Weatherford International PLC (WFRD) 2002 Q2 法說會逐字稿

Please stand by for the commencement of the Weatherford International Ltd. teleconference, July 22, 2002. Good morning and welcome to the Weatherford conference call. All participants will be on a listen only status until the question and answer session of today's call. At the request of Weatherford, this conference is being recorded. If there are any objections, you may disconnect at this time. I would now like to turn the call over to Mr. Bernard Duroc-Danner. Sir, you may begin when ready.

Thank you, good morning. I'll say a few things, and then Lisa will give you some more background, and I'll close the presentation. Q2 was a good quarter considering it was both a cyclical and seasonal low in North America, and our R&D expenditure reached a new high. Setting aside the inversion fees and related costs of 2.2 cents, Q2 came in at 33 cents, between 2 and 3 cents below Q1. The 2 to 3 cents sequential drop from Q1 came from a combination of higher R&D, higher amortization expense and lower contributions from our Universal Compression Equity holdings. The EBITDA from operations sequentially was close to flat as the two geographic halves of our business moved in opposite directions and balanced one another out. Sequentially, our North American revenues declined $10 million with a $19 million drop in EBITDA. The EBITDA decline reflected seasonally high repair and maintenance costs. Which is not atypical for us in a second quarter. Two concurrent manufacturing consolidations at lifts, related to Johnson Screens and the full quarterly effect of the pricing trough reached in March, April. At the same time, our international revenues rose by $36 million, or 12% sequentially, with an $18 million increase in EBITDA, almost perfectly offsetting the North American decline. Our international incrementals of 50% were higher than expected. The technology segment defined by the aggregate of underbalance expandables optical sensing systems and drilling with casing rose to $68 million from $57 million in Q1, 2001. Q2's top line sets the high watermark for our young technology segment. Lisa will take you through more details on the quarter. After her review I will provide brief perspective comments. Lisa?

Good morning. I would like to start by providing further breakdown to the decline in our sequential earnings per share. As noted in the press release we reported diluted earnings per share of 31 cents as compared to first quarters results of 36 cents per share. The breakdown of our sequential earnings per share decline can be synthesized as follows: $4.5 million, or 2.2 cents per share of professional fees relating to our reincorporation were expensed in the quarter. This represents essentially all of the costs associated with this transaction. Increases in research and develop equated to more than one-half a cent. Future R&D increases are not likely to have as significant an impact on our sequential earnings per share. We are approaching our long-term R&D level absent significant change in the Company's makeup. Over one and a half cents is due to the higher depreciation and amortization which is almost exclusively due to our to our technology related investments, such as our Shell expandable license. Lastly, we experienced a one-half cent decline in the contribution from our investment in Universal Compression. Our operational EBITDA was actually flat. Our earnings per share was impacted by a three-cent seasonal decline in Canada and a five-cent decline in the U.S., both of which were mitigated by gains experienced internationally, primarily in the eastern hemisphere. Note although we have reincorporated, our tax rate is consistent with prior periods and does not reflect any benefits of the reincorporation.

Turning to our revenues, our second quarter revenues of $593.9 million represented an increase of $25.6 million from the prior quarter. Revenue composition shifted both geographically and divisionally. On a consolidated basis North American revenues declined 4% as compared to the first quarter. The U.S. revenues were approximately 1% lower, and Canada, which was impacted by spring breakups experienced a 9% decline. International revenues increased 12% sequentially. Every region outside of North America experienced top line growth. The Middle East and Asia-Pacific improvements were the most notable at 25% and 13% respectively.

Let me take a moment to discuss pricing, which is clearly critical to our performance over time. My focus here is on North American pricing, which is obviously the most subject to cyclical change. In the course of the North American cyclical decline, third quarter 2001 to second quarter 2002 pricing has evolved as follows: average pricing moved down 300 basis points in the fourth quarter, 275 basis points in the first quarter, troughing in the March-April time frame to produce an average decline of 200 basis points in this quarter. Second quarter EBITDA was $133.4 million as compared to $140.3 million in the first quarter. Due to the diverging divisional top line trends, a more meaningful analysis of revenue and the EBITDA revenue relationship can be made at the divisional level as opposed to at the consolidated level. The first Drilling and Intervention Services. Drilling and Intervention Services revenues were 1% lower than the first quarter. The international top line increased over 5% sequentially with the most significant gains occurring in the Middle East and Asia-Pacific regions. The international increases were offset by 28% decline in Canada and a 5% decline in the United States. This divisions EBITDA margin declined 211 basis points as a result of the troughing of North American pricing, and higher maintenance and repair expenses. Maintenance and repairs occurred in areas where we could take advantage of seasonally lower activity, which for Weatherford is not an atypical event. International EBITDA incrementals were significantly over 50%, which is outstanding.

Completion Systems. Incremental EBITDA, on incremental revenues was 40%. This gain primarily was due to strong performance in the Middle East where both revenues and EBITDA more than doubled. On a product line basis, expandable sales contributed to the incrementals with the highest level of sales in this product's history and high margins. Artificial lifts, sequential EBITDA and incremental percentage was 19, which was less than typical. This division's EBITDA was impacted by costs incurred for two concurrent manufacturing plant consolidations during the quarter, one in the U.S. and one in Europe. This division experienced sequential revenue growth in all regions, including Canada, despite the seasonal downturn. Furthermore, the revenue growth was across all product lines.

Turning to research and development, from this quarter forward R&D will be isolated from division performance, so you can see our divisional returns free of technology investments. The R&D costs burden the division managing the project. However, our investments often benefit multiple divisions. For your reference, the divisional R&D expenditures are provided in the supplemental information of the press release.

Now turning to the balance sheet. Our debt to capitalization ratio decreased 60 basis points from March 31st to June 30th. Total debt inclusive of $935 million of convertibles and net of cash was approximately $1.8 billion, and our assets securitization was $91 million as of June 30th. Stockholders' equity was approximately $2 billion. We incurred capital expenditures of $68 million this quarter, which includes international capital expenditures of $41 million and expenditures related to our enterprisewide J. D. Edwards software implementation of approximately $10 million. Our system implementation is on schedule and we will have all North American operations fully implemented within the next 9 months. Our full year 2002 capital projections remain at $250 million, with continued international and technology-focused expenditures. In the course of the quarter, we also paid $10 million for acquisitions.

On a go forward basis we will provide a lump sum amount for acquisitions quarterly. Although we understand that this is merely the beginning, we have begun to see the initial impact of our working capital initiative. Working capital days outstanding declined in the quarter in spite of a significantly higher percentage of international sales, which had the longer collection time line. One last note, from time to time we issue stock options as a very useful tool to attract high quality personnel and to reward employees who are promoted. Now, assuming the issuance of stock options at a rate in the second half of the year consistent with the number that we have issued in the first half of 2002, the non-cash impact of expensing the options under the fair value method of accounting for stock options, would be about two cents per share on our 2002 earnings per share. Now let's turn it back to Bernard.

Thanks, Lisa. My comments perspectively will be geographic, then I'll talk a little bit about technology. North America first, we expect our U.S. business volume to rise in the second half of the year. The rise would be slow at first, but absent a changing economy, the pace will pick up. Q4 is expected to show about a 15% higher US top line than Q2, and Q3 will be somewhere in between. West and South Texas should be the first segments to show improvements to be followed gradually by the other regions. Canada is expected to recover, but not quite to last year's second half levels. Specifically, we expect Canada to come short of 2001 by between 5 to 10% the second half of the year. The Canadian business mix should be different with more heavy oil than in 2000, 2001.

International segment. Throughout 2001 Weatherford's international business has grown at a higher rate than underlying rig activity which reflects the breadth of our footprint and the growth in technologies penetration. Q2 is more of the same. Our Q2 on Q1 international revenue growth was 12% while the international rig count activity actually declined marginally, less than 1%, a negative number in the same time period. Looking ahead to year end, we expect Latin America to remain flat. Our business in Argentina and Brazil will actually show improvement and Mexico will remain strong. But Venezuela, which is unusually weak already, is the wild card and could weaken further. A no growth expectation for our Latin American segment is therefore prudent.

By contrast, our eastern hemisphere prognosis is plain good. We expect our top line to continue to growth in Q3 and Q4 in Middle East, North Africa, Russia, Caspian and Far East. Two exceptions. West Africa and North Sea. Our West African business is not expected to grow significantly in the second half of the year until 2003 as projects are delayed. North Sea is waiting on the U K and Norway. Norway will be soft in Q3 for seasonal and labor-related reasons. And that actually comes on the back of no activity being down in the first half of this year. So, Q3, this quarter should be a trough in Norway and a very short trough, we think. Norway will reverse itself and grow considerably in Q4 and further in 2003. The U.K. is a similar prognosis but an altogether a different situation. The ongoing dispute between the U K government and existing operators is likely to suppress activity in Q4. Our best assessment is a possible 15% volume drop to occur late in Q3, early in Q4. If history is to guide us, the U K's North Sea trough in Q4 will be a one quarter event. We are likely to see settlement between the protagonists, activity declines reversed, and a strong catchup into 2003. Decline rates in the U K North Sea are steep. Production declines are quick to occur. This tends to limited the duration of activity declines. To summarize the prognosis for our eastern hemisphere sphere business Q3, Q4 and into 2003 is good. Basically, further volume growth. We expect continued growth in the eastern hemisphere to remain at substantially higher rates than underlying rig activity. Our Latin American business should be flat. 2003 should recover, but it's hard to feel any certainty at this time. Our North American prognosis is cautious, but definitely a recovery scenario. [INAUDIBLE] upside downside pressure test, the international segment has upside from the above assessment. But we know client commitments there in both our core and technology segments gives us confidence and optimism. Our Canadian prognosis feels just right as we ride both gas and heavy oil recovery. While the U.S. segment could have some downside if the recovery is pushed into 2003.

Technology. As a reminder, what we call technology segment at Weatherford are the step change, proprietary and new technologies and the young businesses, not the incremental technological improvements on core parts and service lines. Incremental innovations are part of the ongoing business. They are a cost of doing business. Our technology segment is essentially made up of expandables, underbalanced, optical sensing systems, or intelligent wells, and drilling with casing. Our focus here on expandables and underbalanced are obvious scale reasons, but we'll be happy to answer questions about optical sensing systems and drilling with casings. Expandables with $20.2 million had a strong quarter, in fact, their best quarter ever in their nine quarter history. The geographic spread for first time expandable installations grew by four countries. Algeria, Azerbaijan, Egypt and Venezuela. Closer to home, the Gulf of Mexico saw its first expandable sand screen installation. Decline roster spread widened also in error, Devin [INAUDIBLE]. Shell orders represented 25% of our installations in the first half of 2002. That's an unusually low number, incidentally. Second half will be higher than that.

Whereas the quarters revenues were entirely for expandable sand screen, there is product introductions and followups to prior product introductions to report. One. Following [INAUDIBLE] installation of our first expandable liner hanger last quarter, we have 12 expandable liner hangers on order as of now. Two. We successfully installed our very first expandable application for well remediation. Called metal skin, we effectively relined a severely corroded 250 feet of casing in northern California using our patented technology. This is an industry first. As happy as we are about the quarter's successful first time, metal skin expandable liner hangar, product introduction has miles and miles to go. There will be continued product process testing and introduction over the next three years and possibly longer. Expandable is a family of [INAUDIBLE] processes that has a ways to go and is truly in its infancy. Underbalanced is very well in the quarter with $45.8 million, up 13% sequentially, and up over 50% from Q1 2001 when we started tracking the underbalanced top line. Growth occurred almost exclusively in the eastern hemisphere. With the Middle East and Far East particularly strong

New products were started and/or are starting in Oman, Syria, Egypt, Algeria, China, Malaysia, Russia, North Sea and west Africa. The roster of new underbalanced clients has and is being lodged to include, I think, Conoco, [INAUDIBLE]. We expect the growth in our underbalanced systems to accelerate over the next 18 months. We believe at Weatherford that underbalanced and the family of processes coming out of it show me what it can do infancy to an execution phase. Where engineering and operating capabilities would rival the growth rate in this technology's adoption. A year ago, we would have said that the technology's legitimacy would have been our biggest threshold to overcome in the driver for growth. Not anymore. Our outlook for underbalanced is a multi year growth rate. Which we believe will parallel the horizontal directional market 10 years ago. Although there are still, and will be for a while, more changes to come in underbalanced technology, we view our biggest constraints to be people.

We also view our greatest risk underbalanced over the next 24 months to be allowing our growth rate to overwhelm or engineering and operating capabilities. Over the past quarters we have released detailed top-line information on expandables, underbalanced, et cetera. For reasons of reporting simplicity and competitive discretion, the latter being actually more important, we'd like to report from this point forward on a quality basis an aggregate number for the technology segment. The number would add underbalanced, expandables, optical sensing systems, and [INAUDIBLE] casing top-line and be presented as one number. We'll not change the [INAUDIBLE] definition without informing the public. These four product and process technologies are our most important and distinct step-change technologies. Again, they do not and will not include [INAUDIBLE] incremental technological innovations in our core product lines. Aggregate number for the [INAUDIBLE] step-change technologies in this quarter again, would have been $68 million, up from 57 in Q1. Lisa can help anyone on the call with historical information as need be.

One last point on inversion. Weatherford is operating as a Bermuda based corporation effective June 26, 2002. We have not changed our reported tax rate as of yet. We are waiting for Congressional decisions, if any, to be finalized. With that I'll open the conference call for questions. And if you could, please limit one question per person. Thank you. Operator, you might want to take over.

Thank you. At this time we are now ready for the question and answer session of today's call. If you'd like to ask a question, please press star one. Once again, if you'd like to ask a question, please press star one. We'll wait a moment for questions to come up. Our first question comes from Dan Eggert.

Good morning. I guess first question, or my only question, is with the underbalanced business, could you give us a little more color on the break down between domestic and international business? It sound like international is picking up. And then extending that, you know, what is the composition of the higher end technology versus the basic air drilling applications.

I would say that international -- well, let's make sure that international we consider Canada and the U.S. to be non-international for that definition for clarity sake. Let's say North America would have been 30%, known-North America would have been 70%. And the -- you know, the business which would be qualified as technology versus air drilling services falls almost in the same percentages. There's very little that's done in North America, which is pure underbalanced. I would say there is nothing internationally which is done which is not technology-based. So, I would probably have to say that 70-30 should also be the split between the quality technology segment and the air drilling segment.

I'm just going to cheat here a little bit. You said that your biggest constraint is going to be people. Does that mean that you guys have the equipment available on a global basis to facilitate growth going forward?

Not -- it's a question of time frame. It's much easier for us to add equipment than it is to add people. It takes just longer. And so, the comment on people is a long-term comment. It's a comment looking out 30 months. It takes a very long time to train people. It depends, of course, for what. But for any of the engineering functions which are so critical in underbalanced, it takes a very long time. Equipment is an easy thing. It's a question therefore of degrees of pain. Far greater for people than equipment.

Great. Thank you very much.

Our next question comes from Bill Herbert.

Good morning. Bernard, artificial lift release from our standpoint was quite a bit better than what we were expecting for the second quarter. Give us a sense as to what is transpiring on the heavy oil front in Canada, please.

Activity -- well, first you have to remember that activity was down to something on the order of 20 to 25% of 1997 levels, which was a prior high, not 20-25% below. 20-25% of. That's the first thing. And it just stayed there. It bopped around, but it just stayed there. As of a few weeks ago, not really in the second quarter yet, it's more as we're taking the turn into the third quarter, activity is now, I would say, up by about 5 to 10 rigs. That would represent -- normally you'd have no more than 20 to 25 rigs running for heavy oil. So, do the math. Five to 10 or 20 to 25. Bear in mind in '97 you had close to a hundred. So, that gives you sort of the ratios. And the reason for that simply has to do with the spread between heavy and light, which is very small, which is something on the order of four, five dollars as opposed to 10 to 12. And the fact that activity was suppressed for a long time. And the fact, also, that the downstream capacity for refining heavy oil has loosened up. You had some capacity that went down a year and a half ago, went down because of a fire in the Midwest, and it's back on. Great Lakes, actually, more specifically. And it's back on. All these things conspire to give some life to what was essentially a dead segment throughout the '99, '00, '01 time period. Completely dead.

And one quick follow-up here. We mentioned Softis in Norway for the third quarter. Give us a sense as to what your exposure is to the strike that's underway there right now?

It's not that big. I think Lisa's going to check quickly the top-line in Norway, but I would say Norway is something like 2% of top-line, something like that. Is that right, Lisa?

That's correct.

2% of top line. As I was drafting my notes, I thought that I was -- when I fished them and read them this morning, I thought I was probably paying too much attention to our Norwegian friends. But be that as it may, Q1 and Q2 in Norway, the activity was low. Many of the projects of stat oil were delayed for no particular reason other than internal. And in Q3 you have a strike. I've got to tell you that that sort of a strike is not an uncommon event in Norway, particularly in summertime. I suspect that the strike will dovetail into the vacations in August, and I suspect that you'll find, come the fall, activity in Norway will be quite a bit higher. Not only in Q3, but also in Q1 and Q2, and a lot of the projects that didn't happen in Q1 and Q2 and happen in 'O3.

Our next question comes from Arvin Singer from Deutsche.

Thank you. Good morning. A couple of things that I want to try to understand in terms of what happened in the quarter and what the implications for the second half might be, Bernard. If your international revenues were up $30 million and technology was up $11 million and revenues, assuming all that came in international, which other product lines are you seeing growth in on the international side? And my question, second part, what areas are you seeing the best prospects for pricing recovery in the U.S.?

First question on the $19 million that came with the 11, its's all pull through. Actually, you could almost take, I mean, the simple way of looking at it, is you take expandables and you just figure some completion revenues there, and you take underbalanced and take out some drilling revenues there. I'm not quite sure it's entirely correct, but we'll get you close enough. It's just pull through, period. Second question is what area will see the first pricing increases, is that the question, in the U.S.?

Yeah.

Where the business seems to be the strongest right now is where you'll see the first pricing, and that would have to be Oklahoma and the Crimean basin. How much more activity do we need to get there? Not a discreet function. It's more of a continuous function. But I suppose that somewhere between an extra hundred rigs or so spread around the country, of which maybe, you know, 30 or 40 in the two areas I mentioned, that would trigger enough of a tightening to be able to put in some pricing.

I meant it more in terms of product lines.

Oh, I'm sorry, Arvin. We do things across the board. We have actually -- we actually just put in pricing increases that are based on the price book and across the board. I think -- excuse me. Let me be specific. It's completion and drilling services more so than lift. Lift should beat to a different drum.

Okay. Thank you.

Our next question comes from Kevin Simpson from Merrill Lynch.

Good morning. Bernard, you -- your company and others have had -- you know, at least those with good kind of completion-related exposure and production-related exposure have had very strong growth in the Middle East. Could you talk a little bit about what's happening there? It seems inconsistent. We've seen good spending, but it seems inconsistent with the substantial amount of excess capacity that's supposedly sitting behind the pipe.

That's a long question, Kevin, so I'll try to escape most of it by just giving you innocuous answers. You know, not -- I'll give you answers, but just not the whole answers. First you have to look at where activity is occuring. And you find countries like Oman, countries like Syria, countries like Egypt, countries like Algeria, and those countries not withstanding the press releases and so forth of some of the actors there, are experiencing decline rates and having a hard time keeping the capacity. There are other countries also in the Middle East that share that same situation. These are just things that are not talked about that much. So, those countries actually are struggling to keep the production rate going and hoping to gain some capacity. But for all intents and purposes those countries are struggling, operating at full capacity. The free capacity in the Middle East really is concentrated in very, very few hands. I mean, I think you know Saudi Arabia and the Emirates, Kuwait's to a very minor extent. Everyone else is actually struggling, even with reduced OPEC quotas, are struggling to keep their production capacity at a level that's commensurate with the production rate they're supposed to run at. Indeed, what is interesting is that the minute there is a particular country that seems to be overproducing by 100,000 barrels a day or something like that, and above and beyond what is known of them, there are immediately press reports and things like that on it. And there's very little report on the fact that it is a struggle to keep the production rate going. Now, so, the answer is that there's a lot of -- the Middle East is made up of two different kinds of countries, the big countries, and they presumably have capacity, and there are very few. There's two. Iraq is a different kettle of fish. So, absent Iraq, there's essentially Saudi Arabia and the Emirates, and then the rest. The rest is in a secular struggle to keep their capacity above the production rate and/or to sustain their production rate. I don't want to say much more than that.

Okay. I'm going to kind of ask a -- something as a follow-up that you mentioned a lot of areas of new customers, new geographics on underbalanced. Were those contributors meaningful contributors to the quarter or were those more prospective and we should --

Both. As I drafted it, I think I mentioned actually in the notes that they are ongoing and/or starting. So, Oman, Syria, Egypt, Algeria, China, Malaysia, Russia, southern North Sea and West Africa, I would say half of them are, half of them were in the quarter. The other half are in Q3 start-up market for us.

So, even though you won't be reporting it separately, we should take away from this a -- that you ought to get incremental revenue --

That's correct.

-- in that segment in the second half of the year. '03 what it is, but at least with the broadening of the marketplace, it makes sense that we should continue to see that in '03, as well?

That's actually correct. And I think what we'll do in Q3, Q4, et cetera, we'll provide as much quantitive information about the progress or lack of progress of these various technologies. I don't mind, we don't mind doing that at all. I think that's fine. But yes, your conclusion is correct.

Okay. Thanks. That's it for me.

Our next question comes from Jeff Keberts from Solomon Smith Barney.

Thanks. I questions my question essentially boils down to what comments you have on the current consensus estimates that are out there. But the detail is to maybe expand a little bit on today where do we stand in eastern hemisphere margins versus western hemisphere margins?

The answer to the second question is that if you look at the incrementals that we've had in the eastern hemisphere, international all together, eastern hemisphere is actually higher than international, International includes South America, the EBITDA incrementals were higher than 50%, and that's a little unusual. That's a bit too high. The overall EBITDA margins internationally, Lisa, do you want to answer Jeff's question, because you'll be more precise than I will.

Typically we would see them at 40%. And they were well above 50% this time.

And how would that compare with the U.S. margins right now?

The debt crementals as, are you asking?

No, the existing margins right now in U.S.

They're above. The International revenues are coming in above the specific product line, but we would expect 40% on a go forward basis.

Basically, Jeff, the answer is that international is sitting at 40% margin. Incrementals are higher than that. We have to see a few quarters if we can actually sustain that. They are materially above the U.S. margins Now, the U.S. margins are suppressed in volume and pricing. So, that will turn also.

But with the expectations you described earlier, you would anticipate returning to 40% incrementals in the U.S.?

Given volume and price, yes, Jeff, very much so. With respect to the earnings --

I'm sorry. Just as a clarification, I think Lisa's comments included a statement that the R&D rate that we saw in the current quarter is your expected run rate going forward. Was that a dollar statement or a percentage of revenue statement?

That was a dollar statement. We'll see it going slightly higher, but it won't be increasing at a rate which would have the same impact on our sequential earnings per share. For instance, this year I would expect us to end up at about $75 million for the full year, which would be slightly higher than this run rate, but not significantly.

And the same thing on the depreciation comment?

The depreciation will go up very slightly, yes. You won't see the impact on a sequential earnings per share on depreciation. We did have, for instance, the Shell agreement and a couple other items come in during this quarter which increased it as compared to last quarter.

Okay. Sorry, Bernard. You were going to go ahead and answer the first question.

I think I -- you know, I any that the estimates -- think that the estimates that are out there for Q3 and Q4, I think we are comfortable with them as they now stand would be the answer to that question. '03, you know, it's -- '03 is far away. So, '03, we've got to make sure that we perform properly in Q3 and then we can sustain '03 at that point.

Okay. I'll take that as a tentative sort of comment.

No, it's not tentative. Jeff, don't take it as tentative. The earnings on Q3, Q4 are fine. I'm just saying that if the world doesn't change, you know, '03 is six months away, if the world doesn't change, then we'll be fine. It's not tentative when it comes to Weatherford, it's tentative when it comes to the environment.

Right. Great. Thank you.

Our next question comes from Terry Darland from Goldman Sachs.

Good morning, all. I wanted to try and understand the explanation on what's going on with the sequential EBITDA margins for Drilling and Intervention Services, I guess you had a 200 basis point drop sequentially. About half your business is -- you know, is -- well, a little over a third of your business is U.S. where you had the 200 basis point sequential drop. Your international margins were stronger than I think anybody thought, according to the 50% incremental disclosure. I'm just not fully understanding how you got to the overall decline sequentially of 200 basis points. If your international business was up, your U.S. business was down only 200 basis points on pricing sequentially. What else am I missing there? Is it all Canada, or are there some other factors in there?

Repairs and maintenance were much higher in Canada and U.S., Terry, so you had a cost push. And it's not an unusual phenomenon for Weatherford. When activity goes down, you don't lay people off, particularly when it's a seasonal thing. We typically do a lot of unusual repairs and maintenance and try to do it as quickly as we can. So, you had a lot of that. This year you probably had more than usual. But it's not an atypical phenomenon. So, you have that. Certainly you've had a pricing trough in March, April, but its's just a statistical phenomenon. It got carried over the three months as opposed to one month of trough in Q1. That's pretty much it, really.

If you isolate the repairs and maintenance, it makes up the majority of the debt cremental after pricing. If you look at those two, that was pretty much it.

Is there a current maintenance number that you isolate quarter to quarter where you can give us what the sequential increase was?

I can just say that if you factor in the pricing, the remainder, you can assume that the remainder was repairs and maintenance because it was I'd say 90% of the rest. And I looked back to our other second quarters, and that's typical for this time of year for Weatherford.

As a percentage of revenues, was it more than the prior years or was it about the same?

No, it was about the same. It actually was.

A similar question, I guess, on the lift side. Can you give us that impact from the manufacturing facility consolidation?

It's between $1.5 to $2 million, and it -- one of them is a -- in the United States it's one plant being shut down and moved into another plant. That's a classic consolidation. In Europe it's a bit different. You have two large plants, one in Ireland, once in France. And neither one of them are going to be shut down, but there's a change of manufacturing capabilities and a change of product line flows in both plants to where we'll direct some of the products in one plant and some of the products in another plant in a more coherent manner. So, you've basically got to change your layout, change your manufacturing capabilities, and then a focus after the consolidation is done on different segments of the product line. The thinking on the U.S. consolidation is just cost down. The thinking on the European consolidation is actually cost down, but also quality up and speed of turnaround up. These are done within a matter of one to two weeks these consolidations will be finished, both in the U.S. and in Europe. One and a half to two million dollars, best we can tell, would have been what flowed through in the second quarter.

And on the -- the last question here, on the completions business I think you explained what's going on on the top-line, which was also better than we had expected. On the margin side I'm a little surprised that your margins were as strong as they were. And you mentioned that your western hemisphere business in completions was about flat sequentially. I'm wondering if you can give us a little bit more color on the segments within completions. You did mention the pull through coming from expandables. Which sections, which segments are seeing the biggest benefit from that? And then with Latin America, did that have a meaningful variance on the completions performance in the quarter at all?

No, Latin America, no. Expandables carried the day in completion. The pull through, just the whole suite of products on completion, I'm not sure there was any difference whether it was inflatables, liner hangars, et cetera. Bear in mind that the margin comment on completion should also be looked at in light of the fact that R&D is not in the completion division any more. It's isolated as a cost center. Actually, in the case of completions it's particularly germane because so much of the R&D done in completion was expandables-related, and expandables is not a completion product or process. It's a comprehensive product or process that covers both drilling and completion as well as remediation. So, in many respects it didn't belong in completion. It just was being managed by completion because that's where it's the best managed. So, bear in mind pulling out the R&D out of the completion division does tend to make the numbers look not so much -- not only higher, but look the way they should look, which is untainted by indirect burdens.

I had adjusted for that, Bernard. I think you still had about 37% sequential incremental margins in that business, which is pretty good performance. That's all I had. Thanks.

Our next question comes from James Stone from UBS Warburg.

Yes, Lisa, could you give us a little more detail on what is going on with the DSOs and maybe isolate the numbers for us, U.S. versus international and perhaps give us a little more specificity on where those numbers were in the quarter?

I can. If you looks at our working capital, as I said, the days went down. Our DSOs actually remained flat. And that was all a shift in U.S. to international. We had all of the actual regions coming down, but on a consolidated basis it remained flat because you had more international. I look at it by division and by region. I don't roll up consolidated regions per se. On inventory we also had our day's inventory decrease significantly primarily due to efforts in the completion division group. They have made significant strides in minimizing inventory in spite of introducing new product lines.

Okay. So, if you look at the -- what's sort of the average DSO right now for the U.S. versus the international business?

If I look at the -- the U.S. runs in the mid-70s, and then international, it varies significantly depending on which region they're in. You have Canada in mid-80s whereas you have Latin America 90s, Middle East 90s, et cetera, 90s or slightly above. I don't roll up just international. I break it down even further. So I apologize. I don't have that exact number for you.

The reason is again, Jamie, that there's a tremendous variance from one international region to the other. North Africa runs almost, you know, over a hundred days. I'm saying this from memory. And so does Africa. Now, before one casts these businesses to the flames of hell, one has to remember that it's priced. You price it in the main contracts. If you really want detail on this, just call Lisa offline. She'll give you a detail region by region. That's the best way to look at it.

My follow-up question is just kind of what sort of debt targets do you have or debt capital targets do you have, say, for the end of this year, end of next year? And is that a function of just bringing working capital down or growing the business? How do you see that shaping up?

Well, if you have a flat top-line, you know, in our business, we would say that the -- we would expect that the debt to cap ratio, which is about 37.5% the way we compute it, I would say that towards the end of the year it will probably steer towards 37% or a little under 37%, possibly -- it depends again if we acquire anything, which is why I'm hesitant. If we acquire nothing, it could actually go down to 36, 36.5%. But I'm hesitant, Jamie, because I don't know if we --

But, you know, ex-acquisitions, just giving a sense of what you're going to be doing with free cash flow, if you have free cash flow.

We're just going to reduce Debt. Let's assume that we spend about $40 million more than our depreciation and amortization 250 versus 210, very rough numbers. So, that's $40 million worth of, you know, CAPEX minus depreciation, so, $40 million the use of cash. Let's assume that the numbers that are given on the street for earnings are actually correct. So, if you factor that in, then that represents $130 million of net income. So, you've got $90 million worth of, sort of positive cash flow. Let's assume that we generate again a flat top-line environment. A flatish top-line environment. Let's assume that we generate about another $60 million worth of working capital. That's $150 million. We've bought nothing. We've got $150 million in cash. So, let's factor $150 million against the debt level. Let's divide it by the -- you know, by the equity amount. Basically you're looking at, roughly speaking, you're going to drop your ratios down to 35% or something like that.

Mm-hmm.

I'm doing this realtime.

Okay.

The way to think about it again is that CAPEX is about $40 million higher than depreciation. Net income becomes cash minus that excess of CAPEX. Working capital, should be a positive number.

The answer was working capital should be a positive number?

That's correct.

Okay. Thanks.

Our next question comes from Robin Shoemaker from Bear Sterns.

Good morning. Bernard, I just wanted to ask you if you could elaborate a little bit on your comments on the U.K. sector. I think you indicated you thought maybe the fourth quarter of this year would be the trough. And in terms of the recovery that you mentioned next year or postulated for next year, is that based on something specific, or anything that -- or just simply the fact that the deadlock here will eventually get so -- to such a point that the government will back down and provide some incentives for drilling in 2003?

Let's remember that the issue in the U.K. is the government's decision a few months ago to announce a surtax on profits, 10% specifically. A 10% rise in corporation tax on North Sea production. Now, that has resulted in a -- all sorts of dire predictions and the like on the part of operators saying that North Sea was not economic and blah, blah, blah. There is, there are, we've been through this before historically. There is a sort of tug-of-war going on between the U.K. government and the operators and they're fighting their issue in the court of public opinion in the U.K. And clearly, if I'm an operator, and this is particularly true for Shell and BP, who are the most targeting here, I'm going to go out and talk about major reductions and whatnot.

There are basically two issues that you have to watch. One is as an olive branch the U.K. government has offered the end of a 12.5% royalty on pre1982 fields. But they've given know date for implementing this step. So, putting a date on the reduction in the royalty would be terribly important to end, I think, the logjam. The other aspect of the story is that the decline rates, the production decline that ensue when you reduce activity are steep, as I mentioned. And for both BP and Shell, this is a difficult thing to live with for terribly long. Of course, conversely, it's a difficult thing for the U.K. government to live with when you have reports of laying off some people in some of the more distressed areas of Scotland and whatnot. So, net-net, without getting too detailed here, I think that if you have 28 rigs running in the U.K. today, I think four get released, maybe five late in the third quarter to make a political gesture, I think they stay down until January or February, and an agreement is made between now and then between the operators and the U.K. government.

This sort of play has run its course at least twice in our history, and it's almost the same -- it's almost the same -- every single step feels the same. And fundamentally this is a healthy evolution insofar as without taking sides, we couldn't, it is true that the North Sea needs to see a different cast of operators, very much like the Gulf of Mexico, you need to see a different cast of operators 20 to 30 years ago. I think 20 is probably a better number. You need to see companies that are probably more interested in spending time and money in exploitation, as opposed to classic exploration and development drilling. So, people go back in and redevelop formations. That's what needs to happen. That's what the U.K. government is trying to get to. It's shifting the wealth coming out from the big operators was so important in the 1960s and early 1970s to, you know, the next size of companies that are probably more suited for the North Sea long-term.

Okay. Thank you.

Our next question comes from Steven Gengaro from Jeffries.

Thank you, good morning. Bernard, on the tax rate. As you evaluate acquisitions going forward, are you using, sort of the historical tax rate or are you building in any benefits based on the inversion?

We haven't done that many acquisitions, but the answer is no, we keep the Delaware tax rate. And we will do that until there is certainty.

And just a followup. The expandables, you mentioned Shell at about 25% of installations. You can you give us a sense for where you think that will go over the next 12 months?

More like 50%.

Okay. Thank you.

Our next question comes from Gary Russell from Frost Securities.

Good morning, everyone. My question should be quick and easy. I was hoping to investigate the artificial lift performance a little further. I know we've talked about it a little bit. But can you, Bernard, tell us a little bit more about the strong top-line growth, you talked a little bit about volume and price, domestic and international, and what you think about that outlook going forward and international in particular if there were any particular regions that sit out higher among the rest?

I think probably the most important thing I can say about lift is in the quarter was that this thing we call production optimization, which is software based, is really marketing assets, marketing ally. And a lot of what lift has been able to do in the international markets and also in North America is basically share gains. And it simply has to do with the ability to manage the field and optimize, for very little money optimize the production rate to where the differential production rate is not spectacular. You're not talking about a 50% move or anything like that, but the production rate increases are so good as compared to the costs of production optimization up front for the client that the payback is extremely short. I think last conference call I gave some indications of the payback. I don't have it in front of me, but it's a matter of months. So, it's a very, very, very strong marketing asset they have. That has helped them. On a forward-going basis, I think heavy oil, yes. Some of the questions that were asked before, it's obviously a good thing for lift. How much more productivity will heavy oil enjoy? Well, if the spread remains where it is, you'll have a -- you know, over the next two or three quarters a very strong move up for lift because it is so down. So, that's the seconds relevant factor. And the third one is a much slower factor, which is the introduction every quarter of different sizes of self-generated, self-engineered ESP line. But that's a slower process, and that's probably more of a '03, '04 issue than it is an issue right now. So, net-net, Gary, it would be production optimization is really the most critical factor. And then on a forward-looking basis, heavy oil is probably the other critical factor.

Okay. That's helpful. And then as far as outside of North America, were there any particular countries that show more strengths than others?

I'm thinking as you're asking me that question. It's a patchwork of countries. Certainly not Latin America. I would have to say that once again it is Asia and it is to a lesser extent the Middle East in the case of artificial lift. But the far east would be the strongest one for lift in terms of deltas versus Q1 and last year.

And last detail, I meant to mention this a second ago, but maybe for Lisa, incrementals going forward on that business, as well, can you talk to that, Lisa?

They should be above where they were this quarter. They should be in the 30% range. Which is typical for artificial lift on the incremental side.

Okay. Thanks very much.

Our next question comes from Curt Hallad from RBC Capital Market.

Patience is a virtue. Good morning. A couple of questions actually for you. Bernard, you spelled out quite well what's going on in the Middle East. I was wondering if you could provide some color on what's happening in the far east that provides you with the incremental strength that you've seen.

Oil decline rates and gas are what's happening in the Far East. China, Malaysia, Indonesia, setting aside the Sacalene, which is a big project for us, but that's in a class of it's own. If you lump Malaysia, Indonesia, and China together, and I'm ignoring things like Thailand and Vietnam the smaller, it really has to do with big gas developments and decline rates in oil. That's as short of an answer as I can give you, but it is what it is.

Okay. And then you mentioned -- your comment about West Africa project delays intrigued me. I was wondering if you could expand on that, provide a little color.

It's really for us. The comments I give on the different regions is really for Weatherford, and so, different companies will have different outlooks depending on their own scheduling of projects. But I have a number of projects in West Africa, from the southern tip of Africa all the way up to places like Gabon, the Ivory Coast, we have a lot of projects, and Nigeria, of course, which we see starting late in the year and early next year. And I really don't know -- Curt, I can't give you one trend or one reason why. It just is the way it is. And it seems to be scheduled that way on sort of the chart we look at all the time on projects that are started and that are, you know, finished, there seems to be just a lot of -- a lot of action late in the year, early next year. In fact, it is late in this year. I'm just assuming it will go -- you know, when you're late in the year, anywhere close to Christmas, I presume you'll go in January. That has been my experience over the years. So, I take the leap and think it's a '03 issue.

On the international incremental margins, I guess what we're really seeing is the benefit of the new technology, the lack of competition, et cetera, et cetera. Is that a pretty fair assessment?

I think there's a lot of that, yes. Incrementals is about 50%. As high as the repairs and maintenance was in the U.S. and Canada this quarter, too high. At the same time, not too high, it's a one-time thing. Great. That's it for me. Thanks, Bernard.

Our next question comes from Pierre O'Connor from Hibernia Southcoast Capital.

Morning, Bernard. My question involves revolves around artificial lift, and you've you've discussed quite a bit about it. So this is just in the incremental. Without giving away too much of the competitive situation, could you tell us more about the artificial lift, specifically around ESP? Is there growth there, progressive cavity pump, progress, market share gains, et cetera?

ESPs, the answer is no. I mean, I think ESPs, the volume for the quarter was, you know, I think very small. I mean, you're talking about a million dollars. I'm trying to, you know, go through reports quickly to get you the exact answer, but I remember it to be a million bucks or so. Here we go. Here's my report here. And bingo, I'm not far at all. It was 1.7 million, okay?

Okay.

Now, I'm giving you competitive information here, but it's so small that I think it's -- it's academic. It will remain academic the balance of the year, I suspect. It will not remain academic as '03 and '04 unfold. It's just a question of your internal capabilities, which are growing every quarter in terms of product introduction. If you want to know, you know, which is the product line that did the best, I think I'm looking right now at all of them, and it's about even. I can't really point at any one in particular.

And they were they were all up.

All up. We can't say it was hydraulic or gas or reciprocating or progressing, no. It was definitely led by production optimization. The numbers scream at you.

As you said earlier.

Yes.

And again regionally, just the prospective of growth on that?

That one -- actually, South America may get more life except for Venezuela. And I think that you'll get more life also out of North Africa and a bit more out of the Middle East and maybe a bit less out of the Far East, would be my guess. And of course, the U.S. and Canada beat to the cyclical drum.

That's very helpful. Thank you very much, Bernard.

Our next question comes from Howard Slinker from Slinker and Company.

Please correct me if my question is about the wrong product line, but I think it's expandables where Halliburton has that very large market share. Could you please describe the economics to the customer of your expandables?

Well, I think that that's -- first of all, the comment on Halliburton is correct. I'm not sure they have a very large market share, but they're the only ones that have a presence of any significance in this very young technology other than ourselves.

Right.

When it comes to what does it do for you, it does essentially two things. The most -- probably the most important thing it does is that given the same geometry of a well, it allows you to drill the well, ultimately to maintain the well, also, but to drill the well at somewhere between 30, and some clients say up to 50% lower cost, which is an outrageous number. Let's focus on 30%, which is big enough. That's one. Two, you can actually, given the capabilities of the technology, start thinking about improving the geometry of the well, which has some reservoir productivity benefits. And then the last thing it does for you is specifically it improves the well productivity benefits by minimizing formation damage upon completion. So, that would be more of a sand control application. So, the biggest, biggest application of this process and product technology really is a cost. A well construction, well remediation cost. The geometry and the reservoir management aspects actually in comparison more minor. But the cost impact I would say is revolutionary.

Without giving away proprietary information, in rough terms what would it cost the customer to add this to different sizes of wells?

Well, it's not proprietary information, because I'm not sure that either Halliburton or us know. We haven't decided. I mean, the pricing is still up in the air except for what we put on the market already. It would have to be a fraction of the benefits, a mere fraction. I can only answer it that way because it's just -- there's just too many applications which fall in different categories. This technology -- you know, selecting this technology in your well should become a very easy decision once it's on the market for our clients simply because of the cost-benefit ratio, which is bound to be very favorable to our customers.

I'll ask it another way. You said -- is it fair to assume that the customer gets five or ten times his money back? Between what he pays you or Halliburton in his savings?

Probably not unreasonable. If the conclusion is we're not pricing it high enough, this is a conclusion that's premature because we're talking about academic comments here because a lot of it's not on the market yet. And it's not a comment that's lost on us. I don't want to speak for Halliburton. It's not a comment which is lost on us.

That's not my conclusion. Either way, no matter what you and Halliburton charge, the customer's will have to come to this.

I really believe that to be true. I actually really believe that to be true. It's a question of time, it's a question of making it available, but it's one of those things that comes along in the industry once in a while, which makes a difference, and then blossoms and become a mature market many years later. But it makes a difference in the process.

It does sounds like a really big deal. Thanks.

You're welcome.

We now have a question from John Dowd from Benford, Bernstein.

That would be Sanford, Bernstein. Good morning. Two quick questions. You must have mentioned this but I don't think I caught it. What was the operating income associated with the step change technologies that you talked about?

John, we don't release that. But it's a good number. We don't release that. And the -- we don't release that for obvious competitive regions. Margins are high in that business, and it has pull through. On the other hand, the R&D we're doing is very, very high and doesn't really relate to the top-line we're selling right now, but the future top-line. So, it's a moving target between the R&D and the contribution for the technologies. Wish I could release it to you. When it becomes a mature market, we will.

I thought I heard that you're now grouping different technologies all into one kind of $68 million of revenue.

Right, as a top line, yeah. So, we're in a sense losing a little bit of visibility until we know the quality of the revenues because we don't know which segment they're coming from.

Are we going to be able to measure the operating income going forward so we can measure what the quality is and just make sure it's there and getting better?

I don't know, John, I honestly don't. I'll have to think about that one. I have no objection at all to releasing more information to our shareholders, on the contrary. [INAUDIBLE] on the competitive issues.

I hear you.

I understand your point. You're saying getting less breakdown in revenues. We never gave you operating income, but I see your point. We took something away. Give us something back. I think that's what I'm hearing you say.

Bingo.

I understand. I won't reject it out of hand. Let me think it through. Certainly from a capital market standpoint point we're all for it.

And the second question, I wanted to understand the cost of options. You mentioned two cents, and I don't think I exactly understand what that is or how it relates to other numbers I've seen. If I look at the annual -- the difference between expensing and not expensing options last year, I think it was 29 cents. Is that -- is that comparable to the two cents that you mentioned?

No. Two reasons. The 29 cents is a cumulative of life to date options for the company that are still in the vesting period, or in the expected life period. And second is we have issued -- we issued last year a four-year clips vesting batch of options. So, that is not a repeat occurance. In the current year we issue, as I said, for promotions or to attract new talent.

Basically what Lisa is telling you is that last year we issued options that have a four-year cliff, meaning people don't get anything for four years. If they're still around, then their options vest, and it is what it is. And that number reflects that. On an ongoing basis, the number she gave you is more of an operating number. I suppose you should look at the number last year and the number this year, and consider that they're both meaningful. It depends on the time period.

The two cents referred to the options issued in isolating this year's impact on this year's options.

OK. So those are the options that would vest this year that were issued this year, and lasts year's number --

No, no, the options that were issued this year. They don't vest this year.

This is if we took the options issued this year and expensed them over the expected life of these options, what would the current year impact be of the current year issuances. And if that's not clear, I'd be glad to walk through it if you want to give me a call.

All right. I'll give you a call off-line. Thanks.

We now have a question from Bill Sanchez from Howard Wheel.

Bernard, I was hoping you could give us your current thoughts on your ownership of Universal Compression, and has the poor performance during the quarter influenced your thoughts as to your modernization plans?

Of course not, of course not. Universal has had a trough in earnings. They lag the gas markets, so they turned down the last. And Argentina, basically. They had a significant [INAUDIBLE] in Argentina, between 10 and 15% of their business. They're renegotiating their contracts and did that very, very well with their clients. But in terms of quarterly earnings, they didn't do that great in this quarter. But I suspect it will be much better on a forward-going basis. They're a very well-run company. They excel in the compression business. No, we would not dream of doing that. And certainly not -- certainly not any time soon and certainly not anywhere close to the values that you have right now. The values we have right now, they are what they are. I'm not going to argue with them. But under no circumstances, no.

Thanks, Bernard.

I think that's probably it. If there's any other question -- we'll take one last question. Otherwise I think we've extended our time quite a bit.

We have a follow-up question from Bill Herbert from Siemens Company International.

Just a quick one. Actually, the equity income contribution in the quarter was quite a bit better than we thought was going to be the case. Lisa, is that entirely UKO? Or are there other elements at play with respect to that?

That was more than, we have more than one number, as you know, going into that number. So, no, it was not entirely UKO.

Although UKO I think ended up doing a little better than we expected, to be fair, Bill.

That's what I thought, as well. What are the other issues at play with respect to that number?

Saudi Arabia?

Yes. We have and have always had in our historical numbers other equity investments that play into that. And they're primarily in the Middle East.

We operate in Saudi Arabia out of two different ways. One, we have historically a 49% ownership in a Saudi Arabian company. This goes back to another time, Bill, this goes back 20 years. And we sell products and services and so forth through that 51/49. We have 49. This was a time when it was important to have a Saudi Arabian owner, partner. And we also operate in Saudi Arabia now through a 100% subsidiary in Saudi Arabia, one of the very first ones that were allowed to be set up as such, as a subsidiary, fully owned. And that one you just don't -- Saudi Arabian business, you just see it as part of the revenues and everything else. The 49/51, which is the historical legacy, you just see it as part of that equity. I don't know if there's anything else in equity. I can't remember what else there would be.

There's a couple small ones that we acquired in acquisitions.

But they have to be very small.

They're very small.

So, I think Saudi and UKO put together probably represent 90, 95% of that line.

That's correct.

And actually, your commentary with respect to the Saudi Arabian contribution is consistent with your regional commentary that you provided earlier. Could you provide us what the breakdown is between UKO and the Saudi Arabian business. I don't mind, but Lisa tells me no.

Well, considering [INAUDIBLE] has not yet released.

I appreciate that.

That's the reason. Ex parte I think you can if I can it out. We can give you the Saudi number ex-parties, if you want to.

Okay. Thank you.

You're welcome. Thank you very much.

Thank you for attending today's conference call. This call has concluded. You may disconnect at this time.