NOV Inc. (NOV) Q3 2013 Earnings Report, Transcript and Summary

Welcome to the Third Quarter Financial Results Earnings Call. My name is Paulette, and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. (Operator Instructions) Please note that this conference is being recorded. I will now turn the call over to Loren Singletary, Vice President of Investor and Industry Relations. Please go ahead.

Thank you, Paulette, and welcome everyone to the National Oilwell Varco third quarter earnings conference call. Joining me today is Pete Miller, Chairman and Chief Executive Officer; Clay Williams, President and Chief Operating Officer; and Jeremy Thigpen, Senior Vice President and Chief Financial Officer. Before we begin this discussion of National Oilwell Varco’s financial results for its third quarter ended September 30, 2013, 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 quarter or later in the year. I refer you to the latest Forms 10-K 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 affecting our business. Further information regarding these, as well as supplemental financial and operating information, maybe found within our press release on our website at www.nov.com or in our filings with the SEC. (Operator Instructions) Now, let me turn the call over to Pete.

Thank you, Loren and good morning everyone. Earlier today, National Oilwell Varco announced third quarter 2013 earnings of $1.49 per share on revenues of $5.7 billion. Included in this number were pre-tax transaction charges of $10 million and a pre-tax gain of $102 million from a litigation settlement. Netting these out provided a net income of $573 million or $1.34 per fully diluted share. Jeremy will provide more color on these results later in the call. Additionally, we reported new capital equipment orders for the quarter of $3.31 billion, resulting in a quarter ending record capital equipment backlog of $15.15 billion. This reflects a continued preference for the industry leading high technology products provided by National Oilwell Varco. New orders for the year have surpassed $9.5 billion. I would like to thank all of our employees worldwide for their continued dedication to excellence as we serve the oil and gas industry. I will come back later in the call to add some color on our operations, but at this time, I will turn the call over to Clay.

Thank you, Pete and good morning. We have long discussed four big trends that we expect to continue to shape National Oilwell Varco’s destiny over the next decade. One, the build out of a fleet of floating drilling rigs to explore and develop deepwater frontiers open by technology developments of the past 20 years; two, the blossoming of floating production systems, which we expect to produce most deepwater discoveries; three, the replacement of old jack-up rigs with better shape or new jack-up rigs; and four, the steady progression of unconventional shale technologies into new onshore plays overseas, which will continue to drive steady retooling of land rigs and spur demand for other oilfield technologies. This morning, I would like to update you on what we see within each of these four, how they drove our third quarter results and how they are shaping our strategies. Demand for floating rigs has remained high underpinned by we believe strong driller economics on these investments, good day rates, low cost rigs, quick delivery and available financing. We sold another six deepwater drilling packages into newbuild projects during the third quarter bringing our total for the year to 22. Strong floater demand contributed to Rig Technology’s third quarter capital equipment orders of $3.3 billion, our second highest level ever. Our year-to-date orders totaled $9.5 billion through three quarters and we are not done. We expect fourth quarter orders to be good, maybe great, but down a little from Q3’s grand performance. There are many new potential projects under discussion, but we know the holidays may interfere with contract signings and sometimes we just run out of calendar. Nevertheless, Q4 is off to a solid start and should wrap up an extraordinary year for orders. We recognize offshore rig orders are cyclical exhibiting periods of…

Thanks Clay. National Oilwell Varco generated earnings of $1.49 per fully diluted share in the third quarter of 2013 on $5.7 billion in revenues, excluding $10 million in pre-tax transaction charges and $102 million in pre-tax gains resulting from the settlement of an outstanding legal claim. Third quarter 2013 earnings were $1.34 per fully diluted share, up $0.01 per share from the second quarter 2013 and down $0.18 per share or 12% from the third quarter of 2012. Sales of $5.7 billion improved 2% sequentially largely driven by resumption of activity in Canada post breakup and grew 7% year-over-year despite a 3% year-over-year reduction in the number of drilling rigs worldwide. Excluding transaction charges from all periods and the gains resulting from the outstanding legal claim in the third quarter of 2013, operating profit for the quarter was $853 million, up 3% sequentially and down 10% from the third quarter of last year. Operating margins on this basis were 15% for the third quarter 2013 compared to 14.7% for the second quarter of 2013 and 17.8% for the third quarter of last year. Sequentially, operating profit flow through our leverage with 31%. Now let’s turn to our segment operating results. The Rig Technology segment generated revenues of $2.8 billion in the third quarter, flat sequentially and up 12% compared to the third quarter of 2012. Operating profit for the segment was $606 million and operating margins were 21.3%, up 60 basis points from the prior quarter. On the Q2 conference call, we expected Rig Tech revenues to decrease in the low single-digit percentage range as continued declines in the sale of intervention and stimulation equipment and somewhat lower project revenues would more than offset continued growth in our aftermarket business. Well as expected, revenues for intervention and stimulation equipment declined…

Thanks Jeremy and you know I think both Clay and Jeremy have really given you a very comprehensive overview of both our financials and our operational situation so I’m just going to make a couple of really brief comments. First you know as you take a look at a catalyst that I think you’re going to project out over the next two or three years. You know I keep my eye on a couple of international plays I think number one will be Russia, I think the Russians are going to be very aggressively doing things in the next few years. We have felt that way for a long time and the consequence of that is that we started building a plant over in Russia and we’re going to be prepared to be able to really take advantage of that as we move into the latter half of 2014 and the early part of 2015. I think another area that’s going to very exciting, certainly you should keep your eye on it will be Mexico. You have the changeable laws down there, I think as we move into the rest of the year you will have a constitutional amendment hopefully and then you will have the laws that will come out in the first quarter. I think that’s going to really open up a tremendous area for a lot of the service companies and in particular National Oilwell Varc. So those are two areas I keep eye on, third one for us and Clay mentioned in his comments it's not, I think as you take a look at John and especially the aggressiveness of the shipyards over there we’re uniquely positioned to be able to take advantage of that and to help those shipyards and add the legitimacy that they…

Thank you. (Operator Instructions) And our first question comes from Jim Crandell from Cowen. Please go ahead.

Good morning guys. Great quarter. Great orders.

Thanks.

Pete, first question, could you talk to how the new Brazilian yards are progressing in terms of their building rigs and how this might affect the delivery of rig equipment packages from NOV?

Sure. Jim, actually, the Brazilian yards are we think moving along very, very well. We have – we are in process of doing some – a lot of different work down here today. We are basically talking about four different yards that we are involved with. Now, Jim, by definition, the deliveries are going to be slower in Brazil. When you look at the Koreans, I mean, we are getting those rigs out much, much faster, but even the Koreans if you go back to the early part of this decade had a harder time. You got to get on that learning curve. And that’s going to happen in these yards. And so the revenue that we actually have in backlog for these orders will have a much slower velocity coming out of backlog that we will have, for instance, for something coming out of one of the Korean or Singaporean yards, but overall, it’s been very positive. We are seeing good things down here and progressing is being made every day.

Okay, good. Clay, a question for you, can you talk about some of the cost reduction initiatives you’ve put through since you became COO and can you also talk to how these new facilities coming on will impact Rig Tech margins?

You bet. Jim, we have had a lot of activity and lot of progress in Rig Technology this past quarter and it really continuing through the year, specifically around adding capacity. A lot of initiatives we launched a couple of years ago and they are designed to be able to let NOV meet the needs of our customers with all these orders flowing in. And so as you could imagine, it’s been a little disruptive to our production schedule. Those are continuing week-by-week, quarter-by-quarter. We are making progress. And as we did get those set, we can expect to see benefits from them. Probably, the main initiative underway right now in Rig Technology is to get through this first group of rigs. I think we talked about this a little bit on the last call, but the rigs that we are building today and the rigs that we are delivering now and through the next couple of quarters, really are new designs or new rig floor layouts. We are satisfying new class requirements in the post-Macondo era ABS 2012 be it the other class requirements. And so in a lot of ways, rigs that we built from 2005 to 2010/11 were different designs and we are kind of – we have lost a lot of learning curve effects on those. So in terms of margin progression over the next several quarters, a lot will hinge upon getting the engineering completed on these new rig designs actually getting them constructed in the shipyards and getting them out the door. And as we make the second and third and fourth copies of those same rig designs, I think that’s where you are really going to see the benefits flow through. It’s really pretty much a repeat of what we saw in the 2006, ‘07, ‘08 era. And so we are very confident of how this plays out. Some other things we have underway. We are doing a lot to ease some of the congestion in some of our plants. So for example, we are moving some land BOP products, for example, out of our BOP plant and moving those to a different operation to free up more bandwidth within that plant to be able to handle the extraordinarily high volumes moving through there. We have got plans to also move our rubber components out of that particular plant as well. And so – and that’s just one operation, I would say across the board, lots of things going on manufacturing wise to make our business more efficient.

Okay, thank you. And one quick final one for you Pete, you had a substantial increase in your dividend earlier this year, can you review with us your current thinking about how you are viewing the dividends?

Well, Jim, we have doubled the dividend in May. And what we want to be able to do in this company is continue to increase the dividend on a fairly systematic basis, where we want to return money to our shareholders. We think the dividend is absolutely the best policy. We made a very significant jump in May, but our Board is committed to continue to try to increase the dividend as we move forward. And I think you will see that happen, whether or not I’d say it will double if that’s a little bit different but at the end of the day we’re going to continue to try to increase our dividend to return what we get shareholders in that regard.

Our next question comes from Jeff Tillery from Tudor Pickering. Please go ahead.

On the spinoff of your recent business I think it makes a lot of sense to strategically. I’ve gotten a fair number of questions it's just kind of was this part of the plan all along in terms of scaling the business up a little bit of confusion just around purchasing two of those businesses last year and then spinning them out so quickly. So just interested to hear your color around that.

And it was not the plan initially, what we really did there is we had the opportunity to consolidate from a strategic standpoint the upstream distribution business in North America and around the world and once we started the integration process it became apparent that the stars hadn’t aligned [ph] and that we had the critical mass to actually have a company that standalone, compete world-class in it's own right and so that was really the genesis of why we did that. It was not because of the initial purchase of Wilson and CE (indiscernible) because those are targets that we looked at for many, many years but add value to our shareholders we think this is something that’s going to be very important going forward and just another way that we can return capital to our existing shareholders.

And then my second question is just on the PSNS consumables this is their here in North America, are you seeing anything change on the order front there or do you think or going through something structurally different in terms of the way your customers manage inventories.

Yeah I think it's probably more the latter there, Jeff. We’re seeing the kind of the inventory overhang come down but it's not really changing customers buying habits. As Clay mentioned in his remarks you know our customers have consolidated into a handful of basins. All of our competitors who are supplying them with similar products as consolidated basin as well so our customers have ready access to supply and so what we’re seeing now is they are being really more efficient in the management of their supply chain and they are only ordering products when they need them as opposed to ordering them for additional inventory and so it's almost kind of hand to mouth approach that we’re seeing today and until we see some more rigs and kind of spraying out of some more basin, it will probably be like definitely for the foreseeable future.

Yeah I think we overshot inventories a little bit a couple of years ago when the supply chain was very tight and deliveries were months our customers tend to double order and over order a little bit when the rig count started creeping down. They took delivery on those inventories and so that’s we have ended up with this overhang that we are working through. I can’t tell you when we’re going to get through it but we do know day by day they are chipping a way at it.

It's going to be tough to calibrate if we were on a flattish rig count, we’re still consuming drill pipe or still using products and services and it's simple we are going to see the increase in that without and necessarily associating increasing rig count I just didn’t know if you guys see anything turn yet?

Yeah I don’t think we’re seeing it turn yet I mean Q3 was promising, we did see an uptick in the U.S., Q4 we expect to kind of take down as I mentioned just really more the holiday season than anything. A couple of things that they head picked us a little bit but broadly speaking we don’t see the term just yet so probably sometime hopefully in 2014.

Our next question comes from Jud Bailey from ISI Group. Please go ahead.

A follow-up on the some of the comments Clay you made regarding some of the new design rigs that will be coming out of the yard here soon and getting those behind you. Could you give us a little bit more color, are those going to be largely delivered in 2014 and be done by ’15 or can you give us a little more color on what timing it is deliveries?

Yeah they are being delivered throughout, that’s exactly right through 2014 and then to 2015 these new class designs. The real benefit of all this work is that once you have built that first rig you have got all the engineering done, you have all the lessons learned through the first copy of it. You apply those lessons and this is what I think our team is extraordinarily good at is capturing those lessons and benefiting from them on the next copy. So it's the second and third copies that you really start to see the benefit that’s exactly what we saw in 2008, 2009, 2010 as we kind of got deeper into that wave we start seeing a lot of positives and a lot of efficiency gains. Those were in contrast candidly to issues and problems we faced earlier in that buildup when you are making the first copy. So that learning curve effect is well-established and we are looking forward to benefiting from it as we get into the back half of next year and into 2015.

Okay. And then my follow-up would be my understanding is several contractors right now are for their next the newbuilds are actually looking at new designs or enhanced designs, do you take a little bit different strategy in taking the next, when looking at the next generation given some of the problems you have had, do you take any pricing strategy and whatnot?

We do. I mean, we try as best as we can to factor all that’s in, but it’s when you are building something for the first time, you are always going to face some challenges are a little bit unexpected. And we – I would stress we encourage our customers to stick with proven designs. It really I think reduces the cost and risk of their newbuild programs.

Okay. And then a question for Jeremy, Jeremy, you may have mentioned it, but I may have missed it do you have a revenue out of backlog number updated for 2014?

We didn’t say it, but it will look similar to 2013.

Okay, got it. Alright, thank you. I will turn it back.

Thank you.

Our next question comes from Brad Handler from Jefferies. Please go ahead.

Thanks. Good morning guys. I guess I was – the last question was one I was going to ask as well. So maybe Jeremy, you can fill it in a little bit, so the revenue out of backlog for ‘14, sorry, I am not looking at my notes, but is it been roughly $8 billion for ‘14 and then how much would it be in ‘15?

That’s probably about right. That’s probably about right, Brad.

Okay, got it. And then do you have a ‘15 reference?

No, I don’t think so yet.

Just stand beyond so in the $5 billion, Pete, yes, $5 billion range.

Right.

Based on what we have today, yes.

Okay, okay. Maybe I have a multi-part follow-up, but I think it’s all kind of in the same context and it’s coming back to Rig Tech margins. We have had a conversation, you have helped us in understanding kind of your challenges and we appreciate that. The – how the past of getting back to the 24% margin, I mean, I would certainly appreciate if you, does it happen at some point in 2014 or what are the challenges to having that happen at some point in 2014? And then maybe before I just turn it back to you, related to that is we have – it’s easy for me to certainly understand some efficiencies in learning curve as you are describing them. It’s also easy to understand capacity additions and so some of the expediting costs go down, but it does sound like installation and commissioning challenges have been real as well. And I don’t know how those are enhanced or have those costs come down if you are delivering a lot of rigs in ‘14, but perhaps you can help describe why that also gets a little easier or cheaper or what have you?

That’s a great question, Brad. Let me explain it. When we have setup our initial plans to build a rig, installation and commissioning on a drillship, we typically budget five to six months to accomplish that. What we find is delays some of our own making, many not, some from our shipyard partners, but we are all building a new rig for the first time. So we typically launch those INC projects late and into a project that may drift beyond its delivery deadline and we are under a lot of pressure to speed up our INC activity. So we get asked, hey, can you guys shorten that up to four months or three months. And to accomplish that, it cost us money. We have to – we have taken the extraordinary step of going to 24-hour operations on certain things that we are doing on the INC world. We are paying extra to expedite equipment and people and move resources around our system to try to get back on track on these projects or as close as we can there too. So that’s costing us extra money. So all this – this is all tied together and the installation and commissioning is the last thing we do on a rig and so it shows up there as well. But on that subject, more broadly, I have touched on a number of the factors and I don’t think these are new to anybody for probably worse delineating them all again. The new designs that we are building right now for the first time and the loss of the copy effect from the preceding cycle is an issue, the expansion in our plants has been an issue and the installation and commissioning efforts being that are underway right now as Jeremy…

And margin in that business are accretive to overall rig tech?

Yep. And the third is the shortened deliveries that we have on these rigs means that we have a little less head room and safety factor than we have had in the past, we have talked about this in the past too. We’re making these offshore rigs faster and faster and so to the extent we run into unexpected problems the time frame that we have to recover is much more limited. So that’s a little bit of a risk and finally the fourth issue is in the third quarter, again we had very strong demand once again for jackup rigs, we sold 42 jackup rig packages that’s a little quicker term kind of capital and so we’re putting more volume through our system and so that makes our congestion issues a little more challenging. So those were the kind of the puts and takes going into our margin outlook overall.

And as you, you know to your first question around when you get back to the 24% margins. I would expect as we get through Q1 of next year to see some slow steady progression in margins in the rig tech business but I wouldn’t expect to get to 24% next year. 2015 I think is more likely and if we can get some help as Clay said on the you know orders for pressure pumping equipment that we can ship and turn it into revenue and margin. I think we can get there 2015.

And your next question comes from Stephen Gengaro from Sterne, Agee. Please go ahead. Stephen Gengaro - Sterne, Agee & Leach: Just wanted to hit on the PSNS business and can you give us a sense there and I know you’ve had the U.S. rig count has been everybody is being expecting I think higher more rapidly but you’re still at a very healthy level. How should we think about sort of the structure of the business right now and what you see from a demand perspective in ’14 is it simply rig count intensity driven or is there a sort of an inventory that could help growth there?

Yeah I think we’re cautiously optimistic as how I would describe but we think producer of cash flows have been pretty strong and so we think there is good financial resources to see an uptick in the rig count. As I mentioned in my comments increasingly we see North America become more and more competitive, this inventory overhang issue has been out there. The fact that the industry is kind of restructuring and coal lessening into these the handful of most profitable basins has created some headwinds but I would add this rig efficiency phenomenon that everyone is being talking about we believe ultimately will grow the pie. It's going to make some of the less economic basins now more attractive and more economic and so with ample financial resources and kind of growing opportunities perhaps in another basins you know we think that’s a pretty good backdrop to see expansion sometime out there in 2014. We haven’t seen it yet but I think it's you know we’re entering with a pretty good backdrop for 2014 and I would also reiterate that the very intensive nature of drilling and completion operations in the major shale plays is consuming what NOV makes and so we know day by day these inventories are being wedeled the way by day to day operations.

Yeah I think if you look at PSNS you almost had to segment it by product types I mean things like drill pipe and downhole tools as long as well count is high which it has been those products get consumed and they get consumed pretty quickly. So there was a definitely an inventory overhang for both of those types of products, the downhole tools, and drill pipe. We will work through that at some point in time next year and we will start to see more demand for those products. As you get into the more consumable type items like fluid end expendables, valve, seat liners, pistons. Those are probably going to be consumed as customers need them as opposed to really building up inventory levels, because there is ample supply out there. So it’s just going to be a bit of a mix between the products. Stephen Gengaro - Sterne, Agee & Leach: Okay, thank you. And then as an unrelated follow-up, as we think about CapEx and we think about the tax rate for ‘14, what’s the impact of the spin? Does it change the tax rate much or the CapEx number?

Yes, I think it’s too early to answer that right now. We are still working through the process ourselves. And as we get closer to the finish line, we will come back with more information. Stephen Gengaro - Sterne, Agee & Leach: Okay, thank you.

Thanks.

Thank you, Stephen.

Our next question comes from Marshall Adkins from Raymond James. Please go ahead.

Good morning guys.

Good morning Marshall.

We have heard from the seasonal offshore drillers talk about rig equipment delays and this quarter we see your backlog burn slowing a little bit. Is there anything we should read into that? Are lead times getting along? Is there anything going on there? Is it something else?

No. I mean, we are as we talked about on lots of calls we are pretty loaded up $15.2 billion to our backlog. And so we are having to be very careful about what we sign up to do on deliveries. I think some of the issues you are talking about some of the deliveries, again go back to this, the fact that we are building the first versions of rigs under new class standards with new rig floor layouts for all of us. And we have collectively faced some issues, but would stress that NOV has moved heaven and earth to try to get those rigs back on schedule as best we can and many we have not all, but many. And so I think we are moving progressively towards of that learning curve. We are getting better and better at it month by month.

The other thing I would add, Marshall, just real quickly the backlog burn is pretty high level $2.1 billion, which was consistent with last quarter and just slightly below our peak at Q4. So we are getting better at delivering I think.

So don’t read too much into it other than the new rig design.

Well, that’s about right.

Okay. Second question on the backlog, I will stay on the subject. We have seen a pretty good ramp up this year in the jack-ups you are doing, I can’t believe these numbers are right, but I had like 8 last year and 50ish by the time we end this year and deepwater rigs are going from 24 last year to high 20s this year. Where are we going to go next year? I mean, I am just kind of trying to get my arms around right you are almost at 30 deepwater rigs, you are going to order another 30, it sounds like in your guidance for backlog we fall off a little bit from that. And is that – am I reading that correctly?

Well, there is probably a little conservatism baked in that, but yes, I mean, our customers are pretty busy. They have ordered a lot of rigs. They have a lot of projects underway. Well, time will tell where we end up next year. But I think bigger picture and this is some of the part of the themes that I touched on in the opening comments where it’s an enormous opportunity out there. And with high commodity prices, we are seeing a lot of oil companies, lot of drillers avail themselves to these opportunities. And so we think again, the backdrop, the fundamentals are very strong, day rigs are strong, financings available, the shipyard infrastructure is offering holes at very, very low cost. The risk around building these things is low. And so you are seeing drillers go after that opportunity and grow their businesses by investing in these assets. And with regards to the jack-ups, there is still an awful lot. Over half of the marketed jack-ups are still more than 30 years old. And so there is a lot of rigs to build. On the floater side of things, you take all the floaters that were in existence prior to 2005 and you add all the floaters built since 2005 and you add all the floaters that are on order to be built. You are almost up to half of the rigs working in the state of Texas to go out and drill up the rest of the – two-thirds of the planet covered by deepwater. So we think that’s again a huge opportunity.

And Marshall I might add that the same sort of question was asked of us in ‘07, it was asked of us in ‘08, probably it was asked in ‘09, I just can’t remember, that before of last year – it was asked before of last year, and we continue to be very bullish on the need for the equipment and the rigs that we make for oil exploration and gas exploration in the rest of the world.

Well, the difference this time is you are also going to get a kick from the FPSO even if it does slow a little bit, that would be ramping up I would suspect?

Absolutely, absolutely. As we tell people, these drillships aren’t drilling for practice, they are drilling to discover oil and the approved [ph] solution on that production is going to be the FPSO business.

I will now turn the call back over to Pete Miller, Chairman and CEO to close the call.

Thank you all very much and we look forward to talking to you when we do our year-end results in February. Thank you very, very much.

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