National Oilwell Varco Earnings Call INSIGHTS: Slowed Bidding Process with FPSO, Record-Setting Drill Pipe Production

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On Thursday, National Oilwell Varco, Inc. (NYSE:NOV) reported its second quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Slowed Bidding Process with FPSO

J. David Anderson – JPMorgan Equity Research: Clay, did I hear you say $200 million award for turret this quarter that just came in?

Clay C. Williams – EVP and CFO: Yes, it didn’t show up in Q2, David. It was after the close of the quarter. So, this will – and actually it’s not one turret, it’s a number of pieces of equipment there in a couple of customers, but they aggregate to a lot of signings of orders here just the past couple of weeks it will show up in Q3.

J. David Anderson – JPMorgan Equity Research: Okay. So, it’s actually kind of what I was wondering about. When you guys are bidding on your rig packages, you are generally bidding on FPSO. I think you’ve not talked about it. This is a generally kind of piecemeal. What is the bidding process like right now with FPSO? It’s sort of a new business for you. When you go into that, are you selling a package, are you offering a package or is it individual pieces, and maybe if you can also provide a little context in terms of what that bidding activity is being like in FPSOs now say compared to, I don’t know, six months ago or so?

Clay C. Williams – EVP and CFO: Yes, that’s a great question. Well, first, the answer to your first question is the bidding process has been painfully slowed here in the last few quarters. It’s a market that’s kind of – we’re still recovering I think to some degree from the downturn from ’09. Good news is though it’s distinctly recovering increase or rising and the like. As you know, our strategy here is to try to offer more of a package to offering of FPSO components and in some way change how that industry view these projects and execute these projects. We think by doing that we can improve the efficiency, we can drive more standardization, and so we’re having a number of conversations that are very interesting and some enthusiasm in those – with shipyards and others about how and what that might look like, but that’s a very slow evolution and process. So, that’s kind of going on behind the scenes. In the meantime, we’re in there bidding still more on a component-by-component basis and slugging it out, but outlook is improving. NKT came in and we’ve seen a rising interest in their products for flexible flow lines, which of course plug into FPSOs and APL has a lot of good things going on too. So, our bullish outlook on market demand is as enthusiastic as it ever was and I’m pretty excited about what’s out there over the next couple of years. One final point to make here though is that I think the owner-operators of FPSOs, there’s a couple of large ones that have some – it’s well known that they are struggling a little bit with their business models and I think that’s kind of what our customers are sorting through right now. Who’s going to own and operate these things and how they’re going to make money at it.

J. David Anderson – JPMorgan Equity Research: So kind of an opportunity from competitor weakness?

Clay C. Williams – EVP and CFO: Yeah, partly. Some of those owner-operators are vertically integrated. As you know, we don’t own and operate and we just want to sell components to them but we’re also taking a look at their business model and figuring out what can we do to help them make a better return on investment. Ultimately, that’s going to be the key – the path to success for us and we can transform what we sell, make it more standardized, reduce the risk around building these large complex vessels, so that all parties have a better idea of what’s going to cost, there’s less uncertainty for shipyards, there’s less uncertainty for the owner-operators in these things, and again I’ll stress, it’s a very long-term strategy. That involves a lot of evolution of thinking across everybody to participate in this space, but the end goal here I think is an attractive place where everyone involved here can make good returns and good profits on these projects.

Merrill A. ‘Pete’ Miller, Jr. – Chairman, President and CEO: David, I might add too. If you take a look at what we’ve done with drillships , it’s really been the exact model. If you go back to the mid-90s and look how drillships were built and you look at how they’re built today, it’s totally different. That’s one of the reasons who aren’t having the cost overruns, you aren’t having all the issues you had back in the mid-90s. So it’s our desire and I think it’s our vision and we’ll get there but we’re going to replicate what we’ve done for drillships with the FPSO market.

J. David Anderson – JPMorgan Equity Research: Speaking of profitability, you talked about Rig Tech margins being basically flat in 3Q. I assume flat from the 24.5 number that you guys – ex acquisitions I assume that was the number you were talking about.

Clay C. Williams – EVP and CFO: We’re going to quit reporting ex acquisitions because now everybody is part of NOV, but no, I would say around 24 is what our forecast calls for right now. If you recall, as we move into Q3, we’re going to have a larger contribution from a couple of acquisitions, NKT and Enerflow, because (indiscernible), but they’re not up where Rig Technology margins are. So, as the mix moves more in that direction in Q3 compared to Q2, that will offset some of the margin improvements that we’re expecting in the other parts of the base NOV business in Rig Technology.

J. David Anderson – JPMorgan Equity Research: That was actually what I was getting at. Just maybe if you could just kind of help us understand a little bit of how this mix is shifting. Of course we’re all looking back at the past for – if you’re looking towards the future and things are always changing with you guys in terms of your acquisitions, and by the way you don’t have to justify your acquisitions with us, but in terms of as we’re looking out there with these different components, it sounds like you worked through that lower price backlog on the rig equipment and now that higher price backlog is coming through. Can you just help us understand, so I don’t know, the next year or so, how you see that playing out and how margins start to uplift and what we should be expecting?

Clay C. Williams – EVP and CFO: Yes, I think margins are going to gradually improve here, but I’ll stress gradually, and maybe after moving sideways again for another couple of quarters. The factors driving this are, you cited a big one, we did get improved pricing on rig DEPs through 2011, mostly in the drillship end of things and semi end of things, but that improvement is going to be mitigated by a couple of things. One is these two acquisitions coming in with a little lower margins involved, a pickup in results coming from APL, the turret mooring business. Again, good margins but not as strong as the base Rig Technology margins. Headwinds in the land business particularly coming from our North American customers that I highlighted in my comments and that affects all things from drilling rigs to well servicing rigs to frac spreads and pressure pumping equipment. So it’s a couple of offsetting factors there. I would also throw in the fact that with all the plant construction and expansion that’s going on around the world we have a lot of startup costs and just took on with NKT a very large plant in Brazil that’s got some sort of costs that are going to – it’s going to carry this well. So as opposed to where we were, three months and six months ago in terms of margin outlook some negatives have popped up in the market and also we have added in these businesses, great businesses, good long-term growth prospects but they are going to be a little more limiting on the margin here in the short line.

Record-Setting Drill Pipe Production

Marshall Adkins – Raymond James: Trying to keep it relatively quick here. I think the biggest surprise for a lot of us was how well PS&S and Distribution did, particularly given the declining North American rig count that we have seen. I mean I guess I certainly think of it as if the U.S. rig count is falling in a meaningful way and certainly Canada falling seasonally so sequentially things are going to be (indiscernible). You are one of the guys that you put up pretty good numbers here. Well I want a little more color on you mentioned drill pipe was one of the reasons why that happened but just give us a little more color on both those divisions on why we didn’t see kind of the normal decline in business or the decline in rig count?

Clay C. Williams – EVP and CFO: Yes, drill pipe was the biggest single – our focus on PS&S, drill pipe was the biggest single piece and it just had a great quarter. There were some headwinds operational last quarter, last couple quarters that they worked their way through and record level of production of drill pipe this quarter, they’ve never done as much. Also it’s more focused in North America, that’s not without much contribution from our Chinese plants, and so just a super job by that group and that drove great incrementals and good margins there. The other two standouts in the quarter I would add would be our XL Systems business, which we probably don’t talk enough about. These are marine connectors offshore. They had a real solid quarter as well, and thirdly, just an outstanding performance by our fiberglass pipe. They took on the Ameron acquisition late last year, and this is a great little case study about some of the themes that I was speaking to earlier in terms of how well our guys can integrate businesses and make them profitable. They’ve just done a super job of rationalizing costs of moving glass purchases over to lower priced contracts, resin purchases over the lower priced contracts to really get benefit of economies and scale, doing away with duplicative overhead structures that sort of thing and so they had a terrific quarter as well. So, I would highlight those, I’d say all of our businesses did really well, but I’d highlight those three in particular.

Merrill A. ‘Pete’ Miller, Jr. – Chairman, President and CEO: I might add Marshall, when you look at our PS&S business, and we’ve talked about this a lot. Everybody knows our position in the drilling rigs and everybody knows what we do on drill ships and semisubmersibles, but when you start talking about names like Tuboscope and Brandt, ReedHycalog and our downhole motors and our fiberglass and all that, those are all market leading names and I think we have such good presence in the market, but even though there is some softness with the declining rig count, those market-leading names are going to be the last business that people get rid of. They’re going to get rid of some of the folks that are chasing those market-leading names but not those, and that’s one of the reasons we’ve had success.

Marshall Adkins – Raymond James: And you aren’t getting any – you said, you weren’t getting any of the cost savings from Wilson blown through yet, I mean there is no way?

Clay C. Williams – EVP and CFO: Not much.

Merrill A. ‘Pete’ Miller, Jr. – Chairman, President and CEO: Not yet, but we’ll get it. But again, we had – predominantly there wasn’t that much of Wilson in the distribution numbers and our distribution guys continue to just do a phenomenal job of what I call, rubbing the buffalo off the nickel. Those guys control, they control their costs about as well as anybody, and I think as we integrate quicker and quicker with Wilson deal, you’ll see the same sort of results coming out of that.

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