國民油井華高 (NOV) 2007 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the National Oilwell Varco first quarter earnings conference call. (OPERATOR INSTRUCTIONS) This conference is being recorded today, Friday, April 27, of 2007.

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

Thanks. And good morning, to everyone. Welcome to the National Oilwell Varco first quarter 2007 earnings conference call. I'm Pete Miller and with me today is our Chief Financial Officer, Clay Williams. Earlier today we issued a press release that announced a net income of $275.9 million, or $1.55 per share on revenues of $2.17 billion. This compares to a net income of $120 million or $0.68 a share in the first quarter of 2006 on revenues of approximately $1.5 billion.

Additionally, we also announced today a quarter ending backlog of $6.4 billion. This is an increase of $400 million from the 31st of December, 2006, backlog. New orders taken in the quarter totaled approximately $1.2 billion. This is the fifth quarter in a row that our new orders have exceeded $1 billion. We are very, very pleased with these results. We think they continue to show the ability of this company to execute, the demand for the high technology and high-quality products that we have and then more importantly, the continuing exuberance of the worldwide oilfield market. We're very excited about the future and I think we'll indicate that to you a little bit today on the call. At this time I'm going to turn the call over to Clay to give you a little bit more color on the quarter, and then he'll send it back to me and I'll talk a little bit about some of the drivers that is we believe are going to continue in this business over the next few years and then we'll open it up for Q&A. Clay?

Thanks, Pete. Before we begin this discussion of National Oilwell Varco's financial results for the first quarter ended March 31, 2007, 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 base on limited information as of today, which is subject to change. These 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 to you the latest form 10-K National Oilwell Varco has on file with the Securities and Exchange Commission for a more detailed discussion of some of the risk factors affecting our business.

Further information regarding these as well as supplemental financial and operating information related to our business may be found within our press release on our website at www.nov.com, or in our filing 's with the SEC. Later on this call, Pete and I will be answering your questions. We ask that you limit your questions to two in order to permit more participation.

National Oilwell Varco generated earnings of $275.9 million or $1.55 for fully diluted share in its first quarter ended March 31, 2007 on revenues of $2.2 billion. Earnings were up 15% sequentially and up 128% from the first quarter of 2006. NOV's first quarter revenues improved 4% sequentially and 43% year-over-year. Operating profit was $427.1 million, or 19.7% of sales, an increase of 12% sequentially and an increase of 116% year over year. Flow-through or operating leverage was 53% sequentially and 35% year-over-year. All three of our business segments posted higher revenue, higher operating profit, and higher operating margins compared to the first quarter of 2006 and two of our three segments posted higher revenue, operating profit, and operating margins compared to the fourth quarter of 2006.

We got off to a good start in 2007. The world's oil and gas industry needs the critical technologies and services that NOV provides and we are proud to contribute to such a vibrant, innovative industry, the widespread use of petroleum has done much to lift the standard of living of mankind since the late 19th century when life expectancies were a fraction of what they are today and when most spent their waking hours pursuing agricultural activities far different than what most of us do today. Before petroleum, overnight intercontinental travel was unthinkable and widespread communications limited. Modern medicine simply did not exist, safe, clean, reliable drinking water and modern sanitation was a luxury and retirement from ones vocation was unthinkable for almost everyone. Even dramatic improvements in agricultural productivity owe much to diesel-powered tractors and combines. The centuries since have seen an astonishing improvement in the human condition around the globe, and not coincidentally the blossoming of the oil business exactly corresponds to this phenomenal improvement in standards of living.

Today, most modern conveniences from air travel to the Internet are powered by and enabled by petroleum. Far too few stop to reflect on all that petroleum has given us. The reliable sources of oil and gas that we all enjoy today have been possible only through the sustained and tenacious application of newer, faster, more efficient methods to find and produce oil and gas and we are proud of the job our customers do as they pioneer better and safer ways to find and produce hydrocarbons. This industry is about innovation.

While many point to adverse environmental affects of oil and gas production, NOV and others engaged in this effort work hard every day to reduce the environmental impact of the industry and the collective innovation of our organization, our customers and our competitors have made real differences. For example, Pete and I are proud to report that NOV is a leading provider of waste management services to drilling operations within our petroleum services and supply segment. We're the largest provider of thermal desorption services to treat and recycle drilling fluids worldwide. We use highly engineered devices to heat contaminated drill cuttings to flash out the hydrocarbons which are then condensed and captured for reuse. Drill cutting slurries are transformed into inert rock for safe disposal. We have pioneered drill cuttings transport systems, too, to enable operators to convey their cuttings to our efficient thermal plants. In certain areas, we can actually grind drill cuttings into a fine slurry and then reinject these back into the very same wells from which they came, permanently disposing of them. As a result of the technology now available, many areas around the world have completely eliminated offshore discharge or drill cuttings.

The inspection technologies pioneered by our Tuboscope group also within petroleum services and supplies have permitted tremendous improvements in the detection and repair of leaks throughout the the world's pipeline and flow-line infrastructure, reducing unplanned discharges of petroleum products and their environmental impact. NOV is also the leading provider of fiberglass and composite pipe to the oilfield providing elegantly engineered solutions to the challenge of transporting corrosive fluids, sometimes encountered in the oilfields. VO2 is pumped through our fiberglass pipe to be injected into old oilfields to increase recovery of oil through missable floods. If you filled up your car at the gasoline station this week, odds are that NOV manufactured dual containment composite pipe carried your gasoline from the underground tank to the pump. NOV has played a major role in replumbing many old gas stations over the past several years to reduce the possibility of contaminating groundwater with gasoline.

NOV has been instrumental in the introduction of dozens of new technologies to minimize the impact of oil and gas operations on the environment and our employees continue to execute our mission well for the benefit of our customers. We continue to deliver newer, safer, faster equipment to retool an industry which saw little new capital flow in during the last 25 years and we are pleased to report that the new rigs we are building continued to go to work on time, on budget. This new technology is much better than the old, for example, our new safety light liner system for mudpumps weighs only 40-pounds compared to 240-pounds for conventional liners. It's just a lot easier for crews to replace this wear part.

Our Blak-JAK wash pipe packing system is packed on the floor, not 40 feet in the air, it's 25% lighter and it's changed out far more quickly and safely than conventional washpipe packing. Our downhole drilling motors can be shifted between high speed and low speed without several hours of tripping the bottom hole assembly. Simply cycle the pumps to shift between high speed and low speed. Our automatic drillers continuously adjust the weight on bit and torque to optimize the drilling process and our rig instrumentation and self-aligning satellite systems transmit everything from e-mails to drilling performance to payroll data from the rig to the home office.

NOV's contributions to improving the drilling process through rig machinery are well known. Our new land rigs have a much smaller footprint and move in far fewer truckloads to get to TD and move off location much more quickly than rigs of the past, all reducing their environmental impact. Tour a new modern rig and chances are you will see a tightly choreographed highly automated process a supply sophisticated robotics technologies and electronic controls to the process of drilling. Tour a new, modern rig and chances are you will see a tightly choreographed, highly automated process, apply sophisticated robotics technologies, and electronic controls to the process of drilling. The essence of drilling is transporting and assembling big, heavy pipe into an instrument to precisely target geologic objectives miles underground.

From iron roughnecks to top drives, to motion compensation systems, NOV has been a clear leader in pioneering better ways to drill. It's an important mission. Many around the globe long for improved standards of living which drives growing demand for petroleum products and the conveniences they promise. Safe, reliable transportation, improved sanitation, reliable power. Many investors, particularly those unfamiliar with the intricacies and challenges of drilling for oil and gas, are bewildered by the breadth of products that NOV offers. We have thousands of products targeting improving the efficiency of oil and gas operations. We have many, many patents and drawings and trade secrets and know-how embedded in these, but let me simplify it for you. Ours is a company of thinkers. We work closely with our customers to drive improvement in all that we do.

Clearly, our most valued resource in the execution of our mission are our 28,000 employees. They are great. They have mission and drive and determination and our strong financial results stem from their good ideas and crisp execution, as I said, this is an industry all about innovation. Business is good. We believe that the flattening of the U.S. rig count over the past several months is temporary and activity must rebound to meet our nation's energy needs.

We believe the Rocky Mountains will see an increase in activity soon as winter weather has passed and seasonal regulatory bans on drilling in certain regions are lifted. We expect rigs to go back to work. The Gulf of Mexico and Canada remain weak, and the Canadian breakup started early year, but sustained high gas prices should set this region up for a strong back half of 2007 and a solid 2008. Latin American activity continues to move up, particularly in Brazil and Argentine. The Middle East and North Africa remain very busy, as do the Far East and the North Sea.

We believe an important tipping point was reached in North America last year. It is now spreading worldwide. After 25 years of drilling with 1970s technology, several large progressive operators have discovered the benefits of newer, more efficient rigs. There is emerging a clear preference for modern equipment. Older rigs are being replaced in in the marketplace by these new rigs and as a result, our backlog of drilling equipment has doubled from $3.2 billion a year ago to $6.4 billion today. It grew 6% in the first quarter, despite a general softening of rig day rates in several markets. The rationale for purchasing decisions, for these purchasing decisions is actually quite simple. Newer rigs earn higher day rates and attract the most experienced crews. The best crews with the best tools will do the best job. Operators are noticing and this trend is not about to reverse.

Let me turn now to our operating results, I'll start by noting that we have presented our historical segment results for all quarters of 2006 with stock-based compensation expenses allocated to this segment, which is a slightly different format than we presented in the past. You'll find the new segment results schedule included in the press release and on our website. My comments on the segments will refer to results inclusive of stock-based compensation expenses for all periods.

Revenues for our rig technology segment were $1.220 billion for the first quarter up 7% from the fourth quarter of 2006 and up 71% from the first quarter of 2006. Operating profit was $269 million or 22% of revenue. The group generated sequential flow through of 52% and year-over-year flow-through of 335%, our rig technology segment is performing very, very well. And several strategic initiatives are contributing to its strong financial results. In addition to improved pricing, the group is benefiting from several efficiencies coming out of a lot of heavy lifting accomplished in 2005 and 2006.

NOV rearranged its manufacturing footprint to better load its plants and launched lean manufacturing and cellular manufacturing techniques in several locations. The group has worked closely with its suppliers to manage costs of execution up to and including shouldering the load of managing production in plants owned by our valued suppliers. Higher production volumes permit greater overhead absorption and operating leverage. We've also benefited from standardized product mix and rig designs. These have greatly improved efficiency as well. Building an identical copy of a drilling set significantly reduces the engineering and design costs for us and the risks of delays for our customers.

Our large backlog also permits us to place larger orders with suppliers and gives us all more visibility into the future. The group also benefited from a full quarter's results from Rolligon which we acquired in the fourth quarter. Selective rifle shot investments in new tools and machines have helped, too, but I'll add that we also have just a lot of very dedicated people working hard to take care of our customers. Backlog for the rig technology group increased again this quarter, as we added $1.2 billion in new orders, down about 7% from the fourth quarter, excluding order additions of $133 million in Q4 that came in with the Rolligon acquisition.

The mix of our backlog was approximately 28% land and 72% offshore and 82% international and 18% domestic at March 31. Our scheduled revenue out of backlog on the books totaled about $2.5 billion for the remainder of 2007, $2.1 billion for 2008, and $1.7 billion thereafter. Floatation activity remains brisk, mostly in international markets, including several potential offshore drilling rigs being considered, platform rig upgrade activity in the North Sea and land and offshore rigs for the Middle East, North Africa, India, China, Russia and the Caspian regions. Bidding activity for North American land rigs has softened slightly as expected but interest for land rigs in several major international markets appears to be building. Interest in new offshore rig construction projects remains high with several new shipyards bidding new hauls to various bidding contractors. We are pleased with our performance on the 11 jackups that had been commissioned and execution of our projects continues to be good. As a result of our improving throughput for manufacturing quoted deliveries on drilling components have remained roughly level since last summer. Looking forward to the second quarter of 2007 we expect to see rig technology post another strong quarter in Q2, up slightly in both revenues and margin.

Turning to our petroleum services and supply segment, once again the group posted record revenues and strong margins. Revenues were 692 million, up 3% from the fourth quarter and up 28% from the first quarter of 2006. Operating profit was 171 million or 24.7% of sales. Up slightly from Q4 and up 340 basis points from Q1 of last year. Operating profit flow-through was 34% from the fourth quarter and 37% from the first quarter of 2006.

The full quarter results from NQL and strong domestic sales contributed to the top-line growth offsetting lower seasonal results from pile line. Pipe inspection services in the Eastern hemisphere and the U.S. moved up sharply despite continued destocking of domestic distributors OCTG inventories through Q1 demand continued to rise for pipe coating services and hard banding of drill pipe. Sales of coil tubing, fiberglass pipe, fluid and modules, drilling expendables, multiplex pumps, and dyes and insets all increased worldwide except Canada where market conditions remained seasonally soft.

(Inaudible) control and rig instrumentation sales were down slightly on weaker Latin American results and lower equipment shipments into international markets but nevertheless, both products posted higher operating profit and margins sequentially. On the cost front, the group benefited from lower fiberglass and resin costs but the relative stability of nickel, copper, and bronze prices of the past few months may be passing as we price for new realms of alloy price increases in Q2. Our Downhole Tools product line is integrating our NQL acquisition smoothly and we're enthusiastic that this acquisition will further cement NOV's leading position at the largest supplier of drilling motors worldwide.

We also announced last week that we acquired the assets of Gammaloy and Marlex which rent nonmagnetic drill collars and other Downhole Tools used within the bottom hole assembly and provide manufacturing and support services for various Downhole Tools requiring high precision machining. This acquisition complements our existing offering of Downhole Tools, and positions us to provide a more complete solution to our directional drilling customers. We rent and buy both our motors as well as nonmagnetic drill strength components offered by Gammaloy. We expect to expand the Gammaloy and Marlex product line globally through our extensive international infrastructure, including our new Downhole Tools facility we expect to open in Dubai later this year.

Business remains good and we expect the petroleum services and supply segment to post modest top line improvement but slightly lower margins in Q2, the segment derived about is 11% of its first quarter sales from Canada. Last year, our Canadian service businesses declined about $11 million in operating profit from the first quarter to the second in a very active recount market back then. And of course this decline was due to breakup. The decline this year due to breakup is likely to be more pronounced given that we're midway through a breakup that is the toughest we've seen in several years. However, we continue to see building momentum and single digit price increases in international markets, which we believe will offset the Canadian declines.

Turning to our distribution services segment. Sales softened sequentially after record results in the fourth quarter, revenues were $351.9 million down about 5% sequentially, but up about 8% from Q1 last year. Operating profit was $24.9 million and margins were 7.1% after stock-based compensation charges which impacted margins by about 20 basis points. Operating profit decramental flowthrough was 19% sequentially and incremental flow-through's were 18% from the prior year quarter. The business struggled in the first quarter with difficult market conditions in Canada which accounted for about 20% of its Q1 revenues. One of our large alliance partner customers significantly reduced its Canadian activity in Q1 and we also saw general softening elsewhere in the market, but we responded quickly by closing or rationalizing several stores and cutting costs thereby maintaining good margins in Q1.

U.S. posted solid results led by the Rocky Mountain and Gulf Coast areas. Three new stores were opened in the U.S. during the quarter and the group continues to pursue new alliance agreement's with new partners which contributed to the strong results. International distribution saw strong growth in the North Sea, but flowthroughs were adversely impacted by startup costs associated with a new alliance agreement. Saudi Arabia also posted strong growth in Q1 and we've opened a new store in Egypt.

Looking into the second quarter, we expect revenues to be roughly flat but margins to decline slightly due to the breakup in Canada and to lower expected supply rebates than we saw in Q1. Turning back to National Oilwell Varco's consolidated first quarter income statement, gross margin improved to 28.4% compared to 27.3% in Q4 and 23.1% in Q1 2006. SG&A was roughly flat with Q4, but declined to 8.7% of sales compared to 9% in Q4, 9.5% in Q1 2006. Interest expense and interest income were both up modestly sequentially. The tax rate was 33.4% which is about what we expect for the remainder of the year. Unallocated expenses and eliminations on our supplemental schedule -- supplemental segment schedule were $37.6 million, up $1.3 million sequentially due to higher payroll taxes on incentive compensation paid in Q1 offset by favorable movements and other items.

Turning to the balance sheet, working capital, excluding cash and debt was $1.4 billion at the end of the first quarter, up $88 million from the fourth quarter on 4% higher revenues. Working capital on this basis as a percentage of annualized revenues rose slightly sequentially to 16.6% but is down sharply from the first quarter of 2006, when it was 28% of annualized sales. Billings in excess of cost roughly offset increases in inventory associated with our rising backlog of drilling equipment. Cash flow from operations was $268.4 million in Q1. CapEx was $48 million and we expect CapEx to be about $250 million for the full year. Cash was $1.2 billion at March 31, and debt totaled $846 million. At this point, let me turn it back to Pete for his comments.

Thanks, Clay. I want to make a few brief comments here on some things that I think are going to be the drivers over the next couple of years and one of the reasons that we feel very buoyant about where the market is going. And really I am going to reemphasize a couple of the things that Clay had to say. The big things that are important to us right now are technology and all the increases in technology that are being made in the industry, the changes in the drilling process worldwide, going from a lot of just traditional vertical wells to now extended reach wells to drilling in cities to doing a lot of things like that and then finally, the internationalization of the entire market. We have seen a huge change in who our customers are today, versus who they would have been 10 years ago. And I think that's really had a significant impact in the nature of the entire business.

First let me talk just a moment about technology. Before I forget, I'd like to ask everybody on the phone if you're here during the OTC next week to please stop by our booth. You'll see a lot of really, really interesting new products that we have out there. We're committed to putting a lot of new products and new technology into the field and you'll get a real good sampling of it if you come by next week. But basically, the technology is impacting every sort of rig that's out there. The smallest land rigs, the workover rigs up to the sixth generation deepwater rigs. It's a situation where we're electrifying more rigs, we're controlling more things with computerization, we're making them much safer and we're making them much easier to work on. When you think about some of our best products, our iron roughnecks and top drives, we're starting to introduce a new motor called the permanent magnet motor that allows to us do things with AC technology that have not necessarily been done in the past, we'll have a new draw works, as a matter of fact, at OTC that will really be driven by permanent magnet motors, as well as some mud pumps and I think you'll find them very exciting.

But we are seeing a step change in technology in this industry. And this is really what drives the demand for a lot of our products. Clay pointed out earlier that if you're a drilling contractor today, if you don't have the best rig, you're not necessarily going to get the best rate and clearly, you're not going to get the best people working on the rig. It really matters that the technology is the best. This is not something that is going to change. It's going to continue to be impactful, I believe, over the next two or three years and it really is changing the design today of many drilling rigs, many drill strings and the way we drill wells. Which brings me to the drilling process.

Today, you're starting to see almost a majority of wells being drilled in a horizontal basis. When you start to take a look at the fields like the Barnett shales the Fayetteville shales, they are taking different type of processes to really increase the production they can get out of one well. This really plays well to groups like our Downhole Tools, our quality tubing, M/D Totco, Grant, Tuboscope, because you've got to have the best equipment out there to do it. One example of this is our M/D Totco group, we have over 850 automatic drillers in the field. They're there because you need this automatic driller to have the process necessary to be able to drill these long horizontal extended reach wells. Exxon just completed a well in Sockland Island I think was a world record, 37,000-foot extended reach well. These things are becoming the norm. They're not going to be, they're not going to be in the minority and the equipment that we provide across the board, be it either capital equipment or in our services group, really is what drives the ability to be able to drill wells like this. And then finally, I want to talk just a little bit about the geographic makeup of our customers today.

Clay kind of of took you a little bit around the world. It's really an interesting process for us, because not only are we selling into areas but we're starting to manufacture in a lot of these areas, also. We have large staffs in many of these areas. For instance, one of our centers of excellence on engineering is Norway. We have over 1500 employees in Norway alone and that give us up a leg up, number one on all the business that's done in Norway, we've got tremendous engineering forces there and then thirdly, we're able to manufacture right there and be able to put it into the marketplace in those arenas. And that's just one example. I can take you and give you the examples in China, Russia, the Middle East, where we're doing the same thing. But the internationalization of our customer base gives us a much greater flexibility that have if things do get slow in areas like Canada and North America, that we have got the ability then to switch over and get things done in these other areas which quite frankly, I think are going to be very buoyant.

Just to talk about a few of them in particularly, those of you that have listened to these calls before know that I'm very bullish on Russia. I think Russia will continue to be a fine market. We've sold some land rigs into Russia this particular quarter. I think you'll see some off-shore action in Russia in places like the Bering Sea, but I think the Russian market without a question, the biggest thing that they can export is oil and gas and they need it for their economy and I think you'll see it continuing the expansion of that and we're going to be a player in that particular arena.

Obviously, the Middle East and North Africa are very solid. One of the more interesting things for us in the Middle East is we're seeing a couple of shipyards open up there. We're able to sell drilling equipment packages in there to be placed on jackup rigs so instead of just being a sales area for us, it's now manufacturing and we're seeing a situation where we can actually build the rigs in both the shipyards and in our [Jubilale] facility. North Africa remains very, I think very promising. We delivered some rigs into Algeria this past quarter and we continue to see a demand for those land rigs in those areas.

Norway is absolutely a great place for us. Not only are we able to do a lot of engineering, manufacturing in Norway, but there's a tremendous move on the continental shelf in Norway to be able to put more rigs and a lot of refurbishment of existing platforms there. The Norwegians are very good about wanting the best technology. Many of these platforms are 15, 20 years old, they need new technology on there and we're well positioned to be able to take advantage of that and you're seeing some of that built into the backlog that we currently have.

And then, I couldn't be on a call without talking about China. China remains a very positive place for us. We're doing things in our new Dalian shipyard, we're building some jackups and semisubmersibles there, our Lanzhou facility is still churning out many of our ideal rigs that we're placing around the world. We're doing pipe coating there, we have inspection facilities and we're continuing to expand our fiberglass operations in China and it remains a very, very active center for us.

Finally, I'll talk just a moment about Singapore and Korea. These are areas that are really the nexus of the manufacturing of both jackup rigs, semisubmersibles, and drill ships right now. We're bulking up our offices in Korea as we look to a future into 2010 when we will be delivering many of the semisubmersibles and jackups that are being built there, and then, of course, Clay mentioned Singapore earlier, we were down there at a presentation on the naming of the ENSCO 108 a few weeks ago, and we're very delighted to see everybody could see that the last 11 rigs delivered out of there have been delivered on time, on budget, in particular there was one delivered into Vietnam that was actually two months early. So we think the execution is there. We're seeing a lot of really, really positive things in that regard.

Clay mentioned the backlog. We believe that next quarter, the backlog will grow again. Just as kind of a small note, earlier this week, we signed a $238 million drill ship and so we believe that as we look to the future that we'll see another build of it as we go into the second quarter.

And then finally, I'd like to mention two things that I think are very important to us. Number one, this quarter we'll open up a new 400,000 square foot repair and maintenance and spare part facility. This is going to be in north Houston. We're very excited about what we're going to be able to help our customers with there. We're taking spare parts out of a lot of the manufacturing arena which is best practices to get it out so that we can better take care of our customers and have a state of the art facility to take care of their equipment.

And finally, I'd like to point out that this month, three weeks ago we opened up our Venice, Louisiana, facility again. It was destroyed in Hurricane Katrina 18 months ago and our folks were committed to staying in south Louisiana and opened up the new facility in Venice to show our commitment to both the offshore business there but also, more importantly, to south Louisiana. So we're very, very proud to have those folks get that facility open this past month.

So anyway, that's kind of a quick review of what we're doing. And at this point, I'll turn it over to you, if anybody has any questions.

Thank you. (OPERATOR INSTRUCTIONS) Our first question is from Ken Sill please state your company name followed by your question.

It's Ken Sill, Credit Suisse. And I guess I have to say congratulations.

Thanks, Ken.

Great quarter. Two questions. One, just on an overall basis sequentially, you are going to see a slight improvement in rig technology with the other two segments down. Do you think that that essentially balances out to kind of flat earnings sequentially? Do you think it could actually move up given how strong rig technology has been?

Well, yes, I mean there's a possibility of course that last couple of quarters we've been pleasantly surprised internally with better performance than we expected. And a lot of that's happened in rig. This quarter a lot of the outperformance came in kind of the nonbacklog portion of that business, which jumped up I think 19% to $430 million. A lot of that is repair and service, spare part type work. And we feel pretty good about it. But they operated at a very high level in Q1. But based on kind of what we're seeing internally across all the businesses, the guidance that we gave kind of factors in the expected impacts of the Canadian breakup, which is going to be a big factor this quarter. And just kind of, that's what that, that's based on.

Okay. And then, getting down to the meat of it on drilling technology. 22% margins were very, very strong. Obviously they're going higher. And I'm wondering how much of the margin improvement, you said a lot of it was nonbacklog related. So, how much of the margin improvement related to the price increases we've seen over the last 12 to 18 months is actually starting to show up in the revenue line and how much is left? I mean, just as the backlog monetizes can we see margins continue to move higher for several more quarters or are we getting close to seeing the pricing coming into the backlog in a full way?

Ken, I would say that you're probably, right now we'd probably say it's 50/50 on price increasing and efficiencies. Just to give you kind of a quick anecdote example, last year in the first quarter, we delivered 14 workover units out of our Tampa facility. This quarter we delivered 24. And that was with kind of a small investment, not that many more people, almost no additional management. And so those type of efficiencies are really starting to manifest themselves into our numbers. We believe you'll continue to see a build in the the margins coming out of drilling. I don't know that I'd want to guide it way too high because it really is a situation where we have better margins in our backlog but you're also, as time goes on, you're exposed to more and more costs associated with personnel and sometimes your raw materials and the like. But we think you'll continue to see a build in the margins in drilling.

Yes. I think, too, we can't stress enough how important it is to our business to be able to make multiple copies of the same rig sets or the same type items. You just, when you're building the second version of something or the fifth or in the case of some of these land rigs, the 50th. You just get a lot better at it and get better at managing the costs. So I think efficiencies probably played a much larger role in the margin expansion here than what most outside observers would guess.

Okay. Thank you very much.

Thanks, Ken.

Thank you. Our next question is from Darren Horowitz, please state your company name followed by your question.

Good morning, guys. Darren Horowitz with Ramon James. Clay, let's ship over to PS&S, margins were essentially flat on a sequential basis and that was right in line with where you guys suggested last quarter. You mentioned that now NQL is in the fold, and obviously with the growing shift to more international work versus domestic, when we get past the seasonal weakness in Canada, do these initiatives really start hitting the operating income line in the back half of this year and can you give us a sense of the magnitude?

Yes, we think that growth internationally is going to be able to overcome a lot of the Q2 downturn in Canada with breakup, once we get that past us. I think the second half of the year looks bright. I'm going to stop short of giving you specific margin guidance, Darren, but I think one of the more interesting developments that is we're seeing in our PS&S group are kind of meaningful price increases overseas. Where a lot of these service businesses now are getting 5%, 10% type price increases, and so I think that looks good for the back half of the year.

Okay. And then, my second question is, is actually coming off of one of your competitors' conference calls earlier this morning. When you're look at the outlook for rig tech backlog growth, how do you view that with now two-thirds of the overall rig equipment packages for a lot of the new bill jackups and floaters already being ordered and at the end of the day, do you think that as that tails off, for capital equipment, that you could see even an increase come out a lot of the after market equipment that goes to service those existing equipment packages out there in the market?

Well, let me take the second part of that first, Darren. And without a question, the equipment that we're putting into the field today, I think, is going to pay a greater annuity into the future than the equipment we've had in the past. When I talked about technology earlier, you you're doing an awful lot with electrification today, 30% of a rig in many cases is computerized right now. That means you have a lot more follow-up at a later time. I think a lot of the equipment is getting pushed harder, it's lighter equipment by definition and so I think the after market as you look into 2011 and 2012, will certainly be better than an aftermarket that you might have had in '81 and '82 after the significant buildup 25, 26 years ago. So I don't think -- that's without question.

I think the first part of your question, we would probably differ on our belief on people building rigs. We're on the record as saying, whenever a jackup gets shipped out, you'll probably have another one being ordered. And I think as you take a look at people like Cappel Fells and PPL and some of the bigger ones around the world, you're seeing that happen. I think to say that the world has ordered two-thirds of their offshore rigs and that's it, quite frankly, I wouldn't take -- I wouldn't agree with that.

The main driver here, too, is really the rig day rates, Darren. And the rig day rates still, particularly for offshore rigs and in particular for deepwater rigs are very, very high. So when you run the numbers, the economics still look pretty compelling.

So even though, I guess -- I guess putting both of those things together you could say that even though you've got a lot of new capacity that's uncontracted coming into the market in the back half of next year and you start to see the new build schedule kind of tail off when you get into late '08, or early '09, you still think that we're going to continue adding new capacity because of the economics even beyond '09?

Absolutely. You're going to continue to see rigs built, you're going to continue to see rigs replaced and we've said before, you have to retool the industry at some point. Rigs don't last forever. So I think there's going to be, I mean, there's been rigs being built the last 10 or 15 years at some point it never just stops completely. And you won't see it stop. It will continue on. I think the technology aspects of the new rigs today are going to be very, very compelling and it's going to mean that more rigs need to be built.

Thanks for the insight, guys, keep up the good work.

Thanks, Darren.

Thank you. Our next question is from Scott Gill, please state your company name followed by your question.

Scott Gill with Simmons & Company. Pete, just a little more color on that last commentary. Kind of put a couple of these pieces together. You say that when a jackup rig comes out of the shipyard, there's another new build to fill that slot, just kind of perusing some of the press clippings out there it looks like there's been quite a bit of jackup shipyard capacity that has been added and is being added in the Mid East and Asia. So are you thinking that we'll see an increase in the number of new build jackup orders?

Well, I don't, Scott, you're not going to see an increase in the number of orders because you went from zero to 50 so rapidly. My contention is this. As rigs move out of these shipyards, you'll see new rigs ordered that will take up a slot that frees up.

Okay. And as new slots are created, there will be demand that will fill those as well, correct?

Absolutely. I think you'll see that. But also, you hear an awful lot about the capacity being added. But right now, when you really put the pen to paper, there's a lot of people talking about being able to build jackups, but talking about it and actually doing it and making a commitment to do it are two different things.

Okay. Fair. And then my second question, Clay, you talked a little bit about this in rig technology, the sales from nonbacklog being $430 million, could you maybe give us a little more insight into that business, what's driving it? Is this a sustainable level and do you expect it to grow going forward?

We expect it to continue to grow, although the last couple of quarters have been around 20% a quarter which is very high. It's a combination of two things, Scott. About three-fourths of it are traditional kind of spares after market service repair, a little bit of rental training, that sort of thing. And then the other quarter is capital equipment that doesn't qualify for our backlog. The way we define capital equipment for our backlog is that we apply a 250,000 cutoff and if an order is less than that, we lump it into that nonbacklog piece. And we actually sell a fair amount of capital equipment that sells for less than 250,000.

That is admittedly an arbitrary cutoff. If an order is 240,000 it doesn't qualify, if it's 260,000 it does and it gos into backlog. If you focus in on the 75% that's nonbacklog or sorry, noncapital after market, obviously a lot of parts in there, but we're also, we've seen good growth in parts. We've seen good growth in service. Probably the biggest grower is really our repair work. We've really seen an uplift in that business over the past year. And the nature of it has changed a little bit.

Well, is that repair work because you're working on a lot more older rigs or is it some of the new stuff that just needs to be maintained, too?

Well, it's a a little of both but it's predominantly older rigs, but it's kind of a mix of bringing stuff in to get it overhauled, rebuilt, but also we see a few car wrecks out there. Where you have a green drilling crew and they slam something into something they shouldn't have and so we have to rebuild it. But I would say, a year ago, a lot of that work -- it is kind of like when you take your car into the mechanic and say, I need to fix the transmission and the mechanic says hey, while I was under the hood, I noticed that the ball joints also need to be replaced. A year ago our customers were saying, well, don't mess with the ball joints, fix the transmission let's get that car back on the road. Today, they're saying fix everything. Let's make sure that we're not going to have any downtime related to this equipment. And I think that's because with day rates so high, down time due to equipment failures is very painful for the drilling contractor and for the oil and gas company.

Thank you. Good quarter, guys.

Thanks, Scott.

Thank you. Our next question is from Dan Pickering, please state your company name followed by your question.

Hi. Pickering Energy. Clay, could you give us just a also more background on Gammaloy and Marlex, any information you can give us on purchase price revenues, et cetera?

Dan, we are going to not disclose financials or purchase price. It's an important acquisition for us and something that's, I think a good strategic move for us but have stayed away from disclosing those sorts of numbers and that's kind of in agreement with the sellers. But suffice to say strategically it's a very, very good fit. Their focus is on nonmagnetic down hole components which include Monell drill collars and nonmagnetic drill collars which are required because as you know, when you're trying to figure out which way the drill string is oriented, you do that magnetically and the steel in the bottom hole assembly interfere's with that magnetic measurement. And in addition to providing collars, they also provide components for, for instance, MWD housings and other bottom hole assembly items that also contain the magnetic instrumentation to determine where you're going directionally. But we believe that's going to fit very, very well with our own Downhole Tools business, where we're the leading provider of drilling motors, of drilling jars, other components of the BHA.

Okay

The other thing, Dan, too, is that the vast majority of their sales were North America. And the exciting thing for us is being able to put this into our international template and be able to expand sales from that arena in that manner. So we're very excited about it. It's a great addition to our Downhole Tools.

Okay. Second question, Pete, you've talked about these new yards and I'm just curious. One of the things we have heard a little bit is the yards becoming customers, basically packaging a yard slot with your equipment or competitors' equipment to essentially sell to a drilling contractor both the space and the equipment so they understand the timing. Can you, can you kind of comment on that trend? Is it a big trend, is it a small trend?

It's a trend. I don't know that I'd say it's big right now. I think that it's going to be kind of an interesting play because what you're going to have there is some of the shipyards that are saying, okay, I'm going to have a rig. And one of the neat things is by putting equipment like ours on there, it's well known equipment. And then they can come out and maybe one of the western-based contractors might have a job and he needs a rig in three months rather than have to order a rig and wait 2.5 years, I think he could swoop into one of these yards, buy up that particular rig, know the equipment well and put it to work. So I think that that's kind of the business model that some of them are thinking about. I wouldn't put it as a huge business model at this point. But I think it's one that might gain a little bit of traction.

Okay. Would you hazard a guess in terms of just either percentage of the bids that you see are dollars or number of units? Is that 10% of the business right now or smaller?

It would be smaller than that I think right now. Now, let me also put a caveat on this. In some cases, though, we are selling more directly to shipyards because the shipyards are in fact turn-keying it back in some cases to their traditional customers. So while the equipment, it's kind of a three-party deal. So that's a lot different, though, than the model of a shipyard buying and building on spec. So I do want to put a clarification out there.

Okay. Thank you.

We are doing more business with shipyards directly, but that's, but they've already sold the slot to somebody else who comes in and says okay, we want the NOV equipment put on here.

Right. Got you. Thanks.

Okay, Dan. Thanks.

Thank you, our next question is from Robin Shoemaker. Please state your company name followed by your question.

Yes, thank you. By the way, Clay, thanks for your reflections on the petroleum industry, there's a lot of good food for thought there. I wanted to ask the question you get asked every quarter about with your 250 million capital spending budget, it looks like easily $1 billion of free cash flow this year. And what are your thoughts regarding that deployment of free cash flow?

We -- yes, we do expect to spend $250 million in CapEx. We have historically been very acquisitive and the NQL acquisition in Q4, the Gammaloy acquisition that we just roped up, the Rolligon acquisition we also closed in Q4 along with a couple other deals we spent over $500 million in the past six months. And so we've actually put quite a bit of cash to work through our acquisition strategy. And I really want to emphasize that we believe that there are a lot of good opportunities out there. We continue to look at a lot of potential acquisitions. And also want to emphasize that we are not new to employing this method as a strategy between national oilwell and Varco over the past 10 years, we've acquired over 140 businesses and I think have a pretty good track record of doing that. We try to be very discerning, we tend to look at a lot more potential transactions than we actually close. We actually did a lookback a couple of years ago and statistically found that we only buy about 1 out of every 6 or 7 businesses that we enter into the serious negotiations with. And that's kind of the strategy that we'd like to continue going forward. And that's our preferred place to put capital and cash to work. The acquisitions that we've been doing are all accretive to earnings. And acquired at multiples below where we trade the marketplace so we think that's a good, good method for our Shareholders.

Okay. Well, that's certainly consistent with your past practice. So that's all I had. Thank you.

Thanks, Robin.

Thank you. Our next question is from Roger Read, please state your company name followed by your question.

Natexis Bleichroeder, morning, gentlemen.

Hi, Roger.

Directional drilling. You guys talked about that a a little in the beginning. You did the NQL transaction. Historically NQL would have had a lot of Canadian exposure, can you give us an idea, Clay, of how that business is starting to expand or (Inaudible) how that business is expanding outside of, say, just Canada and North America?

Actually, Roger, I think NQL was probably a little bit misunderstood. It was based in Canada, but most of its sales were outside of Canada. I don't recall the exact mix but I want to say something like 25 to 35% of their sales were local to Canada and the remainder came from the U.S. and international markets. So, and the international market, as we mentioned in the opening comments, continues to be real solid. And so our Downhole Tools business had a great quarter in Q1 but I do think they did experience some softness in Canada with the market up there but they were able to overcome it with sales elsewhere.

But I think also, too, Roger, what you're going to see is that these Downhole Tools specifically motors, are being used in traditional wells today, also, you go to a place like Oklahoma and you're using motors all over the place just on traditional vertical wells because you can get up to 400 RPM with a motor down hole and you're going to drill a little bit faster when you can get that done. So we actually think while horizontal drilling is exciting and we talked about on the way the drilling is changing I think you're also going to see a lot of wells around the world that are going to be drilling with motors just on vertical basis to get the better performance. So we think this is a great business. We're positioned quite well with it. All of the directional drillers, the big players, the Halliburtons, and Schlumberger's they're all customers of ours and we're excited about the potential of that business.

Okay, thanks. And, Clay, getting back to the question to the amount of cash build you have on there, do you expect and getting on the question Robin asked, but do you expect to see an increase in the number of acquisitions going forward, or markets are what they are and you'll just do what you can do within your parameters?

Really more of the latter, Roger. We'd like to do more, but we've seen competition out there over the past couple of years from private equity and in particular what I would call nontraditional private equity in this space. Private equity that's kind of new to this area. One interesting phenomenon that I think happened last year, when the market started getting worried about gas and storage last summer, we, I think it really made it a lot easier for us. And I don't think it's coincidental that we've had a number of significant big closings over the past six months. I think we're finally getting the bids to converge. What the future holds, I don't know. We'd like to put more capital to work through our acquisition program but we -- I guarantee you, we're not going to lose our discipline.

Thank you.

Thanks, Roger.

Thank you. Our next question is from Michael LaMotte with JPMorgan. Please go ahead.

Thanks, guys, and congratulations on the quarter.

Thanks, Michael. Appreciate that.

Help me out. I'm trying to connect the dots between the preamble and the discussion of technology and I guess sort of the idea that there's going to be investment in rigs even if we don't see a whole lot of new drill ships getting announced. And when I look at the revenue of the nonbacklog portion -- I mean that sort of seems the corollary, is that the right line to draw between your comments and the income statement?

I think to a certain extent you could probably draw that line because as an example, if you've got some existing rigs, a lot of the refurbishment, some of the things that Clay was talking about that don't hit the particular level, if you might want some specific pieces of equipment to come out, make your rig a little bit better, make it more highly technical so that you can compete with some of the newer rigs, that kind of 200,000 investment might not make it or it's going to be piecemeal on three or four different things that we don't necessarily add together that make that line look a little bit better. But that would be much more on the refurbishment, I'm going to upgrade my rig so can I compete much more effectively with these guys because I got to do it and therefore I think you will see more on that line.

Are there any issues that could impact supply chain at this point? Specialty materials? The execution has been great. You obviously have a lot more backlog to push through.

Yes. We do still have some head winds on the inflationary front. I think our guys have done a great job managing it, but bearings are still tight. Hydraulic cylinders. Some of the things that we buy that compete, or supply to other industries like the heavy earth-moving equipment industry, for example, still are kind of tough to get. Thankfully, steel has been relatively calm for the last few quarters and I think that's helped. But I will note that we are seeing nickel costs, costs of stainless are likely to rise a little later this year. So we're kind of preparing for that. But there's always, and then of course there's labor. Labor remains very tight, even in Canada where the market conditions are soft, the labor situation is still very, very tight.

In terms of actually getting your hands on the stuff, you're not running into problems with delays because of supplier issues?

We always run into problems with delays but you just have to work very, very closely with your suppliers and we've done that. We've cultivated new sources of supply, particularly from the Far East, we have got some new foundries and casting houses that we're working with. It's a day-to-day battle. But I do think that our folks that run that business have done an exceptionally good job of of managing through that.

And last one for me is, Clay I'm sort of intrigued by your comments on the cellular approach. And just we've talked in the past I know it's an ongoing process sort of the process improvements and focus on efficiency. How far along are you in that conversion? And have you done some math in terms of what the incremental pickup could be for moving in that direction?

We have cellular, within our rig technology group. I want to stress, we also do this in petroleum services and supplies.

Okay.

But if you just take that segment as an example, we have about 24 major facilities around the world. We've got elements of cellular manufacturing rolled out in about 7 of those. A couple of them are fully converted and the others are in the process of converting. And I think we have a few more that are moving this direction here fairly quickly.

As you go through that process, does it slow you down in terms of throughput at all or can you manage that?

I think that's really the challenge of managing the conversion and figuring out to you continue to meet your delivery obligations while you're converting a plant that's operating at a very high level of utilization typically. But we certainly factor in the impact on our operation as we do this. The nice thing about cellular, too, is it's incremental. You can build a cell in one corner of the plant and then a second cell a few weeks later in another corner of the plant, you sort of evolve towards cellular manufacturing.

So it's not all that disruptive, then?

Depends.

Okay.

Can be.

We're working through it pretty good, though.

I was going to say, it's definitely showing that you're working through it pretty good. That's it for me, thanks, guys.

Thanks, Michael.

Thank you, this concludes our question-and-answer session. I will now turn the call back over to Mr.Miller for any closing remarks.

Thanks and we appreciate everyone's interest and we look forward to talking to you at the end of the second quarter. Thank you very much.

Thank you. Ladies and gentlemen, this concludes the National Oilwell Varco first quarter earnings conference call. If you would like to listen to a replay of today's conference call, please dial 303-590-3000 with access code 11087623 followed by the pound sign. Thank you for your participation. You may now disconnect.