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| NOV > SEC Filings for NOV > Form 10-Q on 6-Nov-2009 | All Recent SEC Filings |
6-Nov-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
September 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 nine months ended September 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
ASC Topic 350.
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 ASC Topic 820 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
remainder of 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 remainder of 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 remainder of 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 $385 million or $0.92 per fully
diluted share in its third quarter ended September 30, 2009, on revenues of
$3,087 million. Compared to the third quarter of 2008 revenue declined
15 percent and net income attributable to the Company declined 30 percent.
Compared to the second quarter of 2009 revenue increased three percent and net
income attributable to the Company increased 75 percent, due in large part to
the non-recurrence of $203 million in pre-tax asset impairment, transaction, and
voluntary retirement charges and a higher income tax rate recognized in the
second quarter of 2009, in addition to higher third quarter sales and margins.
Operating profit was $601 million or 19.5 percent of sales for the third
quarter. Excluding $11 million of transaction and restructuring charges, third
quarter operating profit was $612 million or 19.8 percent of sales, compared to
$589 million or 19.6 percent of sales in the second quarter of 2009 (excluding
transaction and impairment charges), and $790 million or 21.9 percent of sales
in the third quarter of 2008. Operating profit leverage or flow-through (the
change in operating profit divided by the change in revenue period-to-period)
was up 38 percent from the second quarter of 2009 to the third quarter of 2009,
and down 38 percent from the third quarter of 2008 to the third quarter of 2009,
excluding transaction, restructuring and impairment charges from all periods.
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 $42.91 per barrel
during the first quarter of 2009, but have been recovering steadily to average
$68.20 during the third quarter of 2009. Higher oil and gas prices over the past
several years led to high levels of exploration and development drilling in many
oil and gas basins around the globe by 2008, but activity slowed sharply in 2009
with lower oil and gas prices and tightening credit availability.
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 decreased to a low of 887 in June 2009. Rig count
has increased slightly since, to 1,048 in October 2009, and averaged 974 rigs
during the third quarter of 2009. Many oil and gas operators reliant on external
financing to fund their drilling programs have significantly curtailed their
drilling activity, which appears to have had 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 has exhibited modest declines nonetheless, falling from its September 2008
peak of 1,108 to 986 in September 2009. During the third 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 Offshore Data
Services, 73 percent of the existing 445 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 $7.3 billion by September 30, 2009.
Land rigs comprised 11 percent and equipment destined for offshore operations
comprised 89 percent of the total backlog as of September 30, 2009. Equipment
destined for international markets totaled 93 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 third quarter of 2009
the Company removed $72 million in discontinued orders on cancelled projects and
project change orders requested by customers. 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
$334 million of projects in its September 30, 2009 backlog that it considers at
risk.
Segment Performance
Rig Technology generated $2,000 million in revenue and $577 million in operating
profit in the third quarter of 2009, producing a record operating margin for the
segment of 28.9 percent. The segment generated 52 percent operating leverage or
flow-through on four percent higher sales from the second quarter of 2009 to the
third quarter of 2009. Compared to the prior year third quarter operating
leverage or
flow-through was 105 percent on four percent sales growth. Revenue out of
backlog of $1,599 million increased 12 percent sequentially and increased
17 percent compared to the third quarter of last year. Execution of the backlog
orders was very strong, which led to higher margin performance for the Rig
Technology segment in the third quarter due to excellent cost control, deflation
in certain inputs, greater experience building and commissioning rigs which
enables better efficiencies, and somewhat better FX movements. As a result our
estimated costs to complete projects have declined steadily through 2009. As of
September 30, 2009 the scheduled outflow of revenue from backlog is expected to
be approximately $1.3 billion in the fourth quarter of 2009, $4.7 billion in
2010, and $1.3 billion for 2011. From 2005 through the current quarter, the
segment has delivered a total of 66 newly built offshore rigs. Aftermarket spare
parts and services revenue was essentially flat in the third quarter as compared
to the second quarter, but sales of smaller capital items which do not qualify
for the backlog declined sharply. Demand for offshore rigs and equipment is
strongest in Brazil, owing to significant drilling equipment needs to develop
new ultradeepwater discoveries, and the segment also continues to pursue a
variety of new offshore rig, intervention vessel, FPSO and platform upgrade
opportunities in other markets. However, tight credit markets and fewer
committed term contracts for rigs by oil and gas companies as compared to market
conditions in 2006-2008 are adversely affecting new orders, which totaled only
$333 million in the third quarter. Demand for land rig and well stimulation
equipment has also been very slow, except for the Middle East and certain Latin
American markets. In particular demand for equipment in North America remains
soft, although the Company's first new Drake rigs delivered into the Marcellus
shale play are performing well, and the Company believes acceptance of new
technology land rigs continues to make steady progress.
The Petroleum Services & Supplies segment generated revenues of $882 million and
operating profit of $82 million or 9.3 percent of sales in the third quarter of
2009 (excluding transaction and restructuring charges). Revenues declined three
percent from the second quarter of 2009 and 33 percent from the third quarter of
2008. Almost all product lines within Petroleum Services & Supplies posted low
single-digit percent sales declines in the third quarter as compared to the
second quarter, as customer spending remained subdued. Decremental operating
leverage was 32 percent from the second quarter of 2009 and 57 percent from the
third quarter of 2008, reflective of sharp pricing declines. Prices are down
30 percent or more year-over-year for many of the items the segment sells,
although discounts vary widely depending upon product and region. The business
continues to face very challenging market conditions with lower levels of
drilling despite the recent modest improvement in North American rig count.
North American sales accounted for approximately 42 percent of the segments
total revenue during the third quarter of 2009. Consumable products sales remain
under pressure as customers cannibalize idle stocks and equipment from stacked
rigs, rather than place orders with the Company, as they reduced operating and
capital expenditures in view of lower activity. International markets have held
up better, with pricing down 5 to 20 percent as the rig count declined one
percent sequentially. Sales of bits and downhole tools improved in North
America, but international demand for these fell in the third quarter in Saudi
Arabia and Europe, driving sequentially lower results.
Drill pipe revenues were roughly flat with the second quarter but margins
improved due to more favorable mix of premium pipe for new offshore rigs and
lower steel costs. Drill pipe backlog and sales are expected to continue to
decline due to the current oversupply, which is not likely to turn around before
late 2010. Lower drill pipe demand also reduced drill pipe coating and
inspection services at high decremental margins. Wellsite Services and coiled
tubing posted slightly lower margins on lower solids control equipment and
string sales, and increased discounting.
The Distribution Services segment generated total sales of $306 million for the
third quarter of 2009, unchanged from the second quarter and down 39 percent
from the third quarter of 2008. Operating profit was $7 million in the third
quarter, down $3 million from the second quarter of 2009, and operating margins
were 2.3 percent, down 100 basis points from the second quarter of 2009. The
sequential decline in profitability arose from lower pricing, a decrease in
supplier rebates on falling annual sales volumes, and lower margins on
industrial products and artificial lift. Compared to the third quarter of 2008
decremental third quarter leverage was 19 percent on a 39 percent sales decline.
Domestic sales were essentially unchanged sequentially, but Canada revenues
increased as the region emerged from seasonal breakup, at excellent incremental
profitability. Total North American revenue mix grew slightly overall
sequentially to 71 percent and international sales declined sequentially and
accounted for 29 percent of the segment's third quarter mix. Pricing pressures
appear to be stabilizing across North America, but many customers are bidding
out much more of their work, which enabled the segment to win some incremental
maintenance, repair and operating supplies contracts during the quarter.
Unconventional shale plays in the Marcellus, Haynesville and Bakken are some of
the most active North American markets, and the group continues to expand its
presence in these areas, as well as expand in Russia.
Outlook
The recent credit market downturn, global recession, and lower commodity prices
. . .
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