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Executives

Pete Miller – Chairman and CEO

Clay Williams – SVP and CFO

Mark Reese – President, Rig Technology

Analysts

Bill Herbert – Simmons & Company

Bill Sanchett [ph]

Robin Shoemaker - Citigroup

Doug Becker – Banc of America Securities

Kurt Keller – Royal Bank of Canada

Marshall Adkins – Raymond James

Dan Pickering – Tudor Pickering & Hole

National Oilwell Varco, Inc. (NOV) Q2 2008 Earnings Call Transcript July 29, 2008 10:00 AM ET

Operator

Good morning ladies and gentlemen, and thank you for standing by. Welcome to the National Oilwell Varco second quarter 2008 earnings conference call. During today's presentation, all participants are in a listen-only mode. Following the presentation, the conference will be open for questions. If you have a question, please press the star followed by the one on your touchtone phone.

If you like to withdraw your question, please press the star followed by the two. We do ask that if you're using speaker equipment, then please lift the handset before making your selection. As a reminder this conference is being recorded today Tuesday, July 29th of 2008. And at this time, I’d like to turn the presentation over to the Chairman and Chief Executive Officer of National Oilwell Varco, Pete Miller. Please go ahead sir.

Pete Miller

Thank you Andrew and good morning. Welcome to the National Oilwell Varco second quarter 2008 earnings conference call. I am Pete Miller, Chairman and CEO of National Oilwell Varco, and with me today on this call are Clay Williams, our Chief Financial Officer and Mark (inaudible), the President of our Rig Solutions Group.

Earlier today we announced earnings of $421.7 million or $1.04 per share on revenues of $3.3 billion. Included in this were pre-tax charges of 40.7 million or $0.16 a share related to the Grant Prideco merger and a new tax charge due to the earnings repatriation that we made out some monies from overseas. Excluding these charges, net income from the period was $486 million or $1.20 a share.

Clay will expand upon these numbers in a moment but we are very pleased with the results we had both year over year and on sequential basis. Additionally today we announced record new capital equipment orders of $2.2 billion. We also shipped a record 1.34 billion from backlog this quarter but still ended up with a $10.8 billion backlog total. This backlog number is our traditional capital equipment number and does not include anything that came from the Grant Prideco acquisition, most specifically drill pipe. However, I will say that drill pipe backlog increased 19% since the end of the second quarter.

We're extremely pleased with these numbers and we're also very pleased about the direction of the business in the future.

At this point in time, I'm going to ask Clay to give you a little bit of color on these numbers, and I'll ask Mark to give an overview of what we're seeing in the marketplace. But suffice it to say, that we're excited about what we've accomplished, but even more excited about what the future looks like. Clay?

Clay Williams

Great. Thanks Pete. Before beginning this discussion of National Oilwell Varco's financial results for the second quarter ended June 30, 2008, please note that some of the statements, please note that some of the statements we make during this call may contain forecasts, projections and estimates including but not limited to comments about our outlook for the company’s business. These are forward-looking statements within the meaning of the Federal Securities Laws based on limited information as of today, which is subject to change.

They are subject to risks and uncertainties and actual results may differ materially. No one should assume that these forward-looking statements remain valid later in the quarter or later in the year. I refer you to the latest Form 10-K National Oilwell Varco has on file with the Securities and Exchange Commission for a more detailed discussion of the major risk factors affecting our business.

Further information regarding these as well as supplemental financial and operating information may be found within our press release on our website at www.nov.com or in our filings with the SEC.

Later on in this call, Pete, Mark, and I will answer your questions. We ask that you limit your questions to two in order to permit more participation.

National Oilwell Varco generated earnings of $422 million or $1.04 per fully diluted share in its second quarter ended June 30, 2008 on revenues of $3.324 billion. On April 24, we were pleased to close our acquisition of Grant Prideco for a combination $3 billion in cash and the issuance of 56.9 million shares of NOV stock. As a result during the second quarter, National Oilwell Varco recognized transaction related charges totaling $62.5 million pretax or $0.10 per share after tax, and additional tax provisions associated with financing the transaction of $29 million or $0.07 per share. Additionally, we generated $7.2 million pretax or $0.01 per share after tax in earnings from Grant Prideco that were later sold during the quarter. Excluding all these items, earnings were $1.20 per share, reflecting very solid operational performance by National Oilwell Varco.

Under GAAP purchase accounting, the company's financial statements include results only from the last 70 days of Grant Prideco operations in the second quarter, including additional prorated amortization and depreciation of 31.6 million, a step up to fair market value of Grant Prideco's assets and liabilities.

In order to provide better comparability of operations on a quarterly basis, if supplementally disclosed adjusted financial statements for the company by quarter, starting from the first quarter of 2005, as if we had combined operations for all periods.

Last quarter, we informed you that Grant Prideco operations would be included in our existing petroleum services and supplies segment. And the supplemental disclosure in our press release and on our website depicts the combined adjusted results on this basis.

Include the expected additional depreciation and amortization charges for Grant Prideco's stepped up balance sheet for fixed assets, tangibles, and revaluation of liabilities for each period but did not include expected cost savings and periods before the merger do not include the results of divested Grant Prideco businesses in any period, and also do not include the amortization of inventory step up which will transition out of the next couple of quarters and be reported separately within transaction costs. Later on, our comments on operations will discuss results on this combined adjusted basis, but first let me touch on a number of transaction items related to the transaction in Q2.

Charges of $62.5 million in the second quarter consisted of costs associated with the accelerated vesting of options, financing fees; transaction costs related to Grant Prideco's previously agreed sale of portions of its Tubular Technology and Services segment of (inaudible) and the amortization of inventory step up. We expect additional transaction costs of approximately $30 million in the third quarter and $16 million in the fourth quarter of 2008 and stepped inventories continue to roll out, and we will continue to disclose these separately.

The completion of the sale of the TTS business of (inaudible) in Q2 brought in approximately $785 million in cash. This amount will be reduced later this year as we pay $270 million in tax on the gain. As I mentioned these businesses generated a little over $7 million in operating profit in the quarter under National Oilwell Varco ownership before they were sold in June.

$29 million additional tax provision I mentioned earlier was incurred due to our decision in the quarter to repatriate $194 million from overseas to pay down some of our revolver borrowings, and it drove our effective book tax rate up to 37.5% in Q2. We expect that most and perhaps all of this to be offset by foreign tax credits held by Grant Prideco prior to the merger, minimizing the cash impact. Excluding this additional tax provision, our rate was 33.2% in the quarter, in line with our expected tax rate going forward.

During the second quarter, we were pleased to settle some of the outstanding litigation Grant Prideco had related to its bit technology receding net $127 million in settlements. They do not show up in the gain in the quarter but are instead booked into purchasing accounting of Grant Prideco's assets. We will continue to vigorously pursue our claims against other infringing parties related to this important technology that (inaudible) business pioneer.

Finally, our press release notes that we transferred certain NOV product lines out of our Petroleum Services & Supplies segment at the beginning of the second quarter, which totaled about $98 million in revenue during Q2. Approximately 71 million of this was the movement of rig instrumentation products into the Rig Technologies segment and a $27 million balance was the transfer of artificial lift and industrial products into the Distribution Services segment. These changes were made in accordance with FAS-131 to reflect in a realignment of management's responsibilities following the Grant Prideco acquisition.

Given the small amounts involved, we have not adjusted for this move in prior periods. The integration of Grant Prideco's operations has gone like clockwork. We achieved savings of $6 million pretax during Q2 on overhead reductions and we expect this to increase to $9.7 million in each of the third and fourth quarters and to rise to approximately $11 million per quarter beginning in 2009 based on steps we've already taken.

This will result in an annual saving rate slightly higher than the $40 million per year we expected when we announced the transaction last December. Most importantly, the merger further strengthens NOV's position as a manufacture to the oil field supplying the critical hardware, technologies and comprehensive service to oil and gas operations worldwide. We are pleased to welcome this vibrant and capable organization to the National Oilwell Varco family and we thank the Grant Prideco legacy employees for their hardwork in helping put the new NOV together. You're doing a super job and we are grateful.

On an overall adjusted combined basis, excluding the transaction related (inaudible) second quarter results were excellent. Consolidated revenues were $3.445 billion, up 9% from Q1 and up 21% year over year. Operating profit was $778 million or 22.6% of sales, up 160 basis point from Q1 markets. Operating profit flow through or leverage was 40% sequentially and 30% year over year.

Now let me turn to specific segment operating results for Q2 on this adjusted combined basis.

Rig Technology generated 1.9 billion in revenue and $506 million in operating profit in the second quarter, yielding an operating margin of 26.5%. Excluding the transfer of the instrumentation products from Petroleum Services & Supplies, the group generated 33% follow-throughs on 15% revenue growth sequentially, and 33% follow-throughs on 31% revenue growth year over year.

Revenue out of backlog increased 18% sequentially to $1.337 billion and reported non-backlog revenue increase 22% due in part to the additional $71 million in instrumentation products revenues, all of which flow through the non-backlog revenue. Excluding these additional instrumentation products revenues, our base rig aftermarket business surged 30% on higher spare parts sales, partially offset by lower sequential sales of small capital equipment that does not go into the backlog. Recall that in Q1, we had a very high level of handling tool sales that didn't repeat this quarter.

As of June 30th, our backlog per capital equipment sales from the Rig Technology's segment stood at a record $10.8 billion due to a record level of orders of $2.216 billion received during the quarter. Seven floating rig packages, surging demand for land rigs, both domestically and overseas, and steady demand for jack up equipment fueled the strong showing.

Equipment for international markets was 91% and orders for offshore equipment totaled 87% of the total backlog at June 30th. We expect revenue from backlog to continue to rise and as of June 30th, the scheduled outflow of revenue from backlog is expected to be a little over $3 billion for the remainder of 2008, about $5 billion in 2009 and nearly $3 billion balance thereafter.

Our Rig Technology segment continues to wrestle with riding costs particularly steel, utilities, logistics and foreign currency related costs, but our efficiency initiatives such as quick response manufacturing and broader outsourcing; our wide manufacturing footprint and modest price improvements are helping us maintain margins, which have remained stable on newly won projects.

In a moment, Mark will share more color on our execution and outlook for Rig Technology, but overall looking forward into Q3, we expect modest growth in revenue and comparable margins to Q2.

Our Petroleum Services and Supplies segment generated revenues of $1.244 billion in Q2, down $69 million from Q1, including a full quarter contribution from continuing Grant Prideco operations in both quarters. However excluding the $98 million in products transferred out on April 1st, revenues were up about 2% sequentially at 23% leverage and revenues increased 10% year over year at 20% leverage.

Our services businesses in Canada saw revenues and operating profit decline from the first quarter to the second due to the annual spring breakup there this year, with revenues dropping $59 million at high leverage from Q1 to Q2. Spring breakup occurs every year in Canada and is a result of transport restrictions on heavy rig movements by the authorities to prevent damage to roads during the spring (inaudible).

Activity and outlook in Canada are both rising, falling the listing of these ban several weeks ago. Fortunately, this seasonal Canadian decline was offset by strong results overall in most of our other businesses.

Drill pipe sales posted sharply higher margins, owing to favorable mix improvements in the types of pipe sold, with premium and large diameter drill pipe rising to 48% and 39% of the mix respectively. We content that the large premium segment, our drill pipe sales will continue to grow as oil and gas companies push complex well path designs behind the (inaudible) capabilities of standard API pipe designs. And NOV is well positioned to capitalize on steadily increasing usage of premium drill pipe in horizontal, directional, and extended reach drilling programs.

Nevertheless drill pipe revenue fell slightly due to shipping vessel delays and disruptions caused by the earthquake in China. Although we do not intend to report drill pipe backlog in future periods, I would nevertheless point out a backlog for drill pipe increase 19% sequentially from Q1 to Q2. The first increased since 2006 as orders surged 85% sequentially, with strong North American land contractor -- with North American land contractors re-entering the market and new build rigs ordering pipes.

Integration of Grant Prideco's drill pipe business is going well, and we are rolling out new drill pipe tracking products and expanding OEM repair and maintenance offerings through NOV's worldwide pipe service operations.

ReedHycalog Bits business acquired with Grand Prideco also performed well in Q2, despite a short downturn in Canada related to breakup. Revenues increased 4% at solid follow-throughs on higher sales in Latin America, Europe, Russia and the Fareast. The Intergauge business also acquired Grant Prideco, delivered a record quarter, and the integration of this business with NOV's leading downhole tools business is proceeding well.

As part of the integration, we are consolidating a number of sales facilities worldwide and leveraging our combined manufacturing capabilities and capacities to improve lead times and reduce cost. The addition of Grant Prideco's bits and downhole products to NOV's offering of drilling motors, monels (phonetic), jars and shock tools completes and impressive comprehensive package of bottom hole assembly hardware, making us a one stop shop for critical iron needed to drill complex well paths, and we are now exceptionally well positioned to capitalize on continued growth in horizontal, directional, and extended reach drilling.

Our Other Petroleum Supplies & Services businesses continued to execute well in the quarter and benefited from rising activity associated with shale gas plays in the US and steadily rising activity overseas. Increased rig construction and reactive basins are fueling demand for the pumps and liners for emission, and solids control and waste management technologies from Grant. Tuboscope is benefiting from sharply higher mill and processor activity in response to pipe OCTG inventories and higher pricing and expansion of its drill pipe repair and maintenance operations.

Overseas demand for fiberglass pipe for large projects began to increase during the quarter, and demand for drilling motors, non-mag, drill collars, and fishing tools in the Middle-East continued to push higher following the opening of our new facility in Dubai last year. Waste management demand in the North Sea and US land also picked up nicely in Q2.

(inaudible) pressures particularly steel, labor and fuel continued to pressure the business for recent price increases most in the mid or in the high-single digit range, and a relentless focus on efficiency have generally been able to hold margins. For Q3, we expect mid-single digit revenue growth and solid flow-through as we emerge out of Canadian breakup and continue to benefit from rising drilling activity.

Our Distribution Services segment revenues of $426 million were up 16% from the first quarter. Excluding the transfer of artificial lift and industrial products from Petroleum Services and Supplies, revenues increased 9% sequentially with strong follow-throughs.

Operating profit was $24.8 million or 5.8% of sales. US revenues ascended to recorded levels fueled by high demand for operating supplies by rigs moving into emerging shale place. Service companies and oil and gas operators also increase consumption of MRO supplies in the phase of higher service activity and high commodity prices during Q2, and margins improved sharply on line pipe sales this quarter. Albeit pressures remain fierce in many mature regions, pricing pressures appear to be abating in new high-growth domestic areas.

Canada declined overall due to breakup, but the business there benefited from cost cutting initiatives executed in prior quarters and rising demand in Southeast Saskatchewan and high shale activity in British Columbia, which drove better than expected results. International sales improved as a number of overseas locations opened up over the past few quarters began to gain traction, notably in the Middle east, Africa and Norway. A large valve project into the Fareast also contributed to strong results as been high cable sale into international offshore rig ups.

In the third quarter, the Distribution Services segment expects to open a handful of new locations to improve coverage of the emerging shale plays across the US and the continue to expand overseas including supporting very high levels of interest by drilling contractors for stores on new build offshore rigs. The group currently has three stores physically located on offshore rigs staffed by NOV personnel.

Third quarter Distribution Services revenues are expected to increase in high-single digit range at very solid follow-throughs.

Turning back to National Oilwell Varco’s consolidated second quarter income statement. Interest expense increased $14.2 million and interest income decreased 5.2 million as a result of borrowing to finance the Grant Prideco acquisition and lower cash balances. That's along lightly as we drew down $2.1 billion on our new revolver to finance the acquisition in April, then repaid most of the borrowings from cash flows out of operations during the quarter and from proceeds from the sale of the TTS businesses sold later in the quarter.

Other expenses went from a credit in the first quarter to a debit of $14.6 million in Q2, due to FX movements on Grant Prideco and Norwegian NOV businesses and much higher bank fees associated with letters of credit issued to back cash down payments to National Oilwell Varco by drilling contractors for new rig orders.

Equity income from our Voest-Alpine joint venture increased slightly to $17.1 million, and we expect some results in Q3. This is a joint venture that supplies green tubes to seamless pipe use for our drill pipe manufacturing business that came in with the acquisition.

Weighted average fully diluted shares outstanding of 404 million shares represent the partial quarter impact of the shares issued for Grant Prideco's shareholders, and we expect the full-quarter Q3 amount to be approximately 420 million shares.

Unallocated expenses and eliminations on our supplemental segment schedule which is pro forma for the Grant Prideco acquisition in all periods were $49.7 million, down $22.1 million sequentially. This item benefited from overhead cost savings coming out of the Grant Prideco merger of about $6 million, the turnaround of high payroll taxes paid in Q1 on incentive compensation by both organizations, and net lower profit eliminations on inter-company sales between segments.

Depreciation and amortization was $106.4 million in Q1, up $44.9 million sequentially due to the effect of the acquisition. We expect total Q3 consolidated National Oilwell Varco depreciation and amortization to be in the range of $120 million excluding inventory step-up amortization.

Q2 amortization of inventory step up of $46.1 million is not included in the DD&A on the supplemental EBITDA schedule, but it's rather included as part of the transaction costs reported on the line below.

Our June 30th, 2008 balance sheet employed working capital excluding cash and debt of $2.3 billion, up $485 million sequentially due to the acquisition. Working capital excluding cash and debt was about 17% of annualized revenue, generally consistent with recent prior quarters.

Cash flow from operations was a record $753 million in the second quarter and leveraged cash flow was $528 million. Customer prepayments and billings in excess of costs, a measure of customer financing of our working capital needs increased $524 million to over $2.6 billion. This contributed greatly to the company's strong cash generation in Q2. It will be reinvested in inventory abroad as we execute our large rig construction backlog.

CapEx was $106.1 million in the second quarter and we expect it will continue to rise quarterly a little over $400 million for the full year. Our cash balance was $1.6 billion, down 487 from the first quarter, and our debt totaled $1.7 billion as of June 30th, up about $1 billion from the prior quarter.

NOV’s corporate credit rating was raised by both major ratings agencies during the second quarter in view of our strong financial condition.

Now let me turn it over to Mark for his comments. Mark?

Mark Reese

Thanks Clay. Good morning. Over the last quarter, our overall inquiry and coding activities remained brisk for all product lines and rig categories, with new land rig inquiries rapidly increasing. As a whole, we're seeing very little softening across many of our product segments.

Let me start with the overview of our three major rig categories. To start with floaters. Inquiries for both our drill ships and semis remained very high with a tremendous amount of emphasis being put on the assets needed to meet Brazil's growth strategies. Other areas driving this demand are deepwater Gulf of Mexico, West Africa and Central Asia.

Jack up inquiries and orders remained very stable, with demand being driven by many of the shower plays such as Persian Gulf, the North Sea and Asia. Land packages, as you probably already aware, the land market has made a bad phase since the first of the year, specifically North America. We started this year believing that the new rig and refurb activity in North America was going to be somewhat larger than we've seen in 2007. however, beginning in Q1, that made a quick switch in going into Q2.

(inaudible) increased our forecast program for ideal, rapid and our newly designed drill rig. This demand is really being driven by the increase in oil and gas prices with majority of the rigs destined to (inaudible).

Moving on to the Middle east and North Africa, we're really excited about these areas. Inquiries on orders are very active for our traditional 1500 horsepower ideal rigs. But we're also seeing more inquiries for our test and design higher horsepower rigs with desert moving systems at high ambient temperature packages. Our MD TOTCO organization has also received very positive feedback from the contractors in this area, then to expand their instrumentation and monitoring services.

Moving on to Russia, this is a mark that holds up a lot of opportunities for NOV and our joint technology. There's a tremendous demand for our higher technology drilling equipment that has a proven track record in drilling and safety performance. We're estimating a potential between 200 and 250 land rigs for this market over the next five years. Most of the applications be driven in (inaudible) and North-central Russia.

We're always looking at expanding our global footprint so we can better serve our customers. A few of the expansions that you should expect to see over the next 12 months; starting at Russia, we're working on plans to expand our land manufacturing business and service capabilities for services growing market. Our current plans on that facility up and operational some time in the first half of 2009.

Middle-east is another area that we're looking at, with a growing demand for these land rigs in this region. We're in the process of expanding our current rig-up capabilities to extend to a four-rig path rig-up facility. This expansion will be fully operational in Q2 of 2009.

And moving back to the States, up in the northeast with all the activity plan for this area, we're working on the final details for the new rig-up facility and service facility to support the projected growth in (inaudible). Will be located in the area of Pittsburg Pennsylvania and we'll house other NOV operation so we can better service our customer base in that area.

In June we held an executive open house for our Houston-based Technical College. This facility is the second that we have opened over the last year. The first thing is located in Kristiansand, Norway. Third is targeted for Singapore in 2009. These facilities are designed to deliver over 700 trained (inaudible) and service engineers into the market over the next 12 months. As everyone is well aware, for decades our industry is under-invested developing trained and experienced personnel.

My thanks go to NOV's Board and Mr. Miller for making this tremendous investment in our people and our industry's future. These colleges are staffed with professional educators and state of the art simulators and learning schools. There are three core curriculums; mechanical, electrical and controls. And the students will not only receive classroom time but they'll work alongside with experienced service engineers getting hands-on experience.

NOV has always been committed to training our employees. It has also made a very large investment to train our customers. In 2007, we ran over 2000 customers through our training facilities. In 2008, we're forecasting to almost double that number.

We're also introducing our new NOV mobile training unit which is really a 50-foot school, and take this trailer straight to our customers' locations or to well site, and we can actually train the crews on the equipment that they're going to run that day. It's been a very successful tool for us as well as for our customers.

I'd like to take this opportunity as well to announce our intention to open up another technical college in Monte, Brazil. This investment will be designed to train our customers' personnel on safe and efficient operations and then on the equipment. We believe this investment will create a huge enabler not only for our customers but for the local workforce to operate the large inventory of NOV equipment either currently operating or under construction for Brazilian waters.

As always NOV continues to lead the charge in bringing new technology into the drilling industry. Our design criteria is deliver safer, lighter and higher performing products for our global customers.

I'll give you a quick update on where we're at with some of these recent developments. Our TDX-1250 Top Drive; we shipped or have on order ten of these revolutionary top drives. This technology delivers an industry-leading 105,000 foot pounds of continuous torque, a very compact and easily maintained package. First of all 50 F80 took place in Q1 in our Orange California facility and the F80 exceeded everyone's expectation.

The next product is our CRT-350. This casing running tool has a tremendous market acceptance and is designed to deliver our customers safer and faster casing operation. As of this call, we have either shipped or have on our order over 85 of these CRT-350. As I mentioned earlier, our newest product is the Drake Rig (phonetic). This rig was designed specifically to accommodate at tight road restrictions and small locations our land contractors are experiencing.

Drake Rig is a 1000 horsepower rig with a 3-piece telescoping mask and a record design that can accommodate some of the harsh terrains raising under sea as well can also accommodate a moving system for pad drilling sign.

Looking into the future as in the past, our biggest challenge is execution. And going forward, we're going to continue to execute. I'm very confident with our ability to deliver on our commitments, but there are always going to be bumps in the road. We currently have over 600 INC and service engineers working in 13 ship yards around the globe. To date we have commissioned and delivered 29 joint packages by working extremely close with the shipyards, contractors and vendors. NOV has not impacted the delivery of any of these vessels.

Before I turn the call over to Pete, I want to personally thank the hard working people of NOV for their commitment to making this happen. They are the best people in the industry and day in and day out they deliver on their commitments. As well, I would like to thank the thousands of vendors that support NOV around the globe. Pete?

Pete Miller

Thanks Mark, and at this point I would like to just kind of summarize on a few things and talk about a few things we have in place. But the reality of the business today, it's about the shale plays, it's about deepwater and it's about continuing to re-tool this business. Technology and efficiency wins. We're able to provide the products and services that people need to be able to win this. I think the shale plays are going to be exciting all throughout the US and quite frankly the world. If you think that the shales are only in the Marcellus and Ainsville, and not at Argentina and Russia and other places, you're wrong. They’re all over and the technology that we learn there is going to be expanded.

And again, I can't emphasize enough the re-tooling of the fleet. The best rig wins. I think that's pretty indicative as you look throughout the United States. We're prepared to make sure that we take care of this.

I'd like to talk about a couple of initiatives that we have in place in our PS&S group. For instance, we're utilizing the same sort of business model that we utilize in drilling. When you looked at what we did when we started building this company ten years ago, it was really to integrate the package to make things easier on our customers. Today, when you look at Tuboscope and Grant Prideco, we're really starting to integrate a pipe management system. We call this the LEON system, and what this enables you to do is you can engineer, manufacture, coat, inspect, repays, re-thread and monitor that pipe, all through the life of the pipe.

And the interesting thing is we're able to take some of the electronics that we learn in the drilling site with MD TOTCO, with our VIC system and things like that, and be able to monitor this pipe. And I think it really has an opportunity to revolutionize the way that people are able to use drill pipe. In our (inaudible) operations we've recently acquired a company that we call portable power that not only enables us to take a lot of the brand equipment out into the field, but also be able to use as portable power to be able to power it up and do it much more efficiently than just depending on the rig. And interestingly enough a lot of those portable power has really cool emissions control and noise pollution. Things that you're going to need as you're drilling these shales in the towns of Freeport, Fortworth and other places around the world. So we think these are the sorts of initiatives that we're on that are really pretty exciting.

If you look at down-hole tools, today we can provide the bits, the motors, the shock subs, the stabilizers, the monel collar, the intergauge openers, we can do these things and provide our customers with this hardware that works just seamlessly, and by the way we also have a really cool product called the telesurb (phonetic) which we think we're going to be able to really develop over the years to be able to take that information that come from all of this and ratchet it to the surface at about 10,000 times the speed with which it's done today.

So these are the kind of things that are going to bode very well for the technology of this industry and I think position ourselves to take advantage of it. And finally in our distribution business, we're using the same sort of business model. As pipe went out earlier, we're integrating, we're putting rig stores on these drilling rigs where we're talking inventory away from our customers, reducing their total cost of ownership, taking care and ensuring that we got the products and the services in place.

And when you look at the number of these deepwater rigs that are going out and the types of rig stores that we're putting on these, we think it's a really, really cool business that's going to expand well into the future. So, we're excited about where we're going, but it takes good people. And I want to make one mention of one thing that we've done over the years and this is our next generation program. And just to kind of give you an example of how this works, we just hired our NextGen 9 program. We have 8 prior to that and the books are out and again our company today doing great business and great work, and they're providing great leadership. And you look today, we just recruited 50 people. And to give you an example of how that worked out, 16 came from the US, five from Canada, six from the Middle-East, five from Singapore, two from Norway, five from China, five from Latin America, two from Russia, and four from the UK. They're all college grads in many disciplines and this is a type of program that's building us with the future.

You know, a lot of companies just try to hire away and move around. We want to build from within. We think that's extremely important and we think it's going to dictate what happens in this company for the next 20 years.

So I would also like to echo Clay and Mark, and thank the 36,000 employees in this company for the great job they're doing. Welcome to Grant Prideco people, I think it's a wonderful company, and we are very bullish, needless to say on where we're going in the future.

So at this point, Andrew, I’d like to open it up to any questions that our listeners might have.

Question-and-answer session

Operator

Thank you sir. (Operator instructions) Our first question will come from the line of Bill Herbert with Simmons & Company. Please go ahead.

Bill Herbert – Simmons & Company

Thanks, good morning.

Pete Miller

Hey Bill, how are you doing?

Bill Herbert – Simmons & Company

I'm well. Thank you Pete. I think I heard Clay mentioned that you guys had seven floater packages in the quarter.

Mark Reese

Yes, Bill. This is Mark. We had five drill ships and two semis.

Bill Herbert – Simmons & Company

Okay. Along those lines, can you share with us what the average order size was per package and what that represents with respect to a percentage increase of where you might of have garnered a similar order last year?

Mark Reese

But really the -- we're staying fairly stable on our margins. Only increase is that we've (inaudible) the customers are sitting on an inflationary issues.

Bill Herbert – Simmons & Company

Okay.

Mark Reese

And you know these packages are tough to nail down a specific price. It will range anywhere from 290 million on a drill ship to 150 to 180 million on a semi. It depends on the configuration.

Bill Herbert – Simmons & Company

Okay, great. And then the follow-up question is with respect to the North American land rig business and the explosion being driven by the shale plays. What -- in the second quarter, what was the percentage improvement in your North America land rig business versus Q1?

Pete Miller

Go ahead, Mark.

Mark Reese

Our backlog jumped up about a third, actually over a third.

Bill Herbert – Simmons & Company

Q1 to Q2?

Pete Miller

But Bill, I also might point out that lot of the explosion in the land business has not hit this backlog. We're dealing with a lot of different things like right now of course, as I point out, the backlog cuts off the 1st of July.

Bill Herbert – Simmons & Company

Sure.

Pete Miller

And a lot of things that we've done, I mean it's we're one month into the quarter. Quite frankly, it's been pretty good month. And so a lot of the things that are coming out of the explosion there, the first part of that, you know, it started kind of when the Ainsville shale was announced, so there was a lot of activity in May and June, but it isn't going to manifest itself into orders necessarily until the third quarter. But it's pretty exciting.

Bill Herbert – Simmons & Company

And Pete, with respect to the crystal ball business here for a second. Could you measure a prophecy as to the number of US land rigs that you expect to sea build over the next call two years?

Pete Miller

What I'll do, Bill, is I'll call attention to Clay's disclaimer on future observations. But I'll tell you what,

Bill Herbert – Simmons & Company

yes.

Pete Miller

I think that natural gas and the next administration is going to be looked upon as very much as a very viable alternative to many of the energy issues we're facing today. And I would not be surprised to see the rig could in the United States and especially when you see things like the Marcellus coming into play, and I've actually said this on record before, 22, 2300 rigs working into the United States does not surprise me at all.

Bill Herbert – Simmons & Company

Right. Okay. Thank you very much guys.

Pete Miller

Thanks, Bill.

Mark Reese

Thanks Bill.

Operator

Thank you. Our next question will come from the line of Bill Sanchett [ph]. Please go ahead.

Pete Miller

Hi Bill.

Mark Reese

Hi.

Bill Sanchett

Just a bit of a follow up to the previous question. You mentioned the five drill ships and two semis ordered during the quarter. They're close to 30 new builds in general offshore I guess awarded during the quarter. Can you give us a sense, Pete, on how many we're still quoting here for potential third quarter orders for NOV?

Pete Miller

You know I will say this. I think one thing we will point out that you know there has been a lot of talk about Brazil. Brazil is not in here. Now we don't have -- there's a lot of things that are going on in Brazil and I think they'll manifest themselves in the future but a lot of the -- you know, we pretty much have established, Bill. We don't put anything into backlog until we've got a solid contract and in many cases without payment. You know we don't put notional things at our backlog; we don't put out allies in our backlog. And so I think what you're going to see is our still an extreme amount of business that's out there and I think as we go through the next couple of quarters you're going to see some nice orders that come in. I mean I think that they'll start -- many of the things that you've heard about Brazil, because people announce things early. That doesn't (inaudible) a lot of engineering, you've got to do a lot of things that prepare for it. But rest assured, we're bullish.

Bill Sanchett

Okay. So, no Brazil floaters at all in the second quarter backlog?

Pete Miller

(inaudible)

Bill Sanchett

Okay. And my follow-up. Clay, could you be a little more specific as it relates to follow-throughs that you're expecting in the third quarter in the PS&S segment? I know you said solid but just trying to get a sense on what you're thinking there or absolute terms?

Clay Williams

Yes, we're -- historically, this business has been around 30%, is kind of our long-term guidance. We'll fall a little short of that this quarter on a pro forma basis excluding all the noise. We get some items this quarter that kind of flow through and none of these are terribly material but you expect them to turnaround. We had some labor pressures in South America and some inflationary pressures. What we began to see in the second quarter was price movements within these businesses that will offset this going forward. So I think that will help the leverage going forward. Additionally, of course Q2, the thing that really impact Petroleum Services & Supplies for Q2 is Canada breakup. And in aggregate, our PS&S business has declined $59 million in Canada and that typically declines at very high decrementals. So, in Q3 what we typically see is Canada starting to bounce back on, usually not as strong as Q1 but when Canada comes back, it comes back with pretty high incremental, so the increase coming out of the Canadian breakup. So, we think Q3 will very likely going to be higher than kind of 30% incremental flow through bar. As we see Canada bounce back and also as we see the turnaround of a number of couple than unusual items that impacted Q2.

Bill Sanchett

Great. Thank you.

Clay Williams

Ok. Thank you.

Pete Miller

Thanks, Bill.

Operator

Thank you. Our next question will come from the line of Robin Shoemaker with Citigroup. Please go ahead.

Robin Shoemaker - Citigroup

Thanks and good morning. I wanted to ask about the aftermarket business a little bit here. I think previously you'd indicated at some point, you might be able to give us an idea of what kind of aftermarket revenues you expect from a drill ship or semi and jack up of the generation that you're building now? And so that's really my first question if you have an idea there?

Pete Miller

You know, Robin, I'll tell you what, the first rig drill ship that went out was the drill mag (inaudible) and it went out at the beginning of the year and it hasn't had any downtime yet. And you know, so we haven't had to ship that many spare parts to it, which we're pretty standard by because it's actually one of the most complex rigs that we've seen. So, if that's an indicator, gosh, there might be a whole lot less than I thought. But having said that, we're excited in the way that that ships run, but we really don't have I think a very good indicator yet. I will say this so as you've seen -- you look at the numbers that we have this quarter, you can see that we did ship a lot more spares. Those are probably for more existing rigs that are on pretty significant day rates and with the things out pretty dramatically. But we're very please with the way these two rigs are running. So, I’m going to beg off that question for another quarter or two.

Robin Shoemaker - Citigroup

Okay. And on the packages that you are building possibly for deepwater rigs going to Brazil, assume those will be large kind of full packages most likely as part of a turnkey rig construction program. And would that include also -- would you be bidding drill pipe and as part of that package?

Mark Reese

You know, if that's something that the customer wants us to supply, we certainly will. You know it's two different pieces of equipment and it's nice having Grant Prideco organization. It's a terrific product to pass on to our customers.

Pete Miller

And it's a product that's fundable. But we certainly would be amenable to giving a little bit of a price break if they want to throw in a few things like that. We'd offer a care or two. So, but I think if you want the best equipment, you're going to lock the best drill pipe and the best drill pipe is Grant Prideco. So, I think we'd feel pretty comfortable maybe buying that.

Robin Shoemaker - Citigroup

Right. Okay. Thank you.

Mark Reese

Thanks Robin.

Pete Miller

Thanks Robin.

Operator

Thank you. Our next question will come from the line of Doug Becker with Banc of America Securities. Please go ahead.

Doug Becker – Banc of America Securities

Thanks. Pete, you're certainly excited about the future. Just trying to pin you down a little bit. Are you willing to say that orders for rigtec are going above the $2.2 billion level as we got forward?

Pete Miller

Oh, Doug, if I ever said that, my General Counsel will be in spec here around for an hour and a half. Let's just say I'm bullish. You know, historically we haven't given guidance on this. We just said that we feel real confident that things are looking pretty good. If you look back over the last four or five quarters, we have said we feel pretty good. I think Robert Schoemaker resigned just a minute before you and he asked me that if I think that quotations are still robust, and I would say they're still robust. So, but the real problem, Doug, too and I want to make sure we emphasize this. We cut all of our backlog off on a date certain, and for instance you know we cut this often 1st of July or really the 30th of June, and we've had orders that came in the 2nd, 3rd of July. Well, quite honestly that didn't bother us that they come in two days late, but it does bother the fact that I might make the backlog a little bit bigger. So, you know by doing that you know it's hard to -- these projects, a lot of them are complex. They don't come to pass and in just a matter of days you know you go around through iterations, you have to tender offers, you have to go back in and re-tender. And so, it's difficult to say that at any 90-day period, these orders are going to come in. I will tell you this, we've said before, kind of look at backlog over the last nine months and it's been very, very robust and I think that you'll continue to see backlog over the next foreseeable future be very good. So that's a long win to way, I could tell you.

Doug Becker – Banc of America Securities

Let me ask you at this way in a way that you have responding in the past. Have you sign any deepwater rig orders so far in the third quarter?

Pete Miller

Yes, we have.

Doug Becker – Banc of America Securities

No number though?

Pete Miller

It's your next issue -- next number?

Doug Becker – Banc of America Securities

You know -- but let me ask a question to Clay. You certainly have been talking about the input inflation, the cost inflation that you're seeing in the business. Margins were up on a pro forma basis. Is it fair to say that so much entirely related to efficiencies?

Clay Williams

Yes, Doug, I don't think we're getting a lot of price-driven margin expansion. We are probably getting a little volume leverage, so as we're doing more, we're doing repeat orders on may of these big rig packages in particular. We're able to -- you just scale the learning curve. When you build the first kind of rig design, you learn a lot and I think we got an organization that's very good at capturing the lessons learned and applying them to version number two of that same rig design and version number three, and you're starting to see multiple offshore rigs built on the same design and efficiencies would fall out of that. In addition to we've talked a lot about this in preceding quarterly conference calls. We've been pushing a lot on working smarter on quick response manufacturing. Mark mentioned a number of new facilities that he plans on opening. Also we've opened up a couple of others here in the past several quarters that are contributing to the improvement we make sort of (inaudible) investments and new machine tools. You know so overall it's kind of a combined effort of all that. But I do think overall it's more efficiency driven than price driven.

Doug Becker – Banc of America Securities

Okay. Thank you.

Pete Miller

Thanks Doug.

Operator

Thank you. Our next question will come from the line of Kurt Keller of Royal Bank of Canada. Please go ahead.

Kurt Keller – Royal Bank of Canada

Hey, good morning.

Pete Miller

Hi Kurt.

Kurt Keller – Royal Bank of Canada

So, easy question first. Distribution in the past, Clay, you guys kind of suggested 11% kind of incremental follow-throughs, whatever terminology you want to use. Seems like business has gained momentum there. Again, is it quite possible that we got attracted to that 11% incremental kind of in the back half of the year?

Clay Williams

Yes, actually we got it was 10% curve but kind of in that range. Of course, you get in any two periods, you get FX and mix issues and all that sort of stuff. But if you kind of take a long-term view of distribution, it's typically at 10% follow-throughs. I think that's probably what we're expecting Q3, Q4 this year.

Kurt Keller – Royal Bank of Canada

Thanks. Then we've marked a very, very rapid turnaround in the North American business as you guys referenced up for this year, got up to 13 bucks a gas, now we're under nine. So is it quite possible that things slow down as rapidly as they've picked up? What's your general sense on the sensitivity around some of these programs related to eight or $9 gas. Pete, do (inaudible) that?

Mark Reese

I'll go ahead and take that, this is Mark. You know we really haven't seen any slow down or enthusiasm like on the rig side. I think a lot of the de-energy that you'll see in the hassle is going to carry through. I can't speak to the economics of the oil companies, but we certainly haven't seen anybody playing on their desire to move forward a lot of these rig packages.

Pete Miller

And Kurt, I'd add too that we still come back to the rig tooling pieces. You know it's I think there's cash out there today and a lot of these rigs are being designed specifically for the shale plays and there are rigs that are sitting out there that can't do these shale plays. And I think if you look at some of the drilling contractors that are best in new technology, they're winning the game. And so, I think you find the guys that are coming back in and say, "We're going to invest in new technology," and I think that even if you saw a decrease in the price of natural gas, you're still going to see the shale plays being drilled and you're still going to see the demand for these new rigs. So, we think there really is a re-tooling and you're going to see some rigs on the downside a little bit. So, we think it's going to stay pretty robust.

Kurt Keller – Royal Bank of Canada

Great. And Pete, you referenced in the past, if we think understand the evolution here the progression of deepwater and land. On the jackup market you reference that every time the slot opens up, it's going to get build, are you still seeing that?

Pete Miller

Absolutely. I think over the last couple of quarters I can draw the numbers to (inaudible) I think I am still a little bit ahead of the game. I think last quarter there was (inaudible) four, five delivered, I think it was six order, so, and I think you are going to continue to see that the jackup business is not the similar in many cases to the land business, you're seeing some retooling, the ability of these jackups to be able to drill more efficiently, I mean, I think everybody read the article last week about – I think (inaudible) reentering one of those deep shell wells that Exxon had passed up on. And while those are in shallow water they still take a rig that control the 30 some of thousand feet, and so that demand for these high performance of efficient jack-ups I think will continue. And as they come out of the ship yard they are going to work. And they are going to work at pretty good day rate, so, we make that pretty indicative of the fact that they are going to remain a good business.

Kurt Keller – Royal Bank of Canada

Thanks.

Pete Miller

Despite all the jack-up deliveries here recently Kirk [ph], 82% of the existing fleet is still more than 20 years old. This is the worldwide the jack-up was pretty old.

Kurt Keller – Royal Bank of Canada

Great. Appreciate the color.

Operator

Thank you. Our next question comes from the line of Marshall Adkins with Raymond James. Please go ahead, sir.

Marshall Adkins – Raymond James

Good morning, guys.

Pete Miller

Hey, Marshall.

Marshall Adkins – Raymond James

So I am looking here at your backlog-driven revenues, I think most people perceive you as a backlog-driven company, but it appears by my math only about 40% of your revenues actually came out of backlog, so the ratio, that percentage seems to be going down, probably because of the Grant Prideco acquisition. Help me to understand going forward, the growth that you anticipate in the backlog-driven revenue and profit side versus the rest of the business which appears to be 60% of your revenue-based?

Clay Williams

We think the outlook for continued revenue growth out of backlog is very bright for the reasons I think which is covered, Marshall, a combination of retooling land rig fleets, retooling the jack-up fleets, and then building out brand new deep water capabilities for drilling where there was known before and packages for kind of all three of those buckets flow into the backlog and frankly, I think, (inaudible) back of the last few years, I think the retooling and secular build-out of the deep water fleet really started in earnest about three years ago, 2005 kind of kicked off that phase of this industry, we think there's going to be right [ph] for years to come.

Pete Miller

We also – and add what Clay was saying we're also positioning ourselves that's really increase the size that non-backlog too because I think it comes back to supporting these rigs as they go out. But even more importantly, when you look at the business model that we're offering up on things like drill pipe management and down hole tools and distribution, we think both of those – all three of those are really going to increase dramatically with what we are able to do with these people on rigs (inaudible) operations are going to be very effective on the deep water rig, so, we think we're going to get a double whammy, not only do we get to build these rigs, but we also get to support these rigs with the many different support elements and the manufacturer products that we have that will continue into the future. So, we know a lot of people tracked out backlog, but I think the other very, very important element of what we do is to rest of our business.

Marshall Adkins – Raymond James

Well, that was not point. It seems like the non-backlog at least recently has been going faster than the backlog, so, does that continue you kind of just looking on growing kind of a similar way going forward?

Pete Miller

I got to actually see the non-backlog business growing even more dramatically, I mean, we have got an interesting position out here. We sell to everybody. There is a very few people on the industry that sell absolutely to everybody. But I don't care if you are a (inaudible) if you're Exxon or if you're Conoco, if you're the drilling contractors, or if you're Halliburton, we sell to everybody. And lot of the reason for that is our business model as we want to produce the tools, and the services to take care of those tools they can take of our customers, but we are not going to compete directly with them in what they do, (inaudible) is a great data acquisition company. We want to provide the tools for them to acquire that data. And so as they grow in there we think we're going to be growing along because we can provide those – first we have the worldwide footprint to take care of that, so we think it's a great story, and it's probably the story that serve (inaudible) known about it.

Marshall Adkins – Raymond James

Right. Follow-up, Clay, just a quick one for you. On just (inaudible) engineering earlier, in the call you're talking about the stepped up inventories rolling out and I didn't hear at all, what we do –what's going on there that I guess you're saying things going to improve, because….

Clay Williams

Yes. Good question, Marshall. Under purchase accounting we have to write-up the value of Grant Prideco inventory as of the date that we close the acquisition (inaudible) so there is a certain amount of purchase price is allocated into inventory, and then as those inventories turn around low out as revenue we relieve that that's step up. So what you're seeing there is a kind of normal turn that Grant Prideco (inaudible) inventory up a door as revenue and we are – to make our financial results more comparable period to period to period not only obscured by that, by that purchase accounting complexity, we are reporting a separate lease transaction cost.

Marshall Adkins – Raymond James

Alright. I assume that rules out over pretty short two quarters, three quarters that you get that done?

Pete Miller

Yes, in fact, I gave a little guidance on my commentary in Q3, it will be in the range of 30 million in Q4, 16million and probably down to zero or close to zero by the beginning of 2009.

Marshall Adkins – Raymond James

Okay, that explained. Thank you.

Pete Miller

Thank you.

Clay Williams

Thanks, Marshall.

Operator

We have a time for one last question. And the final question will come from the line of Dan Pickering with Tudor Pickering & Hole. Please go ahead.

Dan Pickering – Tudor Pickering & Hole

Good morning, guys.

Pete Miller

Hi, Dan.

Clay Williams

Hi, Dan.

Dan Pickering – Tudor Pickering & Hole

I apologize if this question has been asked, I had little bit of trouble with the call. Pete, you're saying some of your bid competitors notably (inaudible) getting involved in the directional side of the business, is that something that we consider?

Pete Miller

No. We are going to provide the tools for that. Dan, and I think that it's important that we do that. We have the world's largest fleet of Donald Motors, I think with our bids in ReedHycalog with what we do with (inaudible) we're going to supply those to the Halliburton's, to the Weatherford's, to the (inaudible) with the world and even quite often to the Smith on the (inaudible), we believe that being the manufacturer of that and having the capability to service those tools, and to take care of our customers puts us in a much better position to prosper. I quite frankly don't especially like to prospect of going directly up against (inaudible). They're very big company. But there are also heck of a customer, and so, our business model is to be in the provider and the supporter of these tools but to leave the directional drilling business itself to our customers. Once it gives us lot more customers out there, because while you got the big bore, you also got all kinds of smaller directional drilling companies that come to us for the support so we think it's much better business model for us.

Dan Pickering – Tudor Pickering & Hole

Got you. Okay. Thanks. And then, Clay, I know that, that your organization has been very busy combining the Grant Prideco and NOV organization, any acquisitions in the quarter do you feel like the company is going to ready to continue to do bolt-on acquisitions or there going to be a digested period here?

Clay Williams

Yes. Actually, Dan, I don't think we are missing the beat [ph]. And I can't speak highly enough about the job that our organization has done pulling together Grant Prideco and NOV was a very big job, but very proud of how it's turned out I think that the ability to integrate acquisitions is a key competitive advantage of NOV. As you know, we have done over a 150 acquisitions over the past decade and I really learned how to execute well. We did have one other small acquisition that we closed during Q2, it rolled into petrol and services and supplies been contribute much in the quarter, but the good basis going into Q3, and we are continuing to look at several other potential acquisitions. This is something we do very routinely; we've got a great crew here that works closely with our operations to execute these deals.

Dan Pickering – Tudor Pickering & Hole

Fantastic. Thank you.

Clay Williams

Thanks, Dan.

Pete Miller

Thanks, Dan.

Operator

Thank you, sir. Management, at this time I will turn the conference back to you for any closing remarks.

Pete Miller

Well, I'd like to thank everybody at National Oilwell Varco, all our employees, who join us from Grant Prideco and the callers listening in today, we look forward to talking to you at the end of the third quarter. Thank you very much for your interest.

Operator

Thank you, management. Ladies and gentlemen, at this time we will conclude today’s conference presentation for the National Oil Well Varco Q2 2008 earnings release conference call. We thank you for your participation in today’s presentation. If you would like to listen to a replay of today’s conference call you may do so by dialing 303-590-3000 and entering the access number of 11116555 followed by the pound sign.

Once again, if you like to listen to a replay of today’s conference call please do so by dialing 303-590-3000 with the access code of 11116555 followed by the pound sign. We thank you for your participation on today's conference call. At this time we will conclude you may now disconnect and thank you for using ACT teleconferencing. Please have a pleasant afternoon.

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