國民油井華高 (NOV) 2009 Q3 法說會逐字稿

Good morning, ladies and gentlemen. And welcome to the National Oilwell Varco third quarter 2009 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Mr. Pete Miller. Mr. Miller, you may begin.

Thanks, and good morning and welcome to the National Oilwell Varco third quarter 2009 earnings conference call. I'm Pete Miller, CEO with National Oilwell Varco and with me on the call today is Clay Williams, our Chief Financial Officer. Loren Singletary who is normally on the call is currently traveling overseas on business and will not be with us today.

Earlier today we announced earnings in the third quarter of $385 million, or $0.92 a share on revenues of $3.1 billion. This compares to earnings of $1.31 a share on revenue of $3.6 billion in Q3 2008, and $0.53 a share on revenues of $3 billion last quarter. We are very pleased with the excellent work put forth by employees in this challenging time to achieve these results.

Additionally, we announced a quarter ending backlog of $7.3 billion, down from $8.7 billion at the end of the second quarter. I will expand on both operations and backlog later in this call and discuss some opportunities that look very promising and exciting over the near term for our order intake. At this time I would like to turn the call over to Clay to give you some color on our quarterly results.

Thank you, Pete. Before I begin this discussion of National Oilwell Varco's financial results for its third quarter ended September 30th, 2009, please note that some of the statements we make during this call may contain forecasts, projections and estimates including but not limited to comments about our outlook for the Company's business. These are forward-looking statements within the meaning of the Federal Securities Laws, based on limited information as of today, which is subject to change. They are subject to risks and uncertainties and actual results may differ materially. No one should assume that these forward-looking statements remain valid later in the year.

I refer to you the latest Forms 10k and 10-Q National Oilwell Varco has on file with the Securities and Exchange Commission for a more detailed discussion of the major risk factors you affecting our business. Further information regarding these as well as supplemental financial and operating information may be found within our press release on our website at www.nov. com or in our filings with the SEC.

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

National Oilwell Varco earned $385 million or $0.92 per fully diluted share on $3.1 billion in revenue in its third quarter ended September 30th, 2009. Once again, National Oilwell Varco benefited from outstanding execution by the Rig Technology group, which posted record margins during the third quarter, while our activity driven Petroleum Services and Supplies and Distribution Services groups continued to skillfully navigate the choppy waters of low rig counts and high pricing pressures producing good results in view of a very tough market.

Third quarter consolidated revenues improved 3% from the second quarter, but fell 15% from the third quarter of 2008 when the worldwide rig count was 39% higher. Operating profit was $618 million, excluding $17 million in pretax transaction and restructuring charges in the third quarter. Operating margins were 20%, up slightly from the second quarter pro forma results excluding charges and down 270 basis points from year ago levels. Operating leverage or flow through was up 38% from the second quarter to the third and down 38% from the prior year quarter.

Our backlog for capital equipment sales within our Rig Technology group declined 15% to $7.3 billion at September 30th from its June 30th levels. Gross orders were $333 million, which included some jackup equipment but no floaters. Orders were partially offset by total cancellations out of backlog of $72 million including some small capital equipment items but mostly due to reductions of scope on a few large offshore projects. Specifically we agreed to permit a shipyard to execute lower margin derrick erection work to improve project efficiency.

Overall, we view approximately $334 million of our backlog, about 5%, as being in arrears and at risk and have seen a total of $306 million cancelled over the past 12 months, about 3% of our peak backlog of $11.8 billion a year ago. This compares to gross orders of a little over $2 billion during the past 12 months. Needless to say, recent orders have been frustratingly slow. Long awaited tenders from Brazil have proven more languid than we expected when we started the year, stumbling through very tough credit markets and rising local content stipulations, despite a high level of resolve by Petrobras following their spectacular deepwater discoveries in the Santos Basin.

But we have good news to report. In mid September, the executive board of Petrobras formally approved a company strategy to build up to 28 new ultra deep water rigs and tenders were finally issued for these a week ago Friday. Specifically, seven drill ships and two semi submersible tenders were provided to Brazilian shipyards for rigs to be purchased and owned by Petrobras. Additionally tenders for new floaters to be purchased and owned by drilling contractors were also sent to 15 companies for new rigs to be predominantly constructed in Brazil. Bids on these are due back to Petrobras late in the first quarter of 2010 and we expect that NOV and/or our competitors will begin to see the first contracts flow into our backlog for these tenders sometime in mid-2010 probably beginning in the third quarter. Although this is later than we expected and as a result, we will fall short of our earlier 2009 guidance, we are nevertheless very pleased to see concrete progress on this long awaited event.

In the meantime, we continue to pursue booking a handful of orders for other new deepwater rigs from Brazil from the 12 new rigs awarded term contracts in 2008 but these also continue to face financing challenges. We have seen some progress with these and may be able to book some or all of these in the fourth quarter this year and will let you know on an update again in our next call. We are confident that NOV will continue to play an important role in the construction of the necessary tools to develop Brazilian deepwater resources and our team is ready to help. We are working to expand our in-country presence through a combination of acquisitions and greenfield expansions to supplement our existing capabilities which include one of our technical colleges [Amacaa] where we train Brazilian professionals to maintain and repair sophisticated NOV drilling equipment. We are confident that we will be able to achieve the local content goals of our customers on these projects which escalate from 20% to 50% through the progression of the new program.

We also continue to pursue new offshore rig construction opportunities outside of Brazil for additional floaters, jackups, well intervention vessels and FPSOs. Urgency around these projects is considerably less than we enjoyed over the past few years but we expect orders to begin to flow at some point. Despite some thawing in credit, our customers continue to face deep headwinds in securing structured financing. Specifically, we see banks requiring much higher levels of equity in projects, typically 25% to 30% and export and trade financing agencies of many governments are now requiring term contracts from oil and gas companies before issuing guarantees on new rig construction projects. The recovery of the credit markets is proceeding at a decidedly glacial pace but we nevertheless do see progress.

Land rig inquiries remain low at least outside of the Middle East. We are very pleased with the performance of our new Drake rig design in the Marcellus Shale and more broadly with the gradual recognition by oil and gas companies of the superior performance of modern AC rigs that we've delivered. Generally higher utilization and day rates for newer land rigs vis-a-vis older rigs confirm a growing market preference for the safety and efficiency of modern technology Nevertheless we have seen scarce few domestic land rig buyers, although a few domestic tire kickers have checked in with us espousing the possibility of a 2010 North American recovery.

Our backlog continues to give us great visibility into coming quarters. We expect Q4 shipments out of backlog to total about $1.3 billion, down from Q3, which would bring our full year revenues out of backlog to about $6 billion. As of September 30th, we had orders scheduled to ship in 2010 totaling about $4.7 billion and another $1.3 billion scheduled to go out in 2011. 89% of our backlog is offshore equipment and 11% is land, which tends to turn much more quickly since it is not gated by whole construction schedules in a shipyard. 93% is for international locations and only 7% is for the US.

Execution of the backlog has been outstanding. And led to exceptional margin performance for our Rig Technology group in the third quarter. The execution of projects benefited from two distinct factors this quarter. First, we are now well up the learning curve on building and commissioning rigs replicating those built earlier in the cycle. Repeat work enables us to apply lessons learned and produce increasingly better efficiencies.

Second, we have benefited from deflation in certain inputs and somewhat better FX movements, reducing our estimated costs to complete these projects. As we update our cost estimates each month we see continual improvement through 2009. Softer demand has produced mounting pricing pressures for rig equipment and we have seen pricing decline 10% to 15 % for offshore equipment and 15% to 20% for land rigs compared to last year. Thankfully, though, better execution, and cost experience has enabled us to offset some but not all of the recent price pressure.

Our Service businesses face tough market conditions but are generally holding up well due to prudent cost reductions and smart decisions by the experienced NOV managers we have grateful to have at the helms of these businesses. Pricing pressures continued through the third quarter despite a modest balance in North American rig counts and most product lines have seen pricing fall by 30% or more since last year.

Our Distribution Services group continues to squeak out good margins, considering the market, due to a high level of commitment and energy to service the needs of our customers.

Our Petroleum Services and Supplies group manufacturers and sells many of the critical consumables into drilling operations but with the worldwide rig count down nearly 1,400 rigs from last year, our customers are generally sitting on more than adequate supplies of these. Several businesses within Petroleum Services and Supplies carried backlogs into the year that had drifted down as customers have redeployed consumables and drill pipe from idled rigs or turned in rental equipment to us in lieu of utilizing fleets of equipment that they already own. Business has become much more hand to mouth as we have moved through the year. However, most product lines seem to find a bottom on pricing during the third quarter. Generally, leading to a little more margin stability as we enter the fourth quarter.

The worldwide oil and gas machine eats equipment every day. Growth for our Petroleum Services and Supplies manufacturing businesses will come when either, A, the grind of day-to-day consumption steadily cuts inventory overhangs or B a broad recovery of drilling activity accelerates the rate at which the machine is eating. Recent improvements in North American gas prices and amazingly high oil prices of late certainly increase the possibility of scenario B if prices are sustained but we remain cautious in our outlook owing to the possibility of further broad economic weakness. We don't know precisely how much excess supply our customers have. But we believe most oil field consumables probably need at least a few more quarters at current activity levels to dissipate.

In the meantime, quietly at work in the background is the steady application of new technologies to both conventional plays and unconventional shales. It is highly noteworthy that the horizontal and directional drilling now accounts for 62% of the US rig count, compared to only 38% five years ago. Bending the drill string around a 90-degree angle places dramatically higher stresses on the downhole tools and tends to wear them out at a much faster rate Bits, drilling motors, nonmagnetic drill collars, drill pipe, coil tubing, all hardware in which NOV has quietly built leading positions bear the brunt of this but are also the necessary hardware required to apply these new technologies. The result is a well bore that may cost two or three times more than a vertical well but they can deliver three to five times more oil and gas.

The Company continued to reduce cost through the third quarter with SG&A declining another 3% following the 10% drop in the second quarter, despite higher revenues. As the year has unfolded, we have been able to reduce personnel expense, travel and outside service cost by about $140 million a quarter. About half of the $17 million in third quarter transaction and restructuring charges relates to the restructuring of our manufacturing base reflective of our desire to use this downturn to continue to become more efficient and productive across all of our plans.

Finally, we have continued to energetically pursue corporate transactions through the third quarter having signed two acquisitions which are expected to close during Q4, in addition to some smaller transactions and have five letters of intent to acquire smaller businesses as well. In particular, we were very pleased to close our joint venture with Schlumberger on our proprietary IntelliServ technology which extends high speed two way Broadband communications down hole through wired drill pipe, replacing rickety morse code MWD mud pulse telemetry systems with a new information super highway. We are delighted with our new partnership and anxious to get to work.

NOV remains exceptionally well positioned and well capitalized with $3.2 billion in cash at September 30th, a $2 billion revolving line of credit, and a wealth of practical integration experience honed over many years and dozens and dozens of acquisitions to tackle the opportunities that are arising during this time. 2009 continues to be a challenging year with no clear recovery in sight but we are grateful to work every day with smart, decisive, experienced leaders who deliver solid results through all kinds of weather.

Now let me turn to our segment operating results. Rig Technology posted revenues of $2 billion in the third quarter, up 4% both sequentially and year-over-year. Operating profit was $579 million, yielding operating margins for the group of 29%. Incremental leverage or flow-through was 52% from the second quarter and 105% from the third quarter of last year. Revenue out of backlog of $1.6 billion increased 12% sequentially and 17% year-over-year. Third quarter aftermarket sales and services which accounts for about 17% of the group's mix, were flat with the second quarter but small capital equipment sales fell sharply from the second quarter to the third. Approximately two-thirds of the group's aftermarket revenues are derived from offshore markets and one-third from land.

The group produced great results in the quarter. Seven new offshore rigs were delivered, bringing our total to 66 delivered so far this cycle. National Oilwell Varco has nearly 600 professionals rigging up a total of 33 new offshore rigs presently in 14 different shipyards. We continue to see favorable cost variances on projects as they were closed out due to efficiency and learning curve effects and cost estimate revisions on projects in progress contributed to the strong results.

Pricing pressures are mounting and day-to-day expenditures on both CapEx and OpEx for rigs still remains very tight. Lower demand has reduced production volumes in many of our factories compared to the high levels of last year. Many are running 50% to 70% of 2008 levels prompting the group to redouble its efforts to improve efficiency through lean manufacturing and QRN techniques to drive further product standardization and to insource to utilize slack NOV machine time to improve absorption.

Demand for pressure pumping and coil tubing in North America remains weak but a handful of international markets like North Africa, India and China appear to be picking up, albeit at lower pricing. Wireline equipment demand has remained steady for international markets. The group is bidding a number of North Sea platform upgrades and FPSO projects for cranes, riser pull systems, offloading and Mooring equipment although we don't expect many of these orders to be placed until 2010. Looking into the fourth quarter, we expect Rig Technology revenues to decline in the high single digit percent range, at higher decrementals, producing operating margins in the mid-20s.

The Petroleum Services & Supplies segment generated total sales of $882 million in the third quarter of 2009, down 3% from the second quarter and down 33% from the third quarter of 2008. Operating profit was $86 million, excluding transaction and restructuring charges, down $10 million from the second quarter on the same basis. Third quarter operating margins dropped to 9.8%, down 70 basis points from the second quarter. Sequential decremental leverage or flow-through was 32%, and year-over-year decrementals ran 57% excluding charges reflective of the significant year-over-year discounting in the group's business.

Almost all product lines within Petroleum Services & Supplies posted low single digit sales declines in the third quarter as compared to the second quarter as customer spending remains subdued. Sales of bits and down hole tools improved in North America but international demand for these fell in the third quarter and in you Saudi Arabia and Europe, driving sequentially lower results.

Drill pipe revenues were roughly flat with the second quarter but margins improved due to more favorable mix of premium pipe for new offshore rigs and lower steel costs. Drill pipe backlog and sales are expected to continue to decline due to the current oversupply which is not likely to turn around before the second half of 2010. Lower drill pipe demand also reduced drill pipe coating and inspection services at high decremental margins. Well site services and coil tubing posted slightly lower margins on lower solids control equipment and string sales and increased discounting. Overall the Petroleum Services & Supplies group generated approximately 42% of its total revenue from North American markets and 58% from international markets. Within the international portion, declining sales to Europe and Russia were offset by growth in the Middle East, Africa and Latin America.

Looking into the fourth quarter of 2009, we expect Petroleum Services & Supplies to decline modestly again as improvements in down hole tools, coil tubing and other modest product sales increases fail to fully offset expected declines in drill pipe revenues. We expect margins to stabilize in the high single digit range.

Sales and Distribution Services totaled $306 million for the third quarter, about flat with the second quarter and down 39% from the third quarter of 2008. Operating profit was $7 million, down $3 million from the second quarter and operating margins were 2.3%, down 100 basis points from the second quarter. The sequential decline in profitability arose from lower pricing, a decrease in supplier rebates on falling annual sales volumes and lower margins on industrial products and artificial lift. Compared to the third quarter of 2008, decrementals third quarter leverage was 19% on the 38% sales decline.

Domestic sales were roughly flat sequentially but Canada increased nicely emerging from seasonal break up and good incrementals. Total North American revenue mix grew slightly overall, sequentially, to 71% and international sales declined sequentially and accounted for 29% of the group's third quarter revenue. Pricing pressures appear to be stabilizing across North America but many operators are bidding out much more of their work which had enabled the group to win some incremental MRO contracts during the quarter. Not surprisingly, unconventional shale plays in the Marcellus, Haynesville and Bakken are some of the most active North American markets and the group continues to expand its presence in these areas as well as expand in Russia.

Artificial lift sales into Mexico are expected to pick up in Q4 after a third quarter pause. Activity in Argentina was hindered by labor issues which affected both distribution and Petroleum Services & Supplies in the third quarter. For the fourth quarter we expect Distribution Services revenue to improve in the low single digit percent range at modestly margins.

Turning to National Oilwell Varco's consolidated third quarter income statement, overall gross margins were flat with the second quarter at 29.1%. SG&A declined $9 million sequentially to 9.1% of revenues, compared to 9.6% in the second quarter. Equity income in our Voest-Alpine joint venture declined $15 million sequentially to $1 million on sharply lower OCTG volumes and pricing and we expect the equity earnings from this unconsolidated entity to slip to a small loss the fourth quarter. Other expense improved $25 million, on lower FX expense which was a $6 million debit in the third quarter, in addition to bank fees and other items on this line totaling about $7 million in Q3.

The tax rate for the third quarter was 33.2%, slightly above our guidance of 32% due to prior year return to provision adjustments and other discrete items. We expect the tax rate in the 32% to 33% range in the fourth quarter. Unallocated expenses and eliminations on our supplemental segment schedule was $54 million in the third quarter roughly flat with prior periods. Depreciation and amortization was $126 million in the third quarter, up $4 million from the second quarter, and CapEx declined again to $43 million, down another $21 million sequentially. We continue to guide our CapEx downward for the full year, and expect to end up below $250 million for 2009.

EBITDA was $734 million in the quarter, excluding transaction and restructuring charges, up about 7% sequentially. NOV September 30th, 2009 balance sheet employed working capital excluding cash and debt of $2.2 billion, down $230 million from June 30th. Working capital on this basis equaled 17.8% of annualized revenue, down from the second quarter. Customer financing on projects in the form of prepayments and billings in excess of cost in excess of billings was $1.4 billion at September 30th, down about $600 million sequentially due to increase in revenues out of backlog during the third quarter. Cash flow from operations for the third quarter was $684 million, and less CapEx of $43 million, yielded free cash flow for the quarter of $641.(Sic) Year-to-date cash flow from operations is $1.969 billion. Now let me turn it back to Pete.

Thanks, Clay. I'd like to take this opportunity to just make a few brief remarks about our operations, some of the things going on around the and world and our market perspective. First off on our operational aspect of things, the key for us is geographic flexibility. As you look at our distribution, folks, we've been able to follow our customers, get into the shale plays where needed. Most recently we opened up a few new facilities in the Marcellus which we think is going to expand dramatically over the next couple of years and the deepwater plays are finally starting to come into fruition in places, especially in the Gulf of Mexico. And, of course, you'll see that expand around the world as we deliver many more of these deepwater rigs that we're currently building. So the key for us in Distribution is to be able to maintain following our customers geographically, maintain variable cost at the highest level, fixed cost at the lowest level and be able to give our customers what they need.

On the PS and S side, our Petroleum Services and Supplies, it's really about new product development and it's about providing the services and tools that our customers need. I think you're seeing us do that and as you see some of the folks are talking about 2010 being a more robust year, we hear the drilling contractors talking about having a little more optimism. And as those customers and our other service customers like Schlumberger and the other service companies expand their role in this drilling philosophy we'll be able to absolutely add equipment to that. But the big thing for that is new product development.

This quarter we're opening up our new drill pipe research facility that's going to be located here in Houston. We continue to push the envelope on product development because that really is going to be the key to anything. I don't care if you're talking about a drilling rig, Distribution Services concepts or our Petroleum Services & Supplies. I think having those new products out there being able to enhance the efficiency of the shale wells and also being able to enhance the efficiency of the deepwater wells is really what's going to be critical for us in that and we're pushing ahead quite well in those areas.

In our rig equipment, it's really about execution and I think as you take a look and you see the numbers that we've talked about here this morning, our rig folks know how to execute. We've been able to take stuff out of backlog at very good prices and very good margins. As you look at this, anybody can put anything into backlog. You can take stuff at almost no margin and put it into backlog. It's the execution for getting it out to backlog profitably that makes all the difference.

I think you can see from the results that we've been telling you about that our folks in our Rig Technology group have done a phenomenal job of not only obtaining backlog but making sure that they monetize that backlog appropriately. For that, we're very, very pleased. That's really the state of our operations. Our folks are working very, very well. We feel very good about our position in the market and our ability to execute and deliver to our customers.

Let me talk just a moment about our market perspective. Again, we're cautiously optimistic. Listening to a lot of the drilling contractors conference calls this quarter and of course with my visits with them, I think they're feeling a little bit better about the jackup market and some other areas. And, of course, if our customers are feeling better, quite frankly, we're feeling better. I think we're cautiously optimistic about things. Specifically, the Gulf of Mexico looks like it might pick up and especially in some of the smaller jackup arenas. As that happens, that really helps us in both the PS&S and Distribution Services side of the business. So I think you could see some improvement there.

What we're seeing around the world that's very positive is a lot of the financing that's being done to help us and help some of our customers with these major products. In particular, is [Giat] which is Norwegian financing group. You have the XM Bank in the United States, the China development bank and the Korean development bank. These are all banks that are actively trying to finance projects as long as a lot of the manufacturing is done within the confines of those countries and quite frankly the neat thing for us is we're in all those countries. And we've got facilities that can hit the local content rules and be able to position ourselves to competitively take advantage of this -- of these projects and put ourselves in great competitive position.

The biggest risk for us of course is going to be the worldwide economy. I think we've seen what's happened in the past year. Last October, it was very disastrous. We've been pulling out of this for the last year. I think the speed with which the GDPs on every country that's out there pulls out of it will dictate what happens to the marketplace in the long run. But we're cautiously optimistic. We do think that we probably hit bottom but I will say that especially as we trough and things like our Petroleum Services and Supplies and Distribution, that doesn't mean you're bouncing up. That just means you've troughed out. That's where we are in the market.

Let me take you around the world a little bit, tell you what we're seeing. I'll start with South and Central America. Brazil, as a matter of fact. Clay mentioned earlier some of the great opportunities we see down there but I'll also expand a little bit. The other thing we're doing is we continue to make sure that our presence in Brazil is significant. Currently we have over 700 employees in the country. We just recently purchased some land in (inaudible) that's very close to (inaudible)which is one of the larger shipyards in the area. And we will continue to expand our presence in Brazil because we think not only is that going to be a good environment for capital equipment expenditures but it's also going to be a place where we're going to be supporting the offshore industry for the next 30 years. With their intent to drill so many deep presalt wells and other deepwater wells out there, having a great footprint there makes a lot of sense. We see Brazil as a great area.

Mexico continues to be very positive, whether it's (inaudible) or the Burgos basin. We have facilities there throughout all of our operations that take advantage and support our customers. That take advantage of the business environment and support our customers and we feel very comfortable that that -- those two markets are going to be positive in the near term.

The Middle East is pretty steady. I think with the oil price increasing, we've had some positive things in Kuwait. We're expanding our operations in Kuwait. We're actually using that as a jump-off point to take care of some of the operations that are ongoing in Iraq. We think that North Africa, Algeria, Libya and Egypt continue to have projects and continue to need, especially in the services side of the business, a lot of the things that we have and I think the natural gas that's coming out of those areas and their ability to hopefully be able to build pipelines that will go into southern Europe with that natural gas will be very interesting in the long run.

Another one that's cropped up on our scope here recently has been India. India's been very positive. I think much like Brazil, they really want to develop a little bit of their own internal oil and gas business. While a lot of the international contractors drilling in the offshore arena, we're seeing more and more opportunities for land rigs in owes areas. Today we currently have some manufacturing in India but we continue to expand our footprint in those areas to be able to take advantage of what's going on.

Russia, we're going to open up a facility Nizhnevartovsk in this quarter. It's a little slower but again, it comes back to the potential element there. We have some good operations out on the Sakhalin Island and, of course, as over the next year or so we'll be delivering some of the larger rigs that are going to be going into the Bering Sea sea to drill some of the arctic environment up there.

China, again, a very exciting arena for us. I think the shipyards there will stay reasonably active and especially trying to develop a little bit more of their internal oil and gas structure. Of course, we have some great facilities in China and I think you see the Chinese moving around the world today, trying to take up a lot of the oil capacity and they want to do as much as they can locally also and so we're positioned to be able to take advantage of that.

And finally, it comes back to North America and I think when you get into North America, it's a tough game and the natural gas business, I'm probably not telling anything to anybody on this call, it's pretty tough right now with the pricing and things but we believe that natural gas can play a heck of an important role I think in the energy security of this country. When you start talking about carbon, I think natural gas is a wonderful antidote to some of the carbon issues. We're cautiously optimistic that you'll see more and more positive things happening with natural gas and then with our ability to be able to drill these shales, we think it will be something that will be exciting as we extend out into the future. That's really where we are in the world.

Just a couple of other quick notes to make. We're excited about the opportunities in Brazil. We're excited about some other opportunities around the world, whether it's in the arctic areas, and some other things. So it's not a one trick pony at this point in time. There are other opportunities out there and we're pursuing them very aggressively and we like where we are in the business. And then finally, we completed as Clay mentioned earlier our JV on IntelliServ this quarter with Schlumberger and we're really excited about this. I think that this technology can really do some very, very unique things in the industry and the speed with which it can get information both going down the hole and coming back up the hole is pretty incredible. So we're excited about it. We have kicked it off. The management team is in place and we push forward from here. And we think it's ging to be pretty exciting. So that's just some quick comments on operations and what we see around the world in the market perspective. And at this time, I'd like to turn it over to any questions that any of our listeners might have.

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from Marshall Atkins from Raymond James.

Good morning, gentlemen. I'm going to leave it up to the next five guys to ask you about your backlog ten different ways. I want to hear about your M&A stuff. It seems to me this is going to be a key part of the story going forward. I mean, you had phenomenal free cash flow. I would expect you guys obviously to put that to work through acquisitions. So Clay, I know you mentioned and you were going pretty fast there, five letters of intent on small companies. But could you spend a little more time, walk us through what you've done to staff up in this area, walk us through the opportunities you're seeing, the relative valuations, et cetera. I don't need specifics but just generically how things look, are you going to have opportunities, are you going to be able to spend the cash you have on acquisitions?

You bet. Great question, Marshall, and this started about a year ago as the financial markets were melting down and Lehman and Bear Stearns and others were facing their problems. We recognized that there were likely to be some pretty extraordinary opportunities come out of this time so as a result, about this time last year we increased our staff in this area. We now have a full-time staff of four professionals that pursue M&A opportunities. We also went through their list and sought to high grade it to lop off some of the smaller things at the bottom that were less impactful on NOV. And went out to try to act when the future looked very uncertain. And they've been very, very busy.

And I'll stress, we have an excellent, excellent team, all four of these folks do a great job and we're very proud of the job that they've done. It's an awful lot of work, bringing any one of these transactions over the goal line and for every one that we bring to closure, we typically have to queue up about a half dozen, six or seven statistically that we look at and do some level of due diligence on so it's a lot of effort that goes into this. Inclusive of deals that we've closed earlier this year, plus the two that we signed that we expect to close here in the next few weeks, plus the five letters of intent, we expect to put about $600 million in capital to work through this effort this year. And so it's a really good effort. That's probably double from what we did in 2008. And the returns are very, very good with this application of capital. We're able to kind of the all in run rate EBITDA after cost savings that we think we're buying at is probably just a shade over four times and that equates with a return on capital in the low to mid-teens for us. We think a very good application of capital.

The challenge that we face as you point out is that our free cash flow has been so strong and it's really outpaced our effort in this area. So since the beginning of the year, we've seen our cash balances grow by about $1.6 billion this year and again, expect to put about $600 million to work through this effort. So to increase the pace of applying capital in this area, we've had a number of discussion was larger companies and probably half a dozen significant sized proposals that we made on the order of plus, minus $1 billion. So far, none of those have come to fruition. Those tend to take much longer, be more competitive and are harder to make sure we execute in a way that's accretive and a good deal for our shareholders but we continue to work on getting one or more of those over the goal line in the meantime.

But we think NOV's unique in the fact that we view M&A as a full-time endeavor. We have a full-time staff employed. This is all they do so it makes this dispassionate and objective when it comes to looking at opportunities. And we're always in the market. We also have a terrific operations staff that has closed and integrated an awful lot of transactions too so when it comes to integrating these acquisitions we have a very high level of competitive advantage there. This is our preferred application of capital and we hope to see more capital go to work through this pipeline.

One quick follow-up. The IntelliServ sale or partial sale I guess, JV, how much cash did you get for that and did you book any profits for that?

Under GAAP rules we did not book any profits related to that. That's just a change in our additional paid in capital on our balance sheet and we agreed with our partner there that we weren't going to disclose what was paid for that.

All right. Thanks.

Thanks, Marshall.

Our next question comes from Jeff Herbert from Weedon.

Thanks, good morning.

Good morning, Jeff.

I'll take the bait and ask about your backlog. Can you help us understand why things didn't turn out the way you expected in 2009? I think your -- you did mention that the Petrobras tenders are out based on a Board meeting in mid-September but you're not expecting orders from that to materialize until the third quarter of 2010. So presumably something else was really behind your expectations for 2009 that didn't materialize.

Yes, Jeff, I mean I think it's a combination of factors and what you have in an environment like this which isn't really all that uncommon, is you see more and more projects moving to the right. I could name four or five major projects that have looked like we're going to come to you fruition in '09 that just didn't and they moved out. That's the bad news but that's always the difficulty you have on prognosticating about backlog. The if a customers orders it on the 20th of September or the tenth of October, it doesn't matter a lot to them but it matters a lot to us because we have a cutoff date on the 30th of September. So you have a date certain whereas If they move it out, it doesn't matter.

What we worry about are project cancellations. We haven't seen much of that. We're seeing stuff pushed to the right. There have been some things in the Caspian Sea we thought were going to happen, that didn't happen in the timeframe within which we though they were going to happen that are pushed out. We've had a couple of projects that we've been working very diligently on that we thought might get signed in September, probably won't be signed -- well, they didn't. They'll be signed in October, November, maybe into January which at the end of the day doesn't bother us a whole heck of a lot other than the fact that we have to report the backlog when we do the earnings conference call.

That's really what has been happening. It's been more of a process of things moving to the right. It's a guessing game. We get with our sales folks and we take a look and we said okay what are the projects you think are coming to fruition here. Let's take a look at different things. As we look at it, we put a date on it. That makes us think, here's what's happening. If the customers decide to push those out for whatever reason, there's not much we can do there.

The other thing, I think this is important. Our backlog is exceedingly conservative. There's nothing notional in it and that's one of the reasons that you've seen a very, very low degree of cancellations. I remember a year ago listening to some people saying oh, the cancellations are going to be enormous when in fact they weren't. We make sure before something goes into backlog that it is fully financed, that we have down payments on it, and that we have the visibility to see what it's really a deal as opposed to maybe just a notional or LOI type deal.

That's where we are, Jeff. Just things moving to the right a little bit on us but they're going to be there and we feel good about them in the future.

Jeff, also worth adding. When we came into the year we were very clear that a lot depended on what happened in Brazil and added that to our guidance. And what has happened in Brazil is that the definition of local content requirements and the reforms being considered in the way blocks are managed by the Federal Government and ANP in Brazil I think has added some delays.

Additionally the credit markets as we've mentioned have been pretty tough. Probably worth noting, I think this was in my opening remarks that banks are requiring higher level of equity participation by some of the drilling partners in these projects. It's one thing to negotiate with the bank and we believe the credit markets are freeing up, but when they add additional requirements for larger equity participation, some of our customers are bringing in partners so the discussions take on a whole new set of dynamics. They have to work out shareholder agreements and prenuptial agreements. So an equity investment just take a lot longer to bring to fruition. I think that added headwind which is a derivative of the state of the credit markets, has delayed things a little more than we expected as we came into the year.

I think you've addressed this in your comments. It doesn't sound like there is anything on the table in the beginning of the year that has fallen off, that's really material. Am I understanding what your comment correctly?

Absolutely. As we take a look at this, Jeff, there has not been anything that people have said that well we're just flat not going to do it anymore. Because most of these projects are pretty viable and especially internationally when you're looking at today's oil price. There really hasn't been anything that's fallen off the table. It's just a question of timing.

In terms of the timing sort of slippage, I'm going to guess you're not going to make a 2010 order forecast but --

That's a real good guess.

But are we -- can you generalize about the slippage? Are we talking about a quarter or a year in terms of slippage? Taking into account credit market conditions and everything you've already mentioned.

It's almost -- it almost is slippage that goes on a project by project basis, Jeff. I'd have to break it down completely and say well, here's one in the arctic that we think is going to happen here and one here is going to slip out another quarter or so. But I think the only way just to generalize, there's going to be slippage but there's not really going to be cancellation of these particular projects. They don't have any orders with us. I don't want to say cancellation. Sounds weird. There won't be a complete cancellation of these projects go forward at least as we can see now. Now if the price of oil goes to $20 a barrel, all bets are off on that. But, I think given the current market environment, there will be some general slippage but I think it will be very difficult to give you an absolute picture of that.

The key thing that you highlighted, Jeff, is that we're not losing a lot. That these projects just aren't being signed and so we're confident at some point they are going to be done.

And lastly, in terms of the local content requirements in Brazil, as they've changed and become a little bit clearer, are they going to cause NOV to need to make any increased investments in Brazil of significance?

Oh, I think the key is significance. I mean, the fact is, we've been investing in Brazil for quite some time and we'll continue to and you'll probably see us work a joint venture or two that will help us out. Not dissimilar to things that we've done in China over the years and things that we've done in Korea and other places over the years so we'll continue to do that. But the bottom line is there's not anything on the content requirements that gives us any pause. We'll be able to hit those and hit them very effectively and we're committed to helping the Brazilians advance their oil and gas business. So it should work out okay for us.

Thank you.

Our next question comes from Robin Shoemaker from CitiGroup.

Yes, good morning.

Good morning, Robin.

Hi. Wanted to ask about the direct -- directionally operating margins in Rig Technology and PS and S. Clay, you mentioned that probably you'll get less delivery from backlog in the fourth quarter, something like 1.3 versus 1.6 this quarter. I would normally assume that that's going to have the effect of lowering margins and as less product is delivered from backlog going forward, that that would continue to be the case but you've got some cost containment initiatives under way so what is your guidance if any about this high 20% operating margin you've achieved in this segment?

Robin, the comments that I just gave a second ago point you in the direction of that moving down in the fourth quarter closer to the mid 20% range is what we expect and it's a -- as you point out, obviously a big fall in revenue out of backlog from Q3 to Q4 based on what we're looking at now. Again, there's a possibility of over achieving as we have done last few quarters but based on what we're looking at now, we think $1.3 billion out of backlog is reasonable and that all rolls up to be high single digit decline in that segment in the fourth quarter vis-a-vis the third and we'll end up in the 25% or maybe 26% range if things hold to what we're forecasting.

Okay. Last -- I think you previously gave a projection for outflow from backlog in 2010 and '11 and if you gave an update of that I didn't hear it on this call. Do you have an updated estimate of backlog deliveries?

You bet. I can't recall what I said last time but right now based on our September 30th backlog we're expecting $4.7 billion in revenue in 2010, and $1.3 billion in revenue in 2011. So that's based on projects on the backlog as of September 30th. As we probably worth pointing out, I know you know this but others may not, as we win orders in the coming fourth quarter and into 2010, some of that can flow as revenue in 2010. So it may have some upward bias in it as the year unfolds.

Okay. And the lastly on this, the aftermarket I presume will now become a little more of higher percentage of Rig Technology revenue compared to what it has been. I think you said 17% in the third quarter.

Yes.

So have you got a sense now with the new generation of deepwater rigs, drill ships and semisubmersibles as to the kind of aftermarket opportunity that each of those types of rigs represents on an annual basis for NOV?

Robin, we don't have that yet and one of the reasons is a lot of them that we put out are running very, very well. We match that up with warranty reserves that we make and we look at the way that some of these are running. We think in the long term, it's probably going to be a pretty decent number, simply because the equipment that we're putting on these things is so much more complex. But we've been reluctant to take a stand at give a number on that simply because these new generation of rigs are so -- they're so new and they're so technically advanced that we just don't have a real handle yet on what that aftermarket's going to look like.

I see. Okay. All right. Thank you.

Thanks, Robin.

Our next question comes from Bill Herbert from Simmons & Company.

Thanks, good morning, guys.

Hey, Bill.

Pete, trying to look out a little bit here and contemplating the floater world ex-Petrobras. Once E and P companies, IOCs and select NOCs begin to believe that essentially $70, $80 crude is not (inaudible) and frankly could be conservative, what do you think is a reasonable normalized environment for floater related orders going forward? I mean, clearly we're not seeing anything now. We were in an environment of four to six per quarter. What do you think normalized going forward is?

Oh, that's always going to be a tough answer, Bill, simply because I think if you could say the price of oil was going to be in the $85 or $90 range and not [efemmoral] as you say, I think you could probably come up with a pretty decent handle. Unfortunately it moves pretty dramatically and I think that if you were to tell me okay, it's going to be pretty close to $80, $85, $90, the entire time, then I would tell you two or three coming in on a quarterly basis would not be abnormal.

And I know a lot of people look at that number and say gosh that seems like a lot, but look at the amount of water that you have around the world and I think especially as IOCs and some of the others want to really increase their own exploration efforts, I think the world needs a lot more of the deepwater rigs and then given the time frame to build these things, whether it's two and-a-half or three years or three to four years, I think having a normalized rate like that would make sense. Having said that, let me put the caveat on it. It's just all based on the price of oil and where you think the price of oil and gas is going.

Right. I guess where I'm trying to go is this. Petrobras has come out and again approved if you will of the additional 28 rigs that it's going to build. Assuming you get your call it 50% market share plus with regard to those, it's probably, I don't know, something approaching five Petrobras floaters per year. Let's be conservative and assume you get one additional floater outside of Petrobras per quarter. So call that four per year. You've got your call it run rate of $300 million to $350 million in non-floater related orders per quarter. That probably moves higher as well. In other words, getting to an environment where you're generating normalized orders of call it $3.5 billion per year, that's not necessarily illogical, is it?

Oh, no, not at all. As a matter of fact, I think we'll look back -- I mean, this has been an abnormal year and it's been an abnormal year not so much of the oil and gas business as much as worldwide economy and I think as you look to the future, I think looking at numbers like that is not abnormal. I think you start to throw in land rigs and you start to thing about the technological advances on land rigs, you start to think of the fact that the clock keeps ticking on rust. We've said this for a long time and we're adamant about it and I think you're going to see more jackup rigs that are going to be needed. We sold jackup equipment this quarter and the fact of the matter is that those are not I think abnormal numbers at all to project into the future.

Right. And Clay, when you distill that into an earnings number with TSS improving as well, conservatively, I don't know, 350 a year in earnings per share free cash flow north of a billion five per year, something like that?

The nice thing about us, we spend a lot of time sort of mesmerized by this backlog but the truth is that the business is much smoother than that. Orders are volatile, they're subject to cutoff. You look at our earnings and our cash flow because in particular these deepwater rigs are built over two or three or four years. The earnings performance is actually quite level and that makes it a much easier business to run.

I think worth noting with regard to the deepwater environment, a couple things. First, Petrobras has done an amazing job figuring outs how to drill through a lot of salt. As the world's population of wells that have successfully penetrated 6,000 feet of salt grows as they continue to drill down there, I think that technology is going to find its way into other basins so you're effectively opening up new frontier was that technology.

Secondly, as deepwater development progresses you build out infrastructure, you build out gathering systems such that the incremental cost of new fields in that basin, the economics look that much better because they're not having to carry the expense of laying a pipeline all the way to the beach. I think those two things along with other technological advancements in this space mean you are likely to see sort of an acceleration over the coming decade, plus, of interest in these deepwater environments. And that requires a lot of rigs and that's what we're here for.

I hear you. Thanks, guys.

Thanks.

This concludes today's call. I would now like to turn it over to Mr. Miller for closing remarks.

Thank you. We appreciate everybody calling in today and we look forward to talking to you next year when we report on our final results for the year and the fourth quarter. Thank you very much.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.