National Oilwell Varco's (NOV) CEO Clay Williams on Q2 2014 Results - Earnings Call Transcript

Jul.29.14 | About: National Oilwell (NOV)

National Oilwell Varco, Inc. (NYSE:NOV)

Q2 2014 Results Earnings Conference Call

July 29, 2014 9:00 AM ET


Loren Singletary - Vice President, Investor and Industry Relations

Clay Williams - President, Chairman and CEO

Jeremy Thigpen - Senior Vice President and CFO


Jeff Tillery - Tudor, Pickering, Holt

Jim Wicklund - Credit Suisse

Kurt Hallead - RBC Capital Markets

Bill Sanchez - Howard Weil

Waqar Syed - Goldman Sachs


Welcome to the Second Quarter Financial Results Earnings Call. My name is Shannon, and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

I would now turn the call over to Mr. Loren Singletary, Vice President of Investor and Industry Relations. Loren, you may begin.

Loren Singletary

Thank you, Shannon. And welcome everyone to the National Oilwell Varco second quarter 2014 earnings conference call. With me today is Clay Williams, President, CEO and Chairman of National Oilwell Varco; and Jeremy Thigpen, Senior Vice President and Chief Financial Officer.

Before we begin this discussion of National Oilwell Varco’s financial results for its second quarter ended June 30, 2014, 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 Forms 10-K and 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 information and operating information, maybe found within our press release on our website at, 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, let me turn this call over to Clay.

Clay Williams

Thank you, Loren. This morning we announced the National Oilwell Varco earned a $1.42 per fully diluted share from continuing operations and $1.44 per share attributable to the company for all operations in the second quarter ended June 30, 2014.

Consolidated revenues from continuing operations were $5.3 billion, up 7% sequentially and up 12% year-over-year. Operating profit from continuing operations, excluding transaction costs was $945 million or 18% of sales. EBITDA from continuing operations, excluding non-recurring items was $1,141 billion or 21.7% of sales.

The second quarter included $31 million pretax or $0.05 per share after-tax in transaction related charges mostly due to the spinout of our distribution NOW business, which we completed during the second quarter, adding this back our earnings were $1.47 per fully diluted share from continuing operations.

Continuing earnings excluding non-recurring items of the $1.47 are consistent with what we have reported in the past and on this basis for all periods, second quarter earnings were up 14% sequentially and up 19% from the second quarter last year. We've seen any changes at National Oilwell Varco this quarter, including our spinout of our distribution NOW business.

This morning we will be detailing our results along new business segments with new disclosures following our reorganization during the second quarter. Among these is our reporting of certain amortization expenses of purchased intangible assets. These were $91 million pre-tax or $0.14 per share after-tax for the second quarter of 2014.

Excluding these and excluding discontinued operations and non-recurring items, second quarter 2014 operating non-GAAP earnings per fully diluted share were $1.61, up 13% sequentially and up 16% year-over-year on the same basis for all quarters.

We offer this supplemental non-GAAP disclosure to win more transparency to our cash flow generating capability per share and Jeremy, will speak to this more in a few moments.

Overall, on either basis of presentation, we are pleased with double-digit earnings growth for our shareholders for the second quarter, which reflects skillful execution of projects and backlog, and improving market conditions across North America and other parts of the world.

In particular, we are seeing the major North American shale plays growing, domestic E&P wellhead cash flows are rising with increasing production and strong commodity prices, and producers are choosing to plow back more their cash into new shale drilling.

Our activity gains were partly offset by seasonal breakup in Canada, our outlook for Canada is strengthening for the second half. Activity is leading to rising demand for frac equipment, coiled tubing units and for newbuild land rigs required to maximize shale drilling efficiency, adding to continued strong land rig demand overseas, particularly in Latin America and Middle East.

Offshore demand held up well for the second quarter, but as we discussed last quarter, we expect the second half of 2014 to be more challenging. We see the market for new floating rig softening for at least the next few quarters due to lower dayrates pressured by new and contracted capacity coming into the market.

Nevertheless, we still see some floater demand through this period for special capabilities required for the Arctic, for high-pressure 20,000 PSI prospects, for the North Sea midwater market and for well intervention and construction activity.

And with very few floater scheduled to be delivered in 2017, we could see opportunistic investors whether traditional drilling contractors or entrepreneurs decide to place orders at some point in 2015.

So with respect to rig systems capital orders, we expect a decline for newbuild floaters but some level of demand for this special floating rigs continuing. We see steady demand for jackups at least for the second half of 2014 and we see a pronounced increase in demand for land rigs for the next several quarters. The land rigs and jackups will not fully offset falling floater demand.

Importantly, analysis of NOV's financial results and rig building through the past decade demonstrates that earnings and cash flow can and do remain strong for cyclical order down terms.

Over the next several quarters, we expect the following factors to underpin solid revenue and earnings performance within our rig systems segment. One, our record backlog with approximately 180 offshore newbuilds underway today; two, equipment demand associated with five-year special periodic surveys of offshore rigs, which we see tripling between now and 2017; three, general equipment upgrade demand around offshore rig for float capacity and BOP's; and four, writing backlog for land rigs and land equipment. We expect these to buffer rig system segment revenues from the volatility in deepwater newbuild orders.

Offshore rig newbuild projects, floaters and jackups accounted for approximately $1.4 billion or 27% of NOV's consolidated second quarter revenues, all within the rig system segment. That segment also generated almost $1 billion from the sale of land rig newbuilds and replacement and upgrade components for both land and offshore drilling rigs.

Again, our backlog should help sustain results for the former for the next several quarters, while rising demand should strengthen the latter for the next several quarter. During the second quarter the rig system segment one orders totaling $2.3 billion, up 8% from the first quarter and its book-to-bill was 110% lifting backlog to a record level of $15.4 billion for the segment. Backlog for rig systems is up 2% since year end 2013 and up 41% since year end 2012.

Offshore newbuild orders included five floaters and two jackups during the second. Our new rig aftermarket segment is closely related to the rig system segment operationally and served to support the growing installed base of NOV drilling equipment operating in the field.

The segment grew 5% sequentially and 17% year-over-year in the second, consistent with its annual growth results for the past several years. It is high margin and highly strategic to our offering in the drilling equipment space. That's why we continue to invest heavily in facilities and skilled personnel to ensure that NOV continues to the high level of aftermarket support our customers expect. It provides clear differentiation to premium NOV drilling technology and we foresee bright future as our installed base of rigs continues to expand.

Our new wellbore technology segment provides critical products and services designed to improve drilling performance, drillbits, drill pipe, including IntelliServ wire drill pipe, tubular inspection and coating, drilling motors and reamers, solids control, waste management, drilling fluids, drilling optimization and instrumentation services provided by the group all served to improve efficiency, safety and environmental impact of drilling operations.

Although, this segment is levered to drilling activity, it posted 13% sequential growth, despite the second quarter global rig count decline arising from the Canadian breakup. Year-over-year wellbore technology segment second quarter sales were up 18%.

Finally, our new Completion & Production Solutions segment provides equipment to complete and produce wells along with some sales into certain industrial markets. This group engineers and manufactures equipment into hydraulic fracture stimulation operations, wireline and coiled tubing technologies, composite piping solutions and critical technologies such as turret mooring systems and flexible pipe to support deepwater field developments. The group posted 12% sequential revenue growth and 7% year-over-year growth.

Orders for the Completion & Production Solutions segment were extraordinarily strong, $1.1 billion for the second quarter, more than double first quarter orders and representing a book-to-bill of 186%, growth was across the Board.

Floating production system components and subsea flexible pipe won some very large second quarter orders. We don't expect to repeat in the third quarter, with strong second quarter frac and stimulation equipment demand appears to be continuing to build as we enter the third quarter.

Second quarter ending backlog for Completion & Production Solutions was a record $2.1 billion, up 31% from year end 2013 and up 60% from year end 2012. Jeremy, will provide more color on markets and operations in just a moment.

As I mentioned earlier, NOV second quarter marked a successful spinout of distribution NOW, which as of the 1st of June as a standalone independent company trading under the symbol, DNOW on the New York Stock Exchange.

Market reception to this exciting new company has been outstanding, owing to denounce leadership and growth plans, and we're pleased that the move has unlocked significant value for our shareholders.

I’d like to thank the employees of both companies for your hard work to help make this happen. Our second quarter results included two months of our distribution services business as a discontinued operation. Concurrent with the spinout, we reorganize our business into the full porting segments, I detailed earlier, organized around customers.

In June, we released pro forma historical financial results going back five years by quarter on this new segment framework to enable you to update your models and trend the data to better assess how we are performing.

We are also disclosing depreciation and amortization expenses by segment to enable investors to compare our EBITDA margins to our peers. I'm pleased to congratulate the new operating heads of our segments on their new responsibilities.

Joe Rovig is leading our Rig Systems and Rig Aftermarket segments; Mike Matta is heading our new Wellbore Technology Segment; and Kirk Shelton is leading the Completion & Production Solutions segment.

I'm grateful for the extraordinary team that we have in place and I want to thank all of our hard working employees and business leaders for continuing to support the critical needs of our customers through our busy second quarter.

Each new segment is presently engaged in a strategic review of its businesses against the backdrop of the four major trends we see providing opportunity to our organization over the next several years.

Namely, one, the buildout of the deepwater rig fleet; two, the buildout of infrastructure to support the development of deepwater oil and gas fields; three, the retooling of the worldwide jackup fleet; and finally, four, the continued growth and proliferation of unconventional shale technologies worldwide.

We explained many time before how we see theses shaping the global energy equation and NOV's fortunes for decades to come. Our strategic goal is to develop it to determine how we will deploy resources to enhance NOV's competitive advantage and financial returns within these trends. As we answer these questions this summer, we will be quantifying specific personnel, facilities and capital needs to execute our strategic plans to grow organically and to enhance our business through selective acquisitions.

On the topic of acquisitions, we have closed five small transactions so far this year for about $110 million in aggregate, less than six times trailing EBITDA and less than five times current EBITDA run rate. We are pursuing a number of conversations around smaller transactions now generally focused on finding excellent buys that fit our strategy, strengthen our franchises and offer strong returns on capital employee.

This takes tremendous diligence. Even though we're almost are strategic buyer, meaning that we have access to efficiencies and cost savings that financial buyers usually don't. We are nevertheless frequently outbid. Rather than chase expensive deals ever higher, we will sought through many potential targets to focus on rifle shot singles, doubles with disciplined returns demanded of the acquisitions we execute.

NOV will also continue to focus on organic growth, research and development, better technologies, products, tight management around costs, investments and more efficient production and operational excellence, expansion investments into new regions and aftermarket support, all of which will translate into more organic growth. Disciplined investment in both acquisition opportunities and organic growth opportunities will enhance our future financial performance.

Turning to our balance sheet and record of cash generation, we are also exploring other ways to enhance shareholder value by optimizing our balance sheet and capital structure. Like multi -- like any multinationals, we had challenges around repatriating cash from overseas. We're exploring ways to either put this excess capital to work or return it to shareholders.

We announced a 77% increase in our regular dividend during the second quarter and believe that as we reassess our organic growth, capital needs through our strategic planning process, we can then turn to look at ways to return more capital to our shareholders. NOV has a strong record of cash generation and reasonable expectations of strong future cash generation mean that we should have capacity to return more capital to shareholders in the future.

Finally, we look forward to sharing our detailed strategic plans with investors in November.

With that, let me turn it over to our Chief Financial Officer to give you more color on the second quarter operating results. Jeremy?

Jeremy Thigpen

Thanks Clay. Before we begin our discussion of the quarterly operating results, let me take a quick moment to explain the change that we have made to the calculation of our adjusted EPS. From this point forward, our adjusted EPS metric will exclude the impact of the amortization of purchased intangible assets as well as discontinued operation and nonrecurring items as we always have.

Going forward, we will be referring to these adjusted earnings per share results as operating non-GAAP earnings per share. Here is why we’re doing it. Since the amortization expense of purchased intangible assets is a non-cash period expense, we believe that the supplemental adjustment will help investors to more clearly understand how NOV's earnings per share relate to our periodic cash flow per share.

Purchased intangible assets arise from the allocation of the purchase price of acquisition in excess of the fair market value of working capital and fixed assets of acquired businesses. Amortization of these differ from depreciation, another non-cash periodic charge and that depreciation expense reflects consumption of hard assets which must eventually be replaced used to produce periodic results, where as amortization of purchased intangibles reflects the initial startup cost of acquisition capital.

Obviously, we will continue to report GAAP earnings and continue to provide a reconciliation between GAAP and our new operating non-GAAP earnings metric which you can see on the last page of our second quarter 2014 earnings release. We intend this to be a supplemental disclosure, not a replacement for GAAP earnings per share but rather to provide the investing public additional insight into the periodic cash results of our operations on a per share basis.

Now let’s discuss the quarterly results. Since Clay already thoroughly covered the consolidated results, I would just like to offer one comment before transitioning into the results of our new segments. Given the additional time and energy associated with the spin-off of our distribution business and the reorganization of our remaining businesses, delivering the quarter with 7% growth and 35% flow-through on a sequential basis and 12% growth and 30% flow-thorough on a year-over-year basis is quite an accomplishment.

So I would just like to say thank you to each member of the NOV family for your unwavering commitment, your focus and your hard work throughout this past quarter. Your efforts and contributions are noticed and appreciated. So thank you very much.

Now let’s turn to the operating results of our newly formed segments. The Rig Systems segment generated revenues of $2.4 billion in the second quarter, up 5% sequentially, driven largely by significant increase in land related sales, which before elimination accounted for approximately 22% of segment revenues. That’s up 18% -- from 18% in the first quarter of 2014 and up from 15% in the second quarter of 2013.

Compared to the second quarter of 2013, Rig Systems revenues were up 14% as one heightened demand for new high spec land rigs primarily in the U.S., Latin America and the Middle East resulted in incremental year-over-year sales in complete rigs as well as critical components, such as top drives, BOPs and pipe-handling equipment and two, recent capacity additions have enabled us to convert 14% more revenue out of our backlog for both land and offshore projects.

Operating profit for the segment was $501 million and operating margins were 21.1%, which represented 110 basis point improvement over the previous quarter, a 220 basis point improvement over the prior year. EBITDA for the segment was $523 million or 22% of sales. As we move into the third quarter, we believe that Rig Systems revenue should remain relatively flat and that our operating margins could remain in the 20% to 21% range.

As we look at Rig Systems margins for the balance of the year and then throughout 2015, we see a number of puts and takes which could result in some modest margin expansion as we move through next year. On the plus side, the price increases that we push through in 2013 have resulted in improving margin in our Rig Systems backlog.

Additionally, in time we believe that we will start to recognize some efficiency gains from the new capacity that we added last year. However some of the benefits associated with price increases and operational efficiencies will be offset by growing percentage of Brazil and China related work, which we expect to be challenging.

Naturally, we will continue to aggressively pursue opportunities to improve our already industry-leading equipment margin. But we believe that margins for the Rig Systems segment in the second half of 2014 will look very similar to the margins that we delivered in the first half of the year.

Now let’s transition to the capital equipment orders for our Rig Systems segment. As Clay already stated for the quarter, we booked four drillships, one semi and two jackups as well as some other packages and discrete components, including lifting and handling equipment, jacking system, spare BOP stacks and another equipment upgrades. In addition to the strong orders offshore, we continue to see heightened demand for complete new land rigs as well as land equipment packages and components for the U.S., Latin America, and Middle East markets.

Of the $2.3 billion in new Rig Systems orders, 59% were driven by new build construction for jackups, semis and drillships while sales of land rigs, land rig components and replacement upgrade components to support existing offshore rigs accounted for the 41% balance from bookings. This $2.3 billion of new orders in the quarter was mostly offset by revenues out of backlog of $2.1 billion, resulting in a book-to-bill of 1.1 times and another record quarter ending backlog of $15.4 billion for the segment. Of this total backlog, approximately 93% is offshore and 94% is destined for international markets.

Looking into the third quarter of 2014, we believe that orders for new floaters will be limited. However, we could see solid orders for jackups as a number of opportunities slipped from the second quarter. We also believe that demand should remain strong for individual offshore components as well as complete land rigs, land equipment packages and individual land components.

Overall, we expect a healthy quarter for orders. However, as we stated on the previous conference call, for the Rig Systems segment, we do not at this time expect to achieve a one-to-one book-to-bill on the third quarter.

The rig aftermarket segment posted revenues of $785 million in the second quarter of 2014, up 5% sequentially and up 17% over the second quarter of 2013 as our large and growing install base of equipment combined with the investment that we've made in additional personnel, training, global warehousing and service infrastructure and inventory have resulted in midteens percentage growth for the past few years.

Operating profit for the segment was $217 million or 27.6% of revenues, up 210 basis point sequentially but down 60 basis points from the prior year due to slightly unfavorable mix. EBITDA for this segment was $224 million or 28.5% of revenue.

As we move into the third quarter, we feel that aftermarket revenues could continue to improve in the low single-digit percentage range, maintaining that midteens percentage year-over-year growth trajectory. And we believe that operating margin should continue to hold fairly steady in the third quarter and for the foreseeable future.

However, I would like to take this opportunity to communicate that this business due to product mix and the timing of service work and repairs have a tendency to be somewhat lumpy. On an annual basis, I feel comfortable providing an outlook of midteens percent growth in fairly steady margins. However, there will undoubtedly be some swings from quarter to quarter. So please be prepared for some slight quarterly choppiness in this segment.

Despite these quarterly fluctuations, we are very excited about the exceptional growth profile and profitability of this segment of our business. And we look forward to providing additional insight into this business in the coming quarters. The Wellbore Technologies segment posted revenues of $1.4 billion, up 13% sequentially and up 18% for the second quarter of last -- second quarter of last year.

As previously stated, the Wellbore Technologies business is driven by activity more rigs, drilling more wells and more footage require more solid control equipment, more fluid, more drill pipe, the inspection and coding of that drill pipe, more downhole drilling tools, more drillbits and more rig monitoring and drilling optimization services.

As such, despite the seasonal decline in Canada, the continued strengthening of the U.S. market coupled with the fact that our customers have clearly worked through the excess inventory that they carried into the first half of 2013 has led to outsized growth for this segment. On this $1.4 billion in revenue, the Wellbore Technologies segment generated $269 million in operating profit, or 18.6% of revenues, which represented 110 basis point improvement over the first quarter of 2014 or 27% flow-through to leverage on the 13% increase in revenue.

On a year-over-year basis, operating margin improved 260 basis point or 33% flow-through to leverage on the 18% increase in revenue. EBITDA for this segment was 26.1%. As you’ve undoubtedly noticed this particular segment carries a fairly heavy load of depreciation and amortization expenses.

Because one the businesses in this segment have made significant investments in roofline and machinery to manufacture and service equipment and tools globally; two, three of these businesses have invested heavily in the respective rental fleet of downhole drilling tools, instrumentation tools and solid control equipment, which account for a sizable percentage of their respective revenue streams.

And three, we’ve made significant investments in game changing acquisition in the segment including but not limited to Grand Prideco drill pipe, ReedHycalog drillbits, Robbins & Myers drilling motors and Andergauge downhole technologies, all of which improved and expanded our product and service offerings to our customers and further strengthened our competitive position.

Looking into the third quarter of 2014, we believe that Wellbore Technologies segment revenues could improve in the low to mid single-digit percentage range. If Canada comes out of breakup, the U.S. market continues to modestly improve and our other key markets in aggregate remain relatively steady. And while our actual results will always depend upon product, customer and geographic mix, we believe on average that this segment should generate plus or minus 30% flow-through on each dollar of additional revenue.

The completion of production solutions segment generated revenues of $1.1 billion, up 12% sequentially and up 7% year-over-year. On a sequential basis, the revenue growth was driven primarily by strong delivery quarter out of our subsea businesses and improving market for well intervention and stimulation equipment including coil tubing units, coil tubing, pressure pumping equipment, well service pumps, fluid and expendables and flow line.

On a year-over-year basis, substantial growth in both our floating production and subsea businesses which were up 82% and 45%, respectively, more than offset the year-over-year decline in sales for our stimulation equipment.

Operating profit for the segment was $158 million, or 14% of revenues, which was relatively flat with the first quarter of 2014 and down 140 basis points from the second quarter of 2013.

As you probably surmised, the year-over-year decline was almost entirely attributable to product mix, with a lower percentage of higher margin stimulation equipment revenues and a higher percentage of lower margin floating production and subsea revenues.

Of note, we’re also continuing to incur high startup costs for our flexible plant in Brazil, resulting in low leverage on higher sequential flexible pipe sales. But on that topic, we're pleased to report that we’re nearing the finish line on the state-of-the-art facility and hope to see improvements as we ended the year.

Second quarter EBITDA for the segment was 18.7%, while the delta between operating margins and EBITDA margins is not as pronounced as it is within the Wellbore Technologies segment. The Completion & Production Solutions segment also carries a fairly heavy D&A load related to investments in roofline and machinery, as well as in fairly recent transformational acquisitions, such as APL, NKT, Interflow and the pumps frac wellheads and frac manifolds from Robbins & Myers.

For the third quarter, we believe that revenues for our Completion & Production Solutions segment could improve in the mid-to-high single-digit percentage range, as we continue to see increasing demand for our well intervention and stimulation equipment, as well as improved revenues for floating production and subsea businesses.

And for the quarter, depending on the overall mix, we could see a slight uptick in operating margins, as we benefit from increasing demand for our well stimulation equipment and associated consumables.

Now let's transition to the capital equipment orders for our Completion & Production Solutions segment. During the quarter, the segment had very strong bookings of $1.1 billion, which was partially offset by almost $600 million of shipments out of backlog, resulting in a 1.8 times book-to-bill and a quarter ending record backlog of $2.1 billion for the segment. Of the $1.1 billion in new orders, approximately 70% of the total was driven by production related equipment and 30% from our well intervention and stimulation equipment businesses.

As we move into the third quarter, we believe the new orders for production equipment will slow substantially owing to timing of projects, but the new orders for coiled tubing units and pressure pumping equipment should strengthen resulting in a book-to-bill for the Completion & Production Solutions segment that could approach if not exceed 1-to-1.

While on the topic of backlog and book-to-bill, it’s important to note that only 53% of the segment’s second quarter revenue came out of backlog, as the remaining portion of this business is selling quick turn spare parts and consumables to support and/or enhance the equipment that we sell from this segment.

Now that we’ve walked through the new segments, let's turn to the remaining elements of National Oilwell Varco's consolidated second quarter 2014 income statement. Gross margin improved to 130 basis points sequentially and 150 basis points year-over-year to 27.7%. SG&A increased $38 million sequentially and $54 million year-over-year. However, as a percentage of revenue, it has remained relatively flat at 9.7%.

Nonrecurring items primarily related to the spin-off of the distribution business totaled $32 million in the quarter. Interest expense increased $1 million sequentially to $27 million and interest income increased $1 million to $5 million. Equity income in our Voest-Alpine JV was strong at $23 million, as the JV experienced across the board increases in sales of green tube, OCTG and line pipe. But as it’s typically the case, we do expect a significant decline in equity income in the third quarter, as the plant will be shut down for two weeks for routine maintenance.

Other expense for the quarter was $21 million versus zero in the first quarter. As you may remember in the first quarter we benefited from favorable movements in currencies and we also recognized a gain on the sale of fixed assets. By contrast, in the second quarter we incurred losses related to foreign exchange, slight losses on the sale of fixed assets as well as higher bank fees.

The effective tax rate for the second quarter was 31.8%, which was higher than the 30.4% rate that we posted in the first quarter of 2014, as we recognized a much higher percentage of U.S. generated income in the quarter. Given our belief that the U.S. will continue to be a source of growth in the third quarter, we expect an effective tax rate of 32% to 33% to the balance of the year.

And finally, if you turn to the last supplemental schedule, you'll see that depreciation and amortization was $190 million, down $1 million from the first quarter. And EBITDA, excluding transaction charges, was $1.1 billion, or 21.1% of sales.

Turning to the balance sheet, I would like to start by highlight a few key points in the quarter. Number one, we continue to see the results of our focus on working capital. Number two, we continue to strategically deploy capital into our business through acquisitions that complement our existing businesses and through infrastructure investments to improve efficiencies to shorten lead times, improve customer service and enhance competitive advantage. And three, we provided our shareholders with a much larger dividend.

Our June 30, 2014 balance sheet employed working capital, excluding cash, of $5.2 billion, down $1.2 billion sequentially. Accounts receivable decreased $883 million, or 17% sequentially, with the reduction being driven by a combination of the DNOW spinoff and strong collections by NOV businesses where accounts receivable from continuing operations were down $130 million despite a $366 million sequential increase in revenue.

We also continue to realize improvements in customer financing where milestone invoicing on major projects outpaced cost incurred by $50 million. Inventory decreased $461 million, or 8%, with an $844 million reduction associated with the distribution spin being partly offset by $383 million build in our continuing operations to execute a record backlog and to support heightening demand for our products in the U.S. market.

Capital spending in the quarter was $175 million due to several significant ongoing operational expansion efforts. Dividend payments were $198 million, representing an $87 million sequential increase. The remaining uses of cash included tax payments of $572 million, cash interest payments of $45 million, acquisitions of $100 million and $253 million in cash with distribution NOW.

As a result, the company generated free cash flow as defined as operating cash flow less capital expenditures from continuing operations of $610 million, which was a 69% increase sequentially. We ended the quarter with a cash balance of $3.9 billion and a net cash position of $737 million. Of the $3.9 billion in cash, only 7% of the balance was in the U.S. at June 30.

Now let me turn it back to Clay.

Clay Williams

Thank you, Jeremy. So to sum it up this morning, we're pleased to report strong double-digit earnings growth both sequential and year-over-year for our second quarter, record backlogs for both Rig Systems and Completion & Production Solutions with both posting book-to-bills north of 1 in the quarter, a 77% increase in our regular dividend during the quarter, completion of a $3.5 billion spinout to our shareholders of an exciting new public company, a whole bunch of new granular disclosure, and our path forward to develop and communicate our strategic plan.

So with that, Shannon, I think we’re ready to open it up for questions.

Question-and-Answer Session


(Operator Instructions) Our first question comes from Jeff Tillery from Tudor, Pickering, Holt. Please go ahead.

Jeff Tillery - Tudor, Pickering, Holt

Hi, good morning, guys.

Clay Williams

Good morning, Jeff.

Jeff Tillery - Tudor, Pickering, Holt

As you think about the M&A program, just could you give us color around kind of businesses that require things are interesting, kind of where you see the best opportunities?

Clay Williams

Yeah, Jeff, generally as I noted in my opening comments, we have a lot of conversations underway. They are generally with smaller companies. And I think I mentioned, we have closed five transactions year-to-date that I think are indicative of kind of what that population looks like. I will continue to -- I would say the flavor of this is continued investment in our aftermarket support of the growing installed base of rig equipment. And so a couple of these have to do with that strategic thrust. We have a lot going on in our tubular services world and have seen great organic growth and acquisition growth in our capability to repair tubular around the globe and we will continue to invest in that.

But kind of the overarching theme here is generally I think we’re seeing smaller transactions and believe that those offer a better purchase economics. The bigger these deals become the more attention they attract. And when that happens, generally the price goes up, the multiples go up and our returns go down. So we’re looking forward. I would really like to put more focus on those smaller transactions and benefit from the higher economics that they can bring to our operation.

Jeff Tillery - Tudor, Pickering, Holt

Great. And the second question I have is just around rig systems. Obviously with kind of the segment recasting, some of the benchmarks we’ve had historically have moved. But as you think about kind of the medium to longer-term margin goals, is that still in kind of the low-to mid 20s, is that how you think about it a normalized margin for the Rig Systems segment?

Jeremy Thigpen

I think low-20s is probably more accurate for normalized margins. As you remember part of our margin enhancement story was around growth in certain product lines that were accretive to overall rig -- the old rig tech margins. Those have now moved into the Aftermarket segment and of course the Completion & Production Solutions segment. So I think low 20s normalized margins is probably appropriate.

Jeff Tillery - Tudor, Pickering, Holt

Thank you very much.

Clay Williams

Thanks, Jeff.


Our next question comes from Jim Wicklund from Credit Suisse. Please go ahead.

Jim Wicklund - Credit Suisse

Good morning, guys.

Clay Williams

Good morning, Jim.

Jim Wicklund - Credit Suisse

You mentioned challenges going forward in Brazil and China. And I know the flex pipe plant in Brazil is little behind the schedule and getting flowing operational. Can you talk to us little bit about Brazil? What to expect? What’s going on? What should we see over the next 12 months or so in Brazil?

Clay Williams

The other good news is so far so good in Brazil, Jim. We’re working on about a half dozen rigs currently. The first should be delivered in September of next year. And so we’re getting well into this build out of -- for NOV 21 deepwater floaters for that market. All of our customers are pressing ahead. And so I would say so far so good. To put in perspective, it’s building in terms of its contribution quarter by quarter. So in the second quarter, we did about $180 million in revenue within rig systems associated with that effort. And the challenges that we were referring to stem from a couple of things, one is that we won that work if you recall back in the 2009-2010 time period when pricing was under pressure. So the margins are good, but they're not great. And so the intrinsic margins in the work is a little lower than the rest of our backlog.

Number two, it’s Brazil. We’ve been in networking Brazil for 30-plus years, a very challenging from a regulatory standpoint, from local content requirement standpoint, from a tax standpoint, from a foreign currency standpoint. So we’re just being a realistic about the incremental margins that will continue to flow from Brazil as we get deeper and deeper into the program, but again operationally so far so good.

And to round up the picture, we're very excited about the about expansion that we’ve had underway in Brazil to support both that new construction as well as all of the rigs that we have at work in Brazil, supporting those on an ongoing basis from an aftermarket standpoint. So these are sort of dual purpose facilities. And I think middle of next year we’re going to open our riser manufacturing plant. We’ve got t other expansion initiatives going on around Brazil and so it will continue to be a very, very important market for us.

On China, the other part of the comment, we’ve seen a lot of our offshore rig building work shift into Chinese shipyards predominantly with jack-ups, although there is a few semi’s coming together in Chinese yards as well. And what we know from experience and to be clear, we work closely with Chinese shipyards a quite a bit in the past. But we know from experience is sometimes those projects can be a little more challenging, but we’re not losing a lot of sleep over the China, China shift is just again being realistic. We know that sometimes it's a little more challenging in those yards vis-à-vis the yards in Korea or the yards in Singapore.

Jim Wicklund - Credit Suisse

Okay. Not sound bad for Brazil considering everybody else’s issues there. My follow-up if I could in completion production. Coiled tubing, you mentioned coiled tubing a couple of times, demand for coiled tubing is picking up. That has been one segment that has lagged from an operating point of view in the U.S. Is your pickup in demand in coiled tubing primarily international? Are we seeing demand pickup in the U.S. as well?

Clay Williams

Most of the incremental is U.S. and North America really, a lot of demand for components going into the larger diameter coiled tubing, so a lot of the incremental coiled tubing demand is around 2-inch. 2-3/8 inch, 2-5/8 inch diameters and so real trailers and the injector heads going into modify and upgrade actually over coiled tubing units is a trend we've seen lightly, but generally a lot of orders on the upswing and a lot more optimism about that market.

The international market has remained steadier. It didn’t fall off the same way North America did. And so we’re seeing some resume demand overseas as well, but it never plummeted the way North America did back in 2012 and 2013.

Jeremy Thigpen

Yeah. And in early ’13 we saw slight drop in demand internationally and some of the U.S. based customers were shipping excess equipment overseas to fulfill needs, but in the back half of ’13, we started to see more orders for new coiled tubing units going into the international markets and it has been pretty steady.

Jim Wicklund - Credit Suisse

That’s encouraging across the broad. Okay. Thank you very much, gentlemen.

Clay Williams

Thank you.


Our next question comes from Kurt Hallead from RBC Capital Markets. Please go ahead.

Kurt Hallead - RBC Capital Markets

Good morning.

Clay Williams

Hi, Kurt.

Kurt Hallead - RBC Capital Markets

Again, I just wanted to follow up, you talked about the prospects looking at varying dynamics to return additional cash to shareholders and one of the, I guess, bottlenecks in that process have been the fact that you have only 37% of your existing cash in the U.S. So in that context, I just wondered if could provide us with maybe some insights on how you maybe able to accomplish some of those goals in terms of returning more cash to shareholders? And how serious the consideration doing the levered recap might be?

Clay Williams

The first, it’s 7% of our cash in the U. S., but you say 37%?

Kurt Hallead - RBC Capital Markets

Yeah. I’m sorry. I must have misheard what you said on the call. Thanks for clarifying that.

Clay Williams

Only 7%, so we are essentially dividending out our U.S. cash flow. So it’s already pushing the envelope in the U.S. And so yes, internally we are looking at different ways to get cash back in the U.S. in the tax efficient manner. It is challenging, but we’re certainly doing that. To next question?

Jeremy Thigpen

Yeah. So, $3.5 billion plus in cash overseas, some of the things we’re looking at presently are ways to repatriate that and to improve the ability to repatriate U.S. cash generated overseas, which would give us more flexibility around either share buyback or upping the dividend with that cash we have on our balance sheet. And we’re alternatively looking for really good, solid acquisitions overseas or probably a combination of both and this is what we’re looking at, Kurt.

Kurt Hallead - RBC Capital Markets

So it’s a levered recap, not necessarily the forefront of your thoughts.

Clay Williams

Not in the near-term and probably I think I detailed the fact that our new segments, the new segment leaders are going through a deep dive on strategic reviews, the strategic plans of their businesses this summer. And so first thing first is to get the strategic. We’re not expecting major departures, but let’s get settled on the strategic plans going forward and the capital needs around those. And then I think that will then lead us into a conversation later this year around the new opportunities to return capital to shareholders.

Kurt Hallead - RBC Capital Markets

Okay, great. Thanks. And then my follow-up question is just on the Rig Systems second half outlook on the order book. We can make our own guesses and assumptions as we have in the past, you provided some general directional guidance of being -- having book-to-bill being under 1. There is a big range of that. So are we talking about an absolute plummet in orders in the back half of the year or more of a -- I’d say more of a gradual decline?

Clay Williams

Yeah. Kurt, over the last two quarters, we provided a little more granularity into our order intake and really broken out what was from new build construction for jack-ups and floaters versus everything else. I wouldn’t call everything else a baseline because that fluctuates each quarter as well, but it will give you some indication as to what we think each orders could look like in that space. And then we also provided some guidance that we think jack-ups could continue to be strong in Q3 and fairly steady in Q4. So probably back into a number that way.

Jeremy Thigpen

Yeah. We’re not going to zero. Let me clear on that. So, I mean, there is a lot of things cooking out there. Land rigs demand is ascending and it's a small piece now, but it's growing and growing quickly. And as Jeremy mentioned, we had a lot of jackups to push from Q2 to Q3 and so that outlook for the back half of year for jackups at least is pretty good.

And then I would add too, I touched on a number of specific floating rig opportunities that are continuing to work out there around 20,000 PSI capabilities, around Arctic capabilities and so even in the floater space it's not going to zero. So we can't, I'm not sure we can be a lot more quantitative than that but direction that's where the three main groups are going.

Kurt Hallead - RBC Capital Markets

All right. I think that helps to clarify. And if I may just sneak one more point -- pointing on your guidance relating to the wellbore technology group, you had a significant increase in revenue sequentially, you have indicated a 13% even with the breakup in Canada and now suggesting a more moderate sequential increase into the third quarter even with the Canadian rebound? Just trying to help, you can try to help connect the dots there because it appears to us that rig activity, well activities on the rise in U.S. you got a rebound in Canada. So just not quite sure why the sequential increase would be say more than half or what it was in the second quarter?

Clay Williams

Yeah. I think there is a possibility for that, Kurt. But really what we've seen in this segment historically and really think a back to our PS&S businesses. When activity starts to pick up and customers work to their inventory, they start -- they kind of start to buy in bulk and add some inventory, so they are not compromise if activity continues to grow. So we think there was a little bit of that going on in the second quarter and don’t know if that will continue in the third or they just kind of go to replenishing inventories if they consume at that point in time.

Kurt Hallead - RBC Capital Markets

Okay. That’s great. That was great color. Perfect. Thank you, guys.

Jeremy Thigpen

Thanks, Kurt.


Our next question comes from Bill Sanchez from Howard Weil. Please go ahead.

Bill Sanchez - Howard Weil

Thanks. Good morning.

Clay Williams

Hi. Good morning.

Bill Sanchez - Howard Weil

Clay or Jeremy, I was hoping perhaps maybe you can give us an outlook on two things. One, I know this is second quarter and now you discussed the expectation of book-to-bill and rig systems going below 1. Just curious if you had any thoughts on the duration of how long you might see book-to-bill stay below that target. I guess my first question is my follow-up? I got to believe the revenue capacity or the revenue efficiency continues to increase, I know Jeremy, you able to give us an expectation on aftermarket growth year-over-year? Is there any thought as we look ‘14 and maybe even next year, what type of topline growth we could perhaps expect out of rig systems?

Clay Williams

Well, the first question, Bill, with regards to the duration of this downturn. We’re not sure, we believe, it's not a one quarter dip. We get at least a few quarters and it could extend beyond that overall.

Long-term our outlook is still very, very bright. There’s an awful lot of development drilling and expiration drilling that still needs to go on in deepwater basins require floating rigs. So we think the fundamental demand is there. But a lot of capacity flowing into the market last year, this year, next year is giving rise to this.

I mentioned some of the special purpose rigs that we’re looking at, another kind of interesting set of conversations. We’ve got a couple of folks looking at 2017, 2018 not seeing any floater delivery scheduled outside of Brazil and thinking of maybe opportunities to introduce to go ahead and sign-up for newbuilds to try to hit that point in the market when very few new rigs are coming in and so there’s a lot of conversations that are underway.

So, our expectation is we’re headed for a cyclical soft patch here. I’m not sure have a lot of insight to offer around how long that might last. With regards to what your, I am sorry, your second question was topline growth for which segments?

Bill Sanchez - Howard Weil

The rig system around the capacity.

Clay Williams

Yeah. The -- that we have a lot of visibility into a $15.4 billion of firm orders and you kind of do the math, that means we’ve got a couple of years of work ahead of us with rising prospect for land rigs and so far continued demand for jackups as well for at least the next couple quarters. And so, not prepared at this point to give you a number year-to-year ’14, ’15, what that might look like, but certainly orders will not be the gating item.

As you correctly point out, we've been adding a lot of capacity throughout our infrastructure to deal with record backlog, a lot of challenges in the supply chain to deal with these record backlogs and so a lot of continued capacity coming online to handle this work to connect the dots there, though, if the downturn in floater demand does stay down a while, we’re not overly concerned because we foresee a big pickup in special periodic surveys, particularly as we move into 2017. I think this is something I reference to my comments as well.

Every five years, all floating rigs need to come back to the shipyard for whole inspections and for drilling equipment to be inspected and the recertified and get new certificates of compliance. And when we look at the demographics of the birth years of the growing offshore fleet, what we see is, they’re all starting to stack up 2017 and 2018. And so, there is going to be a lot of work for us to do even if it's not necessarily building as many new deepwater floaters as have in past.

Jeremy Thigpen

And specifically to your question, Bill, in terms of revenue conversion out of backlog, we had the big capacity, the major capacity additions in 2012 and early 2013. We’re not getting comfortable with those additions. And if you look, we've been running at between $2 billion and $2.2 billion in revenue out of backlog for the last couple of few quarters and I think that's probably a reasonable proxy for the future.

Bill Sanchez - Howard Weil

Yeah. That’s helpful, Jeremy. Just to quantify that, I appreciate it. If I could ask just one more, with regard to the amortization of intangible assets, as we look through the press release, I just try to basically identify that back to specific segment or segments, Jeremy. Is that concentrated in one particular area, we try to reconcile what maybe the…

Jeremy Thigpen

It really show that but if you look at the difference between EBIT margins, EBITDA margins, you can see that disconnect really and it’s really Wellbore Technologies primarily but also in Completion & Production Solutions.

Bill Sanchez - Howard Weil


Clay Williams

And little bit in rig…

Jeremy Thigpen

In rig, but not as pronounces as it is in those two segments.

Bill Sanchez - Howard Weil

But as we look at the restated numbers, I mean, if apple like, at least the first quarter comparison, that’s an apples-to-apples comparison as we think about the 2Q?

Clay Williams


Bill Sanchez - Howard Weil

Okay, great.

Clay Williams

By the way, on that topic, we’re going to continue to break out. It will be running about $0.14 a share. I think we get 10 quarters going back historically on our tear sheet. You can see its $0.13%, $0.14, $0.15 every quarter. So it’s a pretty level load and we will be disclosing that separately from our non-recurring transaction charges.

Bill Sanchez - Howard Weil

Great. I appreciate the time. I’ll turn it back

Clay Williams



Our final question comes from Waqar Syed from Goldman Sachs. Please go ahead.

Waqar Syed - Goldman Sachs

Thank you for taking my question. In terms of the five-year surveys, we’ve seen some offshore drillers defer or even cancel this five-year surveys innovating for better visibility in markets. Are you seeing that in your discussions with the offshore drillers and how does that factor into your guidance on aftermarket business for the coming years?

Clay Williams

Waqar, I think they maybe able defer that but they need do it before they go back to work because it’s a statutory, I think regulatory requirements. It’s been required for decades and it’s the practice across the industry that every five years these come in.

We've been in the industry dialog around how to make that more efficient. Because right now, we’ve been on a run rate of about 40 rigs a year going into shipyards and as I mentioned earlier, see that going up to 130 in 2017, that’s just based on NOV delivered kit. And we’re going to have to do some thing different to accommodate that. That's a tremendous amount of work.

And so, we're exploring with the industry ideas to make that more efficient. We’ve also reorganized internally to bring some of our project management expertise within Rig Systems to bear on these projects. The planning for these is critical. As you can imagine, taking your rig off day rate, putting in a shipyard to accommodate this periodic survey has a high opportunity cost because it’s off day rate.

So, our customer want to get as much done as they can while that rig is in the shipyard. And that can be made much more efficient and minimize opportunity cost if a lot of very tight planning goes into that project well in advance and as long as we can get out to the rigs and survey the equipment. And so, our plan is to try to work with the industry to build better way that’s more efficient and enables them to get the rigs through with -- and minimize the opportunity costs associated with that requirement.

Waqar Syed - Goldman Sachs

So, just to understand in your forecast are you assuming any major regular time of order rates or you feel that every single rig that’s due for five-year surveys gets that done?

Clay Williams

Well, I mean if rigs are not on contract at the time, I suppose they may be able to defer. I don’t know that for sure but nevertheless there’s a lot of new iron out there required by the Coast Guard to come in. So I think that’s a fairly save bet on our perspective.

Jeremy Thigpen

The other thing to point out to is that we’re in conversations with these customers a year in advance of their [FDA] (ph) surveys .So, we know if and when they are coming in and what kind of aggregates they are going to require. This part of that challenge and kind of streamlining this process that Clay was talking about. So, we know what’s coming in.

Waqar Syed - Goldman Sachs

Okay. Great. Now just one last on the Chinese shipyard regarding jackups. Are you -- there is also a view that's being floated around by the offshore drillers saying that many of the rigs that are being built, the jackups are being built in Chinese shipyards may not actually get built. Are you hitting any cancellations there, any concern at the part of the shipyards that the rigs may not get built?

Clay Williams

No the -- I think what you’re referring to the Chinese -- generally we’re offering very attractive terms, for instance, 10% down 90% at delivery. So China is financing the build out of these rigs and whether or not the customer shows up and makes the final payment or not. We’ve got very, very strong contracts with our customers there. And so we’re not concerned about this.

We went through a massive downturn economically in 2009 and had a very small, I think 2%, 3%, 4% of our backlog where customers defaulted in the projects one away. So I think we demonstrated before our contracts are pretty solid and our expectation is that our customers in China are going to see those projects through and that’s -- many of these too. Although they are not necessarily contracted now. You’ve got to Pemex talking about picking up a dozen rigs next year and other 20 or 30 few years after that. Lot of interest out of the Far East, India. So there is a lot of jackup interest out there and in the final thing is if you look at the demographics of the jackup rig is what you're seeing here is retooling, rejuvenating that fleet in earnest and that’s the fundamental driver for demand for these rigs.

Jeremy Thigpen

Yeah. And to be clear, we’re not offering that financing to our shipyard. Customers….

Clay Williams

That’s right.

Jeremy Thigpen

And in fact, we’re getting paid as we go.

Clay Williams


Jeremy Thigpen

We stay cash positive, cash neutral at worst on these projects.

Clay Williams

Yes. Thank you, Jeremy and it’s an important point.

Waqar Syed-Goldman Sachs

All right. Well, thank you, very much. Thanks guys

Clay Williams

Thank you

Jeremy Thigpen

Thank you Waqar.

Clay Williams

Well, that wraps up our call. We appreciate everyone joining us and look forward to speaking to you next quarter. Thanks very much


Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.

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