Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Doug Rock - Chairman of the Board, President, CEO and COO

Don McKenzie - President and CEO of M-I SWACO

Margaret Dorman - SVP and CFO

Analysts

Ken Sill - Credit Suisse

Rob Mackenzie - SBR

Scott Gill - Simmons & Company

Dan Pickering - Tudor Pickering

Robin Shoemaker - Bear Stearns

Kurt Hallead - RBC Capital Markets

Jim Crandell - Lehman Brothers

Alan Laws - Merrill Lynch

Geoff Kieburtz - Citigroup

Brad Handler - Wachovia Capital

Smith International Inc. (SII) Q3 2007 Earnings Call October 23, 2007 11:00 AM ET

Operator

Good morning ladies and gentlemen, and welcome to the Smith International Third Quarter 2007 Investor Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Mr. Doug Rock. Mr. Rock, you may begin.

Doug Rock

Thank you, Tatiana. Good morning, and welcome to the Smith International Third Quarter 2007 Investor Conference Call. I am Doug Rock, Chairman and CEO of Smith; and speaking today are Don McKenzie, who is President and CEO of M-I SWACO, and Margaret Dorman, our Senior Vice President and Chief Financial Officer. This morning, Margaret, Don and I will talk for about 30 minutes and then we'll have another half hour to answer your questions. So that everyone has a chance to ask questions, please ask no more than two questions at one time. If time permits, you can re-queue and ask more questions later in the call.

Now let's talk about Smith's third quarter 2007. Overall, Smith third quarter 2007 revenues increased 17.3% year-on-year, and 6.2% sequential quarters. But once again the story is all about growth in the Eastern Hemisphere and Latin American markets. Year-on-year, our oil field segment revenues grew 19.3%, but Eastern Hemisphere and Latin American combined revenues grew 30% with a corresponding rig count growth of 8.4%.

Our products and services are more suited to complex and deep drilling, and completions along with high-temperature, high-pressure operations. That's why our revenues expand much faster on a smaller rig count gains in the Eastern Hemisphere and Latin America. Most North American drilling rigs are land based, and drill on average, shallow less cost of the wells.

Year-on-year for the quarter, the North American rig count was down 3.4% and revenues were up 7.8%. That's not bad considering the Canadian rig count was down about 30% year-on-year for the quarter.

Margins held steady force in North America, as our product mix has not been affected by the oversupply of products or services with high capital cost content.

We did see some softness in the deep U.S. Gulf market during the quarter, but one should see recovery in that market over the next two quarters as five deepwater rigs are added, bringing the U.S. Gulf deepwater rig count to 42 rigs, which will tie an all time high. Our market shares in the deep Gulf are also at a historic high.

The two hurricanes that threatened the Gulf coast cost us about $10 million in third quarter revenue, about $0.01 per share in profits. Our top performing geographic market for the third quarter was again Latin America, which grew revenues of 20% sequentially and 49% year-on-year.

Latin America trailed Eastern Hemisphere growth over the past two years, but it’s now catching up. Growth in Mexico, Brazil, Argentina and Columbia led the way, and Venezuela wasn't far behind.

Year-on-year, in both Europe and Africa, and the Middle East/Far East areas, revenues grew 27%, although sequentially, the Middle East/Far East revenues were slightly down. That's because we have some softness in the region after many quarters of high growth. We sold the business in Oman which accounted for 12.5 million revenue quarter reduction. Sequentially, Middle East/Far East comparison would be more favorable this quarter.

The highest growth areas in countries in the Eastern Hemisphere included all areas of West Africa, the former Soviet Union, Egypt, Qatar, India and Australia, New Zealand. Malaysia, Indonesia and Saudi Arabia, and both major sectors of the North Sea also showed solid growth.

Our Drill Pipe business, which was impaired last quarter by supplier manufacturing firms returned to a pre-second quarter revenue levels and were $16 million higher in revenues last quarter.

Turning to profitability, Oilfield segment earnings were up 8% sequentially and 28% year-on-year. The primary detractor from higher margin growth was mixed, as worldwide offshore revenues declined and land rig revenues grew. Again, this situation has reversed itself in the fourth quarter. Don and Margaret will give you more specifics concerning this issue.

Revenue per employee for the quarter was $474,000 per year, an increase of 3% from last quarter. We added 600 people in the quarter and now have 19,250 full-time employees at Smith.

Last week, we announced the purchase of a minority interest in At Balance, which is the Shell Technology Venture Company. At Balance is a technology leader in the Managed Pressure Drilling business and combined with Smith's capabilities and well pressure control, drilling chokes and software and rotating pressure control devices make Smith/At Balance have a high capability to be a force in the Managed Pressure Drilling business, which we are in today and it's expanding fast.

Now turning to our business units: Smith Services again showed the best revenue gains, with 13% sequential and 31% year-on-year growth, strong revenue increases for completion equipment, pressure control, drilling devices, tubulars, both rentals and sales, drilling jars, stabilizers and reamers all contributed to the growth.

M-I SWACO's sequential revenue gain of 2.2% was dampened by weaker offshore drilling, which will recover this quarter, but M-I SWACO's year-on-year growth was a credible 18%.

Year-on-year WARP, a micronized barite fluid, had sales more than doubled, and Production Chemical's waste management and specialized completion tools all gained considerable volumes.

Smith Technologies had solid sequential and year-on-year growth in revenues with the highest growth rates coming from diamond bits and borehole enlargement systems, and finally Wilson, a good sequential and year-on-year growth despite the 30% decrease in Canadian rig count. Wilson's year-on-year growth for the Eastern Hemisphere and Latin America exceeded 85% and now accounts for 6.5% of Wilson's revenues.

Finally, as we look towards the fourth quarter 2007, 2008, we have several opportunities and challenges. Clearly the growth rate in North America experienced over the last five years had decelerated and will need higher sustained gas prices, probably $8 per MCF range till we accelerate to North America.

The proposed Alberta Royalty increases for oil, gas and oil sands productions causes uncertainties for our customers going into 2008. Ed Stelmach, the premier of Alberta will address this issue in a speech this Thursday, but a more in-depth government response will likely come several days later from the both the Premier Stelmach and Energy Minister Mel Knight.

With that said, worldwide fourth quarter 2007 activity looks better to us than the third quarter. The worldwide drilling outside of North America will be better in 2008 than 2007. For Smith, our full year 2007 earnings per share results should come in near the top of our previous guidance of $3.15 to $3.25 per share. Our guidance has always is GAAP and it includes the $0.04 per share tax gain in the first quarter of 2007.

In summary, Eastern Hemisphere and Latin American growth looks to be assured over at least the next several years, but North American activity should remain static until natural gas prices improve and the uncertainty of the Alberta Royalty issue is resolved in an industry favorable manner.

Now, Don McKenzie has some comments.

Don McKenzie

Thank you Doug, good morning. I am going to discuss M-I SWACO. First, I will make some overall comments, then address the deepwater market, new technologies and individual business segments. Third quarter revenues for M-I SWACO were $1.115 billion, approximately 2% higher than the second quarter of 2007, and 18% higher than the third quarter of 2006. This is our third billion-dollar quarter, and revenues have now increased in 20 consecutive quarters.

Rig activity as measured by the M-I SWACO global rig count increased 9% for the second quarter to average 4398 rigs. The worldwide rig count increased 6% in Q3 as compared to the third quarter of 2006.

Eastern Hemisphere grew 2.8% sequentially and now accounts for 56.9% of total M-I SWACO revenue. Latin American revenues grew 19.8% sequentially, and accounts for 14% of total M-I SWACO revenues.

North American revenue fell by 5.5% in the quarter and North American revenue now accounts for 29.2%.

Total offshore revenue for M-I SWACO was $534.8 million in the third quarter. This is a decline of 10.1% from the prior quarter. This $60.4 million decline is comprised of 13 days of revenue losses due to precautionary shutdowns in the Gulf of Mexico because of storms, as well as, a lower active deepwater rig count due to repairs in rig move and delays to international contract starts where we are the incumbent. The offshore rig reduction was offset by $84.4 million in land-based revenue increase.

Now, let's look at the deepwater market. The average number of rigs operating in the deepwater market declined 10% in the third quarter. The rig count engaged in drilling and completion of operations averaged 33.8 units. The reduction of 3.3 rigs from the second quarter was primarily due to rig repairs and the impact of weather in the quarter. Of the 33.8 rigs, 27.9 were engaged in drilling operations, while 5.9 were engaged in workover and completion operations.

M-I SWACO's service averaged 17.7 of the 33.8 rigs as compared to 21.9 rigs in the second quarter and generated revenues of $53.9 million. This is a decrease of $29.6 million from our US deepwater revenues in Q2, or 35.4%, due to the previously mentioned storm impact and rig repair. We expect the US deepwater rig count that is active in drilling or completions to improve in the fourth quarter by 5 rigs, and M-I SWACO will benefit from this increased activity.

The international deepwater market averaged 66 rigs during the quarter, representing an increase of 6% or 4 rigs from the second quarter. Brazil and West Africa accounted for essentially all of the increase. Our international deepwater revenues were $104.6 million, up 17% compared to the second quarter results.

Now, I'll review M-I SWACO's new technology revenue. Premium fluids include all other high performance synthetic and water-based fluids. Premium fluid revenues for the quarter were $109 million, which represents a decrease of $6.7 million from the second quarter and entirely attributable to the deepwater Gulf of Mexico.

Total synthetic revenue for the quarter was $67.3 million, down $16.5 million, or 20% from the second quarter. U.S. synthetic revenue has accounted for $8.7 million of this decrease. This decrease in synthetic revenue was offset by increased sales of WARP and ultra drill. The acceptance of WARP technology is accelerating with operators around the world.

New technology revenues, which are generated from technologies that are less than five year old, were $260.6 million for the quarter. That is up 8.1% from the second quarter, and up 39.4% from a year ago.

I will now discuss our product segment. Our fluid segment, revenue which includes drilling fluids, Federal Wholesale and product chemicals, was $747.2 million for the third quarter of 2007. Third quarter revenue increased to approximately $36.7 million or 5.2% from the second quarter and $112.3 million or 17.7% from a year ago. Western Canada and Mexico accounted for almost 100% of the growth in the sequential quarter with gains in the North Sea in Europe offsetting the decrease in U.S. offshore.

Compared to the third quarter of 2006, the majority of our revenue growth came from international operations. The Environmental M-I SWACO solution segment which includes drilling waste management, solid control equipment, pressure control and produced water continue to grow during the quarter. Third quarter revenue grew 4.6% to $226.3 million as compared to the second quarter of 2007. Major growth areas included South America and Africa. Compared to the third quarter of 2006, revenue grew 24%, or approximately $43 million. All of the growth occurred in the Eastern Hemisphere and South America.

Our Wellbore productivity segment includes reservoir drilling fluids, completion fluids, specialized tools and filtration preparation equipment and services. Revenues were $137 million for the quarter. That is down 14.1% versus the second quarter of 2007. Lower rig activity in the Gulf of Mexico was responsible for the majority of the change.

In the coming quarters we expect to see continued growth at M-I SWACO. The outlook for the Eastern Hemisphere and deepwater Gulf of Mexico just continues to be strong, and based upon recent contract awards, our business in Mexico will be growing.

I will now turn the call over to Margaret.

Margaret Dorman

Great Don, thank you. Good morning everyone. Just to quickly recap this morning's release, third quarter earnings totaled a $167 million or $0.83 per share. This represents a 9% profitability improvement over the June quarter and year-on-year earnings growth of 26%.

One of the largest factors that impacted the quarter was the decline in offshore revenues. As Don mentioned M-I offshore operations reported revenues, which were $60 million or 10% below the levels experienced in the second quarter. The softness in the offshore market, however was more than offset by the Canadian drilling recovery that started several recent onshore fluid contracts in Mexico, a strong quarter for premium tubular products and drill pipe in the U.S. market, and an increased demand for environmental equipment and service in the Europe/Africa region.

The profitability improvement over the June quarter was driven by several factors including seasonal pickup in Canada for Smith, which recovered roughly half of the Canadian earnings decline experienced in the June quarter. Higher business volumes in the U.S. market where margins held, even with the weakness in offshore business. And further expansion of our operations and markets outside North America in areas such as Mexico, Continental Europe and the North Sea region.

Consolidated revenues for the quarter totaled $2.25 billion, representing 19% year-over-year growth in our Oilfield segment operations, and a 12% gain in our distribution segment.

On a sequential quarter basis, consolidated revenues grew 6%, largely concentrated in the Western Hemisphere markets. Our onshore business volumes in Mexico, which grew a 146% over the June quarter as we began work on several of the new contracts awarded earlier in the year, combined with increased land-based business volumes in the US and Canada, contributed to the revenue growth over the June quarter.

Revenues for the Middle East/Asia operations declined $13 million or 4% on a sequential quarter basis. As Doug mentioned, second quarter sales from Omani joint venture operations combined with the timing of offshore projects in the Asian markets impacted the reported revenues. Excluding these factors, revenues for the Middle East/Asia region grew 5%.

I've touched on several of the regions, however, the geographic revenue distribution for the relevant period, as well as, the summary for the Oilfield segment is included in Schedule 1 that accompanies the release.

Since Don has covered M-I SWACO, I'll offer some brief commentary on Smith Technologies, Smith Services and Wilson. We experienced solid growth across the Smith Technologies operations. Revenues for the quarter were $259 million, 4% above the June quarter and 13% higher year-on-year. Revenues for the combined drill bit product lines grew 8% over the second quarter's levels, influenced by the Canadian recovery and increased business volumes in Latin America, where we experienced 17% growth rate over the second quarter of 2007.

Smith Services posted extremely strong results for the quarter; revenues were $316 million, 13% above the second quarter’s levels and 31% higher year-on-year. Again, the second quarter sales of Smith Services interest in Middle East joint-venture influenced the sequential comparison. Excluding this impact, revenues grew 18% on a sequential quarter basis and 38% over the September 2006 period. The sequential revenue improvement related to higher drill pipe volumes and premium tubular product sales in the US market, and to a lesser extent, increased demand for fishing and drilling products and services in markets outside of North America, including the Middle East/Asia region, which grew nearly 30% on a sequential quarter basis.

We noted last quarter we had experienced temporary delays in receiving drill pipe inventory during the June period, that is, she was for the most part was off during the September quarter.

And finally, the distribution segment posted one of the highest sequential revenue improvements of the Smith company unit, reporting both year-over-year and sequential growth of 12%. Revenue increase of the June quarter reflects strong results in the upstream energy branch operations driven by the seasonal recovery in Canada and higher line pipe sales volumes to support a number of upstream and midstream customer projects.

Let me make just a couple of high-level comments on the income statement, starting with the operating income. Consolidated earnings before interest and taxes approximated $350 million or 15.6% of revenues, although there was no margin deterioration reported for the oil field or the distribution segment. The higher mix of distribution revenues drove a slight reduction in the overall margins from the prior quarter level.

Oil field segment margins were 20% comparable with the June quarter and 80 basis points above the prior year period. The unfavorable reduction in offshore business mix, and a resulting impact on M-I was offset by a shift towards sales of higher comparable margin product and service offerings including premium tubulars and drill bits.

Net pricing for the oil field units remains marginally above the second quarter's level. The operations have been able to achieve price increases, which exceed the rate of growth in our internal cost, which has contributed to an expansion and also gross profit margin.

M-I SWACO contributed the majority of the net pricing generated during the quarter influenced by improved Eastern Hemisphere contract pricing, although higher petroleum base chemical cost and the rising cost for certain commodity needs partially offset the amount of net pricing realized.

Distribution operating income totaled $25 million in the third quarter. Operating margins were 4.4%, 40 basis points improvement over the June quarter. Sequential incremental operating margins were 8%, influenced in part by a higher mix of project work reported in the energy branch operations.

As for the rest of the income statement. Net interest expense declined modestly from the June quarter reflecting the reduction in average debt levels outstanding during the quarter. Late in the third quarter, we repaid a $150 million of public notes utilizing lower cost borrowings. So we should see this trend continue in the fourth quarter as well.

On the tax front our effective rate was 32% comparable with the second quarter's rate and matching the guidance provided on last quarter's call. While changes in the geographic distribution and earnings will continue to drive increases and decreases in our quarterly rate, we believe our tax rate for the fourth quarter should remain around 32%.

Detailed balance sheet information has been included as part of the earnings release stock and so I’ll just make a few brief comments. Our balance sheet remains very strong. At the end of September we had outstanding debt of $1.1 billion and our debt to total capital ratio remains just below 24%, a 14 basis points reduction from the June level.

Net working capital increased about $200 million in the September quarter influenced by higher business volumes there was quite deterioration and receivable collection base. We have seen extremely strong cash collection at the start of fourth quarter and expect to report improved working capital performance in the December period.

During the quarter we funded $44 million of stock repurchases, 743,000 shares of stock at an average price of $58.75 a share, $12 million of partner distributions and $20 million of regular dividends during the third quarter.

Net capital spending in the September quarter totaled $70 million, roughly $12 million below the second quarter amount, driven by the timing of the drill tool additions in the Smith Services operations. After eliminating our minority partner's interest and capital additions, capital spending approximated $52 million for the September quarter.

We believe net capital spending will total around $300 million for the year. This compares to a depreciation and amortization estimate of roughly a $195 million. Depreciation in the third quarter of 2007 was $50 million, which translates into $38 million after considering that minority partner's interest.

So with that, let me hand the call back to Tatiana for questions.

Question-and-Answer Session

(Operator Instructions) Our first question comes from Ken Sill from Credit Suisse, please go ahead.

Ken Sill - Credit Suisse

Yeah. Good morning, guys. Nice results considering what happened in the Gulf of Mexico.

Doug Rock

Thank you.

Ken Sill - Credit Suisse

One of your competitors yesterday mentioned that they were starting to see a little bit of price erosion in commodity fluids in distant North America. They kind of indicated it wasn’t a big deal yet, but are you guys seeing any of that leaking in the North America after the supplies of the some of the other product lines for other people?

Don McKenzie

Excuse me, in the third quarter our margins in the Rockies and in US land were actually up. We haven’t seen a lot of pricing erosion. We are the market leader; we're going to be the market leader in pricing. We have seen where some of the cost of some of our commodities like Ferrite have increased, but to a great extent we have been able to pass some of that increase on and so, we're pretty bullish on North American land, stay at reasonable levels as it is now.

But if we take a look at, Doug said in his earlier comments that, we're not affected quite as much by high CapEx items like pressure pumping where there is an oversupply and then you get kind of a double factor there with utilization and price. We’re basically, the resources and the assets are in place such as liquid mud flaps and what not and so, we see US land as a very important market and we will continue to be. We are continuing to monitor exactly what's happening there. And like I said, we’re going to be the pricing leader in that market like we are elsewhere around the world. And like I said, we haven’t seen any erosion to date.

Doug Rock

And also Ken, we are not on the high end of the technologies. I mean, we don't sell bits and certain basins in the U.S. and other locations. We don’t operate where there is very low cost commodity type business, so that really helps insulators from that quite a bit.

Ken Sill - Credit Suisse

And then just one follow- on, on that, how much of your contracts in North America internationally are up for renewal, I guess, in the fourth quarter year?

Don McKenzie

In the fourth quarter in the Eastern Hemisphere and South America there are very, very few contracts that are up for renewal. In North America, we have three or four that are up for renewal, and we have a portion of basically every one of those contracts now, and that we are looking at what we are going to do from a pricing standpoint, and I hate to disclose what we are going to do because I am sure that some of our competitors are listening.

Doug Rock

But most of the big ones are really that have been passed off, so they’ve really been continued in some cases without bidding during about and as early this year.

Don McKenzie

That's right.

Ken Sill - Credit Suisse

Okay. Thank you.

Don McKenzie

Welcome. Thank you.

Operator

Thank you. Our next question comes from Rob Mackenzie from SBR. Please go ahead.

Rob Mackenzie – SBR

Hello.

Don McKenzie

Yeah, hi Rob.

Rob Mackenzie - SBR

Hi, sorry I had my phone on mute. Pardon me for that. I wanted to talk with you guys a little more about something, not one of the other companies said on their call and that's the ability to find people again, I know this has been a long-time topic but when Schlumberger just starts talking about having problems, staffing up and finding people to me that could be a material impediment to grow.

Can you talk to us about how, how you are dealing with that people and do you think that will be a meaningful bottleneck in 2008 and 2009?

Don McKenzie

I don't think people will be meaningful, but if I could contrast the kind of people we hire versus say Schlumberger, Halliburton and Baker, maybe it's Exxon and Weatherford. Our key technologies are in mechanics, they are in materials, they are in chemistry, they're in logistics, hydraulics and we are not the people that really evaluate the reservoir. So the geophysicist system, the geologist, the GMG guys, the petroleum engineers, the reservoir people particularly, we have those people, but those aren't our main people. So when you hear about shortages, typically in those geologically related functions, but with the 600 that we've hired pretty much average per quarter for the last three years, mostly outside the U.S. there's been a very little problem at all.

Doug Rock

And from an M-I SWACO standpoint, we will train about 500 engineers, fluid engineers this year. And for example, when we had the downturn in the Canadian activity we were able to place a lot of the Canadian engineers elsewhere in the Eastern Hemisphere where we are actually growing and so we are able to move some of the people around depending on what is happening in the geographic area. But we are continuing to monitor, North America. And if there is any activity, a change or whatsoever we will take those people and move them elsewhere around the world.

Rob Mackenzie - SBR

Okay Don, my follow-up was actually for you as well. Just trying to get a feel for how much of the reduction in Gulf of Mexico, deep water activity from storms you've gotten back and if there is any other influences there, rigs moving into market, out of market that would be moving factors in Q4?

Don McKenzie

Well, what happened in Q3, it was kind of a double whammy if you will. First was the disruption because of the hurricanes and that was 13 days and then a couple of other rigs actually went into a repair mode and so we expect, like we've said in the call five additional rigs to come into the Gulf of Mexico in the fourth quarter and in our share that is going to be fairly significant.

Rob Mackenzie - SBR

Great, thank you very much.

Operator

Thank you. Our next question comes from Scott Gill from Simmons & Company. Please go ahead.

Scott Gill - Simmons & Company

Yes. Good morning.

Don McKenzie

Good morning.

Scott Gill - Simmons & Company

Don and Margaret I heard you talk a lot about the Mexico contributions here in the third quarter and the Latin America revenue growth 49%, very impressive. I am wondering as we look into 2008, if you could kind of give us some sort of guidance as to what that Latin America growth number could look like? I know you still ramping Mexico. So I would expected it to be pretty big, but if you could just provide some color that would be great?

Don McKenzie

I am not going to give you a number, but I will give you some color, I mean, Brazil's got another 8 or 9 offshore rigs. It will becoming in over the next 18 months, so we see significant growth there. We actually see significant growth in Venezuela coming along, and we've been surprised somewhat about the pickup that we've seen in Columbia. So, you'll see a very strong growth, we think at the level that we see in the eastern hemisphere and clearly we've been running in the upper 20% to 30% range that actually on an average is a little over 30% for the last couple of years. But we think the Latin America area would be similar to eastern hemisphere growth, at least for 2008.

Scott Gill - Simmons & Company

Okay, and as a follow-up Doug you highlighted the revenue per rig numbers that you've seen in the eastern hemisphere. Clearly, we are going to get very similar type of numbers of out of Latin America. At what point does that revenue per rigorous start to normalize in other words, are they kind of grows more with the rig count, how far are we away from that?

Doug Rock

Well, I think, that there if you look at the 130 or 140 offshore rigs that are coming in, I guess they are booking them now and the tail end of 2010. We'd certainly be looking at accelerated revenue per rig as these come in over 2008, 2009 at least the first half of 2010 has a lot of floaters not as many jack-ups in that period, and then I think the schedules showing out through the end of 2010. So we are looking at that to continue for the next two to three years at least.

Doug Rock

We believe that in 2008, we are going to see 14 deepwater rigs come back -- comes into the around the world, in 2009, 21 and 2010, 14. So there is a total of 50 rigs that are coming into deepwater and from a M-I SWACO standpoint deepwater rigs, we are 10 land rigs, so that kind of multiple.

Scott Gill - Simmons & Company

Okay. Thank you.

Doug Rock

You're welcome.

Operator

Thank you. Our next question comes from Dan Pickering from Tudor Pickering. Please go ahead.

Dan Pickering - Tudor Pickering

Good morning, guys.

Don McKenzie

Good morning, Dan.

Dan Pickering - Tudor Pickering

I would like to follow-up a little bit on the comment around the deepwater rig additions and, bare with me, I want to check some numbers. Don, I think you said that the Gulf of Mexico deepwater was down about 30 million or so sequentially in revenue, and I think I heard you say, you were working on about 17.7 rigs versus 21.9 rigs last quarter, is that right?

Don McKenzie

That is correct.

Dan Pickering - Tudor Pickering

Okay, and so guess what I am grappling with here is, is your reported revenue is about $3 million a rig there, and the delta was about $7 million a rig. And so, I am trying to understand that the rigs that went down were sort of a ultra high end, you were getting a lot of revenues there and as we step forward the rigs that are being added, do they look more like the average Gulf of Mexico rig or the incremental?

Don McKenzie

I think the missing piece is Doug was the that we lost across a number of rigs with the delta that turned as a result of the two hurricanes that were coming in. You’ve got to put that in and that reduces the 7 million numbers significantly.

Dan Pickering - Tudor Pickering

Okay. So the delta was really the hurricane impact? Okay. And, I guess, my other question then would be, as we look at Canada Doug, I know there are a lot of uncertainties, do we think at this point kind of best chance is Canada has a seasonal recovery, but still down the line year-over-year do we run a risk that Canada doesn’t do anything from here and kind of pulls to 2001 when it was pretty flattish Q3 to Q4, how do you see that market playing out?

Doug Rock

For planning purposes we’ve really planned on pretty much a flat North America going into 2008. I think the question is if Canada reduces significantly and if they go with the full royalty proposal of the royalty panel it could reduce, but then I think the deliveries to the US will -- natural gas will go down quickly and we’ll actually see a short move up in the US. So it’s a tough one to figure, but for planning purposes we are looking at reasonably flat, but we are going to be looking real carefully over the next couple of weeks with what happens with the royalty proposal as an indicator of how 2008 will look in Canada.

Dan Pickering - Tudor Pickering

Okay. And just remind us your biggest business in Canada is best of services at this point, on a percentage basis?

Don McKenzie

On a percentage basis, yeah.

Doug Rock

Yeah, on a percentage basis it’s more bets then, but MI has got a very sizeable business as their services and as those in CE Franklin.

Dan Pickering - Tudor Pickering

Great. Thank you

Doug Rock

Yeah.

Don McKenzie

You are welcome.

Operator

Thank you. Our next question comes from Robin Shoemaker from Bear Stearns. Please go ahead.

Robin Shoemaker - Bear Stearns

Yes. Thank you. I just wanted to follow-up on this deepwater fleet, our rig additions to the fleet just for background purposes, approximately how far in advance of a start up of a new deepwater rig is the drilling fluid contract negotiated in, what is sort of the timing of that and how much incremental business do you expect from new rig deliveries in '08. I mean we can see what the delivery schedule is, but are those contract already awarded or in process?

Doug Rock

Well, typically what will happen is that if a deeper rig comes in and we have a contract for that particular operator, then we will get it. So, it's not a rig by rig basis, its more in line with where is the distribution going to, what operator, and in some cases you may bid it out, but probably in 70% of the cases, its going to go into the blanket agreement that you already have in place.

Don McKenzie

But when we give you the numbers looking forward like the five rigs, we know month-by-month actually by a week, which rigs are going to be drilling and which aren't. So, these are specific rigs, specific timeframes that tie down to really within a week or two of starting up. So, we're confident about these numbers.

Doug Rock

And for that like in 2008, we know there is five rigs coming into the U.S. gulf and another nine will be delivered internationally. And we know kind of where those are going because they were committed in the shipyard and we have a pretty good idea as to, if that revenue stream is going to [flow transferred] to somebody else.

Don McKenzie

And the further you are out 2009, 2010, where they operators contract may or may not turn over, that we don't know, because its going to depend on who the operator is or whether we have contract with that operator.

Robin Shoemaker - Bear Stearns

Got it, okay. So, just on that same subject, your market share I believe you given this in the past, the domestic and international on deep water rigs. Do you have that kind of broken out domestic, internationally your market share?

Doug Rock

Well, what we typically have done is told you the numbers of rigs that we're on, not necessarily the value of the market share and if you take a look at in the third quarter we were on 17.7 or 33.8 of rigs and if we compare that to the previous one its 21.9 and I now think Margaret's got some more data for you.

Margaret Dorman

That’s the U.S. number?

Doug Rock

That's the U.S. number.

Margaret Dorman

Yeah.

Doug Rock

Okay.

Robin Shoemaker - Bear Stearns

Is there a comparable international number or…?

Doug Rock

We don't typically give that out…

Robin Shoemaker - Bear Stearns

Okay.

Doug Rock

For obvious reasons and what we said is our international shares are similar and world wide it's over 50%.

Don McKenzie

That's right.

Robin Shoemaker - Bear Stearns

Okay. All right, thank you.

Doug Rock

And thank you.

Robin Shoemaker - Bear Stearns

Great. Thank you.

Operator

Thank you. Your next question comes from Kurt Hallead from RBC Capital Markets. Please go ahead.

Kurt Hallead - RBC Capital Markets

Hey, good morning.

Doug Rock

Good morning, Kurt.

Margaret Dorman

Good morning, Kurt.

Kurt Hallead - RBC Capital Markets

Just, I want to circle back around Doug you referenced the back that the Eastern hemisphere growth of North 30% in the last couple of years. Any reason to think if that adds at all in 2008 or do you think it's maybe that a constant or accelerate. Can you give some color on that?

Doug Rock

Right now, I mean it seems to be going near we have been running in that 27%, 29% range over the last couple of quarters I don't see that slowing down with the number of rigs that are coming in right now. But as Don mentioned there is some contracts we may do better, we may do worse say, but I don't see anything substantially changing, particularly with all the new rigs coming in and the opening up of some additional areas in the former Soviet Union and also with the rig activity going in to West Africa plus I think Brazil, acceleration in Saudi Arabia and a couple of other areas.

Kurt Hallead - RBC Capital Markets

Okay and then Schlumberger referenced to prospects for some project delays they mentioned in Nigeria, the Caspian and a couple of regions and have a kind follow on impact or flow through impact on your prospects?

Doug Rock

That's part of our business project delays. We've always said if all the countries in West Africa drilled simultaneously, we might not have enough capability to service them all. There are always delays. So we haven't seen a delays that are abnormal or outside of what we've seen in the past neither in a higher percentage of projects.

You know, some projects we've got ready drilling had to wait two years, and this is just the nature of the funding, particularly our national oil companies where the funding has to come from the political side. So, we don't see it to be an abnormal slowdown as a result of delays at this point.

Kurt Hallead - RBC Capital Markets

Okay. And then you referenced specifically in Latin America, Venezuela, despite I guess a lot of the headline, noise and the impact it may have on oil company ownership issues, can you give us some color as to why things are looking so positive…?

Doug Rock

Our relationships with Petrobras and the other companies in Venezuela have been very solid. There are some of the -- they pay us on time, they live up to their contracts. So, Don, you might want to comment, you have a majority of business there?

Don McKenzie

Well, Venezuela, of course, it's difficult to say what you'll have there slightly tomorrow, but Petrobras is stepping in to fill in the void of some of the IOCs that were in there and so there is opportunity in Venezuela. I think it's what we are talking about here, Kurt.

Kurt Hallead - RBC Capital Markets

And then, just kind of to give your perspective on what's -- how would you handicap the prospects for the Canadian tax issue?

Dough Rock

How will I handicap? I believe there will be some form of compromise, but Premier Stelmach, he replaced Ralph Klein and hasn't go through an election. He has got election next year and the polls, some place between 78% and 88% of the people want to see higher taxes. So something is going to happen. It's a question, is it going to be in line, you know, if you kick the Royalty rates on the Oil Sands up 17% which is the proposal, and then 5% each on gas and oil with no grandfathering, which again is the panel’s proposal, that’s pretty draconian, but still the take for the Canadian is not excessive compared to the percent take of, of other countries in the world, if you look at that information. So my guesses will be some form of compromise, and where that compromise winds up or whether that satisfies the EnCanas, the Talismans and Petrocas, I am not sure, but I think there will be a compromise.

Kurt Hallead - RBC Capital Markets

And the bulkier stuff in Canada, if I understand correctly, it's still natural gas, right?

Doug Rock

A lot of that drilling is natural gas, correct, but if you go to offshore, Eastern Canada which is -- and the oil stock, it’s still about 30% of rigs drilling for oil.

Kurt Hallead - RBC Capital Markets

Got it. Thanks.

Doug Rock

You’re welcome.

Operator

Thank you. Our next question comes from Jim Crandell from Lehman Brothers. Please go ahead.

Jim Crandell - Lehman Brothers

Good morning.

Doug Rock

Good morning, Jim.

Don McKenzie

Good morning.

Jim Crandell - Lehman Brothers

Doug, you and I've talked about this before, but more and more of the drilling that takes place is horizontal, more of it uses rotary steerable and two of the three large providers of rotary steerable do on their own big companies, and they seem to be doing everything humanly possible to make sure that their bits are used with their own rotary steerables, and apparently meeting with increased success. I realized that Schlumberger, Weatherford don't have big companies, and you strive to be the premium supplier of drill bits and, but it just seems you are up against a very powerful sort of force here. Could you talk about this issue?

Doug Rock

Yeah, sure if you read, I am sure you did, the Richard's previous report on market shares recently you find out that we are doing very well for several years, and obviously with our relationship with Schlumberger who has gained significant share in the in the directional, in the drilling and measurement business. That's a very helpful to us. So, I'd say with the combination of new products, with our both sequential and year-over-year revenue growth for the last couple years, all I can say is that Smith has been a successful one in those areas. So we are very pleased with where we are going.

Jim Crandell - Lehman Brothers

What do you think the Company's drill bit share and I am not looking for any specific number here, but just a sense is, with Schlumberger integrated project management contract?

Doug Rock

That's so hard when I, I mean….

Jim Crandell - Lehman Brothers

I mean is it very high?

Doug Rock

I don’t know the answer to that. I haven't asked in that number.

Jim Crandell - Lehman Brothers

Okay. My second question here for both Doug and Don here is, do you see at all some of your competitors namely Halliburton, and Baker trying to package fluid that's with a number of their other items for "a lower overall cost to the customer", and that because they offer the broader product line than you were, that provides -- that's competitive issue for you and them there in the field.

Doug Rock

Yes, we don’t see Baker doing as much. We do see Halliburton offering a package and this comes around from time-to-time. We saw it in the early 90s and then the operators turned out with a package, maybe they weren't getting all the leading technology. So their efficiency wasn't as good. But it hasn't been a large trend, though of course with our relationships with Schlumberger, where they are doing integrated their project management, we are involved in most, if not all of those project. But that tends to be in more remote areas. Not areas were operators can get a hold of variety of technologies and services. If I answer your question I have seen Halliburton do more and really Baker very little.

Jim Crandell - Lehman Brothers

Okay. Thank you Doug

Doug Rock

You are welcome.

Operator

Thank you. Your next question comes from Alan Laws from Merrill Lynch. Please go ahead.

Alan Laws - Merrill Lynch

Good morning.

Doug Rock

Good morning Alan

Alan Laws - Merrill Lynch

See what I have here. I have many questions here. You've continually been pretty successful of completing and you're adding earnings value, via tuck-in acquisitions and the recent At Balance like acquisition a toe hold I guess, it looks pretty interesting. How do the M&A pipeline look? I know we ask you this question pretty much every quarter but I just want to know the expectation gaps are really wide out there it. Is there a lot more opportunities there?

Doug Rock

We are review that very frequently and there we have a long list of companies we are interested in, we are talking to. That's not for us to predict how many we close, but mostly in the Eastern Hemisphere and Latin America the areas where we are growing, Don you've got the numbers those we are looking at?

Don McKenzie

I can answer you, but our list is about -- on average with what we've done in the last or what we've looked at in the last three or four years. I think we are probably, not probably, we are looking at seven to-date. Whether they are closed or not is, I don't know but we are actively looking at ways that we grow our business or take a niche technology and use our infrastructure around the world and distribute it around the world. So we are continuing. Certainly the multiples may be a little bit higher today, but if you can find the right thing and use your footprint around the world to improve the overall revenues and earnings of that particularly company then it’s something we are looking at.

Alan Laws - Merrill Lynch

All right. Just as a regional comment. Canada being so weak and so deep down, is there anything in that market that has looked attractive to you?

Doug Rock

Well, essentially as Don mentioned, we're looking more for technologies. I am not saying that if we had a good value asset play, where we could buy something at discount. Assets, we wouldn’t do it, but at this point there is maybe Canadian company or two there. But nothing has come up as a result of this downturn because they are primarily looking for new technology players.

Alan Laws - Merrill Lynch

Okay. So, your second question have us on Smith Technologies, I know this is kind of coming up in the next few months. I was wondering if you had any internal or western surround, you had a margin impact or earnings sensitivity from the six-cutter royalties you begin to play in January.

Don McKenzie

Actually there will be, it’s not January but our deal with Grant Prideco is that we prepaid royalties for six quarters, and actually when we hit the second quarter of next year, because of the percentage use of the beds, it will actually go down.

Alan Laws - Merrill Lynch

Okay.

Don McKenzie

So, there will no margin, and there will be no margin reduction and potentially a margin increase.

Alan Laws - Merrill Lynch

Okay. Thank you.

Don McKenzie

You are welcome.

Operator

Thank you. Our next question comes from Geoff Kieburtz from Citigroup, please go ahead.

Geoff Kieburtz - Citigroup

Good morning.

Don McKenzie

Good morning, Geoff.

Doug Rock

Good morning, Geoff.

Geoff Kieburtz - Citigroup

The oil field margins were flat sequentially, is that a fair characterization for each of the three pieces of oil field?

Margaret Dorman

I think what I've said Geoff is that, certainly the onshore/offshore mix in your mind, you would expect replacing onshore revenues to with offshore reductions. You would expect that to have an adverse impact on the EMI margins. What I had talked about is that, that really that was more than compensated by the shift to the higher comparable margin quarters in Smith Services and Smith Technology. So, to answer your question, I don’t think that would be an accurate representation as each of the unit was flat.

Geoff Kieburtz - Citigroup

Got you. We talked a little bit about the impact to the new rigs, and I think someone was trying to get a handle on it, let me make a stab, that you are getting something in the order of $4 to $5 million in a quarter from a deep water rig, is that a fair estimate?

Margaret Dorman

Yeah, I mean I think what we’ve talked about, Geoff is somewhere a deepwater would be, you know, one to one and half a month, so $3 million or $4 million a quarter.

Geoff Kieburtz - Citigroup

3 to 4, okay.

Margaret Dorman

Yeah, depending on the depth of that rig.

Don McKenzie

If we put it in downhole tools, and that's depending on the rig, it could go up somewhat.

Geoff Kieburtz - Citigroup

Okay. And as these new rigs come into the fleet, would you expect them, I mean, obviously there is a variable, we don't know how many of those you will be contracted on, but is would -- should we expect that, that revenue run rate should be generated from the very beginning or will there be some kind of ramp up?

Don McKenzie

It's an oddity. Usually when they come to spud we provide them with some lower cost spud mud. So you see some higher revenues in the beginning, and usually lower margins. And then once they get into the deeper drilling and certainly get into the reservoirs or the extended reach you’ll see the higher margin stuff being used.

So, typically if they come in you might see a jump in volume with lower margins and then you see the margins pick up once they are into the operations.

Geoff Kieburtz - Citigroup

Okay, but --

Don McKenzie

It’s the drilling multiple wells only from a single cord, so we used to get a spud and then added 26 or 36 inch hole then only do the multiples coming up the bottom there, they extend in the region of a high value work type and ultra deal fluid.

Geoff Kieburtz - Citigroup

Got you. So it's really like a well -- really trying to get out as you probably heard Schlumberger’s comments about the efficiency of these new rigs as they come in to the fleet from the shipyard and their expectation that they would not be generating service revenue at a seasoned rig, kind of rate for, I think, they said as much as two years and I wondered how that might…

Doug Rock

I didn't hear the comment.

Geoff Kieburtz - Citigroup

Okay.

Don McKenzie

I didn't hear the comment neither, but if you look at it Geoff, without a doubt when it comes from the shipyard and goes to the sea trials and goes on its first well there is some bugs that have to be worked out. But typically I would think we took two years, but nonetheless, when they come in we would start generating revenue once its spud.

Doug Rock

And what's more important there is whether it's exploratory or development drilling, development drilling generating much higher revenues.

Geoff Kieburtz - Citigroup

And similar margins or higher margins as well?

Don McKenzie

For similar margins.

Doug Rock

Similar, yeah.

Geoff Kieburtz - Citigroup

Okay. And a question lastly for you Don, you called out the dollar amount of new technology revenue at M-I. I guess a two part question; one is, it seems like its running in just under 25% of M-I revenue now. Where do you see that going and the other part of the question is, is that heavily or disproportionately in any one of the three segments of M-I that you've also given us detail on?

Don McKenzie

Well, I would think that our new technology revenue will improve overtime. We've invested a lot of money in research and development in our M-I new products system. We will also be looking at as we talked about earlier acquisitions that provide a component of new technologies.

When you are talking about the segments, certainly the fluid segment is important in the environmental process and solutions. That has a higher component of new technologies and fluids by about 10% and so as that grows we would expect the margins to improve accordingly.

Geoff Kieburtz - Citigroup

Okay. And just to clarify on the first part of your answer, do you expect new technology as a percentage of M-I revenue to go up?

Don McKenzie

Yes, we do.

Geoff Kieburtz - Citigroup

Any kind of target?

Don McKenzie

Well, if you take a look at, this is a new technology we define as any technology that is less than five year old. So at the end of every year, our field operations are somewhat concerned because we drop things off and as we drop off, so yes, it would improve, but even though you drop things off, you wouldn’t necessarily expect the margin to erode just because you dropped it off.

Geoff Kieburtz - Citigroup

Got you.

Don McKenzie

If we take a look at for example, [sprinkler] technology and I don't know that actually dropped off. But it is a very interesting technology, it is, in terms of rig efficiency and what it can do for operators throughout the world, is an improvement over any other method, and so, consequently margins for that would stay.

Geoff Kieburtz - Citigroup

Great, thank you.

Don McKenzie

Thank you.

Operator

Thank you. Your next question comes from Brad Handler from Wachovia Capital, please go ahead.

Brad Handler - Wachovia Capital

Thanks, good morning.

Doug Rock

Good morning, Brad.

Margaret Dorman

Hi, Brad.

Brad Handler - Wachovia Capital

I guess I just have one question last, overtime, you guys have spoken to the idea of getting 200 to 300 basis points of margin through the course of an extended cycle. I never mean to suggest that was necessarily a target, but it does seem, that was your representation on how it worked. It looks as though, if we're looking at your guidance, 2007 is going to shape up that way. And I guess I was curious for whether or not if composition of your business has changed a little. For example, a bit more kind of an international land as you penetrate there. If there was something that changes about the [tenure] of your ability to move margins over the next couple of years?

Doug Rock

Yeah, I think, you are exactly right, that's what we said with average-over-cycle, in fact, in this cycle that’s what we are averaging, but we've also the cycles who have periods where there are a little bit flatter, and really it's been a deceleration of North American growth that has -- the rest of the world is growing at a rate much higher than I would have thought couple of years ago, because I didn't think that oil prices would be this high, and were 85% or so of US drilling is gas; 85% of rest of the world's drilling outside of Canada is oil.

So, moving there, but again with a flat North American, that was the piece that was creating the other 100 basis point to get us up about 200. That said deceleration. North American gas drilling will accelerate, I just can't tell you whether it's going to be 2008 or 2009 or 2010, but deliverability is going to be down. Consumption is not coming off and they still not kicks in, I think, you'll see rates above that range.

Brad Handler - Wachovia Capital

Okay. So, just to clarify at the -- your sense of the opportunities again in whether it’s international land or just broadly international new different from a year-on-year opportunity to raise margin?

Don McKenzie

No, and particularly I think with the this quarter was mainly, throughout the world, we actually saw a little bit less offshore in deep growing, and I think that was just a factor of the third quarter which we rig by rig would see most of that or much of it coming back in the fourth quarter.

Brad Handler - Wachovia Capital

Sure. Makes sense. Okay, that’s helpful. Thanks.

Don McKenzie

Yeah, you are welcome.

Operator

We have no further questions at this time.

Doug Rock

Well, thank you for joining us for our third quarter call, and we look forward to speaking with you and answering your questions in the fourth quarter. Good bye.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Smith International Q3 2007 Earnings Call Transcript
This Transcript
All Transcripts