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Edited Transcript of NOV earnings conference call or presentation 27-Jul-18 3:00pm GMT

Q2 2018 National Oilwell Varco Inc Earnings Call

HOUSTON Jul 31, 2018 (Thomson StreetEvents) -- Edited Transcript of National Oilwell Varco Inc earnings conference call or presentation Friday, July 27, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Clay C. Williams

National Oilwell Varco, Inc. - Chairman, President & CEO

* Jose A. Bayardo

National Oilwell Varco, Inc. - Senior VP & CFO

* Loren B. Singletary

National Oilwell Varco, Inc. - Chief Investor & Industry Relations Officer

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Conference Call Participants

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* Byron Keith Pope

Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research

* James Knowlton Wicklund

Crédit Suisse AG, Research Division - MD

* James Marshall Adkins

Raymond James & Associates, Inc., Research Division - MD of Equity Research and Director of Energy Research

* Marc Gregory Bianchi

Cowen and Company, LLC, Research Division - MD

* Sean Christopher Meakim

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

* William Andrew Herbert

Simmons & Company International, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the National Oilwell Varco Second Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Mr. Loren Singletary, Chief Investor and Industry Relations Officer. Sir, you may begin.

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Loren B. Singletary, National Oilwell Varco, Inc. - Chief Investor & Industry Relations Officer [2]

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Welcome, everyone, to National Oilwell Varco's second quarter 2018 earnings conference call. With me today are Clay Williams, our Chairman, President and Chief Executive Officer; and Jose Bayardo, our Senior Vice President and Chief Financial Officer.

Before we begin, I would like to remind you that some of today's comments are forward-looking statements within the meaning of the federal securities laws. They involve risk and uncertainty and actual results may differ materially.

No one should assume that these forward-looking statements remain valid later in the quarter or later in the year. For a more detailed discussion of the major risk factors affecting our business, please refer to our latest forms 10-K and 10-Q filed with the Securities and Exchange Commission.

Our comments also include non-GAAP measures. Reconciliation to the nearest corresponding GAAP measures are in our earnings release available on our website.

On a U.S. GAAP basis, for the second quarter of 2018, NOV reported revenues of $2.1 billion and a net income of $24 million or $0.06 per share. Our use of the term EBITDA throughout this morning's call corresponds with the term adjusted EBITDA as defined in our earnings release.

Later in the call, we will host a question-and-answer session. (Operator Instructions)

Now let me turn the call over to Clay.

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Clay C. Williams, National Oilwell Varco, Inc. - Chairman, President & CEO [3]

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Thank you, Loren. This morning, I'm pleased to report that National Oilwell Varco posted solid results in the second quarter of 2018, with revenues increasing 17% sequentially to $2.1 billion. EBITDA was $226 million, representing 21% incremental leverage to our first quarter 2018 results.

On the whole, we continue our steady march out of the worst oilfield downturn of the generation, and I'm very proud of the fight that our employees have demonstrated as we've navigated this ordeal.

NOV has emerged with a great team, focused on producing great results for customers and our shareholders alike.

All 3 business segments performed well during the second quarter. In fact, all 3 posted double-digit revenue growth sequentially, with each segment benefiting from stronger second quarter demand in most major international markets. Canada was the exception, declining 16% on a consolidated basis due to its seasonal breakup and road travel bans, which occur every year during the spring fall. All 3 segments also posted solid sequential top line growth in the United States, with the company continuing to gain share in key products and services in the most active unconventional shale basins.

Specifically, Wellbore Technologies posted brisk growth in bits, MWD tools, downhole drilling tools and solids control technologies, which we've invested in and introduced through the downturn.

Drill pipe sales increases were helped by our new Delta premium connection, and we expect Delta drill pipe sales to double this year. Completion & Production Solutions achieved higher pressure pumping and wireline equipment sales, both here and abroad, along with higher sales of fiberglass tubulars and process and flow equipment. Rig Technologies finalized the creation of our joint venture with Saudi Aramco during the quarter, which brought in an order for 50 land rigs for the Kingdom. This was the largest land rig order ever placed.

The Rig Technology segment also sold 3 drilling rigs into the Vaca Muerta unconventional shale play in Argentina. After steadily declining through 2015, 2016 and 2017, we are pleased to see Rig Technologies backlog being replenished back to $3.5 billion, its highest level since the fourth quarter of 2015.

During the second quarter of 2018, we saw inflationary headwinds building, particularly in the United States. Labor costs are rising in many markets, not just in Midland, Texas due to the very low unemployment levels across the country. We are managing higher steel costs arising from tariffs as best we can with most, but not all, business units reporting that they are able to pass on at least a portion of the higher cost to our customers. Other commodities we buy are also seeing cost increases. Resin for our fiber glass pipe products, for instance, has risen 61% since the beginning of the year. All these factors can take a toll on our incrementals and our margins. However, our ability to recapture cost increases through pricing appears to be improving as oil prices remain high and as macro-driven winds continue to shift slowly to our backs.

We believe that three and a half years of E&P underinvestment, depletion-driven well declines, strengthening synchronized global economic growth and geopolitical flashbang events are all conspiring to drive the worldwide excess production capacity cushion down and oil prices up.

Our oilfield service customers, who comprise about 70% of our revenue base, are very good at postponing maintenance and cannibalizing equipment and keeping it all together with duct tape and bailing wire through at least the first part of the downturn. But as we said since the beginning, they can only do that for so long. So we're not surprised to see higher demand for spare parts for rigs; to see more orders for conductor pipe connections; to see higher demand for tubular coating and inspection services; to see more offshore special purpose surveys (or SPS's). Embedded in this demand mosaic are indications -- many increasingly clearer - that the E&P industry is getting back to playing offense in a $70 per barrel world. The growth that we are seeing in international markets points to E&Ps around the world stretching and warming up and readying themselves to get back in this game. This includes the offshore. Strong second quarter demand for conductor pipe connections for the offshore, for instance, is a good leading indicator of more offshore wells to be drilled in future quarters. Although still mostly focused on smaller tieback opportunities and brownfield developments, our rising levels of quotation and tendering activities for flexible pipe, processing skids and FPSO equipment are beginning to address more medium and large scale opportunities, consistent with industry forecast of more offshore FIDs in 2018. We're excited about the prospect of bringing new and better ways of producing oil and gas from deepwater basins to the next upturn. Technologies that we continued to hone and develop throughout the downturn that will further reduce our customers' cost per barrel.

In the offshore drilling space, we are quoting pipe handling, hookload and motion compensation upgrades to enable rigs to stand out in a crowded field of competitors. Rising SPS project volumes indicate contractors are gearing up for more bidding activity, although we had an urgent phone call to come fix equipment following a failed Do-It-Yourself project by a customer attempting to perform their own overhaul. Since you're not the OEM, please do not try this at home. Predictive analytics and new total cost of ownership aftermarket models represent new and growing opportunities for NOV that we are pioneering with our customers.

We are in the process of installing NOVOS, our exciting, new drilling rig operating system on the first offshore rig, with several more installations planned for customers in the queue. We have over 40 land and offshore rigs either installed or slated to be installed. Interest in this technology is keen.

Several third parties, including major oil companies, are developing apps to drive rig efficiency through this transformative open-platform NOV operating system, which will add to an already robust and growing app library.

The apps permitted by NOVOS, together with multimachine control, will continue to transform the job of the driller from rig driver to process manager. This will unleash the individual drillers' experience and judgment on more important big picture rig processes than tedious manipulation of tools and tongs. NOVOS is empowering drillers to do their very best work.

Technology and best practices never cease evolving in the E&P jungle. The current downturn is demonstrating that low oil prices merely prompt brilliant minds in this industry to think harder. And these brilliant E&P minds have steadily lowered the marginal cost to develop and produce oil and gas from conventional basins, unconventional basins and offshore basins. NOV has been a leader in all these basins as we have designed, built, tested and iterated new technologies to help drive this evolution. We are well-positioned for the upturn, which creeps a little closer every day.

The Middle East continues to be an area of great interest for us. NOV will bring key technologies needed to efficiently exploit the vast resources of this region. NOCs there remain keenly focused on the potential shale technologies developed in North America, specifically extended reach drilling along horizontal laterals and multistage hydraulic fracture stimulation and completion to drive better efficiency and productivity. The region is in need of upgrading its rig fleet and pressure pumping capabilities to achieve these results, which can be further enhanced with new capabilities like higher levels of automation, enabled by our NOVOS control system. Likewise, the Vaca Muerta in Argentina will also benefit from better drilling and completion equipment and technologies. Long precisely-placed horizontal laterals and hydraulic fracture stimulations will continue to be employed globally and will continue to transform the oil and gas industry for decades to come.

To our employees who are listening, I want to offer my thanks and congratulations on the outstanding work that you do every day to take care of our customers.

Loren, Jose and I appreciate everything that you do.

I'll turn it over now to Jose to provide more operational color. Jose?

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Jose A. Bayardo, National Oilwell Varco, Inc. - Senior VP & CFO [4]

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Thank you, Clay. To recap the quarter, NOV consolidated revenue was $2.11 billion, an increase of 17% or $311 million sequentially. EBITDA improved $66 million to $226 million or 10.7% of sales. Operating profit was $52 million or 2.5% of sales, and we posted net income of $24 million or $0.06 per share.

Looking at a couple of notable items on the P&L, SG&A increased $15 million sequentially, primarily due to higher incentive compensation and labor costs. Other expense fell $44 million due to losses associated with FX and certain assets in Q1 that did not repeat in the second quarter.

Cash flow from operations was $239 million, and capital expenditures totaled $63 million. Last quarter, we mentioned that we felt the M&A environment remained constructive, and we were optimistic about closing several acquisitions. During the second quarter, we completed 4 strategic transactions for total consideration of $244 million. While our M&A pipeline is not as robust today as it was last quarter, we continue to see interesting possibilities in the M&A market and we remain very well-positioned to opportunistically pursue compelling transactions.

Turning to results of our operations. Our Wellbore Technologies segment generated $793 million in revenue in the second quarter of 2018, an increase of $82 million or 11.5%. This segment delivered 37% incremental margins, resulting in a $30 million increasing in EBITDA to $133 million or 16.8% of sales. Each business unit within the segment experienced robust growth. Demand for our technologies that helped customers more efficiently and precisely drill wells meaningfully outpaced growth and activity levels in the U.S., and the Eastern Hemisphere shook off its lethargic start to the year. Our U.S. operational results were partially offset by the Canadian spring break-up, resulting in a 7% sequential revenue improvement in the Western hemisphere.

Significantly improved demand from the Middle East and Asia led to a 13% sequential improvement in our Eastern Hemisphere revenues.

Our Grant Prideco drill pipe business delivered a sharp sequential increase in revenue due to strong bookings in Q1. This increase was a welcome change after experiencing meaningful revenue declines over the past few quarters. More importantly, bookings remained strong in Q2 as they improved slightly from Q1.

We are seeing more demand emerging from international markets, particularly in the Middle East, an area in which we are realizing growing adoption of our Delta connections. While drill pipe market conditions are rapidly improving,the business continues to face challenges associated with low volumes, customers who remain capital constrained and inflationary pressures that have been further compounded by tariffs. Notwithstanding these challenges, we remain very encouraged about the potential for this business to deliver outsized growth and strong incremental margins in the mid- to longer-term as we continue to see customer inventory levels decline to extraordinarily low levels.

Our ReedHycalog business saw an 11% sequential improvement in revenue during the second quarter. Comparable growth was achieved by each of our three major product families in this business unit, which include our bits, borehole and coring products, our downhole measurement tools and our eVolve drilling automation and optimization services.

NOV's bits, borehole and coring product line realized particularly strong growth in the U.S. and in the MENA region. Our industry-leading ION-shaped cutter technologies, combined with strong execution of repair and maintenance services, are driving market share gains and commanding premium pricing.

We typically give our drill bit technologies a disproportionate amount of well-deserved airtime during these calls, but it's also worth highlighting that our coring and borehole enlargement offerings are well recognized by our customers for delivering compelling value to their operations.

Our dogleg reamer has become a standard part of the bottom-hole assembly for several customers in Kuwait, Oman, Qatar and Egypt due to its ability to deliver more than 50% reductions in back-reaming and trip-out times.

And our coring business is gaining share in the Middle East, where we recently received a 4-year contract from a large customer and covering all conventional and enhanced oil saturation coring product solutions.

In our downhole measurement tools operation, NOV's Tolteq MWD products drove solid growth in the U.S., Russia, China and Turkey, where we recently secured a large package order for our iSeries MWD products together with our vector-drilling motors. NOV's unique ability to independently provide these products supported our customer's efforts to establish a new directional drilling service operation in the country.

Our downhole business unit realized a 9% sequential increase in revenue, with strong EBITDA flow-through. This improvement was led by 10% growth in the U.S. and a sharp rebound and efficient tool sales and motor rentals in the Middle East. We're also seeing greater adoption of our Agitator axial oscillation systems in the region due to their ability to meaningfully improve drilling efficiencies.

For example, NOV recently worked with a major service provider in the Middle East to improve performance while drilling an 8.5-inch curved section. We recommended using NOV's Agitator HE plus with our HEMIDRIL drill motor, which improved the service provider's ability to drill through the curved section and extend horizontal reach, setting a new field record.

Our latest motor technologies and agitator tools are also driving better performance for our customers in the U.S. Using NOV's ERT power section and our Agitator product, a major operator in the Bakken averaged 286 feet per hour while drilling a well to a target depth of 20,960 feet. The 72.8 hour spud-to-TD time set a record for the company.

Outcomes like this create our reputation for industry-leading motor performance and longevity and help us drive market share gains. The results come from design teams that constantly challenge themselves to drive down the cost for our customers while delivering more torque and improved reliability; and from operational teams who leverage the latest manufacturing equipment and statistical process control techniques to ensure we deliver quality products to our customers.

Our WellSite Services business posted a 7% sequential increase from revenue, led by growth from our solids control services in the U.S., Argentina and Middle East. We're realizing market share gains in part due to our recently introduced SABRE shaker system, which has been proven to handle 1.5 to 2x the amount of drilling fluids compared to other high-performance shakers. SABRE also reduces oil retention on cuttings by approximately 10%, decreasing haul-off and disposal cost.

The business unit MD Totco operation notched key wins in West Texas and the Mid-Continent, the most notable of which was a 20-rig data acquisition system conversion for a customer in West Texas.

Lastly, our Tuboscope business unit delivered a 6% sequential revenue increase. U.S. coating operations improved 12% from increasing demand for drill pipe coating services. Our coating operations in the Middle East also saw significant growth due to delivery of a large order of our Thru-Kote connection sleeves. The delivery helped us set a record during the second quarter for a high sales volume of this patented product, which protects internal pipe coatings during welding operations.

For the third quarter, we expect our Wellbore Technologies segment to again outpace global activity, which should lead to mid-to-upper single-digit percent top line growth. Near term, we expect the impact of improving absorption and pricing on margins to be tempered by inflationary forces, resulting in Q3 incremental margins that are in line with Q2.

Notwithstanding near-term inflationary pressures, we continue to see a multi-year time horizon in which this segment can deliver attractive top line growth with strong incremental margins.

Our Completion & Production Solutions segment generated $738 million in revenue in the second quarter, an increase of 10% or $68 million sequentially. Robust demand for capital equipment in North America and strong operational level execution more than offset the ongoing challenges affecting our offshore-focused businesses. Despite these challenges, the segment delivered 31% incremental margins, resulting in a $21 million increase in EBITDA to $94 million or 12.7% of sales. Shipments slightly exceeded our bookings of $398 million, providing us with a 95% book-to-bill. We also realized a $35 million FX reduction due to a 15% devaluation of the Brazilian real to U.S. dollar. Total segment backlog at quarter end was $955 million.

Our Intervention & Stimulation Equipment business unit posted an 18% sequential improvement in revenue. This growth was the result of the significant increase in deliveries of pressure pumping equipment, improving demand for wireline equipment and coil tubing, healthy contributions from the business' new line of cementing equipment and improving execution in our aftermarket operations.

Bookings for the business unit were in line with the first quarter, resulting in a 99% book-to-bill on substantially higher shipments. The pickup in demand for new coiled tubing equipment we saw in Q1 carried into Q2, and we also realized a sharp increase in the demand for wireline equipment. While we are seeing some trepidation in the North American market for pressure pumping equipment, bookings for support equipment remain solid. And we continue to see opportunities for pump sales to customers who need to replace aging fleets as well as steady demand for repair and refurbishment related work. Industry conditions are improving and driving demand for equipment as are the technology innovations offered by NOV. Our latest data technologies, advanced designs and industry-leading capabilities allow our service company customers to be more effective and more efficient in pushing the boundaries on complex, extended-reach completions.

The market welcomed our recently introduced GoConnect technology for Intervention & Stimulation Equipment. During the first 6 months of this year, one major independent oil and gas operator has leverage 248 days of our GoConnect asset-linked data to improve operations on their completion jobs. The data was streamed from 7 different coiled tubing service companies. Recently, one of our coiled tubing service provider customers committed to equipping their entire fleet of coiled tubing units with our GoConnect data links.

Our latest asset designs are also realizing strong market adoption. We believe our new Genesis line of coiled tubing units is the industry's most technologically-advanced product offering. A number of innovative features enabled the units to safely and efficiently use the largest tubing loads possible for a market that continues to demand longer lengths of larger diameter tubing for extended-reach completion operations. Additionally, the units offer high visibility control cabins, providing a panoramic view of the wellsite as well as new electronic controls with customizable displays. Since we debuted the product at the ICoTA Coiled Tubing and Well Intervention Conference, we have received 8 orders for the new Genesis product.

Our new DynaWinch iMaxx wireline truck is also seeing rapid uptake in the North American market. The unique design configuration offers the industry's most expansive range of vision of the wellsite, providing wireline crews with significantly more visibility than any other wireline truck on the market. The design alleviates challenges associated with poor visibility, enabling crews to operate equipment faster without compromising safety. Despite an extremely short time on the market, we have already sold 14 units, and demand continues to increase.

Our Fiber Glass Systems business unit also realized an 18% sequential increase in revenue. Growing inflationary challenges stemming from increasing cost of raw materials, labor constraints and other inflationary pressures partially restrained EBITDA and flow through. However, the operation executed well as it significantly increased deliveries in the U.S. and South America from its backlog.

After posting three quarters in a row of bookings over $100 million, orders decreased in the second quarter, but we expect the bookings to return to the $100 million-plus range in Q3. This improvement will be driven by more and more domestic and international customers recognizing the long-term cost advantage of corrosion-proof composite pipe in a wide array of applications.

Our Process and Flow Technologies business unit realized a 10% sequential top line improvement as demand for reciprocating pumps and progressive cavity pumps for the U.S. midstream market remains robust. The business unit also executed well against its WellStream Processing backlog. While order intake for the land-oriented production at midstream portion of this operation is strong, bookings in its offshore-oriented WellStream Processing operation remains soft, although tendering activity for large projects is high. Market fundamentals are improving, resulting in increasing tendering activity for all of our offshore businesses. However, awards continue to be delayed, and most are not likely to be issued until late 2018 or early 2019.

We expect our offshore businesses to find bottom in the second half of 2018, and we believe current market dynamics are setting up an environment in which our well-positioned offshore business units will see substantial improvement in 2019.

Our Floating Production business continues to struggle with the challenging offshore market as new orders have remained scarce even though bidding activity is high.

Our Subsea Production Systems business unit saw a sequential improvement in revenue after the torsional stress-related challenges faced in Q1 was resolved. Despite the higher revenue, EBITDA declined due to its mix of offshore projects, and orders remained slow.

However, supporting our optimism for an improving market outlook for the offshores, what we're seeing in our XL Systems Conductor Pipe Connector business, which tends to be a leading indicator for offshore activity. Our backlog is building, and Q2 marks the fifth quarter in a row in which the business unit exceeded 100% book-to-bill.

Looking at the third quarter, we expect to see an additional 6% to 7% sequential improvement in segment revenue, with incremental margins ticking up to the mid-30% range as the rate of decline in our offshore businesses begins to moderate.

Our Rig Technologies segment generated $651 million in revenue, an increase of $168 million or 35%. Revenue out of backlog increased $123 million to $276 million due primarily to much improved progress on the construction of offshore newbuild drilling rigs and the delivery of two land rigs in the Middle East. Aftermarket revenues increased 14% sequentially, achieving their highest levels since the fourth quarter of 2015. EBITDA leverage was 23%, resulting in a $39 million increase in EBITDA to $84 million or 12.9% of sales.

We posted our third quarter in a row of improving bookings. Excluding the $1.8 billion order associated with our Saudi JV, we realized a 12% sequential increase in orders. As noted in the press release, we recently agreed to terminate a long-dated drillship contract with a customer in exchange for commitments to continue forward with other projects and certain other consideration. After deducting this contract, we exited the quarter with $3.5 billion in backlog for the segment.

As Clay mentioned, in addition to the 50-rig JV commitment, we also booked three land rigs, all destined for Argentina. We see more opportunities emerging in international markets and since quarter end we booked an additional rig sale for the Middle East.

In the U.S., at $25,000 a day, land rig day rates are at levels that can support super spec newbuilds, and we are discussing opportunities with some smaller domestic drillers. Larger contractors are more focused on upgrading their existing equipment as opposed to building new rigs. We're also seeing rising demand for higher capability well-servicing rigs emerging in the U.S.

Orders for offshore equipment improved 42% during the second quarter, primarily due to a large package of equipment for a mid-water semi, which included a subsea BOP stack and other equipment. We continue to anticipate the demand for newbuild floaters will remain limited outside of a few potential rigs for niche markets. However, we remain very encouraged regarding the opportunity NOV has to help the industry reactivate and upgrade the existing offshore fleet. Customer dialogue remains constructive, and we're seeing meaningful increases in projects related to reactivations and recertifications for assets preparing for future drilling campaigns.

Near term, we anticipate volatility in our quarterly bookings to continue as the business hovers near-cyclical lows. We also expect the margins to be pressured from a recent focus on converting inventory that has been slow to move during this prolonged downturn into cash while rewarding first-mover customers.

Specifically for the third quarter, we anticipate one to three percent top line growth, with margins falling between 100 to 300 basis points.

We delivered solid results in all three segments during the second quarter due to strong execution by the many talented employees at NOV. While there are some near-term challenges associated with takeaway issues in West Texas, an offshore market has not yet fully healed, and inflationary pressures in the U.S., we believe that a stronger global recovery is beginning to take hold and that NOV is exceptionally well-positioned to capitalize on the market opportunities that will emerge.

With that, we'll open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question will come from the line of James West with Evercore ISI. And our next question will come from the line of Byron Pope with Tudor, Pickering, Holt.

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Byron Keith Pope, Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research [2]

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I'll keep my question to one. And it relates to Wellbore Technologies. I tend to think of that segment as being the top line growth drivers -- driver for you guys over the next year or so. Could you frame where you guys are today in terms of the mix of shorter-cycle and longer-cycle products and services? And the reason I asked the question is it seems as though you've got some tailwind starting to perk up as it relates to some of the longer cycle product lines like Grant Prideco, so I'm just trying to get a feel for the relative mix today.

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Clay C. Williams, National Oilwell Varco, Inc. - Chairman, President & CEO [3]

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Yes. Good question, Byron. About 80% of that business is shorter-cycle components that go directly into optimizing our customers' drilling efforts, and the remainder being longer cycles or capital equipment like drill pipe and some shale shakers and things like that. So yes, it has been performing really well with the resumption of drilling activity across North America. And I'm very pleased to see that business unit's performance over the last several quarters, really. But what I'm most excited about within that space is -- or all the technologies that we've been investing in through the downturn that are specifically focused on delivering a lower tortuously wellbores that are closely geosteered into the sweet spots of the targets that the oil companies really want to aim at. And I think we're really now just starting to get traction some of the technologies. I think Jose highlighted a number in the -- in his remarks that we're pretty excited about. On the longer-cycle stuff, drill pipe had a really good quarter bounce back in the second quarter and good sequential growth. And so very pleased to see that and through -- likewise through the downturn there. We pioneered some new premium connections with our Delta connections, our Delta threads, and that's getting really good traction in the marketplace. Unfortunately though, in the second quarter, the mix shifted to be a little bit lower and smaller size and less fewer landing streams, and so that took a little bit of toll on the incrementals there. But on the whole, very pleased with where we are in our drill pipe business within Wellbore Technologies. And of note, we store drill pipe for our customers next door to our manufacturing facility in Navasota, Texas, and our customer-owned inventory within that yard is at the lowest level we've seen since 2010. So that's setting a pretty good backdrop, I think, for future drill pipe orders.

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Operator [4]

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And the next question will come from the line of Jim Wicklund with Crédit Suisse.

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [5]

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Very good step-up, Clay, from Q1. Nice recovery, well done. There is little doubt, I don't think, in anybody's mind that over the next couple of years, as the cycle unfolds, you'll do better. You make everything that's made in the business. You make it better than most everybody else in the business. And eventually, we need to replenish capital equipment. It's more the pace that has everyone a little questioning. But I noticed in the consensus for revenue growth for '19, The Street has you at higher revenue growth than the other big 4 oilfield service companies. And I'm just wondering if you kind of agree with that. And I realize that we don't have crystal ball into the back half of '18, so '19 is a little bit of a stretch. But when you think about the spending surveys and the work you've done preliminarily, and you guys are always good about thinking far in the future, is a 15% top line revenue growth in '19, higher than everybody else, achievable and likely?

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Clay C. Williams, National Oilwell Varco, Inc. - Chairman, President & CEO [6]

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Well, Jim, we -- as a matter -- I don't generally like to comment on consensus numbers and so forth. And we rarely give that sort of quantitative outlook on growth. What I would tell you is, as I mentioned with a drill pipe as a great example here, 3.5 years of underspending across this sector. And as we can both agree, this is a very capital-consumptive sector. And the activities that our oilfield service customers undertake consumes a lot of capital that a resumption of buying that's meaningful, immaterial and will drive that top line growth at NOV. I think very realistic that, that's going to be a powerful engine for our revenues in 2019 and beyond.

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Jose A. Bayardo, National Oilwell Varco, Inc. - Senior VP & CFO [7]

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I'll also just add to that, that the nature of a capital equipment business is a bit different than that of the service business as Clay is just describing there. So it's really across all of our segments. We think the businesses typically inflect in a different period of time than you expect service companies to inflect. And oftentimes, they inflect a bit harder once they actually do inflect.

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Clay C. Williams, National Oilwell Varco, Inc. - Chairman, President & CEO [8]

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Yes. One -- the other thought here too, Jim, is -- that I would add is what's been missing for all of us, and this includes NOV and as well as the big 4, is the offshore. And that's an important revenue and margin driver for everybody. And although it's very early, our prepared remarks noted that we're starting to see rising levels of bidding activity and quotation activity and specific sales like conductor pipe. Flexible pipe was up this quarter. Signs of encouragement, and the offshore does come back in 2019, we'll probably all exceed growth forecast that are out there.

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [9]

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Which actually leads to my follow-up question. Is deepwater coming back in '19? I look at the Exxons, Chevrons, BPs and Shells and wonder how much of their '19 budgets though, Jim, in the deepwater just yet. And so the bids you're getting, the tenders you're getting, the conductor pipe orders that you're getting, are these -- do you think that there's going to be a resurgence in drilling and development activity overall? Or is this just a transition year to what's going to be a material improvement later on? I'm just curious to know where you all think about -- how much deepwater can improve in '19. You sound very bullish.

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Clay C. Williams, National Oilwell Varco, Inc. - Chairman, President & CEO [10]

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Well, again, I'll stress this is very early. We're seeing indications, a lot of bidding and discussions. What's lacking so far though are -- FIDs are picking up, but we're not seeing as many purchase orders as we would like. So I want to frame it realistically for kind of what we're seeing. Specifically, with regards to our conductor pipe connectors, just about everything we sell through that product line is for the offshore. And so -- and the group that you mentioned is back to buying more of these, so that would point to more wells that they have planned. So we're really pretty excited about that. And one of those companies that you mentioned told me about 3 weeks ago that their deepwater, offshore portfolio now is probably more compelling economically than their unconventional portfolio. (inaudible) making progress on their economics, and so we're kind of setting up for, I think, a recovery in the offshore. And so that's why we're more optimistic about the out-years.

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Jose A. Bayardo, National Oilwell Varco, Inc. - Senior VP & CFO [11]

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I'll add one more thing, Jim. It's Jose. We're not -- we're optimistic that we see improvement in the offshore market in 2019, but there's also an international land market out there. And if you think about our performance...

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [12]

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And it's already coming back, right?

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Jose A. Bayardo, National Oilwell Varco, Inc. - Senior VP & CFO [13]

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Well, it's really just getting started, right?

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James Knowlton Wicklund, Crédit Suisse AG, Research Division - MD [14]

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Agree. But at least we can see that.

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Jose A. Bayardo, National Oilwell Varco, Inc. - Senior VP & CFO [15]

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Right. And if you think about our results to date, so really look at a segment like Wellbore Technologies, who are about 45% up from the trough in that business unit, with virtually all of that improvement coming from one country called the United States of America. And it's really the west of the world is just starting to wake up and for a global enterprise like NOV, that helps a lot. You see the same dynamics in our cap segment as well. So we're excited about where things are shaping up for 2019.

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Operator [16]

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And the next question will come from the line of Bill Herbert with Simmons.

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William Andrew Herbert, Simmons & Company International, Research Division - MD & Senior Research Analyst [17]

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Jose, can you provide us with at least what you have kind of violating Clay's dictum here in terms of providing forward guidance on revenues? But I'm just curious with regard to your thoughts on rig tech, revenue out of backlog but forward [patch] for that for the next 2 to 6 quarters as it were. What do we expect for the balance of the year? And what are your thoughts for 2019?

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Jose A. Bayardo, National Oilwell Varco, Inc. - Senior VP & CFO [18]

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Well, Clay is in the room, so how about if I limit it to just 2018. I'll give you a little bit, which -- (inaudible) the numbers will be coming out in Q when we file it a little bit later this afternoon. So as you look at the last 6 months of the year, our expectation for revenue out of backlog for rig tech is about $587 million. So as you could sort of get a sense for them, the guidance that we provide, it's a small tick up from where we were in the second quarter for Q3.

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William Andrew Herbert, Simmons & Company International, Research Division - MD & Senior Research Analyst [19]

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Got it. And with regard to the Aramco contract, great win for you guys. Do you have a sense as to what that represents likely in terms of annualized revenue generation for you? I mean, it's 50 rigs. So how many of those get out the door on an annualized basis, do you think, at this juncture?

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Jose A. Bayardo, National Oilwell Varco, Inc. - Senior VP & CFO [20]

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We'll be ramping up, Bill, with first rig deliveries expected 2021, maybe recognizing a little revenue on a POC basis before that, but building up to that sort of notional 5 rigs per year. And if you do the math, it's about $36 million of rig on average. I will tell you there's a mix of different rig sizes in that, between 1,500-horsepower and 2,000-horsepower, but our customer -- customers may have the option to upgrade those to large rigs with additional revenue possible.

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William Andrew Herbert, Simmons & Company International, Research Division - MD & Senior Research Analyst [21]

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Okay. And last one for me is you talked about it a little bit in your prepared commentary, but drilling activity in the Permian, flat for the past 2 months. Completions activity in June, flatten out month-over-month. Clearly, the secular outlook for the Permian is awesome, but we're likely to hit a speed bump here with WTI and Midland at [53]. And who knows if it's going lower? Do you have thoughts with regard to how that impacts your shorter-cycle businesses' lever to the Permian?

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Clay C. Williams, National Oilwell Varco, Inc. - Chairman, President & CEO [22]

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Yes. Certainly, like everybody else here, we're facing a little softer outlook, I think, over the next couple of quarters. But I don't think, on the whole, it's going to be terribly material to NOV at this point. What we expect -- our near-term outlook for our stimulation and equipment sales to the pressure pumpers in the U.S. is softening as a result of this as well. But what's encouraging is we're hearing from those customers kind of the same perspectives that I know you've heard as well, which is that the current level of operations consumes a lot of equipment. And so we're still seeing -- we're still having conversations with lots of pressure pumpers for replacement and sort of support equipment to go in to replace pump trunks as they wear them out.

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Operator [23]

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The next question comes from the line of Sean Meakim with JPMorgan.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [24]

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So starting with the shorter-cycle businesses, wellbore and caps, I was wondering if you could maybe talk about the cadence of how those businesses could feel impact to the extent that completions activity gets curtailed in the Permian, and to a lesser degree, rig activity. And by impact, I mean, we did see some reduction in maintenance needs if activity slows. But then on the other hand, we've heard from the largest pumper that there's value in taking advantage of some more caps, maybe catch up on some maintenance work. So I was just curious what you thought the read through could be for your business if and when that materializes.

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Clay C. Williams, National Oilwell Varco, Inc. - Chairman, President & CEO [25]

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Yes. It's hard to say, but you raise something that we see there, which is when things -- areas like this slow down a little bit and equipment comes back in the shop. A lot of customers will actually step up spending to get that equipment ready to go again. And I think the consensus of a few out there is that this takeaway capacity issue in the Permian is transient. And so I think you'll probably have pressure pumpers spending time kind of upgrading and maintaining that equipment, and which means spending money on aftermarket parts and services with NOV. I think you'll also see activity shift to other basins as well, which will probably help mitigate the impact of the Permian. But look, it's early days out there. None of us are quite sure how this is going to unfold, but -- well, we're certainly keeping a close eye on it.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [26]

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Fair enough. And I was thinking about just cash sources and uses. On sources, Jose, we've talked about -- you mentioned a push towards liquidating inventory to a degree, incentivizing customers' who order equipment. Let's generate some cash here near term. Are you seeing signs of ability to maybe improve your receivables metrics? And then on uses, you mentioned the M&A pipeline may be a bit smaller after some of the deals that you've done. Do other uses of cash, maybe on your shares, (inaudible) move up the priority list, just how you're thinking about sources and uses, I think, could be helpful.

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Jose A. Bayardo, National Oilwell Varco, Inc. - Senior VP & CFO [27]

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Sure. Yes. As it relates to the sources, the quarter and the year-to-date have sort of played out as we expected. We knew the first half would be a little softer from a cash flow generation standpoint than kind of what we've seen in the last couple of years, but anticipate it improving as we move through the course of the year. And we started to see signs of that improvement during the second quarter. So we saw things headed in the right direction at a $311 million increase in revenue, with a decrease in working capital, even though it was pretty modest. It's definitely heading in the right direction. And on the AR front, we saw that go down about $135 million. So things heading in the right direction. And as you probably get a sense from the bookings and orders that we're talking about, we're seeing more and more opportunities to move some of that inventory that has been sitting on the shelves over here throughout the course of the downturn. So definitely seeing more opportunities, definitely make more progress, but we still have quite a ways to go. So as we usually talk about our working capital metric, working capital as a percentage of annualized revenue run rate, we're down about 44% this quarter. We still are striving to get down into the mid-30% range by the end of next year. So I said heading in the right direction and think that the cash flow generation will tick up -- continue to pick up as we move through the course of the year. As it relates to uses, so we've been very pleased with the opportunities that we have seen to date to invest capital that we think will turn out to be investments at very high rates of return for our shareholders. Nothing has changed from our perspective in terms of our capital allocation hierarchy and our belief that this business will generate tremendous amount of cash over the next 24 to 48 months. But our number one priority is to make high-return investments for our shareholders. As you look into -- I mentioned in the prepared remarks that the pipeline isn't as robust as it was at this time last year, but we're still seeing interesting opportunities. And we're optimistic about finding some good opportunities to deploy capital. But in the event they do not emerge, the balance sheet is in great shape right now. And we're heading towards a point of where we might view ourselves as being overcapitalized. And if we see that scenario playing out, we'll look to return that capital to shareholders.

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Clay C. Williams, National Oilwell Varco, Inc. - Chairman, President & CEO [28]

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Yes. I'd add too on the M&A front, although it has slowed -- I mean, we had 4 big closings in Q2, so a lot of good progress here. But very recently, we had another opportunity that sort of reemerged that we had thought had disappeared. So there's things like that, that can pop up, that are really good applications to capital, and to Jose's point, earning great returns for our shareholders. And we certainly want to make sure we're taking advantage of those.

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Operator [29]

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The next question will come from the line of Marshall Adkins with Raymond James.

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James Marshall Adkins, Raymond James & Associates, Inc., Research Division - MD of Equity Research and Director of Energy Research [30]

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All your businesses did awesome this quarter, but rig tech was a particular standout after, it seems like forever, of declining offshore stuff. Give us more color on that. Specifically, I'm looking for -- we have a whole bunch of unfinished rigs in the shipyards. Are we starting to see that come around? The aftermarket, you mentioned, is up really nicely. Is that going to be the driver going forward? Is it more of the land stuff? You got the Saudi thing a little further out. I've got several questions on how sustainable this rig tech recovery is. So could you give us more color on that sustainability?

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Clay C. Williams, National Oilwell Varco, Inc. - Chairman, President & CEO [31]

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Great question, Marshall. And what I would say is if you look back over the last 8-plus quarters, I think rig tech, after declining over 80%, has traced out a pretty stable business in the 5 to -- we just did $651 million range, so $500 million to, call it, $700 million range, at high single-digit or double-digit -- low double-digit EBITDA margins. And so fantastic effort by the team over there dealing with a pretty extraordinary downturn in the business. What that business comprised of in the second quarter that we just reported was nearly half aftermarket and the other half, capital equipment. And the resumption of progress on offshore rigs being built in Asia -- and yes, that contribute a little bit, but it was more -- a little more broad-based than that in the offshore. And then pretty good quarter with regards to land rigs we shipped to the Middle East. And so what you're seeing that business is continue to transform itself to be more balanced between land and offshore. And I think for the foreseeable future, it's likely to continue to be that. Jose, I think you mentioned in your prepared remarks that since the close of the second quarter, we've now sold another rig in the Middle East. And so that's -- it's going to continue to be a little lumpy, and margins are going to continue to move around a little bit. But I think we are after the big downturn. I think we're achieving stability here. And then looking forward, what's most exciting to me about Rig Technology is the fact that these new NOVOS control systems are really creating a lot of buzz in the marketplace. And we've got major oil companies keenly interested in putting these to work to improve their operation. We've got real commercial Big Data predictive analytics products that now are in their third year of being used in the field that have demonstrably improved operations. And we've taken the next step of signing up with customers to harness the power of these things to reduce their total cost of ownership. And so we've got aftermarket agreements with a couple of offshore drillers around that. So in terms of kind of Rig Technology, I think we found firm footing. We've got great execution by the team there. We've continued to invest in the next generation of technology, and I think that we're set up for future prosperity.

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James Marshall Adkins, Raymond James & Associates, Inc., Research Division - MD of Equity Research and Director of Energy Research [32]

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All right. So we'll check the sustainability box there. Just unrelated follow-up on the wellbore side. Jose, on the margin bump we saw, it sounds like most of that was throughput-related. You're starting to fire back up the drill pipe factories. How much of that's pricing? And then going forward, help us kind of weigh that --you mentioned costs are going to go up. Should we think about this more as a throughput issue? Or a pricing issue? And how are costs going to affect that out for the next year?

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Jose A. Bayardo, National Oilwell Varco, Inc. - Senior VP & CFO [33]

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Yes. (inaudible) is to date, through the recovery, what we've mostly seen in terms of delivering almost 50% incrementals off of the bottom since Q2 of 2016, the majority of that comes from improved utilization and throughput, offsetting all the absorption challenges we are having in the depths, the down cycle. We're now starting to get more and more opportunities to ratchet up pricing. And actually, our incremental margins for Q2 were a little lighter than what we had expected due to some of those inflationary forces coming in as well as, as Clay alluded to, a little bit of mix issues with a huge bump up that we saw from our Grant Prideco drill pipe business. So as I mentioned in my prepared remarks, we feel really good about the ability for that business to deliver very strong incrementals over a long period of time because utilization certainly helps a lot. We've got that in the U.S. now. We're going to start to build that in the international markets over the coming years, and then we still have pricing opportunities to layer across that. Plus the drill pipe business tends to further enhance incremental margins over the longer term. So feel really good about where that business is headed.

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Operator [34]

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And our next question will come from the line of Marc Bianchi with Cowen.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [35]

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Maybe start with Jose, just a housekeeping item. Can you give us any guidance on the unallocated expense that you're expecting here for the third quarter? It increased quite a bit in the second. Suspect that's somewhat related to rig tech, but curious how you're thinking about there for the third quarter.

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Jose A. Bayardo, National Oilwell Varco, Inc. - Senior VP & CFO [36]

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Yes. You're right. So that the revenue elims, in particular, tend to follow the -- our revenue associated with our rig business to all the intercompany business with our wellbore segments and caps business units selling to the rig segment primarily with some sales going the opposite direction as well. So when you see a big pickup -- in Rig Technologies, you're going to typically see both those numbers tick up on the revenue as well as the EBITDA or OP side. So a little bit disproportionate pickup on the profit side due to the fact that we saw some increases associated with payroll. Really, what we're talking about is incentive comp. We obviously had a pretty rough Q1 and had to make up some lost ground on that front in Q2. So ultimately depends on how Q3 shakes out. What we're seeing right now is we expect it to be flattish overall.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [37]

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Okay, that's great. And then on completion production, you're talking about a second half bottoming in the offshore part of the business. Can you remind us what proportion of revenue is coming from offshore right now? And maybe help frame what the downside looks like between here and the bottom, recognizing timing's really difficult to call on that?

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Clay C. Williams, National Oilwell Varco, Inc. - Chairman, President & CEO [38]

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Yes. I'd say on the order of 20-ish percent.

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Jose A. Bayardo, National Oilwell Varco, Inc. - Senior VP & CFO [39]

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Yes.

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Clay C. Williams, National Oilwell Varco, Inc. - Chairman, President & CEO [40]

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Something in that range is probably the offshore mix. We've got a number of business units in there that's sort of sold to both land and offshore. And -- so that's the kind of our exposure there in that business.

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Marc Gregory Bianchi, Cowen and Company, LLC, Research Division - MD [41]

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Okay. And then would you say something like 20% downside would be extreme, in your view, in terms of here to the bottom on offshore?

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Clay C. Williams, National Oilwell Varco, Inc. - Chairman, President & CEO [42]

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Yes, yes. By the way, sorry, I think I misspoke on that last one. Our offshore mix in the second quarter, I'm looking at here, is 29%, so 71% land.

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Jose A. Bayardo, National Oilwell Varco, Inc. - Senior VP & CFO [43]

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It depends on...

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Clay C. Williams, National Oilwell Varco, Inc. - Chairman, President & CEO [44]

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That's the question that's being asked. That's for the segment overall, but if you look at kind of the pure -- the more pure play type offshore businesses, it's in that 15%, 20% range so...

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Operator [45]

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Thank you. And this does conclude today's question-and-answer session. I would now like to turn the conference back over to Mr. Clay Williams for closing remarks.

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Clay C. Williams, National Oilwell Varco, Inc. - Chairman, President & CEO [46]

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Thank you, Sabrina. Appreciate everyone joining us this morning, and we look forward to hosting you when we report our third quarter results in late October. Thanks, everyone. Have a great day.

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Operator [47]

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Ladies and gentlemen, thank you for participating in today's conference. This does concludes your program. You may all disconnect. Everyone, have a great day.