Revenue Recognition
The Company's products and services are sold based upon purchase orders or contracts with the customer that include fixed or determinable prices and that do not generally include right of return or other similar provisions or other significant post delivery obligations. Except for certain construction contracts and drill pipe sales described below, the Company records revenue at the time its manufacturing process is complete, the customer has been provided with all proper inspection and other required documentation, title and risk of loss have passed to the customer, collectibility is reasonably assured and the product has been delivered. Customer advances or deposits are deferred and recognized as revenue when the Company has completed all of its performance obligations related to the sale. The Company also recognizes revenue as services are performed. The amounts billed for shipping and handling cost are included in revenue and related costs are included in cost of revenue. Revenue Recognition under Long-term Construction Contracts The Company uses the percentage-of-completion method to account for certain long-term construction contracts in the Rig Technology segment. These long-term construction contracts include the following characteristics:
• the contracts include custom designs for customer specific applications;

• the structural design is unique and requires significant engineering efforts; and

• construction projects often have progress payments.

This method requires the Company to make estimates regarding the total costs of the project, progress against the project schedule and the estimated completion date, all of which impact the amount of revenue and gross margin the Company recognizes in each reporting period. The Company prepares detailed cost estimates at the beginning of each project. Significant projects and their related costs and profit margins are updated and reviewed at least quarterly by senior management. Factors that may affect future project costs and margins include shipyard access, weather, production efficiencies, availability and costs of labor, materials and subcomponents and other factors. These factors can impact the accuracy of the Company's estimates and materially impact the Company's current and future reported earnings.
The asset, "Costs in excess of billings," represents revenues recognized in excess of amounts billed. The liability, "Billings in excess of costs," represents billings in excess of revenues recognized. Drill Pipe Sales
For drill pipe sales, if requested in writing by the customer, delivery may be satisfied through delivery to the Company's customer storage location or to a third-party storage facility. For sales transactions where title and risk of loss have transferred to the customer but the supporting documentation does not meet the criteria for revenue recognition prior to the products being in the physical possession of the customer, the recognition of the revenues and related inventory costs from these transactions are deferred until the customer takes physical possession.

EXECUTIVE SUMMARY
National Oilwell Varco generated earnings of $547.7 million or $1.31 per fully diluted share in its third quarter ended September 30, 2008, on revenues of $3.6 billion. Operating income was $790.3 million or 21.9 percent of sales for the third quarter, including charges of $0.04 per share after-tax related to the Company's second quarter acquisition of Grant Prideco, and including the impact of Hurricane Ike estimated to be approximately $0.09 per share after-tax. Compared to the third quarter of 2007, revenues improved 40 percent, and operating profit improved 45 percent during the third quarter of 2008. The Company's third quarter results were adversely impacted by the effects of Hurricane Ike, which struck the Texas Gulf Coast on September 12, 2008. While we were fortunate to avoid serious damage to our facilities, over forty Company facilities and dozens of our Houston-area suppliers were without power for a few weeks. Company-wide we estimate that approximately $114 million in revenues and $55 million in operating income were lost or deferred as a result. A small portion of this is expected to be recovered in the fourth quarter, which was also affected, and most of the remainder is expected to be recovered in 2009. Additionally, hurricane-related flooding affected certain of our operations in Mexico during the quarter, but on a much smaller scale. Grant Prideco Acquisition
On April 21, 2008 the Company completed its acquisition of Grant Prideco, Inc. for a combination of approximately $3.0 billion in cash and the issuance of 56.9 million shares of National Oilwell Varco common stock. The Grant Prideco merger further strengthened National Oilwell Varco's position as manufacturer to the oilfield. Its drill bits and reamers are being integrated into the Company's offering of drilling motors, non-magnetic drill collars, jars and shock tools, to complement its comprehensive package of bottomhole assembly tools used to drill complex wellpaths. Additionally, Grant Prideco's drill pipe products are purchased and consumed by the Company's existing drilling contractor customer base. The Company believes that consumption of drill pipe has been increasing due to the rising complexity of wellpath designs. Overall, the acquisition better positioned National Oilwell Varco to capitalize on continued application of horizontal, directional and extended-reach drilling, through both drill pipe and drill bit product sales.
Integration of the business is proceeding well. The Company is introducing new drill pipe tracking products, and expanding OEM drill pipe repair and maintenance offerings through its worldwide network of pipe service operations. The Company is also consolidating a number of bit and downhole tool sales facilities worldwide, and leveraging combined manufacturing capabilities to improve lead times and reduce costs. The Company achieved savings of approximately $10 million pre-tax during the third quarter, mostly on overhead cost reductions, and expects this amount to increase to approximately $11 million per quarter beginning in 2009. This is expected to result in an annual savings rate slightly higher than the $40 million per year rate in forecasted synergies at the time of the announcement of the transaction. During the third quarter of 2008, National Oilwell Varco recognized purchase accounting related charges totaling $28.0 million pre-tax or $0.04 per share after tax. The $28.0 million in charges were related to charges to "Cost of revenue" for inventory sold during the quarter that had a fair value step up under the Grant Prideco purchase accounting.
Oil & Gas Equipment and Services Market
Worldwide developed economies turned down sharply late in the third quarter as looming housing-related asset write-downs at major financial institutions paralyzed credit markets and sparked a serious global banking crisis. Major central banks are responding vigorously, but credit and financial markets have not recovered through the first few weeks of October. Most economists foresee a slow and uncertain recovery of credit markets, and a credit-driven worldwide economic recession developing. Asset and commodity prices, including oil and gas prices, have declined sharply as a result. After rising steadily for six years to peak at around $140 per barrel earlier in the year, oil prices retreated to the $60 to $70 per barrel range recently, roughly in-line with mid 2007 prices. Higher oil and gas prices over the past several years have led to high levels of exploration and development drilling in many oil and gas basins around the globe. The count of rigs actively drilling during the third quarter of 2008 as measured by Baker Hughes (a good measure of the level of oilfield activity and spending) increased 11 percent from the third quarter of 2007, but the impact of the credit market crisis has not yet been fully felt in the rig count. The Company expects that oil and gas operators reliant on external financing to fund their drilling programs are likely to curtail some of their drilling activity in view of tighter credit markets and lower commodity prices. This is expected to have the greatest impact on gas drilling across North America, despite the fact that gas prices have remained relatively strong compared to historical prices. Most international activity is driven by oil exploration and

production by national oil companies, which has historically been less susceptible to short-term commodity price swings. Therefore we expect international drilling activity to be less impacted by the credit crisis. The high level of drilling activity underway in the last few years has fueled strong demand for oilfield services. Much of the new incremental drilling activity is occurring in harsh environments, and employs increasingly sophisticated technology to find and produce reserves. Higher utilization of drilling rigs has tested the capability of the world's fleet of rigs, much of which is old and of limited capability. Technology has advanced significantly since most of the existing rig fleet was built. The industry invested little during the late 1980's and 1990's on new drilling equipment, but drilling technology progressed steadily nonetheless, as the Company and its competitors continued to invest in new and better ways of drilling. As a consequence, the safety, reliability, and efficiency of new, modern rigs surpass the performance of most of the older rigs at work today. Drilling rigs are now being pushed to drill deeper wells, more complex wells, highly deviated wells and horizontal wells, tasks which require larger rigs with more capabilities. The drilling process effectively consumes the mechanical components of a rig, which wear out and need periodic repair or replacement. This process has been accelerated by very high rig utilization and wellbore complexity. Drilling consumes rigs; more complex and challenging drilling consumes rigs faster.
The industry responded by launching many new rig construction projects since 2005, to retool the existing fleet of jackup rigs (350 of the existing 432 jackup rigs are more than 20 years old); to replace older mechanical and DC electric land rigs with improved AC power, electronic controls, automatic pipe handling and rapid rigup and rigdown technology; and to build out additional ultradeep floating drilling rigs, including semisubmersibles and drillships, employing recent advancements in deepwater drilling to exploit unexplored deepwater basins. We believe that the newer rigs offer considerably higher efficiency, safety, and capability, and that many will effectively replace a portion of the existing fleet. As a result of these trends the Company's Rig Technology segment has seen steady growth in its backlog of capital equipment orders from $0.9 billion at March 31, 2005, to $11.8 billion at September 30, 2008. The Company won a record level of new orders of $2.4 billion during the third quarter of 2008, and believes that the drilling industry will continue to build and upgrade drilling rigs; however, the credit crisis is likely to have a negative impact on new orders in the near term. Many customers rely on external financing to execute these projects, and several new order discussions have been delayed due to the challenges of securing financing. Nevertheless, the Company believes that export banks around the world will continue to supplement private financing in an effort to boost economic activity in the countries where these rigs are fabricated.
During the third quarter the Company secured contracts for six major packages of drilling equipment for deepwater floating rigs, including four for the Brazilian market, along with a handful of jackup rig packages. Land rig sales over the past six months have been strong, particularly for the Company's Ideal Rigs, Rapid Rigs, and new Drake Rig design for North America. Many of these projects are backed by term contracts from oil and gas operators who appear to be increasingly convinced of the safety and efficiency benefits of modern, AC-powered, electronically controlled rigs. The land rig backlog improved 49 percent sequentially and 14 percent year-over-year, to $1.8 billion or 15 percent of the total backlog. Equipment destined for international markets totaled 90 percent of the September 30 backlog. The Company believes that its existing contracts for rig equipment are very strong in that they carry significant down payment and progress billing terms favorable to the ultimate completion of these projects, and generally do not allow customers to cancel projects for convenience. For this reason we do not expect the credit crisis or softer market conditions to result in cancellation of contracts or abandonment of projects that would have a material adverse effect on the Company's financial results.
While the increasingly efficient equipment provided by us has mitigated the effect, high activity levels have increased demand for personnel in the oilfield. Consequently, the Company, its customers and its suppliers have experienced wage inflation in certain markets. Hiring experienced drilling crews has been challenging for the drilling industry; however, we believe crews generally prefer working on newer, more modern rigs. Our products which save labor and increase efficiency (such as its automatic slips and pipe handling equipment) also make the rig crew's jobs easier, and make the rig a safer and more desirable place to work.
Segment Performance
Rig Technology generated $1,926.4 million in revenue and $500.5 million in operating profit in the third quarter, yielding an operating margin of 26 percent. The group generated 31 percent operating leverage or flowthrough (the increase in operating profit divided by the increase in revenue) on 27 percent revenue growth from the third quarter of 2007 to the third quarter of 2008. Compared to the second quarter of 2008 revenue improved modestly and operating profit declined slightly, due in part to the impact of Hurricane Ike on Texas operations which deferred approximately $79.0 million in sales to later periods. Revenue out of backlog increased two percent sequentially to

$1,363.4 million, but record orders lifted backlog nevertheless to $11,793.8 million, up nine percent sequentially. As of September 30, 2008 the scheduled outflow of revenue from backlog is expected to be in the range of $1.5 billion during the fourth quarter of 2008, approximately $5.7 billion in 2009, and approximately $4.6 billion thereafter.
The Petroleum Services & Supplies segment generated revenue of $1,310.5 million in the third quarter, up five percent from the second quarter of 2008 and up one percent from the third quarter of last year (adjusted for a full quarter of continuing Grant Prideco results in both prior periods, but not adjusted for $105.1 million in sales of products transferred to other segments since last year). Operating profit was $329.6 million (excluding $28 million of cost of revenue charges related to the fair value step up of inventory under purchase accounting) or 25.2 percent of sales, and operating profit flow through was 50 percent sequentially, and 151 percent year-over-year. Strong operating activity increases in the domestic market, where the rig count improved six percent sequentially and 11 percent year-over-year, fueled much of the revenue and margin gains. Unconventional shale gas basin drilling was particularly strong in the quarter. The U.S. accounted for approximately 54 percent of Petroleum Services & Supplies segment revenues during the quarter. Hurricane Ike impacted third quarter Petroleum Services & Supplies segment revenues by approximately $35 million, about 60 percent of which is expected to be recovered in the fourth quarter. Revenues from oilfield service products in Canada improved following the resumption of activity in the third quarter following the seasonal breakup decline in the second quarter. This seasonal event drove a sequential increase in the rig count in Canada from 169 rigs in the second quarter to 432 rigs during the third quarter. Canadian revenues were approximately eight percent of the segment's total during the third quarter. International activity remained strong, with notable sequential and year-over-year improvements in sales to Latin American markets during the third quarter. Solids control, composite pipe, bits and downhole tool products posted significant increases sequentially. Drill pipe backlog and revenue improved sequentially as well, but margins declined due to higher steel costs and an unfavorable mix.
Distribution Services segment revenue was $497.6 million in the third quarter, up 17 percent from the second quarter of 2008 and up 38 percent from the third quarter of 2007. Operating profit was $43.7 million or 8.8 percent of sales, a record margin. Operating profit flowthrough was 26 percent sequentially and 14 percent year-over-year. Strong U.S. activity, particularly in the mid-continent and Rocky Mountain regions, drove high levels of domestic sales, and cost reductions in prior periods contributed to improving margins and leverage. Sales into new rig construction and refurbishment of older rigs in the domestic market also contributed to domestic results. The U.S. accounted for about 48 percent of the segment's third quarter revenues overall. Canada sales, about 18 percent of the third quarter mix, increased sharply coming out of the second quarter seasonal breakup, which contributed to strong operating profit flowthrough as well. Saskatchewan and Eastern Canada were particularly strong in the quarter. International revenues were down slightly and accounted for 34 percent of the sales mix, but margins for international sales increased slightly sequentially.
Outlook
The recent emergence of a serious banking crisis, prospects for an emerging global recession, and lower commodity prices are likely to present near-term challenges to our business. Consequently, we are more cautious in our outlook for 2009, and believe we are likely to see orders for new rigs slow, and drilling activity, particularly by independent gas producers reliant on external financing, decline as we enter the new year. The Company is, nevertheless, well positioned to manage through this uncertain period, and should benefit from its strong balance sheet and capitalization, access to credit, and record high level of contracted orders which are expected to continue to generate good earnings well into the downturn. The Company has a long history of cost-control and downsizing in response to depressed market conditions. Such a period may present opportunities to the Company to effect new organic growth and acquisition initiatives, and we are hopeful that a downturn will generate new opportunities. The supply of offshore rigs remains tight in many markets, and certain developments point to improving economics of rig building; namely, rising dayrates for ultradeepwater floaters, falling steel costs, and a strengthening U.S. dollar. The offshore rig dayrate market is generally denominated in U.S. dollars, but rig fabrication is mostly denominated in foreign currencies. Foreign shipyards source steel from foreign mills, and pay local wages in foreign currency. Likewise, the Company manufactures many of its products overseas in foreign currencies as well. Steel prices began to decline 10 to 20 percent in the third quarter 2008. The impact of improvements in all three areas should lift returns on projects. Nevertheless, many ongoing discussions of potential newbuild rig projects in our Rig Technology segment have slowed or stalled, pending better visibility into the credit crisis.

Our outlook for the Company's Petroleum Services & Supplies segment remains good into the fourth quarter of 2008, given continuation of high levels of drilling across North America and international markets, but is likely to see lower levels of sales in 2009 as drilling programs wind down. Certain inflationary pressures, particularly steel and fuel, appear to be abating, but labor costs continue to trend up. We would expect lower levels of drilling activity would negatively affect both volumes and pricing for the group, and offset recent modest price increases. We continue to focus heavily on manufacturing and service efficiency.
The Company's cautious outlook for the Distribution Services segment also reflects a likely downturn in North American activity, which accounts for a majority of the segment's revenues. Specifically, mature regions such as West Texas, South Texas, the mid-continent and Rocky Mountain regions may be at risk for oil and gas company reductions in drilling expenditures. Both pricing and volumes would be adversely affected by such a downturn. Our outlook for international markets, which are more driven by national oil company activity, are historically less volatile and expected to see better market conditions.

Operating Environment Overview
The Company's results are dependent on, among other things, the level of
worldwide oil and gas drilling, well remediation activity, the prices of crude
oil and natural gas, capital spending by other oilfield service companies and
drilling contractors, pipeline maintenance activity, and worldwide oil and gas
inventory levels. Key industry indicators for the third quarter of 2008 and
2007, and the second quarter of 2008 include the following:

                                                                                       %              %
                                                                                    3Q08 v         3Q08 v
                                      3Q08*           3Q07*          2Q08*           3Q07           2Q08
Active Drilling Rigs:
U.S.                                    1,978          1,788           1,864           10.6 %          6.1 %
Canada                                    432            348             169           24.1 %        155.6 %
International                           1,095          1,020           1,084            7.4 %          1.0 %

Worldwide                               3,505          3,156           3,117           11.1 %         12.4 %

West Texas Intermediate Crude
Prices (per barrel)                  $ 118.60        $ 75.32        $ 124.05           57.5 %         (4.4 %)

Natural Gas Prices ($/mmbtu)         $   9.03        $  6.17        $  11.38           46.4 %        (20.7 %)

* Averages for the quarters indicated. See sources below.

The following table details the U.S., Canadian, and international rig activity and West Texas Intermediate Oil prices for the past nine quarters ended September 30, 2008 on a quarterly basis:
. . .