國民油井華高 (NOV) 2008 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the National Oilwell Varco second-quarter 2008 earnings conference call. (OPERATOR INSTRUCTIONS) At this time, I would like to turn the presentation over to the Chairman and Chief Executive Officer of National Oilwell Varco, Pete Miller. Please go ahead, sir.

Thank you, Andrew and good morning. Welcome to the National Oilwell Varco second-quarter 2008 earnings conference call. I am Pete Miller, chairman and CEO. With me today on this call are Clay Williams, our chief financial officer and Mark Reese, the president of our rig solutions group. Earlier today, we announced earnings of $421.7 million, or $1.04 per share on revenues of $3.3 billion. Included in this were pretax charges of $40.7 million or $0.16 a share related to the Grant-Prideco merger and a new tax charge due to the earnings repatriation we've made on some money oversees. Excluding these charges, net income from this period was $486 million or $1.20 a share.

Clay will expand upon these numbers in a moment, but we are very pleased with the results that we had both year-over-year and on a sequential basis. Additionally today we announced record new capital equipment orders of $2.2 billion. We also shipped a record $1.34 billion from backlog this quarter but still ended with a $10.8 billion backlog total. This backlog number's our traditional capital equipment number and does not include anything that came from the Grant-Prideco acquisition, most specifically drill pipe. However, I will say the drill pipe backlog increased 19% since the end of the second quarter. We are extremely pleased with these numbers and we're also pleased with the direction of the business in the future. At this point in time, I'm going to ask Clay to give you color on these numbers and ask Mark to giver you an overview of what we are seeing in the marketplace. But suffice it to say, we are excited about what we have accomplished and even more excited about what the future looks like. Clay.

Great, thanks, Pete. Before we begin this discussion of National Oilwell Varco's financial results for second quarter ended June 30, 2008, please note that some of the statements we make during this call may include 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 federal securities laws based on limited information as of today, which is subject to change. They're 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 the major risk factors affecting our business. Further information regarding these as well as supplemental financial and operating information may be found within our press release, on our web site at www.NOV.com. or within our filings with the SEC.

Later on in this call, Pete or -- ( Inaudible ) -- we ask that you limit your questions to two in order to permit more participation. National Oilwell Varco generated earnings of $422 million or $1.04 per fully diluted share in its second quarter ended June 30, 2008 on revenues of $3,324 million. On April 21, we were pleased to close our acquisition of Grant-Prideco for a combination of $3 billion in cash and the issurance of 56.9 million shares of NOV stock. As a result, during the second quarter National Oilwell Varco recognized transaction-related charges of $62.5 million pretax or $0.10 per share after tax and additional tax provisions associated with financing the transaction of $29 million or $0.07 per share. Additionally, we generated $7.2 million pretax per share or $0.01 per share after tax in earnings from Grant-Prideco operations that were later sold during the quarter. Excluding all these items, earnings were $1.20 per share, reflecting very solid operational performance by National Oilwell Varco.

Under GAAP purchase accounting, the Company's financial statements included results only from the last 70 days of Grant-Prideco operations in the second quarter including additional pro rata amortization and depreciation of $31.6 million, a step-up to fair market value of Grant-Prideco's assets and liabilities. In order to provide better comparability of operations on a quarterly basis, we have supplementally disclosed adjusted financial statements for the Company by quarter, starting from the first quarter of 2005 as if we had combined operations for all periods. Last quarter, we informed you that Grant-Prideco operations would be included in our existing petroleum services and supply segment and a supplemental disclosure in our press release and on our web site depicts the combined adjusted results on this basis. Include the expected depreciation and amortization charges from Grant-Prideco stepped-up balance sheet for fixed assets, intangibles and revaluation of liabilities for each period but do not include expected cost savings and periods before the merger; do not include the results of divested Grant-Prideco businesses in any period and also do not include the amortization of inventory step-up, which will transition out over the next couple of quarters and will be reported separately within transaction costs.

Later on, our comments on operations will discuss results on this combined adjusted basis but first let me touch on a number of transaction items related to the transaction in Q2. Charges of $62.5 million in the second quarter consisted of costs associated with the accelerated vesting of options, financing fees, transaction costs related to Grant-Prideco's previously-agreed sale of portions of its tubular technology and services segment to Vallourec and the amoritization of inventory step-up. We expect additional transaction costs of approximatetly $30 million in the third quarter and $16 million in the fourth quarter of 2008 as stepped up inventories continue to roll out, and we will continue to disclose these separately. The completion of the sale of the TTS businesses to Vallourec in 2Q brought in approximately $785 million in cash. This amount will be reduced later this year as we pay $270 million in tax on the gain. As I mentioned these businesses generated a little over $7 million in operating profit in the quarter under National Oilwell Varco ownership before they were sold in June.

The $29 million additional tax provision I mentioned earlier was incurred due to our decision in the quarter to repatriate $194 million from overseas to pay down some of our revolver borrowings and it drove our effective book rate to 37.5% in Q2. We expect that most and perhaps all of this to be offset by foreign tax credit held by Grant -Prideco prior to the merger minimizing the cash impact. Excluding this additional tax provision, our rate was 33.2% in the quarter, in line with our expected tax rate going forward. During the second quarter we were pleased to settle some of the outstanding litigation Grant-Prideco had relasted to its about its bit technology, receiving net $127 million in settlements. These do not show up as a gain in the quarter but are instead booked into purchase accounting in Grant-Prideco's assets.

We will continue to vigorously pursue our claims against other infringing parties related to this important technology, that our ReedHycalog business pioneered. Finally, our press release notes that we transferred certain NOV product lines out of our petroleum services and supply segment at the beginning of the second quarter, which totaled about $98 million in revenue during Q2. Approximately $71 million of this was the movement of rig instrumentation products into the rig technology segment and $27 million balance was the transfer of artificial lift and industrial products into the distribution services segment. These changes were made in accordance with FAS 131 to reflect a realignment of management responsibilities following the Grant-Prideco acquisition. Given the small amounts involved, we have not adjusted for this move in prior periods.

The integration of Grant-Prideco operations has gone like clockwork. The chief savings of $6 million pretax during Q2 on overhead reductions and we expect this to increase to $9.7 million in each of the third and fourth quarters and to rise to approximately $11 million per quarter beginning in 2009 based on steps we've already taken. This will result in an annual savings rate slightly higher than the $40 million per year we expected when we announced the transaction last December. Most importantly, the merger further strengthens NOV's position as a manufacturer to the oilfields, supplying critical hardware, technologies and service to oil and gas operations worldwide. We are pleased to welcome this vibrant, capable organization to the National Oilwell Varco family and we thank the legacy Grant-Prideco employees for their hard work in helping to put the new NOV together. You are doing a super job and we are grateful.

On an overall, adjusted combined basis excluding the transaction-related, second-quarter results were excellent. Consolidated revenues were $3,345 million, up 9% from Q1 and up 21% year-over-year. Operating profit was $778 million or 22.6% of sales up 160 basis points from Q1 markets. Operating profit flow-through or leverage was 40% sequentially and 30% year-over-year. Now let me turn to specific segment operating results for Q2 on this adjusted combined basis. Rig technology generated $1.9 billion in revenue and $506 million in operating profit in the second quarter, yielding an operating margin of 26. 5%. Excluding the transfer of the instrumentation products from petroleum services and supplies, the group generated 33% flow-throughs on 15% revenue growth sequentially and 33% flow-throughs on 31% revenue growth year-over-year.

Revenue out of backlog increased 18% sequentially to $1 billion, $337 million and reported nonbacklog revenue increased 22% due in part to the additional $71 million in instrumentation products revenue, all of which flow through the nonbacklog revenue. Excluding these additional instrumentation product revenues, our base rig after market business surged 30% on higher spare part sales, partially offset by lower sequential sales of small capital equipment that does not go in to the backlog. Recall that in Q1, we had a very high level of handling tool sales that did not repeat this quarter. As of June 30, our backlog for capital equipment sales from the rig technology segment stood at a record $10.8 billion due to a record level of orders of $2 billion, $216 million received during the quarter. Seven floating rig packages, surging demand for land rigs both domestically and overseas and steady demand for jack-up equipment fueled the strong showing. Equipment for international markets was 91% and orders for offshore equipment totaled 87% of the total backlog at June 30. We expect revenue from backlog to continue to rise.

And as of June 30, a scheduled outflow of revenue from backlog is expected to be a little over $3 billion for the remainder of 2008, about $5 billion in 2009, and nearly $3 billion balance thereafter. Our rig technology segment continues to wrestle with rising costs, particularly steel, utilities, logistics and foreign currency related costs, but our efficiency initiatives, such as quick response manufacturing and broader outsourcing, our wide manufacturing footprint and modest price improvements are helping us maintain margins which have remained stable on newly-won projects. In a moment, Mark will share more color on our execution and outlook for rig technology but overall, looking forward into Q3, we expect modest growth in revenue and comparable margins to Q2. Our petroleum services and supply segment generated revenues of $1 billion, $244 million in Q2, down $69 million from Q1 including a full quarter contribution from continuing Grant-Prideco operations in both quarter. However, excluding the $98 million in products transferred out on April 1, revenues were up 2% sequentially at 23% leverage and revenues increased $10 year-over-year, a 20% leverage.

Our business services in Canada saw revenues and operating profit decline from the first quarter to the second due to the annual spring break up there this year, with revenues dropping $59 million at high leverage from Q1 to Q2. Spring break up occurs every year in Canada and is a result of transport restrictions on heavy movement by the authorities to prevent damage to roads during the spring thaw. Activity and outlook in Canada are both rising following the lifting of these bans several week ago. Fortunately, this seasonal Canadian decline was offset by strong results overall in our other businesses. Drill pipe sales posted sharply higher margins owing to favorable mix improvements in the types of pipes sold with premium and large-diameter drill pipe rising to 48% and 39% of the mix respectively.

We contend that the large premium segment of drill pipe sales will continue to grow as oil and gas companies push complex well path designs beyond the torque and tensile strength capabilities of API pipe designs and NOV is well-positioned to capitalize on steadily-increasing usage of premium drill pipe in horizontal, directional, and extended reach drilling programs. Nevertheless, drill pipe revenue fell slightly due to shipping vessel delays and disruptions caused by the earthquake in China. Although we do not intend to report drill pipe backlog in future periods, I will nevertheless point out that backlog for drill pipe increased 19% sequentially from Q1 to Q2, the first increase since 2006 as orders surged 85% sequentially with strong North American land contractor, with North American land contractors re-entering the market and new-built rigs ordering pipe. Integration od Grant-Prideco's drill pipe business is going well and we are rolling out new drill pipe tracking products and expanding OEM repair and maintenance offerings through NOV's worldwide pipe operations. The ReedHycalog bit business acquired with Grant-Prideco also performed well in Q2, despite a sharp downturn in Canada related to Prideco.

Revenues increased 4% on solid flow throughs on higher sales in Latin America, Europe, Russia and the Far East. The Andergauge business, also acquired with Grant-Prideco, delivered a record quarter and integration of this business with NOV's leading downhole tools business is proceeding well. As part of the integration, we are consolidating a number of sales facilities worldwide and leveraging our combined manufacturing capabilities and capacities to improve lead times and reduce costs. The addition of Grant-Prideco bits and downhole products to NOV's offering of drilling motors, monells, jars and shop tools completes aa impressive, comprehensive package of bottom-hole assemby hardware, making us a one-stop shop for critical iron needed to drill complex well pads. We are now exceptionally well-positioned to capitalize on continued growth in horizontal, directional and extended reach drilling. Our other petroleum services and supply businesses continue to execute well in the quarter and benefited from rising activity associated with the shale gas plays in the US and steadily rising activity overseas. Increased rig construction and reactivations are fueling demand for the pumps and liners from Mission and solids control and waste management technologies from Grant. Tuboscope is benefitting from sharply higher middle-end processing activity in response to tight OCTG inventories and higher pricing, and expansion of its drill pipe repair and maintenance operations.

Overseas, demand for fiberglass pipe for large projects began to increase during the quarter and demand for drilling motors, non-mag collars and fishing tools in the Middle East continue to push higher following the opening of our new facility in Dubai late last year. Waste management demand in the North Sea and the US land also picked up nicely in Q2. Inflationary pressures, particularly steel, labor and fuel continue to pressure the business and recent price increases, most in the mid- and high single digit range and a relentless focus on efficiency had generally been able to hold margins. For Q3, we expect mid-single digit revenue growth at solid flow-throughs as we emerge out of Canadian break up, and continue to benefit from rising drilling activity. Our distribution services segment revenues of $426 million were up 16% from the first quarter. Excluding the transfer of artificial lift and industrial products from petroleum services and supplies, revenues increased 9% sequentially as strong flow throughs. Operating profit was $24.8 million or 5.8% of sales.

US revenues ascended to record levels fueled by high demand for operating supplies by rigs moving into emerging shale plays. And service companies and oil and gas operators also increased consumption of MRO supplies in the face of higher service activity and higher commodity prices during Q2. And margins improved sharply in line pipe sales this quarter. While bidding pressures remain fierce in many mature regions, pricing pressures appreared to be abating in new high-growth domestic areas. [Innada] declined overall due to break up, but the business there benefitted from cost-cutting initiatives executed in prior quarters and rising deand in southeast Saskatchewan and high shale activity in British Columbia, which drove better than expected results. International sales improved as a number of overseas locations opened up over the past few quarters and began to gain traction, notably in the Middle East, Africa and Norway. A large valve project into the Far East also contributed strong results as did high cable sales into international offshore rig-ups. In the third quarter the distribution services segment expects to open a handful of new locations to improve coverage of the emerging shale plays across the US and to continue to expand overseas, including supporting very high levels of interest by drilling contractors for stores on new build offshore rigs.

The group currently has three stores located on offshore rigs staffed by NOV personnel. Third quarter distribution services revenues are expected to increase in the high single digit range at very solid flow throughs. Turning back to National Oilwell Varco's consolidated second-quarter income statement, interest expense increased $14.2 million and interest income decreased $5.2 million, as a result of borrowing to finance the Grant-Prideco acquisition and lower cash balances. Debt swung widely, as we drew down $2.1 billion on our new revolver to finance the acquisition in April, then repaid most of the cash flows out of operations during the quarter and from proceeds of the sale of the TTS businesses sold later in the quarter. Other expense swung from a credit in the first quarter to a debit of $14.6 million in Q2, due to FX movements on Grant-Prideco and Norwegian NOV businesses and much higher bank fees associated with letters of credit to back down payments to National Oil Varco from drilling contractors for new rig orders. Equity income from our alpine joint venture increased slightly to $17.1 million and we expect some results in Q3. This is the joint venture that supplies green tubes, the seamless pipe used in our manufacturing business that came in with the acquisition.

Weighted average fully diluted shares outstanding of 404 million shares represent the partial quarter impact of the shares issued for consideration to Grant-Prideco shareholders and expect the full quarter of Q3 amount to be approximately 420 million shares. Unallocated expenses and eliminations on our supplemental segment schedule, which is pro forma for the Grant-Prideco acquisition in all periods, were $47.9 million, down $22.1 million sequentially . This item benefitted from overhead cost savings coming out of the Grant-Prideco merger of about $6 million. The turnaround of high payroll taxes paid in Q1 on incentive compensation by both organizations and that lowered profit eliminations on inter-company sales between segments. Depreciation and amortization was $106.4 million in Q1, up $44.9 million sequentially, due to the effect of the acquisition. We expect total Q3 consolidated National Oilwell Varco depreciation and amortization to be in the range of $120 million, excluding inventory step-up amortization.

Q2 amortization of inventory step-up of $46.1 million is not included in the DD & A on the supplemental EBITDA schedule but is rather included as part of the transaction cost reported on the line below. Our June 30, 2008 balance sheet employed working capital excluding cash and debt of $2.3 billion, up $485 million sequentially due to the acquisition. Working capital excluding cash and debt was about 17% of annualized revenue generally consistent with recent prior quarters. Cash flow from operations was a record $753 million in the second quarter and leveraged cash flow was $528 million. Customer prepayments and billings in excess of costs, a measure of customer financing of our working capital needs increased $524 million to over $2.6 billion. This contributed greatly to the company's strong cash generation in Q2, and will be reinvested in inventory abroad as we execute our large rig construction backlog. Cap Ex was $106.1 million in the second quarter and we expect it will continue to rise quarterly and be a little over $400 million for the full year. Our cash balance was $1.6 billion, down $487 million from the first quarter and our debt totaled $1.7 billion as of June 30 up about a billion dollars from the prior quarter. NOV's corporate credit rating was raised by most major rating agencies during the second quarter in view of our strong financial condition. Now let me turn it over to Mark for his

Thanks, Clay. Good morning. Over the last quarter, our overall inquiry and quoting activity has remained brisk for all product lines and rig categories, with new land rigs rapidly increasing. As a whole, we are seeing very little softening across any of our product segments. Let me start with the overview of our three major rig categories. To start with, floaters. Inquiries for both of our drill ships and semis remain very high with a tremendous amount of emphasis being put on the assets needed to meet Brazil's growth strategies. Other areas diving this demand are deep water Gulf of Mexico, West Africa and Central Asia. Jack-up inquiries and orders remain stable very with demand being driven by many of the shallow plays such as Persian Gulf, the North Sea and Asia. Land packages - as you are probably already aware, the land market has made an about-face since the first of the year, specifically in North America. We started seeing -- we started this year believing that the new rig and refurb activity in North America was going to be somewhat lighter than we have seen in 2007; however, beginning in Q1, that made a quick switch and going into Q2. We have since increased our forecast program for Ideal, Rabid and our newly-designed Drake rig.

This demand is really being driven by the increase in oil and gas prices with the majority of the rigs destined for the [Boggen], [Haynesville] and the Marcellus plays -- Moving on to the Middle East and North Africa, we're real excited about these areas. Inquiries on orders are very active for our traditional 1500 horsepower Ideal rigs but we're also seeing more inquires for our custom-designed, higher horse power rigs with desert-moving systems and high ambient temperature packages. Our MDTOK organization has received very positive feedback from the contractors in this area, for them to expand their instrumentation and monitoring services. Moving on to Russia, this is a mark that holds a lot of opportunity for NOV in our drilling technology. There is a tremendous demand for our higher technology drilling equipment that has a proven track record in drilling and safety performance. We are estimating a potential of between 200 and 250 land rigs for this market over the next five years. Most of the applications will be driven or end up in North Central Russia. We are always looking at expanding our global footprint so we can better serve our customers. A few of the expansions that you should expect to see over the next 12 months, starting in Russia.

We're working on plans to expand our land manufacturing business and service capabilities to service this growing market. Our current plans are to have this facility up and operational some time in the first half of 2009. Middle East is another area that we are looking at, with a growing demand for these land rigs in this region. We are in the process of expand our current rig-up capabilities to extend to a four-rig pad, rig up facility. This expansion will be fully operational in Q2 of 2009.

Moving back to the States, up in the Northeast, with all the activity planned for this area, we are working on our final details for the new rig-up facility, a service facility to support the projected growth in the Marcellus shale. This facility will be located in the area of Piottsburgh, Pennsylvania and it will house other NOV operations so can better service our customer base in that area. In June, we held an executive open house for our Houston-based technical college. This facility is the second that we have opened over the last year, the first being located in Christiansen, Norway. The third is targeted for Singapore in 2009. These facilities are designed to deliver over 700 trained INC and service engineers into the market over the next 12 months. As everyone is well aware, for decades our industry is underinvested in developing trained and experienced personnel. My thanks go to NOV's board and Mr. Miller for making this tremendous investment in our people and our industry's future. These colleges are staffed with professional educators and state-of-the-art simulators and learning tools. There are three core curriculums: mechanical, electrical and controls.

The students will not only receive classroom time but they'll work alongside experienced, service engineers getting hands-on experience. NOV has been always committed to training our employees. It has also made a very large investment to train our customers. In 2007, we ran over 2,000 customers through our training facilities. In 2008, we are forecasting to almost double that number. We are also introducing our new NOV mobile training unit, which is really a 50-foot school. We can take this trailer straight to our customers' locations or to well sites, and we can actually train the crews on the equipment they are going to run that day. This has been a very successful tool for us as well as for our customers. I would like to take this opportunity as well to announce our intention to open up another technical college in Marqee, Brazil.

This investment will be designed to train our customers' personnel on safe and efficient operation of NOV equipment. We believe this investment will create a huge enabler not only for our customers but for the local workforce to operate the large inventory of NOV equipment either currently operating or under construction for Brazilian Waters. As always, NOV continues to lead the charge in bringing new technology into the drilling industry. Our design criteria is to deliver safer, lighter and higher performing products for our global customers. To give you a quick update on where we are with some of these recent developments, our TDX1250 top drive. We've shipped or have on order 10 of these revolutionary new top drives. This technology delivers an industry-leading 105,000-foot pounds of continuous torque in a very compact and easily-maintained package. Our first 1250FAT took place in Q1 in our Orange County, California facility and the FAT exceeded everyone's expectation.

The next product is our CRT350. This casing running tool has a tremendous market acceptance and is designed to deliver our customers safer and faster casing operation. As of this call, we have either shipped or have on order over 85 of these CRT350s. As I mentioned earlier, our newest product is the Drake rig. This rig was designed specifically to accommodate the tight road restrictions and small location our land contractors are experiencing. The Drake rig is 1,000-horsepower rig with a three-piece telescoping mast and a rugged design that can accommodate some of the harsh terrains these rigs are going to see. As well, it can also accommodate a moving system for pad drilling design. Looking into the future as in the past, our biggest challenge is execution. Going forward, we are going to continue to execute. I'm very comfortable on our ability to deliver on our commitments, but there are always going to be bumps in the road.

We currently have over 600 INC and service engineers working in 13 shipyards around the globe. To date, we have commissioned and delivered 29 drilling package packages by working extremely close with the shipyards and contractors and vendors. NOV has not impacted the delivery of any of these vessels. Before I turn the call over to Pete, I want to personally thank the hard-working people of NOV for their commitment for making this happen. We have the best people in the industry, and day in and day out, they deliver on their commitments. As well, I would like to thank the thousands of vendors that support NOV around the globe. Pete.

Thanks, Mark. At this point I want to summarize on a few things and talk about a few things we have in place. But the reality of the business today is about the shale plays, it is about deepwater, and it is about continuing to retool this business. You know technology and efficiency wins. We are able to provide the products and services that people need to be able to win those. I think the shale plays are going to be exciting throughout the US and quite frankly the world. If you think that the shales are only in the Marcellus and the Haynesville, and not in Argentina and Russia and other places, you are wrong. They are all over in the technology that we learn there is going to be expanded. And, again, I can't emphasize enough the retooling of the Fleet. The best rig wins.

I think that is pretty indicative as you look throughout the United States. We are prepared to make sure that we take care of this. I would like to talk about a couple of initiatives that we have in place in our PS & S group. For instance, we are utilizing the central business model that we utilized in drilling. When you looked at what we did when we started building this company 10 years ago, it was really to integrate the package to make things easier on our customers. Today when look at Tuboscope and Grant-Prideco we are starting to integrate the pipe management system, we call this the Leon system. What this enables you to do is engineer, manufacture, coat, inspect, reface, rethread, and monitor that pipe all through the life of the pipe. And the interesting thing is that we are able to take some of the electronics we learn on the drilling side, with MDTotoco, with the Isis system and things like that, and be able to monitor this pipe. And I think it really has an opportunity to revolutionize the way that people are able to use drill pipe.

In our Brant operations, we have recently acquired a company we call portable power that not only allow us to take a lot of Brant equipment out in the field but also use portable power to power it up and do it much more efficiently than just depending on the rig. Interestingly enough, alot of this portable power has really cool emissions control and noise pollution. Things that you are going to need as you are drilling these shales in the towns of Shreveport, Fort Worth and other places around the world. So we think these are the sorts of initiatives that we are on that are really pretty exciting. Look at downhole tools. Today we can provide the bits, the motors, the shock subs, stabilizers, the Monell collar and the Andergauge openers. We can do these things and provide our customers with the hardware that works seemlessly. And by the way we have a cool product called IntelliServe, that we will be able to develop over the years to take that information that comes from all of this and ratchet it is to the surface at about 10,000 times the speed with which it is done today.

So these are the kind of things that are going to bode very well for the technology of this industry and I think position ourselves to take advantage of it. And finally in our distribution business, we are using the same sort of business model. As Clay pointed out earlier, we are integrating. We are putting rig stores on these drilling rigs. We are taking inventory away from our customers, reducing their total cost of ownership, taking care and ensuring that we have got the products and services in place. And when you look at the numbers of these deep water rigs that are going out and the type of rig stores we are putting on these, we think it is a really, really cool business that is going to expand well into the future.

So we are excited about where we are going. But it takes good people. And I want to make one mention of one thing that we have done over the years, and this is our next generation program. And just to kind of give you an example of how this works, we just -- we just hired our Next Gen9 program. We have eight prior to that, and the people are out in our company today doing great business and great work and they are providing great leadership. And you look today, we just recruited 50 people. To give you an example of how to worked out: 16 came from the US, 5 from Canada, 6 from the Middle East, 5 from Singapore, 2 from Norway, 5 from China, 5 from Latin America, 2 from Russia and 4 from the UK. They are all college grads in many disciplines and this is the type of program that is building us for the future.

You know, a lot of companies just try to hire away and move around. We want to build from within. We think that is extremely important, and we think it is going to dictate what happened in this company for the next 20 years. So I would also like to echo Clay and Mark and thank the 36,000 employees in this company for the great job they are doing. Welcome to Grant-Prideco people to what I think is a wonderful company. And we are very bullish, needless to say, on where we're going in the future. So, at this point, Andrew, I'd like to open it up to any questions our listeners might have.

Thank you, sir. (OPERATOR INSTRUCTIONS) The first question from the line of Bill Herbert with Simmons and Company. Please go ahead.

Hi, Bill, how are you doing?

I'm well, thank you, Pete. I think I heard Clay mention that you had seven floater packages in the quarter.

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

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

Well, really the -- we are staying fairly stable on our margins. The only increases that we have passed through to the customers are sitting on inflationary issues.

Okay.

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

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

Go ahead, Clay.

Our backlog jumped up to about a third -- actually over a third.

Okay.

On Q1 and Q2.

Bill, I also might point out that a lot of the explosion in the land business has not hit this -- this backlog. We are -- we are dealing with a lot of different things like -- like writedown. As we always point out, the backlog cuts off at the first of July.

Sure.

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

And, Pete, with respect to the crystal ball business here for a second. Could you venture a prophecy as to the number of USA land rigs that you expect to see built over the next, call it two years?

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

Yep.

-- I think that natural gas and the next administration is going to be looked upon as very much of a very viable alternative to many of the energy issues we are facing today. And I would not be surprised to see the -- the rig count in the United States and especially when you see things like the Marcellus come into play and I have actually said this on record before, 2200, 2300 rigs working in the United States does not surprise me at all.

Right. Thank you very much, guys.

thanks, Bill.

Thanks, Bill

Thank you. Our next question will come from the line of Bill Sanchez with Howard Weil. Please go ahead.

Good morning.

Hey, Bill.

Just a follow-up to the previous question. You mentioned the five drill ships and two semis ordered during the quarter. There was close to 30 new builds in general offshore awarded during the quarter. Can you give us a sense, Pete, of how many we are quoting for potential third quarter orders for NOV?

A bunch. You know, I will say this. I think one thing we will point out that there has been alot of talk about Brazil. Brazil is not in here. We don't have -- there are a lot of things that are going on in Brazil and I think they will manifest themselves in the future but a lot of the -- you know we -- we have pretty much have established, Bill, we don't put anything in the backlog until we have a solid contract and, in many cases, a down payment. We don't put notional things in the backlog. We don't put LOIs in the backlog. I think what you are going to see is there is still an extreme amount of business that is out there. And I think as we go through the next couple of quarters, you are going to see some -- some nice orders that come in. I mean, I think they will start many of the things that you heard about in Brazil. Because people announce things early. That doesn't necessarily mean that ordered things early because you have a lot of engineering and do a lot of things to prepare for it, but rest assured, we are bullish.

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

That's correct.

That's correct.

My follow-up. Clay, could you be a little more specific as it relates to the flow throughs that you are expecting the third quarter in the PSS segment. I know you said solid but I am trying to get a sense of what you are thinking there.

Historically, this business has been around 30% as kind of our long-term guidance. We have fallen a little short of that this quarter on a pro forma basis excluding all the noise. We had some items this quarter that kind of flowed through and none of these were terribly material, but we do expect them to turn around. We have had some -- some labor pressures in South America and some inflationary pressures, and what we began to see in the second quarter was price movements within many of these businesses that will offset this going forward. So I think that will help the leverage going forward. Additionally, of course, Q2 -- the thing that really impacts the petroleum services and supply group in Q2 is Canada break-up. In aggregate, our PSS business declined $59 million in Canada, and that typically declines to very high decrementals. In Q3, what we typically see is Canada starting to bounce back usually not as strong as Q. But when Canada comes back, it comes with pretty high incrementals with increase in revenue out of the Canadian break-up. We think that Q3 will very likely be higher than our 30% incremental flow through bar. As we see Canada bounce back and also we see the turn around of a number -- a couple of unusual items that impacted Q2.

Thanks.

Thanks, Bill

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

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

You know Robin, I will tell you what, the first big drillship that went out was the Drill MAX for Stena and it went out at the beginning of the year and it hasn't had any downtime yet. So we haven't had to shift that many spare parts to it, which we are pretty astounded by because it is actually one of the most complex rigs that we have seen. So if that's an indicator, gosh, it may be a whole lot less than I thought. But having said that, we are excited the way that ship is run, but we really don't have, I think, a very good indicator yet. I will say this as you've seen -- you look at the numbers that we have this quarter. You can see that we did ship a lot more spares. Those are probably for more existing rigs that are on pretty significant day rates, and we have been moving things out pretty -- pretty dramatically, but we are very pleased with the way the new rigs are running, so I have got to beg off that question for another quarter or two.

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

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

A product that is spongable but we certainly would be amenable to giving a little bit of a price break if they want to throw in a few things like that. We will offer a carrier too. But if you want the best equipment, you are going to want the best drill pipe and the best drill pipe is Grant-Prideco. So I think we will fee pretty comfortable they would be buying that too.

Right. Thank you.

Thanks, Robin

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

Pete, you are certainly excited about the future. Just to try and pin you down a little bit. Are you willing to say that orders for rig tech are going above the $2.2 billion level as we go forward?

Doug, if I ever said that my general counsel would be in here and smack me around for an hour and a half. Let's just say I am bullish. Historically we haven't given guidance on this. We've just said we feel real confident that things are looking good. If you look back over the last four or five quarters, we said we feel pretty good. I think Robin Shoemaker was on before you and he always asks me if I think quotations are still robust and I would say they are still robust. So -- but the real problem, Doug, too -- and I want to make sure we emphasize this, we cut all of our backlog off on a date certain. For instance, we cut this off on first of July or really the 30th of June and we have had orders that come in the second, third of July. Quite honestly, that doesn't bother us if they come in two days late but it does bother the fact it may make the backlog a little bit bigger. So, you know, for doing that it's hard -- these projects, a lot of them are complex. They don't come to pass in just a matter of days. You go around through iterations, you have to tender offers. You have to go back in and retender and so it is difficult to say that any 90-day period, these orders are going to come in. I will tell you this, we've said before, you know, kind of look at backlog over the last nine months, and it has been very, very robust. And I think that you will continue to see backlog over the next foreseeable future be very good. So that's -- that's a long-winded way of saying I am not going to tell you.

Let me ask it this way in a way you have responded in the past. Have you signed any deepwater rig orders so far in the third quarter?

Yes, we have.

No number though?

Your next number is how many? ( Laughter ).

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

Doug, I don't think we are getting a lot of price driven margin expansion. We are probably getting a little volume leverage, so as we are doing more, as we are doing repeat orders on many of these big rig packages in particular, we're able to -- you just scale the learning curve when you built the first kind of rig design you learn a lot. And I think we got an organization that is very good at capturing the lessons learned and applying them to version number 2 of that same rig design and version number three and you are starting to see multiple offshore rigs built on the same design and efficiencies that fall out of that. In addition to, we have talked about this in preceding quarterly conference calls. We have been pushing a lot on working smarter, on quick response manufacturing. Mark mentioned a number of new facilities that he plans on opening. He is opening -- we have opened up a couple of others here in the past several quarters that are contributing to the improvements. We made investments in new machine tools. So overall, it's kind of a combined effort of all that. I think overall it is more efficiency driven than price driven.

Okay, thank you.

Thanks, Doug.

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

Hey, good morning.

Good morning, Kurt.

All right. So easy question first. Distribution in the past Clay, you guys have kind of suggested 11%, kind of incremental flow-throughs, whatever terminology you want to use. Seems like business is gaining momentum there again. Is it quite possible that we would be on track for that 11% incremental done in the back half of the year?

Yes, actually -- we got it toward 10%, Kurt. But kind of in that range. Of course you get, in in any two periods you have FX and mix issues and all that sort of stuff, but if you kind of take a long-term view of distribution it's typically had 10% flow-throughs and that is probably what we are expecting Q3 and Q4 of this year.

Okay. You know we -- very, very rapid turn around in the North American business that you guys have referenced so far this year. Got up to $13 on gas, now we are under $9. Is it quite possible that things could slow down as rapidly as they picked up? What is your general sense on the sensitivities around some of these programs related to $8 or $9 gas. Pete, do you want to take a crack at that?

I will take a crack at that. This is Mark. We haven't seen any slowdown or enthusiasm lightening up on the rig side. I think a lot of the energy that we are seeing in the Haynesville is going to carry through. I can't speak to the economics of the oil companies, but we certainly haven't seen anybody blink on their desire to move forward with a lot of these rig packages.

Kurt, I would add too that, you know, we still come back to the retooling pieces. You know -- I think there is -- there is cash out there today, and a lot of these -- these rigs are being designed specifically for the shale plays, and there are rigs that are sitting throughout that can't do these shale plays. I think some of the drilling contractors that have invested in new technology, they are winning the game. You are finding guys who are coming back in and saying, we are going to invest in new technology. And I think even if you saw a decrease in the price of natural gas, you are still going to see the shale plays being drilled. And you are still going to see the demand for these new rigs. We think -- we think there really is a retooling and you are going to see some rigs on the downside retired a little bit. So we think it will stay pretty robust.

Right. And Pete, you've referenced in the past -- we think understand the evolution here and progression of deepwater and land. On the jack-up market you referenced that every time a slot opens up it is going to get filled. Are you still seeing that?

Absolutely. I think over the last couple of quarters. I can draw the numbers to you, and I think I am still a little bit ahead of the game. I think last quarter were like four or five delivered. I think six ordered. You are going to continue to see that. The jack-up business is not dissimilar in many cases to the land business. You are seeing some retooling. The ability of these jack-ups to be able to drill more efficiently. I think everybody read the article last week about -- I think McMoran reentering one of those deep shelf wells that Exxon had passed up on. While those are in shallow water, those still take a rig that can drill up to 30,000 some odd feet. The demands for these high-performance efficient jack-ups I think will continue and as they come out of the shipyard, they are going to work and going to work at pretty good day rates. We think that is pretty indicative of the fact that they are going to remain -- they are going to remain a good business.

Thanks.

Despite all the jack-up deliveries recently, Kurt, 82% of the existing fleet is still more than 20 years old. This is a -- worldwide, the jack-up looks pretty old.

Great. I appreciate the color.

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

Good morning, guys.

Hi, marshal.

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

We think that the outlook for continued revenue growth out of backlog is very bright for reasons I think we just covered, Marshall. A combination of retooling land rig fleets, retooling the jack-up fleet and building out brand-new deepwater capabilities for drilling where there was none before. And packages for all of those three buckets flow into the backlog. Frankly I think if you look back over the last few years, retooling and secular build out of the deepwater fleet really started in earnest about three years ago. 2005 kind of kicked off that phase of this industry and we think it is going to be bright for years to come.

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

That was my point. Seem like the nonbacklog, at least recently, is growing faster than the backlog. Is that continuing or do you see them growing at a similar rate going forward?

I can actually see the nonbacklog business growing even more dramatically. We have got an interesting position out here. We sell to everybody. Very few people in the industry that sell absolutely to everybody. I don't care if you are Schlumberger or Exxon or Conoco, if you were the drilling contractors, if you're Halliburton, we sell to everybody. And a lot of the reason for that is our business model is we want to produce the tools and services to take care of those tools that can take care of our customers, but we are not going to compete directly with them in what they do. You know Schlumberger is a great data acquisition company. We want to provide the tools for them to acquire that data and as they grow in that we think we will be growing along because we can provide those plus the worldwide footprint to take care of that. We think it is a great story and it is probably the story that is the littlest known about us.

Right. Follow-up, Clay. Just a quick one for you. I am just a dumb engineer and earlier in the call you were talking about the stepped-up inventories rolling out. I didn't hear at all. Walk me through what's going on there. You were saying they were going to improve.

Good question, Marshall. Under purchase accounting, we have to write up the value of Grant-Prideco inventory as to the date we close the acquisition April 21. A certain amount of purchase price that is allocated into inventory. As those inventories turn around and flow out as revenue, we relieve that step-up. You see that normal return of Grant-Prideco inventory out the door as revenue and we make -- to make our financial results more comparable period to period to period and not be obscured by that purchase accounting complexity, we are reporting that separately as transaction cost.

All right and I assume that rolls out over a pretty short two quarters, three quarters?

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

We have time for one last question and that final question will come from the line of Dan Pickering with Tudor, Pickering and Holt. Please go ahead.

Good morning, guys.

Good morning, Dan.

I apologize if this question was asked. I had a little bit of trouble with the call. Pete, we are seeing some of your bit competitors, notably Smith, getting involved in directional side of the business. Is that something that NOV considers?

No. We -- you know we are going to provide the tools for that, Dan, and I think that it is important that we do that. We have the world's largest fleet of downhole motors and I think with our bits and ReedHycalog and what we do with Monell collars we're going to supply those to the Halliburtons, to the Weatherfords, to the Schlumbergers of the world and even quite often to the Smiths on the override. We believe being the manufacturer of that and having the capability to service those tools and to take care of our customers puts us in a much better position to prosper. I quite frankly don't especially like the prospect of going directly up against Schlumberger. They are a very big company, but they are also a heck of a customer. Our business model is to be the provider and the supporter of these tools, but to leave the directional drilling business itself to our customers. Plus, it gives us a lot more customers out there, because while you have got the big four, you have also got all kinds of smaller directional drilling companies that come to us for the support. So we think it is a much better business model for us.

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

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

Fantastic, thank you.

Thanks, Dan.

Thanks, Dan

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

I would like to thank everybody at National Oilwell Varco, all of our employees, the new joiners from Grant-Prideco and the callers listening in today. We look forward to talking to you at the end of third quarter. Thank you very much for your interest.

Thank you, management. Ladies and gentlemen, at this time, we will conclude today's teleconference presentation for the National Oilwell Varco Q2 2008 earnings release conference call. We thank you for your participation on today's presentation. If you would like to listen to a replay of today's conference call, you may do so by dialing 303-590-3000 and entering the access number 11116555 followed by the # sign. Once again, if you would like to listen to replay of today's conference, please do so by dialing 303-590-3000 with the access code of 11116555 followed by the # sign. We thank you for your participation on today's conference call. At this time, we will conclude. You may now disconnect and thank you for using AT&T teleconference.