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| NOV > SEC Filings for NOV > Form 10-Q on 10-Aug-2009 | All Recent SEC Filings |
10-Aug-2009
Quarterly Report
Critical Accounting Estimates
In our annual report on Form 10-K for the year ended December 31, 2008, we
identified our most critical accounting policies. In preparing the financial
statements, we make assumptions, estimates and judgments that affect the amounts
reported. We periodically evaluate our estimates and judgments that are most
critical in nature which are related to revenue recognition under long-term
construction contracts; allowance for doubtful accounts; inventory reserves;
impairments of long-lived assets (excluding goodwill and other indefinite-lived
intangible assets); goodwill and other indefinite-lived intangible assets and
income taxes. Our estimates are based on historical experience and on our future
expectations that we believe are reasonable. The combination of these factors
forms the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results are
likely to differ from our current estimates and those differences may be
material.
Goodwill and Other Indefinite - Lived Intangible Assets
The Company has approximately $5.5 billion of goodwill and $0.6 billion of other
intangible assets with indefinite lives on its consolidated balance sheet as of
June 30, 2009. The Company tests goodwill and other indefinite-lived intangible
assets for impairment at least annually or more frequently whenever events or
circumstances occur indicating that goodwill or other indefinite-lived
intangible assets might be impaired. The annual impairment test is performed
during the fourth quarter of each year. Based on its analysis, the Company did
not report any impairment of goodwill and other indefinite-lived intangible
assets for the year ended December 31, 2008. As described below, the Company
concluded that an indicator of impairment did occur in the second quarter of
2009 and updated its impairment testing at June 30, 2009. Based on its updated
analysis, the Company concluded that it did not incur an impairment of goodwill
for the period ending June 30, 2009. However, based on the Company's
indefinite-lived intangible asset impairment analysis performed during the
second quarter of 2009, the Company concluded that it did incur an impairment
charge to certain indefinite-lived intangible assets of $147 million at June 30,
2009. The $147 million impairment charge is included in the Company's
consolidated income statement for the quarter and six months ended June 30,
2009.
During the second quarter of 2009, the worldwide average rig count was 2,009
rigs, down 41% from the fourth quarter 2008 average of 3,395 and down 25% from
the first quarter 2009 average of 2,681. The second quarter 2009 average rig
count represented the lowest quarterly average in the past six years. In
addition, the Company's updated forecast was behind the Company's previous
forecast completed at the beginning of 2009. While operating profit for the
first quarter of 2009 was in line with the Company's first quarter 2009
operating profit forecast, the Company's consolidated operating profit for the
second quarter of 2009 was below its second quarter 2009 forecast. As a result
of the substantial decline in the worldwide rig count, and the decline in
actual/forecasted results compared to the original 2009 forecast, the Company
concluded that events or circumstances had occurred indicating that goodwill and
other indefinite-lived intangible assets might be impaired as described under
SFAS 142.
Therefore, the Company performed its interim impairment test of goodwill for all
its reporting units at the end of the second quarter of 2009. The implied fair
value of goodwill is determined by deducting the fair value of a reporting
unit's identifiable assets and liabilities from the fair value of that reporting
unit as a whole. Fair value of the reporting units is determined in accordance
with SFAS 157 using significant unobservable inputs, or level 3 in the fair
value hierarchy. These inputs are based on internal management estimates,
forecasts and judgments, using a combination of three methods: discounted cash
flow, comparable companies, and representative transactions. While the Company
primarily uses the discounted cash flow method to assess fair value, the Company
uses the comparable companies and representative transaction methods to validate
the discounted cash flow analysis and further support management's expectations,
where possible.
The discounted cash flow is based on management's short-term and long-term
forecast of operating performance for each reporting unit. The two main
assumptions used in measuring goodwill impairment, which bear the risk of change
and could impact the Company's goodwill impairment analysis, include the cash
flow from operations from each of the Company's individual business units and
the weighted average cost of capital. The starting point for each of the
reporting unit's cash flow from operations is the detailed annual plan or
updated forecast. The detailed planning and forecasting process takes into
consideration a multitude of factors including worldwide rig activity,
inflationary forces, pricing strategies, customer analysis, operational issues,
competitor analysis, capital spending requirements, working capital needs,
customer needs to replace aging equipment, increased complexity of drilling, new
technology, and existing backlog among other items which impact the individual
reporting unit projections. Cash flows beyond the specific operating plans were
estimated using a terminal value calculation, which incorporated historical and
forecasted financial cyclical trends for each reporting unit and considered
long-term earnings growth rates. The financial and credit market volatility
directly impacts our fair value measurement through our weighted average cost of
capital that we use to determine our discount rate. During times of volatility,
significant judgment must be applied to determine whether credit changes are a
short-term or long-term trend.
Projections for the remainder of 2009 also reflected declines compared to the
original 2009 annual forecast. The Company updated its 2009 operating forecast,
long-term forecast, and discounted cash flows based on this information. The
goodwill impairment analysis that we performed during the second quarter of 2009
did not result in goodwill impairment as of June 30, 2009.
The Company performed a sensitivity analysis on the projected results and
goodwill impairment analysis assuming revenue for each individual reporting unit
decreased an additional 20% from the current projections for each of the next
three years (2009, 2010, and 2011), while holding all other factors constant,
and no goodwill impairment was identified for any of the reporting units.
Additionally, if the Company were to increase its discount rate 100 basis
points, while keeping all other assumptions constant, there would be no
impairments in any of the reporting units. While the Company does not believe
that these events (20% drop in additional revenue for the next three years or
100 basis point increases in weighted average costs of capital) or changes are
likely to occur, it is reasonably possible these events could transpire if
market conditions worsen and if the market fails to recover in 2010 and/or 2011.
Any significant changes to these assumptions and factors could have a material
impact on the Company's goodwill impairment analysis. Inherent in our
projections are key assumptions relative to how long the current downward cycle
might last. While we believe these assumptions are reasonable and appropriate,
we will continue to monitor these, and update our impairment analysis if the
cycle downturn continues for longer than expected.
Other indefinite-lived intangible assets, representing trade names management
intends to use indefinitely, were valued using significant unobservable inputs
(level 3) and are tested for impairment using the Relief from Royalty Method, a
form of the Income Approach. An impairment is measured and recognized based on
the amount the book value of the indefinite-lived intangible assets exceeds its
estimated fair value as of the date of the impairment test. Included in the
impairment test are assumptions, for each trade name, regarding the related
revenue streams attributable to the trade names which are determined consistent
with the forecasting process described above, the royalty rate, and the discount
rate applied. Based on the Company's indefinite-lived intangible asset
impairment analysis performed during the second quarter of 2009, the Company
incurred an impairment charge of $147 million in the Petroleum Services &
Supplies segment related to a partial impairment of the Company's Grant Prideco
trade name. The impairment charge was primarily the result of the substantial
decline in worldwide rig counts through June 2009, declines in current forecasts
in rig activity for the remainder of 2009, 2010, and 2011 compared to rig count
forecast at the beginning of 2009 and a current decline in the revenue forecast
for the drill pipe business unit for the next three years (2009, 2010, and
2011).
The Company performed a sensitivity analysis on the projected results and
indefinite-lived intangible asset impairment assuming revenue for each
individual trade name decreased an additional 20% from the current projections
for each of the next three years (2009, 2010, and 2011), while holding all other
factors constant, and a pre-tax non-cash impairment charge of approximately
$79 million would be incurred under those assumptions. If the discount rate
applied to the fair value calculation increased by 100 basis points, and all
other assumptions remained constant, a pre-tax, non-cash impairment charge of
approximately $36 million would be incurred under those assumptions.
The Company will continue to closely monitor indicators of impairment, which
could include, but are not limited to, further declines in worldwide rig
activity, further declines in commodity prices or futures, or further
significant economic declines. If such further deterioration of indicators
occurs, and the Company believes that these negative trends are likely to
persist for a prolonged period of time, then the Company's expected future
earnings and cash flows from operations would be adversely impacted. This may
result in impairment to either or both goodwill and indefinite-lived intangible
assets, and such impairment may be material.
EXECUTIVE SUMMARY
National Oilwell Varco generated earnings of $220 million or $0.53 per fully
diluted share in its second quarter ended June 30, 2009, on revenues of
$3,010 million. Compared to the second quarter of 2008, revenue declined nine
percent and net income attributable to the Company declined 48 percent, and
compared to the first quarter of 2009, revenue declined 14 percent and net
income attributable to the Company declined 53 percent. These declines were due
to lower market activity, the effect of asset impairment, transaction, and
voluntary retirement charges, and a higher income tax rate recognized in the
second quarter of 2009 that did not occur in the prior periods.
During the second quarter of 2009, the Company recognized a $147 million
pre-tax, or $0.23 per share after-tax, impairment charge on its carrying value
of an intangible trade name acquired in its Grant Prideco acquisition. During
the second quarter the Company retested all its carrying values for goodwill and
intangible assets, which was performed due to deterioration seen in the rig
count and performance of certain of its business units compared to forecasts.
Additionally, the Company recognized $56 million in pre-tax charges ($0.09 per
share after-tax) related to acquisitions made in the quarter, and the results of
a voluntary retirement program offered to its long-tenured employees. Legal, due
diligence and other costs associated with acquisitions that were previously
capitalized under GAAP are now expensed under FAS141R. The Company's voluntary
retirement program charge was $46 million, consisting of separation and accrued
medical benefits and options vesting charges, and is expected to result in
annual savings of approximately $33 million per year. Second quarter 2009 net
income was also affected by an income tax rate of 37 percent, higher than
periods preceding this quarter, due to $21 million of additional tax provisions
recognized in the period on prior year income in Norway. These additional taxes
resulted from foreign currency gains on dollar-denominated accounts that were
realized for Norwegian tax purposes. The Company expects its effective income
tax rate to return to the 32 percent to 33 percent range for the remainder of
the year.
Operating profit was $386 million or 12.8 percent of sales for the second
quarter. Excluding the impairment, transaction, and voluntary retirement
charges, second quarter operating profit was $589 million or 19.6 percent of
sales, compared to $720 million or 20.7 percent of sales in the first quarter of
2009, and $778 million or 22.6 percent of sales in the second quarter of 2008
(excluding transaction charges and including a full quarter contribution from
the Grant Prideco acquisition in the second quarter of 2008).
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 have been 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 drillpipe products are
purchased and consumed by the Company's existing drilling contractor customer
base. The Company believes that consumption of drillpipe per foot of hole
drilled, or per rig running, 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 drillpipe and drill bit product sales.
Integration of the business has proceeded well. The Company is introducing new
drillpipe tracking products, and expanding OEM drillpipe 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 and marketing capabilities.
Oil & Gas Equipment and Services Market
Worldwide developed economies turned down sharply late in 2008 as looming
housing-related asset write-downs at major financial institutions paralyzed
credit markets and sparked a serious global banking crisis. Major central banks
have responded vigorously, but credit and financial markets have not yet fully
recovered, and a credit-driven worldwide economic recession deepened during the
second quarter. Asset and commodity prices, including oil and gas prices, have
declined sharply. After rising steadily for six years to peak at around $140 per
barrel earlier in 2008, oil prices collapsed back to average $43 per barrel
range during the first quarter of 2009. 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, but this slowed sharply with falling
oil and gas prices. The count of rigs actively drilling in the U.S. as measured
by Baker Hughes (a good measure of the level of oilfield activity and spending)
peaked at 2,031 rigs in September, 2008, but has decreased to 943 rigs as of
July 24, 2009. Many oil and gas operators reliant on external financing to fund
their drilling programs are curtailing their drilling activity. So far this
appears to be having the greatest impact on gas drilling across North America.
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, but the international rig count is showing
some modest declines nonetheless, falling from its September 2008 peak of 1,108
to 967 in June 2009. During the second quarter of 2009 the Company saw its
Petroleum Services & Supplies and its Distribution Services margins affected
most acutely by a drilling downturn, through both volume and price declines,
while the Company's Rig Technology segment was less impacted owing to its high
level of backlog.
Recent downturns follow an extended period of high drilling activity, which
fueled strong demand for oilfield services between 2003 and 2008. Incremental
drilling activity through the upswing shifted toward harsh environments,
employing increasingly sophisticated technology to find and produce reserves.
Higher utilization of drilling rigs 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 was
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 (according to ODS, 74 percent
of the existing 446 jackup rigs are more than 25 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 deepwater floating drilling rigs, including
semisubmersibles and drillships, to employ 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, and that declining dayrates
may accelerate the retirement of older rigs. As a result of these trends the
Company's Rig Technology segment grew its backlog of capital equipment orders
from $0.9 billion at March 31, 2005, to $11.8 billion at September 30, 2008.
However, as a result of the credit crisis and slowing drilling activity, orders
have declined below amounts flowing out of backlog as revenue, causing the
backlog to decline to $8.7 billion by June 30, 2009.
The land rig backlog comprised 12 percent and equipment destined for offshore
operations comprised 88 percent of the total backlog as of June 30, 2009.
Equipment destined for international markets totaled 92 percent of the 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. During the second quarter of
2009, the Company removed $108 million in orders on which its customers had
defaulted, and booked a gain of $16 million related to down payments and
progress billings it had received. We do not expect the credit crisis or softer
market to result in additional material cancelation of contracts or abandonment
of major projects; however, there can be no assurance that such discontinuance
of projects will not occur. The Company had approximately $320 million of
projects in its June 30, 2009 backlog that it considers at risk.
Segment Performance
Rig Technology generated $1,917 million in revenue and $536 million in operating
profit in the second quarter of 2009, yielding a record operating margin for the
segment of 28.0 percent (excluding transaction and voluntary retirement
charges). The segment generated 25 percent operating leverage or flowthrough
(the decrease in operating profit divided by the decrease in revenue) on
13 percent lower revenue from the first quarter of 2009, and posted $30 million
higher operating profit on $7 million higher revenues when compared to the
second quarter of 2008. Revenue out of backlog of $1,434 million declined
15 percent sequentially and increased seven percent compared to the second
quarter of last year. As of June 30, 2009 the scheduled outflow of revenue from
backlog is expected to be in the range of $2.5 billion for the remainder of
2009, $4.7 billion in 2010, and $1.5 billion for 2011. From 2005 through the
current quarter, the segment has delivered a total of 59 newly built offshore
rig packages. Aftermarket spare parts and services revenue, and sales of smaller
capital items which do not qualify for the backlog, declined five percent from
the first quarter of 2009. Demand for rigs and equipment is strongest in Brazil,
the Middle East, Mexico, and the North Sea (for platform cranes and winches).
Additionally, we are seeing rising interest for equipment for Iraq and China,
and completed a workover rig sale into Russia during the second quarter.
Generally, demand for equipment in North America is very slow; although the
Company's first new Drake rig delivered into the Marcellus shale play is
performing well.
The Petroleum Services & Supplies segment generated revenues of $913 million and operating profit of $96 million or 10.5 percent of sales in the second quarter of 2009 (excluding impairment, transaction, and voluntary retirement charges). Revenues declined 10 percent from the first quarter of 2009 and 27 percent from the second quarter of 2008 (on a combined adjusted basis for a full quarter contribution from Grant Prideco). Decremental operating leverage was 67 percent from the first quarter of 2009 and 60 percent from the second quarter of 2008. Excluding the impact of acquisitions made during the second quarter revenues fell 13 percent sequentially, and decremental operating leverage was 55 percent. The business faced very challenging market conditions and lower pricing in the second quarter, particularly in North America, where U.S. rig counts fell 29 percent and Canadian rig counts fell 73 percent from the first quarter of 2009. Pricing fell as much as 30 percent to 40 percent across some product lines, although the discounts varied widely depending upon product and region. Consumable products sales were down sharply as drilling contractors cannibalized idle equipment from stacked rigs, rather than place orders with the Company, as they reduced operating and capital expenditures in view of lower rig dayrates. International markets held up better, with pricing down 5 to 20 percent as the rig count declined four percent sequentially. Nevertheless, the group posted 9 percent sequential international sales gains, half of which was due to acquisitions. Sales and rentals of downhole tools and bits, composite pipe, and coiled tubing saw large double-digit percent declines, while other products were down only modestly from the first quarter to the second. Virtually all products and services posted sequential drops in North America, which declined to less than half of the group's mix during the second quarter in the aggregate. Drillpipe sales were roughly flat sequentially, but margins improved on a better mix of premium high-torque pipe and lower costs. . . .
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