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National Oilwell Varco, Inc. (NYSE:NOV)

Q3 2007 Earnings Call

October 24, 2007, 10:00 AM ET

Executives

Clay C. Williams - CFO and Sr. VP

Merrill A. Miller, Jr. - Chairman, President and CEO

Analysts

Dan Pickering - Tudor Pickering & Co. Sec.

Marshall Adkins - Raymond James

Kurt Hallead - RBC Capital Markets

Ole Slorer - Morgan Stanley

Robin Shoemaker - Bear Stearns

Roger Read - Natexis Bleichroeder Inc.

Presentation

Operator

Our second quarter earnings of $318million or $0.89 a share on revenues of $2.38 billion. We are very pleased with the results and believe they show the continued world wide vitality of our business and the outstanding performance of our 30,000 employees around the globe.

In addition to our earnings we announced a quarter ending capital backlog of $8 billion with a record new order intake of $1.9 billion in the quarter. This is fuelled by the robust demand for our equipment especially in the deep water and offshore areas.

I will come back in a few moments to going through our operations and backlog in more depth but at this point I would like to turn it over to Clay to expand further on these results.

Clay C. Williams – Chief Financial Officer and Senior Vice President

Thanks Dwight. Before we begin this discussion of National Oilwell Varco’s financial results fourth turned quarter into September 30th 2007, please note that some of the statements we make during this call may contain forecasts, projections and estimates including but not limited to comments about our outlook for the company’s business. These are forward-looking statements within the meaning of the Federal Securities laws based on limited information as of today which is subject to change. They are subject to risks and uncertainties and actual results may differ materially. No one should assume that these forward-looking statements were made valid later in the quarter or later in the year. I refer you to the latest Form 10-K and Form 10-Q National Oilwell Varco has on file with the SEC, for more detailed discussion on the major risk factors affecting our business. Further information about our needs as well as supplemental financial and operating information as related to our business may be found within our press release on our website at www.nov.com or in our filings with the SEC. Later on in this call Pete and I will answer your questions which we ask you to limit to two in order to permit more participation.

National Oilwell Varco generated earnings of $366 million or $1.02 per fully diluted share in its third quarter in its September 30th 2007 on revenues of $2.58 billion. Net income rose 15% sequentially and rose 107% from the third quarter of 2006. National Oilwell Varco’s third quarter revenues improved 8% sequentially and 45%, year-over-year. Operating profit was $545.4 million or 21.1% of sales, an increase of 10% sequentially and an increase of 91%, year-over-year. Flow through for operating leverage was 25% sequentially and 32% year-over-year, all three of our operating segments posted higher revenue and operating profit both sequentially and year-over-year.

National Oilwell Varco executed well during the third quarter resulting in very strong financial results for our company and its share holders. The products, services and 21st century technologies offered by NOV’s professionals continued to benefit from high demand. They bring our customers safer, cleaner more efficient ways of supplying the world’s growing energy needs. We are proud of and grateful for the excellent job that the 30,000 hard working employees of National Oilwell Varco along with our many excellent vendor partners perform every day and we know that our customers and share holders are counting on us to continue to perform well.

Demand for drilling equipment from our rig technology segments surged again this quarter. We booked $1.944 billion in new orders, eclipsing our previous record set in Q3 of 2006 by 6%. Orders were up 10% sequentially, driven entirely by rising demand for offshore rigs, particularly deep water kickable rigs which pushed the offshore mix of our backlog up to $6.8 million or 85% of the total. You know we won large orders for 5 more floating rigs during Q3. The Oil and FP and gas industry’s push into new deep water frontiers is constrained by an acute shortage of rigs capable of tackling the immense challenges of drilling in a mile or more of water. Deep water regions offer Oil and Gas companies the opportunity to find and develop large reserves in under-explored and in some cases, unexplored basins in politically stable regimes.

Technological advancements in sub sea importing production systems POP’s and SPARS over the past 15 years have made deep water development possible and $80 crude prices have made it highly lucrative. As a result the industry is building nearly 70 deep water semi-submersibles and drill ships, each an entry ticket for some lucky oil company into these promising deep water basins. Developing these deep water resources worldwide to meet the rising demand for hydrocarbons in the coming decades is impossible without a larger, better equipped deep water fleet. Although we do not know how many deep water rigs will ultimately be required to generate meaningful production from this frontier, the enthusiasm of our customers remains strong based on several additional projects we are bidding into this space currently. And recent real estate sales prices in the deep water Gulf of Mexico.

We also remain busy quoting packages for jack-ups. There are over 70 new jack-ups expected to roll out of shipyards between now and 2011 and they will join the 410 jack-ups available to drill today. The fleet that they are joined is old, with 299 or 73%, 25 years old or older. Only 16% of the current fleet is less than 20 years old. The new jack-ups coming out are superior to the existing fleet, bring new AC power, electronic controls, sophisticated robotic pipe handling and make up capabilities and higher levels of hydraulic horse power. You know these opportunities set on a jack-up can run as high as $48 million and we can sell $200 to $300 million into a sixth generation drill ship if we sell all that we can into these projects. We expect to continue to sell into these two important trends with secular build out of additional deep water capabilities and the retooling of the jack-up fleet with newer, more capable rigs.

On past calls we described the need to upgrade and retool a land fleet that has been held together with duct tape and bailing wire through the dark days of the late 1980’s and 1990’s. National Oilwell Varco has been instrumental over the past 25 years in pioneering new, making new techniques and improvements in drilling methods. During the great depression of the oil industry from 1983 to 2001, few customers were buying due primarily to an acute and painful lack of cash. The land fleet was sustained by systematically cannibalizing thousands of idle rigs. That begun to change during the middle part of this decade when the supply of idle rigs dwindled to zero and commodity price recovery and more challenging reservoirs prompted more complex wells that began to stretch these old rigs path for design when its expected lives. Drilling consumed rigs, more complex and challenging drilling consume rigs faster. Buying tick tock [ph] in earnest two years ago and as a result nearly 400 new land rigs flowed into the US markets since early 2005, a trend of which NOV has been a beneficiary. Recently this domestic land rig spinning spree paused due to a softening day rig environment across the U.S. The new rigs are performing very well and operators report that utilization of new rigs remains high. However older rigs, owned by scrappy operators are being bid at substantially lower pricing reducing the day rate sea level for all growing contractors across the country. The result is that new built economics are below investment hurdles for most domestic projects currently and NOV’s domestic land rig backlog has fallen by about 50% since last year as a result. Nevertheless we believe that this retooling and replacement cycle must and will resume at some point soon and here’s why.

The engine that prompts the introduction of new technology to this market is ultimately driven by oil and gas company experience. Five years ago, a drilling engineer working for a gas company in the onshore U.S. simply didn’t have a new rig to try. Apart from a handful of flex rigs offered by H&P the only practical choice available in almost all landmark is probably an old 1979 rig. So he could club oil and gas company experience with new drilling technology onshore you would effectively start at zero in 2002. You fast forward to today and those engineers now have a couple of hundred new safer, more efficient hi-tech rigs to try and they are trying them and they are happy with the results. Many oil and gas company personnel have now developed a meaningful experience based with and therefore an informed opinion about new rig technology. And everyday that the larger new rig technology segment of the U.S. land fleet works, the experience curve grows a little higher and NOV and it’s drawing contractor customer deploying this technology won a few more converts. Ultimately it’s the experience and opinion of these customers that will pull the new technology into the land fleet.

The backlog for land rigs for international markets also declined in Q3 after growing for the first half of 2007 owing to high shipments in the quarter and the Ramadan holidays in September. We are optimistic that orders will resume soon given the high level of bidding activity underway across Latin America to North Africa to Middle East, Russia and India. Like the U.S. land market land rigs in these regions are old and tired. We believe that same operator experience dynamic will play out across these international markets, perhaps on a 18 to 24 month lag, to catalyze new demand for new technology. We sold 4 sophisticated desert rigs in Q3 into the Middle East and sold six more to one international customer there after September 30th which flowed in the backlog in Q4. We have lots of additional land rig tenders working internationally today. Why do operators like new rigs so much better? 1979 was probably about the average birthday of the average land rig prior to all this, plus or minus a few years. Drilling has evolved considerably since 1979. 1979 predates drilling with top drives [ph]. 1979 predates robotic pipe make up with iron rough necks. All onshore pipe was made of manually back then. 1979 predates electronic drilling controls and most PDC bit drilling. Rotary rock bit drilling at 100 rpm or less with torque applied from the Kelly at the surface was a principal method of the 1970’s. The industry has since discovered that PDC bits drill faster if you turn them faster which usually requires a down hole drilling motor, again a technology largely pioneered since 1979. To power the drilling motor you need more hydraulic horse power and more and larger pumps at the surface. In 1979 nearly all land drilling was vertical, even offshore, a 40 degree deviation would be considered high. Today 90 degree deviation i.e. horizontal drilling is required to make many onshore prospects economic. But in our 1979 operation the whole de vertical and most of the drill strain intention came from the derrick. You bend that drill pipe around a 90 degree bend and lay a mile of pipeline side in the lateral and imagine how much more torque is now required to turn it. Imagine how much more weight gets pulled through a tree that piped from around a curve.

1979 predates the micro processor single board computers and network systems that permeate today’s modern rig. For that matter 1979 predates personal computers and email and the internet. In short, everything including drilling methods and disco music and weezer suits have changed a lot for the better since 1979. Obviously NOV is a major provider of new rig technology which makes us evolution well into our rig technology segment but we also participate in exchanging drilling methods and a sector of growth trends in other ways too, through our Petroleum Services and Supply segment. More hydraulic horse power to generate down hole torque in drilling motors means more pumps get sold and more pump consumables get used every year. NOV Petroleum services and supplies group is the leading provider of mud pump liners, valves, push rods, food [ph] and modules and other parts to its mission line. We are horizontal and directional in performance drilling with drilling motors means more down hole drilling motor demand in a weasel leading provider worldwide of drilling motors to predominant technology use to drill horizontally. Horizontal drilling is tougher on drill pipe as it rotates against the bottom side of the hole making it wear out faster than it used to. NOV is the largest provider of drill pipe inspection and coating services worldwide and among the largest providers of hard banding to protect tool joints from wear. And if the tool joints on your drill pipe wear out, we can rebuild them and straighten your pipe and repair its threads too through our CubeScope line, a worldwide leader in drill pipe services.

The U.S. horizontal rig count has grown about 20% annually over the last decade, compared to less than 4% annual growth for vertical wells, clearly horizontal drilling is the high growth end of U.S. land drilling fuelled by improved reservoir rock exposure to the well board and well economics. This strategy to be the leading provider of mud pumps, consumable, drilling motors and drill pipe services which enable horizontal drilling positions it well to continue to capitalize on this trend. NOV’s strategic initiatives are not unique to these businesses. We have also targeted secular growth trends in other areas, for example we are the leading provider for tubing units which enable operators to hydraulically fracture treat new wells and re enter and stimulate old wells and help build the majority of the coiled tubing units fully working around the world through our hydro rate [ph[ unit. Each of these cold tubing units utilizes a single strain of steel pipe, 15,000 feet or more in length to re-enter a well and perform stimulation operations like injecting acid or pointing out sand. It’s attractive to operators because it’s quick and the wells can continue flowing cutting the risk of inadvertently damaging the well and reducing the cost and time of pulling the ole completion. It’s kind of like arthroscopic surgery for the oil field and NOV built all the surgical instruments required. Interestingly each strain of coiled tubing wears out about every four months or so and a quality tubing line makes about half of the coiled tubing going into this fleet so we sell the quality tubing razor blades that go into the hydro rig razors we provide. Our Star Fiberglass brand is the leading provider of fiber glass and composite pipe to the oil field. Our Mark and Decker TOTCO business is the leading provider of rig instrumentation services and equipment worldwide and our Brandt All control services is a leading provider of drill cutting separation and waste management equipment world wide. Each has been built over the years to secure leading positions in high secular growth oil field segments with a world wide foot print through a combination of investment in new products and organic growth and through acquisitions. Most importantly, all are performing very well which should lead to operating results.

Rig technology generated $1.522 billion in revenues in the third quarter and operating profit was $373.5 million or 24.5% of revenue. The Group generates a sequential flow through 29% and year-over-year flow through at 34% so at 8% sequentially and 72% year-over-year. Sales out of backlog increased 20% as we continued to execute projects very well benefiting from the many manufacturing and out source initiatives that we discussed on previous calls. Quoted delivery times continued to improve this quarter, despite the growing backlog and mud pumps, draw works and top drives are being quoted two to ten months faster than they were late last year.

Standard ideal rigs and rapid rigs are available in early 2008. Despite faster delivery the backlog continued to grow because it is now heavily tied to new off shore construction and the delivery of NOV components is dated by the whole construction schedule. In other words they don’t want a rig components unless they have constructed a hole to put them in. 15% of the backlog is land, 85% is offshore and 89% of the backlog is destined for international markets. Of the $8 billion in backlog at September 30th about $1.2 billion is expected to flow out in as revenue in Q4 this year, $3.9 billion is scheduled for 2008 and the balance, about $2.9 billion will flow out in 2009 and beyond. The non backlog portion of rig technology revenue fell 18% sequentially to $370 million with individual component sales for rig upgrade and refurbishment projects in the U.S. declining and as we wrap up a large jacking system rebuild project in the Middle East. These items were partly offset by higher spare parts sales and other market sales sequentially so overall our after market business declined only 1% sequentially due to the decline in jack rebuilds with the mix generally shifting away from land towards offshore.

Looking forward to the fourth quarter 2007, we expect to see rig technology revenues move up modestly with flow throughs in the mid to high 20% range. Bidding activity for land rigs for the Middle East, Central Asia, Latin America and the FSU remained high particularly for some of the newer technologies I described earlier and as I mentioned, offshore bidding remained brisk particularly for floaters. However North America Equipment sales activity has continued to drift downward as drilling contractors and pressure pumpers face a softer pricing environment.

Turning to our Petroleum Services and Supplies segment, once again the group posted record revenues and strong margins. Revenues were $805.5 million, up 8% from the second quarter and up 29% from the third quarter of 2006. Operating profit was $193.6 million and operating margins were 24% of sales, up slightly sequentially. Operating profit flow through was 27% from the second quarter and 30% from the third quarter of last year. The Group benefited from higher sequential sales in each of its product lines and from the fourth quarter impact of our future acquisition of Gammaloy Marlex and our Handling Tools Group.

Our sales of coiled tubing rose 10% sequentially as we now have our third mill up and running of quality tubing. Canada rebounded out of it’s very weak Q2, but still remains very soft compared to the last few years. The answer to picture gas prices across North America proposed royalty rate changes in our border and a sharp strengthening of the Canadian dollar do not produce a very encouraging picture for 2008 Canadian Gas drilling. However our Sagthee [ph] oil drilling projects there appear to be strengthening. International markets generally strengthened, particularly in Europe, Latin America, North Africa and the Middle East. Domestic markets performed well but several customers were curtailing spending as day rates soften and operators ponder additional gas competition from LNG and new sources of supply coming in through the Rockies Express pipeline.

Moving into Q4 we expect continued international growth offsetting modestly weaker North American picture resulting in sales and margins about flat with Q3. Our Distribution Services Segment posted a solid quarter as well. Sales were $361.3 million, up 5% sequentially and 2% year-over-year. Operating profits, $25.1 million, or 6.9% of sales up slightly from Q2. Voteries [ph] were 12% sequentially but only 1% year-over-year, due mostly to lower margins in the U.S. portion of the business which accounts for about 60% of the mix. Drilling contractors in the U.S. have reduced day-to-day purchases, increasing pricing pressure on the EMRO [ph] expendables that the group sells. Domestic revenues were up slightly from the second quarter. Canada rebounded modestly out of it’s seasonally weak Q2 and improved margins but our businesses there are down about 24% year-over-year. However Canadian demand for artificial lift products and the oil production is solid and the group is expanding it’s offering in this area. International business grew nicely during the quarter driving very good incremental flow throughs. The group has opened several stores in new international markets over the past few years positioning itself well to benefit from increasing activity we see overseas and is up about 22% year-over-year. Perhaps the most interesting is the store that NOV runs with its own employees aboard the Scorpion Courageous rig, a newly delivered jack-up which flooded this quarter in Indian waters. We have received many inquiries from other contractors about this unique model and we appreciate Scorpion’s vision in pioneering it with us.

Looking into the fourth quarter we expect the Distribution group to post roughly flat results with Q3 as modest North American softness is offset by further international growth. Turning back to National Oilwell Varco’s consolidated third quarter income statement, SG&A increased $8.3 million from Q2 but fell as a percentage of revenue to 7.6%. Other income improved $2.6 billion in the third quarter compared with the second quarter due to foreign exchange gains.

The tax rate declined to 32.4% in Q3 as we reconciled our rate back to our actual 2006 returns filed recently. We expect the rate to move back to the 34% range in the fourth quarter. Unallocated expenses and eliminations on our supplemental segment scheduled were $46.8 million, up $2.3 million sequentially due to higher fringe benefit expenses and other items. Depreciation and Amortization was $56.4 million in Q3, up $4.5 million sequentially due to higher CapEx and purchase accounting adjustments on several acquisitions closed in recent quarters. Our September 30th balance sheet improved working capital, excluding cash and debt of $1.81 billion at the end of the third quarter, about flat with the second quarter despite 8% higher revenues.

Working capital on this basis as a percentage of annualized revenues declined to 17.5%, down both sequentially and year-over-year. Inventory was roughly flat compared to the second quarter but accounts receivables and costs in excess of billings increased $321 million. These were offset by $347 million in additional financing from customers in the form of prepayments and billings in excess of cost. Total financing from customers in these two accounts was over $1.7 billion at the end of the third quarter and these played a major role in reducing the working capital intensity of our Drilling Equipment business from our historical level of 30% to 35% of annual sales Cash flow from operations was $413.2 million in Q3. CapEx was $55.8 million, down $17.8 million from Q2 due to the completion of a handful of expansion projects lately, most notably the Chinese and domestic fiber glass manufacturing operations. Chinese drill pipe cooling [ph] operations, Middle East tool manufacturing and our new after market service center in rig technology in Houston. We expect CapEx to be about $240 million for the full year. We spent $50 million in cash for acquisitions in Q3 closing four acquisitions since the end of Q2. Cash was $1.486 billion at September 30th and debt totaled $846 million.

Now we turn it over to Pete.

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

Thanks, Clay. And at this point I would like to talk a little bit about our operations and then give you a little bit of the flavor of what we are seeing around the world. Now Clay has mentioned our distribution results and I think that what we are getting there is lot of traction with our business model. One of the neat things is we have concepts like SCOPE which is supply chain optimization of performance excellence. We have the rig store we mentioned earlier on the Scorpion Courageous rig and these are kind of neat fields that allow us to kind of follow the business around the world. Distribution really is a very flexible business and we are able to go where the business is. Today, even though there is some softness in North America, the areas that are really positive, things like the Wilson basin, the Shale Plays where there is Barnette or Fayetteville, you are seeing a lot of pipelines being built and we are able to grab a lot of the business in those areas. Well the wealth is as though right now is in our International business. As Clay mentioned it’s risen substantially and I think it’s going to continue to be a big player. When I started with this company, our distribution business was about $500 million a year and I think pretty soon our international run rate will be close to that so I am pleased with what’s going on there.

Our Petroleum Services and Supplies business, there are big issues. Our NQL and Gamble Oil [ph] acquisitions, the integrations going very well. As we told you before most of the products sold in those acquisitions was North American. We put that into our International template and we are starting to see the benefits of that, I think as we roll into ’08. We will see some very substantial benefits to that. Clay mentioned, all the different types of horizontal growing going on, it’s going on all over the world and we are the worlds largest provider of down hole tools for that and I think with what we are doing in this international template it will be very successful as we move into ’08 and ’09. We are opening a new facility in Dubai, in that operation, I think it is going to enhance our business opportunities throughout the Middle East.

Our Fiber glass pipe business has enhanced its operations up in the Car Sands, we have won some good contracts up there which I think are going to be very positive worldwide as you look at the heavy oil that’s been developed, whether it is Venezuela and Canada or other different parts of the world. Recently we bought a new facility, a new business in Argentina, in our Mission operation, Amano [ph]. This allow us really to be able to move product a little bit easier throughout South America which of course with Brazil and some of the things that are going on there is very important for us and we also as Clay mentioned earlier, we are opening up our new coating facility in China this quarter and we think that’s going to be very positive in our ability to both the inspect the coat pipe and casing as some of the Chinese operations start to improve dramatically. Our Brad [ph] operations, we are positioning a lot of equipment so that we can advantage of what we see as the Deep water improvements that you are going to see in the Gulf of Mexico. I think you have heard a lot of the service companies talk about deep water in the Gulf of Mexico, that’s going to start coming. We are building most of the rigs, those will start coming in at some point but I think in the next year to 18 months you will see an improvement in that Gulf of Mexico business which both our distribution and our Petroleum and Supplies Services group are well positioned to take advantage of.

I want to move now just a little bit to our rig technology and I want to talk about what’s going on around the world. Really this is an international player. As Clay mentioned earlier in our backlog today, it’s about 85%, 15% land or offshore versus land and it’s 89% international, 11% domestic. We have the international footprint that takes advantage of being able to find this equipment, put it… find the business and put the equipment into operations around the world. This isn’t going to stop anytime soon. When you take a look at the needs of the world, we start with things like Russia and you heard me talk about Russia an awful lot on these conference calls. I think the stockmen feel it is starting to come on line. I think you are going to see some significant equipment orders there plus the Russians need to really expand their land business and their work over business which we are well suited to take advantage of. If you leave Russia and go to Korea. Today, Korea is the epicenter of the deep water rig builds, whether you are at Samsung, Daewoo or Hyundai Heavy Industries, really you are saying most of the FPSO’s [ph] and almost all of the deep water drill ships built right there. We have got a very significant operation in Korea. We are working with all the shipyards to ensure the on time and effective delivery of these rigs as they come out.

China continues to be both a great center for manufacturing for us but also a great customer. When you look at things like some of the new discoveries in the Bohai bag [ph] you look at the aggressiveness of some of these service companies like Cosul [ph] to improve their rig fleet we are positioned to number one provide them with the equipment that they need and also to be able to manufacture in China and talked about pipe coating earlier, fiber glass pipe, things like that in China that allow us to have a better competitive advantage as we look around the world. Singapore continues to be the epicenter for jack up rigs. We talked a lot about jack ups, just about every jack up rig that is delivered there will be another on ordered Singapore is very efficient in running these, up to this point in time I believe we have delivered about 19 jack up rigs and just about everyone of them has been on time, on budget. These are coming out of very significant yards like Fells [ph] and Laboy [ph] in Singapore and I believe that will continue for some time well into the future.

This past quarter we bought a new company in India, to be able to take advantage of what’s going on both onshore and offshore in India. It’s a great manufacturing centre and at the same time it allows us to support better, the rigs that we are working on the west coast of India. We think that’s going to continue to be a good area. I think most people on this call that follow the industry are aware that ONGC continues to offer tenders, they want to build some rigs and we think having Indian operations number one enhances our ability to be competitive world wide, but secondly gives us the local content that we need to be able to supply the Indian contractors and the Indian businesses.

In the Middle East, continue to be very, very aggressive. We are delivering this quarter two land rigs that will be drilling in Oman. We have a lot of opportunity in Kuwait and Saudi Arabia, you continue to see the land rig count build but more importantly you start to see the off shore account build. And also in the Middle East, a couple of ship yards have really turned in to fairly formidable manufacturers of jack up rigs. In particular MIS does a very good job, we are positioned very well with them and I think you will see a few more rigs built in the Middle East, so it will be destined for both India and Persian Gulf waters.

North Africa, probably one of the more exciting places in the world right now with Egypt, Libya and Algeria. We were delivering a lot of new rigs into Algeria. We are opening up facilities both in distribution and Petroleum Services and Supplies in Egypt and Libya. We think they will continue to be great areas, I think the thing that’s interesting about this is you will see some pipe lines built from North Africa into Europe. This will lessen the dependence on Russian gas and you will see them go into both Spain and Italy and I think it will really increase the operational opportunities in North Africa.

South America, very positive especially I will include Central America in this also. Mexico and Brazil are two very active areas. In Brazil especially we are seeing some off shore rigs being built by local contractors and they will go into the deeper waters of Brazil and again I mentioned our Argentinean acquisition and that allows us to be able to produce some things and move them into Brazil very easily because of the Mercosur and we don’t have to worry so much about trying to move product out of the United States.

So, that’s just kind of a quick run down, we think that the international arena is very vibrant, will continue to be that way. Deep water rigs are going to continue to be built and we like our position in that and I think as Clay’s pointed out, the international land market will continue to be very robust. I think the domestic land market will certainly be a little slower but the neat thing about having a nice back log is I think the best acclaimed market will improve in the near future and we are able to withstand any sort of slow down given what we are doing in other areas around the world. So that’s about it from what we see around here today. I would like to now at this point in time Matsia [ph], turn it over to you for any questions that our listeners might have.

Question and Answer

Operator

Thank you Sir. [Operator Instructions]. Our first question is from Jim [inaudible] with Lehman Brothers. Please go ahead.

Unidentified Analyst – Lehman Brothers

Good morning and nice quarter.

Clay C. Williams – Chief Financial Officer and Senior Vice President

Thanks Jim

Unidentified Analyst

Pete, in terms of floating rigs that have been ordered from the yards but they haven’t yet place your equipment packages. Are we talking at about 10 units?

Unidentified Company Representative

Yes, Jim it’s a tough number to tell you on some times because there’s some options that are sitting out there and we are not sure that when those options will be exercised but I would say certainly there’s going to be 7 to 10 that are still sitting there that are announced right now.

Unidentified Analyst

And do you think on the 12 months basis that 18 to 24 new floating rigs orders is a reasonable range?

Unidentified Company Representative

You know I would be reluctant to answer that. Clearly from what we have seen and from what some of the demands are I can’t argue with the number but I don’t know that I’d pound the table and support it either.

Unidentified Analyst

Okay. Clay,question for you, and Heinz on the last call, when asked about the your U.S. operations the key managers said, I am paraphrasing here but there would be no degradation in U.S. pricing and there were few areas where we could move pricing up modestly with single digits over the next quarter. Did you in fact move prices up in some of the areas and how has there been no degradation?

Clay C. Williams – Chief Financial Officer and Senior Vice President

No we did, we have pushed prices up, its been fairly limited though Jim and, but we have moved prices up, kind of here and there, is definitely getting a lot tougher out there though and a lot of our comments with regards to North American market reflect not what we saw in the third quarter but rather kind of looking more forward into the fourth quarter. We do know drilling contractors are starting to cut back on what they are spending and it’s just getting a little tougher out there so, are expecting it, we are going to work hard to hold prices and do our best but, it from a pricing environment standpoint its getting tougher.

Unidentified Analyst

Okay, how do your margins differ in distribution, international versus domestic?

Clay C. Williams – Chief Financial Officer and Senior Vice President

They are better in international markets.

Unidentified Analyst

Are they a lot better?

Clay C. Williams – Chief Financial Officer and Senior Vice President

Now, pretty close.

Unidentified Analyst

Okay.

Clay C. Williams – Chief Financial Officer and Senior Vice President

Pretty close and it varies a lot. We have a lot of start up expenses flowing through our international expansion. So, I’m kind of normalizing for some of that in ’08. But they’re pretty comparable.

Canada, you know continues to be challenged from a margin perspective because the business is soft up there. But I think international business and the domestic business are comparable.

Now in Q3 domestic business ticked down a little bit due to some of the market developments that I just referred to with slower drilling contractor expenditure.

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

And the other thing Jim, that’s nice on international business especially in distribution, is that normally when we’re expanding, we’re expanding with some of our better customers. And so it’s much more of a deal where we’re going in on an integrated process and it’s not necessarily three bids and a buy like you will see a lot in the United States. So, it’s a little bit more solid business that gives is a little bit more, longer term visibility.

Unidentified Analyst

Okay, got you and last question. Pete, from where you sit would you expect the high drills, BOP business to be sold this quarter before you’ll end?

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

Jim, I can’t answer that. That’d be something you’d have to ask other folks.

Unidentified Analyst

Alright guys, thank you.

Operator

Our next question is from Dan Pickering with Tudor Pickering, please go ahead.

Dan Pickering – Tudor Pickering & Co. Sec.

Good morning guys.

Unidentified Company Representative

Good morning Dan.

Dan Pickering – Tudor Pickering & Co. Sec.

Clay, I think in your comments you sort of implied revenue from rig technology backlogs at about 2 billion level or so. I’m just wondering where your capacity is headed. I mean you’ve done a great job of being able to get more products out the door. As we look into 2008, I mean where does that kind of quarterly revenue capacity trend toward? Are we leveling off here or will it continue to improve?

Clay C. Williams – Chief Financial Officer and Senior Vice President

Our expectation Dan is that it should continue to improve. We have a terrific team running that business and if you look back over the past three years of results what you see is that revenue, particularly revenue out of backlog which is reflective of the big Cap accumulative we’re selling is up nearly fourfold from a first quarter 2005. So, they’ve done a great job and our expectations are going to continue to push it higher. Obviously it gets more challenging as we go further but we have a super team there.

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

Dan and I might also add that we’ve made a lot of riffle shot type of investments and acquisitions you know. As Clay, mentioned we made $50 million worth of acquisitions. And a lot of these are for small operations that they give us, better control of our processes and give us control of our products that we need to be able to expand and get the equipment out of the door quicker.

So, I think you will continue to see us make these sorts of investment are not huge but at the same time they really allow us to get a lot more throughput in our business. So, we just recently opened some new facilities in Norway that really have expanded our ability to get product out there. We bought a gear company here in town that gives us the opportunity to be able to manufacture some of our products a little faster. So, you’ll see us continue to do that sort of thing to be able to enhance our capacity.

Dan Pickering – Tudor Pickering & Co. Sec.

Okay, so 15% to 20% from here is not a stretch it sounds like given the measures you’re taking?

Clay C. Williams – Chief Financial Officer and Senior Vice President

Well we’re going to stop short of quantifying as per our policy but you know we feel pretty good.

Dan Pickering – Tudor Pickering & Co. Sec.

Okay and then as we look at the kind of spares in the after market business it sounds like this Middle East jacking system was a fairly big job. As we looked historically, you know you were down in third quarter versus second last year and then down in the fourth. Are you expecting some… is there seasonality to this business or should we be thinking about the non backlog part of the business as kind of flattish for the next couple of quarters?

Clay C. Williams – Chief Financial Officer and Senior Vice President

Well I don’t… we probed the question of seasonality a little bit and haven’t really found a compelling story there. I think this was more a case of North American drilling contractors cutting their expenditures, Dan. And that’s being replaced off shores so there’s kind of a big makeshift going on. That business as you know kind of moves in shifts and starts but we feel pretty good about the long run development there as we continue to ship more big capital equipment out and grow our install base. That install base needs a lot of after market care and feeding. So, we’re very optimistic about the future.

But it was a big jacking rebuild project. The sequential impact was only ordered about 12 million sequentially.

Dan Pickering – Tudor Pickering & Co. Sec.

Okay. Great that’s my Q. thank you.

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

Thanks Dan.

Operator

Thank you. Our next question is from Marshall Adkins with Raymond James, please go ahead.

Marshall Adkins – Raymond James

Clay, you out did yourself on that overview, never thought I’d hear myself say that.

Clay C. Williams – Chief Financial Officer and Senior Vice President

Thank you.

Marshall Adkins – Raymond James

I want to follow up on Dan’s question a little more detailed than that. Kind of as you look out to ’08 and really even ’09, I kind of always visualize that non capital stuff is pretty high margin stuff and with the higher installed base you have that you know that should be higher than average growth, long term. I mean not talking next quarter or next two quarters but you know next couple of years. Give me some help on kind of what we should look for in terms of revenue trends and margin trends as it breaks down between the non-capital and the capital. Should we see revenues continue to grow on the non-capital long term because of the higher install base?

Clay C. Williams – Senior Vice President and Chief Financial Officer

Yeah, that’s certainly our expectation and if you drive around Bellville, on the north side of town you see our big investment that we made in that vision in our new after market service facility. We have a 400,000 square foot repair maintenance and a after market service facility that we opened there this summer. So, we feel pretty good about the directions that it’s going. You are right Marshall, the margins are better on the after market business than the capital equipment. But I’ll add that the capital equipment has closed some of the GAAP here over the past couple of years as well.

But the basic equipment that we’re selling into the oilfield is getting increasingly more sophisticated, there’s a lot more electronics creating that equipment, on board PLC chips and single board computers and things that take a high level of sophistication in training and experience to be able to manage. And so, our expectation is that installed base of more sophisticated rigs grows that the opportunity set for NOV will grow along with it.

To that end we’re also investing in people. We’ve grown our honorary rig service technicians within the rig technology grew pretty dramatically. It’s more than doubled since the merger. Today we stand at about 900 of those folks and we expect to continue to grow that. We have over 100 folks that are coming on board here soon and we’re going to be investing heavily in their training to repair this equipment.

Marshall Adkins – Raymond James

Okay, that’s helpful. The PS&S side question here. PS&S side obviously just had a great quarter and you mentioned you know part of it is the acquisitions NQL and Gammaloy have started to merge. I kind of think of that business as rig count driven, global rig count driven. Obviously you’re doing a whole lot better than that. So, you know again, not this next quarter or next two quarters but longer term out two, three, four years is that a business that can keep growing faster than the rig count?

Clay C. Williams – Senior Vice President and Chief Financial Officer

I think so and Marshall one of the things I was trying to emphasize in my opening comments was the fact that we’ve tried to consciously and deliberately position ourselves in businesses that have high secular growth trends above and beyond the rig count. And horizontal drilling is a great example. So, within PS&S our mission group is selling more fluid in modules and liners for mud pumps because there is more hydraulic horse power going into the oilfield.

Our downhole tool business is much the same thing. That business sells the coil tubing strings that are the consumable used in coil tubing operations. So yeah, we’ve tried to tie ourselves to things like horizontal drilling and coil tubing operations, compositive pipe of waste management with our Grant group rig instrumentation with Mark and Decker [inaudible]. I think if you look back at PS&S versus the rig count, what you’re seeing is that strategic positioning of NOV in businesses that should grow faster than the rig count.

Marshall Adkins – Raymond James

So, it’s not just the acquisitions it’s kind of more just the structural product lines as well.

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

Yeah and you know Marshall I think the other thing that you can add to this too is while we’re well known in our names for our drilling equipment quite frankly the names that we have in our PS&S group whether it’s MD, TODCO Mission, Tubascope, Brant [ph], those are names that every bit as well known and they have a lot of pizzazz in the market place. And I think it allows us to be able to gain a greater share as we move forward with each one of those products.

Marshall Adkins – Raymond James

Very helpful guys, thanks.

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

Thanks Marshall.

Operator

Thank you, our next question is from Kurt Hallead from RBC, please go ahead.

Kurt Hallead – RBC Capital Markets

Hey, guys. I just wanted to clarify one thing just Clay one of the things that you first mentioned. I think you first mentioned offshore mix 6.8 billion, 85% of the total. Can you just go over that one more time? I didn’t quite grab it.

Clay C. Williams – Senior Vice President and Chief Financial Officer

That is correct. 85% of our total backlog mix Kurt is off shore and it’s about 6.8 billion.

Kurt Hallead – RBC Capital Markets

And off that what’s the deepwater percentage of that?

Clay C. Williams – Senior Vice President and Chief Financial Officer

We haven’t given that. We’ve only reported the total offshore.

Kurt Hallead – RBC Capital Markets

Alright, okay. Alright and then do you have any general assessment here of you know some of the delays that were made. Are there any delays in shipyards and whether or not that impacts you know flow through on the backlogs?

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

You know Kurt at this point in time, you know there’s always a lot of conversation about delays but I think for the most part things seem to be moving through fairly well, you know when we move our equipment into a shipyard, you know we’re moving on a date specific. You know you need your mud pumps or your drill works on a certain time. So, even if the ultimate shipment of the rig might be delayed, you know maybe a month or something like that our equipment going into that rig is not delayed generally speaking. So, it shouldn’t have too much of an impact on the outflow of the backlog.

Kurt Hallead – RBC Capital Markets

Alright and on the deepwater side, I know you referenced a number of different project opportunities coming out. Would that be kind of acceleration of what you guys have already experienced to date or would that be kind of a flat line of what you already experienced in terms of… I think some of there were around 18 to 24 new floating rigs and who knows the timing on that. But 18 to 24, would that be an acceleration of what you’ve already booked or is that pretty much consistent with what you’ve booked?

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

I think what you’re looking at into the future is probably reasonably consistent with what we’ve looked at over the recent past. You know this has been a cycle that’s kind of gone. You know we talked early in the game a couple of… three years ago about jack-ups and we said it would ultimately move to the floaters which it’s done, continued to have jack up inquiries and I think then in the last 18 months you’ve seen the acceleration of the floater inquiries and I think over the next 18 months it will probably be reasonably similar to what we’ve seen.

Kurt Hallead – RBC Capital Markets

Thanks, probably like when you slice and dice your different rig technology businesses, so pretty consistent on floaters, the jack-ups are going to come off what you’ve experienced just in sheer numbers, land business in U.S. obviously down. And then international I think in the past, you said the international business should offset the drop in North America, is that still kind of the consistent view point?

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

Yeah, I think so. I think it’s the issue you know I said about the international business is that it comes online a little bit slower. I mean the tendering process is more arduous, takes a lot longer time but I think that what we’re seeing out there and what our market intelligence tells us is that there is enough business there that will probably offset what you lose in North America.

Kurt Hallead – RBC Capital Markets

Alright and then the last thing I just want to follow up on was you know, my understanding is that a lot of your employees are taxed in a good way. And you know I’m finding it difficult to keep up with the business flow that’s coming through the door. You know can you just discuss some color on how you maybe, if that’s true. If it’s true, how you’re addressing it? And secondly is it causing some issues with potentially some of your customers walking across the street trying to get some things quicker?

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

You know, I think… I feel very good about what we’re doing with folks. You know we know the areas that we did the expansion. I think Clay mentioned earlier, you know we’ve got over 900 folks in the service arena. We probably will bulk that up by another 400 over the next year. We’re doing a lot of different things on training. We’ve got a good employee work force and I’ll tell you what they are hitting it hard. People have hit it hard but we’re getting things out the door and you know we have competition that says they can get it out the door quicker but frequently we find out that they cannot. So, we feel very good about where we are. And we also feel very good about the processes and the programs that we have in place to bring in new employees, to bring in younger employees and to keep re-invigorating the companies. So, we don’t view that as a huge issue.

Kurt Hallead – RBC Capital Markets

Great, thanks.

Operator

Thank you, our next question is from Ole Slorer from Morgan Stanley, please go ahead.

Ole Slorer – Morgan Stanley

Thank you very much. You got your hands full now and there are a lot of new customers ordering rigs. Could you talk a little bit about the process of commissioning these rigs once you’ve delivered equipment and getting them up and running and accepted by the customer. Are you involved in that process and what do you think the efficiency will be in some of these rigs when they start drilling?

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

Ole, we are very deeply involved. You know some of our customers don’t necessarily want us to do the installation and commissioning. And so then they don’t necessarily bring us in right at the start but the vast majority of the rigs that we’re seeing today, we basically are quoting those with installation commissioning. We, as I mentioned earlier the size of our service organization right now, 900 bulking that up to about 1,300 to 1,400 and everyone of those folks can ultimately be involved in installation and commissioning. We’ve increased our [inaudible] group in Korea substantially. We’ve doe a very good job already in Singapore. We’ve, I think I mentioned earlier that there were 19 jack-ups that we’ve already delivered. Those have come out very, very well.

And the neat thing about a lot of these drill shifts is and which I really have to applaud the industry on is that we’re building things that are similar. Every drill shift isn’t different. In the past, I remember we had so many darn tweaks that it was like building a house and everything had to be done in a customized fashion. And what we’re seeing today is that we got a pretty good learning curve on installation and commissioning and it’s going much more efficiently and much more rapidly, I think than many people believe possible.

So, there will be bumps in the road Ole. No question about it but I don’t think they are going to be such bumps that are going to be material to most folks. And I feel very comfortable with the processes and the people that we have in place to address the issues.

Ole Slorer – Morgan Stanley

Yes, that’s interesting because I get some sense that some of the nightmares from the previous construction cycle… I just think that if yours had maybe suspected seems to be. The new flow seems to be very good so far.

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

I think that’s accurate and you know we’ve lived through the old cycle and if nothing else we’ve learned, we’ve learned a lot of lessons and we’re bringing those lessons to bear. But I think more importantly, really is the design that you’re seeing. I mean, if you go to Korea a lot of the designs that you’re looking at… just one right after the other is the same thing. And I think it’s like manufacturing a car, once you’ve got that down, the learning curve is very substantial. So, I feel pretty good about where we’re going.

Ole Slorer – Morgan Stanley

Interesting thanks, just one follow up question with respect to the type of customer you’re seeing… we’re sort of seeing kicked off by a lot of off shore listed companies and then back to Houston a little bit. There seems to be a new wave of Asian and National oil companies associated new players. I mean we’ve heard the announcement of ONGC and Shipping Corporation of [inaudible] and various other lines of shipping and shipping conglomerates that seem to be entering the markets. Do you sense that we maybe starting to enter sort of third type of customer group here of new players?

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

I think you’re spot on Ole. I think as you looked at this you initially started with a lot of Norwegian money. People call them speculators, I didn’t because they were very experienced at this sort of thing and they might sell but they also knew how to run rigs. And then I think you had some of the U.S. based players. And now you are starting to see some of the folks whether it’s Petrobrass that want to put some local Brazilian companies into the business or in ONGC or Gazprom or some of the others you know, the national oil companies. So, I think you are seeing kind of the third wave and it’s an interesting move and those are folks that are probably less inclined to worry about an internal rate of return and more inclined to want that equipment to be there and make them look at their program and say okay, I got a 5 or 6 year deepwater program, I’m going to go ahead and build a couple of rigs to take advantage of that.

Ole Slorer – Morgan Stanley

Okay, sound good. Thank you very much.

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

Thanks Ole.

Operator

Thank you, our next question is from Robin Shoemaker with Bear Stearns, please go ahead.

Robin Shoemaker – Bear Stearns

Thank you and congratulations. I wanted to just get some clarity, Clay when you mentioned that 3.9 billion of backlogs are expected to come out in ’08 and that figure on the last quarter you gave was 2.7 and you’re now saying 2.9 billion in 2009 and beyond and last quarter it was 2.5. So, it’s the vast majority, three times the backlog addition in ’08 compared to ’09 and beyond. It’s kind of curious to me because I would have thought the big wins and the big additions to backlog would’ve been in drill ships and semis for delivery in late ’09 and ’10 but the big backlog growth here was for ’08 delivery.

Clay C. Williams – Senior Vice President and Chief Financial Officer

That’s a good question Robin and it has to do with the difference in revenue recognition between the two types of ways we recognize revenue. The larger, offshore, more complicated projects we recognize on a percentage of completion basis. So, we will recognize revenue pro-ratably as we spin costs on those projects. Not necessarily tied to when the equipment is delivered.

Robin Shoemaker – Bear Stearns

Okay.

Clay C. Williams – Senior Vice President and Chief Financial Officer

And then the more standard type commodity of equipment that we manufacture multiple copies of we deliver on a completed contract basis. We recognize all the revenue on the day that those are shipped out.

Robin Shoemaker – Bear Stearns

Okay my other question is unrelated to that… is that I haven’t heard you say much about the acquisitions opportunities for NOV and clearly the acquisitions machine was working very much in overdrive a few years ago and it’s kind of slow that you got tremendous capabilities with your current balance sheets. So, what is the landscape of acquisitions look like today versus few years ago?

Clay C. Williams – Senior Vice President and Chief Financial Officer

They look good. We’ve been frustrated I would say a little bit for the past couple of years with pricing. And we’re very patient as you know. And have participated in a lot of auctions and looking at potential acquisition opportunities but have been a little bit conservative on pricing and we’ve seen a lot of competition from new private equity players enabled by very aggressive lenders. Obviously that’s a change in the past several weeks with the downturn in the credit markets so we’re pretty optimistic that these may bring a lot of these potential deals down a little closer to earth.

But Robin I also want to correct a misconception that you may have, we have been very busy on acquisitions. We’ve closed four since Q2; we’ve closed another four in Q2. These though have generally been smaller deals as I mentioned, we only spent $50 million during the third quarter in acquisitions but if you worked on acquisitions you’ll know that some of the smaller deals take as much time and hard work as the big ones. So, we’re going to continue to be patient and be disciplined in our required financial returns but we very much plan to use acquisitions, continue to use acquisitions as a strategic tool to build NOV.

Robin Shoemaker – Bear Stearns

Okay, alright. Thank you.

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

Thanks Robin.

Operator

Thank you, we have time for one final question. That question is from Roger Read with Natexis, please go ahead.

Roger Read - Natexis Bleichroeder Inc.

Good morning gentlemen. Clay back to the question on the margin side as you look between after market and new equipment and you know pretty impressive margins here in the third quarter what takes the margins higher or into the mid 20% range or where you indicated the incremental as sort of a mid upper 20’s the right way to think about it. I mean is there a way to push pricing on after market? Is there a way to push manufacturing efficiencies on either side? What pushes that going forward?

Clay C. Williams – Senior Vice President and Chief Financial Officer

I really think continued good cost management is going to be the key to further margin expansion. And we feel pretty good about that. Like I mentioned we have a great team. You know we sort of lump all this stuff together but bear in mind there’s a lot of difference in contributions across the very broad mix of products that we sell.

So, on the high end there’s a very sophisticated drilling system and top drives and rackers and iron rough nicks [ph] and pipe handlers drive the best margins but we also build a lot of led pits and sub structures and [inaudible] and we also have capacitors. We sell cad engines and capacitors to our customers as well. So a lot depends on the mix of the equipment overall. But all of that is being well managed and I think continued improvements in cost and manufacturing will be the key to further margin growth from here.

Roger Read - Natexis Bleichroeder Inc.

Okay and kind of a follow up to that, given the shift to a way predominantly off shore and international; are the margins such on your international off shore orders that that’s favorable to more margin expansion or unfavorable?

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

You know that’s not really either one. It’s pretty consistent you know when you talk about a mud pump whether it goes on land or off shore that doesn’t make a whole lot of difference. We probably have a little some of the off shore stuff has a little bit more of the lower margin things such as cranes you know that’s a pretty competitive business. But I think overall the mixes and such that it would make a whole lot of difference in modeling.

Roger Read - Natexis Bleichroeder Inc.

Okay, so it comes down to execution internally more than anything else at this point?

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

Absolutely.

Roger Read - Natexis Bleichroeder Inc.

Alright then, thanks.

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

Thanks Roger.

Operator

Thank you and at this time I will turn the call back over to Mr. Miller for any closing remarks.

Merrill A. Miller, Jr. – Chairman, President and Chief Executive Officer

Thank you [inaudible] and I appreciate everybody that called in and listened in and I look forward to talking to you again. We may have a call most likely in February with our year end results. Thank you very much for your interest.

Operator

Thank you. Ladies and gentlemen this concludes the National Oilwell Varco third quarter 2007 earnings conference call. If you would like to listen to a replay of today’s conference call [Operator Instructions]. We thank you for your participation today, you may now disconnect.

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