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Executives

Clay C. Williams - Chief Financial Officer and Executive Vice President

Merrill A. Miller - Chairman, Chief Executive Officer and President

Loren Singletary - President

Analysts

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

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

Kurt Hallead - RBC Capital Markets, LLC, Research Division

James Crandell - Dahlman Rose & Company, LLC, Research Division

Geoff Kieburtz - Weeden & Co., LP, Research Division

William Sanchez - Howard Weil Incorporated, Research Division

National Oilwell Varco (NOV) Q3 2011 Earnings Call October 25, 2011 9:00 AM ET

Operator

Welcome to the National Oilwell Varco 2011 Third Quarter Earnings Call. My name is Kim, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I'll now turn the call over to Mr. Loren Singletary, Vice President of Global Accounts and Investor Relations. Mr. Singletary, you may begin.

Loren Singletary

Thank you, Kim, and welcome, everyone, to the National Oilwell Varco's Third Quarter 2011 Earnings Conference Call. With me today is Pete Miller, Chairman, CEO and President of National Oilwell Varco; and Clay Williams, Chief Financial Officer.

Before we begin this discussion of National Oilwell Varco's financial results for its third quarter ended September 30, 2011, please note that some of the statements we make during this call may contain forecast, projections and estimates, including, but not limited to, comments about our outlook for the company's business. These are forward-looking statements within the meaning of the federal securities laws based on limited information as of today, which is subject to change. They are subject to risk and uncertainties, and actual results may differ materially. No one should assume that these forward-looking statements remain valid later in the quarter or later in the year.

I refer you to the latest 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 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 2, in order to permit more participation.

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

Merrill A. Miller

Thank you, Loren, and good morning, everyone. Earlier today, we announced the earnings of $532 million or $1.25 per fully diluted share on revenues of $3.74 billion. This compares to earnings of $481 million or $1.13 per fully diluted share in the second quarter of 2011, and third quarter 2010 earnings of $406 million or $0.97 per fully diluted share. We are very pleased with these results, and they reflect the confidence our customers have in our products and services.

Additionally, we also announced today new capital equipment orders in the quarter of $3.94 billion, a new record for the company. These new orders increased the total capital equipment backlog to $10.27 billion, a 33% increase from the second quarter of 2011. Clay will expand on both the financials and backlog in just a moment.

I would like to thank all of the National Oilwell Varco employees worldwide for their continued tremendous efforts in achieving these results. In particular, I want to thank the Rig Technology sales groups for their yeoman efforts in establishing a record level of new capital orders. Clay?

Clay C. Williams

Thanks, Pete. National Oilwell Varco performed exceptionally well in the third quarter, generating $532 million in net income, as Pete said, or $1.25 per share fully diluted on $3.7 billion of revenues. Sequentially, earnings per share improved 11% on 6% higher revenues. Year-over-year, third quarter earnings per share improved 30% on 24% higher revenues. Transaction-related charges were $6 million pretax or $0.01 per share in the third quarter, roughly the same EPS impact as in both the second quarter 2011, as well as the third quarter a year ago. Excluding transaction charges, earnings were $1.26 per fully diluted share in the third quarter.

Operating profit, excluding transaction charges, was $778 million or 20.8% of sales, up $66 million from the prior quarter, representing 29% flow-through or operating leverage. Compared to the third quarter of 2010, excluding transaction charges, operating profit improved $180 million, representing 25% leverage or flow-through.

There is much to highlight this quarter as performance was excellent across the board. All 3 of our segments posted higher revenues and operating profit both sequentially, as well as year-over-year.

Rig Technology landed a record level of orders for capital equipment, including the largest order ever in the history of our company, during the third quarter. Petroleum Services & Supplies generated record quarterly revenues and pushed operating margins above the 20% level. Distribution Services posted its third highest quarterly sales ever at very strong margins approaching 8%. Overall, we are pleased with the exceptional performance and grateful for the hard work and terrific execution by NOV's nearly 50,000 employees.

Two clear broad themes we've highlighted before, shales and deepwater, continued to shape our industry and drove higher demand for NOV's products and services in the third quarter.

First, unconventional shale and tight sand drilling, along with seasonal recovery in Canada, led to a worldwide rig count increase of 12% sequentially and 15% year-over-year. Within North America, unconventional plays account for more than half of all drilling as propelling many NOV products and services ever higher. All 3 NOV segments benefited from rising unconventional drilling during the third quarter, and we believe shale drilling will continue to shape National Oilwell Varco's performance for many years to come, owing to our strong position in the supply of key technologies, which make shales work.

Modern drilling rigs, like those our Rig Technology Group offer, move quickly and utilize top drives, AC power, electronic controls and robotic pipe handling to optimize operations into safe, repeatable, efficient industrial processes. NOV continued to deliver modern land rigs, like our ideal rigs, in the third quarter to a fleet which must be retooled to fully exploit new shale resources, and the group saw its backlog for land equipment rise 20% sequentially in the quarter. Importantly, announcements of systematic new build plants by major land drillers, mostly backed by current contracts, continued through the quarter. These modern rigs prefer a premium drill pipe, which our Petroleum Services & Supplies group is the largest provider of worldwide.

Our highly engineered Drill Pipe maximized drilling fluid hydraulic power through fiction-reducing thermal set plastic coatings and optimized torque-carrying capacity through sophisticated thread designs and metallurgy. 15 years ago, premium pipe constituted less than 7% of our mix. So far this year, it accounts for 67%.

Horsepower delivered to the bottom of the hole through pressurize drilling fluids, flowing smoothly through a drill pipe, is converted into torque by our market-leading downhole drilling motor designs, which also saw strong demand in the third quarter. This torque is used to turn NOV ReedHycalog tricone or fixed cutter diamond bits, used to efficiently drill long laterals, and its in these where our new thermal abrasion resistant Helios cutters, introduced just a few months ago, are breaking records. Demand for Helios bits, drilling motors and agitators contributed to improved margins and strong performance from our Downhole Tools unit within PS&S during the third quarter.

Shale drilling also spurred demand for solids control and Portable Power gen sets NOV provides, leading to solid double-digit sequential sales growth for our well site services unit within Petroleum Services & Supplies as well. Coiled tubing continues to play a large role in the stimulation and completion of these horizontal wellbores. Demand for NOV's coiled tubing units, along with other frac spread and stimulation equipment provided by our Rig Technology group, led to an 11% sequential growth in orders for this equipment, once again setting new records. Each year, these coiled tubing units will consume 8 or more strings of coiled tubing each, which our PS&S group also provides. With the third quarter startup of a new large diameter coiled tubing mill, this product line posted double-digit growth and record quarterly sales, a record which we expect to be broken again in the fourth quarter. The Petroleum Services & Supplies segment's pumps and flow iron components used in hydraulic stimulations are also witnessing strong demand. And helped by recent acquisitions, these lines posted double-digit sequential growth. Likewise, high frac pressures dictate competent casing. NOV's inspection services for all the 5-inch and 7-inch seemless casing being consumed in the North American shale plays benefited in the third quarter, too.

Our Distribution Services segment reliably provides the consumables required to keep drilling and completion operations moving smoothly, and it, too, saw high third quarter demand from emerging shale plays, particularly in Canada, which led the pack in margins this quarter.

What is striking to me about the evolution of the shale plays is the shortening of the time requirements across so many operations. By that, I mean wells are drilled faster. They are cased faster. Wells are fracked faster, provided crews and equipment are available. They are hooked up faster. The entire system is being honed to maximize returns on the capital that it employs. The adoption of new quick-move rigs, which move in 1 day versus 4 days, where the shaving off of days and weeks off drilling operations through the adoption of better technologies downhole that generate higher rates of penetration, or the minimization of flat spots or nonproductive time from the well progs by innovations like off-line stand building, or stimulation companies taking their frac fleets from 12-hour to 24-hour operations, all seem to focus on ever swifter execution of the task at hand, all the while reducing the time dimension. Or said another way, maximizing productivity per unit of time. To us, this begs the question, "What the reduction of time requirements imply for NOV's demand?" Well, it goes up. The shale energy system consumes everything from rigs to pipe, to mud, to pumps faster. Linear efficiency improvements result in greater demand with linear growth in consumption rates. Consider, for example, an old rig, which takes 4 days to move. It will have its string of drill pipes sit leisurely on the back of a truck for 4 days during its move, which it makes every well. Whereas the drill pipe on a new quick-move rig gets only 1 day respite, and as a result, spends much more of its time downhole actually doing the work. Perhaps, this is why many drilling contractors these days are reporting that drill pipe seems to last only 2.5 to maybe 3 years, whereas a generation ago, a drill pipe would last 5 years easy.

Consumables and equipment are being pressed into actual service more days a month than they used to be. Coiled tubing units increasingly move toward 24-hour operations. Today, the coiled tubing we sell gets worn out in 4 to 6 weeks, less than half the time it would last a decade ago. Higher productivity by crews and iron equals higher consumption. The flip side of improving efficiencies and shortening of time dimensions for certain operations is high and accelerating consumption of components that NOV makes. Consumption further hastened by higher pressures, higher torques, greater weight and more extreme temperatures.

NOV is uniquely positioned to supply critical components to a rapidly blossoming oil and gas shale phenomenon, one that has legs, one that encourages and celebrates ever briefer periodic operations that devours the iron that NOV makes and sells, and one we remain convinced will soon spread to other basins outside North America. We are moving decisively in regions like Eastern Europe, the Middle East, South America and China, which have an abundance of promising shales and, unlike North America, high gas prices. Shale technology will provide a key solution to the growing energy needs of these regions in the decades to come and is evolving unconventional shale energy system, with its efficiency obsessed, time shortening, consumption accelerating drumbeat will continue to drive NOV's performance.

The second big thing pushing our business this quarter was deepwater. The deepwater needs 2 basic ingredients to work, technology and oil price. Technology evolved in the 1990s to a level of reliability to enable low risk development of deepwater resources, making the deepwater possible. As we ended the 21st century, governments around the world leased large tracks of deepwater acreage. But it's oil price that makes deepwater profitable and attractive, and as oil prices moved up over the past decade, the impact on our industry has been steady and predictable. First came exploration, which prompted demand for some deepwater rigs to delineate reserves in this new frontier. Discoveries are now prompting further demand for more deepwater rigs to develop and produce these resources, and we expect this to be followed by rising demand for production systems like FPSOs.

Our Rig Technology group's results for the third quarter reflect high demand for deepwater rigs from an industry gradually transitioning from exploratory drilling to development drilling. Again, NOV is uniquely positioned to benefit from this trend as our level of orders for rigs in the third quarter demonstrate.

Record orders of nearly $4 billion in the third quarter, anchored by the 7 drillship package order from EAS for Brazil, totaling about $1.5 billion. In addition to these, the Rig Technology group also landed another 7 floater packages for a total of 14 floaters, along with 14 jack-up packages for a grand total of 28 offshore rigs during the third quarter. Interest in land drilling rigs remained strong, and although FPSO orders have been slow in coming, we are bidding a large volume of work in the FPSO area and expect orders to start to come through in future quarters. As I mentioned earlier, orders for well intervention and stimulation equipment rose to record levels during the quarter.

According to its public comment, Petrobras intends to sponsor 21 more new floating rigs, which will be built in Brazil. It opened its second round of bids for floaters to develop at Santos Basin a few weeks ago after awarding the first 7 rigs earlier this year. Several drilling contractors and local shipyards participated in the tender, most choosing to bid through Sete, the company Petrobras set up to own and finance rigs. NOV continues to bid drilling packages to the participants, and we're optimistic we will continue to do well as the awards are made. Additionally, we continue to pursue orders for new builds beyond Brazil, and we are closely monitoring several options held by our customers for rigs and packages. Whereas we previously believed most would be exercised, many are now expiring or being extended, so the ultimate disposition of these is uncertain. The all-in cost of offshore new builds has stabilized. Our pricing presently is 6% to 8% higher than year-ago levels. While some customers are wary of current macroeconomic conditions, or are presently too busy with their previously ordered projects and lack additional bandwidth to undertake more, we nonetheless foresee others stepping up and ordering. Given recent rising deepwater fixtures and stable new build cost, we believe that current financial returns on incremental offshore new builds are sufficiently attractive to prompt additional orders.

Q3 revenue out of backlog for Rig Technology was $1.4 billion, and our book-to-bill was 280%. We ended the quarter with $10.3 billion in backlog, and we expect revenue out of backlog to be approximately $1.5 billion in the fourth quarter. $6.4 billion is scheduled to flow out in 2012, $1.5 billion in 2013 and the balance in 2014 and beyond. As of September 30, our backlog was 85% offshore and 15% land, and 87% international and 13% domestic. Notably, the offshore rigs ordered over the past year or so are scheduled for more rapid fabrication in the shipyards than rigs built just a few years ago, 12 to 18 months faster, which will require our organization to work at a pace equal to or higher than we achieved in 2008.

With strong growth in both unconventional shales and deepwater, NOV is investing heavily in expanding and improving our capabilities to service the needs of our customers. Last quarter, we spoke to new coating plants, coiled tubing mills, drilling motor reline facilities, riser inspection and repair, and drill pipe manufacturing capabilities that we are adding, and these will contribute more and more through the coming quarters.

We've also been extending our capabilities through acquisitions. We are pleased to complete our acquisition of Ameron International the first week of October. So you will begin to see the financial impact beginning in the fourth quarter financial results. Strategically, the acquisition combines 2 leading providers of composite and fiberglass pipe, and greatly expands the products NOV can offer in the FPSOs, drilling rigs and other marine vessels. It strengthens our position as the largest provider of composite pipe to the oilfield. It also brings us new infrastructure products and additional water transmission products through our existing water processing equipment lines. We intend to report Ameron's fiberglass composite pipe segment within our Petroleum Services & Supply segment and Ameron's water transmission and infrastructure products segments within our Distribution Services segment.

We also announced our acquisition of STSA in Singapore, which enhances NOV's ability to service our large installed base of pressure control equipment in the Far East. We continue to invest in aftermarket support of all our equipment, knowing our customers rely on our scope and reach to maintain reliability within their operations. The common strategic thread through all these is our acknowledgment that our customers need to perform quickly and in an increasingly just-in-time energy environment. These 2 acquisitions, together with 10 more, total nearly $1.5 billion in cash we have invested in M&A for the past 12 months to enhance our product and service offerings, which we believe offers the highest return on the capital the company generates and invest.

As we move into the final quarter of the year, our outlook remains bright. Although the financial markets reflect broad macroeconomic uncertainty, and we are watching the sovereign debt and banking problems in Europe closely, thus far commodity prices and oilfield activity have remained solid. we believe fundamentally attractive investment opportunities for our customers abound. In NOV, with its terrific team of professionals and its unparalleled technical operating and financial resources, stands ready to help them execute these.

Now let me turn to our segment operating results. Rig Technology revenues were $1,970,000,000 in the third quarter, up 4% sequentially, and up 19% year-over-year. Operating profit was $528 million, and operating margin was 26.8%, down 50 basis points sequentially and down 230 basis points from the prior year.

Operating leverage was lower than normal, 14% sequentially and 15% year-over-year, owing to a gradually shifting mix toward lower margin projects in our backlog as compared to projects won prior to 2008. We expect margins to moderate in the mid-20% range in the next few quarters, bottoming a little higher than we expected before due to: first, higher volumes giving strong levels of orders recently, which improved absorption; and secondly, continued strong execution on costs by the group. We once again benefited from positive cost variances within this segment in the third quarter, thanks to an abundance of manufacturing talent within this team.

Notably, aftermarket revenues for the Rig Technology Group moved up nicely this quarter, helped by our STSA acquisition. Aftermarket parts and services rose 18% sequentially and 31% year-over-year, which offset some of the adverse margin impact to the project mix. We expect aftermarket growth to continue. Over the past few years, we've delivered 120 offshore rigs, along with initial stocks of spare parts. The first wave of these are now coming off their initial warranty period, typically 12 months after spud, and are now starting to buy spare parts and services in earnest. We believe this growing installed base, together with a renewed focus on BOP system reliability and our investment in NOV's worldwide aftermarket infrastructure, will contribute to rising aftermarket sales over the next several years. Looking into the fourth quarter of 2011, we expect Rig Technology revenues to rise in the 5% to 10% range and for the segment operating margins to be in the mid-20s.

The Petroleum Services & Supplies segment generated $1.460 billion in sales for the third quarter of 2011, up 7% sequentially and 34% year-over-year. Operating profit was $299 million, and operating margins were 20.5%. Operating leverage or flow-through was a strong 50% sequentially, helped by a combination of seasonal recovery in Canada and modest pricing levels across most product lines as was 36% compared to the third quarter a year ago.

Sequential sales growth was strongest in North America, where Canada emerged from breakup and the U.S. posted nice shale-driven rig count gains as well. Internationally, the segment posted 3% sequential sales growth, with higher sales in Asia, the Middle East and Africa, partly offset by lower demand in Latin America and Europe. The group continues to monitor inflationary forces in its cost structure, but generally, these were more subdued and seen earlier in the year. Several product lines are carrying startup cost for new operations. Most products within PS&S are successfully obtaining modestly improved pricing, typically 2% or 3%, to offset creeping cost.

Barring a sharp downturn in the macroeconomic outlook, our expectations for the Petroleum Services & Supplies segment are high. The group is uniquely positioned to benefit from oil and gas activity, and we believe continued high oil prices and functioning capital markets will spur more drilling. In the fourth quarter, we expect revenues for the group to rise a few percent but margins to take down slightly, owing to the inclusion of additional revenues from Ameron, which will be diluted to the margins initially.

Turning to Distribution Services. Third quarter revenues were $480 million, up 13% from both the sequential and prior year quarters. Operating profit was $37 million or 7.7% of sales, up both sequentially and year-over-year. Operating leverage or flow-through was a solid 20% sequentially and 24% year-over-year. Revenues for North America grew 18% sequentially, owing to seasonal recoveries in Canada and strong rig activity across the United States. The group is opening new DSCs, targeting shale plays in the Utica, Marcellus and Eagle Ford domestically, and Poland, Indonesia and Columbia internationally. Third quarter results also benefited from artificial list sales in Canada and Latin America and continued sales of consumables into Iraq. We expect fourth quarter sales for the group to grow in the 10% range, with margins to tick down slightly as the contribution from Ameron's infrastructure products and water transmission groups slows in for nearly a full quarter.

Turning to National Oilwell Varco's consolidated third quarter income statement. SG&A increased $17 million sequentially, due to higher incentive compensation accruals but declined as a percent of sales both sequentially and year-over-year to 10.5%. Interest expense declined $1 million sequentially due to our second quarter indenture repayment. Other expenses improved $7 million sequentially due to improvements in foreign currency exchange expenses. Equity income in our Voest-Alpine joint venture improved slightly on higher green tube volumes, but we expect equity income to decline slightly in the fourth quarter. The tax rate for the third quarter was a little over 32%, about flat with Q2 and in line with our expectation for Q4.

Unallocated expenses and eliminations on our supplemental segment schedule was $86 million in the third quarter, up $6 million from the second quarter due to higher intersegment eliminations. Depreciation and amortization was $140 million, up slightly from the second quarter, and EBITDA, excluding transaction charges, was up $80 million sequentially to $938 million or 25.1% of sales.

National Oilwell Varco's September 30, 2011 balance sheet employed working capital, excluding cash and debt, of $3.4 billion or 22.9% of annualized sales, down $112 million from the second quarter and down $312 million from year ago levels. This is due primarily to rising orders and downpayments in our Rig Technology group. Total customer financing on projects in the form of prepayments and billings in excess of cost, less cost in excess of billings, was $1.1 billion at September 30, up $142 million sequentially and up $1.1 billion from year ago levels. Accounts receivable increased $260 million, and inventory rose $151 million sequentially on higher revenues and acquisitions, partly offset by higher accounts payable and accrued liabilities.

Cash flow from operations was $634 million, and levered cash flow was $672 million for the third quarter. CapEx increased $12 million sequentially to $125 million due to high expenditures on new facilities, primarily within Rig Technology and Petroleum Services & Supplies. We expect CapEx for the full year 2011 to be in the range of $425 million, as we pursue a number of expansion opportunities. During the quarter, we spent $56 million on 2 acquisitions. NOV's cash balance was nearly $3.9 billion at September 30, 2011, up $430 million from June 30. Note that this is prior to our Ameron acquisition on October 5, which used $777 million in cash.

So now let me turn it back to Pete.

Merrill A. Miller

Thanks, Clay, and I'm just going to make a couple of brief comments. As we kind of prepared for this conference call, we really discussed what we could talk about, and it's kind of the same thing we've talked about an awful a lot in the past, and that's shales and deepwater. Those are the things that are really making the industry tick right now. And I think on shales in particular, I know there's consternation over the price of natural gas, but when the rigs are pulled off the natural gas wells, they're really put on the wet shales, whether it be the Bakken, the Eagle Ford, Granite Wash, some of the areas that we're seeing up there.

So we continue to believe the shales are going to be very, very active. And one of the things I want to emphasize, that Clay talked about earlier, is what I think has been our prudent spending, and not only had we invested in '09 and '10 downturns, we kept putting money into the business. We expanded our quality tubing lines. We consolidated our supply lines for our Grant Prideco operation. We bought Hochang in Korea. These things have all been very additive to what you see today on these numbers. I think many times, when people buy things, it just kind of gets rolled in. But here, we're starting to see really the benefits of making these investments. And I think it's also the benefit of having the strong balance sheet that we have.

One thing I want to point out on the shales. We're really big believers in first mover, and I think in Poland, Australia, China and South America, the opportunity for shales may not be as great as people want it today, but we're investing in those arenas because it will be great over the next 2 or 3 years, and we want to be the people that are there to supply them. I think expansion in Russia is another thing but that we're very big on right now. I think as the Russian political system kind of changes back over a little bit, I think you'll see more emphasis on the energy arena. And today, we're investing heavily to make sure that we're prepared to be able to supply them with the equipment that they need.

Now one thing I do want to talk about just quickly is technology. Obviously, the lifeblood of NOV is technology. We're the leader in the equipment that we make. Today, some of the things that we're working on is new all-inclusive control systems. As the provider of a vast majority of drilling equipment packages, we're the approved solution for being the control system that's going to look at everything, from downhole to subsea BOPs, all the way back up to actually running the rig. We're going to be announcing some new things, probably in the first or second next quarter of next year. I'm really excited about what we're doing here. Remote monitoring is another one. I think you should take a look at the smart equipment that we're making today. One of the offshoots of Macondo is that you have to know and you want people to know in the Houston offices and the Oslo offices, all over the world, what's going on in their rigs. And because, again, we put most of the equipment out there, we're the approved solution of looking at that, especially when it comes to subsea. And I will also point out that we just opened out a new R&D facility for our subsea operation plus testing. We actually had some investors through there not long ago, and it's really state-of-the-art facility, and I think it's pretty cool. We're doing an awful lot in the Downhole Tools arena. Clay mentioned the Helios bits earlier. I'm excited about all the different products and projects that we have going on. The neat thing, again, about the strong balance sheet that we've had over the past 4 or 5 years has been our ability to make sure that we're reinvesting in the business and to make sure that we have the new products out there.

Finally, our backlog gives us great visibility. If you take a look at where we are today, if you go back and extrapolate that to where we were in 2008, look at our results that came through the '09 and '10, we're starting to build up the same sort of backlog today. So I'm excited about where we are on M&A, good opportunities out there. We spent, we've done an awful lot in the last calendar year, with Ameron being the biggest deal that we've done, but we did APL last December. There's still a lot of opportunity, but the one thing I'll guarantee is we're going to be prudent in our pricing. We're not going to do M&A just to do M&A. We're going to make sure that we're going to get it at a value that's good for our shareholders and we can return money to our shareholders on that.

So anyway, having said that, just a few brief comments. Kim, I'll now turn it over to you for any questions that our callers might have.

Question-and-Answer Session

Operator

[Operator Instructions] And at this time, we have a question from Jim Crandell from Dahlman Rose.

James Crandell - Dahlman Rose & Company, LLC, Research Division

Pete, I think you've called the deepwater outlook very well. You and I have talked about that some of the options will probably be picked up, some of which may not be picked up. It could be picked up by others with deepwater day rates continuing to strengthen. Do you have any sort of change in sense about the options, number one, and sort of deepwater rig orders outside of Brazil, number two?

Merrill A. Miller

Jim, I think that a lot of the options will be exercised. I think some of the ones that weren't were probably not exercised simply because people were a little skittish about the macroeconomic environment, with what's going on in Europe. Are we looking at a double-dip recession, things like that. But the good news is that some of the options have been extended out. Ultimately, over the next, I think year or so, you're going to see a lot of these options. They're going to go ahead and put them in play. They're going to go ahead and exercise what they've got out there. We're still very bullish about where we are in this marketplace. I think as you take a look at the need for deepwater around the world and you take a look at the way they're getting gobbled up right now, I mean, you take a look at kind of the tightness in the market today, I think most people are just saying, "Why do I want to commit right now when I can probably wait a month or 2 and get a little bit better hopeful visibility on the economy and then make my move then?" So I think it's just going to be a question of timing, but we're still very, very bullish on the demand for deepwater rigs.

Loren Singletary

And Jim, this is Loren, and I'll tell you that the drilling contractors that we talked to may not exercise these options. But they will buy rigs in the future. The demand out there, and as you mentioned, the day rates that we have for the ultra-deepwater rigs continue to go up. And there is just a lack of deepwater rigs for all the opportunities that the oil companies have out there today. And so we'll continue to see deepwater rigs being bought over the long term.

James Crandell - Dahlman Rose & Company, LLC, Research Division

And just a follow-up on deepwater, Pete. If you look at your potential for what you could sell through deepwater rigs, I think you had last cycle, actually maybe one, that was up about $300 million. If you look at just these Brazilian rigs and say, okay, 7 rigs for $1.5 billion, it's materially less than that. Including the reduced price for steel, which I assume makes up a big chunk of that, are these packages including less equipment or is there any kind of -- or would you expect there, and I guess the same type of margins in Brazil, which you're earning in the rest of your rig equipment business or in Korea when you typically have supplier package?

Merrill A. Miller

Jim, I think you should you take a look at the rigs that are in Brazil right now, that we're bidding in Brazil, you have to understand these are kind of benign water-type rigs. And so, they have a lot different requirements than you have on the superduper dual-activity-type rigs, the Transocean and Oldpride, now Ensco, that we built. And so the reality is it's just a little different suite of equipment. We're still getting everything on it. Margins are going to be fine on it. It's just the difference in the type of rig. If you take a look at the Transocean-type rigs, those are full dual activity. They've got dual DEPs, or drilling equipment packages, things like that on them. Whereas, the rigs in Brazil, I would say that they want to call them dual activity, but I would say it's kind of 1 1/2 activity, if you will. So the derricks are going to be smaller, you're not going to have a full 2x the drilling equipment package, things like that. So the numbers are still awfully solid, and I think you'll see us monetize the backlog very similar to what we have in the past.

James Crandell - Dahlman Rose & Company, LLC, Research Division

Okay. And last question, Pete is how do you see the orders for equipment packages, the FPSO over the next, let's just say 3 to 6 months?

Merrill A. Miller

Jim, I think they'll be fine. We're taking it -- the FPSO business is a shade different than the drilling equipment business. And you have FEED studies, and you have a lot of different things. When I say FEED, front-end engineering studies. And they take a little bit longer to materialize, and each one of them today is still kind of a project in and of itself. I mean, you've heard me talked before about one of the things we want to do is standardize FPSOs, and I think we can. We're talking to some customers about that. Our engineering groups that are over in Norway working on that, that's a goal that they have. So it's a little bit longer timeframe, but I think we've kind of guided for we'd start seeing some decent orders in 2012, and we're still pretty consistent with that.

Loren Singletary

Jim, this is Loren again. We're tracking over 150 FPSOs that we think will materialize for the next 5 to 10 years. And we feel really comfortable with where we are today in the FEED studies. We're participating in all these FEED studies, so I think you'll see some meaningful results here in 2012 or 2013.

Operator

Our next question comes from Bill Sanchez from Howard Weil.

William Sanchez - Howard Weil Incorporated, Research Division

Clay, you mentioned with regard to pricing on the capital equipment side, year to year, you're tracking 6% to 8% higher. That percentage is similar to what you discussed on the second quarter call. I was wondering if you just talk about kind of the pricing outlook from here. And was some of that a function of perhaps mix, with the Petrobras rigs being included in there in third quarter? And I guess, as a follow-up, as we think about the margins and the Rig Tech here and the impact of that pricing starting to have a positive effect there, you've mentioned margins flat here or down, I guess, a bit the next couple of quarters. It sounds like a second quarter next-year inflection is kind of what you're expecting. Can you talk a little bit about that as well?

Clay C. Williams

Yes, yes. Bill, as you know, it's such a later-cycle business for us, the results that you see in our income statement kind of reflect what was going on in pricing, 18 months to 2 years ago or even longer, because it takes us a while to build these thing and then recognize revenue going on. But generally, the history that we've had with pricing in Rig Technology, I'm going to stay away from talking about pricing on any particular tender like Petrobras, so these will sort of just be broad statements. But generally, pricing declined obviously, as we came out in 2008, when it was very high in 2009. And a 6% to 8% improvement is really kind of off rock bottom, where we ended up late 2009, early 2010, and has picked up 6% to 8% broadly speaking across a lot of the offshore equipment that we sell. Here of late, I think it's kind of stabilized in that region. We still see good demand. And I think, we're certainly paid a premium for what we sell, vis-à-vis the competition because we do a good job executing and offer a terrific value in the technology that we provide. But I think in the next quarter or 2, at least as far as we can see, pricing is going to be stable. In terms of impacting the P&L again, in 2012, we talked about margins moving down for Rig Technology to the back half of 2011 and then kind of starting to recover in 2012. That's the impact of that pricing increase. More so, though, I think it's really the impact of the higher volumes. We had great order quarters here for the last few quarters, really culminating in the third quarter record orders. And as those projects start to flow in in 2012, 2013, that's when you start to see the margin uptick. And that margin uptick importantly is as much volume driven -- probably more volume driven than it is price driven.

William Sanchez - Howard Weil Incorporated, Research Division

Okay. And as my follow-up, I want to turn to PS&S quickly. Can you talk a little bit about just the Drill Pipe business in general? I know I guess by my math, that's probably about 1/4 of the revenue within that segment. And then on past calls, we've discussed a lot about pending orders here for deepwater rigs, and that's a very high margin work for you. Maybe you could talk about the number of deepwater rigs that you still see needing to order pipe. And then, I guess, more importantly, two, what about an eventual replacement cycle starting on the land side, given this compression in useful life here given the intensity of the shales, Clay, or Pete?

Clay C. Williams

Or Loren.

William Sanchez - Howard Weil Incorporated, Research Division

Or Loren? I don't remember.

Loren Singletary

Bill, we are tracking closely, approximately 50 offshore rigs that are going to be delivered here in the next year or 1.5 year. And we know and are in contact with those drilling contractors on a weekly and monthly basis to find out exactly what they're going to need based upon the locations that are going to be drilling in around the world. So there's over 50 of them that work, that are out there that are available to us at this point in time. So it's something that we're on top of. We monitor, like I said, on a weekly basis, so we're going to do quite well with that particular type of drill pipe. And again, that is premium pipe, that will be 6 and 5/8 OD, and 5 and 7/8 OD type pipe. Now, on the land business...

Clay C. Williams

Yes. I'll touch on a couple of numbers, Bill, the mix of Drill Pipe in this quarter was a little less than 20%, so you're a little high on your estimate. The business is doing very well, though it's accretive to our PS&S margins overall. And to finish up on Loren's comment, it's really been dominated last few quarters by orders from land operators, specifically for the shale plays. And it's good and bad. It's good in that the pipe that's used in those shale plays typically has premium connections. They can handle a very high level of torque. The bad is it's smaller diameter. 4-inch XT is kind of the dominant kind of pipe that we're going to invest in and getting the most pricing leverage to see the most demand for. And so, it's a nice high margin level of pipe, but not nearly as good as the bigger, beefier offshore pipe that we sell. So once we start to see 5-inch or sizes larger than 5-inch, 5 and 7/8 inch, 6-inch, 6 and 5/8 inch pipe orders start to fill up these offshore rigs, I think that's when you'll see kind of next leg on margin for Drill Pipe.

Merrill A. Miller

And then Bill, just to close the loop here from all 3 of us on this one, I'll also mention that when you talk about land pokes on Drill Pipe, and especially in the shales, the big customers are actually the rental companies. And a lot of this, the drilling contractors, once you make the turn on these shale wells and go into the horizontal section, and you go into that 4-inch XT, the drilling contractors usually have the operator then ramp that, and said, that pipe is being worn out, as Clay mentioned earlier, pretty dramatically. So we're really kind of getting a free-for ride here. We've got the land drilling contractors, we've got the rental companies, and then we've got offshore guys. So we really like where we are on the Drill Pipe business right now.

William Sanchez - Howard Weil Incorporated, Research Division

But given, Pete, where those product lines, I guess, across the PS&S spectrum are weighted relative to rig count and perhaps lagging a bit, is the outlook you think for 2012 for you, even though 50% of that revenue is pretty much, say roughly is North America, that margins are going to be fairly resilient versus where you exit 2011, if not up a bit?

Clay C. Williams

Yes, I mean, we've been building on margin through the year as you've seen, and partly that's volume, partly that's price. So as we go into 2012, barring a sharp downturn in the rig count, which we all agree is a possibility, but barring that, we would expect 2012 to really look pretty good.

Operator

Our next question comes from Bill Herbert from Simmons & Company.

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

Clay, with regard to Rig Tech margins, if you back out the benefit from, I guess, the riser issues in Korea last quarter, I think that was it. The margins were actually in the 25-ish percent range versus the 27.3% recorded, correct?

Clay C. Williams

Right, that is correct.

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

Yes. The 26.8% in the third quarter, walk us through the margin performance on that front. And then moreover, in thinking about 2012, you mentioned the benefits from absorption, primarily driving the uptick in 2012, the expected uptick, plus to a lesser extent, a better backlog mix. Is there any reason why we should not expect to see kind of the 30% to 35% incremental margins that we witnessed historically for Rig Tech during the expansion phase of the cycle?

Clay C. Williams

Yes. We believe that's very doable in that range. We think it's kind of normal, as it were for Rig Technology. In terms of the margin performance this quarter, a couple of things led to the outperformance. If you recall, last quarter, we were looking for volumes that aren't really pretty flat, maybe up 1%, but more or less, quarter to quarter flat. We did just slightly better than that. We did 4% growth, and so a little higher volumes I think helped in the margin front. But again, I think the main performance driver in the third quarter was just very, very good execution by our group, and once again very good cost control. And as a sort of a third factor, I'd throw in their mix, we had a terrific quarter by our well intervention, stimulation equipment group. And a lot of demand for frac fleets and that sort of equipment, they came in at higher margins. So all that kind of culminated in the outperformance in the third quarter. As we're kind of seeing this roll by quarter by quarter, that's causing us to take a little more optimistic view of what the future quarters hold, here as we finish up 2011 and move into 2012 and thinking now that bottom maybe looks like it's going to be in the 25-ish range. Bear in mind, though, that we're a lot better at building rigs than we are at forecasting.

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

I think you're pretty good at forecasting, but be that as it may, so really, I mean, plausibly here, given your revenue forecast for next year, really a Rig Tech margin in the high 20s is not -- starting with a 3, is not necessarily implausible, correct?

Clay C. Williams

Yes. I caution you, we did -- we had 2 quarters in that group north of 30% in the early part of 2010. And there were a lot of stars that lined up. So I wouldn't want you to get too carried away on the ultimate margin. And I'd stress again, too, that anything in the 20s at all in terms of margin equals a really, really good return of capital for that group.

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

No, it's simply the math, right?

Clay C. Williams

Right.

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

Given your revenue forecasts and the incrementals, which are relatively in line with historical precedent, that's the margin that it spits out, I believe. But I hear you.

Clay C. Williams

Yes, yes. And to finish off the story, too, I mean, the incrementals this quarter, both sequential and year-over-year, in the 14%, 15%, much lower than your 30% to 35%. But again, it's because of this, we're gradually shifting mix away from those tremendous rigs sold in 2008 that we've executed at very, very high margins.

Operator

Our next question comes from Geoff Keiburtz from Weeden & Co.

Geoff Kieburtz - Weeden & Co., LP, Research Division

Pete, you talked a little bit about M&A. And I just wondered with the volatility, let's say, that we've seen in the equity markets, would you say that you have seen increasing opportunities in the M&A market?

Merrill A. Miller

Jeff, that's a great question. And it's a difficult answer because right now there's such volatility that until things settle down a little bit, if in fact there ever will, it's pretty difficult to be able to price because obviously, when the stocks are down, we're sitting there and we're likcing or chops going, "We've got a real opportunity here." But then, the sellers are going, "Wait a minute now. My stock price was up 15% a couple of weeks ago. Do I want to get it to the markets and sell it today?" So it's really -- it's one, especially in a public company, and I think when you -- you can almost read through the Ameron materials, and you can see how that whole process plays out. It's just one of timing, it's one of -- you just don't wake up in the morning and go, "Gosh, I'm going to go buy these guys." It's a lengthy process that takes patience, which we have. So I would say, on a public company, the volatility makes it a little bit more difficult right now. Now private companies are totally different. I think that the volatility makes them take a look out there and go, "Gosh, maybe we ought to get what we can for our money." The public market basically prices your company; the private market doesn't. You price your own company. And so, I think the opportunities is there to buy some of the private situations that we're seeing out there are probably going to be more robust for us over the next 12 months.

Geoff Kieburtz - Weeden & Co., LP, Research Division

Okay. And in that context and with a strong balance sheet and cash flow and an increasing visibility, how are you thinking about dividend these days?

Merrill A. Miller

Geoff, we raised our dividend this year. We started our dividend a couple of years ago at $0.10. I think we're up to $0.11 today. Obviously, we paid a special dividend a couple years back. As we take look at uses of cash, always, number one is going to be M&A, and we talked this with our board, strategically every board meeting, and then we don't -- and I'm talking every board meeting. Our board is on top of the strategy and they're on top of uses of cash. And we'll take a look at whether or not we want to increase our regular dividend. And then, we always revisit the issue of the special dividend. But I would tell you, special is just that, special, and there's no expectation behind it. So those are the 2 major uses of cash, so I think dividend and M&A.

Operator

Our next question comes from Michael LaMotte from Guggenheim Securities.

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

I'd like to just follow up quickly on the Rig Tech margin question and in particular the impact of FPSO orders flowing through with respect to the discussion of a normal 30% to 35% incremental. And especially with this look out to '12 and '13 and start to see orders on that product line start to come through. Are there offsets in efficiency, in pricing, in rig packages that can impact the fact that's a lower-margin product line to begin with?

Clay C. Williams

Yes, that's -- you raised a good point. That's a work in process in FPSOs, and we're trying to fundamentally change how FPSO tariffs are sold and standardize, as Peter mentioned. And so we've got work to do there. But offsetting that, Michael, I'd point to my comments earlier about growth in the aftermarket, which is going to be highly accretive to those flow-throughs. So when we talk 30%, 35%, we're sort of talking a, for what it's worth, or if you can define such a thing, an average mix across the segment. But more deepwater offshore packages, more aftermarket would certainly help us exceed that level. Conversely, more FPSOs, more land rig or service rig volume and mix would pull that down.

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

Okay. And How big is aftermarket overall within Rig Tech today?

Clay C. Williams

About 25% this quarter.

Operator

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

Kurt Hallead - RBC Capital Markets, LLC, Research Division

I just wanted to hit you up first on PS&S. Maybe you guys look out over the next 12 months or so, how would you rank your, say top 5 product lines or areas in PS&S, wisely [ph] do you think it will still Drill Pipe would be number 1? Can you just give us some flavor on how you think it might shake out over the course of the next 12 months or so?

Clay C. Williams

Kurt, in terms of how much we love them, we love them all equally. But if you're asking in terms of size?

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Yes, just relative size, give me some general sense on how you see things evolving over the next 12 months.

Loren Singletary

Kurt, this is Loren. Our Downhole Tool group has made tremendous strides here in the last couple of quarters, and they actually, from a revenue standpoint, are the largest segment in the PS&S group. And obviously, you have Drill Pipe, and you have your Tuboscope group, and you have Wellsite Services, and Mission products. Those are the top 5 groups within petroleum services.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

And you don't necessarily see that ranking changing over the next 12 months?

Merrill A. Miller

I think, Kurt, the one thing about the PS&S business, everybody knows I think we're the leader in rig technology. But when you take a look at a lot of those products that we have out there, being Grand Prideco, Mission products, Brandt, Tuboscope, these are really market-leading names. It's really pretty cool stuff. I almost hate to mention them all because we've so darn many of them. I don't want anybody to feel bad that I've left them out.

Clay C. Williams

And also too, I mean, within the group out there, within their respective spaces, comp businesses like Quality Tubing, which is the leading provider of coiled tubing worldwide, it's not in our top 5 in terms of contribution, but they really do provide a lot of market leadership in that space, XL Systems, the Mission products. Our Intelliserv group has a unique proprietary product that they're -- in service that they're offering to the oilfield.

Merrill A. Miller

And in the fiberglass. As we've mentioned earlier in the call, with the acquisition of Ameron, it's a leader in the field.

Clay C. Williams

I hope we mentioned everybody. If we didn't, we're going to hear about it after the call.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

And you guys may have mentioned it, I might have missed it. The number of land rigs that you had in Rig Tech orders for the quarter, how many were there?

Clay C. Williams

I don't think we mentioned it. It was a good quarter. Looking forward into Q4, we actually expect the quarter to be even better. So a lot of land rig demand out there both internationally as well as North America.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Yes, yes, yes. But do you have a number you can share with us?

Merrill A. Miller

No. Kurt, let me tell you why. As the U.S. guys build land rigs, they do it themselves, and so we sell components to them. And so, we don't -- I can tell you, how many mud pumps, how many drawworks, how top drives, how many derricks, but many times, we're shipping those components to the land guys. Internationally, we sell the entire rig. And so, we've always kind of hesitated. We break down our backlog on offshore versus land, and you can kind of extrapolate in that land business about how many are there. But it's a very difficult thing. It's not that we don't want to tell you. It's just that when someone is buying 15 SCR houses and 15 top drives, that's great business, but those aren't complete rigs.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

And north [ph] of the price points on completing rigs, have you been able to move that up at all? I think U.S. you're still around $15 million to $20 million. Internationally, it could be maybe as high as $40 million? Are those numbers still. . .

Clay C. Williams

We're going to still have a price leverage here. If anything, kind of on the higher ends of those ranges.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Okay. All right. And the,n, I think, taken your complete body language here, I think you guys would probably be in relative disagreement that your Rig Tech orders have peaked out here in the third quarter, would that be a fair comment?

Merrill A. Miller

You know, Kurt, I can go back and take you back to '06, '07 and '08, we had the same question a lot of times. So we keep looking at that peak going, getting up there a little bit. So as you know, we don't predict what's going on there because there are a lot of a rigs out there.

Operator

Thank you. That was our final question. I'll turn the conference back to Mr. Pete Miller.

Merrill A. Miller

Thank you all for calling in, and we look forward to talking to you in February when we have our year-end conference call. Thank you very much.

Operator

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

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