NOV Inc. - Quarter Report: 2008 September (Form 10-Q)
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark one)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30,
2008
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number 1-12317
NATIONAL OILWELL VARCO, INC.
(Exact name of registrant as specified in its charter)
Delaware | 76-0475815 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
7909 Parkwood Circle Drive
Houston, Texas
77036-6565
Houston, Texas
77036-6565
(Address of principal executive offices)
(713) 346-7500
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
As of October 28, 2008 the registrant had 417,323,592 shares of common stock, par value $.01 per
share, outstanding.
TABLE OF CONTENTS
Table of Contents
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
NATIONAL OILWELL VARCO, INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
September 30, | December 31, | |||||||
2008 | 2007 | |||||||
(Unaudited) | ||||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 1,764.9 | $ | 1,841.8 | ||||
Receivables, net |
3,113.5 | 2,099.8 | ||||||
Inventories, net |
3,627.4 | 2,574.7 | ||||||
Costs in excess of billings |
653.9 | 643.5 | ||||||
Deferred income taxes |
205.6 | 131.5 | ||||||
Prepaid and other current assets |
443.3 | 302.5 | ||||||
Total current assets |
9,808.6 | 7,593.8 | ||||||
Property, plant and equipment, net |
1,735.0 | 1,197.3 | ||||||
Deferred income taxes |
229.1 | 55.6 | ||||||
Goodwill |
5,339.4 | 2,445.1 | ||||||
Intangibles, net |
4,339.9 | 774.1 | ||||||
Investment in unconsolidated affiliate |
218.8 | | ||||||
Other assets |
64.1 | 49.0 | ||||||
Total assets |
$ | 21,734.9 | $ | 12,114.9 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 956.6 | $ | 604.0 | ||||
Accrued liabilities |
2,231.4 | 1,761.4 | ||||||
Billings in excess of costs |
2,144.6 | 1,396.1 | ||||||
Current portion of long-term debt and short-term borrowings |
19.2 | 152.8 | ||||||
Accrued income taxes |
308.7 | 112.4 | ||||||
Total current liabilities |
5,660.5 | 4,026.7 | ||||||
Long-term debt |
1,492.7 | 737.9 | ||||||
Deferred income taxes |
2,128.2 | 564.3 | ||||||
Other liabilities |
72.9 | 61.8 | ||||||
Total liabilities |
9,354.3 | 5,390.7 | ||||||
Commitments and contingencies |
||||||||
Minority interest |
90.3 | 62.8 | ||||||
Stockholders equity: |
||||||||
Common stock, $0.01 par value; 417,337,062 and 356,867,498
issued and ouststanding at September 30, 2008 and
December 31, 2007 |
4.2 | 3.6 | ||||||
Additional paid-in capital |
7,977.8 | 3,617.2 | ||||||
Accumulated other comprehensive income |
97.2 | 195.0 | ||||||
Retained earnings |
4,211.1 | 2,845.6 | ||||||
Total stockholders equity |
12,290.3 | 6,661.4 | ||||||
Total liabilities and stockholders equity |
$ | 21,734.9 | $ | 12,114.9 | ||||
See notes to unaudited consolidated financial statements.
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NATIONAL OILWELL VARCO, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In millions, except per share data)
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(In millions, except per share data)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Revenue |
$ | 3,611.6 | $ | 2,579.5 | $ | 9,621.2 | $ | 7,130.1 | ||||||||
Cost of revenue |
2,511.6 | 1,839.2 | 6,743.1 | 5,091.0 | ||||||||||||
Gross profit |
1,100.0 | 740.3 | 2,878.1 | 2,039.1 | ||||||||||||
Selling, general and administrative |
309.7 | 194.9 | 811.2 | 569.4 | ||||||||||||
Transaction costs |
| | 16.4 | | ||||||||||||
Operating income |
790.3 | 545.4 | 2,050.5 | 1,469.7 | ||||||||||||
Interest and financial costs |
(18.6 | ) | (11.5 | ) | (52.8 | ) | (36.9 | ) | ||||||||
Interest income |
10.4 | 12.6 | 36.6 | 31.7 | ||||||||||||
Equity income in unconsolidated
affiliate |
20.1 | | 37.2 | | ||||||||||||
Other income (expense), net |
14.4 | 1.8 | 13.3 | (1.9 | ) | |||||||||||
Income before income taxes and
minority
interests |
816.6 | 548.3 | 2,084.8 | 1,462.6 | ||||||||||||
Provision for income taxes |
263.7 | 177.8 | 706.7 | 490.5 | ||||||||||||
Income before minority interest |
552.9 | 370.5 | 1,378.1 | 972.1 | ||||||||||||
Minority interest in income of
consolidated subsidiaries |
5.2 | 4.5 | 11.1 | 11.7 | ||||||||||||
Net income |
$ | 547.7 | $ | 366.0 | $ | 1,367.0 | $ | 960.4 | ||||||||
Net income per share: |
||||||||||||||||
Basic |
$ | 1.32 | $ | 1.03 | $ | 3.49 | $ | 2.71 | ||||||||
Diluted |
$ | 1.31 | $ | 1.02 | $ | 3.48 | $ | 2.71 | ||||||||
Weighted average shares outstanding: |
||||||||||||||||
Basic |
415.7 | 355.5 | 391.2 | 353.9 | ||||||||||||
Diluted |
418.3 | 357.9 | 393.0 | 354.4 | ||||||||||||
See notes to unaudited consolidated financial statements.
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NATIONAL OILWELL VARCO, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In millions)
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In millions)
Nine Months Ended | ||||||||
September 30, | ||||||||
2008 | 2007 | |||||||
Cash flows from operating activities: |
||||||||
Net income |
$ | 1,367.0 | $ | 960.4 | ||||
Adjustments to reconcile net income to net cash provided by operating
activities: |
||||||||
Depreciation and amortization |
284.1 | 155.6 | ||||||
Equity income in unconsolidated affiliate |
(37.2 | ) | | |||||
Other non-cash items, net |
10.0 | 41.6 | ||||||
Change in operating assets and liabilities, net of acquisitions: |
||||||||
Receivables |
(596.2 | ) | (535.6 | ) | ||||
Inventories |
(450.4 | ) | (419.9 | ) | ||||
Costs in excess of billings |
(10.4 | ) | (184.5 | ) | ||||
Prepaid and other current assets |
69.4 | (161.8 | ) | |||||
Accounts payable |
201.2 | 96.0 | ||||||
Billings in excess of costs |
748.6 | 538.4 | ||||||
Other assets/liabilities, net |
119.6 | 238.1 | ||||||
Net cash provided by operating activities |
1,705.7 | 728.3 | ||||||
Cash flows from investing activities: |
||||||||
Purchases of property, plant and equipment |
(264.2 | ) | (177.4 | ) | ||||
Business acquisitions, net of cash acquired |
(2,987.7 | ) | (287.4 | ) | ||||
Business divestitures, net of cash disposed |
800.9 | | ||||||
Dividend from unconsolidated affiliate |
112.7 | | ||||||
Other, net |
(0.7 | ) | 1.5 | |||||
Net cash used in investing activities |
(2,339.0 | ) | (463.3 | ) | ||||
Cash flows from financing activities: |
||||||||
Borrowings against lines of credit and other debt |
2,727.9 | 1.7 | ||||||
Payments against lines of credit and other debt |
(2,280.3 | ) | (9.7 | ) | ||||
Proceeds from stock option exercised |
83.8 | 104.9 | ||||||
Excess tax benefits from exercise of stock options |
36.8 | 20.0 | ||||||
Net cash provided by financing activities |
568.2 | 116.9 | ||||||
Effect of exchange rates on cash |
(11.8 | ) | 146.7 | |||||
Increase (decrease) in cash equivalents |
(76.9 | ) | 528.6 | |||||
Cash and cash equivalents, beginning of period |
1,841.8 | 957.4 | ||||||
Cash and cash equivalents, end of period |
$ | 1,764.9 | $ | 1,486.0 | ||||
Supplemental disclosures of cash flow information: |
||||||||
Cash payments during the period for: |
||||||||
Interest |
$ | 52.3 | $ | 37.6 | ||||
Income taxes |
$ | 920.8 | $ | 509.9 |
See notes to unaudited consolidated financial statements.
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NATIONAL OILWELL VARCO, INC.
Notes to Consolidated Financial Statements (Unaudited)
Notes to Consolidated Financial Statements (Unaudited)
1. Basis of Presentation
The preparation of financial statements in conformity with generally accepted accounting principles
(GAAP) in the United States requires management to make estimates and assumptions that affect
reported and contingent amounts of assets and liabilities as of the date of the financial
statements and reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
The accompanying unaudited consolidated financial statements of National Oilwell Varco, Inc. (the
Company) present information in accordance with GAAP in the United States for interim financial
information and the instructions to Form 10-Q and applicable rules of Regulation S-X. They do not
include all information or footnotes required by GAAP in the United States for complete
consolidated financial statements and should be read in conjunction with our 2007 Annual Report on
Form 10-K.
In our opinion, the consolidated financial statements include all adjustments, all of which are of
a normal, recurring nature, necessary for a fair presentation of the results for the interim
periods. Effective January 1, 2008, we changed the functional currency of our Rig Technology and
Distribution Services segments in Norway from the Norwegian krone to the U.S. dollar to more
appropriately reflect the primary economic environment in which they operate. This change was
precipitated by significant changes in the economic facts and circumstances, including the
increased order rate for large drilling rigs and components technology denominated in U.S. dollars,
the use of our Norway unit as our preferred project manager of these projects, increasing revenue
and cost base in U.S. dollars, and the implementation of an international cash pool to finance
these operations in U.S. dollars. See Note 11.
The results of operations for the three and nine months ended September 30, 2008 are not
necessarily indicative of the results to be expected for the full year.
Revenue Recognition
The Companys 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:
| the contracts include custom designs for customer specific applications; | ||
| the structural design is unique and requires significant engineering efforts; and | ||
| 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 Companys estimates and materially impact the
Companys current and future reported earnings.
The asset, Costs in excess of billings, represents revenues recognized in excess of amounts
billed. The liability, Billings in excess of costs, represents billings in excess of revenues
recognized.
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Drill Pipe Sales
For drill pipe sales, if requested in writing by the customer, delivery may be satisfied through
delivery to the Companys 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.
2. Grant Prideco Merger and Other Acquisitions
Pursuant to the Agreement and Plan of Merger with Grant Prideco, Inc. (Grant Prideco) (the
Merger), a Delaware Corporation, effective December 16, 2007 (the Agreement Date), the Company
issued .4498 shares of National Oilwell Varco, Inc. common stock and $23.20 in cash (the Exchange
Ratio) for each Grant Prideco common share outstanding on April 21, 2008 (the Merger Date)
totaling approximately 56.9 million shares and $2.9 billion in cash. The Company has included the
financial results of Grant Prideco in its consolidated financial statements beginning on the Merger
Date, the date Grant Prideco common shares were exchanged for National Oilwell Varco common shares
and cash. The Grant Prideco operations are included in the Petroleum Services & Supplies segment.
Grant Prideco is a world leader in drill stem technology development and drill pipe manufacturing,
sales and service and a global leader in drill bit and specialty tools, manufacturing, sales and
service. The Company believes the Merger with Grant Prideco will advance its strategic goal of
providing more products and services to its customers and that Grant Pridecos product range will
add new growth opportunities to the Company and benefit its customers needs worldwide.
The Merger has been accounted for as a purchase business combination. Assets acquired and
liabilities assumed were recorded at their estimated fair values as of April 21, 2008. The total
preliminary purchase price is $7,197.5 million, including Grant Prideco stock options assumed and
estimated acquisition related transaction costs and is comprised of (in millions):
Consideration given to acquire the outstanding common stock of Grant
Prideco: |
||||
Shares issued totaled approximately 56.9 million shares at $72.74 per share |
$ | 4,135.3 | ||
Cash paid at $23.20 per share |
2,932.3 | |||
Grant Prideco stock options assumed |
55.4 | |||
Merger related transaction costs |
74.5 | |||
Total preliminary purchase price |
$ | 7,197.5 | ||
The fair value of shares issued was determined using an average price of $72.74, which represents
the average closing price of the Companys common stock for a five-day period beginning two
available trading days before the public announcement of the transaction. For all stock options
and restricted stock granted prior to 2008, vesting was accelerated under the terms of the stock
option and restricted stock agreements; therefore, there was no modification of the awards as
defined under SFAS 123(R). For stock options and restricted stock granted by Grant Prideco in
2008, 320,500 Grant Prideco stock options and 388,000 shares of restricted stock were replaced with
250,402 National Oilwell Varco stock options and 303,212 shares of National Oilwell Varco
restricted stock, respectively. For the 2008 Grant Prideco grants, vesting was not accelerated in
connection with the Merger, under the terms of the stock option and restricted stock agreements,
except for certain recipients of the 2008 Grant Prideco restricted stock grant.
Merger related costs of $74.5 million include severance and other external costs directly related
to the Merger.
Transaction costs of $16.4 million for the nine month period ending September 30, 2008 were
comprised of $6.0 million for accelerated vesting of stock-based compensation, $4.0 million for
bridge loan fees, $5.8 million related to transaction costs for the disposition of certain tubular
businesses of Grant Prideco in May 2008 (see below for further discussion) and $0.6 million of
other costs.
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Preliminary Purchase Price Allocation
Under the purchase method of accounting, the total preliminary purchase price was allocated to
Grant Pridecos net tangible and identifiable intangible assets based on their estimated fair
values as of April 21, 2008. The excess of the purchase price over the net tangible and
identifiable intangible assets was recorded as goodwill. The preliminary allocation of the purchase
price was based upon preliminary valuations, and our estimates and assumptions are subject to
change upon the receipt and managements review of the final valuations. The primary areas of the
purchase price allocation, which are not yet finalized, relate to identifiable intangible assets,
property, plant and equipment, investment in unconsolidated affiliate, goodwill, certain
preacquisition contingencies and related adjustments to deferred taxes. The final valuation of net
assets is expected to be completed as soon as possible, but no later than one year from the
acquisition date. The following table, set forth below, displays the total preliminary purchase
price allocated to Grant Pridecos net tangible and identifiable intangible assets based on their
estimated fair values as of April 21, 2008 (in millions):
Cash and cash equivalents |
$ | 170.9 | ||
Receivables |
419.7 | |||
Assets held for sale, net |
783.9 | |||
Inventories |
616.8 | |||
Prepaid and other current assets |
209.5 | |||
Property, plant and equipment |
443.5 | |||
Goodwill |
3,164.3 | |||
Intangibles |
3,691.8 | |||
Investment in unconsolidated affiliate |
300.0 | |||
Other assets |
42.6 | |||
Accounts payable and accrued liabilities |
(315.9 | ) | ||
Accrued income taxes |
(623.9 | ) | ||
Long-term debt |
(176.4 | ) | ||
Deferred income taxes |
(1,485.0 | ) | ||
Minority interest |
(24.8 | ) | ||
Other liabilities |
(19.5 | ) | ||
Total preliminary purchase price |
$ | 7,197.5 | ||
Under purchase accounting, a fair value step up adjustment of $89.1 million was made to inventory
and is being charged to Cost of revenue as the applicable inventory is sold. Cost of revenue
includes $28.0 million and $74.1 million of these inventory charges for the three and nine months
ended September 30, 2008, respectively.
Additionally, the Company identified other intangible assets associated with tradenames, patents,
and customer relationships, and the preliminary fair values assigned were $1.2 billion, $0.3
billion, and $2.2 billion, respectively. The initial range of useful lives associated with trade
names, patents, and customer relationships were 40 years to an indefinite life, 5 to 15 years and
16 to 17 years, respectively. Of the $1.2 billion associated with trade names, $0.8 billion has
been initially identified as having an indefinite life.
Disposition of Certain Grant Prideco Businesses
Prior to the Merger, Grant Prideco had entered into a definitive Purchase and Sale Agreement with
Vallourec S.A. and Vallourec & Mannesman Holdings, Inc. (collectively referred to as Vallourec)
to sell four of its tubular businesses for $800 million in cash, subject to final working capital
adjustments and standard closing conditions (including regulatory approval). The transaction closed
May 16, 2008. The amount included in Assets held for sale, net included in the preliminary
purchase price allocation above, relates to this disposition. Additionally, $250.8 million is
included above in Accrued income taxes for taxes related to the disposition.
Unaudited Pro Forma Financial Information
The unaudited financial information in the table below summarizes the combined results of
operations of National Oilwell Varco and Grant Prideco, on a pro forma basis, as though the
companies had been combined as of the beginning of each of the periods presented. The pro forma
financial information is presented for informational purposes only and may not be indicative of the
results of operations that would have been achieved if the Merger had taken place at the beginning
of each of the periods presented. The pro forma financial information for all periods presented
includes the business combination accounting effect on historical Grant Prideco revenues,
adjustments to depreciation on acquired property, amortization charges from acquired intangible
assets, financing costs on new debt in connection with the Merger and related tax effects.
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The unaudited pro forma financial information for the three and nine month periods ended September
30, 2008 and 2007 combines the historical results for National Oilwell Varco for the three and nine
month periods ended September 30, 2008 and 2007 and the historical results for Grant Prideco for
the three and nine month periods ended September 30, 2008 and 2007 (in millions):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Total revenues |
$ | 3,611.6 | $ | 3,066.1 | $ | 10,224.9 | $ | 8,533.3 | ||||||||
Net income |
$ | 567.5 | $ | 427.6 | $ | 1,495.1 | $ | 1,157.0 | ||||||||
Basic net income per share |
$ | 1.37 | $ | 1.04 | $ | 3.61 | $ | 2.82 | ||||||||
Diluted net income per share |
$ | 1.36 | $ | 1.03 | $ | 3.59 | $ | 2.81 | ||||||||
3. Inventories, net
Inventories consist of (in millions):
September 30, | December 31, | |||||||
2008 | 2007 | |||||||
Raw materials and supplies |
$ | 706.3 | $ | 420.4 | ||||
Work in process |
1,383.7 | 939.2 | ||||||
Finished goods and purchased products |
1,537.4 | 1,215.1 | ||||||
Total |
$ | 3,627.4 | $ | 2,574.7 | ||||
4. Accrued Liabilities
Accrued liabilities consist of (in millions):
September 30, | December 31, | |||||||
2008 | 2007 | |||||||
Compensation |
$ | 291.3 | $ | 214.7 | ||||
Customer prepayments |
880.9 | 500.3 | ||||||
Warranty |
112.7 | 91.5 | ||||||
Interest |
18.8 | 13.8 | ||||||
Taxes (non income) |
62.6 | 47.3 | ||||||
Insurance |
50.9 | 42.4 | ||||||
Accrued purchase orders |
533.8 | 582.5 | ||||||
Fair value of derivatives |
87.8 | 111.3 | ||||||
Other |
192.6 | 157.6 | ||||||
Total |
$ | 2,231.4 | $ | 1,761.4 | ||||
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5. Costs and Estimated Earnings on Uncompleted Contracts
Costs and estimated earnings on uncompleted contracts consist of (in millions):
September 30, | December 31, | |||||||
2008 | 2007 | |||||||
Costs incurred on uncompleted contracts |
$ | 4,223.0 | $ | 3,167.2 | ||||
Estimated earnings |
1,933.3 | 1,208.3 | ||||||
6,156.3 | 4,375.5 | |||||||
Less: Billings to date |
7,647.0 | 5,128.1 | ||||||
$ | (1,490.7 | ) | $ | (752.6 | ) | |||
Costs and estimated earnings in excess of billings on
uncompleted contracts |
$ | 653.9 | $ | 643.5 | ||||
Billings in excess of costs and estimated earnings on
uncompleted contracts |
(2,144.6 | ) | (1,396.1 | ) | ||||
$ | (1,490.7 | ) | $ | (752.6 | ) | |||
6. Comprehensive Income
The components of comprehensive income are as follows (in millions):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Net income |
$ | 547.7 | $ | 366.0 | $ | 1,367.0 | $ | 960.4 | ||||||||
Currency translation
adjustments |
(70.9 | ) | 126.5 | (32.8 | ) | 216.3 | ||||||||||
Derivative financial
instruments |
(86.1 | ) | 19.8 | (64.9 | ) | 23.1 | ||||||||||
Change in defined
benefit plans |
0.2 | | (0.1 | ) | (9.0 | ) | ||||||||||
Comprehensive income |
$ | 390.9 | $ | 512.3 | $ | 1,269.2 | $ | 1,190.8 | ||||||||
The Companys reporting currency is the U.S. dollar. A majority of the Companys international
entities in which there is a substantial investment have the local currency as their functional
currency. As a result, translation adjustments resulting from the process of translating the
entities financial statements into the reporting currency are reported in Other Comprehensive
Income in accordance with SFAS 52, Foreign Currency
Translation. For the three months ended September 30, 2008, a majority of
these local currencies weakened against the U.S. dollar resulting in a net decrease to Other
Comprehensive Income of $70.9 million upon the translation of their financial statements from their
local currency to the U.S. dollar.
Derivative financial instruments are directly related to the effects of currency movement, for
which they are designated to offset. The decline in Other Comprehensive Income of $86.1 million
for the three months ended September 30, 2008 was due to the substantial weakening of the hedged
currencies against the U.S. dollar. The change in the value of the derivatives is reflected in
Other Comprehensive Income until the resulting unrealized gain or loss from the underlying hedged
transactions are completed and reported in earnings.
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7. Business Segments
Operating results by segment are as follows (in millions):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Revenue: |
||||||||||||||||
Rig Technology |
$ | 1,926.4 | $ | 1,521.9 | $ | 5,440.4 | $ | 4,150.9 | ||||||||
Petroleum Services & Supplies |
1,310.5 | 805.5 | 3,264.1 | 2,243.4 | ||||||||||||
Distribution Services |
497.6 | 361.3 | 1,288.9 | 1,058.0 | ||||||||||||
Elimination |
(122.9 | ) | (109.2 | ) | (372.2 | ) | (322.2 | ) | ||||||||
Total Revenue |
$ | 3,611.6 | $ | 2,579.5 | $ | 9,621.2 | $ | 7,130.1 | ||||||||
Operating Profit: |
||||||||||||||||
Rig Technology |
$ | 500.5 | $ | 373.5 | $ | 1,412.9 | $ | 983.1 | ||||||||
Petroleum Services & Supplies (a) |
301.6 | 193.6 | 717.9 | 542.4 | ||||||||||||
Distribution Services |
43.7 | 25.1 | 87.3 | 73.1 | ||||||||||||
Unallocated expenses and
eliminations |
(55.5 | ) | (46.8 | ) | (151.2 | ) | (128.9 | ) | ||||||||
Transaction costs |
| | (16.4 | ) | | |||||||||||
Total Operating Profit |
$ | 790.3 | $ | 545.4 | $ | 2,050.5 | $ | 1,469.7 | ||||||||
Operating Profit %: |
||||||||||||||||
Rig Technology |
26.0 | % | 24.5 | % | 26.0 | % | 23.7 | % | ||||||||
Petroleum Services & Supplies (a) |
23.0 | % | 24.0 | % | 22.0 | % | 24.2 | % | ||||||||
Distribution Services |
8.8 | % | 6.9 | % | 6.8 | % | 6.9 | % | ||||||||
Total Operating Profit % |
21.9 | % | 21.1 | % | 21.3 | % | 20.6 | % |
(a) | Under purchase accounting, a fair value step up adjustment of $89.1 million was made to inventory and is being charged to Cost of revenue as the applicable inventory is sold. Cost of revenue includes $28.0 million and $74.1 million of these inventory charges for the three and nine months ended September 30, 2008, respectively. |
The Companys 2008 financial statements include Grant Prideco from April 21, 2008, the Merger Date,
which includes additional amortization and depreciation of $40.7 million and $72.3 million from the
step up to fair market value of Grant Pridecos assets and liabilities for the three and nine
months ended September 30, 2008. As a result of the acquisition and the organizational structure
the Company reviewed its segment reporting and determined that the Grant Prideco product lines,
which includes the results of operations and all assets and liabilities, will be reported within
the Petroleum Services & Supplies segment.
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8. Debt
Debt consists of (in millions):
September 30, | December 31, | |||||||
2008 | 2007 | |||||||
Revolving credit facilities |
$ | 600.0 | $ | | ||||
$100.0 million Senior Notes, interest at 7.5%
payable
semiannually, principal due on February 15, 2008 |
| 100.2 | ||||||
$150.0 million Senior Notes, interest at 6.5%
payable
semiannually, principal due on March 15, 2011 |
150.0 | 150.0 | ||||||
$200.0 million Senior Notes, interest at 7.25%
payable
semiannually, principal due on May 1, 2011 |
209.1 | 211.7 | ||||||
$200.0 million Senior Notes, interest at 5.65%
payable
semiannually, principal due on November 15, 2012 |
200.0 | 200.0 | ||||||
$150.0 million Senior Notes, interest at 5.5%
payable
semiannually, principal due on November 19, 2012 |
151.1 | 151.3 | ||||||
Senior Notes, interest at 6.125% payable
semiannually,
principal due on August 15, 2015 |
174.6 | | ||||||
Other |
27.1 | 77.5 | ||||||
Total debt |
1,511.9 | 890.7 | ||||||
Less current portion |
19.2 | 152.8 | ||||||
Long-term debt |
$ | 1,492.7 | $ | 737.9 | ||||
Senior Notes
In connection with the Merger of Grant Prideco, the Company completed an exchange offer relative to
the $174.6 million of 6.125% Senior Notes due 2015 previously issued by Grant Prideco. On April
21, 2008, $150.8 million of Grant Prideco Senior Notes were exchanged for National Oilwell Varco
Senior Notes. The National Oilwell Varco Senior Notes have the same interest rate, interest
payment dates, redemption terms and maturity as the Grant Prideco Senior Notes.
Revolving Credit Facilities
On April 21, 2008, the Company replaced its existing $500.0 million unsecured revolving credit
facility with an aggregate of $3.0 billion of unsecured credit facilities and borrowed $2.0 billion
to finance the cash portion of the Grant Prideco acquisition. These facilities consist of a $2.0
billion, five-year revolving credit facility and a $1.0 billion, 364-day revolving credit facility.
At September 30, 2008, there was $600.0 million borrowed against these facilities, and there were
$458.4 million in outstanding letters of credit, resulting in $1,941.6 million of funds available
under this revolving credit facility. Interest under this multicurrency facility is based upon
LIBOR, NIBOR or EURIBOR plus 0.26% or 0.28% subject to a ratings-based grid, or the prime rate.
For the nine month period ended September 30, 2008, the weighted average interest rate associated
with the Companys revolving credit facilities was 3.4%.
The Company also had $2.5 billion of additional outstanding letters of credit at September 30,
2008, primarily in Norway, that are essentially under various bilateral committed letter of credit
facilities. The $1.2 billion increase in letters of credit since December 31, 2007 is the result
of significant down payments from our customers, which in turn require our issuing to our customers
advance payment guarantees in the form of letters of credit. Other letters of credit are issued as
bid bonds and performance bonds. The Senior Notes contain reporting covenants and the credit
facility contains a financial covenant regarding maximum debt to capitalization. We were in
compliance with all covenants at September 30, 2008.
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Other
Other debt includes approximately $21.0 million in promissory notes due to former owners of
businesses acquired who remain employed by the Company.
9. Tax
The effective tax rate for the three and nine months ended September 30, 2008 was 32.3% and 33.9%,
respectively, compared to 32.4% and 33.5% for the same periods in
2007. The rate for the nine months ended September 30, 2008 reflects
additional tax provisions related to the Companys decision to repatriate earnings from certain
foreign subsidiaries during the three months ended June 30, 2008. This was partially offset by
increasing benefits in the U.S. from the tax incentive for manufacturing activities and a net
incremental benefit resulting from the movement in exchange rates after the change of the
functional currency to the U.S. dollar for our operations in Norway. This net benefit included a
tax benefit in Norway of $26.9 million for the nine months ended September 30, 2008, resulting from
realized foreign exchange losses on U.S. dollar denominated assets and liabilities, and a $15.1
million loss for the same period, which was reported as income tax expense, from the remeasurement
into U.S. dollars of foreign currency denominated deferred tax assets and liabilities in the
balance sheet. The net benefit from the Norway foreign exchange tax movement is included in Other
in the table below.
The difference between the effective tax rate reflected in the provision for income taxes and the
U.S. federal statutory rate of 35% was as follows (in millions):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Federal income tax at U.S. federal
statutory rate
of 35.0% |
$ | 285.8 | $ | 191.9 | $ | 729.7 | $ | 511.9 | ||||||||
Foreign income tax rate differential |
(28.6 | ) | (17.0 | ) | (71.9 | ) | (45.9 | ) | ||||||||
State income tax, net of federal benefit |
9.3 | 5.2 | 26.0 | 15.3 | ||||||||||||
Foreign dividends, net of foreign tax
credits |
(1.5 | ) | 1.7 | 33.0 | 9.6 | |||||||||||
Benefit of U.S. Manufacturing Deduction |
(7.5 | ) | (2.6 | ) | (12.7 | ) | (4.4 | ) | ||||||||
Other |
6.2 | (1.4 | ) | 2.6 | 4.0 | |||||||||||
Provision for income taxes |
$ | 263.7 | $ | 177.8 | $ | 706.7 | $ | 490.5 | ||||||||
The Company accounts for uncertainty in income taxes in accordance with Financial Accounting
Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes An
Interpretation of FASB No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in
income taxes recognized in an entitys financial statements in accordance with FASB Statement No.
109, Accounting for Income Taxes and prescribes a recognition threshold and measurement
attributes for financial statement disclosure of tax positions taken or expected to be taken on a
return. Under FIN 48, the impact of an uncertain income tax position, in managements opinion, on
the income tax return must be recognized at the largest amount that is more-likely-than not to be
sustained upon audit by the relevant taxing authority. An uncertain income tax position will not
be recognized if it has a less than 50% likelihood of being sustained.
As of December 31, 2007, the Company had $51.6 million of unrecognized tax benefits, including
associated interest and penalties. This represents the tax benefits associated with various tax
positions taken, or expected to be taken, on domestic and international tax returns that have not
been recognized in our financial statements due to uncertainty regarding their resolution. During
the three and nine months ended September 30, 2008, the Company recognized an increase of $0.5
million and $11.8 million, respectively, in the balance of unrecognized tax benefits, of which
$10.4 million was an assumed obligation with its acquisition of Grant Prideco. The Company does
not anticipate that the total unrecognized tax benefits will significantly change due to the
settlement of audits or the expiration of statutes of limitation within 12 months of this reporting
date.
To the extent penalties and interest would be assessed on any underpayment of income tax, such
accrued amounts have been classified as a component of income tax expense in the financial
statements. This is an accounting policy election made by the Company that is a continuation of
the Companys historical policy and will continue to be consistently applied in the future.
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10. Stock-Based Compensation
The Company has a stock-based compensation plan known as the National Oilwell Varco, Inc. Long-Term
Incentive Plan (the Plan). The Plan provides for the granting of stock options,
performance-based share awards, restricted stock, phantom shares, stock payments and stock
appreciation rights. The number of shares authorized under the Plan is 15 million. As of
September 30, 2008, 5,252,584 shares remain available for future grants under the Plan, all of
which are available for grants of stock options, performance-based share awards, restricted stock
awards, phantom shares, stock payments and stock appreciation rights. Total stock-based
compensation for all share-based compensation arrangements under the Plan was $51.6 million and
$33.2 million for the nine months ended September 30, 2008 and 2007, respectively. Included in
the $51.6 million of compensation expense for the nine months ended September 30, 2008 is $6.0
million of compensation expense related to the accelerated vesting for certain restricted stock
awards as a result of the merger with Grant Prideco, which is included in Transaction costs in
the accompanying Consolidated Statements of Income. The total income tax benefit recognized in the
Consolidated Statements of Income for all stock-based compensation arrangements under the Plan was
$16.3 million (of which $2.2 million related to the accelerated vesting for certain restricted
stock awards as a result of the Merger) and $10.4 million for the nine months ended September 30,
2008 and 2007, respectively.
During the nine months ended September 30, 2008, the Company granted 1,368,900 stock options,
334,057 restricted stock awards and 185,000 performance-based restricted stock awards. The grant
of 1,368,900 stock options by the Company is as follows: 1,340,900 stock options were granted
February 19, 2008 with an exercise price of $64.16 and 28,000 stock options were granted on May 14,
2008 with an exercise price of $73.98. Additionally 250,402 stock options were assumed as part of
the Companys merger with Grant Prideco on April 21, 2008. These options generally vest over a
three-year period from the grant date. The grant of 334,057 restricted stock awards made by the
Company is as follows: 325,300 restricted stock awards were granted February 19, 2008 and 8,757
restricted stock awards were granted May 14, 2008. Additionally 303,212 restricted stock awards
were assumed as part of the Companys merger with Grant Prideco on April 21, 2008. The restricted
stock awards granted February 19, 2008 vest on the third anniversary of the date of grant. The
restricted stock awards granted May 14, 2008 vest in equal annual installments over a three-year
period from the date of grant. The restricted stock awards assumed as part of the Companys merger
with Grant Prideco vest on the second anniversary of the date of grant. The performance-based
restricted stock awards were granted February 19, 2008. The performance-based restricted stock
awards granted will be 100% vested 36 months from the date of grant, with a performance condition
of the Companys average operating income growth, measured on a percentage basis, from January 1,
2008 through December 31, 2010 exceeding the median operating income level growth of a designated
peer group over the same period.
11. Derivative Financial Instruments
Except for certain foreign currency forward contracts and interest rate swap agreements discussed
below, all derivative financial instruments we hold are designated as either cash flow or fair
value hedges and are highly effective in offsetting movements in the underlying risks. Accordingly,
gains and losses from changes in the fair value of designated derivative financial instruments are
deferred and recognized in earnings as revenue or cost of revenue as the underlying transactions
occur. Any ineffective portion of the change in the fair value is recorded in earnings as incurred.
We use foreign currency forward contracts and options to mitigate our exposure to changes in
foreign currency exchange rates on recognized nonfunctional currency monetary accounts, forecasted
transactions and firm sale and purchase commitments to better match the local currency cost
components of nonfunctional currency transactions. Such arrangements typically have terms between
two and 30 months, but may have longer terms depending on the project and our backlog. We may also
use interest rate contracts to mitigate our exposure to changes in interest rates on anticipated
long-term debt issuances. We do not use derivative financial instruments for trading or
speculative purposes.
At September 30, 2008, we had entered into foreign currency forward contracts with notional amounts
aggregating $2,473.1 million designated and qualifying as cash flow hedges to hedge exposure to
currency fluctuations in various foreign currencies. These exposures arise when local currency
operating expenses are not in balance with local currency revenue collections. Based on quoted
market prices as of September 30, 2008 for contracts with similar terms and maturity dates, we have
recorded a loss of $48.1 million, net of tax of $20.8 million, to adjust these foreign currency
forward contracts to their fair market values. This loss is included in Accumulated other
comprehensive income in the Consolidated Balance Sheets. It is expected that $5.9 million of this
loss will be reclassified into earnings within the next 12 months. The Company currently has cash
flow hedges in place through
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the fourth quarter of 2010. Ineffectiveness was not material on these
foreign currency forward contracts for the three and nine months ended September 30, 2008.
At September 30, 2008, the Company had foreign currency forward contracts with notional amounts
aggregating $146.3 million designated and qualifying as fair value hedges to hedge exposure to
currency fluctuations in various foreign currencies. Based on quoted market prices as of September
30, 2008 for contracts with similar terms and maturity dates, we recorded a loss of $4.1 million to
adjust these foreign currency forward contracts to their fair market values. This loss is offset
by designated gains on firm commitments resulting in no impact on current earnings. The Company
currently has fair value hedges in place through the first quarter of 2011. Ineffectiveness was
not material on these foreign currency forward contracts for the three and nine months ended
September 30, 2008.
At September 30, 2008, the Company had foreign currency forward contracts with notional amounts
aggregating $960.8 million to offset exposures to currency fluctuation of nonfunctional currency
balance sheet accounts, primarily consisting of accounts receivable and accounts payable and are
not designated as hedges. Therefore, changes in the fair values of these contracts are recorded
each period in current earnings.
We assess the functional currencies of our operating units to ensure that the appropriate
currencies are utilized in accordance with the guidance of Statement of Financial Accounting
Standards (SFAS) No. 52, Foreign Currency Translation. Effective January 1, 2008, we changed
the functional currency of our Rig Technology and Distribution Services segments in Norway from the
Norwegian krone to the U.S. dollar to more appropriately reflect the primary economic environment
in which they operate. This change was precipitated by significant changes in the economic facts
and circumstances, including: the increased order rate for large drilling rigs and components
technology denominated in U.S. dollars, the use of our Norway unit as our preferred project manager
of these projects, increasing revenue and cost base in U.S. dollars, and the implementation of an
international cash pool to finance these operations in U.S. dollars. As a Norwegian krone
functional unit, Norway was subject to increasing foreign currency exchange risk as a result of
these changes in its economic environment and was dependent upon significant hedging transactions
to offset its nonfunctional currency positions.
At December 31, 2007, our Norway operations had foreign currency forward contracts with notional
amounts aggregating $2,550.5 million with a fair value of $91.3 million to mitigate foreign
currency exchange risk against the U.S. dollar, our reporting currency. Effective with the change
in the functional currency, the Company terminated these hedges. The related net gain position of
$108.8 million associated with the terminated hedges has been deferred and is being recognized into
earnings in the future period(s) the forecasted transactions affect earnings, of which $52.7
million has been recognized into earnings at September 30, 2008. The Company has subsequent to
January 1, 2008, entered into new hedges to cover the exposures as a result of the changes to U.S.
dollar functional.
12. Net Income Per Share
The following table sets forth the computation of weighted average basic and diluted shares
outstanding (in millions, except per share data):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Numerator: |
||||||||||||||||
Net income |
$ | 547.7 | $ | 366.0 | $ | 1,367.0 | $ | 960.4 | ||||||||
Denominator: |
||||||||||||||||
Basicweighted average common
shares
outstanding |
415.7 | 355.5 | 391.2 | 353.9 | ||||||||||||
Dilutive effect of employee
stock options
and other unvested stock awards |
2.6 | 2.4 | 1.8 | 0.5 | ||||||||||||
Diluted outstanding shares |
418.3 | 357.9 | 393.0 | 354.4 | ||||||||||||
Basic earnings per share |
$ | 1.32 | $ | 1.03 | $ | 3.49 | $ | 2.71 | ||||||||
Diluted earnings per share |
$ | 1.31 | $ | 1.02 | $ | 3.48 | $ | 2.71 | ||||||||
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13. Recently Issued Accounting Standards
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS 157
establishes a framework for fair value measurements in the financial statements by providing a
single definition of fair value, provides guidance on the methods used to estimate fair value and
increases disclosures about estimates of fair value. In February 2008, the FASB issued FSP 157-2,
which delays the effective date of SFAS 157 for all nonfinancial assets and liabilities that are
not recognized or disclosed at fair value in the financial statements on a recurring basis (at
least annually) until fiscal years beginning after November 15, 2008, and interim periods within
those fiscal years. The Company adopted the provisions of SFAS 157 for financial assets and
liabilities as of January 1, 2008. The Company has determined that our financial assets and
liabilities (primarily currency related derivatives) are level 2 in the fair value hierarchy. At
September 30, 2008, the fair value of the Companys foreign currency forward contracts discussed in
Note 11 totaled $6.7 million. There was no significant impact to the Companys consolidated
financial statements from the adoption of SFAS 157. The Company is currently evaluating the
potential impact that the application of SFAS 157 to its nonfinancial assets and liabilities will
have on its consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit
Pension and Other Postretirement Plans An amendment of FASB Statements No. 87, 88, 106, and
132(R) (SFAS 158). SFAS 158 requires employers to recognize the overfunded or underfunded
status of a defined benefit postretirement plan as an asset or liability in its statement
of financial position and to recognize changes in that funded status in the year in which the
changes occur through comprehensive income of a business entity for fiscal years ending after
December 15, 2006. The requirement to measure plan assets and benefit obligations as of the end of
the employers fiscal year is effective for fiscal years ending after December 15, 2008. The
Company adopted the provisions of SFAS 158 recognizing the overfunded or underfunded status of a
defined benefit postretirement plan as an asset or liability in the statement of financial position
and recognized changes in the funded status in the year in which they occurred through
comprehensive income effective December 31, 2006 with no material impact on the consolidated
financial statements. On January 1, 2008, the Company adopted the requirement to measure plan
assets and benefit obligations as of its fiscal year end resulting in a $1.5 million charge to
retained earnings.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities (SFAS 159). SFAS 159 provides entities with an option to measure many
financial assets and liabilities and certain other items at fair value as determined on an
instrument by instrument basis. On January 1, 2008, the Company adopted SFAS 159 and elected not
to measure any of its currently eligible assets and liabilities at fair value.
In December 2007, the FASB issued SFAS No. 141R, Business Combinations (SFAS 141R). SFAS 141R
provides revised guidance on how acquirers recognize and measure the consideration transferred,
identifiable assets acquired, liabilities assumed, noncontrolling interests, and goodwill acquired
in a business combination. SFAS 141R also expands required disclosures surrounding the nature and
financial effects of business combinations. SFAS 141R is effective, on a prospective basis, for
fiscal years beginning after December 15, 2008. The Company expects that this new standard will
impact certain aspects of its accounting for business combinations on a prospective basis,
including the determination of fair values assigned to certain purchased assets and liabilities.
In April 2008, the FASB issued FASB Staff Position (FSP) SFAS 142-3, Determination of the Useful
Life of Intangible Assets (FSP SFAS 142-3). FSP SFAS 142-3 amends the factors that should be
considered in developing renewal or extension assumptions used to determine the useful life of a
recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets.
The objective of this FSP is to improve the consistency between the useful life of a recognized
intangible asset under Statement No. 142 and the period of expected cash flows used to measure the
fair value of the asset under SFAS 141R, Business Combinations, and other U.S. GAAP principles.
FSP SFAS 142-3 is effective for fiscal years beginning after December 15, 2008. The Company has not
yet evaluated the impact, if any, this standard might have on the Companys disclosures to its
consolidated financial statements.
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Introduction
National Oilwell Varco, Inc. (the Company) is a worldwide leader in the design, manufacture and
sale of equipment and components used in oil and gas drilling and production, the provision of
oilfield services, and supply chain integration services to the upstream oil and gas industry. The
following describes our business segments:
Rig Technology
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 segments 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.
Distribution Services
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 segments 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.
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Revenue Recognition
The Companys 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:
| the contracts include custom designs for customer specific applications; | ||
| the structural design is unique and requires significant engineering efforts; and | ||
| 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 Companys estimates and materially impact the
Companys current and future reported earnings.
The asset, Costs in excess of billings, represents revenues recognized in excess of amounts
billed. The liability, Billings in excess of costs, 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 Companys 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.
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EXECUTIVE SUMMARY
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 Companys 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 Companys 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 Varcos
position as manufacturer to the oilfield. Its drill bits and reamers are being integrated into the
Companys 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 Pridecos drill pipe products are purchased and consumed by the Companys
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 Cost of revenue 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
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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 worlds 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 1980s and 1990s 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 Companys 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 Companys 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 Companys 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 crews jobs easier, and
make the rig a safer and more desirable place to work.
Segment Performance
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
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$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 segments 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 segments 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.
Outlook
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.
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Our outlook for the Companys Petroleum Services & Supplies segment remains good into the fourth
quarter of 2008, given continuation of high levels of drilling across North America and
international markets, but is likely to see lower levels of sales in 2009 as drilling programs wind
down. Certain inflationary pressures, particularly steel and fuel, appear to be abating, but labor
costs continue to trend up. We would expect lower levels of drilling activity would negatively
affect both volumes and pricing for the group, and offset recent modest price increases. We
continue to focus heavily on manufacturing and service efficiency.
The Companys cautious outlook for the Distribution Services segment also reflects a likely
downturn in North American activity, which accounts for a majority of the segments revenues.
Specifically, mature regions such as West Texas, South Texas, the mid-continent and Rocky Mountain
regions may be at risk for oil and gas company reductions in drilling expenditures. Both pricing
and volumes would be adversely affected by such a downturn. Our outlook for international markets,
which are more driven by national oil company activity, are historically less volatile and expected
to see better market conditions.
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Operating Environment Overview
The Companys results are dependent on, among other things, the level of worldwide oil and gas
drilling, well remediation activity, the prices of crude oil and natural gas, capital spending by
other oilfield service companies and drilling contractors, pipeline maintenance activity, and
worldwide oil and gas inventory levels. Key industry indicators for the third quarter of 2008 and
2007, and the second quarter of 2008 include the following:
% | % | |||||||||||||||||||
3Q08 v | 3Q08 v | |||||||||||||||||||
3Q08* | 3Q07* | 2Q08* | 3Q07 | 2Q08 | ||||||||||||||||
Active Drilling Rigs: |
||||||||||||||||||||
U.S. |
1,978 | 1,788 | 1,864 | 10.6 | % | 6.1 | % | |||||||||||||
Canada |
432 | 348 | 169 | 24.1 | % | 155.6 | % | |||||||||||||
International |
1,095 | 1,020 | 1,084 | 7.4 | % | 1.0 | % | |||||||||||||
Worldwide |
3,505 | 3,156 | 3,117 | 11.1 | % | 12.4 | % | |||||||||||||
West Texas Intermediate
Crude Prices (per
barrel) |
$ | 118.60 | $ | 75.32 | $ | 124.05 | 57.5 | % | (4.4 | %) | ||||||||||
Natural Gas Prices
($/mmbtu) |
$ | 9.03 | $ | 6.17 | $ | 11.38 | 46.4 | % | (20.7 | %) |
* | Averages for the quarters indicated. See sources below. |
The following table details the U.S., Canadian, and international rig activity and West Texas
Intermediate Oil prices for the past nine quarters ended September 30, 2008 on a quarterly basis:
![(LINE GRAPH)](https://www.sec.gov/Archives/edgar/data/0001021860/000095012908005430/h64753h6475301.gif)
Source: Rig count: Baker Hughes, Inc. (www.bakerhughes.com); West Texas Intermediate Crude and
Natural Gas Prices: Department of Energy, Energy Information Administration (www.eia.doe.gov).
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The worldwide and U.S. quarterly average rig count increased 11.1% (from 3,156 to 3,505) and 10.6%
(from 1,788 to 1,978), respectively, in the third quarter of 2008 compared to the third quarter of
2007. The average per barrel price of West Texas Intermediate Crude increased 57.5% (from $75.32
per barrel to $118.60 per barrel) and natural gas prices increased 46.4% (from $6.17 per mmbtu to
$9.03 per mmbtu) in the third quarter of 2008 compared to the third quarter of 2007.
U.S. rig activity at October 24, 2008 was 1,964 rigs compared to the third quarter average of 1,978
rigs. The price for West Texas Intermediate Crude was at $63.34 per barrel as of October 24, 2008,
decreasing 47% from the third quarter 2008 average. The 2008 global financial credit crisis has
created a worldwide economic slowdown, which in turn has led commodity investors to bet on a
further reduction in energy demands. This recent turn of events has resulted in a dramatic
reduction in the price of oil and gas in the last several weeks, with oil prices in October 2008
dropping to their lowest levels in 17 months.
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Results of Operations
Operating results by segment are as follows (in millions):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Revenue: |
||||||||||||||||
Rig Technology |
$ | 1,926.4 | $ | 1,521.9 | $ | 5,440.4 | $ | 4,150.9 | ||||||||
Petroleum Services & Supplies |
1,310.5 | 805.5 | 3,264.1 | 2,243.4 | ||||||||||||
Distribution Services |
497.6 | 361.3 | 1,288.9 | 1,058.0 | ||||||||||||
Elimination |
(122.9 | ) | (109.2 | ) | (372.2 | ) | (322.2 | ) | ||||||||
Total Revenue |
$ | 3,611.6 | $ | 2,579.5 | $ | 9,621.2 | $ | 7,130.1 | ||||||||
Operating Profit: |
||||||||||||||||
Rig Technology |
$ | 500.5 | $ | 373.5 | $ | 1,412.9 | $ | 983.1 | ||||||||
Petroleum Services & Supplies (a) |
301.6 | 193.6 | 717.9 | 542.4 | ||||||||||||
Distribution Services |
43.7 | 25.1 | 87.3 | 73.1 | ||||||||||||
Unallocated expenses and
eliminations |
(55.5 | ) | (46.8 | ) | (151.2 | ) | (128.9 | ) | ||||||||
Transaction costs |
| | (16.4 | ) | | |||||||||||
Total Operating Profit |
$ | 790.3 | $ | 545.4 | $ | 2,050.5 | $ | 1,469.7 | ||||||||
Operating Profit %: |
||||||||||||||||
Rig Technology |
26.0 | % | 24.5 | % | 26.0 | % | 23.7 | % | ||||||||
Petroleum Services & Supplies (a) |
23.0 | % | 24.0 | % | 22.0 | % | 24.2 | % | ||||||||
Distribution Services |
8.8 | % | 6.9 | % | 6.8 | % | 6.9 | % | ||||||||
Total Operating Profit % |
21.9 | % | 21.1 | % | 21.3 | % | 20.6 | % |
(a) | Under purchase accounting, a fair value step up adjustment of $89.1 million was made to inventory and is being charged to Cost of revenue as the applicable inventory is sold. Cost of revenue includes $28.0 million and $74.1 million of these inventory charges for the three and nine months ended September 30, 2008, respectively. |
Rig Technology
Three Months Ended September 30, 2008 and 2007. Rig Technology revenue in the third quarter of
2008 was $1,926.4 million, an increase of $404.5 million (27%) compared to the same period of 2007.
Backlog rose to $11.8 billion, up 48% from the same period last year. Backlog and non-backlog
revenue increased 18% and 52%, respectively, from the prior year periods reflecting the rise in
demand for new rigs as well as the equipment, consumables and services needed to reactivate and/or
refurbish many older rigs due to higher oil and gas prices.
Operating profit from Rig Technology was $500.5 million for the third quarter ended September 30,
2008, an increase of $127.0 million (34%) over the same period of 2007. Operating profit
percentage increased to 26.0%, up from 24.5% for the same prior year period. Despite rising
costs, particularly related to steel and utilities, margins improved due primarily to
manufacturing, engineering, and operational efficiency initiatives, favorable product mix and
higher production volumes resulting in greater overhead absorption.
Nine Months Ended September 30, 2008 and 2007. Revenue for the first nine months of 2008 was
$5,440.4 million, an increase of $1,289.5 million (31%) compared to the same period of 2007.
Backlog and non-backlog revenue increased 32% and 28%, respectively, reflecting a rise in demand
for new rigs and products and services to reactivate and/or refurbish many older rigs due to higher
oil and gas prices as discussed above.
Operating profit for the first nine months of 2008 was $1,412.9 million, an increase of $429.8
million (44%) compared to 2007. Operating profit percentage increased to 26.0%, up from 23.7% for
the same prior year period. These increases reflect operational efficiency initiatives mentioned
above, favorable product mix and higher production volumes resulting in greater overhead
absorption.
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Petroleum Services & Supplies
Three Months Ended September 30, 2008 and 2007. Revenue from Petroleum Services & Supplies was
$1,310.5 million for the third quarter of 2008 compared to $805.5 million for the third quarter of
2007, an increase of $505.0 million (63%). Approximately 94% of the increase was attributable to
incremental revenues from the acquisition of Grant Prideco on April 21, 2008.
Additionally, this segment benefited from revenue increases in this segments Downhole Tools,
Inspection, Coating, Fiberglass, and Solids Control businesses as the worldwide rig count was up
11.1% in the third quarter of 2008 compared to 2007.
Operating profit from Petroleum Services & Supplies was $301.6 million for the third quarter of
2008 compared to $193.6 million for the same period in 2007, an increase of $108.0 million (56%),
and operating profit percentage decreased from 24.0%, to 23.0% for the same period, due to the
$28.0 million charge related to a fair value step up adjustment to inventory included in the Grant
Prideco acquisition.
Nine Months Ended September 30, 2008 and 2007. Revenue from Petroleum Services & Supplies was
$3,264.1 million for the first nine months of 2008 compared to $2,243.4 million for the first nine
months of 2007, an increase of $1,020.7 million (46%). The increase is primarily attributable to
the acquisition of Grant Prideco in April 2008 coupled with increases in virtually all of this
segments products and services.
Operating profit from Petroleum Services & Supplies was $717.9 million for the first nine months of
2008 compared to $542.4 million for the same period in 2007, an increase of $175.5 million (32%),
and operating profit percentage decreased from 24.2%, to 22.0% for the same period, due to the
$74.1 million charge related to a fair value step up adjustment to inventory included in the Grant
Prideco acquisition.
Distribution Services
Three Months Ended September 30, 2008 and 2007. Revenue from Distribution Services was $497.6
million, an increase of $136.3 million (38%) during the third quarter of 2008 over the comparable
2007 period with increases across all geographic regions, but primarily in the U.S. and Canada,
reflecting rig count increases of 10.6% and 24.1%, respectively.
Operating profit of $43.7 million in the third quarter of 2008 increased $18.6 million over the
third quarter of 2007. Operating profit percentage increased to 8.8%, from 6.9% for the same prior
year period. Operating profit increased due to higher revenue.
Nine Months Ended September 30, 2008 and 2007. Revenue from Distribution Services increased $230.9
million (22%) in the first nine months of 2008 to $1,288.9 million when compared to the first nine
months of 2007 with increases across all geographic regions reflecting higher rig counts
year-over-year.
Operating profit in the first nine months of 2008 of $87.3 million increased by $14.2 million (19%)
and operating profit percentage decreased slightly from 6.9% to 6.8% compared to the comparable
period in 2007. These decreases reflect competitive pricing pressures in the U.S. due to lower
drilling rig day rates.
Unallocated expenses and eliminations
Unallocated expenses and eliminations were $55.5 and $151.2 million for the three and nine months
ended September 30, 2008, respectively, compared to $46.8 million and $128.9 million for the same
respective periods in 2007. The increase in unallocated expenses and eliminations was primarily
due to greater inter-segment profit eliminations.
Transaction costs
Transaction costs of $16.4 million for the nine months ended September 30, 2008 were comprised of
$6.0 million for accelerated vesting of stock-based compensation, $4.0 million for bridge loan
fees, $5.8 million related to transaction costs for the disposition of certain tubular businesses
of Grant Prideco in May 2008 and $0.6 million of other costs. There were no transaction costs in
the third quarter of 2008.
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Interest and financial costs
Interest and financial costs were $18.6 million and $52.8 million for the three and nine months
ended September 30, 2008, respectively, compared to $11.5 million and $36.9 million for the
respective periods in 2007. The increase in interest and financial costs was primarily due to
debt incurred to finance the acquisition of Grant Prideco.
Other income (expense), net
Other income (expense), net was income, net of $14.4 million and $13.3 million for the three and
nine months ended September 30, 2008, respectively, compared to income, net of $1.8 million and
expense, net of $1.9 million for the same periods in 2007, respectively. The income for the three
and nine months ended September 30, 2008 was due primarily to foreign exchange gains in our
European operations with U.S. dollar holdings. The U.S. dollar strengthened by 8.5%, 8.9% and
11.9% in the third quarter of 2008 compared to the second quarter of 2008, against the Euro,
British pound sterling and Norwegian krone, respectively.
Provision for income taxes
The effective tax rate for the three and nine months ended September 30, 2008 was 32.3% and 33.9%,
respectively, compared to 32.4% and 33.5% for the same respective
periods in 2007. The rate for the nine months ended September 30, 2008
reflects additional tax provisions related to the Companys decision to repatriate earnings from
certain foreign subsidiaries during the three months ended June 30, 2008. This was partially
offset by increasing benefits in the U.S. from the tax incentive for manufacturing activities and a
net incremental benefit resulting from the movement in exchange rates after the change of the
functional currency to the U.S. dollar for our operations in Norway. This net benefit included a
tax benefit in Norway of $26.9 million for the nine months ended September 30, 2008, resulting from
realized foreign exchange losses on U.S. dollar denominated assets and liabilities, and a $15.1
million loss for the same period, which was reported as income tax expense, from the remeasurement
into U.S. dollars of foreign currency denominated deferred tax assets and liabilities in the
balance sheet.
The difference between the effective tax rate reflected in the provision for income taxes and the
U.S. federal statutory rate of 35% was as follows (in millions):
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2008 | 2007 | 2008 | 2007 | |||||||||||||
Federal income tax at U.S. federal
statutory rate
of 35.0% |
$ | 285.8 | $ | 191.9 | $ | 729.7 | $ | 511.9 | ||||||||
Foreign income tax rate differential |
(28.6 | ) | (17.0 | ) | (71.9 | ) | (45.9 | ) | ||||||||
State income tax, net of federal benefit |
9.3 | 5.2 | 26.0 | 15.3 | ||||||||||||
Foreign dividends, net of foreign tax
credits |
(1.5 | ) | 1.7 | 33.0 | 9.6 | |||||||||||
Benefit of U.S. Manufacturing Deduction |
(7.5 | ) | (2.6 | ) | (12.7 | ) | (4.4 | ) | ||||||||
Other |
6.2 | (1.4 | ) | 2.6 | 4.0 | |||||||||||
Provision for income taxes |
$ | 263.7 | $ | 177.8 | $ | 706.7 | $ | 490.5 | ||||||||
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Liquidity and Capital Resources
At September 30, 2008, the Company had cash and cash equivalents of $1,764.9 million, and total
debt of $1,511.9 million. At December 31, 2007, cash and cash equivalents were $1,841.8 million and
total debt was $890.7 million. A portion of the consolidated cash balances are denominated in
various currencies and also may be subject to certain limitations on transfer among countries or
uses without incurring additional tax obligations. The Companys outstanding debt at September 30,
2008 consisted of $600.0 million related to our new revolving credit facilities, $200.0 million of
5.65% Senior Notes due 2012, $200.0 million of 7.25% Senior Notes due 2011, $150.0 million of 6.5%
Senior Notes due 2011, $150.0 million of 5.5% Senior Notes due 2012, $174.6 million of 6.125%
Senior Notes due 2015, and other debt of $37.3 million.
On April 21, 2008, the Company replaced its existing $500.0 million unsecured revolving credit
facility with an aggregate of $3.0 billion of unsecured credit facilities and borrowed $2.0 billion
to finance the cash portion of the Grant Prideco acquisition. These facilities consist of a $2.0
billion, five-year revolving credit facility and a $1.0 billion, 364-day revolving credit facility.
At September 30, 2008, there were $600.0 million borrowed against these facilities, and there were
$458.4 million in outstanding letters of credit, resulting in $1,941.6 million of funds available
under this revolving credit facility. Interest under this multicurrency facility is based upon
LIBOR, NIBOR or EURIBOR plus 0.26% or 0.28% subject to a ratings-based grid, or the prime rate.
For the nine month period ended September 30, 2008, the weighted average interest rate associated
with the Companys revolving credit facilities was 3.4%.
The Company also had $2.5 billion of additional outstanding letters of credit at September 30,
2008, primarily in Norway, that are essentially under various bilateral committed letter of credit
facilities. The $1.2 billion increase in letters of credit since December 31, 2007 is the result
of significant down payments from our customers, which in turn require our issuing to our customers
advance payment guarantees in the form of letters of credit. Other letters of credit are issued as
bid bonds and performance bonds. The Senior Notes contain reporting covenants and the credit
facility contains a financial covenant regarding maximum debt to capitalization. We were in
compliance with all covenants at September 30, 2008.
In connection with the Merger of Grant Prideco, the Company completed an exchange offer relative to
the $174.6 million of 6.125% Senior Notes due 2015 previously issued by Grant Prideco. On April 21,
2008, $150.8 million of Grant Prideco Senior Notes were exchanged for National Oilwell Varco Senior
Notes. The National Oilwell Varco Senior Notes have the same interest rate, interest payment dates,
redemption terms and maturity as the Grant Prideco Senior Notes.
For the first nine months of 2008, cash provided by operating activities was $1,705.7 million
compared to cash provided by operating activities of $728.3 million in the same period of 2007.
Cash was provided by operations primarily through net income of $1,367.0 million plus non-cash
charges of $284.1 million, offset by equity income from our equity method affiliate of
approximately $37.2 million, increases in prepaid and other current assets of $69.4 million,
increases in accounts payable of $201.2 million, increases in billings in excess of costs of
$748.6 million and increases in other assets/liabilities, net of $119.6 million. The increase in
billings in excess of costs and increases in other assets/liabilities were mainly due to increases
in customer deposits and prepayments, and invoicing on rig construction projects. These positive
cash flows were offset by increases in receivables of $596.2 million and increases in inventories
of $450.4 million. Receivables increased due to greater revenue in the first nine months of 2008
compared to the same period in 2007, while inventory increased due to growing backlog orders.
For the first nine months of 2008, cash used in investing activities was $2,339.0 million compared
to cash used of $463.3 million for the same period of 2007. The Company used $2,987.7 million for
acquisitions in the first nine months of 2008, including the business and operating assets of Grant
Prideco. The Company received $800.9 million related to the disposition of certain Grant Prideco
tubular businesses and the Companys pipeline operations and $112.7 million from dividends received
from the Companys equity method investment in the second quarter of 2008. Capital expenditures
totaled approximately $264.2 million in the first nine months of 2008, primarily related to
expansion of Rig Technology operations and the Petroleum Services & Supplies service and rental
businesses.
For the first nine months of 2008, cash provided by financing activities was $568.2 million
compared to cash provided of $116.9 million for the same period of 2007. During the first nine
months of 2008, the Company borrowed $2,727.9 million, primarily to finance the cash portion of the
Grant Prideco Inc. acquisition, from financial institutions and has repaid $2,280.3 million. Cash
proceeds from exercised stock options were $83.8 million for the first nine months of 2008.
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The effect of the change in exchange rates on cash flows was a negative $11.8 million and a
positive $146.7 million for the nine months ended September 30, 2008 and 2007, respectively. The
2007 positive cash flow from exchange rate changes was primarily due to cash holdings in the
Norwegian krone as a result of customer prepayments on contracts in that country, and the
strengthening of the Norwegian krone to the U.S. dollar by approximately 16% during the first nine
months of 2007. At September 30, 2007, the Company had a majority of its cash in local functional
currencies including Norwegian kroner, British pounds sterling, Euros, and Canadian dollars. The
majority of the Companys cash balances at September 30, 2008 were in U. S. dollars.
The Companys cash balance as of September 30, 2008 was $1,764.9 million. We believe that cash on
hand, cash generated from operations and amounts available under the credit facilities and from
other sources of debt will be sufficient to fund operations, working capital needs, capital
expenditure requirements and financing obligations. We also believe any significant increases in
capital expenditures caused by any need to increase manufacturing capacity can be funded from
operations or through debt financing.
We intend to pursue additional acquisition candidates, but the timing, size or success of any
acquisition effort and the related potential capital commitments cannot be predicted. We expect to
fund future cash acquisitions primarily with cash flow from operations and borrowings, including
the unborrowed portion of the credit facility or new debt issuances, but may also issue additional
equity either directly or in connection with acquisitions. There can be no assurance that
additional financing for acquisitions will be available at terms acceptable to us.
Inflation has not had a material impact on our operating results or financial condition in recent
years. We believe that the higher costs for labor, energy, steel and other commodities experienced
in 2007 and the first half of 2008 was largely mitigated by increased prices and component
surcharges for the products we sell. Steel, energy and other commodity prices have declined since
the end of the second quarter of 2008.
Recently Issued Accounting Standards
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards No. 157, Fair Value Measurements (SFAS 157). SFAS 157 establishes a
framework for fair value measurements in the financial statements by providing a single definition
of fair value, provides guidance on the methods used to estimate fair value and increases
disclosures about estimates of fair value. In February 2008, the FASB issued FSP 157-2, which
delays the effective date of SFAS 157 for all nonfinancial assets and liabilities that are not
recognized or disclosed at fair value in the financial statements on a recurring basis (at least
annually) until fiscal years beginning after November 15, 2008, and interim periods within those
fiscal years. The Company adopted the provisions of SFAS 157 for financial assets and liabilities
as of January 1, 2008. The Company has determined that our financial assets and liabilities
(primarily currency related derivatives) are level 2 in the fair value hierarchy. At September 30,
2008, the fair value of the Companys foreign currency forward contracts discussed in Note 11
totaled $6.7 million. There was no significant impact to the Companys consolidated financial
statements from the adoption of SFAS 157. The Company is currently evaluating the potential impact
that the application of SFAS 157 to its nonfinancial assets and liabilities will have on its
consolidated financial statements.
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit
Pension and Other Postretirement Plans An amendment of FASB Statements No. 87, 88, 106, and
132(R) (SFAS 158). SFAS 158 requires employers to recognize the overfunded or underfunded
status of a defined benefit postretirement plan as an asset or liability in its statement
of financial position and to recognize changes in that funded status in the year in which the
changes occur through comprehensive income of a business entity for fiscal years ending after
December 15, 2006. The requirement to measure plan assets and benefit obligations as of the end of
the employers fiscal year is effective for fiscal years ending after December 15, 2008. The
Company adopted the provisions of SFAS 158 recognizing the overfunded or underfunded status of a
defined benefit postretirement plan as an asset or liability in the statement of financial position
and recognized changes in the funded status in the year in which they occurred through
comprehensive income effective December 31, 2006 with no material impact on the consolidated
financial statements. On January 1, 2008, the Company adopted the requirement to measure plan
assets and benefit obligations as of its fiscal year end resulting in a $1.5 million charge to
retained earnings.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities (SFAS 159). SFAS 159 provides entities with an option to measure many
financial assets and liabilities and certain other items at fair value as determined on an
instrument by instrument basis. On January 1, 2008, the Company adopted SFAS 159 and elected not
to measure any of its currently eligible assets and liabilities at fair value.
In December 2007, the FASB issued SFAS No. 141R, Business Combinations (SFAS 141R). SFAS 141R
provides revised guidance on how acquirers recognize and measure the consideration transferred,
identifiable assets
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acquired, liabilities assumed, noncontrolling interests, and goodwill acquired
in a business combination. SFAS 141R also expands required disclosures surrounding the nature and
financial effects of business combinations. SFAS 141R is effective, on a prospective basis, for
fiscal years beginning after December 15, 2008. The Company expects that this new standard will
impact certain aspects of its accounting for business combinations on a prospective basis,
including the determination of fair values assigned to certain purchased assets and liabilities.
In April 2008, the FASB issued FASB Staff Position (FSP) SFAS 142-3, Determination of the Useful
Life of Intangible Assets (FSP SFAS 142-3). FSP SFAS 142-3 amends the factors that should be
considered in developing renewal or extension assumptions used to determine the useful life of a
recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets.
The objective of this FSP is to improve the consistency between the useful life of a recognized
intangible asset under Statement No. 142 and the period of expected cash flows used to measure the
fair value of the asset under SFAS 141R, Business Combinations, and other U.S. GAAP principles.
FSP SFAS 142-3 is effective for fiscal years beginning after December 15, 2008. The Company has not
yet evaluated the impact, if any, this standard might have on the Companys disclosures to its
consolidated financial statements.
Forward-Looking Statements
Some of the information in this document contains, or has incorporated by reference,
forward-looking statements. Statements that are not historical facts, including statements about
our beliefs and expectations, are forward-looking statements. Forward-looking statements typically
are identified by use of terms such as may, will, expect, anticipate, estimate, and
similar words, although some forward-looking statements are expressed differently. All statements
herein regarding expected merger synergies are forward-looking statements. You should be aware
that our actual results could differ materially from results anticipated in the forward-looking
statements due to a number of factors, including but not limited to changes in oil and gas prices,
customer demand for our products, difficulties encountered in integrating mergers and acquisitions,
and worldwide economic activity. You should also consider carefully the statements under Risk
Factors, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007,
which address additional factors that could cause our actual results to differ from those set forth
in the forward-looking statements. Given these uncertainties, current or prospective investors are
cautioned not to place undue reliance on any such forward-looking statements. We undertake no
obligation to update any such factors or forward-looking statements to reflect future events or
developments.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to changes in foreign currency exchange rates and interest rates. Additional
information concerning each of these matters follows:
Foreign Currency Exchange Rates
We have extensive operations in foreign countries. The net assets and liabilities of these
operations are exposed to changes in foreign currency exchange rates, although such fluctuations
generally do not affect income since their functional currency is typically the local currency.
These operations also have net assets and liabilities not denominated in the functional currency,
which exposes us to changes in foreign currency exchange rates that do impact income. We recorded a
foreign exchange gain in our income statement of approximately $29.6 million in the first nine
months of 2008, compared to a $2.9 million gain in the same period of the prior year. The
gain/losses are primarily due to exchange rate fluctuations related to monetary asset balances
denominated in currencies other than the functional currency. Further strengthening of currencies
against the U.S. dollar may create losses in future periods to the extent we maintain net assets
and liabilities not denominated in the functional currency of the countries using the local
currency as their functional currency.
Some of our revenues in foreign countries are denominated in U.S. dollars, and therefore, changes
in foreign currency exchange rates impact our earnings to the extent that costs associated with
those U.S. dollar revenues are denominated in the local currency. Similarly some of our revenues
are denominated in foreign currencies, but have associated U.S. dollar costs, which also gives rise
to foreign currency exchange rate exposure. In order to mitigate that risk, we may utilize foreign
currency forward contracts to better match the currency of our revenues and associated costs. We do
not use foreign currency forward contracts for trading or speculative purposes.
At September 30, 2008, we had entered into foreign currency forward contracts with notional amounts
aggregating $2,473.1 million to hedge cash flow exposure to currency fluctuations in various
foreign currencies. These exposures arise when local currency operating expenses are not in
balance with local currency revenue collections. Based on quoted market prices as of September 30,
2008 and 2007 for contracts with similar terms and maturity dates, we have recorded a loss of $48.1
million and a gain of $24.0 million, respectively, to adjust these foreign currency forward
contracts to their fair market value. This loss is included in accumulated other comprehensive
income in the consolidated balance sheet. It is expected that $5.9 million of the 2008 loss will
be reclassified into earnings within the next 12 months. The Company currently has cash flow hedges
in place through the fourth quarter of 2010. Ineffectiveness was not material on these foreign
currency forward contracts for the first nine months of 2008.
At September 30, 2008, the Company had foreign currency forward contracts with notional amounts
aggregating $146.3 million designated and qualifying as fair value hedges to hedge exposure to
currency fluctuations in various foreign currencies. Based on quoted market prices as of September
30, 2008 and 2007 for contracts with similar terms and maturity dates, we recorded a loss of $4.1
million and a gain of $125.4 million, respectively, to adjust these foreign currency forward
contracts to their fair market value. This gain/loss is offset by designated gains/losses on the
firm commitments. The Company currently has fair value hedges in place through the first quarter of
2011. Ineffectiveness was not material on these foreign currency forward contracts for the first
nine months of 2008.
At September 30, 2008, the Company had foreign currency forward contracts with notional amounts
aggregating $960.8 million to offset exposures to the currency fluctuation of nonfunctional
currency balance sheet accounts, primarily consisting of account receivables and account payables,
and are not designated as hedges. Therefore, changes in the fair value of these contracts are
recorded each period in current earnings.
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The maturity of the below forward contracts by currency is (in millions):
Hedge Classification | Currency | 2008 | 2009 | 2010 | 2011 | Total | ||||||||||||||||
Cash Flow |
AUD | $ | 0.5 | $ | 0.2 | $ | | $ | | $ | 0.7 | |||||||||||
DKK | 30.3 | 9.2 | | | 39.5 | |||||||||||||||||
EUR | 519.1 | 112.2 | 1.1 | | 632.4 | |||||||||||||||||
GBP | 44.2 | 12.2 | | | 56.4 | |||||||||||||||||
NOK | 678.5 | 596.7 | 214.5 | | 1,489.7 | |||||||||||||||||
SEK | | 2.5 | 0.7 | | 3.2 | |||||||||||||||||
USD | 64.9 | 167.8 | 18.5 | | 251.2 | |||||||||||||||||
$ | 1,337.5 | $ | 900.8 | $ | 234.8 | $ | | $ | 2,473.1 | |||||||||||||
Fair Value |
EUR | $ | 3.0 | $ | 2.8 | $ | | $ | | $ | 5.8 | |||||||||||
KRW | 0.8 | 1.7 | | | 2.5 | |||||||||||||||||
USD | 30.2 | 89.3 | 17.8 | 0.7 | 138.0 | |||||||||||||||||
$ | 34.0 | $ | 93.8 | $ | 17.8 | $ | 0.7 | $ | 146.3 | |||||||||||||
Balance Sheet |
DKK | $ | 18.0 | $ | | $ | | $ | | $ | 18.0 | |||||||||||
EUR | 82.4 | 3.8 | | | 86.2 | |||||||||||||||||
GBP | 11.6 | | | | 11.6 | |||||||||||||||||
NOK | 253.6 | 78.8 | 0.5 | | 332.9 | |||||||||||||||||
SEK | | 0.3 | | | 0.3 | |||||||||||||||||
USD | 511.8 | | | | 511.8 | |||||||||||||||||
$ | 877.4 | $ | 82.9 | $ | 0.5 | $ | | $ | 960.8 | |||||||||||||
Total |
$ | 2,248.9 | $ | 1,077.5 | $ | 253.1 | $ | 0.7 | $ | 3,580.2 | ||||||||||||
The Company had other financial market risk sensitive instruments denominated in foreign currencies
totaling $43.7 million as of September 30, 2008 excluding trade receivables and payables, which
approximate fair value. These market risk sensitive instruments consisted of cash balances and
overdraft facilities. The Company estimates that a hypothetical 10% movement of all applicable
foreign currency exchange rates on these other financial market risk sensitive instruments could
affect net income by $2.8 million.
The counterparties to forward contracts are major financial institutions. The credit ratings and
concentration of risk of these financial institutions are monitored on a continuing basis. In the
unlikely event that the counterparties fail to meet the terms of a foreign currency contract, our
exposure is limited to the foreign currency rate differential.
Interest Rate Risk
At September 30, 2008 our long term borrowings consisted of $150.0 million in 6.5% Senior Notes,
$200.0 million in 7.25% Senior Notes, $200.0 million in 5.65% Senior Notes, $150.0 million in 5.5%
Senior Notes, $174.6 million in 6.125% Senior Notes, and $600.0 million in borrowing under our
revolving credit facility. We occasionally have borrowings under our other credit facilities, and
a portion of these borrowings could be denominated in multiple currencies which could expose us to
market risk with exchange rate movements. These instruments carry interest at a pre-agreed upon
percentage point spread from either LIBOR, NIBOR or EURIBOR, or at the prime interest rate. Under
our credit facilities, we may, at our option, fix the interest rate for certain borrowings based on
a spread over LIBOR, NIBOR or EURIBOR for 30 days to 6 months. Our objective is to maintain a
portion of our debt in variable rate borrowings for the flexibility obtained regarding early
repayment without penalties and lower overall cost as compared with fixed-rate borrowings.
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Item 4. Controls and Procedures
As of the end of the period covered by this report, we carried out an evaluation, under the
supervision and with the participation of the Companys management, including the Companys Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of
the Companys disclosure controls and procedures. The Companys disclosure controls and procedures
are designed to provide reasonable assurance that the information required to be disclosed by the
Company in the reports it files under the Exchange Act is accumulated and communicated to the
Companys management, including the Companys Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required disclosures and is recorded,
processed, summarized and reported within the time period specified in the rules and forms of the
Securities and Exchange Commission. Based upon that evaluation, the Companys Chief Executive
Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures
are effective as of the end of the period covered by this report at a reasonable assurance level.
There has been no change in our internal control over financial reporting (as defined in Rule
13a-15(f) under the Exchange Act) that occurred during our last fiscal quarter that has materially
affected, or is reasonably likely to materially affect, our internal control over financial
reporting.
On April 21, 2008, the Company acquired Grant Prideco. For purposes of determining the
effectiveness of the Companys disclosure controls and procedures and any change in the Companys
internal control over financial reporting, as disclosed in this report, management has excluded
Grant Prideco from its evaluation of these matters. The acquired business represented approximately
35.8% of our consolidated total assets at September 30, 2008 and 7.6% of our consolidated operating
profit including related transaction costs for the nine months ended September 30, 2008.
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PART II OTHER INFORMATION
Item 1A. Risk Factors
As of the date of this filing, the Company and its operations continue to be subject to the risk
factors previously disclosed in Part I, Item 1A Risk Factors in our 2007 Annual Report on Form
10-K, as well as the following risk factor:
Recent Worldwide Financial and Credit Crisis Could have a Negative Effect on Our Operating Results
and Financial Condition.
Recent events have paralyzed credit markets and sparked a serious global banking crisis. Most
economists foresee a slow and uncertain recovery of credit markets, and an emerging global
recession. A slowdown in worldwide economic activity would likely reduce demand for energy and
result in lower oil and natural gas prices. Any prolonged reduction in oil and natural gas prices
will reduce oil and natural gas drilling and production activity and result in a corresponding
decline in the demand for our products and services, which could adversely impact our operating
results and financial condition.
Furthermore, many of our customers access the credit markets to finance their oil and natural gas
drilling and production activity. If the recent crisis reduces the availability of credit to our
customers, they may reduce their drilling and production expenditures, thereby decreasing demand
for our products and services. Any such reduction in spending by our customers could adversely impact
our operating results and financial condition.
Item 6. Exhibits
Reference is hereby made to the Exhibit Index commencing on Page 34.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 4, 2008
|
By: /s/ Clay C. Williams | ||||
Clay C. Williams | |||||
Senior Vice President and Chief Financial Officer | |||||
(Duly Authorized Officer, Principal Financial and Accounting Officer) |
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INDEX TO EXHIBITS
(a) Exhibits
2.1
|
Amended and Restated Agreement and Plan of Merger, effective as of August 11, between National-Oilwell, Inc. and Varco International, Inc. (4). | |
2.2
|
Agreement and Plan of Merger, effective as of December 16, 2007, between National Oilwell Varco, Inc., NOV Sub, Inc., and Grant Prideco, Inc. (8) | |
3.1
|
Amended and Restated Certificate of Incorporation of National-Oilwell, Inc. (Exhibit 3.1) (1). | |
3.2
|
Amended and Restated By-laws of National Oilwell Varco, Inc. (Exhibit 3.1) (9). | |
10.1
|
Employment Agreement dated as of January 1, 2002 between Merrill A. Miller, Jr. and National Oilwell. (Exhibit 10.1) (2). | |
10.2
|
Employment Agreement dated as of January 1, 2002 between Dwight W. Rettig and National Oilwell, with similar agreement with Mark A. Reese. (Exhibit 10.2) (2). | |
10.3
|
Form of Amended and Restated Executive Agreement of Clay C. Williams. (Exhibit 10.12) (3). | |
10.4
|
National Oilwell Varco Long-Term Incentive Plan (5)*. | |
10.5
|
Form of Employee Stock Option Agreement (Exhibit 10.1) (6) | |
10.6
|
Form of Non-Employee Director Stock Option Agreement (Exhibit 10.2) (6). | |
10.7
|
Form of Performance-Based Restricted Stock (18 Month) Agreement (Exhibit 10.1) (7). | |
10.8
|
Form of Performance-Based Restricted Stock (36 Month) Agreement (Exhibit 10.2) (7). | |
10.9
|
Five-Year Credit Agreement, dated as of April 21, 2008, among National Oilwell Varco, Inc., the financial institutions signatory thereto, including Wells Fargo Bank, N.A., in their capacities as Administrative Agent, Co-Lead Arranger and Joint Book Runner, DnB Nor Bank ASA, as Co-Lead Arranger and Joint Book Runner, and Fortis Capital Corp., The Bank of Nova Scotia and The Bank of Tokyo Mitsubishi UFJ, Ltd., as Co-Documentation Agents. (10). | |
10.10
|
364-Day Credit Agreement, dated as of April 21, 2008, among National Oilwell Varco, Inc., the financial institutions signatory thereto, including Wells Fargo Bank, N.A., in their capacities as Administrative Agent, Co-Lead Arranger and Joint Book Runner, DnB Nor Bank ASA, as Co-Lead Arranger and Joint Book Runner, and Fortis Capital Corp., The Bank of Nova Scotia and The Bank of Tokyo Mitsubishi UFJ, Ltd., as Co-Documentation Agents. (10). | |
31.1
|
Certification pursuant to Rule 13a-14a and Rule 15d-14(a) of the Securities and Exchange Act, as amended | |
31.2
|
Certification pursuant to Rule 13a-14a and Rule 15d-14(a) of the Securities and Exchange Act, as amended | |
32.1
|
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2
|
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* | Compensatory plan or arrangement for management or others | |
(1) | Filed as an Exhibit to our Quarterly Report on Form 10-Q filed on August 11, 2000. | |
(2) | Filed as an Exhibit to our Annual Report on Form 10-K filed on March 28, 2002. | |
(3) | Filed as an Exhibit to Varco International, Inc.s Quarterly Report on Form 10-Q filed on May 6, 2004. | |
(4) | Filed as Annex A to our Registration Statement on Form S-4 filed on September 16, 2004. | |
(5) | Filed as Annex D to our Amendment No. 1 to Registration Statement on Form S-4 filed on January 31, 2005. | |
(6) | Filed as an Exhibit to our Current Report on Form 8-K filed on February 23, 2006. | |
(7) | Filed as an Exhibit to our Current Report on Form 8-K filed on March 27, 2007. | |
(8) | Filed as Annex A to our Registration Statement on Form S-4 filed on January 28, 2008. | |
(9) | Filed as an Exhibit to our Current Report on Form 8-K filed on February 21, 2008. | |
(10) | Filed as an Exhibit to our Current Report on Form 8-K filed on April 22, 2008. |
We hereby undertake, pursuant to Regulation S-K, Item 601(b), paragraph (4) (iii), to furnish to
the U.S. Securities and Exchange Commission, upon request, all constituent instruments defining the
rights of holders of our long-term debt not filed herewith.
34