The Daily Magic Formula Stock for 12/25/2008 is National Oilwell Varco Inc. According to the Magic Formula Investing Web Site, the ebit yield is 26% and the EBIT ROIC is 50-75 %.
Dailystocks.com only deals with facts, not biased journalism. What is a better way than to go to the SEC Filings? It's not exciting reading, but it makes you money. We cut and paste the important information from SEC filings for you to get started on your research on a specific company.
Dailystocks.com makes NO RECOMMENDATIONS whatsoever, and provides this for informational purpose only.
National Oilwell Varco, Inc. (‚ÄúNOV‚ÄĚ or the ‚ÄúCompany‚ÄĚ), a Delaware corporation incorporated in 1995, is a leading worldwide provider of equipment and components used in oil and gas drilling and production operations, oilfield services, and supply chain integration services to the upstream oil and gas industry. The Company conducts operations in approximately 700 locations across six continents.
On March 11, 2005, we acquired all of the outstanding shares of Varco International, Inc. (‚ÄúVarco‚ÄĚ) with the issuance of 0.8363 shares of National-Oilwell, Inc. common stock for each Varco common share (the ‚ÄúMerger‚ÄĚ). The Company then changed its name from National-Oilwell, Inc. to National Oilwell Varco, Inc. We have included the financial results of Varco in our consolidated financial statements beginning March 11, 2005, the date Varco common shares were exchanged for NOV common shares. We believe that the Merger has better positioned us to compete more effectively in the global marketplace and provide greater scale to increase service to our customers, increase our investment in research and development to accelerate innovation, and increase shareholder value. The fiscal year ending December 31, 2006 represented the first full year of operations of the combined entities.
On December 16, 2007, we agreed to acquire 100% of the outstanding shares of Grant Prideco, Inc. for a combination of $23.20 cash per share and 0.4498 shares of National Oilwell Varco, Inc. common stock. Consummation of the merger requires approval by the stockholders of Grant Prideco and also approval from various regulatory agencies. We anticipate completion of the merger during the second quarter of 2008.
The Company‚Äôs principal executive offices are located at 7909 Parkwood Circle Drive, Houston, Texas 77036, its telephone number is (713) 346-7500, and its Internet website address is http://www.nov.com . The Company‚Äôs annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and all amendments thereto, are available free of charge on its Internet website. These reports are posted on its website as soon as reasonably practicable after such reports are electronically filed with the Securities and Exchange Commission (‚ÄúSEC‚ÄĚ). The Company‚Äôs Code of Ethics is also posted on our website.
The Company has a long tradition of pioneering innovations which improve the cost-effectiveness, efficiency, safety and environmental impact of oil and gas operations. The Company‚Äôs common stock is traded on the New York Stock Exchange under the symbol ‚ÄúNOV.‚ÄĚ The Company operates through three business segments: Rig Technology, Petroleum Services & Supplies, and Distribution Services.
Our Rig Technology segment designs, manufactures, sells and services complete systems for the drilling, completion, and servicing of oil and gas wells. The segment offers a comprehensive line of highly-engineered equipment that automates complex well construction and management operations, such as offshore and onshore drilling rigs; derricks; pipe lifting, racking, rotating and assembly systems; coiled tubing equipment and pressure pumping units; well workover rigs; wireline winches; and cranes. Demand for Rig Technology products is primarily dependent on capital spending plans by drilling contractors, oilfield service companies, and oil and gas companies, and secondarily on the overall level of oilfield drilling activity, which drives demand for spare parts for the segment‚Äôs large installed base of equipment. We have made strategic acquisitions and other investments during the past several years in an effort to expand our product offering and our global manufacturing capabilities, including adding additional operations in the United States, Canada, Norway, the United Kingdom, China, Belarus, and India.
Petroleum Services & Supplies
Our Petroleum Services & Supplies segment provides a variety of consumable goods and services used to drill, complete, remediate and workover oil and gas wells and service pipelines, flowlines and other oilfield tubular goods. The segment manufactures, rents and sells a variety of products and equipment used to perform drilling operations, including transfer pumps, solids control systems, drilling motors and other downhole tools, rig instrumentation systems, and mud pump consumables. Demand for these services and supplies is determined principally by the level of oilfield drilling and workover activity by drilling contractors, major and independent oil and gas companies, and national oil companies. Oilfield tubular services include the provision of inspection and internal coating services and equipment for drill pipe, linepipe, tubing, casing and pipelines; and the design, manufacture and sale of coiled tubing pipe and advanced composite pipe for application in highly corrosive environments. The segment sells its tubular goods and services to oil and gas companies; drilling contractors; pipe distributors, processors and manufacturers; and pipeline operators. This segment has benefited from several strategic acquisitions and other investments completed during the past few years, including adding additional operations in the United States, Canada, the United Kingdom, China, Kazakhstan, Mexico, Russia, Argentina, India, Bolivia, the Netherlands, Singapore, Malaysia, Vietnam, and the United Arab Emirates.
Our Distribution Services segment provides maintenance, repair and operating supplies (‚ÄúMRO‚ÄĚ) and spare parts to drill site and production locations worldwide. In addition to its comprehensive network of field locations supporting land drilling operations throughout North America, the segment supports major offshore drilling contractors through locations in Mexico, the Middle East, Europe, Southeast Asia and South America. Distribution Services employs advanced information technologies to provide complete procurement, inventory management and logistics services to its customers around the globe. Demand for the segment‚Äôs services are determined primarily by the level of drilling, servicing, and oil and gas production activities.
Influence of Oil and Gas Activity Levels on the Company‚Äôs Business
The oil and gas industry in which the Company participates has historically experienced significant volatility. Demand for the Company‚Äôs services and products depends primarily upon the general level of activity in the oil and gas industry worldwide, including the number of drilling rigs in operation, the number of oil and gas wells being drilled, the depth and drilling conditions of these wells, the volume of production, the number of well completions and the level of well remediation activity. Oil and gas activity is in turn heavily influenced by, among other factors, oil and gas prices worldwide. High levels of drilling and well-remediation activity generally spur demand for the Company‚Äôs products and services used to drill and remediate oil and gas wells. Additionally, high levels of oil and gas activity increase cash flows available for drilling contractors, oilfield service companies, and manufacturers of oil country tubular goods to invest in capital equipment that the Company sells.
Beginning in early 2004, increasing oil and gas prices led to steadily rising levels of drilling activity throughout the world. Concerns about the long-term availability of oil and gas supply also began to build. Consequently, the worldwide rig count increased 15% in 2005, 11% in 2006, and 2% in 2007. As a result of higher cash flows realized by many drilling contractors and other oilfield service companies, as well as the long-term concerns about supply-demand imbalance and the need to replace aging equipment, market conditions for capital equipment purchases have improved significantly since 2005 and 2006, resulting in higher backlogs for the Company at the end of 2007 compared to the end of 2005 and 2006. Backlog for the Company was at approximately $9.0 billion at December 31, 2007 compared to approximately $6.0 billion and $2.3 billion for December 31, 2006 and 2005, respectively.
In 2007, most of the Company‚Äôs Rig Technology revenue resulted from major capital expenditures of drilling contractors, well servicing companies, and oil companies on rig construction and refurbishment, and well servicing equipment. These capital expenditures are influenced by the amount of cash flow that contractors and service companies generate from drilling, completion, and remediation activity; as well as by the availability of financing, the outlook for future drilling and well servicing activity, and other factors. Generally the Company believes the demand for capital equipment lags increases in the level of drilling activity. The remainder of the Rig Technology segment‚Äôs revenue in 2007 was related to the sale of spare parts and consumables, the provision of equipment-repair services, and the rental of equipment, which the Company believes are generally determined directly by the level of drilling and well servicing activity.
The majority of the Company‚Äôs Petroleum Services & Supplies revenue is closely tied to drilling activity, although a portion is related to the sale of capital equipment to drilling contractors, which may somewhat lag the level of drilling activity. Portions of the segment‚Äôs revenue that are not tied to drilling activity include (i) the sale of progressive cavity pumps and solids control equipment for use in industrial applications; (ii) the performance of in-service pipeline inspections; (iii) the sale of fiberglass and composite tubing to industrial customers, which is generally unrelated to drilling or well remediation activity but may be tied somewhat to oil and gas prices; and (iv) the sale of pipe inspection equipment to the manufacturers of oil country tubular goods, which is indirectly related to drilling activity.
The Company‚Äôs revenue from Distribution Services is almost entirely driven by drilling activity and oil and gas production activities.
Drilling and well servicing activity can fluctuate significantly in a short period of time. The willingness of oil and gas operators to make capital investments to explore for and produce oil and natural gas will continue to be influenced by numerous factors over which the Company has no control, including: the ability of the members of the Organization of Petroleum Exporting Countries (‚ÄúOPEC‚ÄĚ) to maintain oil price stability through voluntary production limits of oil; the level of oil production by non-OPEC countries; supply and demand for oil and natural gas; general economic and political conditions; costs of exploration and production; the availability of new leases and concessions; and governmental regulations regarding, among other things, environmental protection, taxation, price controls and product allocations. The willingness of drilling contractors and well servicing companies to make capital expenditures for the type of specialized equipment the Company provides is also influenced by numerous factors over which the Company has no control, including: the general level of oil and gas well drilling and servicing; rig dayrates; access to external financing; outlook for future increases in well drilling and well remediation activity; steel prices and fabrication costs; and government regulations regarding, among other things, environmental protection, taxation, and price controls.
Overview of Oil and Gas Well Drilling and Servicing Processes
Oil and gas wells are usually drilled by drilling contractors using a drilling rig. A bit is attached to the end of a drill stem, which is assembled by the drilling rig and its crew from 30-foot joints of drill pipe and specialized drilling components known as downhole tools. Using the conventional rotary drilling method, the drill stem is turned from the rotary table of the drilling rig by torque applied to the kelly, which is screwed into the top of the drill stem. Increasingly, drilling is performed using a drilling motor, which is attached to the bottom of the drill stem and provides rotational force directly to the bit, rather than such force being supplied by the rotary table. The use of a drilling motor permits the drilling contractor to drill directionally, including horizontally. The Company sells and rents drilling motors and downhole tools through its Petroleum Services & Supplies segment.
During drilling, heavy drilling fluids or ‚Äúdrilling muds‚ÄĚ are pumped down the drill stem and forced out through jets in the bit. The drilling mud returns to the surface through the space between the borehole wall and the drill stem, carrying with it the drill cuttings drilled out by the bit. The drill cuttings are removed from the mud by a solids control system (which can include shakers, centrifuges and other specialized equipment) and disposed of in an environmentally sound manner. The solids control system permits the mud, which is often comprised of expensive chemicals, to be continuously reused and recirculated back into the hole.
Through its Rig Technology segment, the Company sells the large ‚Äúmud pumps‚ÄĚ that are used to pump drilling mud through the drill stem. Through its Petroleum Services & Supplies business, the Company sells transfer pumps and mud pump consumables; sells and rents solids control equipment; and provides solids control and waste management services. Many operators internally coat the drill stem to improve its hydraulic efficiency and protect it from corrosive fluids sometimes encountered during drilling, and inspect and assess the integrity of the drill pipe from time to time. The Company provides drill pipe inspection and coating services, and applies ‚Äúhardbanding‚ÄĚ material to drill pipe to improve its wear characteristics. These services are provided through the Company‚Äôs Petroleum Services & Supplies segment.
As the hole depth increases, the kelly must be removed frequently so that additional 30-foot joints of drill pipe can be added to the drill stem. When the bit becomes dull or the equipment at the bottom of the drill stem ‚Äď including the drilling motors ‚Äď otherwise requires servicing, the entire drill stem is pulled out of the hole and disassembled by disconnecting the joints of drill pipe. These are set aside or ‚Äúracked,‚ÄĚ the old bit is replaced or service is performed, and the drill stem is reassembled and lowered back into the hole (a process called ‚Äútripping‚ÄĚ). During drilling and tripping operations, joints of drill pipe must be screwed together and tightened (‚Äúmade up‚ÄĚ), and loosened and unscrewed (‚Äúspun out‚ÄĚ). The Company‚Äôs Rig Technology business provides drilling equipment to manipulate and maneuver the drill pipe in this manner. When the hole has reached certain depths, all of the drill pipe is pulled out of the hole and larger diameter pipe known as casing is lowered into the hole and permanently cemented in place in order to protect against collapse and contamination of the hole. The casing is typically inspected before it is lowered into the hole, a service the Company‚Äôs Petroleum Services & Supplies business provides. The Company‚Äôs Rig Technology segment manufactures pressure pumping equipment that is used to cement the casing in place.
The raising and lowering of the drill stem while drilling or tripping, and the lowering of casing into the wellbore, are accomplished with the rig‚Äôs hoisting system. A conventional hoisting system is a block and tackle mechanism that works within the drilling rig‚Äôs derrick. The lifting of this mechanism is performed via a series of pulleys that are attached to the drawworks at the base of the derrick. The Company‚Äôs Rig Technology segment sells and installs drawworks and pipe hoisting systems.
During the course of normal drilling operations, the drill stem passes through different geological formations, which exhibit varying pressure characteristics. If this pressure is not contained, oil, gas and/or water would flow out of these formations to the surface. The two means of containing these pressures are (i) primarily the circulation of drilling muds while drilling and (ii) secondarily the use of blowout preventers should the mud prove inadequate and in an emergency situation. The Company‚Äôs Rig Technology group sells and services blowout preventers.
Drilling muds are carefully designed to exhibit certain qualities that optimize the drilling process. In addition to containing formation pressure, they must (i) provide power to the drilling motor, (ii) carry drilled solids to the surface, (iii) protect the drilled formations from being damaged, and (iv) cool the drill bit. Achieving these objectives often requires a formulation specific to a given well and can involve the use of expensive chemicals as well as natural materials such as certain types of clay. The fluid itself is often oil or more-expensive synthetic mud. Given this expense, it is highly desirable to reuse as much of the drilling mud as possible. Solids control equipment such as shale shakers, centrifuges, cuttings dryers, and mud cleaners help accomplish this objective. The Company‚Äôs Petroleum Services & Supplies group rents, sells, operates and services this equipment. Drilling muds are formulated based on expected drilling conditions. However, as the hole is drilled, the drill stem may encounter a high pressure zone where the mud density is inadequate to maintain sufficient pressure. Should efforts to ‚Äúweight up‚ÄĚ the mud in order to contain such a pressure kick fail, a blowout could result, whereby reservoir fluids would flow uncontrolled into the well. To prevent blowouts to the surface of the well, a series of high-pressure valves known as blowout preventers (‚ÄúBOPs‚ÄĚ) are positioned at the top of the well and, when activated, form tight seals that prevent the escape of fluids. When closed, conventional BOPs prevent normal rig operations. Therefore, the BOPs are activated only if drilling mud and normal well control procedures cannot safely contain the pressure. BOPs have been designed to contain pressures of up to 20,000 psi.
The operations of the rig and the condition of the drilling mud are closely monitored by various sensors, which measure operating parameters such as the weight on the rig‚Äôs hook, the incidence of pressure kicks, the operation of the drilling mud pumps, etc. Through its Petroleum Services & Supplies business, the Company sells and rents drilling rig instrumentation packages that perform these monitoring functions.
During the drilling and completion of a well, there exists an ongoing need for various consumables and spare parts. While most of these items are small, in the aggregate they represent an important element of the process. Since it is impractical for each drilling location to have a full supply of these items, drilling contractors and well service companies tend to rely on third parties to stock and deliver these items. The Company provides this capability through its Distribution Services segment, which stocks and sells spares and consumables made by third parties, as well as spares and consumables made by the Company.
After the well has reached its total depth and the final section of casing has been set, the drilling rig is moved off of the well and the well is prepared to begin producing oil or gas in a process known as ‚Äúwell completion.‚ÄĚ Well completion usually involves installing production tubing concentrically in the casing. Due to the corrosive nature of many produced fluids, production tubing is often inspected and coated, services offered by the Company‚Äôs Petroleum Services & Supplies business. Sometimes operators choose to use corrosion resistant composite materials (which the Company offers through its Petroleum Services & Supplies business), or corrosion-resistant alloys, or operators sometimes pump fluids into wells to inhibit corrosion.
From time to time, a producing well may undergo workover procedures to extend its life and increase its production rate. Workover rigs are used to disassemble the wellhead, tubing and other completion components of an existing well in order to stimulate or remediate the well. Workover rigs are similar to drilling rigs in their capabilities to handle tubing, but are usually smaller and somewhat less sophisticated. The Company offers a comprehensive range of workover rigs through its Rig Technology segment. Tubing and sucker rods removed from a well during a well remediation operation are often inspected to determine their suitability to be reused in the well, which is a service the Company‚Äôs Petroleum Services & Supplies business provides.
Frequently coiled tubing units or wireline units are used to accomplish certain well remediation operations or well completions. Coiled tubing is a recent advancement in petroleum technology consisting of a continuous length of reeled steel tubing which can be injected concentrically into the production tubing all the way to the bottom of most wells. It permits many operations to be performed without disassembling the production tubing, and without curtailing the production of the well. Wireline winch units are devices that utilize single-strand or multistrand wires to perform well-remediation operations, such as lowering tools and transmitting data to the surface. Through the Rig Technology group, the Company sells and rents various types of coiled tubing equipment, and wireline equipment and tools. The Company also manufactures and sells coiled tubing pipe through its Petroleum Services & Supplies segment.
The Company has a long tradition of pioneering innovations in drilling and well servicing equipment which improve the efficiency, safety, and cost of drilling and well servicing operations. The Rig Technology group designs, manufactures and sells a wide variety of top drives, automated pipe handling systems, motion compensation systems, rig controls, BOPs, handling tools, drawworks, risers, rotary tables, mud pumps, cranes, drilling motors and other drilling equipment for both the onshore and offshore markets. The Rig Technology group also manufactures entire rig packages, both drilling and workover, in addition to well servicing equipment such as coiled tubing units, pressure pumping equipment, and wireline winches.
The Rig Technology group sells directly to drilling contractors, shipyards and other rig fabricators, well servicing companies, national oil companies, major and independent oil and gas companies, supply stores, and pipe-running service providers. Demand for its products, several of which are described below, is strongly dependent upon capital spending plans by oil and gas companies and drilling contractors, and the level of oil and gas well drilling activity.
Land Rig Packages . NOV designs, manufactures, assembles, upgrades, and supplies equipment sets to a variety of land drilling rigs, including those specifically designed to operate in harsh environments such as the Arctic Circle and the desert. Our key land rig product names include the Ideal Rig‚ĄĘ and Rapid Rig ¬ģ . NOV‚Äôs recent rig packages are designed to be safer and fast moving, to utilize AC technology, and to reduce manpower required to operate a rig.
Top Drives . The Top Drive Drilling System (‚ÄúTDS‚ÄĚ), originally introduced by NOV in 1982, significantly alters the traditional drilling process. The TDS rotates the drill stem from its top, rather than by the rotary table, with a large electric motor affixed to rails installed in the derrick that traverses the length of the derrick to the rig floor. Therefore, the TDS eliminates the use of the conventional rotary table for drilling. Components of the TDS also are used to connect additional joints of drill pipe to the drill stem during drilling operations, enabling drilling with three joints of drill pipe compared to traditionally drilling with one joint of drill pipe. Additionally, the TDS facilitates horizontal and extended reach drilling.
Drilling Motors. NOV has helped lead the application of AC motor technology in the oilfield industry. We are now transitioning from buying motors from third parties to building them in our own facilities and further developing motor technology, including the introduction of permanent magnet motor technology to the industry. These permanent magnet motors are being used in top drives, cranes, mud pumps, winches, and drawworks.
Rotary Equipment . The alternative to using a TDS to rotate the drill stem is to use a rotary table, which rotates the pipe at the floor of the rig. The Rig Technology group produces rotary tables as well as kelly bushings and master bushings for most sizes of kellys and makes of rotary tables. In 1998, NOV introduced the Rotary Support Table for use on rigs with a TDS. The Rotary Support Table is used in concert with the TDS to completely eliminate the need for the larger conventional rotary table.
Pipe Handling Systems . Pipe racking systems are used to handle drill pipe, casing and tubing on a drilling rig. Vertical pipe racking systems move drill pipe and casing between the well and a storage (‚Äúracking‚ÄĚ) area on the rig floor. Horizontal racking systems are used to handle tubulars while stored horizontally (for example, on the pipe deck of an offshore rig) and transport tubulars up to the rig floor and into a vertical position for use in the drilling process.
Vertical pipe racking systems are used predominantly on offshore rigs and are found on almost all floating rigs. Mechanical vertical pipe racking systems greatly reduce the manual effort involved in pipe handling. Pipe racking systems, introduced by NOV in 1985, provide a fully automated mechanism for handling and racking drill pipe during drilling and tripping operations, spinning and torquing drill pipe, and automatic hoisting and racking of disconnected joints of drill pipe. These functions can be integrated via computer controlled sequencing, and operated by a driller in an environmentally secure cabin. An important element of this system is the Iron Roughneck, which was originally introduced by NOV in 1976 and is an automated device that makes pipe connections on the rig floor and requires less direct involvement of rig floor personnel in potentially dangerous operations. The Automated Roughneck is an automated microprocessor-controlled version of the Iron Roughneck.
Horizontal pipe transfer systems were introduced by NOV in 1993. They include the Pipe Deck Machine (‚ÄúPDM‚ÄĚ), which is used to manipulate and move tubulars while stored in a horizontal position; the Pipe Transfer Conveyor (‚ÄúPTC‚ÄĚ), which transports sections of pipe to the rig floor; and a Pickup Laydown System (‚ÄúPLS‚ÄĚ), which raises the pipe to a vertical position for transfer to a vertical racking system. These components may be employed separately, or incorporated together to form a complete horizontal racking system, known as the Pipe Transfer System (‚ÄúPTS‚ÄĚ).
Pipe Handling Tools . The Company‚Äôs pipe handling tools are designed to enhance the safety, efficiency and reliability of pipe handling operations. Many of these tools have provided innovative methods of performing the designated task through mechanization of functions previously performed manually. The Rig Technology group manufactures various tools used to grip, hold, raise, and lower pipe, and in the making up and breaking out of drill pipe, workstrings, casing and production tubulars including spinning wrenches, manual tongs, torque wrenches and kelly spinners.
Mud Pumps. Mud pumps are high pressure pumps located on the rig that force drilling mud down the drill pipe, through the drill bit, and up the space between the drill pipe and the drilled formation (the ‚Äúannulus‚ÄĚ) back to the surface. These pumps, which generate pressures of up to 7,500 psi, must therefore be capable of displacing drilling fluids several thousand feet down and back up the well bore. The conventional mud pump design, known as the triplex pump, uses three reciprocating pistons oriented horizontally. Recently, NOV has introduced the HEX Pump, which uses six pumping cylinders, versus the three used in the triplex pump. Along with other design features, the greater number of cylinders reduces pulsations (or surges) and increases the output available from a given footprint. Reduced pulsation is desirable where downhole measurement equipment is being used during the drilling process, as is often the case in directional drilling.
Hoisting Systems . Hoisting systems are used to raise or lower the drill stem while drilling or tripping, and to lower casing into the wellbore. The drawworks is the heart of the hoisting system. It is a large winch that spools off or takes in the drilling line, which is in turn connected to the drill stem at the top of the derrick. The drawworks also plays an important role in keeping the weight on the drill bit at a desired level. This task is particularly challenging on offshore drilling rigs, which are subject to wave motion. To address this, NOV has introduced the Active Heave Drilling (‚ÄúAHD‚ÄĚ) Drawworks. The AHD Drawworks uses computer-controlled motors to compensate for the motion experienced in offshore drilling operations.
Cranes. NOV provides a comprehensive range of crane solutions, with purpose-built products for all segments of the oil and gas industry as well as many other markets. The Company encompasses a broad collection of brand names with international recognition, and includes a large staff of engineers specializing in the design of cranes and related equipment. The product range extends from small cargo-handling cranes to the world‚Äôs largest marine cranes. In all, the Company provides over twenty crane product lines that include standard model configurations as well as custom-engineered and specialty cranes.
Motion Compensation Systems . Traditionally, motion compensation equipment is located on top of the drilling rig and serves to stabilize the bit on the bottom of the hole, increasing drilling effectiveness of floating offshore rigs by compensating for wave and wind action. The AHD Drawworks, discussed above, was introduced to eliminate weight and improve safety, removing the compensator from the top of the rig and integrating it into the drawworks system. In addition to the AHD Drawworks, NOV has introduced an Active Heave Compensation (‚ÄúAHC‚ÄĚ) System that goes beyond the capabilities of the AHD Drawworks to handle the most severe weather. Additionally, NOV tensioning systems provide continuous axial tension to the marine riser pipe (larger diameter pipe which connects floating drilling rigs to the well on the ocean floor) and guide lines on floating drilling rigs, tension leg platforms and jack-up drilling rigs.
Blowout Preventers . BOPs are devices used to seal the space (‚Äúannulus‚ÄĚ) between the drill pipe and the borehole to prevent blowouts (uncontrolled flows of formation fluids and gases to the surface). The Rig Technology group manufactures a wide array of BOPs used in various situations. Ram and annular BOPs are back-up devices that are activated only if other techniques for controlling pressure in the wellbore are inadequate. When closed, these devices prevent normal rig operations. Ram BOPs seal the wellbore by hydraulically closing rams (thick heavy blocks of steel) against each other across the wellbore. Specially designed packers seal around specific sizes of pipe in the wellbore, shear pipe in the wellbore or close off an open hole. Annular BOPs seal the wellbore by hydraulically closing a rubber packing unit around the drill pipe or kelly or by sealing against itself if nothing is in the hole. NOV‚Äôs Pressure Control While Drilling (‚ÄúPCWD‚ÄĚ) ¬ģ BOP, introduced in 1995, allows operators to drill at pressures up to 2,000 psi without interrupting normal operations, and can act as a normal spherical BOP at pressures up to 5,000 psi.
In 1998, NOV introduced the NXT ¬ģ ram type BOP which eliminates door bolts, providing significant weight, rig-time, and space savings. Its unique features make subsea operation more efficient through faster ram configuration changes without tripping the BOP stack. In 2004, NOV introduced the LXT, which features many of the design elements of the NXT, but is targeted at the land market. In 2005, the Company began commercializing technology related to a continuous circulation device. This device enables drilling contractors to make and break drill pipe connections without stopping the circulation of drilling fluids, which helps increase drilling efficiency.
Derricks and Substructures. Drilling activities are carried out from a drilling rig. A drilling rig consists of one or two derricks; the substructure that supports the derrick(s); and the rig package, which consists of the various pieces of equipment discussed above. The Rig Technology segment designs, fabricates and services derricks used in both onshore and offshore applications, and substructures used in onshore applications. The Rig Technology group also works with shipyards in the fabrication of substructures for offshore drilling rigs.
Coiled Tubing Equipment . Coiled tubing consists of flexible steel tubing manufactured in a continuous string and spooled on a reel. It can extend several thousand feet in length and is run in and out of the wellbore at a high rate of speed by a hydraulically operated coiled tubing unit. A coiled tubing unit is typically mounted on a truck or skid (steel frames on which portable equipment is mounted to facilitate handling with cranes or flatbed trucks) and consists of a hydraulically operated tubing reel or drum, an injector head which pushes or pulls the tubing in or out of the wellbore, and various power and control systems. Coiled tubing is typically used with sophisticated pressure control equipment which permits the operator to continue to safely produce the well. The Rig Technology group manufactures and sells both coiled tubing units and the ancillary pressure control equipment used in these operations. Through its acquisition of Rolligon in late 2006, the Company enhanced its portfolio by adding additional pressure pumping and coiled tubing equipment products.
Currently, most coiled tubing units are used in well remediation and completion applications. The Company believes that advances in the manufacturing process of coiled tubing, tubing fatigue protection and the capability to manufacture larger diameter and increased wall thickness coiled tubing strings have resulted in increased uses and applications for coiled tubing products. For example, some well operators are now using coiled tubing in drilling applications such as slim hole reentries of existing wells. NOV engineered and manufactured the first coiled tubing units built specifically for coiled tubing drilling in 1996.
Generally, the Rig Technology group supplies customers with the equipment and components necessary to use coiled tubing, which the customers typically purchase separately. The group‚Äôs coiled tubing product line consists of coiled tubing units, coiled tubing pressure control equipment, pressure pumping equipment, snubbing units (which are units that force tubulars into a well when pressure is contained within the wellbore), nitrogen pumping equipment and cementing, stimulation, fracturing and blending equipment.
Wireline Equipment . NOV‚Äôs wireline products include wireline drum units, which consist of a spool or drum of wireline cable, mounted in a mobile vehicle or skid, which works in conjunction with a source of power (an engine mounted in the vehicle or within a separate ‚Äúpower pack‚ÄĚ skid). The wireline drum unit is used to spool wireline cable into or out of a well, in order to perform surveys inside the well, sample fluids from the bottom of the well, retrieve or replace components from inside the well, or to perform other well remediation or survey operations. The wireline used may be ‚Äúslickline,‚ÄĚ which is conventional steel cable used to convey tools in or out of the well, or ‚Äúelectric line,‚ÄĚ which contains an imbedded single-conductor or multi-conductor electrical line which permits communication between the surface and electronic instruments attached to the end of the wireline at the bottom of the well.
Wireline units are usually used in conjunction with a variety of other pressure control equipment which permit safe access into wells while they are flowing and under pressure at the surface. The company engineers and manufactures a broad range of pressure control equipment for wireline operations, including wireline blowout preventers, strippers, packers, lubricators and grease injection units. Additionally, the Company makes wireline rigging equipment such as mast trucks.
Facilities. The Company conducts Rig Technology manufacturing operations at major facilities in Houston, Galena Park, Sugar Land, Conroe, Anderson, Fort Worth and Pampa, Texas; Tulsa and Duncan, Oklahoma; Orange, California; Calgary, Nisku and Edmonton, Canada; Mexicali, Mexico; Kristiansand and Stavanger, Norway; Etten-Leur, the Netherlands; Carquefou, France; Lanzhou and Shanghai, China; Jebel Ali, UAE; Minsk, Belarus; and Dehradun, India. The Rig Technology group maintains sales and service offices in most major oilfield markets, either directly or through agents.
Customers and Competition. The Rig Technology segment sells directly to drilling contractors, other rig fabricators, well servicing companies, pressure pumping companies, national oil companies, major and independent oil and gas companies, supply stores, and pipe-running service providers. Demand for its products is strongly dependent upon capital spending plans by oil and gas companies and drilling contractors, and the level of oil and gas well drilling activity.
The products of the Rig Technology group are sold in highly competitive markets and its sales and earnings can be affected by competitive actions such as price changes, new product development, or improved availability and delivery. The group‚Äôs primary competitors are Access Oil Tools; Aker Kvaerner AS; American Block; Bomco; Canrig (a division of Nabors Industries); Cavins Oil Tools; Cameron; DenCon Oil Tools; Forum Oilfield Technologies; General Electric; Hong Hua; IDM; LTI (a division of Rowan Companies); M&I Electric; Tesco Corporation; Wirth M&B GmbH; Stewart & Stevenson, Inc.; ASEP; Crown Energy Technologies; Huntings, Ltd.; Vanoil; Parveen Industries; and Weatherford International, Inc. Management believes that the principal competitive factors affecting its Drilling Equipment business are performance, quality, reputation, customer service, availability of products, spare parts, and consumables, breadth of product line and price.
Petroleum Services & Supplies
The Company provides a broad range of support equipment, spare parts, consumables and services through the Petroleum Services & Supplies segment. The Petroleum Services & Supplies group sells directly to drilling contractors; well servicing companies; oil and gas producers; national oil companies; tubular processors, manufacturers and distributors; oilfield distributors; and pipeline operators.
The Petroleum Services & Supplies group provides a variety of tubular services, composite tubing, and coiled tubing to oil and gas producers, national oil companies, drilling contractors, well servicing companies, pipeline operators, and tubular processors, manufacturers and distributors. These include inspection and reclamation services for drill pipe, casing, production tubing, sucker rods and line pipe at drilling and workover rig locations, at yards owned by its customers, at steel mills and processing facilities that manufacture tubular goods, and at facilities which it owns. The group also provides internal coating of tubular goods at several coating plants worldwide and through licensees in certain locations. Additionally, the Company designs, manufactures and sells high pressure fiberglass and composite tubulars for use in corrosive applications and coiled tubing for use in well servicing applications; and provides in-service inspection of oil, gas and product transmission pipelines through its application of instrumented survey tools (‚Äúsmart pigs‚ÄĚ) which it engineers, manufactures and operates.
The Company‚Äôs customers rely on tubular inspection services to avoid failure of tubing, casing, flowlines, pipelines and drill pipe. Such tubular failures are expensive and in some cases catastrophic. The Company‚Äôs customers rely on internal coatings of tubular goods to prolong the useful lives of tubulars and to increase the volumetric throughput of in-service tubular goods. The Company‚Äôs customers sometimes use fiberglass or composite tubulars in lieu of conventional steel tubulars, due to the corrosion-resistant properties of fiberglass and other composite materials. Tubular inspection and coating services are used most frequently in operations in high-temperature, deep, corrosive oil and gas environments. In selecting a provider of tubular inspection and tubular coating services, oil and gas operators consider such factors as reputation, experience, technology of products offered, reliability and price.
The Company‚Äôs Petroleum Services & Supplies group also provides products and services that are used in the course of drilling oil and gas wells. The Downhole Tools business sells and rents drilling motors and specialized downhole tools that are incorporated into the drill stem during drilling operations (‚ÄúDownhole Tools‚ÄĚ), and are also used during fishing, well intervention, re-entry, and well completion operations. The Solids Control business is engaged in the provision of highly-engineered equipment, products and services which separate and manage drill cuttings produced by the drilling process (‚ÄúSolids Control‚ÄĚ). Drill cuttings are usually contaminated with petroleum or drilling fluids, and must be disposed of in an environmentally sound manner. Additionally, efficient separation of drill cuttings enables the re-use of often costly drilling fluids. The Instrumentation business rents and sells proprietary drilling rig instrumentation packages and control systems which monitor various processes throughout the drilling operation, under the name MD ¬ģ /Totco ¬ģ (‚ÄúInstrumentation‚ÄĚ). The Pumps & Expendables business provides centrifugal, reciprocating, and progressing cavity pumps and pump expendables (‚ÄúPumps & Expendables‚ÄĚ) into the global oil and gas and industrial markets.
Tubular Coating . The Company develops, manufactures and applies its proprietary tubular coatings, known as Tube-Kote ¬ģ coatings, to new and used tubulars. Tubular coatings help prevent corrosion of tubulars by providing a tough plastic shield to isolate steel from corrosive oilfield fluids such as CO 2 , H 2 S and brine. Delaying or preventing corrosion extends the life of existing tubulars, reduces the frequency of well remediation and reduces expensive interruptions in production. In addition, coatings are designed to increase the fluid flow rate through tubulars by decreasing or eliminating paraffin and scale build-up, which can reduce or block oil flow in producing wells. The smooth inner surfaces of coated tubulars often increase the fluid through-put on certain high-rate oil and gas wells by reducing friction and turbulence. The Company‚Äôs reputation for supplying quality internal coatings is an important factor in its business, since the failure of coatings can lead to expensive production delays and premature tubular failure. In 2005, NOV created a 60%-owned joint venture in China with the Huabei Petroleum Administration Bureau, which coats Chinese produced drill pipe using NOV‚Äôs proprietary coatings. In 2007, the joint venture opened a second coating plant in Jiangyin City, China.
Tubular Inspection. Newly manufactured pipe sometimes contains serious defects that are not detected at the mill. In addition, pipe can be damaged in transit and during handling prior to use at the well site. As a result, exploration and production companies often have new tubulars inspected before they are placed in service to reduce the risk of tubular failures during drilling, completion, or production of oil and gas wells. Used tubulars are inspected by the Company to detect service-induced flaws after the tubulars are removed from operation. Used drill pipe and used tubing inspection programs allow operators to replace defective lengths, thereby prolonging the life of the remaining pipe and saving the customer the cost of unnecessary tubular replacements and expenses related to tubular failures.
Tubular inspection services employ all major non-destructive inspection techniques, including electromagnetic, ultrasonic, magnetic flux leakage and gamma ray. These inspection services are provided both by mobile units which work at the wellhead as used tubing is removed from a well, and at fixed site tubular inspection locations. The group provides an ultrasonic inspection service for detecting potential fatigue cracks in the end area of used drill pipe, the portion of the pipe that traditionally has been the most difficult to inspect. Tubular inspection facilities also offer a wide range of related services, such as API thread inspection, ring and plug gauging, and a complete line of reclamation services necessary to return tubulars to useful service, including tubular cleaning and straightening, hydrostatic testing and re-threading.
Robert E. Beauchamp 48 2008 Mr. Beauchamp has been a Director of the Company since August 2002. Since 1988, he has served in various capacities at BMC Software, Inc., a leading provider of enterprise management solutions, most recently as President and Chief Executive Officer and as a director. During his career with BMC, he also served as senior vice president of research & development, vice president of strategic marketing and corporate development, and director of strategic marketing.
Jeffery A. Smisek 53 2008 Mr. Smisek has been a Director of the Company since March 2005. Mr. Smisek served as a Director of Varco (and its predecessor, Tuboscope Inc.) from February 1998 until its merger with the Company on March 11, 2005. Since December 30, 2004, Mr. Smisek has served as President and a director of Continental Airlines, Inc. Mr. Smisek previously served Continental Airlines, Inc. as: Executive Vice President from March 2003 until December 2004; and Executive Vice President ‚ÄĒ Corporate from May 2001 until March 2003.
Merrill A. Miller, Jr. 57 2009 Mr. Miller has been a Director of the Company since May 2001 and Chairman of the Board since July 22, 2005. He also served as Chairman of the Board from May 2002 through March 11, 2005. He served as the Company‚Äôs Chief Operating Officer from November 2000 through March 11, 2005. He has served as President since November 2000 and as Chief Executive Officer since May 2001. He has served in various senior executive positions with National Oilwell since February 1996. Mr. Miller also serves as a director of Chesapeake Energy Corporation, a company engaged in the development, acquisition, production, exploration, and marketing of onshore oil and natural gas properties in the United States.
Greg L. Armstrong 49 2009 Mr. Armstrong has been a Director of the Company since March 2005. Mr. Armstrong served as a Director of Varco from May 20, 2004 until its merger with the Company on March 11, 2005. Since 1998, he has been the Chairman of the Board and Chief Executive Officer of Plains All American GP LLC, the general partner and controlling entity of Plains All American Pipeline, L.P., a publicly traded master limited partnership engaged in the business of marketing, gathering, transporting, terminalling and storing crude oil. Mr. Armstrong is a member of the National Petroleum Council and a member of the Board of BreitBurn Energy Partners. 2005
Ben A. Guill 57 2010 Mr. Guill has served as a Director of the Company since 1999. Until April 2007, he was President of First Reserve Corporation, a corporate manager of private investments focusing on the energy and energy-related sectors, which he joined in September 1998. Prior to joining First Reserve, Mr. Guill was the Managing Director and Co-head of Investment Banking of Simmons & Company International, an investment-banking firm specializing in the oil service industry. Mr. Guill also serves as a director of the general partner of Cheniere Energy Partners, L.P. and as a director of Trico Marine Services, Inc. 1999
David D. Harrison 60 2009 Mr. Harrison has been a Director of the Company since August 2003. He has served as Executive Vice President and Chief Financial Officer of Pentair, Inc., a diversified manufacturer in water technologies and enclosures businesses, since February 2000 until his retirement in February 2007. He also served as Executive Vice President and Chief Financial Officer of Pentair, Inc. from 1994 to 1996. From 1972 through 1994, Mr. Harrison held various domestic and international finance positions with a combination of General Electric and Borg-Warner Chemicals. Mr. Harrison serves as a director of Navistar International Corporation, a holding company whose wholly owned subsidiaries produce International ¬ģ brand commercial trucks, MaxxForce brand diesel engines, IC brand school buses, and Workhorse brand chassis for motor homes and step vans.
Roger L. Jarvis 54 2010 Mr. Jarvis has been a Director of the Company since February 2002. Since 2007, he has served as Chairman, Chief Executive Officer and President of Common Resources LLC, a privately held company engaged in the business of exploration for and production of hydrocarbons in the United States. He served as President, Chief Executive Officer and Director of Spinnaker Exploration Company, a natural gas and oil exploration and production company, from 1996 and as its Chairman of the Board from 1998, until its acquisition by Norsk Hydro ASA in December 2005. 2002
Eric L. Mattson 56 2010 Mr. Mattson has been a Director of the Company since March 2005. Mr. Mattson served as a Director of Varco (and its predecessor, Tuboscope Inc.) from January 1994 until its merger with the Company on March 11, 2005. Mr. Mattson has served as Senior Vice President and Chief Financial Officer of VeriCenter, Inc., a private provider of managed hosting services, since 2003, until its acquisition in August 2007. From November 2002 until October 2003, Mr. Mattson worked as an independent consultant. Mr. Mattson was the Chief Financial Officer of Netrail, Inc., a private Internet backbone and broadband service provider, from September 1999 until November 2002. From July 1993 until May 1999, Mr. Mattson served as Senior Vice President and Chief Financial Officer of Baker Hughes Incorporated, a provider of products and services to the oil, gas and process industries.
MANAGEMENT DISCUSSION FROM LATEST 10K
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 approximately 700 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, provide in-service pipeline inspections, 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 ‚ÄúRisk Factors‚ÄĚ. We conduct our operations through three business segments: Rig Technology, Petroleum Services & Supplies and Distribution Services. See Item 1. Business for a discussion of each of these business segments.
National Oilwell Varco generated earnings of $1,337.1 million or $3.76 per fully diluted share in its fiscal year ended December 31, 2007, on revenues of $9,789.0 million. Earnings per share increased 95 percent and revenue increased 39 percent from the Company‚Äôs 2006 earnings and revenues, respectively, as we experienced rising demand for our products and services through the year. Our backlog for capital equipment increased 50 percent throughout the year, despite steadily rising shipments out of backlog, due principally to growing numbers of new offshore drilling rig construction projects initiated during 2007 which placed orders with the Company.
Oil & Gas Equipment and Services Market
Oil and gas prices have increased significantly over the past five years and remain near historic highs, which have led to high levels of exploration and development drilling in many oil and gas basins around the globe. The count of rigs actively drilling during 2007 as measured by Baker Hughes (a good measure of the level of oilfield activity and spending) increased 2.4 percent from 2006, representing the fifth straight year of increasing average annual rig count. Year-to-year growth in domestic, Latin American and Eastern Hemisphere drilling activity was partly offset by Canadian activity declines. Activity in the U.S. and the Eastern Hemisphere grew modestly throughout the year, while Canada declined sharply during the second quarter, as it typically does, and remained weak throughout the second half of 2007. Latin American drilling activity was essentially flat throughout the year.
The level of drilling activity underway is the highest seen since the early 1980‚Äôs, which is fueling high demand for oilfield services. Much of the new incremental drilling activity is occurring in harsh environments, and employs increasingly sophisticated technology to find and produce reserves. Higher utilization of drilling rigs has tested the capability of the world‚Äôs 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‚Äôs and 1990‚Äôs 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.
The rise in demand for drilling rigs has driven rig dayrates higher over the past few years, which has increased cash flows and available financing to drilling contractors. Many have invested in new rigs or placed older rigs back into service. The Company has played an important role in providing both new rigs as well as the equipment, consumables and services needed to reactivate many older rigs. Oil and gas producers demand top performance from drilling rigs, particularly at the premium dayrates that are being paid today. As a result of this trend, the Company has benefited from incremental demand for new products (such as our small iron roughnecks for land rigs, our LXT BOP‚Äôs, our Safe-T-Lite pump liner systems, among others) to upgrade certain rig functions to make them safer and more efficient.
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. Higher dayrates magnify the opportunity cost of rig downtime, and rigs are being pushed to maximize revenue days for their drilling contractor owners. The drilling process effectively consumes the mechanical components of a rig, which wear out and need periodic repair or replacement. This process has been accelerated by very high rig utilization and wellbore complexity. Drilling consumes rigs; more complex and challenging drilling consumes rigs faster.
Changing methods of drilling have further benefited the Company‚Äôs business. Increasingly, hydraulic power ‚Äď in addition to conventional mechanical rotary power ‚Äď is being used to apply torque to the drill bit. This is done using downhole drilling motors powered by drilling fluids. We are a major provider of downhole drilling motors, and we have seen demand for this application of our drilling motors increase over the last few years. This trend has also increased demand for our high pressure mud pumps, which create the hydraulic power in the drilling fluid which drive the drilling motors.
While the increasingly efficient equipment provided by us has mitigated the effect, high activity levels have increased demand for personnel in the oilfield. Consequently, the Company, its customers and its suppliers have experienced wage inflation in certain markets. Hiring experienced drilling crews has been challenging for the drilling industry; however, we believe crews generally prefer working on newer, more modern rigs. Our products which save labor and increase efficiency (such as its automatic slips and pipe handling equipment) also make the rig crew‚Äôs jobs safer and easier, and make the rig a more desirable place to work.
The world is actively building nearly 170 new offshore rigs, and schedules call for 27 new drillships, 45 new semisubmersibles, and 80 new jackup rigs to be delivered into the fleet by the end of 2011. The 628 offshore rig fleet they will join is old; the average age is approximately 25 years. The existing fleet was engineered and constructed prior to many technical advancements,
and 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. Additionally, the large number of floating rig construction projects will add new capacity required to press exploration into new deepwater frontiers.
Land rig construction is strong, and new orders brisk, with most interest directed towards international markets where customers are adopting newer rig technologies. Our domestic land rig backlog has fallen by about half from peak 2006 levels due to lower dayrates in the U.S. as compared to early 2007; however, newer, better rigs are consistently posting meaningfully higher dayrates and utilization than older rigs in the domestic market. We believe the retooling of the U.S. land rig market will continue as favorable operator experience with higher technology rigs will continue to ‚Äúpull‚ÄĚ more of these into the marketplace.
Overall we expect to continue to sell into three important trends in the rig fleet worldwide: the secular buildout of additional deepwater capabilities, the retooling of the jackup fleet with newer, more capable rigs, and the replacement of older land rigs with improved technology.
Revenues for the Rig Technology group in 2007 were $5,744.7 million, up 60 percent from 2006 group revenues of $3,584.9 million. Operating profit was $1,393.6 million or 24.3 percent of revenue in 2007, compared to $608.5 million or 17.0 percent of sales in 2006. Operating profit flow-through or leverage (the period-to-period increase in operating profit divided by the increase in revenue) was 36 percent from 2006 to 2007. The 2007 results benefited from higher new rig construction volumes, higher sales of aftermarket goods and services, rising manufacturing efficiencies and improving pricing, partly offset by higher employee and material costs.
The Company‚Äôs Rig Technology group reported a backlog of capital equipment orders totaling $9,003.5 million at December 31, 2007, up 50 percent from December 31, 2006. The group was awarded $7,080.1 million in new capital equipment orders in 2007, an increase of 18 percent over orders won in 2006. Fourth quarter 2007 orders of $2,192.1 million were the largest quarterly order level ever achieved by the group, and year-ending backlog achieved record levels as well. The Company has the capability to supply up to $50 million of equipment for a jackup rig, more than $250 million of equipment for a new floating rig, and effectively all of a new land rig (which can range in price from less than $1 million for a well service rig to over $50 million for a large harsh environment rig). Backlog for drilling equipment at December 31, 2007 was approximately 85 percent offshore and 15 percent land rig equipment. The delivery of this equipment is typically tied to the construction schedule of the rig, which can take as long as four years to complete. While substantially all of the current backlog will be delivered by the end of 2009, a portion extends out as far as 2011. Approximately 88 percent of the drilling equipment in backlog is destined for international markets.
The Company‚Äôs Rig Technology group manufacturing base relies on a combination of internal and external capabilities, and we have significantly increased the output of our manufacturing plants in response to the high demand. This has been accomplished by optimizing the manufacturing infrastructure between Varco and National Oilwell to enhance efficiency following the March 2005 merger, the rollout of Quick Response Manufacturing (QRM) and lean manufacturing techniques across a number of facilities, and a 37 percent increase in capital expenditures in the group as compared to 2006. We are also providing our vendors with longer range forecasts to assist their planning, placing longer term orders to match our backlog, and qualifying new suppliers throughout North America, Europe and Asia.
The Company‚Äôs Petroleum Services & Supplies generated $3,061.0 million in revenue in 2007, an increase of 26 percent from 2006 revenues of $2,425.0 million, due to rising demand for oilfield goods and services the group provides, the impact of acquisitions, and several international expansion initiatives launched by the group including new facilities opened in the Middle East and Far East. Additionally the group benefited from investments made in its coiled tubing and composite pipe manufacturing infrastructure last year. The group‚Äôs operating profit for the year was $731.6 million or 23.9 percent of sales, an increase from 2006 operating profit of $545.6 million or 22.5 percent of sales. The group generated 29 percent operating profit flow-through from 2006 to 2007.
Margins for the Petroleum Services & Supplies group improved in 2007 as a result of the higher volumes and better pricing, offset by higher personnel and materials costs. The strong results were broad-based, with all major product and service lines up year-over-year. Domestic and international revenues continued to grow throughout the year; however, results in Canada softened on a seasonally-adjusted basis as many of our customers in Canada reduced activity in response to lower gas prices, a stronger Canadian dollar, and higher royalty expenses in Alberta. The group‚Äôs mix of non-North American revenue rose steadily throughout the year, from 38 percent in the first quarter to 43 percent in the fourth quarter, as overseas business grew. The flattening of the rig count in the U.S., and the declining level of activity in Canada compared to the prior year, reduced overall pricing leverage in North America; however, pricing trends remain very regional and product line specific, with pricing of certain products continuing to increase.
The Company‚Äôs Distribution Services group generated revenues of $1,423.7 million in 2007, a four percent increase from 2006 revenues of $1,369.6 million. Operating profit was $94.0 million, unchanged from the prior year. Operating margins were 6.6 percent, down slightly from 2006 operating margins of 6.9 percent. The group generated no incremental operating profit flow-through in 2007, due mostly to a sharp decline in business in its Canadian operations. Revenue growth in overseas markets fully offset lower Canadian sales, but startup costs in several new international locations led to lower flow-throughs from these areas. Domestic operations posted good year-over-year growth at strong flow-throughs, but the business began to experience increasing domestic price pressure through the second half of 2007.
Strategic alliance agreements with new customers fueled much of the Distribution Services group‚Äôs international growth. Once in place the strategic alliances provide the group a stable platform of business around which it can open new locations at lower risk and cost. The group has expanded around the world by following our customers‚Äô rigs into new regions. The group is also selling more MRO supplies internally to legacy Varco organizations, which increased our leverage through greater purchase volumes.
We believe that the outlook for the Company for 2008 remains positive, as historically high commodity prices are expected to keep overall oil and gas activity high, and as the Company enters 2008 with a record level of backlog for capital equipment for its Rig Technology group.
Oil prices and supply remain subject to significant political risk in many international regions. The growth of China and other emerging economies has added significant demand to the oil markets, and new sources of supply continue to prove challenging to find and produce economically. The Company expects the high oil prices that have resulted to sustain high levels of oilfield activity in 2008, provided the world‚Äôs major economies remain strong, and OPEC discipline keeps oil prices high. High commodity prices, drilling activity levels, and drilling rig dayrates are expected to continue to fuel demand for the Company‚Äôs Rig Technology group. The supply of offshore rigs remains tight in many markets, and quotation activity for the Rig Technology group remains brisk. In particular, the Company expects recent deepwater lease awards and announcements of discoveries in Brazil to continue to fuel a high level of interest in floating drilling rig construction projects. Additionally, interest in new international land rigs remains very high, while domestic rig demand has stabilized.
Our outlook for the Company‚Äôs Petroleum Services & Supplies segment remains good, given continuation of high levels of drilling across the U.S., Middle East, North Africa, the Far East, Latin America and the North Sea. While Canadian activity remains slow, we believe the long term outlook there is good given the difficulties the industry has faced in meaningfully growing gas production across North America. Gas production from resource plays (coal bed methane, tight sands and shales) has increased to about 40 percent of total U.S. gas production, and is believed to exhibit higher decline rates than conventional reservoirs.
The Company‚Äôs Distribution Services segment operates in very competitive markets, but we are targeting further international expansion underpinned by new strategic alliances in 2008 to fuel additional growth. The business also continues to be challenged by weak demand in Canada.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
National Oilwell Varco, Inc. (the ‚ÄúCompany‚ÄĚ) 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. The following describes our business segments:
Our Rig Technology segment designs, manufactures, sells and services complete systems for the drilling, completion, and servicing of oil and gas wells. The segment offers a comprehensive line of highly-engineered equipment that automates complex well construction and management operations, such as offshore and onshore drilling rigs; derricks; pipe lifting, racking, rotating and assembly systems; rig instrumentation systems; coiled tubing equipment and pressure pumping units; well workover rigs; wireline winches; and cranes. Demand for Rig Technology products is primarily dependent on capital spending plans by drilling contractors, oilfield service companies, and oil and gas companies, and secondarily on the overall level of oilfield drilling activity, which drives demand for spare parts for the segment‚Äôs large installed base of equipment. We have made strategic acquisitions and other investments during the past several years in an effort to expand our product offering and our global manufacturing capabilities, including adding additional operations in the United States, Canada, Norway, the United Kingdom, China, Belarus, and India.
Petroleum Services & Supplies
Our Petroleum Services & Supplies segment provides a variety of consumable goods and services used to drill, complete, remediate and workover oil and gas wells and service pipelines, flowlines and other oilfield tubular goods. The segment manufactures, rents and sells a variety of products and equipment used to perform drilling operations, including drill pipe, transfer pumps, solids control systems, drilling motors, drill bits, reamers and other downhole tools, and mud pump consumables. Demand for these services and supplies is determined principally by the level of oilfield drilling and workover activity by drilling contractors, major and independent oil and gas companies, and national oil companies. Oilfield tubular services include the provision of inspection and internal coating services and equipment for drill pipe, line pipe, tubing, casing and pipelines; and the design, manufacture and sale of coiled tubing pipe and advanced composite pipe for application in highly corrosive environments. The segment sells its tubular goods and services to oil and gas companies; drilling contractors; pipe distributors, processors and manufacturers; and pipeline operators. This segment has benefited from several strategic acquisitions and other investments completed during the past few years, including adding additional operations in the United States, Canada, the United Kingdom, China, Kazakhstan, Mexico, Russia, Argentina, India, Bolivia, the Netherlands, Singapore, Malaysia, Vietnam, and the United Arab Emirates.
Our Distribution Services segment provides maintenance, repair and operating supplies and spare parts to drill site and production locations worldwide. In addition to its comprehensive network of field locations supporting land drilling operations throughout North America, the segment supports major offshore drilling contractors through locations in Mexico, the Middle East, Europe, Southeast Asia and South America. Distribution Services employs advanced information technologies to provide complete procurement, inventory management and logistics services to its customers around the globe. Demand for the segment‚Äôs services is determined primarily by the level of drilling, servicing, and oil and gas production activities.
Critical Accounting Estimates
In our annual report on Form 10-K for the year ended December 31, 2007, 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 drill pipe sales and long-term construction contracts; allowance for doubtful accounts; inventory reserves; impairments of long-lived assets (excluding goodwill); goodwill impairment 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.
The Company‚Äôs products and services are sold based upon purchase orders or contracts with the customer that include fixed or determinable prices and that do not generally include right of return or other similar provisions or other significant post delivery obligations. Except for certain construction contracts and drill pipe sales described below, the Company records revenue at the time its manufacturing process is complete, the customer has been provided with all proper inspection and other required documentation, title and risk of loss have passed to the customer, collectibility is reasonably assured and the product has been delivered. Customer advances or deposits are deferred and recognized as revenue when the Company has completed all of its performance obligations related to the sale. The Company also recognizes revenue as services are performed. The amounts billed for shipping and handling cost are included in revenue and related costs are included in cost of revenue.
Revenue Recognition under Long-term Construction Contracts
The Company uses the percentage-of-completion method to account for certain long-term construction contracts in the Rig Technology segment. These long-term construction contracts include the following characteristics:
‚ÄĘ the contracts include custom designs for customer specific applications;
‚ÄĘ the structural design is unique and requires significant engineering efforts; and
‚ÄĘ construction projects often have progress payments.
This method requires the Company to make estimates regarding the total costs of the project, progress against the project schedule and the estimated completion date, all of which impact the amount of revenue and gross margin the Company recognizes in each reporting period. The Company prepares detailed cost estimates at the beginning of each project. Significant projects and their related costs and profit margins are updated and reviewed at least quarterly by senior management. Factors that may affect future project costs and margins include shipyard access, weather, production efficiencies, availability and costs of labor, materials and subcomponents and other factors. These factors can impact the accuracy of the Company‚Äôs estimates and materially impact the Company‚Äôs current and future reported earnings.
The asset, ‚ÄúCosts in excess of billings,‚ÄĚ represents revenues recognized in excess of amounts billed. The liability, ‚ÄúBillings in excess of costs,‚ÄĚ represents billings in excess of revenues recognized.
Drill Pipe Sales
For drill pipe sales, if requested in writing by the customer, delivery may be satisfied through delivery to the Company‚Äôs customer storage location or to a third-party storage facility. For sales transactions where title and risk of loss have transferred to the customer but the supporting documentation does not meet the criteria for revenue recognition prior to the products being in the physical possession of the customer, the recognition of the revenues and related inventory costs from these transactions are deferred until the customer takes physical possession.
National Oilwell Varco generated earnings of $547.7 million or $1.31 per fully diluted share in its third quarter ended September 30, 2008, on revenues of $3.6 billion. Operating income was $790.3 million or 21.9 percent of sales for the third quarter, including charges of $0.04 per share after-tax related to the Company‚Äôs second quarter acquisition of Grant Prideco, and including the impact of Hurricane Ike estimated to be approximately $0.09 per share after-tax. Compared to the third quarter of 2007, revenues improved 40 percent, and operating profit improved 45 percent during the third quarter of 2008.
The Company‚Äôs third quarter results were adversely impacted by the effects of Hurricane Ike, which struck the Texas Gulf Coast on September 12, 2008. While we were fortunate to avoid serious damage to our facilities, over forty Company facilities and dozens of our Houston-area suppliers were without power for a few weeks. Company-wide we estimate that approximately $114 million in revenues and $55 million in operating income were lost or deferred as a result. A small portion of this is expected to be recovered in the fourth quarter, which was also affected, and most of the remainder is expected to be recovered in 2009. Additionally, hurricane-related flooding affected certain of our operations in Mexico during the quarter, but on a much smaller scale.
Grant Prideco Acquisition
On April 21, 2008 the Company completed its acquisition of Grant Prideco, Inc. for a combination of approximately $3.0 billion in cash and the issuance of 56.9 million shares of National Oilwell Varco common stock. The Grant Prideco merger further strengthened National Oilwell Varco‚Äôs position as manufacturer to the oilfield. Its drill bits and reamers are being integrated into the Company‚Äôs 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‚Äôs drill pipe products are purchased and consumed by the Company‚Äôs existing drilling contractor customer base. The Company believes that consumption of drill pipe has been increasing due to the rising complexity of wellpath designs. Overall, the acquisition better positioned National Oilwell Varco to capitalize on continued application of horizontal, directional and extended-reach drilling, through both drill pipe and drill bit product sales.
Integration of the business is proceeding well. The Company is introducing new drill pipe tracking products, and expanding OEM drill pipe repair and maintenance offerings through its worldwide network of pipe service operations. The Company is also consolidating a number of bit and downhole tool sales facilities worldwide, and leveraging combined manufacturing capabilities to improve lead times and reduce costs. The Company achieved savings of approximately $10 million pre-tax during the third quarter, mostly on overhead cost reductions, and expects this amount to increase to approximately $11 million per quarter beginning in 2009. This is expected to result in an annual savings rate slightly higher than the $40 million per year rate in forecasted synergies at the time of the announcement of the transaction. During the third quarter of 2008, National Oilwell Varco recognized purchase accounting related charges totaling $28.0 million pre-tax or $0.04 per share after tax. The $28.0 million in charges were related to charges to ‚ÄúCost of revenue‚ÄĚ for inventory sold during the quarter that had a fair value step up under the Grant Prideco purchase accounting.
Oil & Gas Equipment and Services Market
Worldwide developed economies turned down sharply late in the third quarter as looming housing-related asset write-downs at major financial institutions paralyzed credit markets and sparked a serious global banking crisis. Major central banks are responding vigorously, but credit and financial markets have not recovered through the first few weeks of October. Most economists foresee a slow and uncertain recovery of credit markets, and a credit-driven worldwide economic recession developing. Asset and commodity prices, including oil and gas prices, have declined sharply as a result. After rising steadily for six years to peak at around $140 per barrel earlier in the year, oil prices retreated to the $60 to $70 per barrel range recently, roughly in-line with mid 2007 prices. Higher oil and gas prices over the past several years have led to high levels of exploration and development drilling in many oil and gas basins around the globe. The count of rigs actively drilling during the third quarter of 2008 as measured by Baker Hughes (a good measure of the level of oilfield activity and spending) increased 11 percent from the third quarter of 2007, but the impact of the credit market crisis has not yet been fully felt in the rig count. The Company expects that oil and gas operators reliant on external financing to fund their drilling programs are likely to curtail some of their drilling activity in view of tighter credit markets and lower commodity prices. This is expected to have the greatest impact on gas drilling across North America, despite the fact that gas prices have remained relatively strong compared to historical prices. Most international activity is driven by oil exploration and production by national oil companies, which has historically been less susceptible to short-term commodity price swings. Therefore we expect international drilling activity to be less impacted by the credit crisis.
The high level of drilling activity underway in the last few years has fueled strong demand for oilfield services. Much of the new incremental drilling activity is occurring in harsh environments, and employs increasingly sophisticated technology to find and produce reserves. Higher utilization of drilling rigs has tested the capability of the world‚Äôs 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‚Äôs and 1990‚Äôs on new drilling equipment, but drilling technology progressed steadily nonetheless, as the Company and its competitors continued to invest in new and better ways of drilling. As a consequence, the safety, reliability, and efficiency of new, modern rigs surpass the performance of most of the older rigs at work today. Drilling rigs are now being pushed to drill deeper wells, more complex wells, highly deviated wells and horizontal wells, tasks which require larger rigs with more capabilities. The drilling process effectively consumes the mechanical components of a rig, which wear out and need periodic repair or replacement. This process has been accelerated by very high rig utilization and wellbore complexity. Drilling consumes rigs; more complex and challenging drilling consumes rigs faster.
The industry responded by launching many new rig construction projects since 2005, to retool the existing fleet of jackup rigs (350 of the existing 432 jackup rigs are more than 20 years old); to replace older mechanical and DC electric land rigs with improved AC power, electronic controls, automatic pipe handling and rapid rigup and rigdown technology; and to build out additional ultradeep floating drilling rigs, including semisubmersibles and drillships, employing recent advancements in deepwater drilling to exploit unexplored deepwater basins. We believe that the newer rigs offer considerably higher efficiency, safety, and capability, and that many will effectively replace a portion of the existing fleet. As a result of these trends the Company‚Äôs Rig Technology segment has seen steady growth in its backlog of capital equipment orders from $0.9 billion at March 31, 2005, to $11.8 billion at September 30, 2008. The Company won a record level of new orders of $2.4 billion during the third quarter of 2008, and believes that the drilling industry will continue to build and upgrade drilling rigs; however, the credit crisis is likely to have a negative impact on new orders in the near term. Many customers rely on external financing to execute these projects, and several new order discussions have been delayed due to the challenges of securing financing. Nevertheless, the Company believes that export banks around the world will continue to supplement private financing in an effort to boost economic activity in the countries where these rigs are fabricated.
During the third quarter the Company secured contracts for six major packages of drilling equipment for deepwater floating rigs, including four for the Brazilian market, along with a handful of jackup rig packages. Land rig sales over the past six months have been strong, particularly for the Company‚Äôs Ideal Rigs, Rapid Rigs, and new Drake Rig design for North America. Many of these projects are backed by term contracts from oil and gas operators who appear to be increasingly convinced of the safety and efficiency benefits of modern, AC-powered, electronically controlled rigs. The land rig backlog improved 49 percent sequentially and 14 percent year-over-year, to $1.8 billion or 15 percent of the total backlog. Equipment destined for international markets totaled 90 percent of the September 30 backlog. The Company believes that its existing contracts for rig equipment are very strong in that they carry significant down payment and progress billing terms favorable to the ultimate completion of these projects, and generally do not allow customers to cancel projects for convenience. For this reason we do not expect the credit crisis or softer market conditions to result in cancellation of contracts or abandonment of projects that would have a material adverse effect on the Company‚Äôs financial results.
While the increasingly efficient equipment provided by us has mitigated the effect, high activity levels have increased demand for personnel in the oilfield. Consequently, the Company, its customers and its suppliers have experienced wage inflation in certain markets. Hiring experienced drilling crews has been challenging for the drilling industry; however, we believe crews generally prefer working on newer, more modern rigs. Our products which save labor and increase efficiency (such as its automatic slips and pipe handling equipment) also make the rig crew‚Äôs jobs easier, and make the rig a safer and more desirable place to work.
Rig Technology generated $1,926.4 million in revenue and $500.5 million in operating profit in the third quarter, yielding an operating margin of 26 percent. The group generated 31 percent operating leverage or flowthrough (the increase in operating profit divided by the increase in revenue) on 27 percent revenue growth from the third quarter of 2007 to the third quarter of 2008. Compared to the second quarter of 2008 revenue improved modestly and operating profit declined slightly, due in part to the impact of Hurricane Ike on Texas operations which deferred approximately $79.0 million in sales to later periods. Revenue out of backlog increased two percent sequentially to $1,363.4 million, but record orders lifted backlog nevertheless to $11,793.8 million, up nine percent sequentially. As of September 30, 2008 the scheduled outflow of revenue from backlog is expected to be in the range of $1.5 billion during the fourth quarter of 2008, approximately $5.7 billion in 2009, and approximately $4.6 billion thereafter.
The Petroleum Services & Supplies segment generated revenue of $1,310.5 million in the third quarter, up five percent from the second quarter of 2008 and up one percent from the third quarter of last year (adjusted for a full quarter of continuing Grant Prideco results in both prior periods, but not adjusted for $105.1 million in sales of products transferred to other segments since last year). Operating profit was $329.6 million (excluding $28 million of cost of revenue charges related to the fair value step up of inventory under purchase accounting) or 25.2 percent of sales, and operating profit flow through was 50 percent sequentially, and 151 percent year-over-year. Strong operating activity increases in the domestic market, where the rig count improved six percent sequentially and 11 percent year-over-year, fueled much of the revenue and margin gains. Unconventional shale gas basin drilling was particularly strong in the quarter. The U.S. accounted for approximately 54 percent of Petroleum Services & Supplies segment revenues during the quarter. Hurricane Ike impacted third quarter Petroleum Services & Supplies segment revenues by approximately $35 million, about 60 percent of which is expected to be recovered in the fourth quarter. Revenues from oilfield service products in Canada improved following the resumption of activity in the third quarter following the seasonal breakup decline in the second quarter. This seasonal event drove a sequential increase in the rig count in Canada from 169 rigs in the second quarter to 432 rigs during the third quarter. Canadian revenues were approximately eight percent of the segment‚Äôs total during the third quarter. International activity remained strong, with notable sequential and year-over-year improvements in sales to Latin American markets during the third quarter. Solids control, composite pipe, bits and downhole tool products posted significant increases sequentially. Drill pipe backlog and revenue improved sequentially as well, but margins declined due to higher steel costs and an unfavorable mix.
Distribution Services segment revenue was $497.6 million in the third quarter, up 17 percent from the second quarter of 2008 and up 38 percent from the third quarter of 2007. Operating profit was $43.7 million or 8.8 percent of sales, a record margin. Operating profit flowthrough was 26 percent sequentially and 14 percent year-over-year. Strong U.S. activity, particularly in the mid-continent and Rocky Mountain regions, drove high levels of domestic sales, and cost reductions in prior periods contributed to improving margins and leverage. Sales into new rig construction and refurbishment of older rigs in the domestic market also contributed to domestic results. The U.S. accounted for about 48 percent of the segment‚Äôs third quarter revenues overall. Canada sales, about 18 percent of the third quarter mix, increased sharply coming out of the second quarter seasonal breakup, which contributed to strong operating profit flowthrough as well. Saskatchewan and Eastern Canada were particularly strong in the quarter. International revenues were down slightly and accounted for 34 percent of the sales mix, but margins for international sales increased slightly sequentially.
The recent emergence of a serious banking crisis, prospects for an emerging global recession, and lower commodity prices are likely to present near-term challenges to our business. Consequently, we are more cautious in our outlook for 2009, and believe we are likely to see orders for new rigs slow, and drilling activity, particularly by independent gas producers reliant on external financing, decline as we enter the new year. The Company is, nevertheless, well positioned to manage through this uncertain period, and should benefit from its strong balance sheet and capitalization, access to credit, and record high level of contracted orders which are expected to continue to generate good earnings well into the downturn. The Company has a long history of cost-control and downsizing in response to depressed market conditions. Such a period may present opportunities to the Company to effect new organic growth and acquisition initiatives, and we are hopeful that a downturn will generate new opportunities.
The supply of offshore rigs remains tight in many markets, and certain developments point to improving economics of rig building; namely, rising dayrates for ultradeepwater floaters, falling steel costs, and a strengthening U.S. dollar. The offshore rig dayrate market is generally denominated in U.S. dollars, but rig fabrication is mostly denominated in foreign currencies. Foreign shipyards source steel from foreign mills, and pay local wages in foreign currency. Likewise, the Company manufactures many of its products overseas in foreign currencies as well. Steel prices began to decline 10 to 20 percent in the third quarter 2008. The impact of improvements in all three areas should lift returns on projects. Nevertheless, many ongoing discussions of potential newbuild rig projects in our Rig Technology segment have slowed or stalled, pending better visibility into the credit crisis.
Thanks, Marcia. Good morning. Welcome to the third quarter 2008 National Oilwell Varco earnings conference call. I‚Äôm Pete Miller, Chairman and CEO of National Oilwell Varco. And with me on the call today are Clay Williams, our Chief Financial Officer, and Jeremy Thigpen, the President of our Downhole Tools and Pumping Solutions group.
Earlier today, we announced earnings of $548 million or $1.31 a share on revenues of $3.6 billion. Included in the results are $0.04 charge for costs associated with our recent Grant Prideco acquisition and about $0.09 of after-tax charge associated with the Hurricane Ike disruption that we had in Houston.
While the facilities made it through Hurricane Ike very well, we lost a lot of power, and as a result, lost about two weeks of productive capacity out of many of our facilities. That‚Äôs what entails this $0.09. This in fact will be recouped over the next couple of quarters as we ship out products that we deducted out. Overall, we are very, very pleased with the results that we had in this quarter.
Additionally, we announced a record capital intake of new orders of $2.4 billion, bringing our current backlog up to a record level of almost $12 billion. It‚Äôs really $11.8 billion, but I like to say $12 billion. Clay will provide a lot of detail on this in just a moment, but I think it does indicate the continuing need to retool our business and to rebuild the infrastructure that we have around the world. We are very pleased with these results as I said earlier.
While there is anxiety and concern over the near-term prospects of the oil and gas business, most especially because of the financial anxiety around the world, we believe our outstanding employees, our strong balance sheet, our exceptional products and our wonderful business model are going to present us with opportunities that we haven‚Äôt seen for quite some time. We feel very, very good about our opportunities and the way we are going to advance through the future.
At this point, I‚Äôd like to turn it over to Clay Williams who will give you a little bit of color on the numbers, tell you a little bit about our backlog, and then we‚Äôll turn it over to Jeremy to talk a little bit about his business in the Downhole Tools and the Pumping Systems. Clay.
Thanks, Pete. Before we begin this discussion of National Oilwell Varco‚Äôs financial results for its third quarter ended September 30th, 2008, please note that some of statements we make during this call may contain forecasts, projections and estimates including but not limited to or comments for the outlook of the company‚Äôs business.
These are forward-looking statements within the meaning of the federal securities laws based on limited information as of today, which is subject to change. They are subject to risks and uncertainties and actual results may differ materially. No one should assume that these forward-looking statements remain valid later in the year.
I refer it you to the latest form 10-K and S-4 that National Oilwell Varco has on file with the Securities and Exchange Commission for a more detailed discussion of major risk factors affecting our business. Further information regarding these as well as supplemental, financial, and operating information may be found within our press release on our website at www.nov.com, or in our filings with the SEC.
Later on in this call, Pete, Jeremy and I will answer your questions. We ask that you limit your questions to two in order to permit more participation. National Oilwell Varco generated earnings of $548 million or $1.31 per fully diluted share in its third quarter ended September 30th, 2008, on revenues of $3.6 billion.
The results include a $0.04 per share transaction charge related to our second quarter merger with Grant Prideco in line with our prior guidance and an estimated impact of $0.09 per share from Hurricane Ike. Excluding both items, earning would have been approximately $1.44 per share, a terrific result for stormy quarter, in more ways than one.
Hurricane Ike took a significant toll on our Texas employees, customers and suppliers in the quarter, as Pete mentioned, and continue to have an impact into the fourth quarter. While we were fortunate to avoid any serious damage to our facilities, 40-plus NOV facilities and hundreds of our Houston area suppliers were without power and working shorthanded.
Company-wide, we estimate that $114 million in revenues were lost or deferred, mostly in our Rig Technology segment at high decremental leverage. Unfortunately, only a small portion of this will turn around in Q4 which was also affected during the first few weeks of this month, but most will come back in Q1 2009.
Additionally, hurricanes affected certain portions of our operations in Mexico, but thankfully on a much smaller scale. Things are returning to normal, and we are working hard to take care of our customers.
Our thoughts and prayers are also with our local and Mexican employees and their families as they patch roofs and replace sheet rock and try to get their homes back to normal too after severe hurricane season.
Yet another hurricane descended upon the financial markets just a few days after Ike carrying with it a blizzard of questions about our order book. Before I review the third quarter operating results for our three segments, which by the way were excellent, I‚Äôd like to take a few minutes to tell you more about the nature of our backlog.
Most importantly, the backlog ascended to a new record of $11.8 billion, roughly 14 times the amount of orders we had when National Oilwell and Varco merged three and a half years ago. It has increased every quarter since the merger due to the pressing need to upgrade an old, tired land rig fleet and jack-up rig fleet to modern new AC power, electronic controls and robotic pipe-handling technologies, and to build out a deepwater fleet capable of drilling vast, unexplored swaths of the planet covered by 500 feet of water or more.
In the third quarter, we shipped nearly $1.4 billion out of backlog, a little less than expected due to the impact of Hurricane Ike. We expect nearly $1.5 billion to be recognized in revenue from backlog in the fourth quarter of this year, $5.7 billion in 2009, and the balance of $4.6 billion thereafter.
Despite the severe crisis -- the credit crisis, National Oilwell Varco managed to post a record level of orders of $2.4 billion during the third quarter, including four deepwater packages for Brazil and two more deepwater packages for other established publicly-traded drilling contractors.
Notably, only three of the four Brazilian floaters were among the 12 letters of intent issued by Petrobras in March. The fourth was for a domestic Brazilian drilling contractor moving ahead with building in anticipation of growing demand for that market.
Our backlog contains only contracted work. It does not contain letters of intent for notional projects. Nothing goes into the backlog without a contract. Our contract on major projects do not permit cancellation for convenience. Our contracts do not allow for cancellation for lack of financing.
We require substantial down payments to begin work, sometimes 10%, usually much more and require progress billings which are structured to, in the aggregate, keep NOV cash positive during the construction.
As of September 30th, NOV has collected in cash or has cash due by the end of next week amounts that exceed our investments in these projects by more than $3 billion. If all of our customers were to walk away from all of their projects, thereby defaulting on their contracts, we have substantially more in cash than we‚Äôve invested so far, plus, we have the undelivered inventory too. And much of the delivery is fungible; items like top drives, draw works, and mud pumps that we sell day in and day out.
But let me be clear, we expect our backlog of projects to move ahead as planned in accordance with their contracted terms. As of September 30th, 90% of our backlog was for international markets. 66% of our backlog or $7.8 billion was directed at major offshore rig new builds. 19% or $2.2 billion was for various offshore components spanning platform rigs, construction vessels, FPSOs and replacement or upgrade items for offshore drilling rigs. And 15% or $1.8 billion was for land equipment, of which $1.1 billion was for a domestic market expressing a strong preference for modern rigs.
This illustrates well the breadth and diversity of our product offering through our Rig Technology segment. In aggregate, we are 31% complete with the $7.8 billion of major offshore projects I referenced, which totaled $11.3 billion when first ordered. 56% of these orders were placed with NOV when the 12-month WTI strip was below $75 a barrel.
Most of our large offshore projects are contracted through shipyards which accounts for 58% of our total backlog. Based on their latest public financial statements, our top-five shipyard customers have $6.6 billion more in cash than they have in debt, which totaled less than $3.5 billion. They appear to us to be very well capitalized.
Most of their customers are established drillers. Only 13% of our backlog is for start-up drilling operations and slightly more than half of these are established shipping companies with existing strong cash flows venturing into drilling. 34% of our total backlog is either with government-owned enterprises, have secured export-import financing guarantees, or is in the process of applying for guarantees now.
We have one customer behind on payments, which places $182 million of our backlog, about 1.5%, at risk. We‚Äôve notified that customer that we have stopped work until we are paid. Notably, we have collected $40 million more than we currently have invested in their project. In short, we are very comfortable with the stability of our current backlog.
However, we recognize that financing new, large projects has become much more difficult for industry participants lately, and we expect that NOV‚Äôs orders will be down over the next few quarters. We are continuing to work with our customers on new rig construction projects, but several are pausing in the face of lower commodity prices and tougher financing. That‚Äôs okay. In the meantime, we have a solid $11.8 billion worth of work to do, plenty to tide us over.
NOV is well positioned to weather this storm. On September 30th -- our September 30th balance sheet illustrates how the company has completely de-levered our business on a net debt basis despite a large cash acquisition in the second quarter. We‚Äôve done this through solid cash flow from operations, which is $1.7 billion year to date.
Free cash flow after CapEx, but before acquisitions, has been $1.5 billion through the first three quarters. As a result, on September 30th, we had cash in the bank totaling $1.8 billion, and debt fell to $1.5 billion, only $19 million of which is current. Majority of our debt is due between 2011 and 2015.
I am also pleased to report that as of yesterday, we have fully repaid the remaining balance on our revolving lines of credit that we secured to finance the acquisition of Grant Prideco. This means we‚Äôve repaid over $2 billion in acquisition debt since April 21st, 2008, and that we now have over $2.5 billion of available capacity on our lines. We entered this financial hurricane with a rock solid balance sheet.
We also entered the storm with a very strong portfolio of service businesses, something that National Oilwell Varco doesn‚Äôt get enough credit for. Many on Wall Street seem to pigeonhole National Oilwell Varco as a rig builder and a backlog story. This is easy to understand, given the sharp rise in rig construction and headline grabbing order and backlog results we have been consistently posting.
I‚Äôd like to offer a new framework to use when thinking about NOV. In reality, our portfolio business is a far more diverse and durable. NOV is a full-cycle participant in the oil field.
Our Petroleum Services & Supplies and Distribution Services segments are highly driven by rig count and oil field activity. We‚Äôve noted in the past that Rig Technology segment is mostly, but not entirely, fueled by capital expenditures by oil field service companies and lags the other two segments by a year or two.
Notably, about 23% of Rig Technology sales in the third quarter are not CapEx driven, but were rather from the aftermarket support of our large installed base which is growing monthly. Aftermarket support is generally tied more to activity levels than to CapEx.
All three segments are fundamentally driven by oil and gas prices, but the Petroleum Services & Supplies and Distribution groups comprising 43% of Q3 earnings are a first derivative of commodity prices, while the Rig group, comprising 57% of Q3 earnings is a second derivative.
Combining two groups of cyclical business where one lags the other even though they are based on the same fundamental driver tends to add stability to earnings and cash flow. As activity falls, we expect to see it first in our PS&S and Distribution areas, while our strong backlog in Rig should enable us to bridge the valley. If one side of our house hits the downturn, the other can provide cash and capital to invest in the extraordinary opportunities that inevitably arise in depressed markets.
NOV is a far more thoughtfully constructed company than the highly cyclical rig builder that we are often perceived to be with balance between activity-driven and CapEx-driven lines that are sometimes out of phase.
Significantly, NOV occupies exceedingly strong positions in a number of oil field services arenas, not just rig construction. We‚Äôre the largest provider of tubular inspection, internal coding, hardbanding, and threading services worldwide. We are the largest provider of pump expendable and small centrifugal pumps worldwide.
We make more than half the world‚Äôs coiled tubing and coiled tubing units. We are a leading provider of solids control equipment, shell-shaker screens and thermal absorption treatment of drill cuttings. We are a leading provider of composite pipe to the worldwide oil field. We are a leading provider of procurement and distribution services to the upstream oil and gas industry. We are the largest manufacturer of drill pipe, collars and spiral wave.
In a moment, Jeremy will tell you more about the remarkable position his business has built in the supply of downhole tools used in horizontal, directional, and performance drilling. There is a lot more here at NOV than just building rigs, and the third quarter margins of Petroleum Services & Supplies and Distribution Services, both records, offer excellent evidence of the great work these groups perform for their customers.
To summarize, we think that strong worldwide oil field activity-driven service franchises backstopped by a strong, worldwide provider of capital equipment with solid orders to execute over the next three years make for a powerful combination that can handily weather the cyclical ups and downs of the oil business.
Finally, if there is a silver lining to the current credit meltdown and the downturn in the drilling business that everybody believes is coming, it is this. We are very, very good at executing transactions in a capital-starved world.
NOV was born in a capital-starved world. That‚Äôs where Pete, Jeremy and I spent most of our careers. Capital-starved world open up extraordinary opportunities to those with cash and capital. We‚Äôve stepped up our efforts to find solid acquisition opportunities and believe that the deeper activity falls, the more interesting the acquisition opportunities will get.
This process takes time and patience, but having closed close to 200 acquisitions in the past dozen years, between National Oilwell and Varco we have the talent and fortitude to do some great things here, not to mention a bulletproof balance sheet.
Turning to operations, overall, excluding the transaction-related noise, third quarter results were excellent. Consolidated revenues were $3.6 billion, up 5% from the second quarter and up 18% year-over-year, including continuing Grant Prideco operations in all periods on an adjusted compliant business.
Operating profit was $818 million or 22.7% of sales excluding transaction charges. And operating profit flow-through or leverage was 24% sequentially and 32% year-over-year compared to the adjusted combined historical quarters.
Rig Technology generated $1.9 billion in revenue and $500 million in operating profit in the third quarter, yielding an operating margin of 26%. The impact of Hurricane Ike hit this group the hardest, deferring about $79 million of revenue. As a result, revenue out of backlog increased only 2% sequentially to $1.363 billion and overall segment revenue increased only $15 million.
Operating profit fell slightly, owing to high decrementals on the deferred work due to under absorption. Orders for land rigs jumped significantly in the third quarter, due to lots of demands for AC land rigs for North America backed by termed contracts, including several orders for ideal rigs and our new Drake Rig design. We expect the first Drake to spud in mid-2009.
We continue to quote lots of land rigs into markets in the Middle East, North Africa and Latin America with 9 to 14 month deliveries, but have seen the market for land rigs in Russia and China cool recently due to credit and political issues.
On the offshore front, in addition to the six floater packages I mentioned earlier, Rig Technology also secured a handful of jack-up packages consistent with the past several quarters. While the credit picture has been discouraging lately, several factors point to improving economics of rig building namely, rising dayrates for ultra-deepwater floaters, falling steel costs and a strengthening US dollar.
Offshore rig building tends to be naturally belong to the dollar for drilling contractors. Because the dayrate market is denominated in US dollars, the rig fabrication predominantly occurs overseas. Shipyards source steel from foreign mills and buy lots of welding hours denominated in Sing dollars and Yuan, and National Oilwell Varco manufactures much of what we sell into these projects overseas too. Improvements on all three areas, dayrates, steel and FX should lift returns on projects, credit notwithstanding.
Looking into the fourth quarter, we expect Rig Technology to post strong sequential growth set and operating profit flow-through in line with our long-term 30% guidance resulting in margins comparable to our second quarter margins.
Petroleum Services & Supply segment generated revenues of $1.3 billion in the third quarter, up $66 million or 5% from the second quarter, including a full quarter contribution from continuing Grant Prideco operations in both quarters.
Operating profit leverage or flow-through on this same basis was 50% owing to excellent results from ReedHycalog, which picked up TReX royalties, solids control and the seasonal rebound out of break-up in Canada.
Year-over-year including a full quarter from Grant Prideco and adjusting for products transferred to other segments in the second quarter, Petroleum Services & Supplies revenues improved about 10% at 44% flow-throughs. Hurricane Ike impacted Q3 Petroleum Services & Supply segment revenues by about $35 million, about 60% of which we expect to recover in Q4.
Orders for drill pipe improved again this quarter, after nearly doubling last quarter, driving our backlog for drill pipe back up close to $1 billion. Revenues improved, but drill pipe margins declined due to the hurricane impact and unfavorable mix of smaller API pipe and higher steel costs.
The group outsourced more green tubes due to a planned shutdown of our Voest-Alpine mill during the quarter. If the rig count moves down as expected, we would expect drill pipe demand to soften somewhat.
Recent high demand from domestic operators for drill pipe together with high domestic rig counts in the third quarter lifted the domestic mix of US revenues for the entire Petroleum Services & Supplies group to 54% during the third quarter.
We have seen no credit crisis impact in the field internationally nor in North America, but nevertheless believe that an impact is coming probably in early 2009. At this point, we expect North America will be hit hardest and that most International operations would continue with their 2009 drilling plans.
Looking forward to the next quarter, we expect strong results with low single-digit sequential growth in the Petroleum Services & Supplies group, but expect margins to fall slightly due to mix and temporarily higher steel cost in drill pipe, which should begin to turn around in Q1.
Distribution Services had an outstanding quarter with a record result. Revenues were $498 million, up 17% from the second quarter and up 38% year-over-year. Operating profit was $44 million, and operating margins were 8.8%. Sequential operating leverage or flow-through was 26% and year-over-year flow-through was 14%.
U.S. operations led most of the increase rising 18% in revenues with 20% plus flow-throughs on improving margins and activity with the Mid-Continent and Rocky Mountain areas leading the way. The hurricane impact was minimal on domestic operations but did delay shipments out the Port of Houston for a modest amount of international revenue and contributed an overall slight sequential decline in international sales. However, international margins improved as compared to the second quarter.
Canada posted strong results coming out of break-up due to high demand for pipe in Saskatchewan and Eastern Canada. Artificial lift also posted a strong quarter. We‚Äôre cautious in our outlook for Distribution Services for Q4 owing for the potential for a drilling slowdown and pricing pressure late in the year in North America, which accounts for about two-thirds of the group‚Äôs revenues. Consequently, we expect revenues for this group to be down a couple of percentage points and for margins to fall in the fourth quarter.
Turning back to National Oilwell Varco‚Äôs consolidated third quarter income statement, SG&A increased $36 million sequentially on a GAAP basis as we picked up a full quarter of Grant Prideco results and accrued higher incentive compensation levels to benefit cost.
Interest expense declined $5 .6 million as we steadily paid down Grant Prideco acquisition debt. Other expenses swung $29 million from a debit in Q2 and a $14 million credit in Q3 due to large FX movements in Europe.
Equinity income from our Voest-Alpine JV increased slightly to $20 million where higher pricing helped offset a mill shutdown and a stronger dollar impact. And allocated expenses and eliminations on our supplemental segment schedule which is pro forma for the Grant Prideco acquisition for all periods for $55.5 million up $5.8 million due to higher incentive accruals and a turnaround for insurance credits in Q2, partly offset by higher savings from the Grant Prideco acquisition.
Depreciation and amortization was $116 million in the third quarter, excluding transaction-related inventory step-up charges and exceeded our Q3 CapEx of $104 million. EBITDA was $974 million in the quarter.
Our September 30th, 2008 balance sheet employed working capital excluding cash and debt of $2.4 billion, up $84 million sequentially and equaling 16.6% of annualized revenue, consistent with recent prior quarters. DSOs improved slightly from Q2. Cash flow from operations was $462 million and less Q3 CapEx of $104 million yielded free cash flow for the quarter of $358 million.
Now, let me turn it over to Jeremy for his comments.
Thanks, Clay. I really appreciate this opportunity to share with our listeners some additional information about a few of those product lines that are not quite as visible as our rig or distribution businesses.
Our particular portion of the PS&S segment accounts for approximately $2 billion in annualized revenue and is comprised of four different distinct product areas that we refer to as mission products, drill-stream telemetry, downhole, and drill bits and services.
With mission, we design and manufacture a complete portfolio of multipurpose pumps utilized in both drilling and production. We also provide the fluid end modules, pistons, liners and other expendables that enable our customers to optimize their performance, simplify their maintenance processes and reduce their total cost of ownership by extending the life of their pumps.
I suppose the simplest way to describe mission is to tell you that it‚Äôs a microcosm of NOV. We have the most recognized, respected, and trusted brand names in the market, impeccable quality, industry-leading technology, a global manufacturing and distribution network and well-positioned and well-capitalized customers that just happen to include NOV distribution, NOV rig solutions and all the world‚Äôs largest land and offshore drilling contractors.
Therefore, while we are certainly keeping a watchful eye on the global economy and its impact on commodity pricing and drilling activity, especially in U.S. land, we feel very comfortable with our position. As of this morning, we have not yet experienced any weakening in our day-to-day expendables business. We still have a healthy backlog of CP packages for the various new builds that are in process, and with our premium products, we continue to capture market share both domestically and abroad.
However, in the event that we do experience a slowdown in the U.S., we believe that we‚Äôre well positioned to quickly shrink our pipeline to reflect the change in demand. Quite honestly, a modest slowdown would not be the worse thing in the world for our business.
Today, we are running two ten-hour shifts at most facilities, and we are still heavily dependent up on our outsourcing to keep up with demand. Therefore, if required, we will quickly move to in-source manufacturing, eliminate overtime, and if needed, reduce our number of shifts. Whatever happens, as the undisputed leader in the market, we will be well equipped to continue to prosper.
Although not nearly as large or as established as our mission product, our drill-string telemetry product, more commonly know as the IntelliServ Network, is an exciting new technology that continues to impress the early adopters of the service. The real-time information provided by the Network enables our customers to instantaneously interpret data that is typically only available after the well is drilled. Therefore, our customers are now able to enhance drilling performance while significantly reducing the risk associated with downhole tool failures and wellbore instability.
While market acceptance is a bit slower than we would like, I‚Äôm pleased to report that we successfully commercialized the technology and expanded the network to provide high-speed data telemetry services to customers in the U.S., Mexico, South America, the North Sea, and Australia.
To date, the performance of this system has proven to be exceptionally reliable and our customers are demonstrating their commitment to the technology by awarding us with multi-well and multiyear contracts. Given these contracts and our ever strengthening contracts with companies like Schlumberger, Halliburton, Baker and Weatherford, we fully expect for this technology to begin gaining real traction in Q1.
Finally within our downhole and bit product lines, we design, manufacture and service a complete array of downhole tools utilized in both drilling and well intervention applications. Over the past few years through significant investments in acquisitions and product development, and our global service and manufacturing capacity, and our rental fleet, we have migrated from a relatively small North American-based business with a fairly limited product offering to the industry‚Äôs largest and most comprehensive independent supplier of downhole tools.
Whether our customers require drill bits, or motors, drilling jars, shock tools, non-mag drill collars, underreamers, stabilizers, or any combination of the above, we are the only independent supplier currently capable of meeting all of their downhole needs on a global basis.
As I think about our downhole and bit products, I am probably most pleased by the way in which the legacy downhole, Andergauge and ReedHycalog employees have so quickly recognized the value of this newly-combined entity, and so eagerly latched on to each other to pursue various growth opportunities.
For example, all of our folks immediately recognized that Andergauge is a perfect compliment to downhole. It markets to the same customers. It supplies technology that can and should be run in tandem with our other downhole tools. It requires capitals to support the build of its rental tool fleet, and it requires global manufacturing and service capabilities.
Therefore, with downhole‚Äôs existing customer relationships and supply contracts, NOV‚Äôs strong balance sheet, downhole manufacturing facilities in Canada, the U.S., the U.K., the UAE and Singapore, and downhole service facilities in every major operating area around the world, we have all the pieces in place to immediately and substantially grow the Andergauge product line.
To help put this opportunity into perspective, prior to the application, Andergauge outsourced 100% of its manufacturing and supported its worldwide operations out of only two service facilities, one in Aberdeen and one in Houston. Now that we have combined Andergauge and downhole, we‚Äôre in the process of manufacturing Andergauge components in-house and migrating tools to our various facilities around the world. As you can imagine, both of these actions are driving tangible growth and revenues in operating margins.
As another example of collaboration, we‚Äôre recognizing the value of sharing resources between downhole and bits. Within downhole, we enjoy outstanding relationships with companies like Schlumberger and Halliburton, Weatherford and Baker, however, our exposure to the operators has been somewhat limited.
Conversely, within bits, we‚Äôre in front of operators every day, actively competing for every section of every well. This obviously represents a great opportunity for us to gain market intelligence, while also leveraging our relationships and our technologies to present a single face and a more comprehensive solution to our various customers.
We‚Äôre also actively coordinating our engineering efforts across our various product lines. Perhaps the most exciting example of this collaboration involves the utilization of ReedHycalog‚Äôs BlackBox technology, which is a downhole vibration recorder.
With BlackBox, we‚Äôre able to gain a better understanding of drilling dynamics in various environments and applications. And with this information, our engineers are now able to analyze different combinations and different configurations of our existing tools to meet our customers various drilling challenges. They‚Äôre also able to use this information to develop new technologies that will help our customers to enhance drilling performance.
As I hope you can see, we are extremely excited about these various growth opportunities, and we believe that we can leverage the strengths of our newly combined businesses to capture market share even in a soft market.
Having said that, we are actively preparing the organization for potential slowdown. Our guys in the U.S. know that they‚Äôre not going to receive the same amount of capital for new tools and machines as we approved in ‚Äė07 and ‚Äė08. And they also know we could begin migrating some of our existing U.S. tools to some of our newer facilities in newer markets, including Veracruz, Tripoli, Abu Dhabi, [Alcabor], Mumbai and [Tangu]. And our manufacturing guys know that they need to be prepared for potential reduction in demand.
Much like I described in our mission plans, our downhole facilities are currently running two ten-hour shifts and all of our bit plants are operating on three eight-hour shifts. Therefore, if required, we know that we can quickly shrink our pipeline and our expense base without cutting so deeply that we risk compromising the future health of our business.
In summary, barring a total collapse in the economy and commodity prices, we like other NOV businesses are very well positioned to continue to flourish in any market with recognized, respected, and trusted brand names, impeccable quality, industry-leading technology, global manufacturing and distribution, and well-positioned, well-capitalized customers. In short, we‚Äôre in good shape.
Thank you for your time, and I‚Äôll turn it over to Pete.
Thanks, Jeremy, and thanks, Clay. I just want to make a couple of quick comments myself, and then I‚Äôll turn it over for Q&A. I think one of the things that‚Äôs for everybody to realize, while we certainly believe that North America is going to get softer, I think everyone out there realizes that, kind of one of the unique things about our business today is, it basically is very rapidly self-correcting.
If you look at the number of wells that are being drilled today, the vast majority are becoming horizontal wells. There are shale plays, and quite frankly the completion curves on shale plays are very significant. When you stop drilling and all of a sudden cut into the production capacity, it‚Äôll all of a sudden cut into the amount of gas out there which in turn means you better start drilling again. We‚Äôve seen this happen whether you go back to the ‚Äė99, whether you go back to 2001. And so, we do believe things will be rapidly self-correcting.
Secondly, you‚Äôve heard a lot of the drilling contractors talk about the need for the newer rigs. I think yesterday Nabors mentioned that their new rigs are in great shape and they were going to get rid of old rigs and they were going to actually cut some up. Quite frankly that plays into exactly what we have been talking about for a long time. We need infrastructure replacement.
Irrespective of what happens over the next year or so or two on the financial economy, rust never sleeps. And if you are going to continue to need the infrastructure replacement, we think we are in great shape to be able to handle that.
I think Clay gave you a very good definition and description of what our backlog‚Äôs all about and it gives us plenty of opportunity to be able to withstand any shortfall, but be able to prepare ourselves to give this industry the things that it needs. It‚Äôs all about technology. It‚Äôs all about repairing that infrastructure.
Real quickly, on an international basis, I think there is a lot of areas that continue to be pretty exciting. The Northeast and -- I mean sorry, Middle East and North Africa are still great areas. And for them, and, again, it comes back to replacement of reserves. It‚Äôs not so much the price today, even though they are concerned about that, but it‚Äôs much more of building up the reserves for the future.
Quite honestly, I can‚Äôt make a big argument that I don‚Äôt like $70 or $75 oil, because I think it will help the economy rebound faster. It also is not going to impact their projects that they are doing in places like the Middle East, and we continue to have very robust activity there in bidding products.
Kind of one of the more interesting areas too that I think is flying below the radar is Latin America. You look at a lot of the IPMs going on in places like Mexico. Jeremy just mentioned, we are there with our products to help the folks out on these IPM situations. Brazil, while it may cut back a little bit, I think in the short term, on the number of rigs that they are announcing, they still have to continue to want to advance and get the equipment down there to be able to increase their productivity.
You noticed, I think it was yesterday in the Chronicle, they talked about having production of 4.2 million barrels a day by 2015, and that was from their CEO. And let me assure you if they are going to do that, they are going to need rigs, and they‚Äôre going to need the support of those rigs and they‚Äôre going to need the equipment that we have.
So, we feel very comfortable that while there certainly are some short-term wins. And maybe even would push into the immediate term, we are positioned to take advantage of this, and I think really do some fairly unique things.
One other area that I‚Äôll talk about for a second, and it‚Äôs not exactly a country, but it‚Äôs the Arctic. We‚Äôre seeing a lot more interest in the Arctic, the types of rigs that can in the Arctic. They are saying there is more opportunity up there. And if you look at the Stockman rigs we an announced a couple of quarters ago in the Baltic Sea, I think you‚Äôll see that there is more and more things that will be done in the Arctic arenas. So, they need new rigs, and those, quite frankly, are very expensive rigs. So, we are excited about some of the prospects there.
Finally, let me touch just a second or two on technology. Clay mentioned our Marcellus, our Drake rig for the Marcellus shale, really a cool rig. We‚Äôve already sold a bunch of these, designed, specifically for the terrain and type of wells that are being drilled up there, and we are doing more and more things every day with AC technology, our permanent magnet motors.
So, all in all we feel pretty good about where we are positioned. We certainly aren‚Äôt Pollyanna‚Äôs. We understand there‚Äôs headwinds out there, but we also understand that my hair didn‚Äôt get gray because I haven‚Äôt been through this before. The fact of the matter is we‚Äôve got a management team that knows how to do things, and we‚Äôre going to do things that are correct. But right now we are excited about where we are. We are excited about our balance sheet. I think there are a lot of good things going on, as well as a lot of challenges.
Finally, I‚Äôd like to thank all of our employees. It‚Äôs been a tough time, between hurricanes in China, between flooding in Mexico -- I am sorry earthquakes in China, flooding in Mexico, and hurricanes in the Gulf Coast, our folks have come through it well. They have continued to be very productive and help this company out. And for that, we are very, very thankful.
So, at this time, Marcia, I‚Äôd like to turn it over to you for any questions that our callers might have.