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Weatherford International Ltd. (NYSE:WFT)

F2Q08 Earnings Call

July 21, 2008 9:30 am ET

Executives

Bernard J. Duroc-Danner, Ph.D. - Chairman of the Board, President, Chief Executive Officer

Andrew P. Becnel - Chief Financial Officer, Senior Vice President

Analysts

Jim Crandell - Lehman Brothers

William Herbert - Simmons & Company International

Ole Slorer - Morgan Stanley

Dan Pickering – Tudor Pickering & Co. Sec.

David J. Anderson – UBS

Michael LaMotte - J.P. Morgan

Robert Mackenzie - Friedman, Billings, Ramsey & Co.

Operator

Good day Ladies and Gentlemen and welcome to the second quarter 2008 Weatherford International earnings conference call. My name is Ericka and I’ll be your coordinator for today. At this time all participants on a listen-only mode. We will be facilitating a question and answer session towards the end of the conference. (Operator Instructions)

I would now like to turn the presentation over to your host for today’s call, Mr. Bernard Duroc-Danner, Chairman and CEO.

Bernard J. Durco-Danner

Andy, why don’t you get started.

Andrew P. Becnel

For our second quarter of 2008 we report fully diluted earnings of $0.43 per share before non-recurring items. During Q2 our operations extended their streak of consistent execution. High quality well site performance, successful ramp up of younger technologies, and incremental seeding of new product lines all continued as expected. Predictably however, Q2 was a challenging quarter for Weatherford from a financial point of view given the seasonal decline in Canada and acceleration of mobilization costs associated with new contracts. Our reported earnings this quarter exclude an uplift of $71 million after tax or $0.10 per share from the following three items: One, an $81 million after-tax gain on the establishment of our joint venture in Qatar with QPC; two, a $17 million in after-tax costs incurred in connection with our exit from sanctioned countries and our ongoing government investigations; (3) $7 million after-tax gain related to our discontinued E&P operations.

EPS Comparison; at $0.43 earnings per share are down 14% sequentially and are up 26% year-on-year. The sequential drop of $0.07 was comprised of the following: a $0.06 of sequential decline from the field and a net $0.01 decline from non-operational items. Increases in corporate, R&D, interest, and other cost $0.02 while the 15.9% effective rate for the quarter helped by $0.01. Our effective tax rate for the full year is projected to land between 17% and 18%. On the corporate side, investments in process improvement, supply chain, service delivery, and support functions added to expense. A $4 million loss in fx added to other expense. Year-on-year the field contributed $0.12 while non-operational items hurt earnings by $0.03.

Operating Performance Consolidated Overview. On a consolidated basis sequential revenue grew $33 million or 2%. International revenue was up 10% or $111 million with double-digit percentage growth posted by Latin America and Europe/West Africa/CIS regions. Revenue growth in the United States also ran into the double digits. These strong performances were muted by the traditional seasonal decline in Canada. Excluding Canada, revenue grew 10% sequentially and is up 24% compared to the same quarter last year. Through the first half of 08 our international revenue is up 31% with Latin America up 23% on an 8% recount increase and Eastern Hemisphere up 33% on a 9% increase in recount. We expect international recount growth to accelerate in the second half of 2008. Consolidated EBITDA before corporate and R&D declined $54 million sequentially with operating margins at 23.0%. The [veer] detrimental in Canada coupled with mobilization costs in Mexico more than offset EBITDA improvements in the US and the broader international markets. North American margins are up 40 basis points compared to the year ago quarter. Year-to-date international margins are up 170 basis points to 24.2% on incremental of 30% compared to the first six months of 07.

Geographic Performance. Financial performance within our four geographic regions was as follows:

North America 45% of total revenue. Revenue fell $78 million or 7% sequentially on an 11% decline in recount. For perspective, revenue last year fell 12% on a 16% decline in recount. Revenue is up 15% compared to Q2 of 07 and is up 11% year-to-date 08 on year-to-date 07. EBITDA was $224 million down $67 million with margins at 22.2%. Canada’s decline in income was similar to last year’s although this year’s stronger sequential improvement in the US market in part compensated for the decline. All product lines grew in the US. Despite Canada’s decline artificial lift, well construction, and stimulation and chemicals still managed to grow top line in North America as a whole.

Middle East/North Africa/Asia Pacific 25% of total revenue. Revenue increased $34 million or 7% sequentially. Revenue was up $121 million or 28% compared to Q2 of 07 and is up $248 million or 30% on a year-to-date basis. EBITDA was $131 million up $10 million sequentially. Margins were 23.5% up 40 basis points with incremental of 29%. Compared to the year ago quarter margins are up 120 basis points on incrementals of 28%. Strong performances in Algeria, Kuwait and Libya as well as Australia, China and Indonesia stood out. By product line wireline, well construction, completion, and integrated drilling all experienced noteworthy increases.

Europe/CIS/West Africa 18% of total revenue. Revenue grew $42 million or 12% sequentially. Revenue was up $99 million or 34% compared to Q2 of 07 and is up $202 million or 38% year-to-date 08 on year-to-date 07. EBITDA was $99 million up $6 million sequentially. Margins were 25.4% down 140 basis points with incremental of 14%. Product and service mix restrained sequential incrementals. Compared to the year ago quarter margins are up 140 basis points on incrementals of 30%. Norway/UK/Russia all had solid improvements. All product lines grew with the most substantial moves put up by drilling services, well construction, and artificial lift.

Latin America 12% of total revenue. Revenue grew $35 million or 15% sequentially. Revenue was up $65 million or 31% compared to Q2 of 07 and is up $95 million or 23% year-to-date 08 on year-to-date 07. EBITDA was $58 million down $2 million sequentially as accelerated mobilization costs increased current quarter expenses. Though not budgeted at the quarter’s outset because we had not yet received the award, this acceleration was a conscious decision. Margins were 21.5% down 410 basis points sequentially. On a year-to-date basis margins were up 50 basis points. On a sequential basis Mexico, Brazil and Venezuela were the top performing countries. Region wide revenue grew in all product lines.

Cash Flow. During Q2 we generated EBITDA of $604 million with D&A running at $172 million. Operating working capital consumed $184 million of cash. At the end of the quarter we stood at 136 days of working capital. Receivables balances were flat with the growth in working capital attributable to the increases in inventories and preparation for growth in the second half of the year and in 09. After deducting interest expense and cash taxes, operating cash flow was $280 million for the quarter compared to $147 million in Q2 of 07. Capital expenditures were $527 million for the quarter net of lost and hold revenue. In light of the Chicontepec awards in Mexico and incremental project wins in the East, we’re increasing our cap ex forecast for 08 by $400 million to $2.2 billion.

Capital Structure; as of quarter end our ratio of net debt to net capitalization stood at 34.6% with total net debt at $4.3 billion. Cash balances totaled $268 million at quarter end.

Guidance; Bernard will cover our operational outlook in his comments. I have the following updates for you for 2008 non-operational items: Corporate expense $140 million, net interest expense $250 million, tax rate full year effective rate between 17% and 18%. Share Count; we exited the quarter at 682.4 million basic shares outstanding and 703.9 million fully-diluted shares outstanding.

I’ll now hand the call over to Bernard.

Bernard J. Duroc-Danner

Q2 is never our easiest quarter to shine. As most of you know we are for historical reasons heavily Canadian, far more than our peers. Not that long ago Canada was 25% of our company. This Canadian Q2 was worse than we expected. It wasn’t any better than Q207 was a trough for us. Summing up the forces in motion Q2 saw five moving parts: One, Canada hitting the same trough it reached in 07; two, early and impressive strength across the board in the United States in both volume and pricing; three, good performance for Middle East/Asia Pac in both top line and incrementals; for performance for Europe/West Africa/CIS top line below percent incremental due to mix; four, acceleration of bookings in Eastern Hemisphere was the highest level bookings to date; and five, a conscious decision early in the quarter to start and accelerate mobilization in Mexico.

Company-wide sequential comparisons are meaningful because of the relative weight of the Canadian breakup. Year-on-year comparisons [coeless] around the number 25%. Year-on-year Q207 on Q208 grew top line by 23%, earnings by 26.5%, and employee count by 25%. Year-on-year the Eastern Hemisphere and Latin America grew by 30% and 31% respectively. Sequential growth was 9% Eastern Hemisphere and 15% Latin America. Adding the two together the international segment grew sequentially by 10% and year-on-year by 31%. We expect Eastern Hemisphere and Latin America year-on-year growth to accelerate as the year progresses.

Sequential incrementals in international segments were unusually suppressed in Latin America. The reason is the margins were reflected by large mobilization costs in Mexico. By contrast sequential incrementals in Middle East and Asia Pac were 29% in spite of their own share of mobilization activity, while Europe/West Africa/CIS incrementals were lower in Q2 for idiosyncratic product mix reasons. Year-on-year incrementals for the Eastern Hemisphere, both Middle East/Asia Pac and Europe/West Africa/CIS combined were close to the target 30%. As discussed below that level incremental should be reliable [inaudible] going forward for the international segment as a whole. There are always ups and downs from one quarter to the next but essentially reliable on a trend line basis.

Product Lines. I’ll take you straight to the synthesis. One, Canadian numbers distort the relative performance of course so you have to look on an ex-Canada basis. So on an ex-Canada basis the three fastest growing project lines were artificial lift, wireline, and integrated drilling. Wireline and lift had outstanding quarters. Artificial lift includes our equities stake in Borats, the world’s largest manufacturer of ESPs is extremely strong from all perspectives. Wirelines built a very large backlog of renewed contracts making the prognosis stronger yet than the trading results. The growth was driven by technology, both measurement and conveyance. Integrated drilling encompasses much more than project management in rigs. I will cover in more detail progress on our integrated drilling later in my prepared comments. Other than lift, wireline integrated drilling we expect drilling services that is directional on the balance of the fastest growth rates in the next six quarters.

A few words on world records on technology this quarter; in the Gulf we ran our LWD triple combo at 32,600 psi operating pressure. Also in the Gulf of Mexico in a different instance we ran our LWD triple combo at 359-degrees Fahrenheit circulating temperature and over 400-degrees Fahrenheit static temperature. In Norway we ran the world’s first up sea installed optical fiber brag grading pressure temperature in our temperature sensing and finally we drilled under balance the deepest and hottest whole section ever attempted at 390-degress Fahrenheit. In China, we drilled on under balance a deeper and hotter hold section ever attempted at 390 degrees Fahrenheit. Similarly, our under balance technology was selected for what is likely to be the deepest and hardest ground drilled offshore in the Gulf of Mexico.

Not a world record but of added note, a first round of the installation of new carbonate reservoir draining system which includes inflow control technology, [inaudible], hydraulic packers, all that package modularly to horizontal limestone applications. This was completed in Saudi Arabia. Also in Saudi Arabia we ran the longest expandable sand system at 2,300 feet.

Upstream technology is central to our identity and strategy and will be increasingly so. We’ve acquired over the past five years with $900 million of intellectual property in the early stages of development. We have grown our R&D which is trending towards $200 million per annum at the same rate as the company’s top line. We continue in addition to invest between $200 million to $300 million per year, that seems to be the average, on acquiring new intellectual property. In the event some of you noticed that average moving up, you’re right. It is. In effect at this stage Weatherford is investing between $400 million and $500 million per annum on R&D and new technology developments, probably one of the industry’s highest ratios to revenues.

Employees; by the end of the quarter we had 42,152 employees. The employee count increased by 1,563 over the quarter or 3.3% sequentially and 4,286 or 11.3% in the first half of the year alone. Year-on-year we added 8,500 employees or 25.3% as per the comment above. The second half of 08 we expect to hire another 5,000 employees as we gear up for 2009.

Costs and pricing; both costs and pricing are moving. Taking an overall view of our operations we’re seeing on average a labor cost increase of about 8% and raw materials increases about 25%. Weighted average of different field grades and on domestic alloys, miscellaneous metals, fuel, diesel and [inaudible] chemical feedstock. Pricing has risen in all markets except Canada. Canada’s turn will come. Pricing in the US is rising as we speak by 10% to 15% on a weighted average basis. The rise occurred in the course of Q2 and is continuing in early Q3. There are wide differences in product lines though. This is an average. Pricing in the international markets is a more complicated issue as the divestiture of market situations make trends more opaque. We isolate and analyze pricing on a real-time basis and we do so by product line in geographic markets worldwide. Our most recent analysis shows pricing strengths in the international segment that exceeds the US with a weighted average increase of over 15% for the most recent batch of renewed contracts and incremental volumes. With the exception of a few idiosyncratic situations our pricing in the international markets strike us as an opportunity to push further, particularly as we get into 2009.

Comment on incremental; as I said earlier on a forward basis such 30% incrementals in the international segment should be a reliability optics. This applies to both hemispheres.

Important events and acquisition activity; we spent in the quarter $72 million on six small acquisitions. The acquired assets and companies are all technology deals except for one which is a very small company. The largest transaction was the acquisition of a tubular running services technology called Iron Dirtman whose consideration represented more than half of the total acquisition expenditures. After last quarter’s acquisitions of Norwegian V-tec this is the second significant technology commitment in our to the running services legacy product line.

Extended comments on integrated drilling; by Q109 we expect to have nine integrated drilling projects underway, eight in the Eastern Hemisphere and one in Mexico. Two of the projects involve managing client rigs together with our down haul products and services. One involves combining coil-tubing units, our own coil-tubing units, with our downhaul products and services. And finally six or two-thirds the total number of projects involve [ARAM] rigs and downhaul products and services. Eastern Hemisphere integrated projects will round in total 37 rigs and two coil-tubing units. 24 of the rigs which are essentially nine rigs except one offshore rig, 24 of the land rigs and both coil-tubing rig units are Weatherford owned and designed. The rigs are on average mid- to heavy equipment. The average contracted life of the Eastern Hemisphere projects is about three years. The Eastern Hemisphere projects are spread in six countries. All are in varying degrees of mobilization and all will be running by Q109 or in the course of Q109.

In the Western Hemisphere there’s only one integrated project on a mobilization and that is in Mexico. The Paramex contract calls for 20 rig operations albeit the rigs are smaller than our Eastern Hemisphere brethren. Although we normally do not comment on project details either to respect client preferences or for competitive reasons, Chicontepec has gotten much attention. We can report the following on Chicontepec. All our close product lines have been contracted and priced. Delivery dates are within the project’s anticipated timeframe. Of the 20 rig fleet 10 of the rigs are contracted and 10 are Weatherford owned.

Hiring and training in Mexico as well as Colombia, Valenzuela, and Argentina in added support is well advanced. In total we’ll add 715 new employees. Infrastructure is also well advanced. We’re opening July 31. That’s in a week or so. Our new headquarter base is Puerto Rico which is a 50,000 square feet facility for assembly, calibration, testing, repair and maintenance. It is equipped with a full electronic lab for directional and wireline and all necessary pressure testing equipment. The facility will also have adjacent offices of 200 people at both Weatherford and Paramex personnel.

By the end of September, which is only two months away, we’ll open our second base which is within the field. That base will have also a 50,000 square feet facility with repair, maintenance, etc. and testing equipment on a 100-acre lot. The facility will provide housing for 100 people. By way of background we had originally very little infrastructure on and around Chicontepec or Puerto Rico. As to the timing of the start off, it is essentially now. The first two rigs and crews have been mobilized and are on location in Puerto Rico. They will spud the first two wells within a week, by the end of the month. The directional well construction, completion, wireline, and stimulation equipment with respective crews are also on location and ready for operation on both sites. The remaining 18 rigs and downhaul products and services are staged for additional spud in batches of four a month effective in August. By year end the entire operation should be running. That’s probably more detail than we provide for projects on a mobilization obviously.

Foreclosing comments on the same contract; one, Chicontepec is strategically important for Paramex in both scale and time. That’s not an overstatement. That’s accurate. It may be equally strategically important to Weatherford also in scale and time depending on our performance. Two, Chicontepec isn’t any different in operating challenges than the other eight integrated projects we are starting up. If anything, it is easier in drilling conditions and infrastructure. Three, Chicontepec contracts for $900 million of business which approximately half is our product lines. We do not expect much contribution to P&L in 08. We factor the returns in our assessment of 09. To a degree Chicontepec is a free call unless one assumes the project when started off will provide negative returns. We do not believe that to be remotely the case. On a forward basis we see integrated projects as a very important part of our business. The rate and quality of integrated rig project opportunities are strongly arising throughout the international markets.

Forward Views; One, Canada, with hydrocarbon pricing environments of $130 oil and $10 gas the Canadian market has bottomed out. Client toll suggests a strong recovery in H208 and H109 led by heavy oil, shale, and broad scale new gas plates. Two, the US market will strengthen further in H208 and 09. The oil segment lower 48 and [deporter] and the gas segments are ready for healthy volume increases. No doubt, we expect at this time robust 09 in the United States. Three, the international play, setting aside improved prospects in North America quantum long-term growth remains predominantly an international play. With each quarter that passes we see more quantitative evidence of the international markets depth, breadth, and longevity. In both the Eastern Hemisphere and Latin America growth rates will be strong and sustained. The growth process will be long, longer than any relevant timeframe for forecasting purposes.

In closing let me provide you some specific guidance. For 2008 the balance of the year but overall we assess Eastern Hemisphere growth prospects at 40% per annum and Latin America 25% per annum matching our 2007 performance. This is a combined 37% international top line growth 07 on 08 that we anticipate. For 2009 we’d like to suggest a 40% growth rate for the international segments both hemispheres combined.

With that I will turn the call back to the Operator for the Q&A session.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Jim Crandell - Lehman Brothers.

Jim Crandell - Lehman Brothers

Good to hear that things are going well at Chicontepec. With the drilling conditions and infrastructure easier than other IPM work there, with your subcontractors lined up, and your facility on or ahead of schedule, what are the risks in your judgment of this being a solidly profitable contract in 09? You talked about the chances, I think you said that it was not even remote that it could be a loss contract, but could go wrong here as far as that project is concerned that could make it say a lower margin project than what you are forecasting?

Bernard J. Duroc-Danner

Given that we’ve assigned no P&L in 08, that gives us I think time to sort out the quality of the crews, good functioning of the equipment, which is typical in those projects. But the answer looking into 09 is I can’t think really of anything that could make this into a non-performing contract in 09. We have six months to sort out the teething problems on the contract.

Jim Crandell - Lehman Brothers

Bernard, have Paramex’s plans changed at all relative to Chicontepec? I know there’s been some change orders already; probably some future ones to come which I think have enhanced the outlook for you. Do you think your work within the next 12 months will ultimately exceed this $900 million and will change orders even improve the margin picture from here?

Bernard J. Duroc-Danner

Chicontepec is as I mentioned in my comments a particularly important reservoir field for Paramex. It is a field that is in early development. It is a large field. The development scale, number of wells to be drilled per annum, is in the 1,500 to 1,800 wells per annum or something like that and the time that it’ll take off the field is something north of 10 years. So clearly the architects who are responsible for part of the drilling on Chicontepec will do well operationally. We’ll be in a good position; not a guaranteed position but a good position to stay on that field throughout that period of time and probably grow with the drilling activity to develop that field. So it becomes in a way if you perform well it becomes almost like a contract annuity if I can use that term of a large scale for a very, very long time, almost as if you had acquired a company to a degree by giving you a top line and a source of cash flow. But again you have to perform from an operating standpoint which means you have to be efficient, you have to be fast, you have to be accurate. The wells are not difficult but still you have to be the three things I just mentioned.

Jim Crandell - Lehman Brothers

Bernard, on your three IPM contract awards in the East that you won this quarter, were these competitively bid awards and are there any of some size you can comment further on?

Bernard J. Duroc-Danner

Of the three, two were competitively bid, one was negotiated. I would say that if you take the eight projects that are being mobilized, in different stages of mobilization right now, and you put them all together, the top line that it should represent in the aggregate for the first year of them all running together would be approximately $1 billion to $1.1 billion a year. Of that number there is about $800 million to $900 million which is our products and services. There isn’t much pass-through. The reason is that those contracts typically in the East do not include tubular. Tubulars normally run 25% or so of any project. The fact they’re not there means the pass-through becomes a very small number as a percentage of the whole. It’s different in Chicontepec.

Jim Crandell - Lehman Brothers

And you also commented Bernard about wide differences in pricing in the US by product line. Can you elaborate on the areas where you’ve been able to put through more significant price increases and the segments where it’s difficult?

Bernard J. Duroc-Danner

I don’t want to. I can tell you that on the product side we’ve been able to do very, very well. Our products are of course a broader range or moving from artificial lift through to liner hangers and completion, etc. etc. On the service side is where there are major differences. Some of the services are doing very, very well. Other services basically you’re in cost recovery mode essentially. And that’s where the difference is greater. I’d rather not mention the product lines.

Jim Crandell - Lehman Brothers

Last question for Andy, can you give us a sense given the big ramp up of year-end Canada over some of the revenue growth that you think you can achieve in Canada versus last year and then from the second quarter level the level of incremental margins that can come out of Canada?

Andrew P. Becnel

You’re thinking year-on-year second half of 08 versus 07?

Jim Crandell - Lehman Brothers

Yes.

Andrew P. Becnel

I think it should be in the 20% range.

Jim Crandell - Lehman Brothers

And what margins, using the second quarter as a base, on the incremental revenue do you think you can achieve coming out of the seasonal trough?

Andrew P. Becnel

There’ll be very, very healthy margins obviously. They always are in Q3 in terms of incrementals. They’ll be north of 60%. I think we might very well be in that area going into Q4 depending on how we do on pricing and volume. I think it’s safe to assume from a rig count perspective of looking something on or around 400 rigs in Q3 and something north of that in Q4. The healthier that is, the better we do on utilization, the better we do on pricing and it also depends on where the work is in Q4, you could see very healthy incrementals in Q4 and Q3.

Operator

Our next question comes from William Herbert - Simmons & Company International.

William Herbert - Simmons & Company International

Bernard and Andy, what was the dollar magnitude of start-up costs for Q2 in Mexico?

Bernard J. Duroc-Danner

It’s hard to be precise about these things because of when you start. I think $15 million is probably right; there about.

William Herbert - Simmons & Company International

And we’ve got a couple of phases left before year end, so how should we think about a road map for Latin American margins as the year unfolds? Are they flat from this point forward until we get to a sufficient level? Do they go down? Do they revive? How should we think about that?

Andrew P. Becnel

I think you should see them relatively flat from where they were in Q2. For Q3 and Q4 with a substantial recovery as that project’s margins grow on it, you get the kinks worked out and start-up costs behind you, and the rest of the underlying business for Latin America improves. You should think north of 24%-type margins for full year 09.

William Herbert - Simmons & Company International

Certainly with regard to Mexico once again, what’s the current run rate of Mexican revenues and what should we expect 09 revenues from Mexico to be?

Bernard J. Duroc-Danner

I think you’re running at $250 million in Mexico. And your second question, you wanted the 09?

William Herbert - Simmons & Company International

Yes. A range is fine.

Andrew P. Becnel

Bill it depends on where it is. Just take that $900 million of the project, assume better than 25% underlying growth on the rest of the business on a per annum basis, and then how do you want to split that $900 million. And that just depends on when a well site’s ready, how many wells get drilled this year. It’s easier for you to figure out average costs if you will or average revenue per well, so I think it’s better if we report that ex-post so as not to get you too far ahead or too far behind.

William Herbert - Simmons & Company International

So the current run rate’s $250 million.

Bernard J. Duroc-Danner

$250 million looking back. Looking forward stick on a 30% increase or there about and you put as much on Chicontepec as you want in 09. We will not be late. We’re obviously not late. So we’ll be ready.

William Herbert - Simmons & Company International

And what were the Mexican revenues in 07?

Bernard J. Duroc-Danner

$200 million?

Andrew P. Becnel

Just south of $200 million.

William Herbert - Simmons & Company International

Last one for me, with regard to US pricing, pressure pumping pricing, what are you guys seeing on that front? Is it bleeding modestly? Is it stagnating? What’s going on-on that front?

Bernard J. Duroc-Danner

It’s not weakening any further which is already a positive. There is recovery for some of the most painful cost increases; example fuel and the like, it does not have the balance on the upside and the other products and service lines have.

William Herbert - Simmons & Company International

And would you expect before year end in pressure pumping that you would be the beneficiary of net pricing gains?

Bernard J. Duroc-Danner

It depends how much new capacity some of the smaller players - I mean, we’re a small player ourselves but we’re static - but of the smaller players that are more aggressive and also smaller [inaudible] anyway, how much capacity is put on.

Operator

Our next question comes from Ole Slorer - Morgan Stanley.

Ole Slorer - Morgan Stanley

Bernard, I didn’t quite catch what you said about the nine large integrated drilling projects. How do these projects compare in size on average with Chicontepec?

Bernard J. Duroc-Danner

You’ve got eight projects. Nine is eight in the East and one in the West, the one in the West being Mexico. Probably best to look at the numbers. I gave two indications that the overall billings for 09 or the first year of all eight of them running together, which will be by the end of Q1 presumably, that runs about $1.1 billion for 12 months and is about three years commitment. So you’ve got roughly $3.3 billion between the eight, so $3.3 billion divided by eight gives you an idea of what the overall commitments are. Some are large; some are not so large.

Ole Slorer - Morgan Stanley

So these in aggregate are a little larger than Chicontepec, is that the way we should view it?

Bernard J. Duroc-Danner

I think the average project is about $400 million to $425 million except Chicontepec which is $900 million. But there are eight of them. The other aspect of these projects is that they have a higher Weatherford part of service line intensity than Mexico insofar as you don’t include tubular. That’s a major difference. And tubulars as you know is between 20% to 25% of any project and so the fact there is no tubulars means that the amount of pass-through in the East is something like 15% of the ticket on average whereas obviously in Mexico it’s different.

Ole Slorer - Morgan Stanley

So the annual run rates on these eight contracts should be larger?

Bernard J. Duroc-Danner

Yes, it is, of course. The eight contracts are contracted for a longer period than Mexico. Mexico is just one year if you think about it. These contracts run roughly at $1.1 billion give and take and then of course without pass-through it’s more like $900 million for one year, so you understand.

Ole Slorer - Morgan Stanley

What does that [inaudible] in your opinion this step change in integrated project management or whatever you want to call it full year?

Bernard J. Duroc-Danner

First I think it’s rewarding to see that combining expertise in running rigs works very well with directional and on the balance on the rest of it. It really does. It works not only from a marketing standpoint, it also seems to work from an operating standpoint. That is something that is gratifying. The second is that it is what we anticipated. This does not come as a surprise but perhaps the level of interest is a bit higher than we had anticipated, but we thought that would be a useful class of service for our clients. There is a concern on being able to run these things properly because in the end it’s all about efficiency; it’s all about speed of drilling and accuracy of drilling; and we spend a lot of time on making sure that we operate these things properly. And then of course the other reaction is one of managing the process by which we commit to more because the backlog of interest for these things strike us as being strong, actually stronger than it was in the training 12 to 18 months; it was strong already. So there’s a lot of momentum albeit we don’t see this integrated drilling as being more than, right now it’s going to be about 10% of what we do roughly. As you saw Chicontepec may be closer to 15% of what we do in 09 and later on we don’t see that going much beyond 20% of what we do but it’s a very good 20%, a very good 15%. Best we can tell.

Ole Slorer - Morgan Stanley

You’re forecasting an acceleration in international growth in 2009 relative to 2008. Could you talk a little bit about how you see the incremental margins? You talk about 15% pricing on some of the revenues that you are recontracting or growing. First of all, what percentage of your business is falling over to this new 15%? Are we talking about a two-year contract, so therefore are we talking about a third to half of your business benefitting from this type of rollover or a quarter in the second half of the year? How should we think about this?

Bernard J. Duroc-Danner

It’s hard to have very precise metrics on this but I would say over a period of say six months about a third of the services and contracts in international markets continuously rolled if you will. That’s about right, and that’s a very iffy metric. In terms of the margins, our incrementals, from one quarter to the next you’re going to have things up or things down [inaudible]. Numbers are what they are, but you shouldn’t expect things to be exactly in the right bucket at the right time. However, on any kind of Q3 quarter basis on a trend line basis you’re incrementals in the international market will be north of 30%. We’re quite certain of that.

Ole Slorer - Morgan Stanley

So then comparing that with let’s say Europe/Africa/CIS we had a very strong sequential year-over-year revenue growth. Sequentially you’re margins didn’t really go up, so can you talk a little bit about was this about pricing, was it about mix?

Bernard J. Duroc-Danner

I think I would just say that we really – I mean, in the end it’s a little bit of chaos in all situations meaning that there is some randomness and that if you were to look at the Q3 margins, I don’t suspect they’ll be very good and I will not have much of an explanation for it either. It will be that times of delivery or shipments and the classes of products that have much higher margin than others and there you are. There is nothing more compelling about it and we looked at it about as closely as anyone can.

Ole Slorer - Morgan Stanley

So, we should not reach through on anything like execution or anything like that.

Bernard J. Duroc-Danner

No. Out of all the eight projects that are being mobilized there is only one in that sub region, right? There’s only one. The other seven are in Middle East, North Africa, Asia PAC, they’re the ones having good margins. They had lots of thought out cost mobilization blah, blah, blah. Actually, the Europeans and African/CIS, they only have one project. It’s a large project but I mean it doesn’t compare to the other seven, right. So, in a sense it’s counter intuitive. This is why the best thing I can tell you is there is always some measure of how numbers line up and that’s how it should be.

Ole Slorer - Morgan Stanley

So based on that Bernard and what you’re seeing at the moment in Canada, you feel comfortable about the third quarter consensus expectations?

Bernard J. Duroc-Danner

I’m never comfortable fully although I am as comfortable as I can be.

Operator

Your next question comes from Dan Pickering – Tudor Pickering & Co. Sec.

Dan Pickering – Tudor Pickering & Co. Sec.

You talked about pricing in North America, particularly in the US picking up Bernard between 10% and 15% during the quarter. Can you give us a little bit more color there? Is that driven by cost going up there or just kind of holding the line? Or, is this really an activity pricing move?

Bernard J. Duroc-Danner

It started off as cost Dan and almost as a sort of something we needed to do. Bear in mind that we’re 50% products 50% service at Weatherford. Some of our fields might be 80% service so we have more materials exposure right off the bat and we’re very sensitive to materials cost and we do manage our supply chain with a lot of attention. So, we spotted obviously the trends in all classes of materials early so it becomes one was driven by necessity. But then, when the necessity curve was joined by sensitivity, it had to go up and this was pretty obvious already in Q1 then you have more momentum and then we just went for more.

Dan Pickering – Tudor Pickering & Co. Sec.

We’re beating the IPM thing to death but I think it is important. The industry obviously indicated that Weatherford had been very aggressive on pricing with Chicontepec and I’m trying to understand if your mix is different than they’re mix, your cost is lower than their costs or their assumptions and margins are higher than yours? I’m trying to understand why their view of this project and your view of this project is so different.

Bernard J. Duroc-Danner

I would also say consider the course including what I tell you meaning that we’ve got obviously some of our most beloved competitors who are less than happy. First, we operate in Mexico. We have operated in Mexico for a long time. We actually operate in Chicontepec, very modestly in terms of scale but we know our cost structure over there, that’s one. And two, the pricing that was utilized in Chicontepec is actually higher than the pricing we have in Mexico north and south so just as a point of reference. It’s not like we decided to walk in Mexico and we have no idea what the cost structure is and low and behold we won a big contract because we were cheap. No, we operate in Mexico, we know the cost structure and that pricing is actually higher than what we have right now, for what it’s worth. Three, I could take you through the mechanics and tactics of contractual pricing, this is not the place to do it obviously, not on a public call. But, I do chuckle when I listen to the comments of the outrage of this and the outrage of that. If I take you through the mechanics it is not at all the same thing as what has been discussed.

But, to a degree, this is irrelevant. This is irrelevant. What is relevant is not so much why we won but it is relevant that we did win and the only question that you should ask is are you going to operate properly, item one. Item two, do you understand your cost structure? Well, I can’t answer the first one because the proof will be in the pudding. The only thing I can tell you is that we are early, we are spudding in a few days our first well and at a very minimum the client will not be screaming because the contractor, the service company is behind. Nine times out of 10 the client is unhappy about the timing, everything is late. We are not late, that is the fact number one. It came at a cost in Q2, I understand but, in retrospect I would do it again, and again, and again. It was the right move from a business standpoint. Alright, so we’re not late but will we operate well? I don’t know. Time will tell. I think we will just like the other eight projects in the East, we put a lot of time and attention on it.

In terms of understanding our costs, there again, time will tell but we know the cost structure in Mexico. I would sort of argue that the fact that a lot of our technology is one that is a cost saving type technology either in time of execution or I take EM or take open wire line, the compact product line, we very typically are time savers. But, I won’t even go down that road just to tell you that the best we can tell, with all the experience we have, not only is this a strategically very important contract for us because of the magnitude and longevity but also Dan, it’s quite easy from an execution standpoint. It’s quite easy to understand the cost structure that you are going to have and I think we nailed it down. Certainly, on all the outside elements we nailed it down very nicely. For us, I think subject to us executing properly, there’s not a lot of movement on the cost up or down within sort of the range that have estimated.

Dan Pickering – Tudor Pickering & Co. Sec.

Bernard, if you looked and including all your startup costs and assuming you execute well, will the 50% of the revenues you generate from your products and services, is that going to be at least as good of a margin as the rest of the Latin American business?

Bernard J. Duroc-Danner

Oh yes, I think it’s actually higher. Just to make you happy, just to say it, we actual think higher.

Dan Pickering – Tudor Pickering & Co. Sec.

Two other quick questions, one is, is rig ownership something that you are going to spend more money on, on a go forward basis? And two Andy, if you could just help us with on an all encompassing basis in the second quarter, not just Mexico but where do you think your startup costs in aggregate for these IPM projects were in Q2?

Bernard J. Duroc-Danner

I think I’ll have a hard time giving you these kinds of numbers because we didn’t try to isolate them whereas we did in Mexico. But, I’ll let him work on that while I answer the first question. Only Dan, on the rig side when there is an interest in combining rig operation with products and services whether a formal interest or an informal interest. Meaning, in some instances we actually have clients who will still contract all of their products and services separately from the rig as if they were distinct. But, it is clear that because we have one we’ll get the other and under that circumstances or under the formal integrated drilling project type circumstance, we’d be interested in investing in rigs. Otherwise, no. As for the other question do you want to answer that.

Andrew P. Becnel

Mexico you know.

Dan Pickering – Tudor Pickering & Co. Sec.

Mexico we know, we’ve already pinned that right around $15 million.

Andrew P. Becnel

In the East Dan, I’d really rather not go there in terms of where it is and where it’s going to be for the remainder of the year. Trust that startups in the East are factored in to the 30% incremental guidance that we give. We have better visibility on that because we look at a portfolio of projects on any given time and we feel that it’s fair and we tend to be accurate on assumptions as to what will fall away and what will not and what kind of start up costs are associated with those projects on average. We’ve baked that in to our thinking for the year. What was unique about Mexico is we were actually awarded the contract during the quarter so we really had to get on with it in terms of the mobilization and startup was much more rapid from the time perspective and things were compressed and so that was just not something baked in to the thinking after the Q1 call and that’s really the only reason we pointed out to you this time.

Bernard J. Duroc-Danner

Because the Mexico decision, we behaved like a private company. If you were a private owner you would have moved immediately because what your risk is in Mexico is not performing operationally, your risk is not whether you understand your cost and all that kinds of stuff, that’s not the case. The risk is are you going to operate properly and that means being there early, that’s step one.

Operator

Your next question comes from David J. Anderson – UBS.

David J. Anderson – UBS

As I recall about a year ago you had about five IPM projects under your belt and now you’re talking about nine I know you’re talking about nine right now. Where do you think this goes another year and what are your constraints in terms of adding more of these projects?

Bernard J. Duroc-Danner

Obviously of the five of a year ago, if I remember correctly there should be already three that are running and then we are faced by another three and then we add another four. And that’s going to be a moving target. David, if we were to talk in 2010, I’ll just go right about 2009, I think the integrated activity will be approximately 20% of our top line or something like that. And I’m trying to stay as close as possible to 20% that would be essentially our own products and service lines and not take on too many projects that have a lot of pass-through. Yes, I know Mexico is an exception but Mexico is unique in many respects.

J. David Anderson - UBS

I think you had mentioned it before, but what do you expect that to be in 09? What percentage?

Bernard J. Duroc-Danner

In 09 we expect to have in the East about $1.1 billion running, maybe $1.2 billion of integrated drilling projects; that’s item 1. And in South America you’re going to get, I don’t know let’s call it $700 million, $800 million, $900 million worth of Chicontepec, maybe $800 million. And so between $1.1 billion and $1.8, we’re at $2 billion. So depending on what your denominator is for us in 2009 that will give you the percentage.

J. David Anderson - UBS

On a different subject, you’d highlighted the higher labor costs and material costs. Is there any particular region that you’re taking more of a hit in than others due to say produce mix or some other reason?

Bernard J. Duroc-Danner

David, I don’t know. Probably that isn’t the case. Steel and stainless and so forth and [inaudible] pricing by and large.

J. David Anderson - UBS

Do you have any kind of sense as to how many in terms of basis points how much is kind of knocked off in terms of your margins?

Bernard J. Duroc-Danner

So far I think we’ve managed to cover things nicely with pricing. And I’ll mention something else on the labor side, let me not forget, but on the pricing we managed to cover really the cost of the cost of business and I suspect we’ll do a little bit better than that on a forward-looking basis, so that’s one thing. I don’t think you have any movement on the margin side at all that’s cost driven. I reported on the cost because I think it’s an important thing that people ought to know. On the labor side as I think it through, your question, let me modify my answer. I think it is on a trailing basis the [inaudible] factor in the international market as it has been in North America. On the forward basis I suspect it will be less of a factor in the international market and more of a factor relatively speaking in North America. Why is that?

Well it’s the gradual process David of replacing OECD personnel with non-OECD personnel. Non-OECD personnel is being trained. We certainly hire and train at a rate which probably is among the highest in the industry and of course once they are hired and trained, what is the difference between a non-OECD and an OECD personnel? It’s much cheaper. As the non-OECD mix in the labor pool, it grows over a period of time. It doesn’t take a lot of time, David. Actually your labor costs are going to go down. So let me summarize as I think my comment on the labor side should be taken. They are correct from a training basis. But they should be taken probably as more indicative of a cost issue in North America and in the North Seas. For the rest I think on the contrary, the labor side will actually go the other way and I’m pretty certain of this David. The material side you get the same everywhere you go. There are some markets where materials are regulated. There aren’t that many.

Andrew P. Becnel

Just one thing to add, David. With the recovery in Canada that’s expected, you should expect and we do expect and what’s factored into our thinking is a decent rise in labor costs. It always happens with an increase in activity especially coming out of a slump. And US, not too different. We’re at such a high level of activity, I know it wasn’t very exciting a year ago to talk about the US as if we were stuck in a tunnel of sorts, but still a tunnel that was a high average rate count. And here we are stepping up above 1,900 rigs probably going across 2,000 and higher and labor gets expensive and so with that wages go up.

J. David Anderson - UBS

One last question on Canada. I think if I’m not mistaken Canada comprised about 15% of your overall top line a few years back.

Bernard J. Duroc-Danner

25% David. As bad as that.

J. David Anderson – UBS

Where do you expect that to get? Obviously we have a ramp up coming. How high can that get again? I know things have changed a little bit.

Bernard J. Duroc-Danner

Let me just have fun with that question if I can David because it isn’t always easy to have fun on a conference call. I suspect that Mexico will be larger than Canada. And I also expect Canada to do well.

Operator

Our next question comes from Michael LaMotte - J.P. Morgan.

Michael LaMotte - J.P. Morgan

Andy, quick question on some numbers for you, first of all on the investigation related charges there’s $0.04 in the first half. Where do we stand with those and when can we expect those to start coming out?

Andrew P. Becnel

Boy, I hope as soon as possible. We keep everybody updated through our public disclosures and I’d like to stick to those in terms of progress and what not. But obviously it’s a distraction and we’d like to see it all be finished up as quickly as possible. Until it is finished, we’ll continue to incur costs at least on the fees and consulting side to take care of things.

Michael LaMotte - J.P. Morgan

Do you all feel challenged at all in terms of bidding for some of these international projects as a consequence of that?

Bernard J. Duroc-Danner

No. I would say that probably the expense that we incur, partly because the company tries to do absolutely everything it possibly can to look at every aspect of what we do so that it’s not only compliant but I think a bit ahead of compliant. On the other hand, no it does not. It should not really.

Michael LaMotte - J.P. Morgan

On the acquisition front, what are we looking at in terms of the run rate of annualized revenue contribution from the I guess it’s 17 now deals done year-to-date?

Bernard J. Duroc-Danner

We should give you a list of how much [inaudible] so much year-to-date. Year-to-date has been acquisitions of I hate to say it of technology because that’s not something that’s terribly popular insofar as it has a bang later on. It has a bang a year later or two years later, sometimes even longer than that. Andy, do you have a sense of how much revenues the ones that are not technology?

Andrew P. Becnel

It would be very dominium for 08. For those that are not technology, if we are let me just say exceedingly fortunate, you might be looking at $40 million to $50 million of top line contribution for all of 08.

Bernard J. Duroc-Danner

And where was the revenue going to go, Andy? Probably half and half?

Andrew P. Becnel

It’s going to depend especially on the technology side. I would say even spread with where we are today but many of the things that we look at and try to get ramped up is obviously to push things through our supply chain, and it’s going to depend on where orders hit and how quickly if it’s a service type business we can set things up in international markets.

Michael LaMotte - J.P. Morgan

Last one from me. When did construction begin on your facilities in Poza Rica? 100,000 square feet’s pretty significant.

Bernard J. Duroc-Danner

Andy, do you want to answer that?

Andrew P. Becnel

Sure. We actually began construction almost two months ago. The facility that we had was actually an existing facility on a nice piece of land. We were very fortunate to get it. I was actually just there about three weeks ago. They’ve made a great amount of progress on it and it’ll be a facility we’re proud of. We haven’t always been proud of our infrastructure in every place. We’ve worked hard to try to do better especially in Mexico and other places; put up places that we can bring our clients to and that suit our operations and help us work efficiently. So it was about two months ago that things started in terms of the acquisition of that facility and working on it.

Bernard J. Duroc-Danner

Two things are happening currently David. On the one hand we started mobilizing equipment, people are taught in the training program, etc. At the same time we went on an expedited process of the two facilities, the one which is not really in the field but on the edge of the field. [Inaudible] being sort of the more urban facility even though it’s outside of Poza Rica. At the same time we commissioned the two building constructions and as Andy said the first one was an existing structure. We just modified and converted it, etc. We did have a location on and around Chicontepec. It was very modest but appropriately modest. The business we have is very modest too. And that’s that. With not only the scale but the expected timing of the longevity of the contract called for a different infrastructure.

Michael LaMotte - J.P. Morgan

One more question on the 750 people addition to the headcount. I assume at least at the start a good number of those will be non-Mexican nationals. Is that mix going to change over the duration of the contract? Are you going to cycle people through?

Bernard J. Duroc-Danner

First of all, Paramex provides a number of people. That is number one, so that you understand. Number two, I would think Michael that most of the new employees will be Mexican. It’s true. You’re right. There will be Colombians, Argentines, Valenzuelans with some experience that will be - it’s already happening - that are going to be directed towards Chicontepec but to act more in a way trainers and to provide some measure of guidance to the younger hires on the Mexican side, but I would say that of the 750 people and excluding the Paramex contingent I would say about 80% to 85% would be from Mexico.

Michael LaMotte - J.P. Morgan

Just trying to get a sense in terms of training component I guess as opposed to reallocation of that human resource.

Andrew P. Becnel

Very, very heavy on the training side to the extent Latin America’s been growing very quickly. We recognize that it’s a cost-sensitive market overall; all of Latin America. And it behooves you to have locals. It’s no different than any other place that we look at on a global basis, so there’s been very heavy training out of markets in terms of local training on wireline, directional, underbalanced, what I call more blue collar technical areas and the folks that come out of the program, there’s already 50 individuals who’ve already cycled through on the directional and underbalanced side and about an equal number on the wireline side. And those folks are ready to go. So stay local.

Bernard J. Duroc-Danner

One last comment, Michael, there’s so much focus on just one single contract. If you sort of step back, we are doing the hiring and training and so forth and so on of more than twice the number of people that we’re working on in Chicontepec in the East. I mean there’s very little focus on that and this is going on at the same time. You’re going to be hiring something close to 2,000 people in different parts of the world. We’re doing it as we speak for the other eight contracts. So it’s not unique and we do not use experts unless we absolutely have to use experts. And if we use experts it is a transition; it is not a permanent assignment. Can’t afford them.

One last question Operator if there is one and then we’ll follow with the end of call here.

Operator

Our next question comes from Robert Mackenzie - Friedman, Billings, Ramsey & Co.

Robert Mackenzie - Friedman, Billings, Ramsey & Co.

Thanks for all the color Bernard on Chicontepec. That helps a lot. I have a follow up question to beat a dead horse I guess probably for Andy here, though. Andy with your guidance of Latin American margins flat in the third and fourth quarter from this, however in the press release you guys talked about starting to mobilize four rigs a month starting in August, so it seems like Mexican costs compared to 2Q should be up in 3Q and 4Q once again. What else in Latin America is serving to offset that on the strong side to give you flat margins?

Andrew P. Becnel

Well don’t forget to include the revenue. You’ll have a healthy revenue uptake in Q3 and Q4 again, associated with that project as well as margin on it. So that does enough if you will to offset the costs associated with the start-up. The rest, let’s just think about outside of the project but heaven forbid it becomes all of Latin America much less all of Weatherford, this quarter we signed $450 million of incremental contracts just out of Mexico. Don’t focus on just one thing. Brazil market is incredibly vibrant. Venezuela is coming to life; doing very well. Both Mexico and Brazil were up 20% sequentially from a revenue perspective. Colombia’s coming back. Ecuador with the strike stuff unresolved is a very healthy market.

Bernard J. Duroc-Danner

Even Argentina.

Andrew P. Becnel

Argentina with their poor commodity pricing constraint so it’s very wide spread. For us Latin America’s not all about Mexico. It’s going to be an important market for us but there’s a lot of other progress being made.

Bernard J. Duroc-Danner

I had a closing comment, which is that if we did not have Chicontepec I would still suggest that in 09 Latin America would grow at the same rate as the Eastern Hemisphere which is 40%. In other words, absent Mexico, absent Chicontepec, Latin America is as strong as the East and it makes now for one market which is the international market with a lot of differences locally is growing at the same rate. Absent ex-Chicontepec.

Robert Mackenzie - Friedman, Billings, Ramsey & Co.

And a quick follow up Bernard to your comments on service pricing. Can you give us some color surrounding, and our costs, how much fuel cost inflation has impacted you, not just North America but everywhere around the world? And is that kind of inflation, in essence where your customer sells it to you, is that going to be the catalyst you guys need to get some of these underperforming product lines vis-à-vis pricing starting to recapture their cost inflation here?

Bernard J. Duroc-Danner

We are getting protected on the fuel side outside of North America. Within North America other than logistic costs there are just one or two service lines in direct exposure to this, the primary one being stimulation. And that’s just a North American phenomenon because outside you’re well protected. So there is no fuel charge margin erosion going on outside of North America. Within North America there is certainly some on and around stimulation. I think now we are able to get proper protection on the margin side for fuel costs escalation. That’s a good thing. Probably the only comment I made on that particular type of service is that I am less red-blooded on increases in pricing for stimulation only because we’ve got an aggressive supply expansion which is continuing. So therefore it is harder to see major expansion in pricing above the cost of recovery. But it’s just stimulation in North America. The fuel impact internationally, and in other kinds of services in North America, is not an issue.

That concludes the conference call. Thank you very much.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a wonderful day.

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Source: Weatherford International Ltd. Q2 2008 Earnings Call Transcript
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