Good day, ladies and gentlemen, and welcome to the National Oilwell Varco First Quarter 2018 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Loren Singletary, Chief Investor and Industry Relations Officer. Sir, you may begin.

Welcome, everyone, to National Oilwell Varco's first quarter 2018 earnings conference call. With me today are Clay Williams, our Chairman, President and Chief Executive Officer; and José Bayardo, our Senior Vice President and Chief Financial Officer. Before we begin, I would like to remind you that some of today's comments are forward-looking statements within the meaning of the federal securities laws. They involve 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. For a more detailed discussion of the major risk factors affecting our business, please refer to our latest forms 10-K and 10-Q filed with the Securities and Exchange Commission. Our comments also include non-GAAP measures. Reconciliations to the nearest corresponding GAAP measures are in our earnings release available on our website. On a U.S. GAAP basis for the first quarter of 2018, NOV reported revenues of $1.8 billion and a net loss of $68 million or $0.18 per share. Our use of the term EBITDA throughout this morning's call corresponds with the term adjusted EBITDA as defined in our earnings release. Later in the call, we will host a question and answer session. [Operator Instructions]. Now let me turn the call over to Clay

Thank you, Loren. In the first quarter of 2018, NOV generated $1.8 billion in revenue, a decrease of 9% sequentially, and an increase of 3% year-on-year. EBITDA was $160 million, down $37 million sequentially, representing 21% decremental leverage to our fourth quarter 2017 results. Our performance was disappointing and less than we expected, leading us to announce preliminary results several days ago, specifically calling out some of the challenges we faced in the quarter. While some of these were outside our control, many were not. We were focused intently on improving execution, and this morning, I'm going to go straight into operations to explain what we're seeing and doing in more detail. And importantly, show why despite this slow start, we believe that 2018 is shaping up to be a much stronger year. Wellbore Technologies revenues declined a little less than 1% sequentially in the first quarter, down $4 million to $711 million, but strong Western Hemisphere growth, up 7% sequentially, was obscured by lower drill pipe sales and lower sales in the Eastern Hemisphere. Customers continue to deploy excess drill pipe from stacked rigs to working rigs, which has kept demand low and contributed to drill pipe revenues declining 12% sequentially. However, that may be changing as our first quarter drill pipe book-to-bill exceeded 200%, reaching the highest volumes we've seen since the third quarter of 2015, helped by our new delta proprietary thread design. With more than 1,000 rigs operating in the United States diminishing excess drill pipe inventories and E&P companies beginning to speck our sophisticated thread design. The outlook for drill pipe has begun to brighten. Excluding drill pipe, Wellbore Technologies North American revenues increased 7% sequentially, and Latin American revenues increased 6% sequentially, driven by stronger demand and share gains for downhole tools including bits,…

Thank you, Clay. To quickly recap the quarter, NOV consolidated revenue was $1.8 billion, a decrease of 9% or $174 million sequentially. EBITDA declined $37 million to $160 million as decrementals were limited to 21%. Looking at the line items of the P&L, as anticipated, SG&A increased $10 million sequentially due primarily to the nonrecurrence of certain credits realized in the fourth quarter. Interest expense decreased $1 million due to a full quarter impact from the retirement of our $500 million, 1.35% senior note in December. Equity income increased $3 million, primarily due to rapidly improving results in our post-Alpine joint venture which we realized a 14% revenue growth sequentially. Other expenses increased $40 million, primarily due to losses associated with FX and certain owned assets. We reported a GAAP loss before income taxes of $63 million and tax expense of $3 million. The negative tax rate was a result of the valuation allowances applied to foreign tax credits and an increase in nondeductible expenses associated with the recent tax reform legislation, which prevented our tax benefits from fully offsetting income realized in a number of foreign countries. While we operate at or near breakeven income levels, relatively small changes in income by jurisdiction or discrete items will result in significant volatility in our effective tax rate's from quarter-to-quarter. We anticipated that incentive compensation and income and property tax payments would meaningfully reduce cash flow from operations in the first quarter. However, delayed orders and deferred deliveries further contributed to our increase in working capital resulting in a $129 million net use of cash from operations. As Clay mentioned, inventory that was expected to ship and translate into revenue by quarter end did not make it out the door and remained on our balance sheet in greater quantity than expected.…

[Operator Instructions]. Our first question is from Byron Pope from Tudor, Pickering, Holt.

Just have one question. I tend to think of Wellbore Technologies, many technologies within that portfolio, is being early cycle in nature. And it seems like it's just a matter of time before we see the Eastern Hemisphere come around. So Clay, could you just frame, based on what you're hearing and seeing from customers with regard to inquiries, which regions or countries in the Eastern Hemisphere you would expect to lead the recovery there?

Yes, Byron. We're currently hearing a more interest out of the Middle East. Of course, Middle East, through the downturn, has remained at higher activity levels and seen less of a falloff. But kind of what I'm hearing lately from, in particular, national oil companies across that region is they're looking to the productivity gains that have been made in the Western Hemisphere, and really focus on how to replicate those. And in particular, deliver the sorts of long laterals and highly productive wellbores that have been accomplished here in the United States, and so I think a lot of excitement there. Also encouraged by recent developments in Asia. That region, I think, turned down harder than many others in the downturn, and has been hit particularly hard. But in the last quarter or 2, I think, we're getting some more interest there, so that's encouraging. And then lastly, we kind of referenced this in our prepared remarks, a lot of people are very focused on, in particular the Vaca Muerta shale in Argentina, and recognize that newer and more modern levels of technology need to be brought to bear to that formation I think to achieve the sort of results that our producers in North America have achieved with unconventional. So again, there's a lot to be encouraged about in terms of the uptake for the technology NOV offers.

That's helpful. And then just one follow-up with regard to the North America part of Wellbore Technologies. I assumed, based on what you guys are seeing in terms of footage drilled, even if we were to see the pace of incremental rig adds and based on the Permian slow, the trends that you guys are seeing with regard to footage, horizontal footage drill, I would assume, continue to progress in fairly conservative faction. Would that be a fair way to think about it?

I appreciate you bringing that up, Byron, because as you know, is that Wellbore Technologies is probably more driven by footage drilled than actual well count. And the industry continues to improve productivity per rig. In fact, if you look at just over the long-term the footage drilled per active rig is up fourfold from where it was, say 30, 35 years ago, back in the early '80s, so steady gains being made there. But in a lot of ways, that just means we're consuming tools and rigs faster. It's, as I say with cars, it's not the age, it's the mileage. So that's really what NOV benefits from.

Our next question is from Sean Meakim of JPMorgan.

So maybe given the dichotomy you talked about between hemispheres in wellbore. Can you maybe just give us a little bit more granularity of what drove the decline in Eastern hemisphere? Is it just slow start to budget implementations in those types of markets? You mentioned drill pipe being a source of weakness, was that more weighted towards EH as well where the 2 connected, I guess, maybe the western side seem to make sense as you broke that down for us, which was very helpful. Maybe we could drill a bit more on the eastern sides.

Sure, Sean. It's Jose. And effectively, the primary reason is really the typical slowdown that you see in the Eastern Hemisphere in Q1. So it's certainly not unique to NOV. I think maybe we were a little overly optimistic in terms of what the budgeting cycle might look like in 2018. If you'd recall back in 2017, with a slight improvement in commodity prices, you saw activities sort of continue to carry forward and build. This year, even though we had a better commodity prices and arguably a faster pace of improvement in commodity prices, we went back to sort of a traditional budgeting process, particularly in the Eastern Hemisphere. Let's say that we remain very optimistic about where things are headed in the Eastern Hemisphere, in general, a couple of quarters ago, we started seeing that area of the world come to life a little bit more for us. And that wasn't even a result of improved drilling activity, it was really more a result of the scarcity that just takes place over time as operators and service companies consume the inventories of the product they had on hand. So when people come back with those budgets, we are optimistic about what 2018 will look like as the year unfolds. As it relates to the drill pipe question, it's really, obviously, with the 12% sequential decline, it's pretty bad everywhere. But extremely encouraged about what we're seeing in terms of the bookings that we attained this quarter as well as the continued falloff in customer on pipe that we see within our Tuboscope yard. So feel good about where things are headed.

Got it. Okay. That all makes sense. On Rig Technologies, given some of the issues that you outlined, maybe you can you give us an update on how you see the cadence, what's in there today in terms of backlog? Perhaps maybe what you see as likely what you defined as likely 2019 and beyond? You said that the business has become lumpier in terms of the throughput, so that will be great just to get a little update on kind of how you see that cadence based on what you can see today.

Generally, Sean, and you're very familiar with this, but our -- we've been working down our backlog of newbuild offshore rigs, which we entered the downturn with a lot of projects underway, and so those have sort of been diminishing over time. And as I mentioned, and again, in prepared remarks, maybe subject to a little more drama in terms of getting them completed in a steady fashion and being able to forecast progress and those. And what we're seeing now is the replacement of that with more land rig demand. So almost 60% of this quarter's orders for rig technology were for land rigs and we've got a pretty good start on Q2 with the sale of 2 more land rigs into Latin America, and outlook is brightening for demand there. And so what we see -- how we see that business progressing through the remainder of 2018 is kind of continuing to complete these offshore rigs and then pivoting to the land rig business, which we think is very promising for NOV. I think for next quarter, we are looking for about $260 million or maybe $270 million to come out of the existing backlog. And for the remainder -- or for the full year, I guess, 2018...

900

About $900 million to flow out as kind of the current -- currently what's in there. But as Jose mentioned, I think there is a lot of sort of building demand for better technology to achieve higher levels of productivity in drilling. And that really rests on a more modern rig fleet. And the rig fleet throughout most of the international markets is still a generation behind, really the super spec AC sort of capabilities that we have here in North America. And that will be the engine that will drive demand and results for rig technology.

Our next question is from James West with Evercore ISI.

Clay, I wanted to dig in a little bit more on NOVOS. This is something you've been highlighting more and more. I got a chance to spend some time with your guys that have developed this, and I'm hearing from a lot of the -- at least several of the drilling joint contractors that they were very happy with the software. Could you just talk about maybe the penetration that you guys have so far with NOVOS? And then also, I'm curious of the 15 apps that have been developed and more that are being written right now, is there any types of trends that you're seeing with those applications? Or are they kind of all across the drilling spectrum?

Yes, they're really kind of all across the drilling spectrum, James. And coming from all corners of the oil and gas world, so we have drilling contractors that have written apps, we have service companies that have written apps and we have major oil companies that have written apps, and in fact, we had a successful test on an app here in the first quarter from one of the majors that we're very excited about. And so a lot of interest in developing a specific applications that work within our NOVOS environment. And just to explain to listeners who may not be completely familiar, this is -- the NOVOS system is an operating system that operates drilling rigs. And it's an open architecture system that permits third parties to come in and write applications to control the rig in a safe environment, in an envelope that we define to execute their specific operations on the rig. It enables third parties to automate certain steps on the rig. And really what we're trying to accomplish with that software package is to bring more process control and automation to the repetitive actions that are done on rigs. And so there are dozens, if not hundreds, of specific steps in the drilling of a well that are accomplished through a lot of manual steps executed by the driller and the crews. And so in many ways, drillers are really kind of rig drivers. And what we're trying to do is lift that profession up and make that individual more of a process manager and a team leader, less intently focused on driving the rig and more focused on kind of the work environment and the people to think ahead and to let the machines do the repetitive work on the rig. And so it's a really interesting development, I think. And the move here towards effectively sort of crowdsourcing rig activities and doing that in a way that it enables third parties to launch apps that underpin their services or their operations on a rig is pretty interesting. So not surprisingly, I think we're seeing a lot of interest in this and really good adoption. There's 1 large drilling contractor in particular that's been a good partner in this, and then as well as a number of other smaller joint contractors onshore. And now we are migrating this technology offshore this quarter. And there are a number of folks out there. And the last thing I would add on NOVOS, James, is that it's been noticed by the oil companies. And so we're -- I think some drilling contractors are experiencing a lot of pull on this technology and capability from their customers.

That's great to hear. It's very exciting. And just one kind of unrelated follow-up from me. The Middle Eastern tenders that are out there today, which are some pretty big ones, am I correct in thinking that all of them basically spec in this new super spec type of land rigs?

Well, we can always hope but not quite yet. We do have, again, there is a lot of interest overseas for kind of newer, more modern capabilities and technologies. But I would say it's still a mixed bag in terms of [indiscernible] over there. But the good news I think for NOV in the longer-term is [indiscernible] very aware of the technology of new super spec rigs. And so we are seeing some of these standers start to fall that in.

The next question is from Marshall Adkins of Raymond James.

So Clay, I'm sitting here thinking about this, I mean, we got oil up sharply last 9 months, Brent's at 75 today. Every U.S. company we talked to is out of equipment. And most of them have depleted their inventories, and I would assume that's the case for offshore as well. So what am I missing? I mean, Q1 seems to be very transitory in nature, and we should see a meaningful improvement in your business in the back half of '18, and really going into '19 given the later cycle and the lagging part -- the buying phase that you insisted. What's wrong with that logic?

I think that describes it perfectly, Marshall. Obviously, as we mentioned, we are disappointed with Q1 but we do view it as largely transitory. The trends are intact. I -- the only sort of caveat I would make to what you just said is offshore, there are a lot of stacked rigs and so cannibalization continues. We did see a lot of encouragement in the first quarter around spare parts orders that point to maybe we're near the end. So I am a little hesitant to say that our offshore customers are out of spare parts just yet. One quarter doesn't make a trend, but certainly a really strong move on spare parts orders at 22% sequentially in Q1 is pretty solid there. But yes, I think you step back and look at how the company evolves out of this downturn, I think we would have all predicted it would start with consumables and a lot of quick turn items in Wellbore Technologies, which we've seen that pricing leverage would return around those product lines and then a little later in the recovery demand for capital equipment. And so far, we seem to be sort of on that progression.

Are you saying -- with the recent upward surge in the last few months, are you seeing more green shoots across the board in the offshore side? And you mentioned that the parts, but are you seeing more stuff on the consumables offshore, et cetera, et cetera? Has that -- have those discussions changed?

Yes. But what I would add is that they tend to be more conversations and -- we're not seeing the purchase orders falling yet. And so the offshore has lagged, certainly, the North American land market and certain other markets around the globe. But what is encouraging is the number of conversations that we're having, for instance, around our new FPSO topside package initiative appears to be rising. We're getting some feed studies here and there. So yes, I think we are seeing some green shoots and $75 a barrel Brent is precisely the thing that we need to start turning those into purchase orders.

One last quick one for me. Free cash flow of potential seems to be pretty meaningful looking out to later this year and '19. Could you all just comment on your thoughts there?

Sure, Marshall, it's Jose. Yes. So we continue to believe that we will generate an ample amount of free cash flow over the next couple of years. Obviously, Q1 wasn't great from a free cash flow perspective, as we commented. It was anticipated, but also magnified by the fact that inventory stuck around a little bit longer than we had hoped. So we still have the same goals and objectives as it relates to working capital. It is a huge area of emphasis across the organization. As we talked about before, our goal is to get back to historical norms in terms of working capital levels, which we look at as working capital as a percentage of revenue run rate. And what that means is that over the course of call it the next 24 months, we will be able to get back in the vicinity of sort of 35% range for that metric, which, if we do that and if we perform operationally the way we expect to, we'll realize ample amount of free cash flow.

Our next question is from Ken Sill with SunTrust.

Two questions that are kind of minor issues but interesting. Schlumberger is back talking about the rig of the future. They're going to deploy 1 in the U.S. and a couple internationally. Is that a project where they're kind of competing with your designs? Or it's just an alternative to your designs, but they use your parts? It's hard to gauge talking to them what their potential is and I'm just wondering what you guys read on that is.

Ken, being a provider of rig equipment and complete land rig packages, obviously, we've been paying close attention to what they're doing. I think they're probably in a better position to comment on them than we are.

Come on, you know they won't comment on it.

To focus on enhancing our rigs, developing our rigs with features like the NOVOS control system, for instance, we introduced a new drawworks package to upgrade 1,500-horsepower of drawworks to 2,000-horsepower drawworks, which we think is something that is -- we're already finding actually that North American drillers find that attractive. We are kind of focused on our own rigs and rig offerings to the marketplace and can't tell you precisely what they're focused on.

Okay. Another question, obviously, you can't tell us you're working on R&D, but with longer laterals, we're hearing people taking laterals out to well beyond 2 miles now, which inhibits the use of coiled tubing at the far end. Is there anything in the skunk works related to either an enhanced workover rig that's more automated? Or some way to make coiled tubing so it can get further out?

Yes. So larger diameter coiled tubing, higher strength coiled tubing, we've focused on to reach further out. We have completion tools, including sliding sleeves where you can change the way that you access the wellbore further out. We are -- we manufacture well servicing rigs, which you join a pipe to reach out further into the laterals, and we're seeing higher, basically, customer demand for higher mass on well servicing rigs and more pumping capacity and kind of better pipe handling capability driving further demand. So yes, we're kind of all over that trend, including some hybrid units that we're developing to. And so in terms of accessing that wellbore, yes, there are several different ways that NOV is helping customers achieve that. I would add too that in terms of creating that wellbore, you heard on our prepared remarks all the things that we're doing with regards to geosteering, to directional drilling and drilling a straighter wellbore, including Rotary steerable tools and other directional drilling tools because one of the big challenges that E&P company faces, torque and drag is sort of cumulative as that lateral goes longer and longer and longer, so that becomes a problem further out and vibrations, and maintaining oil control and the like. So both the creation and the drilling of that wellbore and also the completion of that wellbore, we have a lot of things going on.

Our next question is from Marc Bianchi with Cowan.

Again Jose, looking at the guidance here for second quarter, I suspect there's some proportion of kind of catch up from what you lost in the first quarter. Is there any way you can help us think about how much of it is just due to the catch up? And then how much is sort of the underlying performance of the business as we try to take a better baseline for modeling beyond second quarter?

Yes, sure, Marc. I can't get into specifics associated with precisely how much slipped from 1 quarter to the next. But there are a couple of elements you got to consider when thinking about the impact to the second quarter and beyond. So certainly we had some of those equipment deliveries get deferred from Q1 to Q2, which will help the revenue in the second quarter. But the other item that corresponded with the deferred deliveries is deferred orders. So orders that took longer to materialize than what we would have otherwise anticipated, meaning a lot of orders came in very, very late in the quarter. So there's a little bit of an element of things slipping from Q1 to Q2, which boost Q2. And then there is another issue associated with timing of those orders that came in late in the quarter which will likely push what we otherwise would have expected in Q2 to take place in Q3. So it's a little bit of a mixed bag there.

Okay. Okay, that's helpful. And I guess, another one for, maybe for Clay. If you guys are talking about the M&A potential now potentially putting on hold and kind of capital return. At the point you do get to thinking about capital return, how do you weigh opportunities for further M&A versus stock buyback versus dividend? And how does the level of stock come into play for that?

That's a great question. And so, as we've mentioned in the past, kind of our hierarchy of attractiveness typically is around organic investment to support our ongoing operations and development of new technologies here internally. And then acquisitions of businesses to sort of enhance our businesses and to deploy capital in new attractive areas. And then the return of excess capital is what we look at and with regards to either through a dividend, special or increasing our regular dividend, or through share buybacks. And so as Jose mentioned in his prepared remarks, we're not prepared yet to increase our capital return to shareholders, but we are in close consultation with our board. And as the year progresses, the way we think we will, will be, I think, probably looking more closely at that, but we will be comparing it to our other potential applications of capital. The company has been busy on the M&A front, and we continue to see a lot of attractive opportunities out there. We had 3 closings in the first quarter and we've got several companies now that we're in the middle of discussions with. And so it continues to be a pretty interesting market for M&A. But basically, to answer your question, we sort of compare application of capital net direction versus either share buyback or an increase in dividend.

Our last question is from Jud Bailey of Wells Fargo.

A question on C&P margins. I appreciate kind of issues going on in the front half of the year in terms of mix, et cetera. How do we think about margins in the back half of the year assuming things progress as you think. Is it reasonable to think we can get back to kind of where you were 2Q, 3Q last year, kind of 14%, 15% type margins in the back half of the year if you start to see decent order flow return? Or help us think about margins in the back half of the year for that segment, if you don't mind.

Hey Jud, it's Jose, I'll start with and Clay will add, if you like. Ultimately, it depended on what the revenue flow and what the opportunity set is. But the thing is, as you know, that's been creating challenges for us on the margin front are the cross currents and the decline in the offshore-related components of that segment. We think we're getting close to a bottom as it relates to those types of issues but we still think over the next quarter or 2 that, that will continue to be a drag on potential incrementals for that segment. With as we get into the back half of the year, certainly expect that business to start generating much more meaningful incremental margin improvements.

Okay. Yes, and my follow-up, I just wanted to circle back on the Rig Systems guide, pretty strong revenue growth but low incrementals. I apologize if I missed the explanation on that. But what's kind of driving the mix there with the lower incrementals relative to pretty strong kind of improvement in the revenue?

Yes, what we try to describe there is a lot of these initial newbuild land rig sales that are going out the door, we have had, as you know, quite a bit of excess inventory sitting in our yards. And also our rewarding first mover customers with some pretty attractive pricing, so here we are in the very initial stages of the recovery of the land markets. We're anticipating less-than-ideal incrementals associated with those but that would be a very short-lived phenomenon.

At this time, I'd like to turn the call over to Mr. Williams for closing remarks.

Thank you all for joining us this morning, and we look forward to sharing our second quarter results with you in July.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone, have a great day.