National Oilwell Varco, Inc. Earnings Call Nuggets: Ultradeepwater Rigs, Rig Tech Margin

On Wednesday, National Oilwell Varco, Inc. (NYSE:NOV) reported its first quarter earnings and discussed the following topics in its earnings conference call. Here’s what executives shared with analysts and investors.

Ultradeepwater Rigs

James Crandell – Dahlman Rose: Pete, in the past few weeks we’ve seen some big ultradeepwater discoveries, higher day rates for ultradeepwater rigs and Seadrill in particular stepping in and ordering more floaters. How has this just in the past few weeks changed the psychology toward ordering more ultradeepwater rigs out there?

Merrill A. ‘Pete’ Miller, Jr. – Chairman, President and CEO: Jim, it’s changed the psychology to be very positive. I think you’ve heard me say before, Seadrill is kind of a harbinger of what’s going on in the industry. They’re clearly very progressive and when you take a look at the economics that are out there today and some of these day rates that these deepwater rigs are getting, then you tie that back to what the shipyards are charging for these rigs today in conjunction with our DEP or drilling equipment packages and then I think the other third part of that’s really cool, what Clay mentioned is cutting almost a year off their delivery time. Those economics, the discoveries that you’re talking about really show that the world needs more of these deepwater rigs. We think it’s going to be a very positive ordering environment over the next few quarters, and we’re excited about what we’re seeing out there in the industry. Again, it’s a pretty compelling financial argument when you look at it and you see the payback for these drilling contractors. It’s a very good ROI.

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James Crandell – Dahlman Rose: Good. That’s great to hear Pete. The second question I had is there any way that you can Clay could try to quantify for me the ordering of additional BOP stacks by contract drillers for deepwater, to what extent are they ordering additional stacks for their rigs, to what extent are they ordering additional stacks for a number of rigs and I guess what kind of increment should we build on our assumptions for new blowout preventer orders in addition to just the number of rigs being ordered?

Clay C. Williams – SVP and CFO: Well, Jim, it’s been slowly rising. Obviously interest in BOP equipment has been slowly rising ever since the summer of 2010 and this quarter it really showed up in the form of several loose BOPs as we call them. BOPs that are not necessarily associated with the newbuild rig, but rather subsea stacks that are either to support a fleet of rigs out there in case of stack where they get dropped or they need a change out of the stack or to support even an individual rig. We hear that the E&P community is more and more expressing an interest in each rig having a second redundant stack to speed operations and be available to be run on riser quickly. Then the kind of the third is this level of maintenance that most go on with offshore equipment, as you know offshore rigs need to come into the shipyard every five years and all of the components go through a major overhaul. So having spare stacks available to support that effort just speeds that up and makes, ultimately makes the fleet more efficient. So, we’re seeing this quarter solid demand from a couple of drilling contractors going into their fleets and then also foresee that to recur in Q2 as well with good orders.

Rig Tech Margin

Robin Shoemaker – Citi: Yes, so I wanted to ask about Rig Tech margin in the quarter. You mentioned there was an impact from the addition of NKT on the Rig Tech margin, but I am also thinking that first quarter ’12 kind of roughly corresponds to the low point in the rig ordering cycle and probably pricing cycle in the first half of ’10. So, would – and now you mentioned that second quarter Rig Tech margin, I think would be slightly lower. So, apart from NKT, what would the first quarter of ’12 be the low point reflecting the first half of ’10 pricing dynamics?

Clay C. Williams – SVP and CFO: I think the first half of ’10 pricing dynamics contributed to the margin this quarter, Robin, but it’s not that – it’s not as one-for-one as you might otherwise think, because we sell lots of different pieces of equipment and kit that flow out at different times, so it’s really a compilation of pricing probably dating back to even 2009 all the way up through items that were sold in late 2011. So, it’s more of an aggregation of the pricing through that period that came out during the first quarter. I do want to correct one thing. We did not close NKT until the first week of April, and so there is no NKT flexibles contribution to the P&L results that you’re seeing here for the first quarter. That’s something now that we do expect to start contributing nearly a full quarter’s performance in the second quarter of 2012. So, we’ll get not quite 90 days, but pretty close to 90 days from NKT and that will bring the margins down again just a – right now, our forecast call for margins to move down just a little bit more in Q2. So 24.4% operating margins for this quarter and down in probably the 24% range in Q2. Although I didn’t explore it in much detail in my earlier comments; probably worth reiterating, the basis for that margin decline, which has been pretty steady over the past two years, really comes out of the orders that were won by NOV in 2007, 2008 that were delivered two years later, early to 2010 in a more deflationary environment, and so we benefited from really a lot less inflation than we have forecast; actually lower cost when we were executing rigs in early 2010, less over time and probably most importantly was the fact that we had, by that time, delivered a lot offshore rigs and scaled learning curve and we’re seeing the learning curve effects in our operations in early 2010. So, that led to much higher margins than we expected. So, for the first half of 2010, we are little bit over 30% and since then we’ve been guiding folks towards the margin decline. So, this quarter the downturn in margins; 160 basis points, really reflects the continuation of that trend. And although, we may not be quite at bottom, yet we’re pretty close.

Robin Shoemaker – Citi: And 26%; I think you’ve said in the past is kind of like a normalized margin for Rig Tech?

Clay C. Williams – SVP and CFO: Yeah.

Robin Shoemaker – Citi: Okay.

Clay C. Williams – SVP and CFO: Yeah, I think so. I think we can work our way back up. We did get improving pricing in Rig Technology through 2011, and in fact, here in the last quarter too, I think we probably picked up another 1% or 2% in pricing for the DEPs that we’re selling. And so, we think there is a little bit of expansion ahead, but also to caution you, we’ve added NKT to the mix, which is going to be dilutive. APLs as well our turret mooring systems are going to be a little bit dilutive. And so – but I would characterize something in the mid-20s is probably was more normal for this Group, and also point out as well that manufacturing business, producing 24%, 25%, 26% operating margins mix an extraordinarily high return on capital. In fact last quarter, the quarter that you’re looking at here first quarter 2012, if you annualize the results from Rig Technology on a (NOPAC) basis, tax effect the operating profit, divide it by the capital employed in that business, we did about 31% return on book capital and I think 64%, 65% return on tangible book capital. So very, very strong returns that go along with mid-20% margins.

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