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NOV > SEC Filings for NOV > Form 10-K on 14-Feb-2014All Recent SEC Filings

Show all filings for NATIONAL OILWELL VARCO INC | Request a Trial to NEW EDGAR Online Pro

Form 10-K for NATIONAL OILWELL VARCO INC


14-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General Overview

The Company is a leading worldwide provider of highly engineered drilling and well-servicing equipment, products and services to the exploration and production segments of the oil and gas industry. With operations in over 1,235 locations across six continents, we design, manufacture and service a comprehensive line of drilling and well servicing equipment; sell and rent drilling motors, specialized downhole tools, and rig instrumentation; perform inspection and internal coating of oilfield tubular products; provide drill cuttings separation, management and disposal systems and services; provide expendables and spare parts used in conjunction with our large installed base of equipment; and provide supply chain management services through our distribution network. We also manufacture coiled tubing, manufacture high pressure fiberglass and composite tubing, and sell and rent advanced in-line inspection equipment to makers of oil country tubular goods. We have a long tradition of pioneering innovations which improve the cost-effectiveness, efficiency, safety, and environmental impact of oil and gas operations.

Our revenues and operating results are directly related to the level of worldwide oil and gas drilling and production activities and the profitability and cash flow of oil and gas companies and drilling contractors, which in turn are affected by current and anticipated prices of oil and gas. Oil and gas prices have been and are likely to continue to be volatile. See "Risk Factors". We conduct our operations through three business segments: Rig Technology, Petroleum Services & Supplies and Distribution & Transmission. See Item 1. "Business" for a discussion of each of these business segments.

Unless indicated otherwise, results of operations data are presented in accordance with accounting principles generally accepted in the United States ("GAAP"). In an effort to provide investors with additional information regarding our results of operations, certain non-GAAP financial measures, including operating profit excluding nonrecurring items, operating profit percentage excluding nonrecurring items and diluted earnings per share excluding nonrecurring items, are provided. See "Non-GAAP Financial Measures and Reconciliations" in Results of Operations for an explanation of our use of non-GAAP financial measures and reconciliations to their corresponding measures calculated in accordance with GAAP.

Operating Environment Overview

Our results are dependent on, among other things, the level of worldwide oil and
gas drilling, well remediation activity, the price of crude oil and natural gas,
capital spending by other oilfield service companies and drilling contractors,
and the worldwide oil and gas inventory levels. Key industry indicators for the
past three years include the following:



                                                                                           %             %
                                                                                        2013 v        2013 v
                                                     2013*       2012*       2011*       2012          2011
Active Drilling Rigs:
U.S.                                                  1,761       1,919       1,875        (8.2 %)       (6.1 %)
Canada                                                  354         365         423        (3.0 %)      (16.3 %)
International                                         1,296       1,234       1,168         5.0 %        11.0 %

Worldwide                                             3,411       3,518       3,466        (3.0 %)       (1.6 %)

West Texas Intermediate Crude Prices (per barrel)   $ 97.91     $ 94.11     $ 94.90         4.0 %         3.2 %

Natural Gas Prices ($/mmbtu)                        $  3.72     $  2.75     $  4.00        35.3 %        (7.0 %)

* Averages for the years indicated. See sources below.


Table of Contents

The following table details the U.S., Canadian, and international rig activity and West Texas Intermediate Oil prices for the past nine quarters ended December 31, 2013 on a quarterly basis:

[[Image Removed: LOGO]]

Source: Rig count: Baker Hughes, Inc. (www.bakerhughes.com); West Texas Intermediate Crude Price: Department of Energy, Energy Information Administration (www.eia.doe.gov).

The average price per barrel of West Texas Intermediate Crude was $97.91 per barrel in 2013, an increase of 4% over the average price for 2012 of $94.11 per barrel. The average natural gas price was $3.72 per mmbtu, an increase of 35% compared to the 2012 average of $2.75 per mmbtu. Average rig activity worldwide decreased 3% for the full year in 2013 compared to 2012. The average crude oil price for the fourth quarter of 2013 was $97.34 per barrel and natural gas was $3.84 per mmbtu.

At February 7, 2014, there were 2,392 rigs actively drilling in North America, compared to 2,020 rigs at December 31, 2013; an increase of 18.4% from year end 2013 levels. The price of oil increased to $99.98 per barrel and gas increased to $4.78 per mmbtu at February 7, 2014, representing a 1.8% increase in oil prices and an 11.9% increase in gas prices from the end of 2013.


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EXECUTIVE SUMMARY

During 2013 National Oilwell Varco, Inc. earned $2.3 billion in net income attributable to Company, or $5.44 per fully diluted share. Earnings per diluted share decreased 7% from prior year levels of $2.5 billion or $5.83 per fully diluted share. Excluding other costs (as defined in the "Non-GAAP Financial Measures and Reconciliations" in Results of Operations) from both years, diluted earnings per share of $5.52 in 2013 decreased 7% from $5.91 per share in 2012.

During 2013 revenue grew 14% from 2012, to $22.9 billion, and operating profit declined 4% from 2012, to $3.4 billion. Generally, 2013 benefitted from the acquisition of Robbins & Myers as well as higher international drilling activity, which saw international rig counts (as measured by Baker Hughes) increase 5% from 2012. This enabled all three of the Company's reporting segments to post higher year-over-year revenues in 2012.

For its fourth quarter ended December 31, 2013, the Company generated $658 million in net income attributable to Company, or $1.53 per fully diluted share, on $6.2 billion in revenue. Compared to the third quarter of 2013 revenue increased $485 million or 9% and net income attributable to Company increased $22 million. Compared to the fourth quarter of 2012, revenue increased $487 million or 9%, and net income attributable to Company decreased $10 million or 1%.

The fourth quarter of 2013 included pre-tax other costs of $16 million, the third quarter of 2013 included pre-tax other costs of $10 million and a pre-tax gain of $102 million resulting from the settlement of a legal claim, and the fourth quarter of 2012 included pre-tax other costs of $51 million, and a net $69 million tax benefit related to certain U.S. foreign tax credits in the quarter. Excluding the pre-tax gain, tax benefit and other costs from all periods, fourth quarter 2013 earnings were $1.56 per fully diluted share, compared to $1.34 per fully diluted share in the third quarter of 2013 and $1.49 per fully diluted share in the fourth quarter of 2012.

Operating profit excluding other costs and the litigation gains was $973 million or 15.8% of sales in the fourth quarter of 2013, compared to $853 million or 14.7% of sales in the third quarter of 2013, and $954 million or 16.8% of sales in the fourth quarter of 2012.

Oil & Gas Equipment and Services Market

Worldwide, developed economies turned down in late 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 responded vigorously through 2009, but a credit-driven worldwide economic recession developed nonetheless. Developed economies struggled to recover throughout 2010 and 2011, facing additional economic weakness related to potential sovereign debt defaults in Europe. As a result, commodity prices, including oil and gas prices, have been volatile. After rising steadily for six years to peak at around $140 per barrel (West Texas Intermediate Crude Prices) earlier in 2008, oil prices collapsed back to average $43 per barrel during the first quarter of 2009, but slowly recovered into the $100 per barrel range by mid-2011 where they held relatively steady since (although the fourth quarter of 2012 dipped to average $88 per barrel). After trading in the range of $6 to $9 an mmbtu from 2004 to 2008, North American gas prices declined to average $3.17 per mmbtu in the third quarter of 2009. Gas prices recovered modestly, trading up above $5 six months later, but then slowly settled into the $3 to $4 per mmbtu through 2011 before turning down sharply in early 2012 to the $2 range. In the fourth quarter 2012, gas prices recovered to average $3.40 per mmbtu; and, for the full year 2013, gas prices averaged $3.72 per mmbtu. The gas price collapse appears to be a direct result of rising gas supply out of unconventional shale reservoir development across North America, including gas associated with liquids production from shales.

The steadily rising oil and gas prices seen between 2003 and 2008 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. Strengthening oil prices since then have led to steadily rising oil-drilling activity over the past two years.

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 876 in June, 2009. U.S. rig count increased steadily to 2,026 by late 2011, but began to decline with lower gas prices to average 1,809 rigs for the fourth quarter of 2012. The average U.S. rig count declined to 1,758 rigs in the first quarter of 2013, and remained relatively flat throughout the year. Many oil and gas operators reliant on external financing to fund their drilling programs significantly curtailed their drilling activity in 2009, but drilling recovered across North America as gas prices improved. Recently low gas prices have caused operators to trim drilling, driving the average U.S. gas rig count down 58% from the fourth quarter of 2011, to an average of 371 in the fourth quarter of 2013. However, with high oil prices, many have redirected drilling efforts towards unconventional shale plays targeting oil, rather than gas. For the fourth quarter of 2013, oil-directed drilling rose to almost 78% of the total domestic drilling effort, and remains near its highest levels in the U.S. since the early 1980's.


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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 exhibited modest declines nonetheless, falling from its September 2008 peak of 1,108 to 947 in August 2009. Recently international drilling rebounded due to high oil prices, climbing back to average 1,321 rigs in the fourth quarter of 2013.

During 2009 the Company saw its Petroleum Services & Supplies and its Distribution & Transmission margins affected most acutely by a drilling downturn, through both volume and price declines. Resumption of drilling activity since enabled both of these segments to gain volume, stabilize and lift pricing, and improve margins since the fourth quarter of 2009. The Company's Rig Technology segment was less impacted by the 2009 downturn owing to its high level of contracted backlog, which it executed well. It posted higher revenues in 2009 than 2008 as a result. Its revenues declined in 2010 as its backlog declined, but increased 12% in 2011 as orders for new offshore rigs began to increase.

The economic decline beginning in late 2008 followed 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 1.) retool the existing fleet of jackup rigs (according to RigLogix, nearly 62% of the existing 513 jackup rigs are greater than 25 years old); 2.) replace older mechanical and DC electric land rigs with improved AC power, electronic controls, automatic pipe handling and rapid rigup and rigdown technology; and 3.) 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.

As a result of these trends the Company's Rig Technology segment grew its backlog of capital equipment orders from $0.9 billion at June 30, 2005, to $11.8 billion at September 30, 2008. However, as a result of the credit crisis and slowing drilling activity, orders declined below amounts flowing out of backlog as revenue, causing the backlog to decline to $4.9 billion by June 30, 2010. The backlog increased steadily since, as drillers began ordering more than the Company shipped out of backlog, and finished the fourth quarter of 2013 at a record $16.2 billion. Approximately $8.5 billion of these orders are scheduled to flow out as revenue during 2014, with the balance flowing out in 2015 and beyond. Of this backlog, 93% of the total is for equipment destined for offshore operations, with 7% destined for land. Equipment destined for international markets totaled 94% of the backlog.

Segment Performance

The Rig Technology segment generated $11.7 billion in revenues and $2.5 billion in operating profit or 21.5% of sales during 2013. Compared to the prior year, revenues improved 16% while operating profit dollars increased 8% year-over-year. For the fourth quarter of 2013, the segment generated $3.3 billion in revenues and $692 million in operating profit or 20.9% of sales. Compared to the prior quarter, revenues increased $365 million or 12%, and operating profit decreased $14 million. Compared to the fourth quarter of 2012, segment revenues grew $414 million or 14%, and operating profit increased $56 million. Year-over-year operating leverage or flow-through was 14%. Margins have moved down steadily since mid-2010 due to an adverse mix shift in the segment, the addition of lower-margin acquisitions, and incremental expenses to support several strategic growth initiatives. The mix shift arises from offshore projects contracted at high prices in 2007 and 2008, which were subsequently manufactured in low cost environments in 2009 and 2010, resulting in high margins for the group which peaked in the third quarter of 2010. As these projects have been completed and replaced with lower priced projects, margins have gradually declined. Revenue out of backlog increased 20% sequentially and increased 14% year-over-year. Non-backlog revenue, which is predominantly aftermarket spares and services, increased 7% sequentially and increased 15% from the fourth quarter of 2012. Orders for four deepwater floating rig equipment packages, and twenty five drilling equipment packages for jackup rigs, contributed to total order additions to backlog of $3.6 billion during the fourth quarter. Interest in offshore rig construction has remained strong as announced dayrates for deepwater offshore rigs remain strong, rig building costs have stabilized at attractive levels, and financing appears to be available for most established drillers. The segment also benefitted from the shipment of several land rigs in the fourth quarter; and, despite the continued decline in demand for pressure pumping equipment in North America, the segment's well intervention and stimulation product sales increased 11% sequentially, as unexpected demand in the quarter was filled with existing inventory.


Table of Contents

The Petroleum Services & Supplies segment generated $7.2 billion in revenue and $1.2 billion in operating profit, or 16.9% of sales, for the full year 2013. Compared to the prior year, revenue increased 3%, but operating profit declined $289 million, as the 8% year-over-year reduction in the U.S. drilling rig count (as measured by Baker Hughes) led to pricing pressures and under-absorption in a number of the segment's manufacturing and service facilities. For the fourth quarter of 2013, the segment generated $1.9 billion in revenue and $363 million in operating profit, or 18.9% of sales. Compared to the prior quarter, revenue increased $116 million or 6%, and operating profit increased $42 million, representing 36% incremental operating leverage. Sequentially, drilling and completions activities in Canada continued to improve following the annual seasonal slow-down known as "break-up". This increase in activity created slight incremental demand for the segment's products and services, which generated 1% sequential growth for the segment in Canada. In the U.S., a relatively flat rig count, combined with fewer billing days in the quarter due to holidays, led to a 3% sequential decline. Demand in the U.S. for drill pipe and downhole tools remained muted in the quarter due to a still over-supplied U.S. land drilling and well-service market. Internationally, driven by some large year-end project shipments, revenues for the segment increased 18%. Compared to the fourth quarter of 2012, revenues increased $155 million, and operating profit increased $23 million, as both pricing pressures and under-absorbed facilities continue to pressure margins. For the fourth quarter of 2013, approximately 51% of the segment's sales were into North American markets, and 49% of sales were into international markets.

The Distribution & Transmission segment generated $5.1 billion in revenue and $247 million in operating profit or 4.8% of sales during 2013. Revenues improved 30% from 2012, primarily due to the acquisitions of Wilson during the second quarter of 2012 and CE Franklin during the third quarter of 2012. For the fourth quarter of 2013, the segment generated $1.3 billion in revenue and $60 million in operating profit or 4.8% of sales. Revenues declined $89 million or 7% from the third quarter of 2013, and operating profit decreased $18 million. Compared to the fourth quarter of 2012, revenues decreased $15 million or 1% and operating profit decreased $18 million. Sequentially, revenues declined 8% in the U.S., as the holidays and severe weather disruptions led to fewer billing days in the fourth quarter. Additionally, the segment was challenged as some large project sales into international markets in the third quarter did not repeat in the fourth quarter. The fourth quarter 2013 year-over-year revenue decline is directly attributable to the decline in the U.S. rig count over that same period. For the fourth quarter of 2013, approximately 81% of the group's sales were into North American markets and 19% into international markets.

Outlook

Following the credit market downturn, global recession, and lower commodity prices of 2009, we saw signs of stabilization and recovery in many of our markets in 2010 and into 2011, led by higher drilling activity in North America and slowly improving international drilling activity. Order levels for new deepwater drilling rigs have rebounded sharply, and the Rig Technology segment continues to experience a high level of interest as dayrates for deepwater offshore rigs remain at high levels. Still, margins, which were 20.9% in the fourth quarter of 2013, may continue to be challenged to expand beyond current levels due to lower-margin contributions from recent subsea production equipment acquisitions, a soft outlook for land drilling, workover and pressure pumping equipment markets in North America, low gas and natural gas liquids prices, higher costs of execution due to significantly compressed project timelines, continued flow through of lower priced projects, and incremental expenses to support long-term strategic growth initiatives.

Our outlook for the Company's Petroleum Services & Supplies segment and Distribution & Transmission segment remains closely tied to the rig count, particularly in North America. The fourth quarter saw U.S. rig counts relatively unchanged from the prior quarter, resulting in an average U.S. rig count in the fourth quarter that was down 3% from the average U.S. rig count in the fourth quarter of 2012. The fourth quarter saw average Canadian rig counts improve almost 9% sequentially and almost 3% year-over-year. As a result, revenues for both segments improved sequentially in Canada; however, for both the U.S. and Canada, pricing and volumes remain under pressure as pressure pumpers, drilling contractors and oil companies continue to carefully scrutinize operating and capital expenditures. Additionally, economic weakness may pressure oil prices, which could lead to further activity declines, particularly among North American operators which may rely on cash flows from gas production and/or external financing to fund their drilling operations. In contrast, activity generally seems to be continuing to increase in most international markets outside North America.

The Company believes it is well positioned, and should benefit from its strong balance sheet and capitalization, access to credit, global infrastructure, broad product and service offering, installed base of equipment, and a record level of contracted orders. In the event of a market downturn, the Company also believes that its long history of cost-control and downsizing in response to slowing market conditions, and of executing strategic acquisitions during difficult periods will enable it to capitalize on new opportunities to effect new organic growth and acquisition initiatives.

Still the recovery of the world economy continues to move forward with a great deal of uncertainty. If such global economic uncertaintanties develop adversely, world oil and gas prices could be impacted which in turn could negatively impact the worldwide rig count and the Company's future financial results.


Table of Contents

Results of Operations

Years Ended December 31, 2013 and December 31, 2012

The following table summarizes the Company's revenue and operating profit by
operating segment in 2013 and 2012 (in millions):



                                               Years Ended December 31,                Variance
                                                 2013              2012             $             %
Revenue:
Rig Technology                               $     11,716        $  10,107       $ 1,609          15.9 %
Petroleum Services & Supplies                       7,184            6,967           217           3.1 %
Distribution & Transmission                         5,117            3,927         1,190          30.3 %
Eliminations                                       (1,148 )           (960 )        (188 )        19.6 %

Total Revenue                                $     22,869        $  20,041       $ 2,828          14.1 %

Operating Profit:
Rig Technology                               $      2,522        $   2,335       $   187           8.0 %
Petroleum Services & Supplies                       1,212            1,501          (289 )       (19.3 %)
Distribution & Transmission                           247              185            62          33.5 %
Unallocated expenses and eliminations                (558 )           (464 )         (94 )        20.3 %

Total Operating Profit                       $      3,423        $   3,557       $  (134 )        (3.8 %)

Operating Profit %:
Rig Technology                                       21.5 %           23.1 %
Petroleum Services & Supplies                        16.9 %           21.5 %
Distribution & Transmission                           4.8 %            4.7 %

Total Operating Profit %                             15.0 %           17.7 %

Rig Technology

Revenue from Rig Technology for the year ended December 31, 2013 was $11,716 million, an increase of $1,609 million (15.9%) compared to the year ended December 31, 2012. Deepwater offshore demand as well as demand in international markets continues to be a driving force for the increase in revenue for Rig Technology as revenue out of backlog contributed $8,740 million in 2013. Increased sales of individual capital components, a continued increase in activity in the Company's aftermarket and FPSO businesses as well as the acquisition of Robbins & Myers all contributed to the increase in revenue for Rig Technology. In addition, a nonrecurring gain of $102 million was recognized in the third quarter of 2013 related to a legal settlement. North American markets continue to see a decrease in demand for land drilling equipment. This is evidenced by a decrease in rig count in North America from 2012 and has resulted in a steady decline in sales of land rigs and pressure pumping equipment in the U.S. and Canada. The average rig count in the U.S. for the year ended 2013 decreased over 8% compared to the year ended 2012 and decreased 3% in Canada over the same period.

Operating profit from Rig Technology was $2,522 million for the year ended December 31, 2013, an increase of $187 million (8.0%) compared to 2012. Operating profit percentage decreased to 21.5%, from 23.1% in 2012. The decrease in operating profit percentage continues to be primarily due to a shift in product mix as lower priced offshore projects replace projects contracted at higher prices in 2007 and 2008. FPSO revenue continues to increase with operating margins that are dilutive while land rig and pressure pumping equipment revenue, with margins that are generally accretive, continues to decline. In addition, our shipyard customers are compressing delivery schedules which have been leading to increased freight and personnel costs. Expenses associated with acquisition integration efforts, numerous strategic growth initiatives and capacity expansions worldwide have also contributed to the decrease in operating profit percentage.

Included in operating profit are certain other costs which include items such as transaction costs and the amortization of backlog and inventory that was stepped up during purchase accounting. Other costs included in operating profit for Rig . . .

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