Smith International, Inc. Q1 2008 Earnings Call Transcript

Apr.22.08 | About: Smith International (SII)

Smith International Incorporated (SII) Q1 FY08 Earnings Call April 22, 2008 11:00 AM ET

Executives

Doug Rock - Chairman of the Board and CEO

Donald McKenzie - President and CEO, M-I SWACO

Margaret K. Dorman - Sr. VP, CFO and Treasurer

Analysts

Scott Gill - Simmons & Company

Robin Shoemaker - Bear Stearns

Jeff Tillery - Tudor Pickering

Michael LaMotte - JPMorgan

William Sanchez - Howard Weil

Geoff Kieburtz - Citigroup

Charles Minervino - Goldman Sachs

Operator

Good morning, ladies and gentlemen and welcome to the Smith International Incorporated first quarter 2008 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, Chairman and Chief Executive Officer. Mr. Rock, you may begin.

Doug Rock - Chairman of the Board and Chief Executive Officer

Yes, thank you, Rosa. Good morning and welcome to the Smith International first quarter 2008 investor conference call. I'm Doug Rock, Chairman and CEO of Smith and speaking today are Don McKenzie, who is President of M-I SWACO; and Margaret Dorman, our Senior Vice President and Chief Financial Officer of Smith.

This morning Margaret, Don, and I will speak 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. Time permits, you can re-queue and ask more later in the call.

Now, let's talk about Smith's first quarter 2008 results. Again our primary growth came from outside North America. Combined Eastern Hemisphere and Latin America revenues were up 24% year-on-year, while North American revenues grew 4% over the same time frame. Overall, Smith's revenues of $2.37 billion grew 12.5% year-on-year and our Oilfield segment revenues which exclude Wilson distribution revenues grew 15.4% year-on-year.

In sequential quarter, Smith revenues grew $74 million or 3.2%. In the first quarter of 2008, non-North American revenues were 61% of Oilfield segment revenues, up from 56% revenues a year ago. Non-US revenues were 66% of Oilfield segments sales for the first quarter 2008. Also for the first quarter 2008, Europe/Africa/CIS revenues were 32% of revenues for Smith, just 2% short of our US total, which means that Europe/Africa/CIS could soon become our largest operating area if US gas drilling doesn't accelerate further.

EBIT margins grew both sequentially and year-on-year with Oilfield margins of 20.1%. We had a 60 basis point sequential quarter margin growth. The results of a highest Oilfield margin Smith has recorded since the early 1980s. Due to the geographic revenue mix, our tax rate was up 60 basis points from last quarter which reduced our comparable earnings by $0.01 per share.

During the first quarter 2008, we also saw a 38% decline on drill pipe sales compared to the fourth quarter 2007. Because we don't manufacture drill pipe and sell drill pipe as an agent, our margins are lower on drill pipe and other products. We currently see some recovery in drill pipe sales in the second quarter 2008 but not back in the fourth quarter 2007 levels. Without sequential drill pipe sales decline Smith Services revenues would have increased 5% sequentially and 14% year-on-year.

With our worldwide Oilfield revenues for the first quarter 2008 15.4% and the rig count up 2% from the same period, we continue to meet our long-term objective of growing our revenues at 10% to 15% faster than the overall rig count. We are able to do this because of our higher exposure to technically challenging drilling, such as offshore and deepwater wells, deeper natural gas wells, extended rich directional wells, unconventional natural gas place and high temperature, high pressure wells.

Our fast growth market segments are Environmental Solutions, Wellbore Productivity, Borehole Enlargement, Managed Pressure Drilling, Wellbore Departure, Multi-zone Completions and Control Drilling Systems further allow us to exceed overall market growth projections and also grow margins in relatively flat markets.

Looking at our area markets, Latin America stood out with sequential quarterly growth of 7% and the year-on-year quarterly growth of 54%. Year-on-year Mexico, Brazil, Columbia, and Argentina, all grew better than 35% and sequentially, Venezuela grew the fastest with Brazil and Argentina close behind. Next, Europe, Africa, and CIS grew 25% year-on-year and 3% sequentially. The Former Soviet Union, Norway and Africa had a strongest growth in this area. In the Middle East, Asia-Pacific growth was somewhat less, although we had significant year-on-year growth in Saudi Arabia, Qatar, China, India and Malaysia. The sale of our business in Oman mid last year decreased the comparable growth rates in this area by 7% year-on-year. In the North America, Canadian sales were up 9% sequentially but down 12% year-on-year, while US sales were flat sequentially and up 7% year-on-year.

Based on higher natural gas prices, if 2008 has a reasonable upside from our current revenue earnings expectations, I think it will come from North America. The Smith US rig count is currently near 22-year high, and if natural gas prices are sustainable between $9 and $10 per Mcf and as you know today there are in the mid $10 range, I'd expect another 100 plus rigs to be operated in US by 2008 year-end. I'd also expect the fast recovery of Canadian drilling from spring break-up. We'll know that answer in the next few months. For now we are staying with our current 2008 earnings guidance until we see how the year further unfolds.

Looking to the second quarter 2008, we know two things for sure. First, Canadian revenues will be down to the spring break-up and second, the rest of the world's revenues will be up, whereas the rest of the world is up enough to compensate for Canada's approximately $100 million anticipated sequential Smith quarterly revenue decline we'll have to see. However for the last five years, the rest of the world's growth has been greater than Canada's decline for the second quarter, that's why we've had 21-consecutive quarters of earnings growth and revenue growth. From a people productivity standpoint, first quarter revenue per employee at $475,000 per employee per year was up 1% sequentially and flat year-on-year. We ended the first quarter with 20,056 full-time employees, as we added 310 people outside of North America and had a reduction of 121 employees in North America. We expect to further improve people productivity this year, primarily through revenue growth as we'll keep adding people and expanding markets.

Looking at the individual Smith operating units; M-I SWACO had 19% year-on-year revenue growth, led by excellent growth in Production Chemicals, Environmental Solutions and Wellbore Productivity. Smith Technologies year-on-year growth was 13%, with higher growth rates in our GeoDiamond and Borehole Enlargement product lines.

At Smith Services, both the completion systems and drilling product groups had revenue growth in excess of 20% year-on-year and combined sequential growth of 9%. And Wilson had a solid quarter with record revenues of $568 million and a 110 basis point improvement in margins over the fourth quarter 2007.

In summary, the 2008 is off to a solid start, with operating earnings of 15% year-on-year and 5% sequentially. We look forward to an acceleration of earnings in the second half of 2008, led by an expected six to seven consecutive quarter in delivery of new build offshore rigs and awakening land drilling market in North America.

Now, Don MacKenzie has some comments.

Donald McKenzie - President and Chief Executive Officer, M-I SWACO

Thank you, Doug. Good morning. I am going to discuss M-I SWACO. First, I will make some overall comments, address the deepwater market, and then the individual business segments.

First quarter revenues for M-I SWACO were $1.2284 billion approximately 3% higher than the fourth quarter of 2007 and 18.7% higher than the first quarter of 2007. The M-I SWACO global rig count increased to 152 rigs or 3.7% from the fourth quarter to average 4598 rigs. Compared to the first quarter of 2007, the rig count increased by 326 rigs or 7.6%, 285 on land and 41 offshore. Approximately 72% of the growth in land-based rig and 100% of the growth in offshore rig occurred outside North America. The total offshore revenues for M-I SWACO were $601 million for the first quarter. This is an increase of 4% from the prior quarter. The offshore count was up 12 rigs or 2.1% and average 580 rigs for the quarter.

North American revenues grew by 5.2% versus a rig count increase of 5.2 and accounted for approximately 46% of a sequential growth from the fourth quarter of 2007, about 89% of the North American growth came from offshore. Compared to the first quarter of 2007, North American revenues were flat, while the rig count increased 3%.

Latin American revenues increased to 5.9% in the sequential quarter and 60.6% compared to the first quarter of 2007. The rig count in this market was flat sequentially but 13% year-over-year, Venezuela, Columbia, Ecuador and Trinidad accounted for the bulk of this sequential growth, while Mexico was the primary driver of growth versus Q1 '07.

The Eastern Hemisphere revenue grew 1.6% sequentially and 22.7% annually and accounted for approximately two-thirds of our total growth compared to the first quarter of 2007. The Eastern Hemisphere now accounts for 57.4% of total M-I SWACO revenue. Rig count for the total Eastern Hemisphere increased 2.4% and 13.3% for the quarter and year-over-year comparisons respectively.

Now let's look at deepwater. The average number of rigs operating in the US deepwater market increased by 13.5% in the first quarter. The rig count engaged in drilling and completion operations averaged 38.6 units. The increase of 4.5 rigs from the fourth quarter was primarily due to the move into the Gulf of Mexico from South America. Of the 38.6 rigs, 76% were engaged in drilling operations, while 24% were engaged in work over and completion operations. M-I SWACO serviced an average of 21.6 of the total as compared to 18 rigs in the fourth quarter and generated revenues of $80.2 million. This was an increase of $12.2 million or 18% from our US deepwater revenues in Q4 '07.

The international deepwater market averaged 62 rigs during the quarter, down 4 rigs from the fourth quarter. Our international deepwater revenues were $73 million, down 13.3% compared to our fourth quarter results due to completion of various projects and the move of several rigs to shallow water.

Now, I will review M-I SWACO's new technology revenues. Premium fluid revenues, which include all of our high performance synthetic and water-based fluids, were $109 million for the quarter, which is a decrease of $16.8 million from the fourth quarter of 2007. Total synthetic revenues for the quarter were $86.5 million, up $13 million or 17.6% from the fourth quarter. After an outstanding fourth quarter, ultra drill revenues decreased by $74% as projects in a number of locations were completed. In comparison to the first quarter of 2007, ultra drill revenues were up 6.6%. WARP revenues were also down significantly in the first quarter, but flat compared to the first quarter of 2007. The first quarter has historically been the lowest for WARP due to winter maintenance in the North Sea. New technology revenues, which are generated from technologies that is less than five years old, were $242 million for the quarter, that is down 11.3% from the fourth quarter and up 12.6% from a year ago.

Now I will discuss the product segment; our Fluids segment revenue, which includes drilling fluids, federal wholesale and production chemicals, was $820.8 million for the first quarter of 2008. First quarter revenue increased $45.8 million or 5.9% from the fourth quarter of 2007 and $129.5 million or 18.7% from the first quarter of 2007. North America, the North Sea and the Caspian accounted for the bulk of the sequential growth.

The Environmental and Process Solutions segment, which includes drilling waste management, solids control equipment, pressure control, and produced water. First quarter revenue was $251.4 million flat with the fourth quarter of 2007. Compared to the first quarter of 2007, revenues grew 23.5% or approximately $47.9 million. All of the growth occurred in the international markets.

Our Wellbore Productivity segment includes reservoir drilling fluids, completion fluids, specialized tools, and filtration equipment and services. Revenues were $156.3 million for the quarter, which was a decrease of 4.3% versus the fourth quarter of 2007 and was a result of reduced completion activity in the North Sea, the Caspian and the Middle East. Compared to the first quarter of 2007, Wellbore Productivity revenues increased 11.4%. In the coming quarters, we expect to see continued growth at M-I SWACO. Activity in our international and deepwater Gulf of Mexico markets continues to be strong and we should continue to see improvement in the North American land market.

I will now turn the call over to Margaret.

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Thanks, Don. Good morning, everyone. We're pretty pleased with how the quarter unfolded and leave it more to good start to the year. I'll finish up our prepared comments this morning covering the quarter's financial details.

Just to summarize, first quarter results were $175 million or $0.87 per share. Earnings grew 5% sequentially and 15% year-over-year after taking into consideration the $0.04 non-recurring tax gain recorded in the March '07 quarter. The year-over-year profitability improvement was driven by Smith Oilfield segment operations, which saw earnings expansion of 17%. Exceptionally strong non-North American growth supported by more than 40% growth in FSU business volumes. Higher activity levels in the Norwegian sector of the North Sea and more than 50% growth in Latin America influenced by the increased number of land-based drilling programs in Mexico, Brazil and Argentina contributed to the year-on-year earnings expansion.

On a sequential quarter basis, the earnings improvement was put equally between the Oilfield and Distribution segment. Improved financial performance from the Distribution segment, which reported revenue growth of 8% with significant earnings growth over the fourth quarter's levels, had a favorable impact on Smith's bottom line.

Oilfield business lines also reported revenue and earnings improvement over the December quarter, influenced by increased spending by operators in the deepwater Gulf of Mexico, the Caspian and the North Sea market. Higher demand for based fluids, waste management equipment, our new third generation Rhino Reamer tool accounted for just over 90% of the sequential Oilfield segment revenue growth.

As usual, I'll briefly cover the Smith Technologies, Smith Services and the distribution unit. Smith Technologies had another outstanding quarter. Revenues were $275 million, 13% above the prior year period and 3% higher than the December quarter. The year-over-year improvement was supported by 15% growth in drill bit volumes and strong demand for our third generation Rhino Reamer tool, which features our first Integrated Dynamic Engineering Analysis, or IDEAS, generated balance cutting structure, which has provided superior performance for operators in a number of offshore drilling applications.

From a sequential quarter perspective, the majority of the increase was driven by the performance of our North American operations, which benefited from the seasonal pick-up in Canada, increased demand in US offshore market for borehole enlargement tools and to a lesser extent pricing.

The sequential comparison was also influenced by the inclusion of a number of Eastern Hemisphere export orders in the fourth quarter, which didn't recur in the March period. Excluding export orders, Smith Technologies revenue grew 5% over the December quarter, with relatively balanced growth generated in both the North America and the international market.

On the pricing side, we believe we've realized a reasonable portion of the US price list increase implemented in mid January which also helped contribute to the sequential earnings growth. Smith Services reported revenues of $300 million, 6% higher year-over-year, however about 4% below the December quarter. Those comparisons were impacted by the significant decline in the level of drill bit shipment from last quarter, as pipe volumes continue to be lumpy period to period. Excluding the impact of lower margin drill pipe sales, which we currently expect will improve modestly in the June period we saw 14% year-over-year and 5% sequential growth in the third for the G&A.

The year-over-year core business growth was influenced by increased demand for higher relative margin business lines including premium tubular products, HYDRA-JAR tools and high performance completion equipment. Sequentially, we were favorably impacted by new contract awards in Latin America and increased market penetration in the West African market.

The Distribution segment also had very good results in the quarter, year-over-year revenue growth of 4% and at 8% the best sequential growth of any of our units. The improvement over the March 2007 period largely resulted from strong demand in the industrial and downstream sector of the business, which grew 10% over the prior year period, combined with the increase level of midstream capital projects.

Sequentially, the seasonal increase in Canadian activity levels, as well as increased customer spending in the LNG and mining sector, and a higher level of refinery and petrochemical turnaround activity all contributed to the Distribution Group's strong top line growth.

In the supplemental data schedule that accompanies the release, we've included the consolidated geographic revenue breakdown for the relevant periods. Excluding the impact of the distribution revenues, our North American and international split for the first quarter was 39% and 61% respectively.

Let me make just a couple of high level comments on the income statement, starting with operating income. Consolidated earnings before interest and taxes totaled $379 million or 16% of revenues. Consolidated EBIT improved $23 million over the December 2007 period and overall margins expanded about 50 basis points. Smith's Oilfield operating earnings totaled $361.5 million, translating into operating margins of 20.1%, the highest level achieved this cycle. Margins grew 60 basis points on a sequential quarter basis and 20 basis points above the March '07 quarter, making Smith the only company in our peer group that's reported so far that's been able to expand margins on a year-on-year basis.

Sequential incrementals were 50% influenced by the replacement of the lower margin passthrough drill pipe sales and Smith Services with a higher relative margin product mix and the significant improvement in profitability levels in M-I Mexico which had a very poor December quarter. Year-over-year incrementals, which I generally prefer to speak to you, were 21% much stronger than the 90% year-over-year incrementals posted in the December 2007 period, with each of our Oilfield units contributing with solid margin expansion.

Operating margins in the Distribution segment improved to 110 basis points in the first quarter. Operating income increased to $29 million, $8 million higher than the fourth quarter on revenue growth about $41 million. The sequential incrementals were influenced by improved tubular product pricing and a favorable sales mix in our industrial and downstream operations, driven by higher margins MRO business volumes related to plant turnaround.

Operating cash flow or EBITDA for the Distribution segment increased to just over $30 million in the March 2008 quarter or $122 million if we annualized first quarter's results. Operating margins for the Distribution segment improved to 5.1% in the first quarter with the energy sector margins for Wilson currently in the 9% range. As for the rest of the income statement, net interest expense was in line with the December quarter, reflecting the reduction in average debt levels during the latter part of the period.

On the tax front, our effective tax rate was 32% slightly above the fourth quarter's rate due to the expiration of a US research and development credit at year-end and a slightly unfavorable shift in geographic earnings. While changes in the geographic distribution, the earnings will continue to drive increases and decreases in our quarterly rate. We believe our tax rate for the 2008 fiscal year should remain in the 32% to 32.5% range.

Detailed balance sheet information has been included as part of the earnings release so I'll just make a few brief comments. Our balance sheet remains very strong. We added just over a $150 million of net working capital in the quarter, influenced by a couple of days deterioration in our receivable collections which would expect to improve in the June quarter and a slight inventory build to support upcoming customer projects. Even with a higher required investment working capital, we generated excess cash approximately $70 million last quarter. Over the past 12 months, we've been able to reduce debt levels by $230 million. At the end of March, totals debt approximated $916 million in debt-to-total capitalization stood at 19%, a 210 basis point decline from the December level.

Net capital spending in the March quarter totaled $60 million, materially below the fourth quarter's amount, driven by the timing of rental tool additions in the Smith Services operations. After eliminating our minority partner's interest in capital additions, capital spending approximated $45 million for the quarter. Depreciation for the first quarter was $52.6 million, which translates $40.5 million after considering our minority partner's interest. Looking forward we believe spending for 2008 will come in around $320 million to $330 million on a net basis which is the CapEx number you see on the cash flow statement. We believe that 2008 spending forecast compares to full year depreciation and amortization estimate of $215 million.

So with that, I will hand the call back to Rosa for questions.

Question And Answer

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions). Our first question comes from Scott Gill from Simmons & Company. Please go ahead.

Scott Gill - Simmons & Company

Yes, good morning.

Doug Rock - Chairman of the Board and Chief Executive Officer

Hi, Scott

Scott Gill - Simmons & Company

Margaret, my first question for you is you are walking through the year-over-year revenue growth in bits and reamers, I thought I heard you say 15%. You also talked about higher prices. Yet technology is only registering revenue growth of up 12%. Can you kind of walk us through the difference in those numbers?

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Yes, Scott, I think the number was 13%.

Scott Gill - Simmons & Company

13?

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Yes.

Doug Rock - Chairman of the Board and Chief Executive Officer

Yes. So essentially what we are saying is that the diamond bits and the bottom stuff grew faster than the cone bits because it averages out to 13 and those grew 15.

Scott Gill - Simmons & Company

Okay. And Doug for you on Brazil we seem more than a handful of a new build deepwater rigs get contracted into that market. I was wondering if you could talk a little bit about your prospects for the drilling fluids business in Brazil and just kind of refresh our memory as to what your current market share is in that market?

Donald McKenzie - President and Chief Executive Officer, M-I SWACO

Well, this is Don McKenzie. We enjoy a significant market share in Brazil at this point and time. I think it's around 50%, but don't hold me to that number. And the contract is up coming. We've got lot of new technology fluids down there and of course, we typically do a very, very well in deepwater. We are investing in infrastructure in order to participate not only in the Petrabras work but also the IOC work. And we've got the high percentage of the IOC work that's drilling in Brazil right now. So we are very bullish on Brazil for the rest of 2008 and actually over the next five year.

Doug Rock - Chairman of the Board and Chief Executive Officer

And I might add there Scott that even our services and bit groups have a number of locations there and we're strong throughout Smith International in Brazil.

Scott Gill - Simmons & Company

Hey, Doug, if I could just follow this up real quickly, how would you rank Brazil in terms of growth market for Smith over the next three to five years, is it your top market or within the top three or four?

Doug Rock - Chairman of the Board and Chief Executive Officer

Top three or four. In the major markets, it would be the former Soviet Union, but looking out five to 10 years with the amount of work that will have to be done on two 2P Jupiter and Carioca, the new field. It will be the number one growth offshore market over the next 10 years, but those fields won't be producing for five plus years.

Scott Gill - Simmons & Company

Okay. Thank you.

Doug Rock - Chairman of the Board and Chief Executive Officer

Thank you.

Operator

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

Robin Shoemaker - Bear Stearns

Thank you. Doug, you didn't mention the earnings guidance, so I assume that the 370 to 380 you gave us at the beginning of the year is still your expectation?

Doug Rock - Chairman of the Board and Chief Executive Officer

I believe I mentioned early on that we weren't changing it.

Robin Shoemaker - Bear Stearns

Oh, you did. Okay, I'm sorry. I wanted to ask you then about your expectation of the rig count in North America perhaps increasing by a 100 rigs by the end of the year. Do you see that as kind of a stretch goal, in other words that the industry's capacity is such that that would be the kind of highest level of increase we could see? Or is that really kind of just a demand driven number?

Doug Rock - Chairman of the Board and Chief Executive Officer

Just demand driven I think.

Robin Shoemaker - Bear Stearns

Okay.

Doug Rock - Chairman of the Board and Chief Executive Officer

When you look at the neighbors the number of rigs that they have and some of the others, I think you could probably go north towards of a couple hundred rigs if gas shot up into that $11 plus range. But from where we are right now that's my best guess.

Robin Shoemaker - Bear Stearns

Okay. I think then you had a drill bit price increase in the… I think end of the 2007. Is there any other initiative that where you would you see pricing in the context of this market where we might see the rig count pick up by a 100 rigs or so either in bits or fluids?

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Hey, Robin. This is Margaret. Yeah, as I noted in my comments we had initiated a new price list on bit in mid January and things that we pick up a reasonable amount of that prices, so I think we are pretty pleased on that front. As for other price increases, we typically don't talk about those before we announced some, but it seems to us that the pricing environment across the globe and across all of our product and service lines look pretty solid at this point.

Doug Rock - Chairman of the Board and Chief Executive Officer

And clearly the more rig count growth we get the more aggressive we can be on our pricing.

Robin Shoemaker - Bear Stearns

Right. Okay. So this bit price increase in early '08 was in addition to the one you had in late '07?

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

I think we are probably talking about one and the same, it was the mid January.

Robin Shoemaker - Bear Stearns

Yeah.

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Pricing.

Robin Shoemaker - Bear Stearns

Okay.

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

I think we are talking about the same one.

Robin Shoemaker - Bear Stearns

Same one. All right. Okay. Thank you.

Doug Rock - Chairman of the Board and Chief Executive Officer

Thank you.

Operator

Our next question comes from the Jeff Tillery from Tudor Pickering. Please go ahead.

Jeff Tillery - Tudor Pickering

Hi, good morning.

Doug Rock - Chairman of the Board and Chief Executive Officer

Good morning.

Jeff Tillery - Tudor Pickering

I wanted to ask a question around Oilfield incremental margins and kind of your expectations as we get to the second half of the year. I mean seem like within M-I SWACO your margins on an incremental basis were probably hurt to a degree by SWACO being down, being flat, while insurance being down slightly and the premium influence business being a little bit slow as well. Do you think you can get incremental margins back to kind of mid to high 20% level as we exit the year?

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Jeff, this is Margaret. We don't typically talk about incrementals on a business unit basis. But again, as I talked about our year-over-year Oilfield incrementals were in the low 20s. Those improved from what we saw in the fourth quarter. And as the business mix improves going forward my expectation would be that maybe those incrementals get better.

Doug Rock - Chairman of the Board and Chief Executive Officer

Our two highest margin product areas are Smith Services and Smith Technologies. And to the extent we see growth in North America I would certainly tend to push the incrementals higher.

Jeff Tillery - Tudor Pickering

Okay. And my follow-up question is just around Mexico. I know there was some start-up cost and the floods hurt a little bit in Q4. Do you feel like you got all that back in Q1, or do you think there is a little bit of benefit left to be seen going forward?

Donald McKenzie - President and Chief Executive Officer, M-I SWACO

This is Don McKenzie again. We think that there is more benefit to be incurred. We are working with IPM in Mexico and as we work together to drill those wells faster, we're paid on a per meter basis, the margin should improve even more. So we're very optimistic about Mexico as we get into the second, third and fourth quarter of this year.

Jeff Tillery - Tudor Pickering

And my last question is for you, Don, just around petroleum price increases and how that's impacting M-I. Can you talk about your ability to either pass on those cost increases or how you deal with those?

Donald McKenzie - President and Chief Executive Officer, M-I SWACO

Well, first of all, when you talk about based oil and what not, every contract that we have is an index mechanism where we can charge it. Unfortunately, some of the indexes are trailing three months, so as the price continues to go up there is a slight impact and we've calculated that. But if the price of oil stays relatively constant or even drops a little bit, it would have a marginal impact on margins.

Jeff Tillery - Tudor Pickering

Okay. Thank you very much.

Operator

Our next question comes from Michael LaMotte from JPMorgan. Please go ahead.

Michael LaMotte - JPMorgan

Thanks. Good morning.

Doug Rock - Chairman of the Board and Chief Executive Officer

Hi, Michael.

Michael LaMotte - JPMorgan

Margaret, congratulations on top CFO by the way.

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Thank you, Michael. Thank you.

Michael LaMotte - JPMorgan

Sure. Doug, first question for you, if I think about the comment that you have been able to grow 10% to 15% faster than the rig count and given the revenue per rig numbers that you have talked about in the past for your deepwater businesses. As we go into '09, how much of an acceleration do you think we'll get in that 10% to 15% numbers, is it going to be 25% faster the rig count or more?

Doug Rock - Chairman of the Board and Chief Executive Officer

Well actually, the reality is, if we don't grow as much in North America we grow faster because a number of offshore rigs coming in, but if we grow faster in North America because the gas prices will actually moderate that growth, it will still be in that range but it won't be as high. So essentially, we'll be above that, if it's just primarily grow than offshore rigs. If the US come back it's lower than offshore rigs, but again total profitability goes up.

Michael LaMotte - JPMorgan

Okay. So the rate of change clearly North America, I mean even adding a 100 rigs from here is much, much slower than what offshore theoretically could be in '09?

Doug Rock - Chairman of the Board and Chief Executive Officer

That's correct, because the revenue per rig is so much less.

Michael LaMotte - JPMorgan

Okay.

Doug Rock - Chairman of the Board and Chief Executive Officer

The margins are higher because offshore we don't get, I mean total to the company offshore we certainly get the highest margins for M-I but we don't give the high amount of say bits, but we do get some of our Rhino Reamer's and other things from services but not quite as much as the margin improvement as M-I SWACO gets.

Michael LaMotte - JPMorgan

Okay. And Don if I missed it, I apologize production chemicals.

Donald McKenzie - President and Chief Executive Officer, M-I SWACO

Yes.

Michael LaMotte - JPMorgan

In the quarter, what was that number?

Donald McKenzie - President and Chief Executive Officer, M-I SWACO

I didn't give that number, but it was pretty significant. Do you have that Margaret?

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Production chemicals, first quarter $90.4 million.

Michael LaMotte - JPMorgan

Okay. And then sorry last one certainly on the strategic side, how is the acquisition market look today?

Doug Rock - Chairman of the Board and Chief Executive Officer

I was, quite a few properties that we are looking at right now. We buy maybe out of every 10 or 11 we look at, so we can't guarantee that we'll close any but the deal flow is very strong. We had a quite broad book on that.

Michael LaMotte - JPMorgan

Anything I mean in the past when we've seen markets look like they were going to roll over say as they looked say from December through late January, early February, that tends to sort of send a panic those that we are on the fence line for selling tend to rush through the door as they have been. First of all did that happen or was that too quick and second of all, has the recovery and mood and sentiment particularly around North America and gas oriented businesses. Have you seen a change I guess in terms of buy out buyer?

Doug Rock - Chairman of the Board and Chief Executive Officer

We haven't found any kind of sellers but if you find some, then send them our way.

Michael LaMotte - JPMorgan

But maybe a better way to ask the question is how is the deal flow compare on a year-over-year basis?

Doug Rock - Chairman of the Board and Chief Executive Officer

I think probably as strong or little bit stronger. I'd characterize it that way.

Michael LaMotte - JPMorgan

Okay. And the mix international versus domestic?

Doug Rock - Chairman of the Board and Chief Executive Officer

Mainly what we are looking at is not non-North America because we are looking primarily at technologies. But I wouldn't tell you if something came through for North America at the right price that we certainly would that.

Michael LaMotte - JPMorgan

Okay. And last one for me. Can you provide some color and context around the JV in Russia?

Doug Rock - Chairman of the Board and Chief Executive Officer

The one with Integra?

Michael LaMotte - JPMorgan

Yes.

Doug Rock - Chairman of the Board and Chief Executive Officer

Essentially when Integra was formed and then become public, we had a company that represented Smith Technologies called Smith Eurasia and it was formed by a guy named Mark Sadykhov who was a former employee of ours, and we rolled that right into Integra and he also had some drilling stuff. So we actually did a little venture with Integra to start up a directional drilling, Smith drilling services in Western Siberia and then we have added to that to do some rental equipment and some other types. But it's not… we do business in Russia in many ways. We bought these couple companies with M-I, we do most of our business direct with the Russian production companies. We also work through companies Integra, it's such a large market and world market, it's just one of the multiple ways where we do business.

Michael LaMotte - JPMorgan

With the growth in re-entry in Western Siberia in particular now, is the Smith Eurasia the principal avenue to address that growth or as you say could become multiple?

Doug Rock - Chairman of the Board and Chief Executive Officer

It's one of the multiple avenues.

Michael LaMotte - JPMorgan

Okay, great. Thanks.

Doug Rock - Chairman of the Board and Chief Executive Officer

Thank you.

Operator

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

William Sanchez - Howard Weil

Good morning.

Doug Rock - Chairman of the Board and Chief Executive Officer

Good morning.

William Sanchez - Howard Weil

Margaret, were you a little surprise at the drop in drill pipe sales either sequentially or on a year-over-year basis and if so, you talked about the 60 basis point margin expansion in Oilfield. Could you help us with maybe one or more how that margin perhaps would have looked had drill pipe sales been a little bit different than what the actuals came in at?

Doug Rock - Chairman of the Board and Chief Executive Officer

Yeah, the drill pipe didn't have a high percentage of that, maybe in the 10 basis point kind of range. But, yeah, we were surprised but then again we're not a large marketer of drill pipe. So it tends to pretty lumpy. So if we have one order that gets push out, we don't get it. Yeah, we're surprised by the size of it, but it also as I said looks like it's coming back somewhat in the next couple of quarters.

William Sanchez - Howard Weil

Okay. So it sounds like it's only about a 10 basis point adjustment if you will, it doesn't make any structural change to kind of your margin expectations as we go --?

Doug Rock - Chairman of the Board and Chief Executive Officer

Essentially you can look it like this. You assume your margins are quite a bit lower than our average margin and it's only a drop of $27 million or so as 1% of a revenue, you can work out pretty quickly that it comes out probably less than 10 basis points.

William Sanchez - Howard Weil

Sure.

Doug Rock - Chairman of the Board and Chief Executive Officer

I think I calculated around eight, but I'm not sure, Margaret does a better job than I do on that.

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Yes. The bottom line is pretty insignificant impact, but the deposit was the fact that the drill pipe was replaced with the higher margin product service lines in the Smith Services operations.

William Sanchez - Howard Weil

All right. And that trend I guess margin is expected to continue here?

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

That's our expectations.

William Sanchez - Howard Weil

Thank you all.

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Absolutely thanks.

Doug Rock - Chairman of the Board and Chief Executive Officer

You're welcome.

Operator

Our next question comes from Geoff Kieburtz from Citi. Please go ahead.

Geoff Kieburtz - Citigroup

Thanks. Good morning.

Doug Rock - Chairman of the Board and Chief Executive Officer

Good morning, Geoff.

Donald McKenzie - President and Chief Executive Officer, M-I SWACO

Good morning.

Geoff Kieburtz - Citigroup

You may have said this, I kind of got behind on all to keep in track all the numbers. Overall, Smith Oil Services' revenue from the offshore market, what is that?

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

I think the comment I made Geoff was that if you look at the sequential top line growth of the Oilfield business that roughly 90% of that was came out of the offshore market.

Geoff Kieburtz - Citigroup

Okay.

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Yeah, 90%.

Doug Rock - Chairman of the Board and Chief Executive Officer

But you wanted to know what the total?

Geoff Kieburtz - Citigroup

Yeah.

Doug Rock - Chairman of the Board and Chief Executive Officer

It's around half.

Geoff Kieburtz - Citigroup

Around half. Okay. And as you look at your expectations for margin improvement over the next year, can you give us some sense of the relative importance of volume mix and pricing for Oilfield Services in aggregate?

Doug Rock - Chairman of the Board and Chief Executive Officer

I don't think we have breakdown but certainly there is a volume aspect and certainly with additional growth in North America and the offshore international, it would be a function of the type of business that we do. Those will be the two main drivers.

Geoff Kieburtz - Citigroup

Okay. So mostly volume and mix pricing would be secondary to those too?

Doug Rock - Chairman of the Board and Chief Executive Officer

Well, I'd say the more, we get more pricing acceleration if we can get more rigs. If you look over the last five years, our margins were up some place around 850 basis point, so we are averaging 160, 170 basis points a year or something like that. But we've been as high as 310 basis points and as low as last -- last year about a 100. So I think as we get acceleration, pricing moves and it starts to put those multiples, those basis points on there.

Geoff Kieburtz - Citigroup

Okay. I guess what I'm really trying to get a handle on is the outlook would seem to be for a more rapid growth in offshore rigs over the next year and a half, then we'll probably see in land rigs and I'm trying to get a better handle on how that might impact Smith if I kind of make it little broader, can you offer any comment sir?

Doug Rock - Chairman of the Board and Chief Executive Officer

Clearly it's to our advantage, but I can't give you an exact range. We think that margin should accelerate certainly going into the end of the second half when you see a pick up of offshore mix and certainly as you see more rig active in North America, just even coming out of the second quarter breakup. So everything does suggest margin improvement. I think you're looking for maybe a range which I can't give you that exact number because it's part of the total mix that we achieve.

Geoff Kieburtz - Citigroup

All right. I guess improvement you've had, would you expecting it to improve at a faster pace?

Doug Rock - Chairman of the Board and Chief Executive Officer

Yes, with volume and with the proper reasons.

Geoff Kieburtz - Citigroup

Okay. And would that...

Doug Rock - Chairman of the Board and Chief Executive Officer

We can't really do all your work for you though. You got to make some guesses.

Geoff Kieburtz - Citigroup

Come on Doug, it'd be a lot easier if you would.

Doug Rock - Chairman of the Board and Chief Executive Officer

And also be risky, what do you think?

Geoff Kieburtz - Citigroup

And would that differ a great deal between the three Oilfield segments?

Doug Rock - Chairman of the Board and Chief Executive Officer

Yeah. I think the incrementals are traditionally on the technologies than on the services are higher because of the fixed cost base plus the product offering in North America than M-I that doesn't have the fixed cost space. So typically in the past where we've had high-20s incremental margins on the Oilfield Service we've said that the technologies and the services are greater than M-I, so there is some differential there.

Geoff Kieburtz - Citigroup

And would mix benefit M-I more than the technology and services?

Doug Rock - Chairman of the Board and Chief Executive Officer

Yes. The offshore helps particularly deep offshore helps M-I more than the other two.

Geoff Kieburtz - Citigroup

Okay, great. Thank you.

Doug Rock - Chairman of the Board and Chief Executive Officer

You are welcome.

Operator

Our next question comes from Charles Minervino from Goldman Sachs. Please go ahead.

Charles Minervino - Goldman Sachs

Hi, good morning.

Doug Rock - Chairman of the Board and Chief Executive Officer

Good morning.

Charles Minervino - Goldman Sachs

I guess just touching on the previous series of questions a little bit more. Can you talk to us a little bit about beyond the fluids in the environmental business, which products that you offer, do you see benefiting the most as these new offshore rigs come on?

Doug Rock - Chairman of the Board and Chief Executive Officer

Well, I think you hit on the key, you certainly got the environmental. I think this whole area of wellbore productivity where we combine the tools with the completion fluid, this is a business that grown from nothing seven or eight years ago to over $0.5 billion. I think cleaning out the wells, getting them ready for production is huge. You can see the tremendous growth in the production chemicals as it moved from more of the North American market to a worldwide market. And when you get into the tools, just about all types of downhole tools, particularly the reamer types of tools that we've talked about specialty bits, I think everything we're focused on has an advantage of the deep offshore market.

Charles Minervino - Goldman Sachs

Okay. And when you look at the margins, can you give us a sense of what margins are like for your offshore business versus your onshore business?

Doug Rock - Chairman of the Board and Chief Executive Officer

They are better.

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Yeah. Typically they're better and in the case of M-I, you're selling a premium fluid, it's a much better.

Charles Minervino - Goldman Sachs

Can you give us any sort of a quantification there, is there a couple 100 basis points? Is it substantially? Just trying to get a sense of as these new rigs come, understanding what that might mean for you on the margin side?

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Shuffle [ph] what normally said is that we can see premium fluid margins that rival what we see on the bit side, now that doesn't help you much, but it's a significantly better margins than what we would see on our a low-end land application.

Doug Rock - Chairman of the Board and Chief Executive Officer

That is exactly correct.

Margaret K. Dorman - Senior Vice President, Chief Financial Officer and Treasurer

Yeah.

Charles Minervino - Goldman Sachs

Okay. Thank you very much.

Doug Rock - Chairman of the Board and Chief Executive Officer

And I think as Don tells you, if you look at the number rig days in the Gulf Coast, the amount of revenues we're doing on the revenue side about $4 million per deeper water rig per quarter. So I mean that's the revenues driver and the margins are higher.

Charles Minervino - Goldman Sachs

Okay. Thank you.

Operator

(Operator Instructions)

Doug Rock - Chairman of the Board and Chief Executive Officer

No more questions, Rosa.

Operator

At this time, we have no further questions.

Doug Rock - Chairman of the Board and Chief Executive Officer

Thank you very much for joining us for our first quarter 2008 investor conference call. And we look forward to talk again for the second quarter in three months. Thank you.

Operator

Thank you, ladies and gentlemen. This concludes Smith International Incorporated first quarter 2008 investor conference. Thank you for participating. You may all disconnect.

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