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National Oilwell Varco (NYSE:NOV)

Q3 2010 Earnings Call

October 26, 2010 9:00 am ET

Executives

Clay Williams - Chief Financial Officer and Executive Vice President

Merrill Miller - Chairman, Chief Executive Officer and President

Loren Singletary - President

Analysts

William Herbert - Simmons & Company International

James Crandell - Barclays Capital

David Smith - J.P. Morgan

Kurt Hallead - RBC Capital Markets Corporation

Operator

Welcome to the Third Quarter National Oilwell Varco 2010 Earnings Conference Call. My name is Christine, and I will be your operator for today's conference. [Operator Instructions] I will now turn the call over to Loren Singletary, Vice President of Global Accounts and Investor Relations. Please go ahead.

Loren Singletary

Thank you, Christine, and welcome, everyone, to the National Oilwell Varco Third Quarter 2010 Earnings Conference Call. With me today is Pete Miller, Chairman, CEO and President of National Oilwell Varco; and Clay Williams, Executive Vice President and Chief Financial Officer.

Before we begin this discussion of National Oilwell Varco's financial results for its third quarter ended September 30, 2010, please note that some of the statements we make during this call may contain forecasts, projections and estimates, including but not limited to comments about our outlook for the company's business. These are forward-looking statements within the meaning of the federal securities laws based on limited information as of today, which is subject to change. They are subject to risks and uncertainties and actual results may differ materially. No one should assume that these forward-looking statements remain valid later in the quarter or later in the year. I refer you to the latest Form 10-K and Form 10-Q National Oilwell Varco has on file with the Securities and Exchange ComMission for a more detailed discussion of the major risk factors affecting our business. Further information regarding these, as well as supplemental financial and operating information, may be found within our press release on our website at www.nov.com, or in our filings with the SEC. Later on this call, we will answer your questions, which we ask you to limit to two in order to permit more participation.

Now I will turn the call over to Pete, for his opening comments

Merrill Miller

Thank you, Loren. Good morning. Earlier today, National Oilwell Varco announced third quarter 2010 earnings of $404 million or $0.96 a share on revenues of approximately $3 billion. This compares with essentially similar results in the second quarter of 2010 and displays our continued outstanding execution of the Rig Technology business and significant improvement in the margins and operations in our Petroleum Services & Supplies business and our Distribution businesses. Clay will provide more color on these numbers in just a moment.

Additionally, we announced new orders for capital equipment of $1.2 billion. This reflects the increasing demand for new state-of-the-art equipment and is the first quarter since the third quarter of 2008 that our book-to-bill ratio was one or greater. We are very pleased with these results as they are representative of hard work of our employees around the world and the improving environment for the products and services that NOV provides to its customers. I will now ask Clay to expand upon these results.

Clay Williams

Thank you, Pete. National Oilwell Varco's third quarter 2010 net income attributable to the company was $404 million or $0.96 per fully diluted share, compares to $0.92 per share in the third quarter of 2009 and $0.96 per share in the second quarter of 2010, all on a GAAP basis. Included in the third quarter 2010 results were $2 million of pretax transaction charges. Excluding transaction charges from all periods, third quarter 2010 earnings were $0.97 per share compared to $0.95 per share a year ago and $0.97 per share last quarter. As I do each quarter, I'll focus my comparative remarks on results excluding these unusual items.

Once again, the company generated steady strong results. Third quarter 2010 revenues of $3 billion were up about 2% from the second quarter of 2010 and down 2% from the third quarter of 2009. Operating profit, excluding transaction charges, was $598 million or 19.9% of revenue in the third quarter.

Within our Petroleum Services & Supplies segment, almost every business unit saw sales rise from the second quarter to the third, as 19% sequential improvements in North American rig counts prompted higher demand for bits, drilling motors, pumps, liners, valves and other consumables, and also a pull-through more services including solids control services, casing, tubing, line pipe inspection and downhole tube rentals. Business units across the board generally posted single-digit sequential sales gains with Drill Pipe sales improving the most, up 10% sequentially.

Land activity increases in unconventional shale plays were sufficient to overcome significant reductions in our Gulf of Mexico businesses, which declined $24 million sequentially for the segment due to the Deepwater moratorium and reduced shallow water drilling activity. The impact of the Gulf slowdown affected Drilling Fluids, Waste Management Service, Drill Pipe and Conductor Pipe Connection sales the most. But we were able to redeploy most of our Gulf personnel into growing land opportunities in the Marcellus, Bakken and elsewhere. Overall, North America accounted for about 56% of the segment's third quarter sales and international markets, 44%.

The company's Distribution Services segment also benefited from more drilling in unconventional shale plays in the third quarter, recovery out of seasonal breakup in Canada and from selling supplies into new land rigs being constructed for the domestic market. Distribution also benefited from sales into the Gulf Coast cleanup operations too, although these sales are winding down now. North America accounted for 81% of the group's third quarter sales, up significantly from the second quarter.

International sales, excluding Canada, were relatively flat for both Petroleum Services and Supplies and Distribution Services from the second quarter to the third. Generally, sequential revenue gains in Russia, China and the Middle East were offset by declines in Africa and several other markets.

Rig Technology posted slightly lower revenues and margins from the second quarter to the third. Lower revenues out of backlog were only partly replaced by higher aftermarket and capital spares sales. Non-backlog revenues were helped by additional service work and spare parts sales arising from new BOP regulations, which drove BOP aftermarket bookings $10 million higher and capital equipment bookings $45 million higher sequentially, excluding BOPs from the new drill ship packages. A number of domestic deepwater rigs are using the pause during the moratorium to catch up on upgrade and maintenance work, and we see BOP aftermarket work continuing to rise.

Through the quarter, we also saw some customers bring NOV-made BOP equipment back to us for repairs and maintenance, who were previously using third-party repair shops and spares. Additionally, demand for top drives, controls and other sophisticated drilling systems for land rigs and coil tubing, well stimulation and pressure pumping equipment continued to march upward through the quarter, particularly for domestic customers.

From land rigs to bits, to drill pipe, it was clear that North American shale plays dominated the landscape during the quarter, although with a new interesting twist. Just a few quarters ago, these unconventional shale drilling programs targeted gas almost exclusively. Lately, though, sustained high oil prices have prompted energy entrepreneurs to apply new shale technologies to emerging oil plays. Consequently, we see oil-directed drilling in the U.S. continue to rise steeply and it now totals 42% of domestic drilling efforts. Additionally, operators continue to carry unconventional shale development technologies and strategies into new basins in Europe, Asia and the Middle East, where they are executing several pilot projects.

There are many ways that NOV benefits from the continued proliferation of unconventional shale technology. First, the cornerstone of all successful programs is a well manufacturing concept, where drilling operations strive for repeatability and learning curve effect. A key attraction of all shale plays is their substantially reduced geologic risk vis-a-vis conventional drilling operations.

Shales were historically deposited in broad marine environments. They were rock that literally filled up ancient oceans. And as a result, they are found over vast expanses with relative homogeneity, at least when compared to more typical reservoir rocks like sands and carbonates, which can vary significantly in a matter of meters. As such, they limit themselves to highly repeatable operations with low geologic variability.

The most successful well manufacturing operations are executed with what are often referred to as fit-for-purpose drilling rigs, such as NOV's IDEAL Rig, our Rapid Rig and our Drake Rig models. These rigs incorporate AC power, electronic controls, top drives, automatic pipe-handling systems and quick rig up, rig down features that weren't available in the 1970s when the majority of today's rig fleet was built; and in the hands of a professional crew can knock out wells safely and efficiently. We have continued to sell many, many of these types of rigs as well as upgrade top drives and pipe handling systems into the shale plays across North America.

Secondly, shale plays consume a disproportionate amount of drill pipe. They're usually drilled with smaller diameter 4-inch drill pipe, which is bent 90 degrees to extend a few thousand feet horizontally. This bending imposes greater wear and tear on drill pipe along with higher torque requirements. And as a result, we've seen rising demand for our premium Hi Torque XT connections on drill pipe. Interestingly, we've also seen a shift towards rental tool companies providing drill pipe into these plays. Many drilling contractors simply don't want to wear out their pipe on these programs, so rental tool companies are stepping in to provide the pipe.

Another observation about this market is that the long-term rule of thumb most contractors had about drill pipe life, that it would typically last four or five years, simply doesn't apply to the shales where drill pipe life is more like 2 1/2 to three years. As a result, NOV is seeing rising drill pipe demands, specifically four-inch XT for these shales in North America. And we expect to gradually ship overseas as international shales become more prevalent. Our book to bill within drill pipe continued to climb this quarter, even with sequentially higher revenues in drill pipe. It has exceeded one for the past three quarters.

Third, the turning of drill pipe 90 degrees cannot be done blindly. It requires downhole electronics, which shifts the direction of the well bore to intersect the right geologic targets. These downhole electronic MWD sensors rely on measuring the earth's magnetic field to get oriented. And since just about everything that goes downhole is made of steel and steel interferes with magnetic fields, drillers must use non-magnetic drill collars to house the downhole electronics to execute these measurements. NOV is a leading provider of non-magnetic drill collars worldwide.

Fourth, fifth and sixth, drilling these wells goes much faster with fixed-cutter diamond bits, affixed to downhole drilling motors powered by the hydraulics of fluids pumped down the drill pipe. These types of bits drill best and fastest when they are turned at high rates of speed, 200 RPM or more, that can only be practically achieved by using drilling motors. As a result, the old style of drilling, delivering torque to the bit by turning the entire drill string from the surface, is steadily being replaced by the use of hydraulic power and drilling fluids to generate torque of just above the bit or just above the rubbery steerable assembly. The drilling motor converts hydraulic horsepower into torque downhole. One implication of this shift, is that the efficiency of the drill string of transmitting hydraulic power to the bit is determined by the roughness of the inner surface of the drill pipe. The smoother the pipe, the lower the hydraulic pressure losses down the drill string. This can be dramatically improved by applying thermal set plastic coatings inside drill pipe.

NOV pioneered tubular and drill pipe coating and remains the leading applicator of internal coatings, is a leading provider of downhole drilling motors and one of the largest providers of bits worldwide.

Seven, NOV is a leading provider of mud pumps, valves, and fluid-ins used to generate the hydraulic horsepower at the surface to turn the bit. One of the long-term trends in our business is the addition of more and more drilling mud pumps to rigs at higher operating pressures to provide more hydraulic power. After a well is drilled, it's usually fracture-treated with a dozen or more stages, a process which utilizes pressure pumping equipment, blenders and mixers where, eight, NOV is also a leader, followed by the drill out of temporary plugs in the well usually executed with coiled tubing.

NOV is also a leading provider of both coiled tubing units, nine, and coil tubing itself, 10, and has recently benefited from sharply higher demand for larger diameter units and tubing. We're also seeing rising utilization of units and the advent of reel trailers resulting in higher consumption rates of coiled tubing. These previously lasted three to four months and now are often worn out within a matter of weeks.

So there you have ten ways NOV participates in the shales. In short, we are a worldwide technology leader in providing many, if not most, of the critical hardware and technologies enabling a profitable, safe, efficient development of new unconventional shale resources.

Turning to the offshore. Like everyone in this industry, we were relieved to see the Gulf of Mexico blowout capped. Early this summer, we placed large orders for long-lead time castings for BOP equipment to be in a position to respond to pressing needs of our customers to upgrade and augment their pressure control devices. We've seen interest in new rams rise through the quarter, particularly for our new patented low shear force ram that has successfully sheared the largest drill pipe we make. The high level of BOP refurbishment work in our aftermarket repair facilities I referenced earlier is continuing into the fourth quarter.

In spite of the accident, deepwater production will press forward. And like we are with the conventional shale plays, NOV is uniquely positioned to benefit from the steady march of the petroleum industry into new offshore frontiers. Deepwater drilling cannot be performed without deepwater rigs. And while the moratorium, the credit crisis and a handful of yet-to-be-contracted new builds have resulted in headwinds to our thesis, we maintain that the world will continue to build out a viable fleet of deepwater floating rigs to develop the extraordinary resources located in deepwater basins.

To this end, we are pleased to book two large deepwater drill ship packages for Brazil that had previously been caught up in the credit market downturn for the past two years. These were part of the 12 contracts led by Petrobras in mid-2008 and will be built in Asia.

Additionally, last quarter, we mentioned that we were seeing a rising number of drillers soliciting budgetary quotes from shipyards and equipment providers for floating rigs. And this continued through the third quarter, perhaps helped by the emergence of attractive pricing and payment terms being offered by the shipyards. We are advancing a couple of deepwater projects rapidly unrelated to Brazil, which we expect to turn into orders within the next few quarters.

The third quarter also saw a sudden increase in interest in jack-up rigs, catalyzed by a number of tenders for high-spec premium jack-ups in international locations. More so than the floaters, the jack-up rigs fleet appears to be bifurcating in terms of capabilities with premium day rates rising faster than rates for older conventional rigs. To us, the demographics of the jack-up fleet, which are highly transparent, paint a clear picture of a world with a lot more rig building on the way. 2/3 of today's existing jack-up rigs were born in the ten years between 1974 and 1984. Most of the fleet is the same age, and it's an old age. 71% of the jack-ups, 327 out of 459 are beyond their notional 25-year design life.

If you add expected deliveries of jack-ups this year to all the jack-ups delivered since January 1, 2006, a five-year span in which our industry was very, very busy, we have been running at about 21 jack-ups delivered each year. If we assume the industry will replace these tired old jack-ups at the same average pace of the past five years, then we can expect to continue to build jack-ups at this pace through the year 2026. The last jack-up replaced will then be 41 years old, and the rigs delivered at the beginning of this retooling cycle will be celebrating their 20th birthday.

This broad retooling cycle spanning decades illustrates the pressing needs to replace old, mechanical rigs across many categories, not just jack-ups. Day rate structure for land rigs in the U.S. now point to a clear preference by oil and gas companies for new technology. At recent auctions, old, used mechanical rigs were struggling to attract bids much above scrap values. Extrapolating 500 new AC land rigs delivered into the U.S. land fleet over the past several years points to another decade-plus of building to fully retool the land for the year.

And internationally, where the evolution toward new rig technology is even less well developed, the trends point to many, many more years of rig building beyond that. The rig building never goes in a straight line. Nevertheless, despite the cyclicality of orders over the past couple of years, NOV continues to demonstrate some of the most stable earnings posted within oilfield services through the downturn.

Last quarter, we also discussed our strategic interest in FPSO products. And since then, we announced our intention to enhance our offering in this area through the acquisition of Advanced Production and Loading PLC, or APL, from BW Offshore for $500 million. FPSO stands for floating production, storage and offloading vessels, a clever idea that avoids laying expensive subsea pipes in lieu of pumping oil directly into tankers, which swing by from time to time.

The fleet of FPSOs in operations has grown from zero in the late 1980s to over 150 in service today, with Asia, Africa, and Brazil representing the largest markets. FPSOs are flexible and cost-effective, often constructed from old converted tankers, which makes for roomy deck space and generous weight and therefore processing allowances. There are a couple of dozen construction or conversion projects under way today, and reportedly over 100 projects being considered for FPSO production, including a number of potential LNG projects.

Currently, we can sell cranes, whole drill systems, riser pool systems, and mooring equipment into a typical FPSO project, which can combine to total about $25 million to $30 million on a single large FPSO. At less than $100 million a year in revenues for NOV in the past few years, this has not been a major market for us previously. However, we expect APL to change that. It will bring us market-leading turret mooring systems, internal, external, submerged disconnectable technologies that can add $50 million to $100 million to our FPSO package, and with over 50 turret and terminal systems installed around the world.

NOV brings manufacturing and assembly experience and assets, relationships and operating history with and within shipyards and extensive experience comMissioning marine vessels to APL. We believe the combination will permit NOV to establish an integrated package offering to FPSO operators, with the turret forming the centerpiece with can pull through sales of related deck machinery.

Most deepwater drilling in the past few years has been exploratory and largely successful. As new reservoirs are found, they enter the development stage, which entails more drilling and more production activities, and for the deepwater, will likely include more use of proven FPSO technologies. To us, the strategy of expanding our FPSO product offering is a logical extension of the success we've enjoyed in the offshore rig arena. We are excited about this transaction, which we hope to close during the fourth quarter.

NOV's third quarter order for capital equipment for Rig Technology totaled $1,175,000,000, slightly above revenues out of backlog, which resulted in a small increase in backlog during the third quarter. Excluding the two Brazilian floaters, the segment still posted a solid double-digit sequential increase in orders, reflecting broad demand for equipment from land, offshore and well stimulation sectors. We expect fourth quarter revenue from backlog to be roughly flat with Q3. And backlog on the books as of September 30, 2010, is expected to flow out as revenue of $3.3 billion in 2011 and about $0.4 billion in 2012. 81% is offshore and 19% is destined for land markets; and 15% is domestic and 85% international.

In Brazil, we expect Petrobras opening of the commercial portion of the tenders for the new, for up to 28 new deepwater drilling rigs to occur this quarter, perhaps in November and awards to flow sometime thereafter. We believe Petrobras' recent successful capital raise should help pave the way for the long-awaited execution of this project. Oil rigs are to be constructed in-country. We are pleased with the plan our operations group has developed to comply with the local content requirements of this tender. We expect orders from this to potentially flow into our capital equipment backlog sometime in the first half of 2011.

But obviously, this remains subject to a number of moving pieces in Brazil, and further delays are possible. Petrobras has signaled that they may choose to own a controlling interest in some, perhaps most of these rigs and intend to contract others to be built and owned by drilling contractors. We remain convinced that Petrobras is committed to building these rigs, and we expect them to contribute meaningfully to our order flow next year.

Now let me turn to our segment operating results. The Distribution Services segment generated outstanding results for the period. Revenues of $424 million during the third quarter of 2010 were up 16% from the second quarter of 2010 and up 39% from the third quarter of 2009.

Third quarter operating profit was $24 million or 5.7% of sales, up over 200 basis points from the second quarter of 2010 and more than double the operating margin posted in the third quarter of last year. Operating leverage or flow-through was a very solid 19% sequentially and 14% year-over-year, well above the long-term average of about 10% for this group.

The segment posted strong double-digit sequential sales gains in both the U.S. and Canada, which benefited from the seasonal recovery out of breakup and rising unconventional shale activity. U.S. revenue gains were led by sequential sales increases across most of the major unconventional shale plays as well, particularly in liquids-rich areas like the Eagle Ford and the Bakken.

International sales were stable, with increased sales in capital spares, composite pipe and Mono artificial lift and power section products through distribution, offsetting operating declines in Mexico and lower industrial products sales in Australia.

We expect reduced sales into the Gulf of Mexico cleanup effort and lower capital spare sales to lead a modestly lower revenues overall for the segment in the fourth quarter. Margins are expected to remain strong nevertheless.

The Petroleum Services & Supplies segment generated total sales of $1,089,000,000 in the third quarter of 2010, up $56 million or 5% from the second quarter of 2010 and up $207 million or 23% from the third quarter of 2009. Operating profit was $164 million or 15.1% of sales, up 170 basis points from the second quarter and up 530 basis points from the third quarter of last year.

Operating leverage or flow-through was 46% sequentially and 38% year-over-year, a little above typical long-term volume-driven leverage in the 30% to 35% range. Wear and tear from higher levels of drilling, particularly in the shales, led to higher demand for consumables such as Mission mud pump, parts and liners, quality tubing, coiled tubing, ReedHycalog Bits and brands solids control equipment. Tube and scope inspection in coating services witnessed higher demand, as OCTG inventories in North America rose, which appear to be leveling now. Star composite pipe sales into the oilfield improved, partly offset by lower international sales.

Portable power rentals benefited from Gulf Coast cleanup operations and shale activity. XL Systems declined in part due to the moratorium, but saw a backlog rise nonetheless, for its deepwater offshore products.

In addition, the higher Q3 drill pipe sales to the North American land contractors, Grant Prideco posted higher sales to Asia and saw orders increase nearly 1/3 from Q2.

Generally, pricing for most products appears to be stable, with only a handful of products able to increase pricing, usually just a couple of percentage points to offset inflationary forces. For the fourth quarter of 2010, we expect revenues and margins to remain roughly flat with the third quarter.

The Rig Technology segment generated revenues of $1,650,000,000 in the third quarter, down slightly from the second quarter of 2010 and down $350 million or 18% compared to the third quarter of 2009. Operating profit was $480 million and operating margins were 29.1%. Decremental leverage or flow-through was 28% from the third quarter of last year to the third quarter of this year.

Revenues from backlog declined 8% sequentially. But project margins actually improved slightly, benefiting from lower-than-expected freight and logistics costs. The group continues to execute superbly, as they have throughout this cycle delivering three drill ships, three semi-submersibles, four jack-ups and several land rigs including our 100th IDEAL Rig. The group also sold several more complete land rigs during the quarter for both domestic and international markets, including some higher technology rigs for the Russian market.

Top drive demand has remained very high for the three quarters running now, through a combination of discrete orders to upgrade existing rigs as well as complete rig packages including NOV top drives.

Looking into the fourth quarter of 2010, we expect Rig Technology revenues to remain roughly flat with the third quarter and expect margins to decline slightly into the mid to high 20% range, owing to a declining mix of high-margin offshore rig fabrication revenue.

Turning to NOV's consolidated third quarter income statement. SG&A increased $11 million sequentially due to higher amortization expense, slightly higher bad debt accruals and incentive compensation. Other expense increased $20 million due to mostly adverse FX movements in the euro and the Norwegian kroner.

The third quarter benefited from a lower-than-expected tax rate of about 29.5% due to a higher mix of income from foreign locations at tax rates below the 35% U.S. statutory rate. The rate also benefited from the expiration of reserves on tax positions taken in years past. We expect the rate to return to the 31% range in the fourth quarter.

Unallocated expenses and eliminations on our supplemental segment schedule increased $4 million, due mostly to higher incentive compensation accruals. Depreciation and amortization increased $3 million from the second quarter to the third to $127 million. And CapEx increased $16 million sequentially to $62 million, a little less than half of DD&A. We expect CapEx for the full year to fall below $250 million. EBITDA excluding transaction, restructuring and devaluation charges was $714 million or 23.6% of revenue.

National Oilwell Varco's September 30, 2010, balance sheet employed working capital, excluding cash and debt, of $3.7 billion, up $185 million or 5% sequentially, due primarily to the decrease in billings and excess of costs and increases in inventory. Working capital is presently running about 31% of annualized sales. Cash flow from operations picked up nicely this quarter, despite the working capital increase, to $453 million. As a result, our ending cash balance improved $382 million and totaled $3.1 billion at quarter end.

Now let me turn it back to Pete .

Merrill Miller

Okay, thanks, Clay. And I think Clay really gave us a good overview of the market. I just want to add a couple of things to it, and I'll be pretty brief here. But in particular, I'll emphasize the shales again, and the liquid part of those shales. When you start to talk about the Eagle Ford, the Bakken, the Granite Wash, Niobrara and the western part of the Marcellus, you're really looking at some very interesting plays there with liquids. I think those are going to be plays that are going to take some time to work. And I think the rig count is going to be pretty resilient with that.

The other thing that's pretty interesting are the international shale plays. And one of the complaints that I get all the time is our international shale plays are going to be a lot slower because the infrastructure has to be built out. Let me remind everybody on this call, we build infrastructure. And so actually, that will play very nicely into the fairway of what we're doing.

Clay also mentioned the bifurcation of the rig market. This is something we've talked about extensively, exhaustively. Those of you that have listened to t e calls are probably tired of hearing it, but the best rig wins. And what we do though to make sure that we continue to produce those is to bring new products out. And I think the lifeblood of any company is developing new products. It's improving the products that you have. And when I talk about R&D, I would tell you that NOV is much bigger on the D side. We do a lot of R. But the D in developing the products that we have and continually improving those is extremely important to us.

When you take a look at things like top drives, today, we have the TDX-1250, which is probably the best big top drive -- not probably, it is the best big top drive in the market. This is one that if you've got deepwater rigs, big rigs, big land rigs, you want to have this on there, because it enhances the capability of you drilling much more efficiently.

We continue to enhance our control systems. I think if you take a look at some of the things that have come about because of new requirements, it's going to be remote control, remote information. It's going to be getting the information from these rigs and being able to look at it on a real-time basis off the rig itself. Having control systems that can do this and having smart equipment, having equipment and having equipment that's set up with RFID chips that can give you that information and tell you how the equipment is operating, tell you what's going on downhole I think it's going to be imperative.

And also included in that, is going to be training. And I think with the sophistication of this equipment that we're getting, it really has to have a lot more training today and with that in mind, we have set up academies in Norway, Singapore and Houston to be able to train people every day, every week to be able to make sure that they know how to operate this equipment, but more than that, make sure that they can maintain this equipment in a manner that makes it the most professional in the business.

So I think these new products are really what's going to drive these rigs in the future and it's what the operators want today, and it's one of the reasons that you're seeing this rig market becoming bifurcated. Take a look at people like Seadrill, Precision, some of the folks that are putting a lot of money into their rigs, and they're the ones that are having the best utilization. So we're excited about this and we're going to continue to develop new products to make sure that we stay at the forefront of this business.

We're also extremely pleased with the APL acquisition. We think this is really going to bring a lot to us. If any of the APL employees are on this call in Norway or around the world, we're looking forward to welcoming you to this family. We're looking forward to the products out there. And I think it really, I tell people, B follows A, if you take a look at all the deepwater drilling, it's going to have to be produced and what it's going to be produced with? Predominantly FPSOs. So we like being in this space. We think it's going to really throw a lot of business our way over the next four or five years.

And finally, Clay pointed out that we've got a pretty significant balance sheet, very strong. And with that, I think there's a lot more M&A opportunities out there today. I will caution you, M&A is an art, not a science. And it's a science in the sense of being able to value companies, and we do that fairly disciplined. But it's an art in the sense of being able to negotiate, to woo the companies to want to be part of this organization.

I will say this, I think the M&A opportunities out there today are as good as they've been in quite some time. And we're looking forward over the next six months to a year, being able to talk about different opportunities that we have and being able to bring those opportunities through fruition.

So that really is just kind of a quick overview of some things that we've been thinking about. And at this time, Christine, I'd like to open up the call to any questions that our listeners might have.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Jim Crandell from Barclays.

James Crandell - Barclays Capital

First question has to do with, Pete and Clay, are the new builds outside of Brazil. It seems with the jack-ups, we knew that a lot of premium jack-ups were out there. But it seems like a light is going off here. In my count anyway in the last month or so, we have nine jack-ups. So it is -- you're probably aware of more than that. But it seems as if there's a lot more that are getting ready to order jack-ups. And it also seems that the number of companies now, at least looking harder at ordering new ultra-deepwater rigs. How do you see those two segments outside of Petrobras playing out?

Merrill Miller

Jim, we're actually pretty optimistic about it. I think you've really kind of outlined it there. We've felt like the jack-up market was poised to do some interesting things. And I think what's really manifested itself has been when you look at the marketplace itself, I think a couple of years, everybody said, well, the jack-ups are going to get oversubscribed and you're going to have too much capacity. But what we're finding out again it comes to bifurcation, and you're starting to see these new jack-ups are really what people want. And there's a lot of reasons for that. It's the cantilever, independent leg, it's the control systems, the top drives, the pipe handling, the off-line activity that these things can do that makes them that much more efficient. So I think you're going to continue to see a nice little market for that. Plus I think the shipyards, don't discount the fact that they're getting more aggressive. The shipyards want to continue to have this work done. When Clay talks about the financing of these places in Korea and Singapore, there's a lot of local financing, government financing, because they want to keep those shipyards operating. So I think it's a combination of the best rigs wins, plus, they're probably becoming a little bit more affordable, if you will. And I think some of that is all coming to bear. And we like what we're seeing over the next year or so in this marketplace.

James Crandell - Barclays Capital

And do you see that also happening, as increased interest and much more activity surrounding the ultra-deepwater space too, Pete?

Merrill Miller

Yes, I think so. We've contended all along that the ultra-deepwater space really needed more rigs. And I think the only reason you haven't seen much happen the last couple of years has really been financing. I mean it really is a situation when you go back to the third quarter of '08 when the financial system was imploding, making a lot of people have things on the table at that point in time that they pulled off the table. I think what you're getting today, a couple of years later, is the stuff that's being put back on the table. So we think that there will be some activity in that. But also, let me put caution out there. These projects don't just crop up overnight. Somebody had to make the decision, I want to buy that rig, so it's done tomorrow. These are a little bit more time-consuming, and it will take a while to negotiate deals, take a while to spec them out. But the fact of the matter is they're there and they will push into the future, no question about it.

James Crandell - Barclays Capital

Pete, could you give a little bit more color on Brazil? Recently in the past, you've talked about your expectation that they would order at least seven rigs in the first half of the year, which you reiterated on this call. But you even spoke to, I think, the fact that they could order more than that here in 2011. How do you see things shaking out in 2011 as far as rig orders coming out of Brazil?

Merrill Miller

Jim, I think what you're going to see is we've talked a lot about the seven-plus-two initial order. And that has got seven drill ships and two semi-submersibles or the potential of that, going to a couple of different shipyards. But the absolute potential of this is 28 rigs. And I think it's hard to gaze into the future to think absolutely what they're thinking down there. But I will tell you this, we're firmly committed ourselves to doing things in Brazil. But the Brazilians are committed to wanting to have some local build in their rigs and they want to do these things in their shipyards. And I think it's going to happen. I think you could see as many as 28 done. My gut feel is it's going to be between the nine and 28. You could have 16 as an example. But clearly, it's going to happen. And we think that the tenders will be opened up probably this quarter, but you never can tell. And this is not -- the thing about this and I've said this before, this is actually fairly normal for an international tender. I mean, for it to extend out like this doesn't mean that there's anything nefarious happening. It's kind of what happens. I mean, I've been in this company for 15 years now and I think I'm still working on some tenders and some parts of the scope that started back 15 years ago. Not that, that will happen here, I don't mean that. I think it's going to happen, Jim, and it's going to be anywhere from about nine to 28 rigs.

James Crandell - Barclays Capital

And that, Pete, that would be over what period of time?

Merrill Miller

I think they'd make those orders probably within the next year. Maybe 18 months, but no longer than that.

James Crandell - Barclays Capital

So you said the most likely case is we could see, again, 16 deepwater rig orders over the next year to 18 months?

Merrill Miller

I think -- I hope -- I'd say that's most likely -- I'd say the nine is the most likely, but it's just going to be between the nine and the 28.

Clay Williams

They need an awful lot of deepwater rigs down there. And to us it's very telling too that Petrobras changed the terms of the tender earlier this year to enable them to move beyond nine that they would, in fact, own or would provide equity financing for us. So that indicated to us that they're still moving forward. That plus the fact that they raised so much capital here a few weeks ago, we think bodes well for orders there.

Operator

Our next question comes from Kurt Hallead from RBC Capital Markets.

Kurt Hallead - RBC Capital Markets Corporation

I just want to follow up that in the context of your PS&S business, a number of different product lines make up that segment. What's been the history of when the pricing improvement will start to roll through some of those business lines after rig count starts to improve? I know you mentioned that there hasn't been really any significance on the pricing power just yet. So I don't know if we're maybe getting on the cusp of that? Or whether you still think it's some time in the 12- to 18-month time period before you get some flow-through on pricing. Can you give us some color on that, please?

Clay Williams

Kurt, if I had to guess right now, I think your 12 to 18 months time frame is probably a good time frame. When you move through a sudden sharp downturn and a severe downturn like we did in 2009, our customers pretty much across the board come back in and demand lower pricing and press for longer contracts. And so you end up with some contracts at lower pricing that just sort of have to burn off. You also find that you have to put a lot of more iron and crews and equipment and manufacturing capacity back to work before you get back up into utilization range that permits pricing leverage. And so we feel pretty good that the foundation has been laid, that things are starting to consolidate, we're starting to see some stability across a lot of our markets in PS&S. And to us, that tells us that pricing leverage is out there. And now it's just a question of quarter-by-quarter marching a little closer to each quarter. If you look back on PS&S on a pro forma basis, inclusive of Grant Prideco and excluding all of the merger noise, we looked a lot like we did in 2005. And back then, I think the segment averaged about 14%, 15% sort of operating margins, which this quarter, we did 15.1%. And it was really as we moved into 2006 that we began to see utilization levels hit the necessary threshold to be able to push through pricing increases. And that's resulted in margins for this group moving up into the low 20% range. And so I think, let's say at 2011, we start to see progress on that front, start to see margins really move up a little more strongly.

Kurt Hallead - RBC Capital Markets Corporation

In the context then if you look at the biggest business elements or I guess bits and pipe and I guess, drill pipe inspection, when you look at the Drill Pipe business, I think you guys have said in the past that you expect kind of a restocking process, maybe toward the latter part of, if I'm not mistaken, later part of this year into the early part of next year. I'm not quite sure given the shale element of how you see that market shifting, how it's changed and maybe how it's changed your perspective of restocking for drill pipe?

Clay Williams

I think actually the thesis is unfolding along the lines that we expect, if anything, maybe just a little bit earlier. But it's the mix that we're seeing a much higher mix of four-inch XT pipe for the shale plays. And it appears that is kind of the standard drill pipe that shale play operators are starting to coalesce around. And that's great news for us. The XT connection is a proprietary premium connection that we offer. If there's bad news to that, it's that four-inch is a little smaller than average. It's a little lower-priced product offering. But yes, I think it's all headed in the right direction. The other good news that we see out is that the offshore market, which had carried us a lot through 2009 with the new builds coming into the fleet, buying strings that piped out to those new builds, took a little pause at the end of '09 and through 2010. And now here late in 2010, it looks like the offshore market is starting to come back a little more strongly too. I think again, that's a business that we expect to continue to look better quarter-by-quarter as we move into 2011.

Kurt Hallead - RBC Capital Markets Corporation

For Pete, you kind of made a reference there on the M&A part. I guess it's kind of like a college recruiting process, right? So you're trying to get a new group of freshmen in there to help your team. Can you give us some general sense as to what the mood is out there with respect to M&A? And whether or not now that we're off the trough and we're heading back into an up cycle, is it getting much more difficult to convince some partners out there to become part of the NOV team? Or is the mood such that there is some more likelihood that additional deals can get done, whether it's for NOV or the industry in general?

Merrill Miller

Actually, Kurt, I would say that the mood is much more optimistic today on getting things done. It's interesting when you kind of move out of out a trough, it's almost counter-intuitive. When you're in the trough, you don't necessarily want to sell, because you're kind of sitting there going oh, -- and a lot of people don't necessarily want to buy. Because you say, is it going to keep going lower? Or what's the deal? But when you start to see a little but of signs of life , I think both parties become a little bit more optimistic about wanting to do something. So I'm very optimistic as to where we are today. M&A kind of seems to move in waves on us. And I would say today, we've got a lot of opportunity out there. We're always looking at a lot of deals. But I think we're a little bit, as we look at some of the deals that we're seeing today, we're a little bit more optimistic that we can bring these things to the finish line. It's never a guarantee. I mean, there have been deals that we thought we had in the bag that at the last minute fall apart, other deals that we never thought we had a chance on, at the last minute come together. But we're pretty optimistic. And we think that it's probably more of a better and more optimistic market today for M&A to be done, and I think that's really pretty much across the industry, with Schlumberger just kind of completing the Smith deal. You saw the GE-Dresser deal. I just think there's a lot of potential out there today and we're pretty excited about it. We like where we are, with the balance sheet to be able to take advantage of it.

Kurt Hallead - RBC Capital Markets Corporation

And then you expect NOV to kind of really continue to emphasize and maintain the manufacturing part? Or you think you're going to have to get in some non-traditional NOV-type businesses, services or otherwise?

Merrill Miller

We still like what we do on manufacturing, and I think that we do it quite well. And I think we're situated for it. We'll look at a lot of different opportunities. But I think that clearly, the thing that matters the most to us is kind of continuing to expand upon the things that we think we do very well and the things that we believe we're situated very well in the market to take advantage of.

Operator

Your next question comes from Bill Herbert from Simmons and Company.

William Herbert - Simmons & Company International

Clay, back to Drill Pipe here. So book-to-bill in excess of 1x for the last three quarters, been hitting obviously an enormous uptick with the rig activity. In an environment in which we could be flattening out with regard to rig count growth and seeing some slippage with regard to dry gas rigs in exchange for oil and liquids-rich rigs, how do you expect the Drill Pipe story to play out in that environment? Both from a volume and a pricing standpoint.

Clay Williams

That's a great question, Bill, and let me inject, I think, a key observation. It's not just raw rig count that matters anymore. It's really the wear and tear exerted by whatever rigs are drilling. And so what we would suggest that you juxtapose on the rig count is how many are these rigs are drilling horizontally or drilling extended-reach wells, are drilling complex well pads to hit multiple geologic targets. Because the wear factor on that pipe goes up some huge multiple of a more traditional vertical rig. And so the rig count's going to rise and fall and continue to be cyclical. But there's a very, very steady trend of more and more operators adopting horizontal drilling and complex well pad drilling and extended reach drilling. And that's the real driver for drill pipe consumption, and so that bodes well for margins and consumption of pipe.

William Herbert - Simmons & Company International

So you got a mix shift, for example, from high-service intensity plays such as the Haynesville and to another one such as Eagle Ford, Bakken or what have you. And just the trend of increasing laterals and rising service, intensity wear and tear and what have you, that would drive a multiplier over "activity". How about on the pricing front?

Clay Williams

Pricing is actually, that's just one of the few products where we're getting a little pricing leverage for certain site ranges that I referenced here. Where we've seen demand move up, we're starting to get -- it's not big. It's mid to maybe high single-digit type moves. But it speaks to the fact that Drill Pipe is getting tighter. And again, it's not just wear and tear, also too, these complicated well pads also require much higher torques and higher torque connections. And that's where we have a very strong proprietary position.

William Herbert - Simmons & Company International

Are most of your alliance sales, if you will, for the big land contracts or large, I guess historically, they've been afforded discounted pricing, have those pretty much been done for next year? Or are those yet to come?

Clay Williams

No. They've cycled down a little bit last quarter to -- they sort of buy in big lots. They were largely replaced by rental tool company buying, and we are expecting that the contractors to come back and buy more. So it's kind of -- in any particular quarter, you see swings and floats between groups, but that's kind of the current state of affairs. But what they're finding is they all need pipe and they need the right pipe.

Merrill Miller

And they need the pipe coded. We happen to code the pipe too and that helps when the pressure losses...

Clay Williams

We can hard-band it...

William Herbert - Simmons & Company International

I like it, I get the message. Yes, that's all good. Pete, going to FPSO and your M&A strategy on that front. We bought one captive, if you will, technology subsidiary from a prominent FPSO contractor. And we've expanded the revenue per FPSO from call it $20 million thereabouts to, I don't know, on the high-end now, about $120 million or half of a high-end drill ship. I'm just curious as to the remaining M&A opportunities within FPSO, I mean, you've got a number of captive technology subsidiaries remaining within the leading FPSO contractors. Is there value in doing something with those, just on a conceptual basis? Or are we looking for something else? Walk us through in terms of what the road map is for FPSO, in terms of an M&A strategy in front of us?

Merrill Miller

I think, Bill, as you take a look at -- one of the things you mentioned is the people that have the captive operations, and we think that is very attractive. I think a lot of companies today when they take a look at their strategies, they really want to become more of a pure play. And sometimes, you've got way too many things involved in that and people don't know if you're a manufacture or if you're an FPSO operator or whatever it does. So we think there's opportunity in being able to kind of bring that space together, if you will, and provide us with some more opportunity to add to what we can put on that FPSO. I think that's one part of it. Second part of it is there are other discrete things that are out there. And FPSOs, much like drilling rigs, are advancing in technology. And so we want to make sure that we're staying at the forefront of that technology, so there some other opportunities. As an example, we've made a financial investment in a company up in Aberdeen that's really looking at some new technologies that we think can help define some of the things that FPSOs do. And so we're going to continue to put seed money like that in some of the technology, expand that, and also to look out there at some of these captives and to see if they might be interested in becoming more of a pure play and getting those, selling those to us. And so there's a lot of potential out there. I'm really excited about this FPSO business.

William Herbert - Simmons & Company International

Last year, I think sensibly, we were a little bit loath to stretch the balance sheet too hard from an M&A standpoint. And M&A has been a prominent theme that you've installed on this call. Walk us through with regard to your balance sheet, your thoughts with regard to using your ample balance sheet with regard to M&A going forward? I think historically, the threshold in a less certain time was $1 billion or higher we'll use stock. Where do we stand today with regard to that threshold?

Merrill Miller

Let me clarify that, Bill. Because actually, we were pretty aggressive in 2009 and pressed for all cash deals and had a number that were north of $1 billion that just frankly, we couldn't get the stars to align and the parties to agree, and so we were unable to get those done. Our strong preference is to use cash. So I just want to be real clear about that. We did use -- do you remember back when we acquired Grant Prideco, we used a significant portion of stock on that transaction, but that was pressed for by the sellers. And we actually wanted to use more cash. So we appreciate our cash balance and our strong balance sheet position and believe that with the cash flow we've enjoyed the last few years, as well as attractive financing available today that, that's a much better to go. So we're going to continue to stay on that track.

Operator

The next question comes from David Smith from Johnson Rice.

David Smith - J.P. Morgan

I wonder if you could help us better understand your opportunity on the FPSO market, just in terms of how many FPSOs per year do you think might get ordered going forward? And maybe how do you think about market share opportunity on those? I assume the APL?

Clay Williams

You bet. A couple of points on that. As I mentioned, we're aware that there's over 100 potential projects for which FPSOs are being considered that are kind of out there at any given time. So this is sort of true for the drilling rig space, there's going to be a certain number of potential customers thinking about projects. And so I don't want to give you an impression that those are all going to turn into orders, because they probably won't. Suffice to say, though, there is a big healthy level of interest in FPSOs. There have been other industry estimates of FPSOs to be ordered over the next five years, for instance. I'm going to stop short of quoting that to you. But these are pretty widely followed data sources out there that are in a couple of hundred range over the next five years. A couple of things, this is a well-proven technology. There are roughly 160 in service around the globe. They've been at work for two-plus decades as a technology, APL business has over 50 installed through it. So I think this technology has achieved a level of maturity that takes the technical risk out of it, number one. And then number two, it's just very compelling from an economic standpoint. As you're moving into very, very remote deepwater basins and look at the cost of installing a subsea pipeline to build out infrastructure, FPSOs, to me, just make a lot more sense. They offer a lot of flexibility. They're relatively cheap and easy way to bring oil to market. And so we think as the industry moves further away from the beach, the economics of the FPSO are going to become more compelling. And so rather than give you a number or a forecast like that, our interest in this space is really driven by what we think is a pretty bright future for FPSO technology. It goes hand-in-hand with deepwater drilling.

David Smith - J.P. Morgan

I know that BW [BW Offshore Limited] reported APL separately. But I have to think of their accounting for APL maybe isn't relevant to how that would look in your portfolio. Can you give us some color just on how to think about margin expectations at least relative to how they reported?

Clay Williams

I'm a little reluctant to get too detailed before we actually close the transaction. Suffice to say though, we have a good history of improving the margins in businesses like this. There were Hydralift that we acquired back several years ago. Hitec, for instance, in Norway, we acquired several years ago, which had some just brilliant engineering and technical capabilities. And then I think the NOV organization was able to bring a lot of manufacturing expertise to those, and that combination resulted in much better margins from those business. So broadly, that's kind of the template here. We have a lot of fabrication and machining and assembly assets; a lot of very, very experienced, talented professionals within our Rig Technology group that know what they're doing; and a lot of experience working in shipyards on big, complicated marine projects. And so those are all the things going into the mix here. And in the past, that's been a good recipe for us.

Operator

Gentlemen, that concludes the question-and-answer session for today. I'll turn it back to Pete, for final remarks.

Merrill Miller

Well, thank you all for calling in. And we look forward to talking to you when we give the full year 2010 report after the first of the year. Thanks very much for your interest.

Operator

Thank you for participating in the Third Quarter National Oilwell Varco 2010 Earnings Conference Call. This concludes the conference for today. You may all disconnect at this time.

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