國民油井華高 (NOV) 2006 Q2 法說會逐字稿

Ladies and gentlemen, welcome to the National Oilwell Varco second quarter earnings conference call.

[OPERATOR INSTRUCTIONS]

I would now like to turn the conference over to Pete Miller Chairman and Chief Executive Officer, please go ahead sir.

Thanks, this is Pete Miller, the Chairman and CEO of National Oilwell Varco, and with me today on this conference call is Clay Williams our Chief Financial Officer. And we'd like to thank all of you for calling in and having the interest in what we're doing here.

Earlier today we announced net income for the second quarter of 2006 of $147.9 million or $0.84 per share on revenues of $1.657 billion. This compares to Q1 of 2006 income of $120 million or $0.68 a share on revenue of $1.511 billion. Clay will provide more color on these numbers in just a moment.

Needless to say we are very pleased with this results as we complete the first full year of the merger between Varco and National Oilwell. Additionally today we announced a backlog of $4.1 billion as of June 30, 2006.

This is an increase from $3.2 billion at the end of the first quarter of 2006 and includes new orders of approximately $1.5 billion for the quarter, a record for us. I'll expand upon this number a little bit later in the call, but I would also like to add that yesterday we signed a contract for a drill ship of $230 million, approximately.

This is clearly one of the largest orders we have ever signed, while our customers told us we could talk about the size of the order, they have asked us at this point in time not to reveal who they are, and we'll talk about that--or we will reveal that a little bit later, when time goes on in the next few weeks.

Needless to say again, we're very excited about what we're doing, we think the quarter was very positive and at this time I'd like to ask Clay to expand upon the financials and I'll come back a little bit later and talk about our operations and then we'll open it up to questions and answers.

Great, thanks, Pete.

And by the way the $230 million order is not in the backlog number we released this morning, it will shop up in our Q3 backlog. Before we begin this discussion of National Oilwell Varco's financial results for second quarter ended June 30, 2006, please note that some the statements that we make during this call may contain forecasts, projections and estimates including, but not limited to, our comments about the outlook for the Company's business among others.

These are forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are based on limited information as of today which is subject to change. These forward-looking statements are further 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 10K that National Oilwell Varco has on file with the Securities and Exchange Commission for more detailed discussion of some of the risk factors affecting our business. Additionally we may at times refer to results excluding certain merger, integration, stock-based compensation expenses, and a certain estimated pro forma results as if National Oilwell and Varco had been merged during 2004, or during the first 70 days of 2005.

Further information regarding these may be found within our press release on our website at www.nov.com or in our 8K filings with the SEC. Later in this call, Pete and I will answer your questions. We ask that you limit your questions to two in order to be able to permit more people to participate.

National Oilwell Varco generated earnings of $147.9 million or $0.84 per fully diluted share in its second quarter ended June 30, 2006 on revenues of $1.657 billion. This was up 23% sequentially from the first quarter 2006 net income of $120.3 million or earnings of $0.68 per fully diluted share which included $0.03 per share of integration cost related to the Varco merger.

Integration costs were minimal in the second quarter of 2006 and we have discontinued reporting these separate. Excluding integration charges from the first quarter earnings rose 18% sequentially. Compared to the second quarter of 2005, a year ago, the first full quarter for the combined company following the Varco merger, earnings were up 115% excluding $0.04 per share in integration charges from a year ago period.

Overall NOV's second quarter revenues improved 10% sequentially and 36% year-over-year. Operating profit was $246.6 million an increase of 25% from the first quarter. Excluding $7.9 million in integration charges from the first quarter, operating profit grew 20% sequentially representing 28% flow through or operating leverage.

Compared to the second quarter of the prior year operating profit flow through was 30% excluding $10.5 million in integration charges from the second quarter of last year. All three of our business segments were posted higher revenue, higher operating profit and higher operating margins compared to the second quarter of 2005 and in spite of the seasonal downturn in Canada, all three posted higher sequential operating margins in Q2.

Much has been accomplished at National Oilwell Varco in the first full year following the merger, and we are pleased that organization is performing so well. The combination of a very strong market together with the operational efficiencies brought about by the merger, has led to significantly hire profitability. This has only been possible due to the hard work and common sense of the very capable employees that Pete and I have the good fortune to work with here every day.

NOV has benefited from some smart moves made by many of its managers over the past year, and we are grateful to be on their team. In particular, we want to highlight our rig technology group which posted second quarter operating margins in excess of the 15% goal we articulated early in the merger. The rig technology group's team has shouldered most of the integration load and has emerged from this disruptive process with higher profitability and record backlog. Along the way the group also introduced a number of new technologies to improve our service and products.

The new rapid rig introduced in the second quarter is a direct result of combining the engineering capabilities of National Oilwell and Varco. Several product lines within our petroleum services and supplies group have also been integrated very effectively by our management teams there, and our distribution services group continues to break new margin records in part by extending it's part powerful market reach to Varco legacy product lines such as [MBCO], Varco spares, and branch solids control. Our company continues to benefit from excellent market demand despite recent softening in gas prices across North America, gas prices still remain at exceptionally high levels compared to just a few years ago. While we acknowledge the potential for further gas declines due to the overhang in storage which by the way, just got 7 BCF better today which was the the first ever summer time draw, we have not seen any declines in gas drilling activity.

On the contrary pricing and demand across most of our products across North America continues to build, therefore we expect continued margin expansion overall as price increases enacted within the second quarter begin to take hold and as we rollout new pricing in certain areas.

In spite of the North America gas storage picture, we remain bullish on the outlook and here is why. Gas drilling in the U.S. has more than tripled over the past decade but U.S. gas production is still roughly flat at about 19 to 20 TCF. This should be a stark warning about the long-term gas deliverability challenge facing the industry to satisfy growing energy demand on this continent.

What has changed over the past decade has been the mix of gas coming from unconventional plays, tight sands, shales and coal bed methane, which has grown from about 10% or so a decade ago to about 40% today. Comparing the gas rig count growth with the very anemic gas supply response leads us to conclude that North American gas production is now much more hardware and drilling intensive that it used to be.

Not coincidentally, our new rapid rig, new (inaudible) units offerings and nitrogen vaporization units target unconventional gas play. The real strength of National Oilwell Varco is the breadth of its offering, so much of what we sell goes into more stable international oil markets and oil prices are setting new records.

58% of the rig technology groups Q2 revenues were from non-North American locations and with 73% of our drilling backlog destined for international markets the international revenue mix should continue to grow. Our backlog for domestic land drilling equipment arguably the most gas price sensitive segment grew 22% sequentially but totaled only about 15% of our total backlog for rig equipment.

Further, the large offshore rigs that have dominated or order flow for the rig technology group for the last few quarters are being built to upgrade and enhance drilling fleets for the challenges of the 21st century these rigs have been commenced to position their owners for oil drilling in complex and challenging waters for the next 25 years. It is frankly hard for us to envision any of our customers cancelling a $0.5 billion floater because gas dipped below $5.

Our packaged contracts generally do not permit cancellation anyway. The primary energy supply for the world, oil remains scarce and volatile and is likely to continue as such. As China's fleet of vehicle grows from 30 million to 130 million and as hundreds of millions of people emerging from poverty around the world begin to consume more oil and as foreign national oil companies play a larger role in the oil production equation.

In short we believe $6.00 gas and $75.00 oil will keep drilling activity high and will continue to stress the existing fleet of 1970's vintage drilling rigs. The world needs more rigs and it needs better rigs. Like all mechanical equipment, rigs wear out. NOV is playing a critical roll in helping our customers upgrade their fleets with new iron which can dramatically improve the speed, efficience and safety of drilling operations.

New safe efficient rigs continue to be the best places to work and these are helping our customers attract skilled workers to their operations. NOV is exceptionally well positioned to tackle these challenges, we understand well that our customers count on us for the best technology, the best people and the best service to keep their operations running smoothly.

We remain focussed on executing our critical mission for their benefit. Revenues for our rig technology segment were $845.8 million for the second quarter, up 18% from the first quarter and up 47% from the second quarter of 2005. Operating profit was $136.1 million or 16.1% of sales, sequential flow through or operating leverage from the first quarter to the second was 27% and second quarter year-over-year flow throughs were 31% excluding integration charges from prior periods.

Excluding charges last year related to two international rigs, year-over-year operating leverage was 23%. Backlog for the rig technology group surged again this quarter rising 30% from the first quarter to a record $4.1 billion. Representing a 3.5 fold increase since June 30, 2005.

The record $1.5 billion in new orders was up about 14% from the first quarter of 2006 and we expect to see continued growth in the backlog next quarter. The offshore mix within the drilling equipment backlog is 76% and the international markets continue to dominate the order flow.

Offshore equipment will generally reside longer in our backlog than land rig equipment. For example, one of the drill ship packages that we won last quarter takes it's first delivery a hex pump 14 months after the contract was signed the remaining equipment including rackers, pipe handing systems, dericks, draw works, and controls is scheduled for delivery between months 14 and 20, and commissioning and rig up wraps up about 28 months after contract signing.

We are not the critical path on this project, rather, we will deliver equipment as the rig is actually fabricated at the shipyard. Our customer doesn't want equipment any earlier because there is no rig to put it on yet. Revenue from backlog increased 25% sequentially in Q2 and non-backlog revenue rose 8%. Revenues out of backlog will likely be in the $1.1 to $1.2 billion range for the second half of the year. About $2.2 billion of the backlog is scheduled to flow out as revenue in 2007 and the balance or about $800 million in 2008 and little bit in 2009.

Along with price, our contract terms have improved, most do not permit cancellation and those that do, require our customer to pay us for what we have done so far. Down payments, customer deposits, and billings in excess of cost all measures of customer financing of our working capital rose to $580 million by the end of the second quarter. We are pleased that this group is delivering the equipment and critical spare parts that the industry counts on us for. We have delivered six major drilling packages so far in 2006 all without delay.

Looking forward, we expect to see revenues up in the third quarter in the high single digit range and margins continuing to rise into the range of about 17% or so. We continue to expect normal long-term flow throughs of about 22% for the group. Our petroleum services and supply segment generated excellent results once again in the second quarter.

Revenues were $589.9 million and operating profit was $129.7 million or 22% of sales. Revenue growth was 9% from the first quarter, and 31% from the second quarter of 2005, which compares very well with the 13% rig count growth year-over-year worldwide. The group generated 23% flow through sequentially below it's long-term average of 30% due to a sharp swing in mix away from Canada where service business declined about $11 million in operating profit, a little more than last year.

Other products within the group overcame the Canadian break up to lead to higher margins overall. Record results were posted by several product lines within the group. Mission drilling expendibles and multi-plex pumps, mono-industrial pumps and power sections, star fiberglass pipe exports, Martin Decker, rig instrumentation line, branch solids control equipment, sales and services and Tube-O-Scope pipe inspection all posted top line growth and incremental profit.

Demand for quality tubing, oil tubing remains strong but results were impacted by an unplanned mill maintenance in Q2 and we look forward to adding our third mill to quality there by year end. Demand for Griffith Vector mud motors and jars remains high as well and we saw the U.S. growth partly offset Canadian seasonal declines within this product line. Most products and services that went into the petroleum services and supplies group continue to press pricing in the mid-single digit range each quarter, but the margin impact in these efforts is being mitigated a little bit by inflationary forces across the oil field as personnel and raw materials and energy expenses continue to rise.

We are also experiencing a little more resistance to price increases in certain areas, but nevertheless expect margins to continue to expand in Q3 with modest top line growth as Canada recovers. Over the long run excluding swings in mix and other factors we continue to expect flow throughs from this group to be in the range of 30%. The distribution services segment posted another record margin level in the second quarter despite a small decline in revenues due to the Canadian break up.

Operating margins were 6.5% up from 6.4% in the first quarter of 2006 and 3.7% in the second quarter of 2005. Revenue fell about 2% to $319.1 million from the first quarter as the group's Canadian operations declined $16 million. U.S. and international locations saw sales improve about 4% sequentially.

Year-over-year revenues grew 24% an operating profit of $20.8 million was flat with the prior quarter and up $11.2 million year-over-year. Greater international buying in bulk and mill purchases from strategic suppliers along with better delivery cost efficiencies helped drive the improving margins. The group continues to expand into new attractive markets and has opened seven stores across North America so far this year.

In addition to selling more Varco legacy products as a result of the merger, the group is also selling more internally providing consumables used by Tube-O-Scope to conduct its business for example. We expect the distribution group to continue to perform well for the remainder of 2006. As Canada recovers seasonally and look for margins in the 6.5% range on low single digit growth in the third quarter. We continue to expect long-term flow throughs for the distribution business, excluding swings and mix and other factors to be around 10%.

Turning to the consolidated second quarter results SG&A increased sequentially by $10 million due to the non-recurrence of federal legal--as a favorable legal settlement in the first quarter and higher incentive compensation accruals and stock option expenses in the second quarter. Other expense increased $8 million from the first quarter due to unfavorable FX movements, mostly related to the major European currencies.

Income tax rate for the quarter was 33 .8%, slightly higher than last quarter due in part to additional deferred tax liability arising from the new Texas gross profits tax and additional taxes on dividends out of the Netherlands offset by other favorable items. We expect the tax rate to remain in the 34% range through the remainder of the year. Unallocated expenses and eliminations on our supplemental schedule were up to $31.7 million up $4.3 million from the first quarter. Inner segment profit eliminations increased about $9 million sequentially offset by favorable movements and other items.

Turning to the balance sheet working capital excluding cash and debt was $1.633 billion at the end of the second quarter down about $61 million. Working capital on this basis as a percentage of annualized revenue fell from 28% in the first quarter to 24.6% in the second quarter. Higher inventory balances associated with rising backlogs were largely offset by larger customer deposits on new orders and more favorable billing terms on projects which favorably impacted accrued liabilities.

Accounts receivable increased sequentially $63 million but DSOs fell due to higher revenue. Capital expenditures in the quarter totaled $52.5 million up $22.3 million from the first quarter. The largest increase was in our petroleum services and supplies group which accounted for 67% of our second quarter CapEx.

We continue to invest in solids control equipment, drilling motors and jars and rig instrumentation packages to satisfy the needs of our customers, in addition to the new oil tubing mill that we are adding. Our rig technology group also increased its CapEx this quarter to expand it's machining and assembly capabilities.

For the year we now expect to spend around $190 million after investing $83 million through the first half up from the guidance we provided last quarter. Depreciation and amortization was $38.7 million, about flat to last quarter. Cash totaled $515.7 million at June 30, 2006, up $252.7 million sequentially. Debt totaled $835.9 million and net debt or debt less cash totalled $320 million. Net debt to total capitalization was 6.5% at the end of the quarter.

At this point let me turn it back to Pete for his comments.

Thanks, Clay.

At this point in time what I would like to do is just kind of take you through a brief overview of our operations what we're seeing out there, and then also go through a little bit of a geographic outlook on where we think some of the better places in the world are right now.

As Clay mentioned our distribution group just did a great job this quarter. They had all time high operating margins of 6.5%, they opened seven new facilities and they're really having some success with some procurement strategies. I'll tell you, I think one of the things to know here is that as drilling rigs are running around the world, operators are asking a lot more out of those rigs, as they ask more out of those rigs, the rigs are having a lot more wear and tear on them.

When you start paying $25,000 a day for a rig, you want to get as pressure out of it, you want to make as much footage as you can. I think that our distribution group is playing a great roll in continuing to supply these rigs with all of the rope, soap, and dope and all of the things they need to continue to run in this fashion.

So I think you'll continue to see an expansion of our revenues and hopefully our profits in this group as we go to the future, but they have done a great job in being able to support our customers in the field worldwide. I think it's also an additional response to our direct integration progress where we actually tie right in with our customers to be able to reduce their costs and be able to respond to their needs on a much quicker base, so they have done a great job there, and I expect to see that continuing into the future.

Our petroleum services and supplies group, again, as Clay kind of pointed out as he went through his presentation, these are great names. We have the leading names, we have the best quality and quite frankly, we have the best products and services. We're enhancing this by putting new products and services out of there, but I think a thing to remember here, we all are looking in the rearview mirror a little bit to see what's going to happen to us, if there's something catching up with us on gas.

I think we're all concerned about what could happen to North American gas, but we feel very confident that as we look at that with our petroleum services and supplies group that because of the high quality of what we do we think that even today where people are maybe moving away from some of it because we may not be able to get it exactly when they need it they'll come back to us.

Quality always wins and we have some great names. Example of that is our Tube-O-Scope operation, you look at your coating, you look at our inspection, our coating plants basically are filled today. Every piece of drill pipe that's going out there is running through our coating plants and we've got a great backlog, and they are doing a great job keeping up with the business that the industry is demanding, and our inspection group is doing the same sort of thing with coming out with new products that can expect pipe and tubing and tubulars much better.

Quite frankly, there's very few pieces of pipe, casing and tubulars in the country that don't get touched by our Tube-O-Scope group. Our MB Topco group, again, same sort of thing, you've got a Topco piece of equipment almost on every rig in the United States, but they're also looking at new ways of doing things.

For instance our business of drilling products, which basically tie everything together, you can take your back room tie it together and--and float into it your headquarters and make everything so much easier and these days of Sarbanes-Oxley this is imperative that you do things like that. Our folks are on the front line coming up with new products that can get that information from the rig to the back room immediately and they're doing a great job with that.

Our brand folks again coming out with new products at the OTC this year we showed our free flow system. Really having a great response in the north sea with this. We think this is a system of handling cuttings that is probably unparallel with the business and it's this kind of brain power that continues to push our products to the forefront and again these all are tremendous name.

Our mission group has come out with products like our Black Jack and our Safety Lite Liner, and a key that you'll see throughout here as I talk about these products, safety and ease of use. We want to make things safe on the drilling rig for the employees, and we also want to make the drilling rig a better place to work for the employees. And you're going to hear that from me continually here as I talk about some of these products, but our Black Jack makes the changing out of expendables on a mud pump extremely easy our Safety Light Liner is saving on back wear and tear and those are important things as you take a look at what is going on on a drilling rig.

Our down hole tools group is coming out with new products, we now have a two speed motor, which is pretty well unprecedented in this business, our--our sealed bearing motors really have a much better operating efficiency than almost anybody in the business, and our asset management program where we actually take over the assets of our customers are really resonating throughout the business and leading to increased sales, and I think as Clay pointed out, that's why you see such great numbers out of this PS&S group.

Finally in our fiberglass pipe and I think this is a great group to take a look at because we have--when you talk about capacity at National Oilwell Varco, it's not a static number, it's a dynamic number. And our fiberglass pipe people are a prime example through brain power they have been able to increase the through put in their plants with a deminimus investment. Sure, we might want to build some new plants, but at the same time we're increasing the through put of our existing plants to be able to take advantage of what we have and be able to produce more product for our customers. Our fiberglass pipe folks are doing a great job of that.

Our quality tubing it's really kind of the same thing. While Clay mentioned we're adding a new plant and through brain power out there, they actually looked at the new plant and with a very diminimus investment we were able to actually increase before the plant even started running what we thought the through put in that plant was going to become.

The quality tubing folks are really producing today a lot of the coil tubing that's being used throughout the world in a much greater fashion than it has been in the past few years so you can kind of see as I run down those names they are tremendous names a lot of new products and they are all quality names and I think that's really been the lynch pin of what we have been doing in our PS&S group.

What I would like to do now is move to our rig technology group this is kind of where there's a lot of sizzle on the steak, an awful lot of the--just about all of the backlog is with this group, and again, this kind of comes back to the brain power aspect of how can you increase capacity. It's a lot about the process, our coil tubing group up at Fort Worth kind of said here is our capacity we can't do more than this and low and behold every quarter they do more. And they do more because they are smart, they utilize the--they look at the processes they have, and they move more things through.

The coil tubing group has really also seen an increase in demand in their product because of things like coal bed methane drilling which really utilizing coil tubing very effectively, they need our components, a lot of the pressure pumping, frak jobs, they need our components on those.

And then we just completed--we talked a little bit about it last quarter and we have a new operation in Belarus in Minx, Belarus which is actually producing western style equipment for the--for the Russian market on these products, and I think this is going to be a real success. I visited over there earlier this quarter and came away very impressed with what we're doing.

In our actual rigs solutions group this is really where we're making the drilling rigs and we're really having again a lot of success with the new products that we're talking about. Iron rough beds, AC top drives you are talking about better and better small work over rigs that are electronically controlled.

We're really kind of on the leading edge, these are all safe they are making the rigs much more efficient and they're really producing an awful lot for us in the business arena. A lot of what we are selling today are components. When you take a look at the United States rig count today 1,600 plus those rigs all need some stuff to make them more efficient and we have the components to be able to do that.

Again, the iron roughnecks that's one of the best pieces of equipment we have out there. It makes life on the rig easier and safer. A lot like I talked about on some of the mission products earlier, the rapid rig that we introduced at the OTC and actually sold at the OTC, which was a first, it actually can reduce the number of people that it takes to run the rig, and the rig will run in a much safer fashion.

That's really been the push for us as we take a look at what we're doing operationally it's all about new products, it's all about quality and it's about taking care of our customers and increasing our capacity through brain power, through process improvements, and I think we have been showing that for quarter to quarter and will continue to do that as we push through the future.

What I would like to do now is just take you through a little bit of a geographic tour and talk a little bit about what's going on around the world and then I'll open it up for questions. Clearly one of the best places in the world, and this should come as no surprise to anybody, is the Middle East. he Saudis continue to increase their rig count they continue to need more-- more and more equipment.

The Kuwaitis have come on recently and they are probably one of the hotter deals going right now, I think the Kuwaitis, much like the Saudis are drilling different types of wells and they want to improve the type of equipment they have. The neat thing for us when you build a big drilling rig that the Kuwaitis need that can move rapidly with the tires and everything necessary is about a $30 million job.

So we think there are going to be some great opportunities on that, and I'll move through this fairly quickly we've got Algeria, which I think will probably be the hottest spot in North Africa. They want to have new rigs to enhance their capability of drilling again much like every place throughout the Middle East a different type of drilling.

In Oman we see some tremendous opportunities for smaller rigs that are going to be working there to enhance their productive capacity. But interestingly enough what we're also seeing in the Middle East today are tremendous manufacturing opportunities. A couple of new shipyards have come on line.

Those shipyards are going to be building some jack-up rigs for use in the Persian Gulf. The Persian Gulf is going to become one of the hottest spots. You see a lot of the drilling contractors whether it's Global Santa Fe or Rowan that are moving their rigs there, and we're going to be there to support them but they are also going to be building some rigs there, which really has helped us build our backlog and gives us a tremendous area in which to do that.

Second hot area as always is Russia, of course Putin is now saying that Russia wants to become the OPEC of natural gas, I'll let you decide whether that's good or bad. On the business side they clearly need western equipment. There's a debate about whether or not they want to have western investment but clearly they need the western equipment to come in so that they drill the wells that they are going to do need to drill.

You see the Stockman field which has slowed up a little bit because of political reasons, but at the same time they have got to push ahead, I think some equipment is going to be needed in there very shortly and we think Russia is probably as you look maybe not the most immediate market, but it clearly is going to be very much of a positive market over the next decade. It's-- it's a tremendous market. You have heard me talk about it before, the potential of the market is incredible.

The Caspian Sea continues to expand, BP has had some great success there. I think in both (inaudible) you are going to see a continued investment in added drilling equipment and building different production facilities that they need and then also as--I think in the Ukraine and a lot of the Stans, some of these guys are really going to start drilling much more and they need equipment because they don't necessarily want to be beholden to Russia to get all of their natural gas.

The north sea I think continues to be a very good place for us. The Norwegian outer continental shelf, but I'd also like to make one comment here, our Norwegian operations have done a phenomenal job in getting business. Our operations in both (inaudible) have played an integral part in the building of this backlog that we talked about earlier.

They have done a fantastic job up there. We make great products and really some of the best things that we have done over the years when we expanded this company and merged, I think bringing in some Norwegian companies has really been positive, and we're starting to see the real impact of that, but I think there will be some good activity on the outer continental shelf of Norway and you're starting to see some more platform activity in the north sea and clearly refurbishments.

China, again, kind of a two-fold story. Not only is a great manufacturing base for us, we now have six facilities there. It's also a great market for our western products. To give you an example, historically we have sold over 100 Top Drives into China. The demand for even more Top Drives to go in there is very positive.

I think the thing to keep an eye on in China for the future is you're going to start to see a fairly good offshore movement there. I think the south China sea is going to need a lot more rigs I think there are going to be platforms there and I think it's going to become a much greater market than it is today. I think you're also going to see some of the chinese shipyards switching over to FPSO, so that's, again, a very attractive area for us.

Korea, many of the floaters that we're building today. We're going to be working with the Koreans whether it's Daewoo, Hyundai, or Samsung, and we're expanding our operations in Korea very dramatically. In the Asia-Pacific clearly it's, again it's a Singaporean deal, and if you're going to have a quality jack-up, Singapore is a great place to get it.

I think the PPL yards people like that down there are doing a great job, and I think you are going to continue to see a demand for jack-ups as we go into the future also it's a very good refurbishment market. There's many rigs that are coming in through there to either--floaters to become much bigger or to be able to handle deeper water or jack-ups that just need to have more equipment or better equipment put on them.

The South American and Mexico market, really you're talking there predominately it's Brazil and the deep water market that's very attractive. Mexico we continue to see a lot of activity in the--in the Mexican Gulf of Mexico and there's also some enhanced land activity. So we think both of those areas continue to be--be very positive and finally I'll just talk for a moment about North America.

Again, clearly a gas issue. I think we're taking a look at what is going to happen there, and clearly we try to keep our finger on the pulse of what is going on and the neat thing for us is with our distribution businesses and our day-to-day businesses Tube-O-Scope and the like, we're able to know when rigs are going up and rigs are going down and quite frankly today it's still a very positive market.

Also I think one thing to note here is many of the new rigs that are going into that market today are really not additive as much as they're going to be ultimately replacement rigs. So I think efficiency is the driver in the North American market, you've got to have very efficient rigs, if you don't you are not going to keep those rigs working. The best rig always wins, and the best rig is most efficient.

As I mentioned earlier if you are charging $25,000 a day for the rig, the rig better be drilling very effectively. Finally on the backlog as we mentioned earlier it's 4.1 billion, just to give you a couple of numbers around that, that's 24% land and 76% offshore. Domestically that's 27% of the backlog and international that's 73% of the backlog.

So that gives you, I think a fairly good flavor as you can see it's very heavily oriented to the offshore arena which is much more of a longer term arena and it's heavily oriented to the international arena which is again very much of an oil arena. Also on a basis of our customer split, the top seven customers make up about 48% of the backlog, so you can see it's a pretty wide ranging backlog there's not any one customer that has got 20% or 30% of it and so it's very wide ranging, very disparate and we think one that is very indicative of the National Oilwell products and services.

Finally what I would like to do is again for the employees listening in I would like to thank the men and women of this company for doing such a fantastic job over the past year of bringing Varco and National Oilwell together. There has been a lot of heavy lifting, there's been a lot of sacrifice, there's been a lot of dedication and I greatly appreciate as does Clay the efforts put forth by everybody to make this the Company that we are today. So having said that, I would like to turn it over for any questions that our listeners might have.

[OPERATOR INSTRUCTIONS]

Our first question comes from Marshall Atkins with Raymond James, please go ahead.

Hey, guys, that was an excellent overview of a very good quarter. Let me drill down if I may on the offshore rigs that are scheduled to come on line over the next five years or so.

We have got roughly 60 jack-ups, roughly 30 floaters, two things can you give me some sense of your market share in the packages that have been awarded? And secondly, how many of those rigs have had the drilling packages awarded?

Marshall, we--I think we get the market share question every time and I defer every time.

Well we got to try every time.

We-- we get our fair share. I tell everybody-- and I-- and I stand by this, that there's not a rig built in the western world that doesn't have something on it from us. But we're doing very well.

I would say this on the jack-ups the majority of the jack-ups that you have talked about there have probably already have their equipment ordered. There's a few still left but the majority of the number--if you are using the 60 number they've had the equipment ordered.

On the 30 floaters there's still a lot of that to be ordered. We've got some of the numbers, but again, because I think some numbers differ, we don't want to talk a lot of times publicly about numbers, but ours might differ a little bit from yours, but I think there's still a lot of pizzazz to be had there in the floater market.

So maybe 1/3 has been ordered or would it be more like 2/3?

I would say north of 50%, but probably not quite to 2/3. But I'd also like to make one other point on the jack-ups while a lot of that has been ordered we also are believers that you'll continue to see the jack-up market be a good market well into the next decade.

We're starting to see some things there and I'm on record of having said this a few times that we think 10 to 15 jack-ups a year being ordered in the foreseeable future is pretty standard.

All right. Second--second question, Clay this is a quick one. Obviously your foreign exchange you took a pretty big hit on that, it looks like you would have blown away the number even bigger if you didn't have that. I know this is probably impossible to give-- any guidance there? Can you give us any--any kind of expectation on what we are ought to do modeling wise on the FX stuff.

Well, with regards to how rates are going to move, obviously not. What I will tell you, Marshall is that we--like a lot of other oil field service companies are generally long the dollar.

We operate in an industry that tends to transact in dollars. We have a lot of foreign location where we have costs in foreign currencies and so there's sort of a natural mis-match. What we saw this quarter was the dollar weaken against the major currencies about 4% or 5%, and our largest exposure is to the British pound and that was about 2.5 million of the FX move for us this period.

The euro was the next biggest piece and then the croner and a few others that sort of all added up to our exposure this quarter. One of the things that we're doing is rationalizing our legal entities around the world.

And kind of merging National and Varco, the legal entities involved there, and following that we'll end up with a little different mix of functional currencies and clean up some inner company balances that will minimize our exposure. What happened in this past quarter, the rates moved before we really had that process done. I think we'll be in a lot better shape, two, three, four quarters from now.

Great. That's very helpful thanks again, guys.

Thanks, Marshall.

Our next question comes from Scott Gill with Simmons and Company, please go ahead.

Good morning.

Good morning, Scott.

First, for you Clay you may have gone through this so I apologize. Within PS&S, can you give us the eastern hemisphere sequential growth rate Q2 versus Q1? What drove the growth and if you could contrast just in general eastern hemisphere margins versus North American margins in PS&S?

Sequential growth rate for PS&S was a little more than 10%. Scott?

Eastern hemisphere.

Yeah, that would include--this is international so it includes South America. But--in other words eastern hemisphere plus South America was up about 10% but I think all of that growth came out of the eastern hemisphere so South America was fairly flat sequentially.

What-- what drove that in particular and then if you could contrast those margins to eastern hemisphere versus North America, please?

I don't have a split out of margins that are on that basis in front of me here. It really varies more by product line growth, but as Pete mentioned the strong demand and results in the Middle East, North Africa, Far East in particular good results out of the North Sea region kind-- kind of lead the way and Latin America was, again, a little flattish.

I think there -- we had some issues in South America for the past couple of quarters. You know you have had elections in Mexico which tends to slow things down little bit. There was a strike in Argentina. You've had Ecuador, Bolivia and Venezuela all make nationalization moves that have chilled activity down there a little bit. Most of the-- most of the international growth we're seeing is eastern hemisphere currently.

Okay. And then for you, Pete, you talked a little bit about the U.S. land rig business. You probably have better visibility into the industry's ability to supply that market. Can you just provide some sort of guidance for folks like us as to what the potential net capacity additions really are for the U.S. landmark? How many rigs are actually possible to be added to this market on a-- say a per quarter basis?

Yes, Scott there lot of numbers bouncing around out there, I think in particular, I've seen one recently that they're going to be an additive of 400 rigs over the next year. That's a tough number to quantify, but that's also we think probably 400 is not what is going to happen.

I think there are a couple of dynamics here that people probably aren't giving enough credit to and the first one is that not every rig coming out is additive. I talk an awful lot about efficiency and I'll just anecdotally tell you I'm on the board of directors of a little ENP company, we're not little, but an ENP company and we were talking about it the other day, and they basically had an older rig that was drilling some wells for them and they replaced that with one of the newer highly efficient rigs that had a lot of the equipment, and the types of things we're talking about on it and it knocked like five days off of a 20-day well.

Pretty darn substantial, and I think you are starting to see the operators demand more and more out of these rigs, so we believe what you are probably going to see are an infusion of rigs and at the same time you'll see an exit of a few of the lower rigs on the lower wrung and while some of those rigs maybe working today I think as rigs get laid down those will leave the system and probably won't work much anymore after that.

So, it'ss a tough number. I don't think the industry worldwide can provide 400 rigs, I don't think the industry in the United States can absorb 400 rigs. 400 rigs is a lot of people.

You have a lot of things that have to be done, drillers and tool pushers and superintendents that are all very highly skilled positions, they're going to have to be there, so I'm a little skeptical that the industry can bring that many in. I'm also-- you hear a lot of numbers bandied about and you hear different places around the world that can produce those rigs and we're fairly skeptical of that also.

Thanks, Scott.

Our next question comes from [Daniel Unreiss] with Goldman Sachs, please go ahead.

Good morning.

Good morning, Daniel.

My question is about the pricing environment for offshore rigs in your rig technology division. We are seeing some headline numbers that are sometimes even above what you said you would normally get for those rigs is that pricing-- could you give us an update on that?

Yeah, it's certainly getting a lot better as we've said before really not a lot of opportunities to move price in 2005 orders were beginning to flow in, beginning kind of Q2 of '05 for jack-ups and then late in the year we saw the surge in demand for floaters and we also kind of got the merger squared away, but--but really the economics on building new rigs dictate our ability to raise pricing more than anything and that's what improved in late '05 as leading edge day rates moved up, Daniel.

Starting in Q4 of '05 I think we began to get meaningful moves in pricing, and that sort of continued through Q1 and Q2, and they are going up a lot. I'm going to stop short of quantifying them for you. But I'll also add along with everybody else in this industry, we have seen a lot of inflationary forces in our business.

Steel this year is probably up another 5% to 10% between structural steel and castings and forgings. We're paying a little more for direct labor, and other inputs. So I think some of the margin expansion that we would otherwise expect to see given the price increase is getting undercut a little bit by inflationary forces.

How should we think about the margins that you are booking now with the pricing you just described versus the 16% or 17% guidance you had versus the third quarter? How much more upside do we have?

The margins are substantially better.

So when you talk about the 22% incrementals longer term, you should be able to do much better than that in the next-- through '07 at least?

Well, I--I think we're talking about one segment of our business here, which is the offshore area. I think what we're seeing is probably margins coming out of the offshore sales start to get-- look a little better than what we get on the land side.

Land side there's a lot more pass throughs, and that has a lot to do with the actual incrementals that we post. When I reference pass throughs what I'm talking about are engines and compressors and drill pipe and the things that a lot of times we buy from others and turn around and include in a rig package and our ability to mark that up is--is limited and sometimes is zero.

And so that certainly has an impact. The mix of what we call structural iron also affects the--the flow through so to the extent we're selling dericks and substructures and masts, which are much lower margin portions of what we offer, that can also drag down our--our overall incrementals. Where we do the best are the drilling machinery and the packages that we're selling now tend to be pretty long on drilling machinery.

Got it. In terms of revenues I think--did I hear you right did you say high single digit revenue increase sequential in rig technology?

That's our latest look at it. That's for Q3. Okay.

Great. Thank you.

Thank you Daniel.

Our next question comes from Ken Sill of Credit Suisse, please go ahead.

Yeah, good morning, guys.

Morning. Ken.

I want to dig into the margin question a little more, so obviously the backlog is better. You had a 200 basis point sequential improvement, you're forecasting another 100 basis points in Q3.

When you went through this exercise back at Varco, Clay, I seem to remember you guys ended up at about 20% gross margins in rig equipment and with incrementals at 22 is that-- is kind of 100 basis Q3 and maybe more in Q4 and slowing down but rising margins through '07 reasonable expectations for us?

Yeah I'm going to really limit the guidance to just the next quarter or two, Ken.

Yeah.

And that's kind of how-- how we see it playing out that the margins continue--should continue to move up as we see better priced backlog flow out, and reap the benefits of all the efficiency moves that have been made in business over the past year.

And then looking at the pricing we've been doing some work looking at steel costs which are kind of flattish but you are saying inflation and forging and casting, is there any--other than material and steel is there another big item of inflation that could lower the margins or is there a lot of specialty steel in what you guys manufacture, because my understanding was nickel and it's gone through the roof.

Yeah, alloys have moved more than regular carbon steel. We have seen structural steel move up 5% to 8% through the first half of the year. Some of the alloys we buy are more like 8% to 10%, but in perspective. But all of our inputs are moving around a little bit.

Recently, for instance, the--the resin that we buy for our fiber glass pipe began to move up and in fact in Q2 our cost rose for pipe just a little bit. And the other big input we have into everything that we do are people and people in the oil field continue be tight, although again, I want to stress the labor pool we draw from is probably a little broader than some of our customers. Finding a welder in this day and age is easier than finding a driller.

But clearly the margin expansion is more than offsetting--the pricing is more than offsetting the cost?

Right, and that's why we expect to see continued margin expansions.

Okay. Great quarter. Thanks.

Thanks, Ken.

Our next question comes from Michael Lamotte with J.P. Morgan, please go ahead.

Great quarter, guys.

Thanks, Michael.

Pete, if I could ask you to expand upon your activities in China a little bit, you mentioned 6 facilities, but with the mix of business shifting offshore with expansion in TDM and the west going on there are you doing more than masts and subs and sort of the heavy metal stuff in China?

Yeah we--we actually right now, Michael are--are able to produce almost complete rigs and as you look at an example probably the only thing we're not doing in China today is the top drive.

We're doing the iron roughnecks, vast substructures, mud pumps, draw works, we're doing the electronics now we're expanding into just about everything over there that we can do and as you take at look at some of the things in the south China sea as an example, they'll still be some of the probably more technically advanced things done here, but we'll do an awful lot more of that in China, and that's the goal.

Our goal--we worked in China now to make sure that we got the quality up to speed, but also to maker sure that we had the design up to speed because I think that's critical when you think about China, it's not only a manufacturing place, but you have to make sure you have the design right.

Some of the facilities over there don't design it the same way that we do here, we're able to design here, design in our Shanghai office to get the right things produced. So I think you'll see us continue to make more and more over there. And ultimately move some of the products that we're not quite as protective of on intellectual property over in that direction.

What is the mix of sales in China versus for export that you are manufacturing?

We predominately manufacture for export out of that market. We continue to sell a little bit into the domestic market but it's probably 75% to 80% for export.

Okay. Quick question for you, Clay, of the 11 million in operating income that was due to the Canada seasonal slow down in Q2.

Uh-huh.

How much of that comes back in Q3?

Oh, probably half.

Great. Thanks, guys.

You bet.

Gentlemen we have time for one final questions Robin Shoemaker with Bear Stearns, please go ahead.

Thank you. Pete, I was intrigued with what you had to say about Norway and I guess that's principally hydro lift and high-tech and what are their principal products that are doing particularly well in this rig building cycle for those companies?

I think when you talk about there, they're kind of both a little different, but in high tech as an example, when we bought that back in the late 90s, early 2000, Robin, that was really a controls issue.

We have our cyber based system we do an awful lot with controls and we are able to tie all of the equipment together and be able to do some fairly unique things with it by being able to tie it together.

With hydrolift conversely it was much more of an equipment type purchase, where we have an awful lot of tremendous, they've got a great top drive as an example that we still build.

Iron roughnecks probably the best cranes going, when you take a look at we actually have active heave offshore cranes, we have a knuckle boom crane that we manufacture through our hydrolift operation that really is almost a crane of choice on most of these large drilling rigs.

We do an awful lot with Reiser handling systems, Reiser tensioner systems, so they brought an awful lot of arrows to the quiver that we didn't have before.

Right. Okay. And on the mud pumps is the hex pump now kind of standard for new rigs or are people still ordering conventional mud pumps to go on new jack-ups and deep water rigs and kind of--what is the split there if you have a general idea?

I don't have the exact split but, Robin, there's still traditional mud pumps are a very big part of what we're doing, but the hex pump is also a very big part of what we're doing and especially for instance when you look on some these new floaters, a lot of these are going out with the hex pumps.

I wouldn't say it's a 50/50 split, I think one thing about this industry is sometimes we're very slow to accept some of the newer products until somebody else proves them out, but I think when you are spending $600 million on a drill shift, you want to make sure you have got the absolute top of the line, and I think the hex pump is there.

But we're very pleased with the hex pump as with any new product that has a couple of challenges, predominately, I think the extendable light isn't quite what we'd like it to be. We're doing a lot of work on that, and we'll get that up to speed very shortly. So it's been--I think it has been well received, but has it been received 100%, not yet.

Uh-huh. Okay. And just finally on technology, the rapid rig and the ideal rig in--you updated us on the rapid rig, what--what's the progress of the ideal rig and how many have you sold of those?

It's been outstanding. I think we're well into the 30s.

Yeah I don't have the exact--

I don't have the exact number, Robin, but I think it's 30 plus that we've already sold of those that are on order or delivered at this point in time, and I would expect that number to continue to increase pretty dramatically as we go to the future, and that's really just--that's not the only number of land rigs that we've sold that's just specifically the ideal rig which we sell in a package we don't component that out we basically say here is the ideal rig you get it and we're 30 plus with I believe a lot more to come in the future.

Right. Okay. Thank you.

Thanks robin.

This does conclude our question and answer session. Gentlemen, please continue with any closing comments you may have.

We appreciate everybody's interest and we look forward to talking to you at the end of the third quarter. Thank you very much.

Ladies and gentlemen, this does conclude the National Oilwell Varco second quarter earnings conference call you may now disconnect and thank you for using AT&T teleconferencing.