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NOV > SEC Filings for NOV > Form 10-Q on 4-Aug-2014All Recent SEC Filings

Show all filings for NATIONAL OILWELL VARCO INC

Form 10-Q for NATIONAL OILWELL VARCO INC


4-Aug-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Introduction

National Oilwell Varco, Inc. (the "Company") is a worldwide leader in the design, manufacture and sale of equipment and components used in oil and gas drilling and production, the provision of oilfield services, and supply chain integration services to the upstream oil and gas industry.

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 other items, operating profit percentage excluding other items, diluted earnings per share excluding other items and operating (non-GAAP) earnings, 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.

Rig Systems

The Company's Rig Systems segment makes and supports the capital equipment and integrated systems needed to drill oil and gas wells on land and offshore. The segment designs, manufactures, and sells land rigs, offshore drilling equipment packages, including installation and commissioning services, and drilling rig components that mechanize and automate the rig process and functionality.

Equipment and technologies in Rig Systems include: substructures, derricks, and masts; cranes; pipe lifting, racking, rotating, and assembly systems; fluid transfer technologies, such as mud pumps; pressure control equipment, including blowout preventers; power transmission systems, including drives and generators; and rig instrumentation and control systems.

The Rig Systems segment primarily supports land and offshore drillers. Demand for Rig Systems products primarily depends on drilling contractors' and oil and gas companies' capital spending plans, specifically capital expenditures on rig construction and refurbishment.

Rig Aftermarket

The Company's Rig Aftermarket segment provides comprehensive aftermarket products and services to support land rigs and offshore rigs, and drilling rig components manufactured by the Rig Systems segment.

The segment provides spare parts, repair, and rentals as well as technical support, field service and first well support, field engineering, and customer training through a network of aftermarket service and repair facilities strategically located in major areas of drilling operations.

The Rig Aftermarket segment primarily supports land and offshore drillers. Demand for Rig Aftermarket products and services primarily depends on overall levels of oilfield drilling activity, which drives demand for spare parts, service, and repair for Rig System's large installed base of equipment; and secondarily on drilling contractors' and oil and gas companies' capital spending plans, specifically capital expenditures on rig refurbishment and re-certification.

Wellbore Technologies

The Company's Wellbore Technologies segment designs, manufactures, rents, and sells a variety of equipment and technologies used to perform drilling operations, and offers services that optimize their performance, including:
solids control and waste management equipment and services, drilling fluids, premium drill pipe, wired pipe, tubular inspection and coating services, instrumentation, downhole tools, and drill bits.

The Wellbore Technologies segment focuses on oil and gas companies and supports drilling contractors, oilfield service companies, and oilfield rental companies. Demand for Wellbore Technologies products and services primarily depends on the level of oilfield drilling activity by oil and gas companies, drilling contractors, and oilfield service companies.


Completion & Production Solutions

The Company's Completion & Production Solutions segment integrates technologies for well completions and oil and gas production. The segment designs, manufactures, and sells equipment and technologies needed for hydraulic fracture stimulation, including pressure pumping trucks and pumps, blenders, sanders, hydration units, injection units, flowline, manifolds and wellheads; well intervention, including coiled tubing units, coiled tubing, and wireline units and tools; onshore production, including composite pipe, surface transfer and progressive cavity pumps, and artificial lift systems; and offshore production, including floating production systems and subsea production technologies.

The Completion & Production Solutions segment primarily supports service companies and oil and gas companies. Demand for Completion & Production Solutions products depends on the level of oilfield completions and workover activity by oilfield service companies and drilling contractors and capital spending plans by oil and gas companies and oilfield service companies.

Discontinued Operations

On May 30, 2014, the Company completed the spin-off of its distribution business into an independent public company named NOW Inc. and the results of operations for the distribution business have been classified as discontinued operations for all periods presented. Unless indicated otherwise, the information in the Management's Discussion and Analysis of Financial Condition and Results of Operations relates to our continuing operations.

Critical Accounting Policies and Estimates

In our annual report on Form 10-K for the year ended December 31, 2013, 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; impairment of long-lived assets (excluding goodwill and other indefinite-lived intangible assets); goodwill and other indefinite-lived intangible assets; purchase price allocation of acquisitions; service and product warranties; 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.


EXECUTIVE SUMMARY

For its second quarter ended June 30, 2014, the Company generated $609 million in income from continuing operations, or $1.42 per fully diluted share, on $5.3 billion in revenue. Compared to the first quarter of 2014, revenue increased $366 million or 7% and income from continuing operations increased $61 million or 11%. Compared to the second quarter of 2013, revenue increased $575 million or 12%, and income from continuing operations increased $115 million or 23%.

The second quarter of 2014 included pre-tax other items of $32 million, the first quarter of 2014 included pre-tax other items of $18 million, and the second quarter of 2013 included pre-tax other items of $57 million. Excluding the other items from all periods, second quarter 2014 earnings from continuing operations were $1.47 per fully diluted share, compared to $1.29 per fully diluted share in the first quarter of 2014 and $1.24 per fully diluted share in the second quarter of 2013.

Pre-tax other items of $32 million, $18 million, $57 million for the second quarter of 2014, first quarter of 2014, and the second quarter of 2013, respectively, included costs related to acquisitions, such as transaction costs, the amortization of backlog and inventory that was stepped up to fair value during purchase accounting, the costs of the spin-off of the Company's distribution business and certain legal costs.

Operating profit, excluding other items, was $945 million or 18.0% of sales in the second quarter of 2014, compared to $817 million or 16.7% of sales in the first quarter of 2014, and $770 million or 16.5% of sales in the second quarter of 2013.

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. During the first quarter of 2009, oil prices averaged $43 per barrel, 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). As a result of relatively high and stable oil prices, oil-drilling activity over the past two years has increased. In the third quarter of 2009, North American gas prices declined to average $3.17 per mmbtu. 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. However, the average quarterly price per mmbtu climbed steadily since the second quarter of 2012 to an average of $4.61 per mmbtu in the second quarter of 2014 significantly up from a full year 2013 average of $3.72 per mmbtu. Recent price upticks seem to be a product of relatively colder weather; and, as a result, the supply of natural gas stockpiles diminishing.

The count of rigs actively drilling in the U.S. as measured by Baker Hughes, Inc. (a good measure of the level of oilfield activity and spending) decreased to a low of 876 in June, 2009 as many oil and gas operators, reliant on external financing to fund their drilling programs, significantly curtailed their drilling activity. As commodity prices improved, the U.S. rig count increased steadily to 2,026 by late 2011, but began to decline to average 1,852 rigs during the second quarter of 2014. Recently low gas prices have caused operators to trim drilling, driving the average U.S. gas rig count down 64% from the fourth quarter of 2011, to an average of 318 in the second quarter of 2014. However, with high oil prices, many have redirected drilling efforts towards unconventional shale plays targeting oil, rather than gas. For the second quarter of 2014, oil-directed drilling rose to 83% of the total domestic drilling effort, and remains at its highest levels in the U.S. since the early 1980's.

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 1,108 in September 2008 to 947 in August 2009. Since that decline, international drilling activity has increased and averaged 1,348 rigs in the second quarter of 2014.

During 2009 the Company saw its Wellbore Technologies and Completion & Production Solutions 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 over 2009 results. The Company's Rig Systems segment was less impacted by the 2009 downturn owing to its high level of contracted backlog, which it executed well. It posted higher revenues and operating profits in 2009 than 2008 as a result. The segment's revenues decreased in 2010 as its backlog declined, remained relatively flat in 2011, and rose 24% year-over-year in 2012 as orders for new offshore rigs increased.

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, 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 the credit crisis and slowing drilling activity in 2009, orders in the Rig Systems segment declined below amounts flowing out of backlog as revenue, causing the segment's backlog to decline to $4.4 billion by the end of 2010. Since 2010 lows, the backlog increased steadily as drillers ordered more than the Company shipped out of backlog, and the segment finished the second quarter of 2014 at a record $15.4 billion. 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 as of the end of the second quarter of 2014.

Manufacturing lead time for orders in the Completion & Production Solutions segment's backlog is considerably shorter than that of the orders in Rig System's backlog. This segment's backlog has increased since 2009 as levels of drilling activity worldwide moved higher. Backlog in this segment was $2.1B at the end of the second quarter of 2014. Of the $2.1B, 66% of the total is for equipment destined for offshore operations, with 34% destined for land. Equipment destined for international markets totaled 83%.

Segment Performance

The Rig Systems segment generated $2.4 billion in revenues and $501 million in operating profit or 21.1% of sales in the second quarter of 2014. Compared to the prior quarter, revenues increased $116 million, and operating profit increased $50 million, representing 43% incremental operating leverage. Compared to the second quarter of 2013, segment revenues grew $291 million or 14%, and operating profit increased $118 million, representing 31% incremental leverage. The segments 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. Margins have also been negatively impacted by the compression of delivery schedules from our shipyard customers, which have challenged the limits of our supply chain and increased our overall project costs. Second quarter 2014 revenue out of backlog for the Rig Systems segment increased 6% in comparison to the first quarter of 2014 and 14% year-over-year. Orders for seven deepwater floating rig equipment packages, and one drilling equipment package for a jackup rig, contributed to total order additions to the segment's backlog of $2.3 billion during the second quarter of 2014. Offshore rig newbuild projects, floaters and jackups, accounted for approximately $1.4 billion, or 27%, of the Company's consolidated second quarter revenues, all within the Rig Systems segment.

The Rig Aftermarket segment generated $785 million in revenues and $217 million in operating profit or 27.6% of sales in the second quarter of 2014. Compared to the prior quarter, revenues increased $35 million, and operating profit increased $26 million, representing 74% incremental operating leverage. Compared to the second quarter of 2013, segment revenues grew $115 million or 17%, and operating profit increased $28 million, representing 24% incremental leverage. Year-over-year revenue and operating profit growth is mainly attributable to increased demand for spare parts, repairs and services along with continued investments in capacity expansions.

The Wellbore Technologies segment generated $1.4 billion in revenue and $263 million in operating profit, or 18.2% of sales, for the second quarter of 2014. Compared to the prior quarter, revenue increased $168 million or 13%, and operating profit increased $42 million, representing 25% incremental operating leverage. Revenues were up sequentially as a reduction in active rigs drilling in Canada was offset by a strengthening U.S. market. Compared to the second quarter of 2013, revenues increased $224 million, and operating profit increased $79 million, representing 35% incremental leverage. Both revenues and operating profit were positively influenced by a higher average rig count year-over-year and the fact that our customers have worked through the excess inventory they carried into early 2013.


The Completion & Production Solutions segment generated $1.1 billion in revenue and $157 million in operating profit or 13.9% of sales during the second quarter of 2014. Revenue increased $125 million or 12% from the first quarter of 2014, and operating profit increased $20 million, representing 16% incremental leverage. The revenue increase was due to higher shipments of subsea flexible pipe and well stimulation equipment. Compared to the second quarter of 2013, revenues increased $70 million, and operating profit increased $30 million. Year-over-year the segment experienced similar results as contributions from acquisitions and higher sales of offshore production equipment were offset by decreased demand for land related pressure pumping equipment and coiled tubing units. Operating leverage was negatively impacted by a higher mix of subsea and floating production businesses.

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. Since that time, order levels for new deepwater drilling rigs, as well as new jackup drilling rigs, have rebounded; but, softening day rates for deepwater drilling rigs could result in a near-term reduction in new orders for deepwater drilling rigs. Some of this expected reduction could be offset by increasing demand for new land drilling rigs and equipment packages, primarily in the North American, Latin American and Middle East markets. And, as the fleet of offshore and land drilling rigs worldwide continues to grow, we are confident that our Aftermarket business will continue to support our growing installed base of equipment with spare parts, service and repair. Strict regulatory drilling requirements worldwide will keep demand for the segment's offerings at high levels.

Our outlook for the Company's Wellbore Technologies segment and Completion & Production Solutions segment remains closely tied to the rig count, particularly in North America. Average U.S. rig count during the second quarter of 2014 saw modest gains of 4% and 5% compared to the first quarter of 2014 and second quarter of 2013, respectively. The second quarter of 2014 saw average Canadian rig count decreased 62% sequentially and increased 30% year-over-year. As a result, revenues for both segments improved sequentially in Canada. Domestic land drilling and well service firms are increasing activity, which is leading to increased demand for drilling and stimulation equipment to develop unconventional shales. Activity generally seems to be continuing to increase in most markets outside North America as well.

Subsequent to the second quarter of 2014, both the United States and the European Union announced economic sanctions against Russia affecting its energy, defense and banking industries. The Company had sales of approximately $60 million and $100 million for the three and six months ended June 30, 2014 to customers in Russia. Some or all such sales may be restricted in the future by these sanctions. The Company's net investment in Russia was approximately $140 million at June 30, 2014. The severity of delayed or lost future revenue, and any possible impairment of our net investment, will depend on the duration of the sanctions and other government actions.

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.


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, and worldwide oil and gas inventory levels. Key industry indicators for the second quarter of 2014 and 2013, and the first quarter of 2014 include the following

                                                                                           %            %
                                                                                          2Q14        2Q14
                                                     2Q14*        2Q13*       1Q14*       2Q13        1Q14
Active Drilling Rigs:
U.S.                                                   1,852       1,761       1,781        5.2 %        4.0 %
Canada                                                   202         155         526       30.3 %      (61.6 %)
International                                          1,348       1,305       1,337        3.3 %        0.8 %

Worldwide                                              3,402       3,221       3,644        5.6 %       (6.6 %)

West Texas Intermediate Crude Prices (per barrel)   $ 103.35     $ 94.10     $ 98.75        9.8 %        4.7 %

Natural Gas Prices ($/mmbtu)                        $   4.61     $  4.01     $  5.18       15.0 %      (11.0 %)

* 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 June 30, 2014, on a quarterly basis:

[[Image Removed: LOGO]]

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


The worldwide quarterly average rig count decreased 6.6% (from 3,644 to 3,402) and the U.S. increased 4.0% (from 1,781 to 1,852), in the second quarter of 2014 compared to the first quarter of 2014. The average per barrel price of West Texas Intermediate Crude increased 4.7% (from $98.75 per barrel to $103.35 per barrel) and natural gas prices decreased 11.0% (from $5.18 per mmbtu to $4.61 per mmbtu) in the second quarter of 2014 compared to the first quarter of 2014.

U.S. rig activity at July 25, 2014 was 1,883 rigs increased two percent compared to the second quarter average of 1,852 rigs. The price for West Texas Intermediate Crude was at $102.09 per barrel at July 25, 2014, decreasing one percent from the second quarter average. The price for natural gas was at $3.78 per mmbtu at July 25, 2014, decreasing 18 percent from the second quarter average.

Results of Operations

Operating results by segment are as follows (in millions):



                                           Three Months Ended           Six Months Ended
                                                June 30,                    June 30,
                                           2014           2013          2014         2013
 Revenue:
 Rig Systems                             $   2,372       $ 2,081      $  4,628      $ 3,992
 Rig Aftermarket                               785           670         1,535        1,221
 Wellbore Technologies                       1,446         1,222         2,724        2,445
 Completion & Production Solutions           1,127         1,057         2,129        2,059
 Eliminations                                 (475 )        (350 )        (872 )       (661 )

 Total Revenue                           $   5,255       $ 4,680      $ 10,144      $ 9,056


 Operating Profit:
 Rig Systems                             $     501       $   383      $    952      $   753
 Rig Aftermarket                               217           189           408          331
 Wellbore Technologies                         263           184           484          366
 Completion & Production Solutions             157           127           294          263
 Unallocated expenses and eliminations        (225 )        (170 )        (426 )       (307 )

 Total Operating Profit                  $     913       $   713      $  1,712      $ 1,406


 Operating Profit %:
 Rig Systems                                  21.1 %        18.4 %        20.6 %       18.9 %
 Rig Aftermarket                              27.6 %        28.2 %        26.6 %       27.1 %
 Wellbore Technologies                        18.2 %        15.1 %        17.8 %       15.0 %
 Completion & Production Solutions            13.9 %        12.0 %        13.8 %       12.8 %
 Total Operating Profit %                     17.4 %        15.2 %        16.9 %       15.5 %

Rig Systems

Three and Six months ended June 30, 2014 and 2013. Revenue from Rig Systems was $2,372 million for the three months ended June 30, 2014, compared to $2,081 million for the three months ended June 30, 2013, an increase of $291 million (14.0%). For the six months ended June 30, 2014, revenue from Rig Systems was $4,628 million compared to $3,992 million for the six months ending June 30, . . .

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