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Executives

Bernard J. Duroc-Danner - Chairman, Chief Executive Officer and President

John H. Briscoe - Chief Financial Officer and Senior Vice President

Analysts

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

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

Ole H. Slorer - Morgan Stanley, Research Division

James C. West - Barclays Capital, Research Division

Angeline M. Sedita - UBS Investment Bank, Research Division

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Michael W. Urban - Deutsche Bank AG, Research Division

Scott Gruber - Sanford C. Bernstein & Co., LLC., Research Division

Weatherford International (WFT) Q2 2012 Earnings Call July 25, 2012 8:00 AM ET

Operator

Good morning. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Weatherford International Second Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, today's call is being recorded. Thank you.

I would now like to turn the conference over to Mr. Bernard Duroc-Danner, Chairman, President and Chief Executive Officer. Sir, you may begin your conference.

Bernard J. Duroc-Danner

Thank you. Good morning, everyone. John will start with his comments and followed by mine.

John H. Briscoe

Thank you, Bernard, and good morning, everyone. Before my prepared comments, I would like to remind listeners that this call contains forward-looking statements within the meaning of applicable securities laws, and also includes non-GAAP financial measures. A detailed disclaimer related to our forward-looking statements is included in our press release, which has been filed with the SEC and is available on our website at weatherford.com or upon request. Similarly, a reconciliation of excluded items and non-GAAP financial measures is included in our press release and also on our website.

Finally, in order to allow more callers to ask questions, I ask each caller in the Q&A to limit their questions to one initial question and one follow-up question.

I will start my comments with some brief remarks on the operating results, but these will be much briefer than normal, as I will defer more to Bernard. I will then focus the majority of my comments on the restatement of our previously issued results due to additional adjustments to our income taxes.

In the second quarter 2012, we generated -- before income taxes, we generated earnings before income taxes of $205 million or $276 million on a non-GAAP basis compared to non-GAAP earnings before income taxes for the first quarter of 2012 of $296 million, as detailed in the non-GAAP reconciliation table in our earnings release.

Second quarter earnings before income taxes was unfavorably impacted by certain excluded items highlighted in our press release, totaling $71 million on a pre-tax basis. The excluded items for the second quarter were primarily composed of a $100 million accrual for the potential settlement of the sanctioned countries' investigation, $24 million for severance exit and other charges and $53 million gain associated with the sale of our subsea controls business.

Second quarter revenues of $3.8 billion were 5% higher sequentially and 24% higher than the same period last year. North America revenue was up 25% versus the second quarter of 2011 and down 4% sequentially. International revenues were up 23% versus the same quarter of 2011 and up 14% sequentially.

Segment operating income of $539 million improved 29% over second quarter 2011, while declining $15 million or 3% sequentially.

Segment operating income margins of 14% were flat compared to second quarter 2011, while declining one point sequentially.

North America operating margins for the quarter declined 430 basis points sequentially to 16%, primarily due to the impact of the extended Canadian spring breakup. International operating margins improved 210 basis points sequentially to 13%.

Corporate, general and administrative expenses of $53 million declined $11 million compared to the prior quarter but continues to run at elevated levels due to additional professional service fees incurred in the quarter related to the income tax remediation.

During the second quarter 2012, we generated EBITDA, defined as non-GAAP operating income plus depreciation and amortization, of $731 million, with depreciation and amortization of $310 million compared to EBITDA of $729 million and depreciation and amortization of $301 million in the prior quarter.

Capital expenditures were $554 million for the quarter, net of $30 million of loss in whole revenue or approximately 15% of revenue. Full year 2012 CapEx is projected to be between 10% and 15% of revenue. Actual CapEx in the second half of the year will be driven primarily by how we see our incremental growth developing in 2013.

Net debt for the quarter increased $641 million, primarily due to increases in capital expenditures and working capital metrics for accounts receivable, while inventory metrics improved. We continue to target 76 days and 75 days for receivables and inventory, respectively, by the end of 2012, as we continue our focus on working capital improvements and work to improve our CapEx returns.

Subject to the risks and uncertainties regarding forward-looking statements highlighted in our press release and public filings, we expect North America should have significant revenue and margin improvement in Q3 compared to Q2, due in large part to Canadian seasonality but also to improving margins in the U.S.

International should show modest top line growth and continued margin improvement. Q3 non-operating costs are projected at about $60 million for corporate general and administrative cost, depreciation and amortization at $310 million, interest at $127 million, and R&D at about $72 million a quarter. Increases in corporate, general and administrative costs are for planned additional procedures related to the tax remediation.

We have not closed our books for the second quarter as our review of tax accounting is ongoing. However, I currently estimate an annual effective tax rate of approximately 37% to 39%, although the actual rate, without excluded items, may vary from quarter-to-quarter. The increase in my guidance for the 2012 effective tax rate is primarily due to changes in the mix of earnings, as we project lower earnings in deemed profit jurisdictions and the impact of a tax law change. This should yield non-GAAP quarter numbers, excluding items, in the range of $0.30 to $0.32 per fully diluted share on an after-tax basis for Q3 2012.

Turning my attention to our tax remediation. We are reporting our results on a pre-tax basis because we have identified additional income tax items during 2012 that are related to prior periods, $36 million in the first quarter and now an additional $56 million in the second quarter, totaling $92 million. Due to the materiality of these income tax items to 2012, we must record them in the prior years, and we will therefore restate our prior year financial statements. We will not issue restated financial statements until we have completed additional procedures and reviews of our accounting for income taxes. In plain terms, we do not intend to reissue financial statements for prior years until we have completed additional procedures related to income tax accounting and performed, at a minimum, our third quarter tax provision review process.

I want to emphasize that while I recognize this announcement is disappointing, I believe that we are making progress on the path to resolving the income tax accounting material weakness and I point to these factors related to these additional second quarter income tax items as clear indicators of progress.

First, these additional income tax items were identified by our additional procedures and improvements implemented during 2012 to existing procedures or procedures implemented during 2011. These changes and enhancements were part of our income tax remediation work plan.

Second, we identified the additional income tax items by executing the above procedures. We believe this indicates our processes and procedures are yielding the incremental improvements in the quality of the company's income tax accounting. This supports our remediation at the income tax material weakness.

Of the $92 million of additional income tax items, $28 million resulted from the normal process of filing tax returns and adjusting the prior period accrual to the actual taxes as filed on the return. Year-to-date, we have filed about 250 tax returns, so the error averages about $100,000 per return. These returns have been reviewed in the period in which the returns were filed as the process is designed to work. $67 million of the additional income tax items relates to accruals for uncertain tax positions. Other tax items are in offset of $5 million. The income tax items identified do not appear to indicate a pervasive issue related to these income tax exposures.

During the third quarter, as part of our 2012 tax calendar, we intend to perform significant procedures related to our annual tax provision process. These procedures, tax basis balance sheets and tax payable roll forwards, will now be expanded beyond our original planned actions. This expansion should either identify additional prior-year income tax items or give us greater comfort in the progress of our income tax remediation efforts.

We have also decided to perform other procedures and accelerate other planned activities during the third quarter. If the results of these planned activities and the normal third quarter tax provision process are positive, then we would expect to file our restated financials and catch up on quarterly filings in early November. If we identify additional out-of-period items or other issues that cause us to conclude we cannot file our second quarter, third quarter and restated financial statements with reasonable assurance they are correct, then we expect to again report pre-tax earnings and operating results for the third quarter and provide an update on our tax remediation progress. If this occurs, we will still expect to complete all filings by the 2012 Form 10-K filing due date.

I want to provide full transparency with our income tax remediation process. To that effect, we have included a presentation titled, Material Weakness Remediation Update, in the Form 8-K filed yesterday that included our earnings release. This presentation clearly states our goal of eliminating the income tax material weakness by year end, provides specific actions we have completed, the status of organizational changes within tax and continuing remedial actions.

Our remediation process has moved from strategic objective to a tactical plan that is pragmatic, action oriented, aligned across the business and is expressly designed to provide a sustainable tax function designed for Weatherford. Above all, me and my team will dedicate ourselves to resolve the income tax material weakness by year end.

I also believe these efforts will drive the effective tax rate lower in the future for Weatherford. While we expect our tax rate to move lower after 2012, it should move lower at a measured pace, and it will take a number of years to achieve optimum tax performance. Long term, our tax structure will also be more efficient, in addition to being more effective. These 2 go together by design.

I'll now turn the call over to Bernard.

Bernard J. Duroc-Danner

Thank you, John. My comments will be split into 2 sections. As someone could not possibly care more deeply about the company and has his net worth in our company stock, I watch the same pain as our shareholders and travails involved in straightening our income tax management and income tax accounting practices.

There are a few things to keep in mind: the material weakness and the corrective measures under way are for income tax accounting, not the company's accounting as a general statement. Put another way, there never were any issues on and around pre-tax earnings then or now. This should be clear, but bears repeating.

Second, it does not involve cash.

Third, as long and grueling of a process as it may seem, we are making progress to remediate our income tax weakness and place this issue behind us. The latest decision to adjourn filing revised Ks and Qs, it's necessary to avoid endless waits for loops of finding more past errors in accounting of income taxes, which yield more restatements, which monopolize more resources in what is ultimately a sterile iteration until our final historical income tax numbers are set.

We have and we're looking with stern fairness [ph] for any and all possible past income tax accounting errors. We want to correct them all and build from a sound base. We're making progress. Since the self-diagnosed error spotted in February 2011 by our own internal audit, the scope and scale of historical errors has steadily decreased. The numbers are becoming smaller. Our hope is that we found during Q2 the last errors out there, but we cannot be certain yet. Our plan, therefore, between now and year end has 3 steps.

First, find and correct all remaining income tax accounting historical errors, if any are left. There may be none to be found, or there may be some. We don't know. We will find out by year end.

Two, complete the income tax remediation of our material weakness in income tax accounting to the satisfaction of our auditors. This is also by year end. The remediation process is, by definition, a year-end event, if successful.

Last, rebuild our tax planning and implementation group under the leadership of Jim Parent, our newly appointed VP of Taxes. By year end, we'll be moving towards intelligently using our multinational tax structure for what it was designed, lowering our long-term income tax rates worldwide, both cash and book.

On that last issue, as John mentioned, the effective income tax rate for year '12 is in the range of 37% to 39%, up from 35%, an early estimate. It is a high tax rate by any measure. We will gradually lower our overall tax rate effective '13 through '16. The mix of business and regional distribution of profitability will have, always does, a role to play as to where tax rates end up. But the rigor, effectiveness and efficiency with which we intend to manage our income tax planning and the execution will minimize future tax rates, and we'll have seen the last of our income tax accounting errors.

The second section in my comments will focus on operating results and the outlook for the balance of the year. Q2's operating results were essentially flat on Q1. The numbers were very close at the EBIT line and almost identical on pre-tax earnings line. Future revenues rose 5% or just under $200 million in spite of a sharp Canadian breakup, suggesting a healthy revenue uplift in the second half of the year.

Specifically, Q1 on Q2, Canada fell sharply. Latin America, the European-Caspian-SSA-Russia region and, to a degree, the U.S. had strong quarters and made up for it. MENAAP was weak as expected, no better nor worse. MENA is finishing this recovery process. North America was the net of a well-behaved U.S. and a worse Canadian breakup that was anticipated. U.S. had a good quarter. Revenues and operating income were up on Q1, driven primarily by Lift and Well Construction. Stimulation weakened further by the much smaller rate than in prior quarters.

Canada's Q2 was all breakup. The weather issues in Western Canada had been well reported. I won't belabor the point. The effect on NAM results were very significant, in part because we are by legacy very Canadian in exposure. Canada's seasonal drop in EBIT Q1 on Q2 was the highest decline in absolute dollars terms in company history. It affected all product line across the board. U.S. performance softened the blow.

Latin America had a strong quarter with revenues and EBIT up substantially over Q1. Latin America's EBIT of $104 million was the highest Q2 on record and second-highest EBIT ever. Mexico was the single biggest mover, but the overall regional also did well. Incrementals were modest at 15%, 1 5, percent, partly because of the winding down by year end of the existing POC contracts in Mexico and partly because there were a number of starts-up in the region. Latin America is laying the foundations for further strong performance in the second half of the year and 2013.

The European-Caspian-SSA-Russia had a very strong quarter and was the quarter's stellar performer. Revenues were up sequentially $83 million or 15%, and EBIT rose $60 million to $120 million in the quarter. The incrementals were strong 70%, 7-0, partly reflecting good seasonal pickup, partly driven by stellar performance in Russia and SSA. It was the highest EBIT ever reached by this region in the company's history, that's in absolute dollars. The EBIT margins though, at 18.4%, remain low. The historical peak was in 2007, when it averaged just under 25%, 24.5% to be exact.

MENAAP was exactly as expected. Asia Pacific had another good quarter progressing over Q1, both revenues and EBIT. MENAAP continued to be seriously hurt by the winding down of unfavorable contracts, primarily in Iraq and Turkmenistan, but primarily Iraq. Iraq is an issue of poor pricing, terms and condition on 3 large prior contracts. Turkmenistan was an issue of client performance on one large prior contract. That contract is now closed.

All in all, NAM's EBIT dropped by $88 million because of Canada. This was made up by international, which shows $73 million, if you want to squint to see how the quarter ended up.

Q2's non-operating or corporate numbers were marked by continued high overhead associated with the quarter's intense work on and around income tax accounting. The expenses were lower than Q1 but remained materially higher than historically and higher than it will be once the income tax remediation work is completed.

From an operating standpoint, the quarter was good performance and a number of regions laid the groundwork for strong second half in 2013, which brings me to my forward views. The prognosis is positive and pretty much across the board. We remain constructive on NAM, both top line and margin. We believe Canada will have a strong second half, with a market predominantly oil-based and for us a nationally high market share in Canada, we expect to do well as the year progresses.

The United States. We remain of the view that notwithstanding a sharp drop in gas-related activity, the oil and hybrid market segments and our product mix focus will secure constructive second half of '12. To provide the same context as I did in Q1, this quarter, pressure pumping accounted for about 9% of NAM's EBIT, down from 10% of NAM's EBIT in Q1, while Lift accounted for 33% of EBIT up from 25%.

As expected, we did not see much further downside for our NAM pressure pumping. By contrast, we see further volume pricing and absorption-led margin improvement in Lift, of course, the balance of the year. We also expect positive improvements in formation evaluation, Well Construction and Completion.

Latin America should have a strong second half with broad-based continuous progress across the region. It is of course Mexico, Colombia, Brazil and Argentina and the far-end [ph] segment of the Venezuela. But it is also a number of smaller high-margin markets, such as Ecuador, Bolivia, Peru and Trinidad. We have a solid backlog of business at improved pricing and traditionally, the second half is seasonally the strongest in Latin America. The European-Caspian-SSA-Russian region should remain strong throughout the second half with incremental margin improvements. So all of the above regions that I just described, this is the same or consistent outlook we have had for some time. There are no changes, just a greater sense of reliability.

MENAAP is the obvious turnaround, at least the MENA segment. We expect MENA to improve in the second half of '12 from both a top line and margin standpoint. Although we're still completing some of the unfavorable contracts at a diminish rate, while most start-ups in Saudi, Kuwait, Iraq, et cetera have been successfully initiated. There are more start-ups under way still in Saudi, Algeria and Northern Iraq, but the denominator of healthy contracts now running is larger and building. Makes it easier to absorb start-up costs.

This suggests a improved level of profitability the second half of the year. A few added comments of what have been 2 difficult markets. Algeria from a contractual standpoint has turned around for us, suggesting a better, more constructive outlook for that country in the second half of '12 and 2013. Iraq will evolve into an operation of improving profits as the year unfolds, both in Southern and in Northern Iraq. Iraq used to be a country of high profitability for us in years past. It should return now to reasonable profitability and returns, commensurate with the risk and difficulties undertaken in that country. To summarize, profitability and margins in MENA will commence a process of positive adjustments and correction in Q3 and build from there.

Asia has strong backlog overall. We expect Asia to continue showing good improvements in the second half of the year for all these financial metrics.

To summarize, our international outlook in the second half of '12 is a good progress. We feel confident with this. We expect the second half of the year to show continuous improvements in international volume and margins in every region.

All in, second half 2012 should have strong operating performance and show financial progression on all markers. North America should hold its own and remain positive in revenue, EBIT and margin trends. But clearly, the international segments should drive the numbers.

We also progress -- showed progress on returns. Capital-wise, we expect to commit our internally generated cash flow this year to funding what we anticipate will be a circa 20% top line growth when the year is counted '11 on '12. We target our capital intensity to about $0.75 to $0.80 of incremental CapEx and working capital per dollar revenue growth. If you want to get to the net CapEx number, all you have to do is add back, add to that number about $500 million worth of maintenance CapEx for the company as a whole and that gives you the CapEx number as a whole.

Given the incremental margins we set at as yardsticks, our returns should improve throughout this year and the next. Improving our returns and managing our capital more efficiently are imperatives for this company. We expect to achieve this without losing traditional growth and entrepreneurial strengths we are known for. Our mark is the capital efficiency. CapEx, maintenance and growth combined, should remain in the range of 10% to 15% revenues. It averaged 11% in 2011. Our target year-end DSO and DSI are, respectively, 76 and 75 days or better. DSI, inventories, offers the most opportunity of further down the road to capital efficiency. We are also pressing with tightening objectives receivables as in DSOs.

Assuming a comparable level of organic revenue growth in 2013, as we had in '12, we should finance the growth and still have solid free cash flow in '13 in excess of internal growth needs. The levering will be likely used to [indiscernible] that.

Other issues. We have slowed the pace of divestments due to the very low valuation prevailing in the financial market. We still do expect the sale of the second non-core asset between now and year end. The company this quarter set aside $100 million accrual for settlement with the Justice Department on issues relating to alleged violations of sanctioned country laws -- or sanctioned countries laws. The settlement and the terms are not a uncertainty, but they now appear palpable.

Lastly, just to repeat what John mentioned, assuming a midpoint 38% tax rate, midpoint of 37%, 39%, Q3 should be therefore in a $0.30 to $0.32 range or the pre-tax earnings equivalent.

With that, I will return the call for a Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question will come from the line of Bill Herbert with Simmons & Company.

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

A couple of modeling questions for you guys here. John, was the breakup sort of in line with last year, worse or more, I guess, benign?

John H. Briscoe

It's worse than last year and longer. It started earlier and then the rains that came in June caused it to hang on longer than anyone expected.

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

Okay. So then if that's the case, then revs down something like 40% and U.S. revs, what, up close to 5% quarter-on-quarter, something like that?

John H. Briscoe

You're directionally correct.

Bernard J. Duroc-Danner

That's seasonal, Bill.

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

Okay. And Latin America was the big surprise, frankly, in terms of the strength of the revenue generation. Coming out of Q1, I think you guys were thinking that Q2 to Q4 was going to be roughly flat with Q1, distilling [ph] and up 20% year-over-year. But Q2 step changed higher, up almost 20% quarter-on-quarter. What are we thinking here now in terms -- and it sounds like your commentary imparts additional growth for Q3 and Q4, are we up something close to 40% year-over-year?

Bernard J. Duroc-Danner

That might be a little bit high, Bill, but maybe between 30% and 40% for the year.

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

Okay. I'm struck by the fact that the visibility has improved so dramatically within the space of a quarter. Or did you have the growth in your hip pocket? I mean, what was the evolution there?

Bernard J. Duroc-Danner

I think we thought that it might unfold this way. I think this was a case of pacing ourselves a little bit and promising what we could see coming and rather just focus on execution more than anything else, Bill. The market positions evolved the way we thought they would. But then again, we've been wrong in the past, so a bit more cautious.

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

Got it. And the disappointment operationally in the quarter was the MENA margin progression. We knew it was not going to be sterling, but it was weaker quarter-on-quarter. How should we think -- but how should we think about the rate of improvement in the second half is what I'm getting to, Bernard. Sorry about that. Are we [indiscernible] margins?

Bernard J. Duroc-Danner

Well, unfortunately, you don’t see the MENA margins. But what I can tell you is that the doubling in margins of MENA, given where they were in Q2, wouldn't give you much. So let me simply put it this way. Mathematically, let me put it to you this way. I think you would be looking at a material change in margins in MENA in Q3. But then again, Bill, in MENAAP, it's Asia Pacific which is driving the profitability numbers. It is not MENA through Q2. I think in Q3, Asia Pacific will continue to do very much the same sort of good execution, good progression you see in Latin America and in the European-Russian region, but just MENA will go from essentially nothing to something. Something that will remain single digit but therein lies the progress. Okay?

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

Got it. And then last open for me, promise. Tax rate, John, 37% to 39% or something along those lines for the guidance. Should we be incorporating something like a 40% tax rate for the second half of this year?

John H. Briscoe

No. You should be modeling to get to 38% as the midpoint of that range for the full year. So wherever you have your numbers in your model, just have the end of the year for the full year, the rate at the -- picking the midpoint for the full year. There will be some variability though. There's always variability quarter-to-quarter.

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

Assuming you did 33% to 34% Q1, though, then that implied a 39% to 40% tax rate Q2 through Q4, correct?

John H. Briscoe

When you look at the catch-up that we had to do in the second quarter because of the rate being lower in the first quarter, that is true. When you look at where we will be for the full year and what the average rate will be for a full year's worth of income and taxes, then you should be at about that midpoint.

Operator

Your next question will come from the line of Jim Crandell from Dahlman Rose.

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

Bernard, you've described Artificial Lift as a backlog-driven business, and certainly it's been a powerful driver of North America. And the flat -- if there were to be a flattish outlook in North America that were to continue, let's just say through 2013 for the sake of argument, can Artificial Lift still drive overall revenues and margins higher in a meaningful way, given its growing importance to Weatherford?

Bernard J. Duroc-Danner

For North America? In a flat drilling environment, Artificial Lift has about a, I would say, 2 year capital goods to consumable good cycle to go through. Meaning that when -- there's a number of wells have not been placed on Artificial Lift yet. That's one issue, catch-up. And then beyond that, the first cycle of maintenance of all the wells had been placed on capital equipment with Artificial Lift recently. So we have that sort of a inbred growth coming in Lift, assuming again a flat liquid market. Because it's not a gas market at all for Artificial Lift. With respect to the visibility on it, the backlog in Lift -- it's not only in Lift, but the backlog in Lift is such that, unless there is a substantially unfavorable evolution of the market in North America, meaning a pullback in the liquids segment -- a significant pullback in the liquids segment, you will find that we have quite a bit of visibility as to what will happen to that particular business through the first half of next year. So we actually know, unless there is a grand change in the business, we actually know that the volumes and so forth, and the margins on a forthcoming basis, assuming also that supply chain functions properly.

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

Okay. And this should -- given your visibility on the backlog, would you anticipate -- is this a business that you think you can put more price increases through?

Bernard J. Duroc-Danner

Yes, in moderation. Because you have to be careful not to -- I mean, not to, I think, push the envelope too far. Just in general -- or put another way, I wouldn't want to talk about it too much. The other side of the equation is, can you lower your manufacturing supply chain cost structure? Can you lower your delivery cost structure? Can you absorb better with more volume? The Artificial Lift product line, with all that it entails in 2013 worldwide, with these numbers are sort of -- will change some, will represent worldwide something now between 20% to 25% of the company as a whole. This is worldwide. We normally give North America numbers. That's excluding of course the interest we have in ESP, our company abroad [ph]. So I think the play on Artificial Lift will quickly become also an international play is what I'm trying to tell you. And you have to look at that also as something that will contribute a lot to how well we do next year.

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

Okay. And my 5 -- follow-up question is 2 sort of related questions about Iraq. Number one, are you confident at this point that the MOC, SOC contracts, which are holding back results here or at least detrimental to results, will all roll off in the third quarter? And then secondly, you went out of your way to talk about Northern Iraq also being maybe a significant contributor to improved results going forward. And can you talk about the outlook for Kurdistan and Northern Iraq, particularly in light of Chevron's purchase there recently?

John H. Briscoe

A lot questions, Jim. First, shamefully, 2 years ago, we took on more than just the particular contract you're alluding to, which is in the Missan-Buzurgan play. That one is declining just in terms of the impact on the company, meaning that the quantity of work being done there will either be finished in Q3 or declining to the point where in Q4, it will present just a much-reduced impact. So it's either over with in Q3 or predominantly over with in Q3. I will also point out to you there were 2 other large contracts in Iraq in the south also, which were not -- which were done on -- with unfavorable terms. They also are coming -- are either going to be finished in Q3 or will essentially become in terms of impact on MENA, have a much smaller effect. That's the first thing. I think the second question you asked is the -- I think the outlook for Iraq in general. For us, I think we're signing -- we've signed contracts on different terms and conditions, different segments of the business in Southern Iraq, that's one, staying away from some of the large turnkey projects on the basis that the risk return effects at least for our side of the equation, as being unfavorable. So we signed contracts and exposed in Southern Iraq more in the production side of the business and workerless side of the business and these sorts of things. And we have tried a number of start-ups and we're doing a number of start-ups in Southern Iraq. Again, on contractual terms that are far better than what we had. I will also say that in Southern Iraq, it's hard to have the same kind of profitability and returns that you have perhaps in Saudi Arabia and Kuwait, et cetera. In the North, where we have a similarly sized operation in the North, you're absolutely correct that the commitment of Chevron by buying out the geological plays of Reliance is a very important move for that market. I'll also point out that the prior move by Exxon was even more momentous and important. And there are other moves that are likely to come forward in that particular play. So this is going to become as important of a market as Southern Iraq. Hopefully, will be -- will remain a play with economics and returns that are sort of more akin to what you find in some of the other Middle Eastern markets rather than Southern Iraq, which again is a very, very tough market. I think that sums up your questions.

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

Your next question will come from the line of Ole Slorer with Morgan Stanley.

Ole H. Slorer - Morgan Stanley, Research Division

Again, Bernard, back to the problematic contracts in Iraq. You previously guided that this would exit from your mix in the second quarter. Are these now slipping into the third quarter as well?

Bernard J. Duroc-Danner

They are. They are, Ole. I think it's -- it's a fair criticism that we haven't finished them all in Q2. I think we finished some. There's more than just one. We finished some. I alluded to the one in Turkmenistan being over. And also the rate at which they're going in Southern Iraq is diminished. We haven't finished them all in Q2, as I hoped we would. But I will say, though, that simply because some are gone, and the ones that are remaining are -- have a lower level of immediate activity, all in, the impact in Q3 will not be 0, as I hoped. But it will be less -- materially less than it was in the past, which is why you will see MENA go from essentially no margins to beginning it's crawl back to where it normally was and should be. I'll remind you that MENA was, with North America, our highest-margin market in the past.

Ole H. Slorer - Morgan Stanley, Research Division

Exactly. As you exit the year, what would you expect MENA margins to be? You can give us a little wide range, if you want to but...

Bernard J. Duroc-Danner

Double digit. Double digit is probably all I'm -- I would responsibly say. And you will say, that's not saying much, Bernard. You have to understand, without giving you too much information, there is no digit. So -- I mean, as per the information from one of your colleagues early on, which is expect the doubling, I think was the one who questions on Q2 to Q3 of MENA margins. So that was the question like that, which mathematically is fun when you have [indiscernible] digits. So in a way, it's a -- the multiples are not material but you go from low digit to double digit is as much as I can tell you, Ole, in Q4.

Ole H. Slorer - Morgan Stanley, Research Division

Excluding the loss making contracts and looking at the kind of business that you've signed recently, would it be unreasonable to think that they could be exits 2012 margins in the mid-high teens?

John H. Briscoe

No. That would be very reasonable.

Ole H. Slorer - Morgan Stanley, Research Division

And when it comes to the margin picture in general on international, showing progress, but where do you think that the year could exit?

John H. Briscoe

Well, just to give you a little bit more granularity. You noticed that the margins in the European and so forth region are sort of bumping [ph] on 20%. Now you should expect anything dramatic there. There's seasonality also, that plays, which [indiscernible] that is a slow march in that particular set of regions, Europe Caspian, et cetera towards going back to the low 20s and so forth which were and maybe at some point, be able to return to the prior heights. It's a slow, gradual path, and it is credible in so far as we demonstrated we were able to do that. That's one. Then turn your attention to Latin America. Now Latin America, it's obviously a region that has been well managed, good execution, both in terms of growth and in terms of also just margins. There's one giant market there -- there are many giant markets. There's one particularly important for us, which is Mexico. So Mexico comes up from an election, and normally what happens is a cycle of investments over the next 2 years. Now I'm not saying this is a guarantee, but this is not an unreasonable assumption to make, given the normal rhythm of politics and the implication in terms of how countries are run. Within Mexico, we have a very good infrastructure, very good organization, which we built over the years. What you ought to know is that, nothing right or wrong about it, it is just the way it is, we have a number of POC contracts which represents a very large chunk of what we do in Mexico. We thought [ph] naturally the life is always expiring at year end. To the extent that the POC margins, and they are what they are. No one's arguing anything either ways. They extend these POC margins when they come at the end, perhaps, are in sort of economic operating reality higher than what the POC margins are reflecting, since that reflects the margins of the overall life of the contract. Such is the logic of POC. When these contracts come to end at year end, it is not unreasonable to expect in 2013, all things remaining equal, margins will rise in the particular region. That's another factor aside from the fact very much like the European, et cetera, et cetera region, it is well managed and progressing on all cylinders beyond Mexico, in all the markets identified, the primary ones being Colombia, Brazil, Argentina, Venezuela, the foreign segment, which is the Orinoco play and of course, some of the smaller markets, which I think should get some recognition because in the aggregate, they are rather important for us. Ones I mentioned, which is Bolivia, Peru and Trinidad and Ecuador and so forth like that which in the aggregate they're rather significant and very high margins. So progressing on that, honestly, an uptick in Mexico, and of course, just the natural end, and this is not an issue of us being sort of, can we complete these POC contracts by year end or is it going to slip one quarter like it did in Iraq? No, because POC just -- the contract ends at that point in time. It's a matter of just timing of the contract. That's all. So you can see margin [indiscernible]...

Ole H. Slorer - Morgan Stanley, Research Division

[indiscernible] on the percentage of completion of contracts in Iraq. When -- can you remind us, when did you sign those contracts?

Bernard J. Duroc-Danner

Which one, the Mexico or in Iraq?

Ole H. Slorer - Morgan Stanley, Research Division

Yes, the POC contracts in Mexico.

Bernard J. Duroc-Danner

Oh, my goodness. I think 2 years ago, 2.5 years ago. It will be 3. They are 3-year contracts. Something like -- close enough.

Ole H. Slorer - Morgan Stanley, Research Division

Okay. So that was signed at the opposite trough of the international margin cycle.

Bernard J. Duroc-Danner

That's correct. And there was nothing. Look, it's easy enough to -- for us to criticize ourselves, let alone to criticize -- for you to criticize us, say we shouldn't have had these contracts. But times were what they were.

Ole H. Slorer - Morgan Stanley, Research Division

So they were signed at the trough. They're taking longer to complete. So assuming...

Bernard J. Duroc-Danner

No, I said they've taken the time they were supposed to do. You cannot go any faster. They won't allow you to. You have a certain amount of equipment on it, and it's not -- you can't re-accelerate them. You have to do -- follow the program as set in this particular instance by SEMEX [ph], except we're doing them very efficiently and so they're actually quite profitable. But less than the actual margins reflect because you follow the overall history of the contract, including the [indiscernible] and blah blah blah that took place the first 6 to 9 months because that's the proper logic of POC contracts.

Ole H. Slorer - Morgan Stanley, Research Division

Anyway, international [indiscernible], you're bidding kind of at this point at below 20% margins.

John H. Briscoe

No. We're very, very careful on what we take on in international market. We do not need to load up our wagon in terms of more volume of business. We are not growth driven. If you see our sort of vibrant growth going on at Weatherford, it's probably the animal spirit is alive and well, in spite of all of our travails, first, legal and now in tax accounting, which hopefully, will be behind us. But the animal spirit is still there. We're far more focused in what we go after. And we've turned down business, which we would never have turned down in the past before. Having said this, I don't know how 2013 will be. But if there are no major changes in the way the world is, meaning it remains mediocre, it looks very similar in terms of growth outlook to what 2012 will end up being, which is when the full year is counted, you'll be 20% of growth year-on-year or something like that. We'll have to wait until the quarters are counted.

Operator

Your next question will come from the line of James West with Barclays.

James C. West - Barclays Capital, Research Division

A quick question on the Artificial Lift side in North America. You obviously articulated pretty strong demand. Is pricing now for Lift above prior cycle peak level? I think we started the year maybe 10% below peak. Are we now back above or at peak levels?

Bernard J. Duroc-Danner

We are close to prior peak level. I'd say about 3% or 4% below. But be careful, James. This particular pricing defining hasn't flowed through the P&L at all. And it probably will not flow into our P&L, given the size of backlog, until the first half of next year. It's a -- you cannot change your pricing in your existing backlog. At least, we don't. In fact, it's a -- so you have -- you will go through basically layers upon layers of work until you get to the high-pricing one.

James C. West - Barclays Capital, Research Division

Okay. But where you're bidding now is pretty close to prior peak?

Bernard J. Duroc-Danner

Yes. It depends again on -- it's a complicated thing, because you've got such a broad offering. But if you want to have a sense that you are, I'd say, within 5% overall of what would have been some measure of the prior peak.

James C. West - Barclays Capital, Research Division

Okay. Okay, fair enough. And then could you remind us your expansion -- your capacity expansion plans for that business, particularly in North America, given the strong demand?

Bernard J. Duroc-Danner

It's actually -- a fair amount of the CapEx is on or around that. And it's -- I would say it's about overall again because we've got different product lines, it's about 1/3 volume expansion across the board.

James C. West - Barclays Capital, Research Division

Okay, okay. Got it, that's helpful. And then one last question for me. Still on North America, but on Canada, your prognosis for the second half in Canada. Are you looking at year-over-year growth in activity? It think there's been at least some controversy around that, given the decline in commodity prices. Or is this your growth of more mix function for your product lines?

Bernard J. Duroc-Danner

Well, there's always an issue of market in a particular company. In our particular case, the -- our assessment year-on-year is that, in spite of the breakup in Q2, which just lasted 3 months as opposed to basically 2 months, that's the issue and it just happened. For the year, we still expect the growth in Canada, which is, I would say, somewhere midpoint between 10% and 20%, so year-on-year or something like that.

Operator

[Operator Instructions] Your next question will come from the line of Angie Sedita with UBS.

Angeline M. Sedita - UBS Investment Bank, Research Division

On the international margins, obviously, a positive commentary on international margins as far as contract awards and moving into the second half. So Bernard, based on what you're seeing and what you said, I would assume it's fair to assume that international margins should be at least in the mid-teens, not at the low teens, as far as their exit rate for 2012. Is that fair?

Bernard J. Duroc-Danner

That's actually correct, Angie. That's actually correct.

John H. Briscoe

Yes, you're correct.

Angeline M. Sedita - UBS Investment Bank, Research Division

Okay. So that's that. And then on the ENI production contract that you won, could you give us some timing and -- details in the timing, start dates, when it will kick into full gear and margin expectations -- or generally, margin expectations?

Bernard J. Duroc-Danner

Three things. It should be kicking in actually -- basically started up now in Q3. So you'll see a little bit of it in Q3, in full effect in Q4. That's item one. Item two, the margins on it are not high, 20%. Item three, it's pre-funded. In other words, this is -- in other words, in terms of returns, it's -- there is no capital outlay. It's pre-funded by the client. And it will last about, I would say, 18 months, something like that, maybe 19, 20. I can't exactly remember, Angie. But it's something like that, from the time we start. In other words, they'll go throughout Mexico. To make it simple, it will start, let's say it starts this quarter. But you continue and start [indiscernible] the clock on October 1, okay? And it will go through, roughly speaking, through Q1 of 2014 or something like that. And it's -- if that's helpful.

Angeline M. Sedita - UBS Investment Bank, Research Division

Very helpful. So then finally, you obviously took the charge on the blue [indiscernible] for what this number could be for the involvement in the sanctioned countries. Do you have any more clarity from where you were at the beginning of the year on the FCPA side? I believe you may have restarted conversations with the Department of Justice. And then also on the oil for food program, that is the smallest of the factors, correct?

Bernard J. Duroc-Danner

Actually, there are only 2. There are only 2. Author 3 [indiscernible] is included in one of them. There's only 2 sort of if you will -- set of issues. Sanctioned countries and oil for food. That's one. And then FCPA is the other. And what you ought to know, Angie, is that -- the issues at Weatherford, which may not have been handled as well they should've been handled in terms of the whole speed and efficiency of the legal process. I'm not sure we're terribly good at it. The whole set of issues started and were primarily sanctioned countries. What has been referred to so often when you see those via FCPA issued should [indiscernible] perhaps because of what the [indiscernible] FCPA is a well known word on Wall Street. It's also there. It grew out of it, which happens actually quite often also. But I mean, the original core issues are the ones that we have taken a provisional charge for of $100 million because the settlement looks not certain at all but probable. So one, my answer to you is therefore should our assumption that it is probable prove out to be correct and a settlement be found on around sanctioned countries, then our attention will move on to settling and closing the FCPA issue, which is the [indiscernible] remaining.

Angeline M. Sedita - UBS Investment Bank, Research Division

Okay. So then I should infer, based on what you just said that the FCPA would be a lesser amount than the $100 million you just took on the sanctioned countries?

Bernard J. Duroc-Danner

I can't tell you that, Angie. Even if I knew, I couldn't tell you that either on the conference call or in private. But what I will tell you, again, is that the scope -- and I am not a lawyer, you understand, so I'm just listening to what I'm told and I'm using common sense. The scope and scale of the issue on and around sanctioned countries I think it is safe to say we're certainly as, most likely more, significant than they were on what is referred to as FCPA. I'll leave it at that.

Operator

Your next question will come from the line of Kurt Hallead with RBC.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Just wondering if you might be able to provide us a little bit of a bridge on the North American and International progressions that get you from the second quarter earnings number to the third quarter. Just want to make sure I understand the kind of magnitude of the changes that you guys are referencing by the different regions.

Bernard J. Duroc-Danner

That's a modeling question, which I will let John summarize. If you want to do it on the call, John will do it. That's up to you.

John H. Briscoe

Yes. I can give you just a couple of comments and Kurt, we can spend more time after the call. But Canada is always low margins in the second quarter, and so we see the margins coming back up significantly in Q3 and Q4. Q1, though, is always the biggest quarter for Canada from a margin, as well as a top line standpoint. But as Bernard mentioned, we see the full year exiting very constructive, up at the top line for Canada and also up at the total dollar amount of margin with consistent margins to prior year -- consistent margin percent.

Bernard J. Duroc-Danner

Internationally, you'll see Latin America continue to improve throughout Q3 and Q4, roughly, I'm being simplistic, versus a very good Q2. You'll find the European, Russia and so forth and so on improve some in Q3. Then you're still having seasonality. So that will stop in Q4. And of course, MENAAP will jump. Why am I using a word like jump? Because essentially, they're so low. So they will have a correction and claw their way back to what is a more normal level of profitability in Q3 and even further in Q4. Those are your moving parts. So progression [indiscernible] America for leveling off for the near term. You'll see the seasonality coming out of Europe and a positive move forward coming out of MENAAP. In North America, U.S. continues to be certainly not a racehorse. It continues to be in plowing a positive way, Canada turns. That's it. And then, I just -- the specific numbers, I think would be too long on a conference call, but those are the moving parts and it's not complicated.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

I appreciate that color as for the outlook for the remainder of the year. And I was also just generally curious, as you look at the $0.10-or-so improvement sequentially into the third quarter. How do you characterize that, 60% North America given Canada, and 40% international? So what's the rate of improvement?

Bernard J. Duroc-Danner

I would say -- well, I think that's probably not an -- well, I'd say, probably half and half, probably -- but I mean, I -- Kurt, it's hard to know what -- get overly precise on what is absolutely nothing but best effort forecast. Clearly, for people that are very Canadian, the swing is material. It is what it is. And so a lot of it will be that. Just simple, simple weather-related issues if you think about it, nothing else. And also you have high levels of maintenance expenses, always, when you're down during the breakup, which -- and so all these things. But again -- then again, there's a fair amount coming out of Latin America and MENAAP. So maybe 60-40 is reasonable. You're close. And frankly, we don't know. Because it's in the pudding.

Operator

Your next question will come from the line of Mike Urban with Deutsche Bank.

Michael W. Urban - Deutsche Bank AG, Research Division

Most of my questions have been answered. I did want to follow up on Artificial Lift a little bit. Obviously, that's been a focus for you and doing quite well. We've heard a little bit, especially I think in some of the emerging plays in North America about a shift to using more ESPs in North America, which you haven't traditionally seen on shore. One, is that something that you're seeing? And two, is that a market you're prepared to address if so?

Bernard J. Duroc-Danner

I always smile when I hear these stories because they're very [indiscernible] the ESP manufacturers. Look, I like ESP. It's a large business and optimizing ESP fields [indiscernible]. The [indiscernible] optimization business is in Lifts. And I think we'll probably optimize -- and [indiscernible] as much ESP clearly optimizing the world, which is very good business as there are other forms of lift. The reality, I'll make it simple, Michael, is that operators use ESPs really in only one situation, when they have absolutely no other choice. They start using ESPs. They very quickly switch out of it, if they have a choice. Why? Consumes more power, item one. Item two, you have sensitive pump parts down the well bore, which means they tend to break. And sensitive means expensive, which means the repair costs are much higher and furthermore, because there's sensitive parts down the well bore, that means you got shutdowns more often. Net-net, unless you have need to lift more than 1,000 barrels a day at 10,000 feet, you'd be crazy if you use ESPs. But I'm not going to say bad things [indiscernible] about ESPs. I don’t care, but the net answer, Michael, is no. We don't see that trend. And if we did, we'd be very happy about it. How was that?

Operator

Your final question will come from the line of Scott Gruber with Bernstein.

Scott Gruber - Sanford C. Bernstein & Co., LLC., Research Division

I wanted some clarity on the tax rate guidance, if you could. Surprised that it's going to step up a little bit more to basically in line with peer U.S. company. John, are you having to basically wipe the slate clean with the international substructure and rebuild? Is that why it's so high and why it's going to take some time to optimize?

John H. Briscoe

Well, I don’t want to say wipe the slate clean because that's not a true characterization. But when we went through the restatement last year, we did learn a lot of things that are causing our rate to be higher. Some of this is through some withholding taxes that, based on how things were structured and how things were being executed, it was triggering additional withholding taxes in jurisdictions where we, in some cases, may generate low income or it may even be a deemed profit jurisdiction. So that's having a negative impact on our overall rate and makes it appear that we're at a U.S. rate. So withholding taxes is an issue that we're going to focus on. And we have other opportunities to optimize our effective tax rate that, to be honest with you, this year, we're just not going to be able to focus on those to the extent that we will in future periods. We're very focused on the remediation and making sure that we get the accounting processes working effectively. We have significant opportunities around planning and structuring, but we really need to start ramping those up and they don't -- if you do something in the third or fourth quarter, you don't see a benefit during the current period.

Scott Gruber - Sanford C. Bernstein & Co., LLC., Research Division

Got it, all right. If you could quickly -- if you could just restate the overhead expense you expect for the third quarter and how much the excess accounting fees you're occurring right now and the legal fees, how much those account for in that number?

John H. Briscoe

The increase in my guidance or the increase from the third quarter -- from the second quarter to the third quarter is all related to additional fees on the income tax work. There's not a significant increment related to legal. It's all income tax work.

Scott Gruber - Sanford C. Bernstein & Co., LLC., Research Division

Okay. But how much could we see come out, say, in '13, when some of these things should be rolling off?

John H. Briscoe

Well, it's difficult for me to project that when we're very focused on the task at hand right now, but you would see, once we get the remediation behind us, you will see a decline. But that decline will, I think, pick up speed as we move forward. So you shouldn't expect that there's just the big step change. When we have things working smoothly, then you'll begin to see that, that decline rate. And it will run over about a year, where we'll continue to decline, maybe 18 months, as we continue to get more efficient. So I think there's a good long-term opportunity for cost improvements as we're executing the way we should.

Bernard J. Duroc-Danner

It's fair to say in closing that the entire focus right now is just on having no more tax accounting issues, putting it all behind us as quickly as we can and never mention it ever again. And we should become efficient on around that to become the second issue. The first one is closing this up. With this, I think we'll close the conference call. Thank you for your time.

Operator

Ladies and gentlemen, this does conclude today's conference. Thank you all for joining, and you may now disconnect.

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