. All the fleets that we have introduced over the past three quarters, these criteria have been met, and that’s why we have been adding them, right. So we are currently today operating at 82% in terms of 24 hour operations, which has been obviously a key driver for efficiency. And other than that we are focusing in on term contracts. So we have about 90% of our pressure pumping contract volume on term. And we do that because we see that as a key element to help drive efficiency. That’s how we get predictable work. And we have a close working relationship with our customers for planning and scheduling. And also having term contracts and longer term relationships other than the spots, also helps us in the way we work together with them in terms of technical collaboration as well as new technology introduction. So, I am reasonably optimistic about our ability to continue to gain share in that market. What’s going to happen to base pricing, I think base pricing as of now we are looking for it to flatten out.

Jeff Tillery - Tudor, Pickering, Holt

Your second question is just around the seismic outlook. I know the backlog can be choppy for that business, but it was up a reasonable amount sequentially to exit Q1, does that -- has that changed at all the Schlumberger outlook for the marine seismic business as the rest of the year plays out?

Paal Kibsgaard

No, we haven’t changed our outlook for the seismic business since January. So like you said, the backlog was up 196 million sequentially and 49 million year-over-year. This was driven both by land and marine. And in terms of the 2014 outlook for seismic, we maintained the outlook that we did in January, that it’s going to be flattish in terms of overall spend this year. We continue to see pressure on basic marine pricing, we saw that in Q1. But in terms of Q2 and Q3 activity and our bookings and utilization is looking quite reasonable. So we did no change to what we looked at in January.

Simon Farrant

Okay, that’s all the time we have for questions today. Now on behalf of the Schlumberger management team, I would like to thank you for participating in today’s call. Greg will now provide the closing comments.

Operator

Thank you. Ladies and gentlemen, this conference will be available for replay after 9 a.m. central time today, through May 17. You may access the AT&T teleconference replay system at any time by dialing 1800-475-6701 and entering the access code 316978; international participants dial 320-365-3844. Those numbers once again are 1800-475-6701 or 320-365-3844 with the access code 316978. That does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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