National Oilwell Varco, Inc. Q1 2008 Earnings Call Transcript

| About: National Oilwell (NOV)
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National Oilwell Varco, Inc. (NYSE:NOV) Q1 2008 Earnings Call April 30, 2008 10:00 AM ET


Merrill A. “Pete” Miller, Jr. - Chairman, President and Chief Executive Officer

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


Jim Crandell – Lehman Brothers

Collin Gerry - Raymond James

Kurt Hallead - RBC Capital Markets

Dan Pickering - Tudor, Pickering, Holt

Scott Gill - Simmons & Company

Analyst for Roger Reid - Natixis Bleichroeder

Michael LaMotte – JP Morgan


Welcome to the National Oilwell Varco earnings conference call. (Operator Instructions) At this time, I’d like to turn the conference over to Pete Miller, President, CEO, and Chairman.

Merrill A. “Pete” Miller, Jr.

Welcome to the National Oilwell Varco first quarter 2008 earnings conference call. I am Pete Miller, President and CEO of National Oilwell Varco, and with me on this call today is our CFO, Clay Williams.

Earlier today we announced earnings of $398 million, or $1.11 per share on revenues of $2.68 billion. This compares to year-ago earnings of $276 million, or $0.78 a share on revenue of $2.17 billion. We are very pleased with the start to what we expect to be an excellent year.

Additionally, we announced new capital equipment orders of $2 billion, which increased our backlog in our Rig Technology group to $9.9 billion. Clay and I will provide more color on this backlog in a moment.

Also, after the quarter end on the 21 of April, we closed on the Grant Prideco acquisition. We are excited about the prospects for this business and would like to welcome all the Grant Prideco, ReedHycalog and XL Systems’ employees to the National Oilwell Varco family. We are delighted to have you join us.

At this time, I would like to turn the call over to Clay and have him give you some color on our results. When he’s finished I’ll come back and give you a little bit of an operational overview and then we’ll open it up for questions.

Clay C. Williams

Before we begin this discussion on National Oilwell Varco’s financial results for its first quarter ended March 31, 2008, 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 or in our filings with the SEC.

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

National Oilwell Varco generated earnings of $398 million or $1.11 per fully diluted share in its first quarter ended March 31, 2008 on revenues of $2.7 billion. Earnings per share rose 6% sequentially and rose 42% from the first quarter of 2007. NOV’s first quarter revenues improved 1% sequentially and 24% year-over-year. Operating profit was $569 million or 21.2% of sales, an increase of 33% year-over-year but 1% decrease sequentially. Year-over-year flow-through or operating leverage was 27%.

As Pete mentioned National Oilwell Varco completed its $7 billion acquisition of Grant Prideco last week. Pete and I are excited about the very bright future that lies ahead for our customers and employees alike as a result of this important strategic step. The merger furthers NOV’s vision of being the manufacturer to the oilfield, supplying critical hardware, industry leading technologies and comprehensive service to oil and gas operations.

To our new NOV employees from Grant Prideco who may be listening, let me tell you how delighted we are that you’re now part of the NOV family. Welcome.

Later in my remarks, I will discuss financial results from Grant Prideco’s first quarter and update you on our integration efforts. Starting with the second quarter of 2008, we will begin reporting Grant Prideco’s four main operating units: drilling products and services, ReedHycalog Bits, IntelliServ and XL Systems within our existing petroleum services and supplies segment, following a FAS 131 review of the results in our post merger organization.

Under purchase accounting rules, we will pick up only a partial quarter of Grant Prideco results in our Q2 financial statements, specifically the operating results from the 70 days between April 22 and June 30.

To help assist you in your modeling, we will later today post on our website a pro forma set of historical financial statements by quarter for the combined company, including the expected effect of additional depreciation and amortization burden associated with the step-up of Grant Prideco’s balance sheet. This estimate of the step-up is subject to change as we complete our detailed reevaluation of its assets and liabilities over the next year in accordance with purchase accounting rules.

Three points of note regarding the acquisition, first, we intend to continue Grant Prideco’s past practice of reporting results from our joint venture with Voest-Alpine in Austria as equity earnings rather than consolidating revenues and operating profits. This joint venture supply green tubes to our drill pipe manufacturing operation.

Second, we will continue to pursue the closing of Grant Prideco’s previously agreed sale of its TCA, Atlas Bradford, and other tubular technologies and services businesses to Vallourec. We expect to close this later in Q2 and will treat their result as discontinued operations in our Q2 financial statements.

Third, to finance the cash portion of the Grant Prideco acquisition, we expanded our revolving line of credit to $3 billion, on which we drew a little over $2 billion last week. We will receive approximately $800 million in cash consideration from Vallourec upon closing the TTS transaction. And after taxes expect to net a little over $500 million, de-levering National Oilwell Varco somewhat from where we are today.

Importantly, we received a very attractive interest rate and are currently paying about 3.6% on the incremental debt. As I mentioned, I will work through Grant Prideco’s Q1 operating results a little later, but first let me review National Oilwell Varco’s Q1 results.

Overall, National Oilwell Varco performed well in its quarter ended March 31, 2008 continuing its excellent track record of efficiently and safely fabricating the highly sophisticated drilling rigs the world needs.

Demand, particularly for deepwater floaters from Brazil and other markets continue to be strong and National Oilwell Varco generated orders of $2 billion in Q1, for its rig technology segment, including five drillships and one semisubmersible rig.

Strong orders lifted our backlog to a record $9.9 billion, up another 10% sequentially. We expect orders will continue to be strong into Q2, 2008 given that we have already landed a couple of deepwater floaters only a few weeks into the quarter. And several more discussions about floaters are continuing which bodes well for the remainder of the year.

Land rig inquiries, both international and domestic are up sharply. But, surprisingly, our backlog for land equipment dipped slightly in Q1. Nevertheless, customer enthusiasm for NOV technology continues to build, in our opinion, due to the great operational success of the modern AC powered electronically controlled rigs we sell.

Therefore, we believe that contracts for more new land rigs will start to flow soon, particularly for Latin America, the Middle East, Russia, and the Caspian region. Most incremental domestic demand is focused on shallower rigs with small footprints for the Appalachian region. Across the worldwide land market, we are bidding literally dozens and dozens of rigs.

Pressure pumping equipment declines have contributed to the lower land backlog at March 31. Demand dropped sharply this quarter as North American pressure pumpers are curtailing expansion plans in the face of sharply lower pressure pumping prices and following significant capacity expansions over the past few years.

Nevertheless, we believe that this remains a high secular growth area in the long run and we expect to resume shipments into this market after the new equipment is absorbed and as new shale plays kick in with incremental demand.

Canada is back to buying units after a year long hiatus and international demand remains steady, particularly for China. Our outlook for North American has improved sharply owing to a much brighter mood amongst gas drillers who are seeing substantially improved gas prices, both in the U.S. and Canada.

Inquiries for rig equipment and oilfield services for North America, particularly for shale plays such as the Marcellus, Haynesville, Bakken and others has jumped and we believe the second half of the year looks very bright.

Near term, the seasonal break-up in Canada will suppress Q2 financial results but Q3 and Q4 look much better. As a reminder, last year National Oilwell Varco saw its overall Canadian revenues decline 26% from the first quarter of 2007 to the second quarter sequentially impacting earnings by about $0.04 per share.

Tubing and casing inventories in North America continued to tighten during Q1 as Chinese imports rolled over and as continued strong levels of drilling depleted OCTG stocks. As a result, pipe prices are rising and we are hearing from our pipe mill and pipe processor customers of their plans to step up production.

The overall rising demand for oilfield services across North America is permitting us to raise prices across most product lines. However, we are also facing rising costs. Fuel prices are up sharply worldwide, particularly for higher grade alloys. While higher oil prices benefit our customers in the long run, energy is a large component of what we build and a large component of what we buy from our suppliers. Inflation is talking a toll on our workforce too and we are continuing to face rising labor costs.

Overall, price improvements in our service businesses will be required to hold margins flat but we are guardedly optimistic that we can squeeze out additional margin improvements, mostly by continuing to get more efficient at what we do.

Overall, NOV’s international sales were up slightly this quarter but choppy. Rig technology overseas sales continued to rise to meet the demands for more rig iron and distribution’s international expansion initiatives produced growth, but our PS&S group international sales were down slightly sequentially offsetting these gains.

Excellent double-digit sequential services revenue growth in the Middle East, where we’ve recently expanded, failed to overcome lower sales in the North Sea and Continental Europe due to weather, and lower sales in the Far East due to project delays.

Latin America’s picking up as we are rigging up on new service jobs currently. We posted solid sequential gains in this region too, particularly in Argentina. International expansion initiatives we discussed last quarter continued and we expect to continue to invest in the start-up of a number of these for at least the next few quarters.

Now let me turn to segment operating results for Q1. Rig Technology generated $1.6 billion in revenue and $406 million in operating profit in the first quarter, yielding an operating margin of 25.3%. The group generated year-over-year flow-through at 36%, on 31% revenue growth.

Sequentially sales were roughly level and operating profit declined slightly. Importantly, we see the flattening revenues and margins as a momentary pause in this business and expect to resume mid-single digit sequential growth and slight margin expansion again starting in Q2.

Specifically, Q1 saw non-backlog sales rise 15% sequentially, but sales out of backlog declined 4% sequentially, largely offsetting the gains in services and smaller capital goods that don’t run through our backlog.

Within the Q1 revenue from backlog of $1,132 million offshore project revenue continued to rise as expected, but we shipped fewer work-over rigs, well stimulation units, power swivels, and mud pumps, leading to the overall revenue out of backlog decline of 4% compared to Q4.

Based on projects on the books at March 31, 2008, we expect revenues out of backlog to resume its quarter-by-quarter growth and total about $4.4 billion for the remaining three quarters of 2008, $4.2 billion for 2009, and the balance $1.3 billion scheduled to flow out in 2010 and beyond. Orders received after March 31 should layer in on top of these scheduled revenues. Our $9.9 billion ending backlog for rig technology at Q1 is now 90% international and 10% domestic, and 88% offshore and 12% land.

The rig technology segment continues to wrestle with rising costs, particularly steel, of 5% to 20% depending on the alloy in the source and FX related costs. But our efficiency initiatives, such as QRM and broad outsourcing have helped us maintain margins which have remained stable on newly won projects.

The steady completion of older lower-margin equipment rolling out of backlog, rising manufacturing efficiencies, higher volumes and absorption, and modestly higher prices on spares leads us to expect overall margin improvements in 2008 for the segment.

Execution for the group remained strong. We have delivered 24 offshore rigs so far this cycle and we are presently performing installation and commissioning operations on 20 more. As with all complex construction projects we have had a few hiccups, but they have been very few. And we are grateful for the excellent job our folks are doing for our customers.

The petroleum services and supply segment generated record results in both revenue and operating profit in Q1. Revenues were $830 million, up about $12 million or 1% sequentially and up 20% year-over year. Operating profit was $195 million, up $6 million form the fourth quarter and operating margins were 23.5%, up 40 basis points from the fourth quarter and flat with last year. Operating profit flow-through was 49% sequentially and 18% year-over-year.

Sequential improvements in margins were driven by surprisingly strong seasonal improvements across North America. Our mission business saw greater sales of drilling expendables like pump liners and valves. This business was pressured in previous quarters by inventories of these consumables being cannibalized from idle rigs, leading to pricing pressure. But the good news is that these excess inventories appear to be dwindling.

Mono sales of downhole motor power sections jumped this quarter due to higher demand for motors to support horizontal drilling. Horizontal and directional drilling continues to steadily gain share as a percentage of total drilling across the U.S. and along with pressure pumping is a critical factor in deriving the compelling economics of the shale gas plays unfolding in North America.

NOV’s downhole tools and Mission businesses are well placed to benefit from this trend. Our Tuboscope pipe inspection and coating business also posted solid sequential gains worldwide and our fiberglass pipe business benefited from a large sale of pipe into the Tar Sands in Canada, which led to good margin improvements there.

Rig instrumentation performed well in Q1 on all fronts, but solids control services and equipment declined slightly on lower equipment sales and rough North Sea weather, offset by an acquisition of the onsite power generation business. We expected to pick back up as new zero-discharge drilling regulations kick in the Western U.S. later this year and on higher shell play volumes across North America. Q1 sales of coiled tubing declined sequentially due to lower demand from pressure pumpers in the U.S. and higher steel costs from pressuring margins there.

Moving into Q2, we expect modest growth in revenues for the Petroleum Services and Supply segment in the mid single digit range before the addition of Grant Prideco businesses, which began to flow into the segment on April 22. Specifically improvements in Grant’s solids control and Mission are expected to overcome a sharp seasonal Canadian breakup affect. Most business units are pushing pricing again, but face rising costs, which leads us to expect margins to remain roughly stable.

Our distribution services segment revenues were $366 million, leveled with the fourth quarter of 2007 and up about 4% from the first quarter of 2007. Operating profit declined $2.1 million sequentially to $18.8 million and operating margins were down 60 basis points from Q4 to 5.1%, and down 200 basis points year-over-year. Seasonal revenue gains in Canada failed to fully offset revenue declines in the U.S. from Q4 to Q1.

Competitive pricing pressures in both countries continue to mount. Generally lower rig day rates have led many domestic drilling contractors to bid out more of their daily MRO supply span, reducing margins. In the U.S., the group saw fewer supplies being sold into well hookups in the Rockies during the quarter and in Canada, the world’s tax changes are causing some Alberta gas drilling to shift towards southeast Saskatchewan.

Canadian operations continue to restructure and the group recently raised delivery pricing to improve margins which remain below acceptable levels. International revenues increased in Q1, owing to the opening of several new DSCs in recent quarters, most notably in the Middle East. Africa and Asia-Pacific also posted strong quarters, partly offset by softer sequential results in Venezuela and Europe.

Costs associated with international expansion initiatives continued through Q1 and the group will be opening new DSCs in Brazil, Norway, Libya and India in Q2. Looking into the second quarter, we expect Canadian breakup to reduce results there, but U.S. international improvements to make up the shortfall. Margins are likely to be roughly flat.

Turning back to National Oilwell Varco’s consolidated first quarter income statement. Consolidated gross margins were steady just below 30%, but SG&A increased $11.7 million from Q4 and rose as a percentage of revenues from 8.1% to 8.5% due principally to higher payroll taxes on incentive compensation paid in Q1, offset by reductions in other items. Interest expense improved $3.5 million due to lower debt levels through the quarter. Debt declined $148 million due to our repayment of senior notes at maturity and the repayment of a joint-venture loan in China. Interest income declined despite higher cash balances in the quarter, due to a sharp reduction in interest rates.

Since we used most of our cash last week in the Grant Prideco acquisition, and since interest rates are down, we expect most of our interest income to disappear in Q2. Our other income line has had a lot of movement the past two quarters, mainly from foreign exchange impacts which make up the largest portion of this line. And we benefited from a large swing to the positive this quarter.

Last quarter, Q4 ‘07, we had an FX charge related to Norway where we had significant growth in work in progress and accrued liabilities related to projects there. This quarter, we made an accounting determination that our Norwegian operations are now U.S. dollar functional and made the conversion from the kroner to the dollar.

Our kroner cash holdings benefited from a $15 million FX gain before we converted them to dollars in Q1, adding to the other income Q1 turnaround where a sequential reduction in bank fees and minor gains on sales of fixed assets. Now that the FX conversion in Norway is complete, we expect the other income line to quiet down in future quarters.

The Q1 tax rate fell slightly sequentially, benefiting from net positive discrete items which brought it in below the 33% that we had expected. We expect our tax rate to be in the 33% range through the remainder of the year as we pick up operations from Grant Prideco.

Unallocated expenses and eliminations on our supplemental segment schedule were $51.5 million, up $5.6 million sequentially on higher payroll taxes paid in Q1 on incentive compensation. Depreciation and amortization was $61.5 million in Q1, up $3 million sequentially due to higher CapEx and a full quarter impact of Q1 acquisitions.

Our March 31, 2008 balance sheet employed working capital excluding cash and debt of $1.833 billion, down $45 million from the fourth quarter and about 17.1% of annualized first quarter sales. In aggregate accounts receivable, inventory and costs in excess of billings rose $528 million from December 31, 2007. But these were offset by accounts payable, crude liabilities and taxes, and billings in excess of costs totaling $618 million since December 31.

Cash flow from operations was a record $603 million in Q1 and leveraged cash flow was $460 million. CapEx was $54.3 million in Q1. We expect 2008 CapEx to run in the $400 million range including Grant Prideco for the remainder of the year. Our cash balance was $2,139,000,000, up $298 million from the fourth quarter. And our debt totaled $743 million as of March 31.

I’m also very pleased to report that NOV’s corporate credit rating was raised last week by both major ratings agencies in view of our strong financial conditions.

At this point, let me take a moment to speak to operating results from Grant Prideco for its quarter ended March 31.

Overall, the business generated a solid quarter highlighted by record results in its ReedHycalog unit and improved margins in drill volume. Revenues for the drilling products and services segment were $285 million in Q1, down 8% sequentially but up 3% year-over-year. Operating profit was $114 million or 40.1% of sales, up 50 basis points sequentially and down 70 basis points year-over-year. Production volumes were down sequentially due partly to lower Chinese production due to a higher mix of sour service pipe and the New Year holiday.

Overall lower production, though it was offset by higher prices per foot, up about 4%, and a rising mix of premium pipe. Drill pipe orders improved sequentially to the highest level since the first quarter of 2007 but nevertheless fell a little short of revenue shipped out of backlog. This led to Q1 ending backlog for the group of $662 million, down about 11% or $79 million from the December 31, 2007 backlog of $741 million.

I’ll note that Grant Prideco’s last reported backlog in its 2007 10-K included $42 million in products book in its continuing XL Systems business and excluded backlogs associated with discontinued operations and TTS being sold to Vallourec.

We expect that Q2 sales will be up slightly, but higher raw material costs will drive margins down before the additional depreciation and amortization from purchase accounting. We’re also cautiously optimistic that drill pipe orders will continue steady for the next couple of quarters.

Grant Prideco’s ReedHycalog segment reported very strong results with record revenues in Q1 of $171 million, up 6% sequentially and up 13% year-over-year. Operating profit was $55.4 million or 32.3% of sales, 640 basis points higher than Q4 and 210 basis points higher than the first quarter of 2007. Operating profit improved $13.6 million sequentially and $9.6 million year-over-year.

Bits, reamer and coring revenues benefited from very strong results in Canada, partly offset by lower sales in the Eastern Hemisphere due to weather and a late start to the year by NOCs. Margins improved sequentially from Q4 due to the consolidation of four bit-manufacturing facilities into a new state of the art factory in Conroe, Texas. The cost associated with this move adversely impacted operating results for the second half of last year, but the cost of the move are largely behind us.

Looking forward into Q2, we expect revenues to decline about 10% high detrimental even before additional purchase accounting depreciation and amortization, due to the effects of the seasonal break-up in Canada. But believe the business will perform well through the second half of 2008 as the North American drilling environment improves.

Equity earnings from the Voest-Alpine joint venture were $15.8 million in Q1, a decline of $9.7 million or 38% from Q4. Operating results were impacted by lower OCTG pricing and higher raw material costs, but the primary reason for the decline was a large consolidating elimination entry of profit on green tubes held by Grant Prideco in inventory. We expect the Q2 JV earnings will be up slightly as this profit in inventory elimination declines.

IntelliServ posted a $5.5 million operating loss on Mazda activity in Q1 and we expect similar results in Q2. We are beginning the process now determining ways in which NOV can help support the launch of this promising new technology, but the timing and meaningful revenues from IntelliServ remains uncertain at this point. Nevertheless, we are encouraged by inquiries we have received from operators and service companies about IntelliServ and believe it has a very bright future ahead.

Finally let me conclude with a few words about integration. We are pleased to report that we are on track to capture the $40 million in annual consolidation benefits we estimated we would achieve when we first told you of the merger in December. Our corporate groups were integrated last week and most of the cost savings will roll in quickly. Operationally we are integrating the products from the two organizations and are very enthusiastic about our combined outlook.

We both serve the same customers. Working up from the bottom of the typical drill string in a horizontal or directional well, Grant Prideco’s bits are literally connected to NOV downhole drilling motors, shock subs, jars and non-mag collars. These are, in turn, attached to Grant Prideco reamers, drill collars, heavyweight and drill pipe, which is in turn connected to an NOV top drive hanging from an NOV traveling block connected to an NOV crown mounted in an NOV derrick.

Directional drillers specify and select the bit, the downhole drilling motor, the non-mag collars and the reamers to drill a smooth curve to hit geologic targets efficiently. As of last week, we provide the industry’s most complete package of these critical components to drill complicated horizontal, directional and multilateral wells, an offering that will enable us to provide superior customer service.

Drilling contractors purchasing NOV rigs also buy Grant Prideco drill pipe. Grant Prideco drill pipe customers also buy coating, inspection and hard banding services from NOV. NOV’s two dozen drill pipe service centers around the world repair worn-out tool joints, recut Grant Prideco premium threads and apply proprietary hard banding to Grant Prideco manufactured drill pipe.

As a long-term service provider to Grant Prideco, NOV has watched it steadily strengthen its leading position as the provider of highly engineered drill pipe solutions. We’ve also watched as horizontal drilling, extended reach wells, deep water drilling, multilateral drilling and increasingly complex well paths have taxed drill pipe capabilities leading to larger diameters, dual upset, high slip crush strength drill pipe designs, premium high torque connections and improved metallurgy, all proprietary advancements pioneered by Grant Prideco.

Higher stress and strain on drill pipe as a result of its being pushed to its design limits by these emerging styles of drilling have shortened its life on an average and made it much more of an expendable than in years past. We’re pleased to have the world-wide leading provider of this highly engineered drilling tool as part of our offering and believe it enhances the level of service that we can provide to our customers.

Now let me turn it over to Pete.

Merrill A. “Pete” Miller, Jr.

What I want to do at this time is just make a few brief comments about operations and what we’re seeing in the world, and then we’ll turn it over to Q&A.

Basically there’s some themes out there today that I think are dictating what’s going to happen to our business over the next three or four years, and quite frankly it makes them very exciting. I think the first one are the shale plays. And you take a look at these non-conventional plays, whether it’s the Barnett, the newly announced Paynesville, and the Marcellus up in the Northeast or the Bakken up in the Dakotas. These are very exciting for all of our businesses.

When you take a look at it, when we talk about our bits, our drill pipes, our downhole tools, our mission products, our grant products, or MD Totco products across the board, they’re actually going to go on these rigs and they’re going to be utilized to be able to drill these unconventional wells. Further than that, going I think which is really what’s exciting today is I think there’s going to be more of a land rig demand in the Lower 48, because you have to have some fit for purpose rigs.

Specifically, you look at something like the Marcellus and you’re in there up in the Appalachian Mountains and it takes a different type of rig to be able to drill on pads. It’s going to be a different type of rig that’s up there today. And we’re already seeing the excitement that this is creating with a lot of our contractor friends in the United States, and I would offer up that the land rig building in the Lower 48 is going to improve dramatically this year.

It was interesting, in October, it looked like it would be a very slow year and many of our customers were telling us they wouldn’t buy for a period of time. In the past six weeks, that’s changed very dramatically. And that really is a direct result of these shale plays.

And also, remember this, these shales are not just in the United States. They’re all over the world. And, I think at some point in time, the technology to do these is going to be transported, and it’s going to be exported, outside of the United States, and we’re positioned quite well to be able to take advantage of this.

I think the second big thing clearly is deep water. If you take a look at what we’re doing in our backlog, a lot of that is deepwater rigs being built in Korea. Already this quarter, we’ve signed up more deepwater rigs. We do not see an abatement of this right now. The world needs deepwater rigs.

I think when you take a look at the basins that are around the world, they’re going to continue to be plays where the major’s going to want to be involved with them. There are going to continue to be areas where the NOCs are going to want to continue to drill deep water. I think the demand for those rigs will continue and, quite frankly, we offer the best technology for those rigs.

But, even more importantly, once these deepwater rigs go into service and, specifically, we’ve put a few of them in service here in the last three or four months, they’re really going to be just like the shale plays. They’re going to add to many of things that we do operationally. Whether it’s bits, again downhole tools, distribution across the board. As a matter of fact, one of the deepwater rigs going out here in the next few months is going to have one of the rig stores from our distribution group on the rig. And we anticipate that’s going to happen well into the future.

So, these are going to be operations that are going to continue to pay annuities to National Oilwell Varco as we go well into the future. Not only do we get to build the rig, but we get to support the rig, and support the drilling of the wells that those rigs do. I think the international strength is going to continue.

And, when you look at the price of oil, needless to say, that means that a lot of people, a lot of countries, are trying to improve their reserves. And we have positioned ourselves, with our template. Currently we’re in 49 countries; we have over 700 locations worldwide. And this allows us to be able to do things that a lot of folks cannot do by being able to support the products and services through this international arena.

I’ll come back in just a minute to talk, in particular, about a couple of other places we’re very excited about. I think technology is going to continue to be a theme that’s going to play very well to the things that we do. When you look at these deepwater rigs, the specific bit for purpose land rigs, we have the technology that’s able to do things.

When you look at drill pipe, when you look at IntelliServ, drill bits, you look at the things that we do with MD Totco it’s all about technology. We’ll continue to push that and we think that’s going to really differentiate ourselves well into the future, and I think you’ll see these results bode well for 2008 because of this.

Execution, Clay mentioned this earlier. We take a look at what we’re able to deliver. We’ll continue to execute well. We’ve opened up some new test stands for different products that will help us get more out the door as we advance through this year. We’re going to continue to have rifle shot investments that are going to enable us to be able to hit our customers’ demands, and we feel very comfortable that we’re able to execute this close to $10 billion; we wanted to make sure that we can execute that flawlessly.

And then finally, one of the things that we’re interested in and we’re seeing right now with many of the new contracts being signed by existing rigs, there’s probably going to be more of a demand for refurbishment and upgrades this year. A lot of these rigs are signing up for projects in which they need new equipment, whether it’s a new string of riser, whether it’s new types of subsea BOPs, Iron Roughnecks, top drives or whatever, they’re putting a greater demand on these rigs. So we think that we’ll even see an improvement in the refurbishment and in upgrade as we move forward.

Internationally, we continue to see a lot of excitement in Russia. You’ve heard me talk about that many times on these calls. We think that will continue to be a great business. They have a tremendous demand right now for land rigs. We’re looking at many different opportunities to bid on those over there. Last quarter I mentioned that we had won the Shtokman field, the first group of semi-submersibles that are going in there, and I’m very pleased to say that’s going along very well. I think there will be more opportunities there and I’m excited about what we’re doing.

The Middle East and North Africa continues to be an area that’s very active. I think you’ll see the Saudis increase their rig count even more. You’re seeing more and more offshore operations there. We repositioned ourselves in Dubai with our downhole tools, with our distribution, with our Brandt group, with just about every group that we have to be able to support the operations throughout that area. I think you’ll see more non-conventional drilling in that and that’s going to be an area that will continue to be really exciting.

Brazil, I don’t need to say much about that. I think everybody knows what’s going on in the deep water arena there. It’s been very positive for our industry and I believe will continue to be well, well into the future.

And then, finally the one area I’ll talk about is the Lower 48. And when I talk about those shales, we’re getting more and more excited about that. I think you’ll see the continuing increase in the rig count through the year, but more specifically the fit for purpose rigs that I’m talking about and the tremendous demand for the products and services that we have to be able to drill these non-conventional wells that will be drilled into these shales.

Overall, we’re very excited about the business. We mentioned the backlog earlier, it’s $9.9 billion. We continue to have a very, very robust bidding cycle in place. We continue to look to the future very positively, and I think overall we’re in very good shape to take advantage of what we believe is a very exciting worldwide oil and gas business.

So at this time I’d like to open it up for any questions that anybody might have.

Question-and-Answer Session


(Operator Instructions) Your first question is from Jim Crandell – Lehman Brothers.

Jim Crandell – Lehman Brothers

Pete, can you comment on your expectations for orders for floating rigs and for jack-ups going forward? My recollection is that you were looking over the next two years for 18 to 24 floating rigs and jack-ups, maybe a bit less than that. Can you talk about that, particularly in light of the continued strength here this quarter and maybe next quarter in new floating rig orders?

Merrill A. “Pete” Miller, Jr.

Well, Jim, what we’ve said all along and I’ll start with the jack-ups, is basically we believe that just about every time a jack-up gets delivered there’ll probably be another one ordered. That’s been reasonably consistent over the couple of years, I should say and I think it’ll probably continue on.

As with anything there’ll be some lumpiness, but I think last quarter, or a couple quarters ago, there were six or seven jack-ups announced. And that really is a technology play. I think you’re going to see a lot of these jack-ups aren’t necessarily additive as much as they might be replacement jack-ups into the market. So we think that the jack-up market will probably stay pretty steady. It’s not going to spike up so much but it will stay steady.

I think on the floater market, what we’ve seen has been a continued demand for these floaters. When you look back at what’s been ordered over the past couple of years, I’m not sure that I would say exactly what the number you’re talking about, but I wouldn’t be far off of that.

I think one of the interesting things about the floaters is that now we’re actually talking to folks about floaters that can operate in 12,000 feet of water. And so it’s not so much that they’re going to be adding it as much as they’re going to have floaters that are out there that can differentiate themselves from the floaters that are currently there.

And I think that technology is what’s going to drive that a little bit. And it really is, because all floaters aren’t the same. A 400-foot jack-up’s a 400-foot jack-up; but these floaters, some of them can only go on 5,000 feet of water, some are 7,500, some are 10 and now we’re talking about 12. So I think it will continue to be a good market.

Jim Crandell – Lehman Brothers

And how many of the floater orders that you got, or if you even want to include the couple in this quarter, would you say you got the entire package for?

Merrill A. “Pete” Miller, Jr.

We’re doing real well on that right now. I think I told people in the past, if we get the maximum on these floaters, it’s about $300 million. Generally, when we don’t get the maximum, it will be the subsea BOP, might be the riser system or something like that. Normally, the rest of it though, we’re able to get. We’ve been doing real well in that category, especially, with one of our shipyards in Korea, Samsung, we do very, very well in that regard.

Jim Crandell – Lehman Brothers

Clay, if you look at Grant Prideco, what would you expect now taking into account cost savings, operating performance, etc. would be the net effect of Grant Prideco on your EPS over the rest of this year and look out into ‘09 as well?

Clay C. Williams

Well Jim, we think we got great things ahead and are excited about it but as a matter of policy, we don’t give pre-earnings guidance and somewhat refrain from giving a specific number. But we believe it’s a pretty exciting deal and within that is just a great fit between the bit business that Grant Prideco brings to our own downhole tools business.

And then, within drill pipe, we believe we have a fair amount of insight into that business through Tuboscope, and believe the drill pipe is becoming much more of a consumable as well. And so, we think there are good things ahead.


Your next question is from Collin Gerry - Raymond James.

Collin Gerry - Raymond James

Did you give us how many floater packages were in the order flow this quarter?

Clay C. Williams

There were six total, Collin.

Collin Gerry - Raymond James

Pete, on the refurbs and the upgrades going forward this year, any guess as to what the revenue opportunity there is. I imagine it’s going to vary drastically per rig. But what do you think the opportunity on a per rig basis for some of these floaters coming into the yard would be?

Merrill A. “Pete” Miller, Jr.

Well, I think that really does vary dramatically Collin. It just depends on what the specific job is. I can think of a couple off the top of my head that’s going to be very significant because we’re already taking a look at some of the demands and they need a lot of stuff. Others will be a little less. And if I told you a number, I’m not sure it’d be too meaningful in the long run. But it’s a neat deal right now because so many of these jobs are going to need different types of equipment, and the contractors are taking the opportunity that if they’re going into a long-term contract they want to make sure that they get that equipment on early. So I do believe it’s going to be a real positive development for us as we go through the year.

Clay C. Williams

Yes, a lot of that equipment will be specified too by the E&P customer.

Collin Gerry - Raymond James

The rosier outlook for North America, you spent a lot of time on that, the shale plays obviously, increase in land demand. Care to venture a guess as to how many maybe incremental land rigs we could add to the fleet over the next 12 or 18 months, whether it come from you or whether it come from somebody else? I’m just thinking from a demand perspective, what are contractors maybe thinking they’re going to need over the next 12 to 18 months?

Merrill A. “Pete” Miller, Jr.

No, I think it’s going to be though, Collin, There are a lot of things that are impacting this marketplace right now. And I think again, when I talked about the Marcellus Shale, you look up there, and they need a certain type of rig. You talk about different pad drilling. Pad drilling takes a different type of rig than are many rigs today.

And I think the technology that people are seeing and again, you look at a [Helmet Complain] as an example, and they’re keeping all their rigs very active because they have some of the higher-tech rigs. So I think there’s going to be a demand there. We’re starting to see it improve pretty significantly and that’s the reason I mention it. And I think it is going to be a very positive market for us as we move forward.

Collin Gerry - Raymond James

So it sounds like we’re in the early stages and we’ll see how that maybe unfolds and maybe a little better guidance in the next couple of quarters as to how we see that play out?

Merrill A. “Pete” Miller, Jr.

Yes, and I think it all depends too on how rapidly things like the Marcellus and the Haynesville and some of these come into play. And clearly, they’re going to be dependent upon the price of natural gas, too.

Collin Gerry - Raymond James

Some would argue with that.

Merrill A. “Pete” Miller, Jr.

But if you take a look at that, I think the speed with which those plays play out will really dictate the demand for rigs.


Your next question is from Kurt Hallead - RBC Capital Markets.

Kurt Hallead - RBC Capital Markets

I know you have always been very optimistic about the business but it seems like there’s been even an incremental shift in tone here clearly. Pete, you got a lot of different elements here that are driving the outlook on the rig technology side.

And figure when you put them all in a bag, you shake them up, and you compare them to maybe where you were a year ago, two years ago on the prospective orders, you think you’re able to hold things as flat, or do you think that you can actually start to reaccelerate on the order front when you look at the different mix?

Merrill A. “Pete” Miller, Jr.

Well, Kurt, I think actually there are some positive things happening. I think if you look at what’s gone on in the last three or four years, we had a process that was started by jack-up rigs and then you had some land rig business come into it and then later you had the floater business come into it. And today, you’re probably seeing a little bit of lessening on the jack-up business but the floater business continues to be very good. And I think the land business appears to be picking up a little bit.

And so we think we’re in a pretty good mode right now that’s going to continue to see a demand for the products that we have. Now having said that, you also have the law of big numbers. We were starting three or four years ago with a backlog that was a billion dollars, building it up to close to $10 and then today you’ve got a backlog of $10 and you go okay, what are we going to do to keep feeding into that?

I think we’re going to keep feeding into it and I feel very good that there’s a lot of stuff out there today and I think the biggest change today are when you look around the world at some of these discoveries in deep water. And those deep-water discoveries are going to need a lot of rigs to develop them.

And I think you see it with the announcements of people like Transocean with long term contracts and some of the others, the Seadrill’s of the world that are out there. So we’re still very bullish about the worldwide demand for the products that we make.

Kurt Hallead - RBC Capital Markets

You discussed the strategic fit of the Grant Prideco businesses into what you’re doing. You have referenced the benefit that you’re going to get derived from the cost savings. Any stab here on what revenue synergies you can derive from the acquisition.

Clay C. Williams

We are optimistic we’re going to get some additional incremental sales, but it’s never been our style to quantify those or to put them out there publicly. I do think, though, we’ve got an excellent track record on businesses that we’ve acquired and would point to that that I think we’ve done a good job maximizing and optimizing those synergies. So again, I just can’t say enough about how good the fit is between Grant Prideco’s products and NOV’s products and so we think there’s good things ahead.


Your next question is from Dan Pickering - Tudor, Pickering, Holt.

Dan Pickering - Tudor, Pickering, Holt

I wanted to look at the Rig Technology business. Clay, it looked like Q1 was a little bit light of where you had indicated it might be in the backlog side of the backlog from revenues on your fourth quarter call, and yet it feels like you’re taking up the rest of the year. And so I’m just wondering, did we have some things that slipped out of Q1 into the back quarters or did business just pick up enough that it looks like we’re going to accelerate through the rest of the year here?

Clay C. Williams

Yes, that’s exactly what happened, Dan. We had some things that didn’t ship, and it was really the equipment that we recognized revenue on a completed contracts basis that was down. The project revenues where we recognized revenue on a percentage of completion basis continued to move up exactly as we’d planned. So we do think that’s a momentary slow-down here this quarter.

Dan Pickering - Tudor, Pickering, Holt

So no execution issues, more just timing issues?

Clay C. Williams

Right, right.

Dan Pickering - Tudor, Pickering, Holt

Pete, you mentioned the Marcellus and Appalachia several times, could you just, what is your product offering for that market? Is that a standard thing for you? Would it be a new rig that you developed? How do you attack that market?

Merrill A. “Pete” Miller, Jr.

Actually, what we’re doing right now, Dan, is we’re working with a couple of specific customers, and really developing a new type of rig. It’s actually, when I say a new type of rig, it’s really going to be one that is going to have a footprint and a design and a deliverability when we move it that’s going to allow it to go in smaller pieces, going to allow it to handle.

If you go up into the Marcellus a lot of the roads up there, you have the switchbacks, you’ve got a lot more issues in the Northeast about weight of rigs, you’re going to have a 60,000-pound limit. You are going to have to have trucks that can turn on these switchbacks, and so we’re working with these customers to really develop a rig that can drill in that area very effectively, move fast, and be able to drill multiple wells from the same location. So it really will be a new concept.

That’s just from the capital side; the other side of it though is really what it means to our Services business, our petroleum services and supplies. Because again, when you start talking about the things that we do with Tuboscope and Brandt and downhole tools and the bits and pipe, it’s really going to utilize a lot of the products that we have there.

And I’m really excited about the Marcellus. I think it’s an area that’s mature, but because of the different technologies that the industry has developed, I think it’s going to be an exciting play and clearly we expect to be, with some of our new design technology, to be a big part of it.


Your next question is from Scott Gill - Simmons & Company.

Scott Gill - Simmons & Company

Pete, you talked a lot about technology and Clay, you mentioned rising steel costs and I know you’ve given us the revenue per new build rig opportunity before, but this morning, on upstream you see where there’s $1 billion floater rig being built for the Arctic, can you just refresh us? What is your revenue opportunity now for deepwater rig considering all these things? And if you could contrast an Arctic-style rig to maybe one that we’re seeing in a more benign environments like for Petrobras in Brazil?

Merrill A. “Pete” Miller, Jr.

I think, Dan, what you’re looking at today, and not standard, but maybe a 10,000-foot deepwater rig that we’re looking at for normal places around the world would, our revenue opportunity is about $300 million, Scott. I think that’s up a little bit from where we’ve been in the past and in some cases and in a lot of cases, we get the entire $300.

On an Arctic rig, and when you start talking about $1 billion, depending on the design of the rig, many cases a lot of that money is going into the actual design of the rig itself on the pontoon so that it can withstand all the ice flows associated with what you have there. It’s not so much different on the top side, because once you get to the top side, it’s really just about winterization. We do that on a lot of rigs up in Alaska already.

But it’s more about how can the pontoons and then the floating systems withstand the ice that’s going to be created there. So that’s where you see a lot of the incremental cost associated with that, which we wouldn’t participate in.

Scott Gill - Simmons & Company

On these land rigs, for example, the Marcellus Shale, can you give us a feel for what the revenue per rig opportunity is for those new build land rigs?

Merrill A. “Pete” Miller, Jr.

I think it could be anywhere from about $8 to $12 million in that area, depending on what the final design looks like. Maybe a little bit more.

Scott Gill - Simmons & Company

So cheaper than your ideal rigs, correct?

Merrill A. “Pete” Miller, Jr.

They’re smaller rigs for the most part. And in many cases the smaller rigs, less steel, less cost. So they would be a little bit smaller in that regard.

Scott Gill - Simmons & Company

Clay, on your guidance when we look at rig technology and you look at the revenue that’s supposed to come from backlog, it looks like at least the backlog sales will be much greater than the 5% that you gave for the overall segment. As a matter of fact, they should be well into double-digits. Is that mostly going to be in Q3 and Q4 or is that going to be somewhat just conservative guidance for Q2 here?

Clay C. Williams

Yes. Scott, it ramps up through the year quarter-by-quarter.


Your next question is from Analyst for Roger Reid - Natixis Bleichroeder.

Analyst for Roger Reid - Natixis Bleichroeder

I wanted to ask a little bit about the Russian land market. Could you characterize the types of land rigs that you’re shipping into that market and whether they’d be more garden variety standardized or you’re looking to build more fit-for-purpose rigs there?

Merrill A. “Pete” Miller, Jr.

In the Russian market, it’s really a panoply of a lot of different things. In some cases, you’ve got some bigger rigs depending if you’re in the southern part of the market there. You could do as much as 2,000 horsepower rigs with winterizations and then you go into parts of Eastern Siberia, and you’re dealing with much smaller rigs, things that are maybe a Cabot 900-type rig, which in some cases are trailer mounted. But you’re seeing a little bit of a demand for just about every type of rig in there.

There’s places like on the Yamal Peninsula that they want to have rigs that can drill to about 14, 15,000 feet and then if you get into places like Kazakhstan, they want to have rigs that are 20 and 25,000 feet. So, really what you see in the Russian market is an array of products and not that much that’s fit-for-purpose. They’re fairly standard rigs with the differential being you’re going to have a significant amount of winterization on them.

Analyst for Roger Reid - Natixis Bleichroeder

In the Saudi market, sounds like anecdotally on the ground, things are still humming along pretty nicely for you. Can you comment a little bit about what they’ve said recently in terms of reevaluating their major projects once [Al-Kurasom] and IFIR are done with? It doesn’t sound like that’s what you’re seeing.

Merrill A. “Pete” Miller, Jr.

No. I think what we’re seeing is probably a continuation of wanting to expand what they’re doing. I think many times, what’s going to be said maybe publicly versus what’s being done is not necessarily the same, but we continue to see at least an interest in what they might be able to do to take a look at continuing to drill wells.

Because I think for the Saudis what’s more important than production is having reserves. And I think to develop those reserves; I think they’ll continue to look at the type of equipment and things that we do to be able to develop that.


Your final question is from Michael LaMotte – JP Morgan.

Michael LaMotte – JP Morgan

Clay, on the cost side, you mentioned labor as inflation. We all know what’s going on the material side. Can you remind us how you’re hedged materials-wise and what your purchasing schedule looks like relative to your delivery schedule? And then on the labor side, I’m wondering how much of that squeeze is really ex-pat labor and dollar related and maybe could we see some relief on that front over the next twelve months if the dollar strengthens?

Clay C. Williams

First on the hedging, when we win a contract we very aggressively get out and place purchase orders with our suppliers to make sure that we’ve got material costs locked in, and that’s not instantaneous. So we’ll have a few months there where we do have some exposure on things moving. But by and large, we recognize the potential to have margins erode because of higher costs of what goes into these projects, so we get out and move pretty quickly to try to get that locked in.

On the labor side, yes, we have very extensive international manufacturing operations and so a lot of the cost inflation that we’re seeing on the things that we’re making, is really the translation of pounds and kroner and other currencies around the world back to dollars and FX has really taken a toll.

And as a side story on that, we’re hearing the same thing from our joint contractor customers. When they go to get bids on building these new rigs in foreign shipyards, the foreign shipyards face the same effect. It’s just costing more to build things in yuan and Sing dollars than it did a short while ago. So the meltdown of the dollar is definitely having an impact on our business.

Michael LaMotte – JP Morgan

In terms of quantification, is it costing you 100 basis points, 200 basis points? Is there any measure gauge that you can give us?

Clay C. Williams

Well, it’s hard to measure. We measure costs everyday and we’re seeing it in standard cost rules that we’ve done on some of our standard products that are made overseas. But what we’re trying to do is very aggressively offset that with pricing. So pricing is moving up, but the net-net is I don’t think you’re going to see a lot of price-driven margin expansion.

Michael LaMotte – JP Morgan

So the balance will focus on efficiency, is the way we should think about margins going forward.

Clay C. Williams

You bet. You bet. Just keep up with cost increases.

Michael LaMotte – JP Morgan

Just with the credit market turmoil of the first quarter, I know you’ve got some speculative rigs in the backlog and that you’ve been very good about getting pre-payments and your working capital is certainly not an issue. Do you see any risk in the backlog related to credit-related issues?

Merrill A. “Pete” Miller, Jr.

No. It’s not in our backlog. In our existing contracts, we have a lot of confidence, our customers are credit worthy, and as you point out, we’re getting very good payment terms so that we don’t get exposed from a working capital standpoint.

I’ll add though, that in addition to FX, I think we have a group of customers that rely on structured project financing for their projects. So as we work through these projects and put these bids out there, that particular group of customer is facing a little more headwinds with regards to securing financing for these projects. So incrementally it’s getting a little tougher for them.


And at this time, I’d like to turn the call back over to Mr. Miller for any closing remarks.

Merrill A. “Pete” Miller, Jr.

We appreciate everybody calling in today, and I’d also like to invite everybody to stop by our booth at the Offshore Technology Conference next week. Thank you and we’ll talk to you at the end of the second quarter.

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