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National Oilwell Varco (NYSE:NOV)

Q4 2011 Earnings Call

February 02, 2012 9:00 am ET

Executives

Loren Singletary - Vice President of Investor & Industry Relations

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

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

Analysts

Douglas L. Becker - BofA Merrill Lynch, Research Division

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

James C. West - Barclays Capital, Research Division

Brian Uhlmer - Global Hunter Securities, LLC, Research Division

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

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

Robin E. Shoemaker - Citigroup Inc, Research Division

Operator

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

Loren Singletary

Thank you, Dawn, and welcome, everyone, to the National Oilwell Varco Fourth Quarter and Full Year 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 fourth quarter and fiscal year ended December 31, 2011, 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, 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 more detailed discussions 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. [Operator Instructions]

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

Merrill A. Miller

Thanks, Loren, and good morning, everybody. Earlier today, we announced fourth quarter 2011 net income of $574 million or $1.35 per fully diluted share on revenues of $4.26 billion. These earnings are 8% and better than the third quarter of 2011 and 29% better than the fourth quarter of 2010. Earnings for the entire year of 2011 totaled $2 billion or $4.70 per fully diluted share on revenues of $14.66 billion. These results are 20% better than 2010.

Additionally, we announced new capital equipment orders in the quarter of $1.7 billion, bringing the total new orders in the year to $10.8 billion, which eclipses our old record of $7.3 billion set in 2008. We are very excited about these results and optimistic about the ordering atmosphere for 2012. I want to thank all of the employees around the world at National Oilwell Varco for their tremendous work in achieving these stellar results for our shareholder. I will expand further on our operations in a moment, but we'll now turn it over to Clay to provide some color on our results.

Clay C. Williams

Thank you, Pete. National Oilwell Varco posted excellent results in the fourth quarter, earning $574 million or $1.35 per fully diluted share on $4.3 billion in revenue. Operating profit was $848 million for the fourth quarter, up $76 million from the third quarter and up $224 million from the fourth quarter of last year on a GAAP basis.

Excluding transaction charges from all periods, fourth quarter operating profit was $860 million, up 11% from the third quarter and up 38% from the fourth quarter last year. Operating margins on this basis were 20.2% in the fourth quarter of 2011 compared to 20.8% in the third quarter and 19.7% in the fourth quarter of last year.

Sequential operating leverage or flow-through was 16% on the 14% increase in sales. This is a little lower than we typically see for 2 reasons: First, we had nearly a full quarter's contribution from our Ameron acquisition, which closed October 5, and was responsible for about 25% of our consolidated sequential revenue growth. These businesses came in at a little lower margin as expected, but our integration initiatives to improve efficiency are fully mobilized and we are pleased with the progress so far. Four months into the Ameron combination, we're very excited about what we see and in particular about the composite pipe powerhouse we are building.

Second, most of the rest of the sequential sales growth, 67%, came from our Rig Technology segment, at slightly lower sequential margins, consistent with the gradual mix shift we've described in the past. Outstanding execution, once again, by this team, they’re boosted revenue out of backlog a remarkable 26% sequentially, up $368 million over the third quarter.

Overall, the fourth quarter marked a strong finish to a strong year for NOV. 2011 saw National Oilwell Varco generate record net income of $1,994,000,000 on record revenues of $14.7 billion. Compared to the full year results for 2010 and excluding transaction charges from both years, revenues improved 21% at 21% operating leverage year-over-year. Cash flow from operations was a very solid $2.1 billion and the company reinvested $1.5 billion in our business, 1/3 in organic growth opportunities and 2/3 in acquisition growth opportunities. Another $0.5 billion went to scheduled debt repayments and dividends to our shareholders.

For 5 straight years in every single quarter, NOV has generated at least $500 million in operating profit and margins of at least 19%, a pretty good streak. And lest we forget, these 5 past years included the downfalls of Lehman Brothers and Bear Stearns, a $700 billion TARP bailout bill, a 70% collapse in commodity prices, a historic downgrade of U.S. debt ratings and the worst credit market meltdown in a generation. Nevertheless, NOV performed like a honey badger, illustrating the company's uniquely durable portfolio of oilfield equipment and services.

As we've discussed in the past, we expect 3 big trends to continue to shape NOV's fortunes in the coming years: One, deepwater development; two, retooling old land and jack up drilling rig fleets; and three, shale developments.

First, sometime in the mid-1990s, deepwater technologies blossomed. Seismic advances illuminated deepwater structures, motion compensation systems permitted floating rigs to keep drillbits on bottom and drill these structures efficiently despite heaving seas and floating production vessels hooked to subsea systems provided a way to economically produce the discoveries that followed.

Science and entrepreneurial innovation in rapid succession opened up the rest of the planet, specifically the 2/3 of the globe covered by more than 500 feet of water to oil and gas development, which was inaccessible by our industry through its first century. The capability to drill and produce reliably in this environment, coupled with $100 oil, led predictably to rising demand for deepwater rigs. The late 1990s saw a handful of floating rigs built inefficiently, almost all late and way over budget. But a second larger wave, beginning in 2005, witnessed vastly improved execution and definitively signaled the industry's intention to make the 21st century, the deepwater century.

NOV has played a key role in this evolution by driving consistency of design, implementing more responsive cellular manufacturing techniques and training hundreds of highly skilled service technicians in our 4 technical colleges to commission these vessels. We have delivered 62 floating rig packages since 2005, with only one delay due to issues with our equipment, an outstanding record that is a testament to the high level of professionalism demonstrated daily by our Rig Technology team.

The thing about deepwater drilling is that it begets more deepwater drilling. The initial armada that moved out into deeper waters made discoveries that require follow-on development drilling to produce. The success has whetted appetites for more exploration. That's why paradoxically, the deepwater rig market is tightening and day rates are moving up in spite of a slew of new rig deliveries over the past several years, and that's why we are confident that there will be more to come.

We believe drillers closely consider ½ dozen or so major factors when they launch offshore new build projects. Day rate environment, currently good and getting better and somewhat a derivative of oil price. Availability of financing, currently stable. Cost of the rig, which is stable and reasonable. Balance sheet capacity, which will vary by customer. Operational bandwidth to crew and manage a new rig, which also will vary by customer and risk of delays in building, which is currently low and approaching 0, at least with NOV rig packages.

We believe most of these factors, save operational bandwidth, are to the positive today. Day rates are rising. Credit is available, to the extent operational bandwidth gives some drillers pause, stems from their voracious appetite for many new rigs that they ordered in 2011.

Drilling equipment package pricing is up 6% to 8% year-over-year but has stabilized recently, while hull costs are actually down 1% or 2% in the last few months, as the Asian shipyards continue to try to replenish the declining commercial vessel backlogs. Stability has taken some of the urgency out of decisions to exercise options. And recent option activity has been a mixed bag. Some had been exercised, we have extended some for cash or modest uplifts in pricing, while other option holders have elected to let theirs expired out of the money. Options activity notwithstanding, we believe 2012 finds us in an environment still highly conducive to building deepwater rigs, which underpins our positive outlook.

A little further down the road, we see rising demand for production systems to monetize deepwater discoveries. We think the most interesting of these are floating production storage and offloading systems or FPSOs, which are clever substitute for a pipeline. Our APL turret mooring products position us well to sell into future FPSO construction. However, orders were slow in coming in 2011. Nevertheless, we are scoping and quoting record levels of projects. And given that there had been 180-plus deepwater discoveries announced around the world over the past several years, our long-term view for demand here is very bright.

Onto retooling. The average jack-up was born in 1982. That's really old for a rig. The average land rig around the globe was born during the Carter administration. Kellies, master bushings, rock bits, 30-degree deviated drilling, rotary phones, IBM Selectric typewriters and 8-track tapes were the leading-edge technologies then. Today, these rigs are old, tired, rusty and inefficient. They are being replaced.

In November, our ReedHycalog unit, in conjunction with World Oil magazine, published our annual rig census, where we count rigs across many markets as we've done since the early 1950s. This year's version was headlined, again, paradoxically: North American rig fleet shrinks as activity climbs. It's true despite high rig counts across North America, despite high and modestly rising day rates, despite the highest level of land rig building for North America in a generation, the number of rigs available to drill is dropping. The death rate is exceeding the birthrate. Machines like rigs have finite lives, both physically and technologically. And this generation of jack-up and land rigs that has served us well, that we have relied upon to fuel rising levels of oil and gas consumptions since the 1980s are in their sunset years.

Public land drillers have announced the retirement of 200 land rigs in the past few months, despite generally rising day rates. Obviously, the market makes an enormous distinction between new rigs and old rigs. The retooling phenomenon is most advanced in the U.S., where about 40% of the fleet has been replaced over the past several years. However, this likely overstates the impact somewhat because many rigs early in the replacement cycle were simply copies of old 1970s designs. The effective replacement rate is probably closer to 1/3. And at the current rate, we are probably replacing 6% or 7% per year. The 3,000 or so rigs in the international markets, land rigs in the international markets are in the very early days of retooling. Nevertheless, NOV and our competitors have sold new rigs now into most major markets, so early adopters are starting to prime the demand pump in these regions by differentiating themselves through performance.

The replacement of the jack-up rig fleet is probably roughly 1/3 of the way through too, inclusive of rigs still being constructed in shipyards to be delivered by 2014, representing about a decade's worth of serious effort. The strength of the jack-up cycle in particular has surprised many analysts but we believe it will continue. Lately, we have seen the customer base shift to national oil company owned or controlled drilling contractors for a conventional 350-foot or 400-foot leg cantilever jack-ups, and IOC-driven mega jack-up projects that can approach $0.5 billion in total costs.

Overall, we believe extrapolation of progress thus far in replacing these rig categories implies another 20-plus years to go. No question that the next 20 years, we'll see commodity price and day rate volatility starts and stops, but building will need to happen more years than not.

And finally, the third major trend driving NOV's destiny is shales. A major catalyst for the retooling of the land rig fleet in particular is the shale revolution. Like the deepwater revolution, the shale revolution was born of science and entrepreneurial ingenuity, thus creating jobs across North America, creating wealth for mineral rights owners, helping local governments balance their budgets and EIA report by EIA report, demonstrating a U.S. that is remarkably moving closer to energy independence.

So here's an economics question for you. If 14th century alchemists had actually been successful at transforming rocks into gold, what would have happened to the price of gold? Answer, pretty much what is happening to the price of gas now. As 21st century alchemists have figured out how to turn rocks into gas. Like everyone else, we're wondering where North American gas prices find support and what does gas drilling look like once the dust settles. But encouragingly, the entrepreneurial spirit is alive and well in our industry, which is repositioning, rotating, some say, sprinting, from gas to liquids, which still enjoy robust pricing. Kind of like how gas in Continental Europe still enjoys robust pricing, 5 or 6x higher than it is in the U.S.

We predict this equilibrium spanning the Atlantic will equilibrate over the next several years, as the industry employs technologies honed here into shales located there to make Europe more energy self-sufficient. To this end, we are expanding our rig up and manufacturing operations in Poland and elsewhere across Europe and adding new European rig designs to our offering, to help our customers make this happen.

The shale revolution is gaining traction elsewhere too, in places like China and Argentina. The EIA sees nearly 6,000 Tcf in shales across about 3 dozen countries. So how long do Europe and other countries continue to pay $10 or more for an Mcf of gas? NOV is a key supplier and the leading supplier of many the technologies that go into successful shale programs: rigs, drill pipe, drilling motors, bits, coiled tubing and pressure pumping equipment, just to name a few.

And although shale gas supply will certainly present structural pricing challenges from time to time, temporary slowdowns in drilling should quickly correct imbalances given steep decline curves that wipe out 75% or more of most wells production within the first 2 years. Against the backdrop of this very drilling and hardware intensive process, our outlook for drilling and hardware demand remains bright.

Commodity price volatility and rig count activity storms they unleash are nothing new to NOV. Over the years, we've learned that the best course for our company is to always invest for the long haul. We remain passionate in our views on deepwater development, on retooling a fleet of rigs critical to the world's energy equation and of an amazing new incremental source of energy wealth from shales. Our strategies and investments in 2011 reflect our high level of conviction in these themes.

But when it comes to the continued growth and success of NOV, our most valued resource is an exceptional workforce we are honored to serve. Pete, Loren and I are exceedingly grateful to work with a team of professionals at NOV, who daily provide terrific service, products and technology to the world's oil and gas industry. We thank you all for your hard work in 2011 and look forward to a terrific execution in an exciting 2012 and beyond. You are the best.

Now let me turn to our segment operating results. NOV's Rig Technology segment generated revenues of $2.3 billion in the fourth quarter, up 18% sequentially and up 32% compared to the fourth quarter of 2010. Operating profit was $603 million, yielding operating margins for the group of 26%, a decline of 80 basis points from the third quarter and 250 basis points from the fourth quarter of 2010. Incremental operating leverage or flow-through was 22% of the sequential sales improvement of $346 million, and incremental leverage or flow-through was 18% from the fourth quarter of 2010 on the $559 million revenue improvement, with a little less than the 30% to 35% we would typically expect.

This is due to the gradual decline in margins we'd been guiding to for about a year arising from a mixed shift in the group. High operating margins north of 30% that we're seeing in the first half of 2010 from projects sold at exceptionally high pricing in 2007 and 2008, being executed in a low-cost deflationary environment. As fatter margin projects wind their way out of the backlog, we are reverting to a more normalized margin. Therefore, our guidance for this segment calls for margins to flatten in the 25% range before beginning a very gradual rise in the second half of this year.

As a later-cycle business, in effect, we're seeing the economic downturn of 2009 manifesting in the group's P&L right now. Importantly, performance remains superb, as the group's annualized fourth quarter NOPAT returns on tangible capital achieved triple digits this quarter.

On previous calls, we've noted that construction cycles for offshore rigs are shortening, a result of increasingly hungry shipyards in Asia finding themselves with more and more idled assets that they can redirect to rig building, speeding the process. They are committing to build schedules that are 6 to 10 months shorter now, which requires a little faster delivery of drilling equipment packages into these projects by NOV.

Unlike a land rig project, where NOV essentially builds the entire rig and is wholly responsible for the critical path, the offshore rig critical path still resides almost entirely within the shipyard. It takes longer to make a hull than it takes to make the drilling equipment package. But nevertheless, we have to step up our delivery rates to meet the needs of our customers, so we've been investing in expansion initiatives. This quarter saw our revenues out of backlog jumped 26% sequentially to a new record level of $1,775,000,000, as we responded to these more challenging build schedules.

Our fourth quarter orders for Rig Technology were $1,668,000,000 and included 3 floaters and 6 jack-up packages. Year-ending backlog totaled $10,164,000,000, down just a shade from September 30. For the full year, orders totaled a record $10,849,000,000. We expect about $6.6 billion of our orders on the books at year end to flow out as revenue during 2012. $1.8 billion to flow out in 2013 and the balance to flow out in 2014 and beyond.

86% of our backlog is destined for the offshore, 14% for land and 86% is international, while 14% is domestic. Outlook for orders remains good with several major projects seeking bids now.

Land bookings jump from the third quarter matched by higher land revenues, leaving our land backlog about flat. Land orders were balanced between domestic and international sales. And in addition to complete drilling and workover rigs, we sold several rig component packages. Demand for pressure pumping, oil tubing units and frac equipment remained exceptionally strong, with 2012 largely sold out and several expansion initiatives underway to respond to demand.

We're delivering nearly 1 frac-sander a day now. Mix for wellbore stimulation equipment was steady at about 60% North America, 40% international. We continue to see interest from emerging international shale markets as oilfield service companies begin to layer in infrastructure to accommodate hydraulic fracture stimulation. Domestically, pressure pumper seemed to be settling on larger diameter, 2-inch coil tubing. While internationally, 1 3/4 inch is still preferred. Larger diameter permits accessing longer laterals without buckling and offers higher flow rates and better hydraulics but also requires much larger, heavier reels that can present transportation challenges.

Non-backlog revenue for the group declined 4% sequentially this quarter due to lower aftermarket sales around the holidays. We saw the same thing in the fourth quarter of 2010, when non-backlog revenue declined 1% from the third quarter to the fourth. Year-over-year, it was up 11% for the fourth quarter and annual growth rates for the aftermarket has averaged over 20% over the past 6 years.

For the full year, Rig Technology generated $7.8 billion in revenue and $2.1 billion in operating profit or 26.6% compared to $7 billion in revenues, $2.1 billion in operating profit and 29.7% operating margins in 2010. The mix effect we’ve described in the past led to lower operating margins for the year as expected, but the group generated very strong returns on capital for the year and $10.2 billion in backlog after record orders, positions Rig Technology for a strong performance in 2012. During the fourth quarter, the group commissioned 6 offshore rigs, bringing our total to 23 for the year and over 120 offshore rigs since 2005. Looking into the first quarter of 2010 -- or sorry, 2012, we expect Rig Technology revenues to be roughly flat with the fourth quarter at slightly lower margins.

The Petroleum Services & Supplies segment generated total sales of $1,570,000,000 in the fourth quarter of 2011, up 8% from the third quarter and up 38% year-over-year. Operating profit was $301 million or 19.2% of sales. Margins fell from 20.5% in the third quarter, as the contribution from Ameron came in at a little lower margin and a couple of the products within PS&S posted lower margins due to unfavorable mix and some higher costs. Most notably, margins for Drill Pipe declined sequentially due to much higher sequential purchases from third-party of third-party green tubes, owing to our third quarter maintenance shutdown of the Voest-Alpine mill and adverse euro movements early in the fourth quarter. Margins, nevertheless, remained accretive to the segment margins over all. And we expect that these cost factors will be transient and for Drill Pipe margins to improve in the first quarter. Further in the year, our outlook remains strong for Drill Pipe demand given that there are dozens of new build offshore rigs, which we expect to buy premium Drill Pipe.

Mix and cost headwinds in certain businesses were partly offset by strong sequential performance at downhole tools, with higher royalty revenues and strong sales growth in Canada and in the eastern hemisphere. Wellsite services also had an excellent sequential performance, with growth in equipment sales and rental and leasing operations in the U.S. XL Systems posted a strong finish to the year and Tuboscope, Quality Tubing and Mission all showed sequential sales gains as well. For the full year 2011, Petroleum Services & Supplies segment generated a record $5.7 billion in revenue, up 35% from $4.2 billion in 2010. The segment generated $1.1 billion in operating profit, almost double operating profit levels for 2010 and representing 35% leverage on the year-over-year sales growth.

Operating margins of 19.4% for the year were up from 14% in 2010. Looking into the first quarter of 2012, we expect Petroleum Services & Supplies segment sales to grow in the low-single-digit percentage range sequentially and for operating margins to push back above the 20% level.

Turning to Distribution & Transmission, first note that it has a new name. The change to this quarter reflects the inclusion of Ameron's water transmission and infrastructure products groups from October 5 onward. For the quarter, the group generated $560 million in sales and $45 million in operating profit or 8% of sales. Compared to the third quarter, sales improved 17%, mostly due to Ameron. And year-over-year quarterly sales grew 32%.

Sequential operating leverage or flow-through excluding charges was 10% and year-over-year flow-through was 11%. Margins for the newly acquired businesses, in the aggregate, were in line with the segment margins. The legacy NOV distribution portion of the segment saw revenues up slightly, with strong flow-throughs due to terrific performance in Canada. International was up slightly and the U.S. was down slightly, owing to rig moves towards liquids plays together with related drill site construction delays and weather issues in a few markets.

Mono posted good performance, once again, with strong demand for power sections and artificial lift equipment. Fourth quarter results capped a strong year for the segment overall, with a record $1,873,000,000 in sales, a record $136 million in operating profit and 7.3% operating margins. Revenues were up 21% and flow-throughs were 18% for the year. Typical flow-through for the group runs about 10%, so we were pleased with the strong incremental and resulting margins for the group.

For the first quarter of 2012, we expect Distribution & Transmission revenues to be down slightly, and slightly lower margins as compared to the fourth quarter. National Oilwell Varco's consolidated fourth quarter income statement saw SG&A increased $35 million sequentially due to acquisitions and sales growth. SG&A as a percent of sales was 10% in the fourth quarter, down from 10.5% in the third quarter and down from 11.8% in the fourth quarter last year. Transaction costs were $12 million pretax and the equity income in our Voest-Alpine joint venture was $12 million, up slightly from the third quarter. We expect similar profitability in the first quarter of 2012.

Other expense moved $13 million unfavorably from the third quarter to the fourth due to the non-recurrence of favorable FX moves in Q3, which offset bank charges and other items on this line, which usually run about $11 million a quarter. FX was relatively quiet this quarter.

The tax rate for the fourth quarter and for the full year was 32%, about what we expect in 2012. Unallocated expenses and eliminations on our supplemental segment schedule was $89 million in the fourth quarter, up $3 million from the third quarter due to higher inter-segment eliminations. Depreciation and amortization was roughly flat at $142 million, and EBITDA excluding transaction charges was $1 billion for the quarter and $3.6 billion for the year.

NOV's December 31, 2011, balance sheet employed working capital excluding cash and debt of $3.5 billion or 20.6% of annualized sales, up $84 million from the third quarter on higher inventory and accounts receivable, partly offset by higher accrued taxes and liabilities. Total customer financing on projects in the form of prepayments and billings in excess of costs, less cost in excess of billings, was $865 million at December 31, down $276 million due to the large increase in revenue out of backlog. Cash flow from operations was $622 million for the fourth quarter and $2,143,000,000 for the year.

CapEx increased $41 million sequentially in the quarter to $166 million, bringing full year capital expenditures to $483 million. We expect CapEx in 2012 to move into the $600 million range as we pursue a number of expansion opportunities launched last year, as well as follow through on projects brought in with Ameron. Cash spent on 9 acquisitions totaled $1,038,000,000 for the year, and dividends paid to our shareholders totaled $191 million during 2011. Finally, NOV's cash balance was $3.5 billion at December 31, 2011.

Now let me turn it back to Pete.

Merrill A. Miller

Thanks, Clay. I'd like to make a few brief comments and I'll turn it over for questions in just a moment. But you know, as we look back on the past year, there's really been 3 things that we've emphasized greatly in this company, and the first one has been efficiency. And that's driving cost out of the system and that's being able to deliver products on time, on budget. And we've invested heavily, we've gone into our facilities, we've changed things around, we've gone to cellular manufacturing. You've heard us talk about this an awful lot. We've expanded. We bought new facilities. And this has allowed us to do a couple of fairly unique things. We have been able to drive almost a year out of the delivery of deepwater rigs. If you would have been ordering those back in '06 and '07, it was about a 36-month lead time, today it's 24 months. The reason for that is great shipyards, Samsung, Hyundai, the people in Korea, the people in Singapore have all done a very good job. But more importantly, we're able to get throughput out much more rapidly than we could before because of these efficiencies. We're driving down costs. You see great margins that are coming out of it, and we're going to continue to emphasize this.

The second thing is personnel. Personnel are extremely important. They're the most important thing we have in this company. We're investing heavily in training. We've opened up colleges around the country for our technical people. We currently have them in Norway, in Singapore, Brazil and here in the United States. But interestingly, in these colleges, we actually, last year, sent 5,000 of our customers' people through them. And this year, we expect to surpass 6,000 of that. So we're able to not only train our own people, but we're able to train our customers' people, so that we can better take care of these products as they're in the field.

We also have agreements with Purdue University, Rice University of Texas and Texas A&M, that we utilized and having different classes and different courses for our people internally, so that we can emphasize manufacturing, sales management and other things that we do such as taking technology and turning it into a profitable venture.

And then finally, the thing I want to mention our new products. The lifeblood of the company is making sure that you're having the best technology out there that really our customers can utilize to create efficiency in the oilfield. The shales have really created that. We're pushing more and more different things in the shales. We see the technology, as Clay kind of mentioned, we're turning that stuff into gold, making it a little bit cheaper. But we have a lot of new products. We continue to press ahead on our R&D efforts. We introduced a new frac pump recently. Our Helios bit, which is something that I think is going to be very, very effective in drilling these shale wells. And a lot of products like that. So when we think about things, it's about efficiency, it's about personnel and it's about new products. We think those are what's going to lead us into the next couple of years to really be the market leader that we continue to be.

So we're excited about it. We like what we're seeing, in the first part of 2012. I think 2012, while it will have some challenges, will be a very, very exciting year for us.

So, Dawn, at this point, I'd like to turn it over to our callers for any questions they might have.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Douglas Becker from Bank of America.

Douglas L. Becker - BofA Merrill Lynch, Research Division

Maybe as we think about PS&S going forward, there's a few moving parts here. I know that we will see some acceleration in Drill Pipe, the Ameron acquisition could be coming in, getting some synergies there. And then just -- we guess, we have the low natural gas prices. Do you see the potential for 30%, 35% incrementals like we've seen in 2010 and 2011 as we go through 2012?

Clay C. Williams

Yes. Doug, I think so. In Q4, as we -- if we talked about last quarter, we had Ameron coming in so far so good on integrating that business and improving the margins that we see incremental from that, and so that will help. And as we expected last quarter, we dropped a little below 20% margins. We're posting 19.2% this quarter. Going into 2012, as we began to get traction on those efforts, plus we continue to see improvements in our other businesses in terms of efficiency, maybe a little better pricing. We perceive marching up above the 20% range. And so I think 30%, 35% incrementals generally make sense. One thing though that I'll point out is that, the pricing gains that we appear to be getting in the fourth quarter and as we move into 2012 within PS&S are a little more limited, they're a little more focused on either specific products and technologies or specific geographic areas like the Eagle Ford or the Bakken, where you're seeing rigs moving into that area. So it's more of a little -- little more of a mixed bag. In the past, PS&S has been able to post incremental margin gains north of 35% during periods when the rig count is running up. And right now, we're seeing the rig count in North America a little more flattish and pricing gains a little more limited as a result.

Douglas L. Becker - BofA Merrill Lynch, Research Division

Makes sense. And then just -- so I'm still very positive on the retooling of the industry. Have you noticed any short-term changes in maybe some of the more price sensitive or North American-sensitive land rigs, coil tubing, frac spreads or stimulation equipment in terms of orders?

Clay C. Williams

No. We've -- again, a good demand but I think pricing is probably stabilized but demand remains high. We haven't had any -- although I think most of our customers are a little nervous like we are about gas prices. We haven't seen anybody backing off their ordering for well stimulation equipment or land rigs. And again, it's -- we do a lot North America, but we're also seeing a lot of interest from international markets too. So those, of course, are unaffected by the recent gas price downturn.

Operator

Our next question comes from James Crandell from Dahlman Rose.

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

Many of your traditional customers seem to be taking a bit of a pause in their deepwater rig ordering. Given the strength in deepwater day rates that we've seen recently, do you expect this to be short lived?

Merrill A. Miller

Yes, Jim, I think so. I mean, if you look at this, there's a couple of things that are impacting this right now. My comments, I mentioned that the speed with which we're getting these things out, we've knocked about a year off. And so, I think the customers are taking a look at that going, instead of having to plan 3, 3.5 years out, now they can kind of look ahead to 2 years and it gives them more flexibility. And also, I think as you look at some of the rigs that are being built right now, there's probably a pause that people are waiting to see some of those get contracted. And as they get contracted, then I think you'll see them come in and, okay, let's go and let's order. So we're actually fairly optimistic as we look at the project list that we review every week, and we kind of look at the things out there. We think that the ordering in fact will pick up from some of the traditional customers.

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

Okay. And I realize you don't run your business off ODS-Petrodata data. But if you look at all your deepwater rig orders we've seen and what National Oilwell has brought, do you think there's still some orders that are generally known to have happened in the industry or reported in ODS-Petrodata that for some reason you haven't put into your backlog? And is that number larger than usual right now?

Merrill A. Miller

Well, we -- as we take a look at that, Jim, obviously ODS-Petrodata, I mean that's out there and it's public. We generally don't make our information public for a lot of reasons. I mean, obviously, competitive reasons and everything else. But I would say that we probably have a little bit better knowledge as we look at things, simply because -- as I've said many times, if you're going to order a rig, you got to come to us. Not even if you don't want to order from us, you can at least use us as a stalking horse. And so, we think that we've got a little bit better insight into this and probably, the things that we know don't necessarily match up with ODS-Petrodata. And obviously, having said that, I'm kind of bouncing around a little bit. But clearly, there's stuff out there and stuff that we know about that's not necessarily known publicly.

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

Okay. And last question. Clay, one for you. Can you give a sense as to the overall breakdown of PS&S? How much of that total segment now was North America? And in your North American business, a guess as to how much could be natural gas oriented?

Clay C. Williams

Yes. Jim, in the fourth quarter, the total North America was 58%. It's revenues by destination. U.S. is right at 50%, Canada is about 8%. That's within the PS&S segment. And with regards to how much of that is gas, it's purely a guess, perhaps 1/3 of the U.S. land fleet is drilling for gas. It's probably a pretty good proxy.

Operator

Our next question comes from James West from Barclays Capital.

James C. West - Barclays Capital, Research Division

Clay or Pete, with $3.5 billion in cash on the balance sheet and just on my numbers, I have you generating some $5 billion or so in free cash flow the next 2 years. It seems like you got a lot of firepower to put to work. I know you guys are focused on M&A. Do you think that we'll see deals here in the near term? Has the acquisition market improved? And I've heard from some that at least one of the competitors for deals has kind of dropped out of the market, to which may clear the way for you to get some work done.

Merrill A. Miller

Yes. I think, James, as we've said many, many times, our preference is really to utilize our cash to grow the company. And we've done that, we think very effectively through M&A. Obviously, in the last quarter, we brought in Ameron. And that was, I think, give or take about an $800-million deal. There are a lot of things that we're looking at today. I think that the buying opportunities are there. It's always kind of nice when people take a little bit of a pause and they think, maybe there's some choppy waters ahead because that really makes the buying opportunities much more attractive for us. If you take a look at our history, we probably made the best deals when things were kind of down a little bit. We're very disciplined. We stay very true to our core values on that. And if other people are willing to overpay, that's kind of the way it is. We get in very few auctions. We kind of put a value on something, and tell people this is what it is, and we've been successful at doing that. Having said that, it does appear that some competitors for things have dropped out, and we're very optimistic that we'll probably be able to announce a few deals here in the near future. A lot of good things that we're looking out, out there right now.

James C. West - Barclays Capital, Research Division

Okay. Good to hear. And then just somewhat related follow-up on that, what’s your exposure to pressure pumping equipment sales? Are there certain product lines that go into stimulation equipment that you are currently not in that maybe you would acquire companies to get into or maybe organically get into those certain products?

Clay C. Williams

Yes. The most conspicuously absent product has been a pressure pump. And here over the last 18 months or so, we've developed our own. So we've approached that organically and have a couple of dozen 2,400-horsepower pumps at work in the field and doing very, very well. So as you know, we package a lot of frac spread equipment, well stimulation equipment and so we've had a lot of pressure pumps kind of pass through our operation being unitized and going into the field that way. And we also have, over the years, probably made more drilling pumps than anyone. So we make a lot of pumps on the one hand but we weren't really focused in this area before. So a couple of years ago, we recognized that and launched organic initiative to develop our own pressure pump. And so far, so good. Very, very excited by the prospect for that.

James C. West - Barclays Capital, Research Division

And does that include float-ins as well, Clay?

Clay C. Williams

Yes, yes.

Merrill A. Miller

Absolutely.

Operator

Our next question comes from Brian Uhlmer from Global Hunter Securities.

Brian Uhlmer - Global Hunter Securities, LLC, Research Division

I just want to follow-up on James' question on the pump. I know you've got about 20 or 30 of those out in the field or so as of this date. Can you follow up on how testing is going with those? Number one. And number two, are you looking at that as adding to the new market or as these things wear out, that you pass through that, you're going to have also a very robust replacement market as you put your pumps on some of the equipment that you've previously delivered using other folks' pumps.

Merrill A. Miller

It's a good question, and I would say it's all of the above. Obviously, as we have this pop out there and we're very, very pleased with this performance at this point in time. And again, we're good pump manufacturers. This was almost just kind of a natural offshoot for us. But the thing about it is, we'll also have a footprint on it, that not only will we put it on new equipment that goes out, but as you have to replace pumps on existing equipment, it will be able to be retrofitted onto those trailers very easily. So we think it's a tremendous business, and also it's kind of a follow-up to the fluid end part of it. The expendable side of that business is outstanding. Not only do we have the expendable side on our regular drilling pumps, but now with the expendable side on these frac pumps and they go through expendables, very, very rapidly. That's a real positive business for our Mission group.

Clay C. Williams

Brian, on this same theme too, in addition to the frac pump, over the last 2 years or so, we've added other products that contribute to go into that pressure pumping phenomenon that we're seeing so much demand for. So we're, for instance, a lot of flow iron, we brought in through acquisitions. We made an acquisition last year that brought us some frac-sander products that are used to transport and to move profit to locations and around locations. So those sorts of -- we're kind of quietly been building out more and more in this area to satisfy the needs of our customers.

Brian Uhlmer - Global Hunter Securities, LLC, Research Division

Okay. And my follow-up kind of along those consumable lines. Is really do -- you mentioned artificial lift in power section business, you had some capacity expansion in the powerlift -- I mean, in the power section business. As you would deliver all those horizontal rigs this year and a lot of your rigs, do you see that ongoing demand increasing fairly substantially as we go through 2012? And then, on artificial lift, what other areas -- what's your strong foothold right now? What other areas of artificial lift do you think you want to expand into either organically or through acquisitions?

Clay C. Williams

Yes. We've -- through our Distribution & Transmission segment, we have long sold a lot of artificial lift products and it's kind of a variety of things. Mostly -- in the past, mostly we bought in those from other suppliers. But here, again, over the last couple of years, we've been quietly building out our own products, our own kind of manufacturing capabilities. Mono within distribution manufactures the rotors and stators that, really, form the progressing cavity pumps that are used in certain artificial lift applications and it's the same design and technique that goes into downhole drilling motors. And so that business sells in to both of those. The strategy here is pretty straightforward. With a sharp increase in a number of rigs drilling for liquids, on down the road as those wells start to make water, start to lose initial reservoir energy, they're going to need to have artificial lift to lift them. And so we want to be position ourselves to sell into that trend. Likewise, we have seen a big explosion in demand for downhole drilling motors used to drill horizontally, and are the leading supplier of those kinds of motors to the industry. And so -- and it's basically, the same kind of manufacturing technology. To that end, we've been expanding our manufacturing capabilities in Europe and expanding our motor reline and servicing capabilities here in North America to meet the demand.

Merrill A. Miller

And, Brian, I'd also add that when you talk about drilling motors today, you really are going to be using those on almost every type of well that you drill, even if it's just a traditional vertical well. They add so much to your efficiency and your ability to get hydraulic horsepower to the bit and torque, that it's really almost a natural part. Where in the past, to having a drilling motor was something unique, today it's almost just like having drill colors and a drill bit. You're going to have that motor there and our market position on those is quite good.

Operator

Our next question comes from Michael LaMotte from Guggenheim Securities.

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

Clay, in your prepared remarks, you mentioned that the FPSO orders were slow in coming in 2011. But obviously, you've been in the market, marketing the concept. And in particular, I guess more of a modular or kit approach as opposed to sort of the one-off in custom designs. I was wondering, if you could just sort of address how that's going? And maybe talk about the uptake of a more modular concept relative to what we saw in the drilling rig market in the earlier 2000s.

Clay C. Williams

Yes. We're about -- we required APL in December 2010. So we're, what, 13 -- 12.5 months into it, so it's still early days. We kind of also bought the business as we're seeing the effects of the financial market meltdown in 2009 sort of show up in the business. And so our sense is, right now, the whole subsea space is now just starting to kind of pull itself out of that downturn and getting serious about placing orders. We've also pointed out in the past, Michael, that the sanctioning of large subsea development projects doesn't move very quickly. You're talking about billions of dollars of expenditures for the FPSO, for the subsea wellheads, for the flow lines and manifold. And so getting approval within an IOC, plus getting approval usually within their partners' organizations takes a while. So this doesn't move quickly and that's no surprise to us. But as we've discussed with you and with others through 2011, our plan here really is to make this more modular. And we think that, that really will enhance the value to our customers. One of the big challenges that the owner operators of FPSOs have is after the initial contract, they'll sign a contract to produce a field for, let's say, 10 years. The economics -- the ultimate economics on that project will often hinge on whether or not they can find a second field to move that FPSO onto after the initial contract expires, out in year 11. So the sales pitch basically is to say, look, if we have a more systematic design of the turret, which is physically where the FPSO actually plugs into the field, it's going to increase potentially the number of fields that, that FPSO can go into and work on its second career and improve the returns to our customers. So in a nutshell, that's kind of the plan. And it seems to work well. We think we're going to get some traction out there with that, and hope to standardize those designs and that's a big part of our strategy. So I'd say so far, so good. But we'll know for sure once, I think, orders start to flow. And I think orders ought to start to flow this year 2012.

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

That was actually going to be my follow-up. I think with the subsea orders expected to ramp up this year, just in terms of timing, I would imagine construction of FPSO is a longer lead time item. So should we see that even ahead of trees [ph], do you think?

Clay C. Williams

Yes. I think we're going to start to see some activity in 2012. And as also referenced in my comments, we're quoting more projects now. We've got more feed studies going along. We've got a lot of people who are very, very interested in this hardware and a lot of activity. It just hasn't necessarily translated through the contracts yet.

Merrill A. Miller

And then again, as we've said a lot of times, Michael. I mean, kind of B follows A. and you take a look at the number of deepwater rigs that we're putting out there. As I tell people, they're not drilling for practice. They're drilling so they can find oil and gas. And the approved solution when they find it, really, is going to be the FPSO mode of production. So we think that you'll probably see, certainly, this year and in 2013, you'll see a greater demand for the products that we have in that regard.

Operator

Our next question comes from Marshall Adkins from Raymond James.

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

Let's talk backlog for a minute. I think in the third quarter, your backlog came in huge, a lot of bigger than most of us thought and this quarter may be a little bit shy of what we thought. It seems to me like that's just a lot of lumpiness. Going forward, should we expect the backlog adds that we had this quarter to be more run rate or was this kind of a one-off lumpiness where it was down a little more than it would be on a run rate?

Merrill A. Miller

Marshall, as we talk about backlog, and we've said this an awful lot. You almost have to look at backlog not necessarily on a quarterly basis but over about 2 or 3 quarters. Because you take a look at the quarter we just came out of, effectively, it's a 9-week quarter. You've got 2 weeks of Christmas, a week of Thanksgiving that you don't, really, aren't get to get much of anything done. And as we've always kind of said, it doesn't really matter to us if somebody orders something on the 30th of December or the 5th of January. But it does matter to that backlog because we cut it off on the 1st of January. So I think by definition, you'll see a little bit of lumpiness. You'll see some coming in a little bit better and some coming a little bit weaker than you think. But when you look at it over the long term, for instance this year, we did about $10.8 billion of new orders. And we think the coming year will also be a positive year. But I think it's very difficult for us to say, it's all going to come in the first quarter or the second quarter or the third quarter. We are optimistic that it will be a positive year on new orders.

Clay C. Williams

Yes, yes. And actually, that's why we really encourage everybody to look at the fundamentals here. The costs of these rigs is pretty reasonable, pretty stable. You have a lot of hungry shipyards, in Asia in particular. And the day rates, which could drive the returns particularly for the deepwater assets are -- the bias is that they're moving up now. And so that sets up a pretty good year we think for 2012 orders.

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

Yes. Hard to believe it slows down, if freights are going up. That's why I asked the question.

Merrill A. Miller

Absolutely, absolutely.

Clay C. Williams

Right, right.

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

All right. Second question, the distribution side, the biggest margins we've ever seen, that I'm remembering in that business. How much of that was the Ameron versus being added to the mix versus maybe just a more sustainable distribution business?

Merrill A. Miller

Actually, I'll let Clay give you the exact numbers on it. But I'll take this point just to say, most of it is our regular distribution business. Our folks are phenomenal at this. I mean, we've got people that are out there, Marshall, as you take a look, you can go back 3 or 4 years, we're always much better than the competition. We've got some folks that really know this business and they really deliver to our customers and they're really able to rub that buffalo off the nickel. I mean, these guys are really, really good at being able to run an efficient operation. I just have to do a shout out to them.

Clay C. Williams

Yes. The short answer to your question is, that they were all about the same. Ameron came in roughly in line with our legacy businesses within the distribution segment. Actually, they were just a shade below and then our legacy business outperformed just a shade. But if you squint, they're all about the same.

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

But clearly, I don't remember margins ever being high? Is that fair?

Clay C. Williams

Yes. We did -- a little over 8%, I think, a few years ago. But their -- what we've seen this latest cycle since 2009 is, really, good, sustained margins out of the group. That just feel like they're more sustained and more solid than we were seeing '06, '07 and '08. So I mean, just to Pete's point, outstanding execution by that team.

Operator

Our next question comes from Robin Shoemaker from Citi.

Robin E. Shoemaker - Citigroup Inc, Research Division

I wanted to ask you about, Clay, a little -- just clarify your guidance on the Rig Tech margins. So it sounds like from what you're saying, you're kind of expecting Rig Tech margins in '12 to be kind of flattish with '11. A little bit lower in the first half and higher in the second half as, I guess, deliveries pick up. Is that roughly correct?

Clay C. Williams

Yes, that is correct, Robin. And one kind of potential misunderstanding that I want to make sure we dispel is we've guided to margins kind of drifting down in that segment. Don't expect the V-shape sort of pattern. We think mid-20s margin is a more normalized kind of margin, and the margins over the past several quarters have been slowly moving down into that range. And we've guided to bottoming mid-20s, around 25%, let's say and then start to slowly lift out of that late in 2012. So that's kind of the pattern we see over the next 4 quarters. And again, I'll stress, margins at 25%, 26%, 27% for Rig Technology equals outstanding returns on capital. So that's a terrific margin. One that's rarely equaled by other manufacturers both within our industry and other manufacturing businesses more broadly.

Robin E. Shoemaker - Citigroup Inc, Research Division

Yes, okay. So then on the top line of Rig Tech, you mentioned $6.6 billion of revenue from backlog. And then, in '11, the growth in non-backlog revenue was pretty impressive, and it increased over the quarter-by-quarter through year. So kind of ending up in this mid-$500 million per quarter level. Is -- should we expect kind of double-digit growth like you had in 2011, again in '12 in the non-backlog portion?

Clay C. Williams

Yes. I think that's a good -- year-over-year, I think that will be a good kind of range for growth for the non-backlog business. It did actually decline 4% sequentially. But we look back at last year's fourth quarter, it was down 1% sequentially. We suspect that had something to do with the holidays. When we look at that business longer term, the aftermarket business which comprises almost all that non-backlog revenue, over 6 years, has posted compound annual growth rates north of 20%. And very, very strong performance. And so for 2012, we see good growth ahead for that business as well. One thing when it comes to our overall segment revenues for Rig Technology, we had a big, big increase in revenue out of backlog in Q4, up $368 million sequentially. We do foresee that coming down, Q1. And if you look back at revenue out of backlog for that segment, which is on the supplemental information we provide on our website. What you see is it's not uncommon for that business to jump up and down, $200 million or $300 million quarter-to-quarter. And what we saw in Q4 was a big spike up in well stimulation equipment deliveries in particular, and also land rig package deliveries. Both of which are recognized on a completed contracts basis. So that completed contracts rev rec model for Rig Technology drives a lot of volatility there. So that's kind of some of the basis for our outlook for the first quarter of 2012.

Operator

That was our last question. I will now turn it back to Mr. Miller for closing remarks.

Merrill A. Miller

Thank you, Dawn, and thank you all for listening in, and we look forward to talking to you when we release our results for the first quarter of 2012. Thank you very, very much.

Operator

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. The dial back number for the playback is 1 (888) 843-7419. And if you need an international number, that number is (630) 652-3042. You may reference the passcode 31317518#. Once again, thank you.

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