NOV Inc.
Q2 2016 Earnings Call Transcript

Published: 28 Jul 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the Second Quarter 2016 National Oilwell Varco Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder, today's conference maybe recorded. I would like to introduce your host for today's conference, Mr. Loren Singletary, Vice President of Investor and Industry Relations. Sir, please go ahead.

[Loren Singletary:]

Thank you, Michelle, and welcome, everyone to the National Oilwell Varco second quarter 2016 earnings conference call. With me today is Clay Williams, President, CEO, and Chairman of National Oilwell Varco, and Jose Bayardo, Senior Vice President and Chief Financial Officer. Before we begin this discussion of National Oilwell Varco's financial results for its second quarter ended June 30, 2016, please note that some of the statements we make during this call may contain forecasts, projections, and estimates, including, but not limited to, comments about our outlook for the company's business. These are forward-looking statements within the meaning of the federal securities laws based on limited information as of today, which is subject to change. They are subject to risk and uncertainties 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. I refer you to the latest Forms 10-K and 10-Q National Oilwell Varco filed with the Securities and Exchange Commission for a more detailed discussion of the major risk factors affecting our business. Further information regarding these, as well as supplemental financial and operating information, may be found within our press release on our website at www.nov.com or in our filings with the SEC. Please be aware that our use of the term EBITDA throughout the call this morning will correspond with the term adjusted EBITDA as defined in our press release. We also use other non-GAAP measures as described in our press release. On a U.S. GAAP basis for the second quarter of 2016, National Oilwell Varco reported revenues of $1.72 billion and a net loss of $217 million or $0.58 per share. Now, let me turn the call over to Clay.

[Clay C. Williams:]

Thank you, Loren. In the second quarter of 2016, National Oilwell Varco did post revenues of $1.7 billion, down 21% from the first quarter and down 56% from the second quarter of 2015. Revenues declined more than expected, due mostly to offshore drilling contractors further delaying acceptance of new builds. The $26 crude oil prices we saw in February inflicted new agony on the oil field, sending second quarter expenditures further downward and driving U.S. rig counts to record lows going back seven decades. NOV generated a loss of $0.30 per fully diluted share excluding severance, facility closure costs, and other items, totaling $0.28 per fully diluted share in the second quarter. EBITDA was $25 million for the quarter and operating loss was $153 million, excluding $117 million in other items from both. Operating cash flow was $128 million for the quarter. Our managers continued to aggressively downsize our business to match the available market, enabling NOV to manage to decremental EBITDA leverage, ex other items, of only 22% sequentially. Our workforce was reduced 10%, and SG&A declined 16% during the quarter, solid cost reduction results in the face of continuing pricing and absorption pain. EBITDA leverage ex other items has been 30% on the 70% revenue decline since the present cyclical downturn began. We continue to manage costs aggressively, but we're also maintaining our investment in promising new opportunities we see for our business when prosperity returns. New technology and lower costs will lead to higher incremental roles and margins for NOV in the eventual recovery, and I will speak to our efforts in both areas. First on cost, our team is resolute in our commitment to improve efficiencies, reduce capacity, and generate higher profitability. During the second quarter, we detailed additional cost reduction steps that totaled over $400 million in annualized savings that will flow in over the next few quarters. Plans developed and actions taken during the second quarter are on top of considerable work performed already, having reduced our annual personnel cost well over $2 billion from peak levels. Since the downturn began, we have closed or are closing over 250 facilities to reduce capacity in view of lower demand. We have also insourced work being previously outsourced to retain as many of our employees as possible and to help with absorption. Importantly, we do not believe we have sacrificed our ability to ramp up and respond to the eventual recovery. In a moment, Jose will take you through our detailed operating results by segment, but overall we expect these specific actions to lead to modestly higher EBITDA in the third quarter on a modest decline in revenues, with more savings driving even higher EBITDA in the fourth quarter on roughly flattish sequential revenues. Like others in our space, we believe we are seeing some isolated green shoots of activity, and we are encouraged that the North American rig counts have begun to increase. We have seen demand rise in recent weeks for certain products and services for North America

[Jose A. Bayardo:]

Thanks, Clay. To quickly recap our consolidated results, revenues for the second quarter of 2016 were $1.7 billion, down 21% from the first quarter and in line with the 19% sequential decline in global rig counts. Revenues declined 23% in North America and 20% internationally as the North American and international rig counts fell 35% and 7%, respectively. Adjusted EBITDA was $25 million, down $102 million from the first quarter of 2016. Sequential decremental EBITDA leverage was limited to 22% as efforts to resize the business and reduce our cost structure had their intended effect. Operating loss, excluding other items, was $153 million. Looking at select other line items of the P&L, SG&A decreased by $56 million or 16% sequentially and by $125 million or 30% year-over-year. SG&A is now down $944 million on an annualized basis since the fourth quarter of 2014. Interest and other financial costs expense increased $5 million sequentially, mostly driven by incremental interest costs of approximately $2.5 million, attributable to a large capital lease we booked in late Q1, as well as other charges we do not expect to repeat next quarter. Therefore, we anticipate interest expense to be between $27 million and $28 million for Q3. Other expense for the quarter increased $13 million sequentially, driven primarily by a greater loss on disposals and fixed assets. Our GAAP effective tax rate was 35.8% for the quarter, and our rate, excluding other items, was 41.5%. As a reminder, in the current environment, relatively small changes in the split between domestic and international results can have a disproportionate impact on our tax rates. In the third quarter, we anticipate the tax rate to be approximately 38%. Turning to the balance sheet and cash flow, working capital decreased $253 million from the first quarter of 2016. A decrease in working capital was primarily the result of a $247 million reduction in inventory levels, a $190 million reduction in customer financings, which is the decrease in cost in excess of billings, netted against the decrease in billings in excess of costs and customer prepayments, and a $168 million reduction in accounts receivable. The reductions in working capital were partially offset by decreases in accrued liabilities and accounts payable. While working capital decreased by over $250 million, we continue to carry more working capital than required to support the business at today's activity levels as converting inventory and receivables to cash remains challenging in the current environment. Cash flow from operations totaled $128 million. After deducting $77 million in capital expenditures, $19 million in dividend payments, $15 million for acquisitions, and $14 million in other items, we were essentially breakeven from a cash flow perspective for the quarter. Therefore, net debt remained mostly unchanged at approximately $1.6 billion. During the quarter, we paid down our commercial paper by $100 million, leaving us with a balance of approximately $110 million. At June 30, 2016, we had a cash balance of $1.7 billion, $3.3 billion in total debt, and our debt-to-capitalization was 16.8%. Our Rig System segment generated revenues of $564 million during the second quarter of 2016, down 39% sequentially from $926 million and down 71% from the $1.9 billion posted in the second quarter of 2015. Sharp revenue declines were anticipated in the second quarter due to reduced backlogs and more projects approaching completion. However, the falloff in revenue was stronger than expected as customers who lack contracts or face pressures from operators to delay projects do what they can to defer deliveries. Second quarter EBITDA for Rig System segment was $49 million. Efforts to resize the rig systems business and reduce the cost structure to mitigate the effects of the falloff in revenues had the intended result leading to decremental margins of only 24%. EBITDA margins fell 610 basis points to 8.7% of sales. Operating profit, excluding other items, was $30 million or 5.3% of sales. For the second quarter, the split between offshore and land-related revenue was roughly two-thirds onshore and one-third land. New construction of offshore rigs accounted for $213 million in revenues or 12% of NOV's consolidated revenue. New orders were down $31 million sequentially to $66 million in the second quarter, representing a 10-year low. Book-to-bill was 15% when new orders are compared to the 44 – compared to the $441 million shipped out of backlog during the quarter. Q1 bookings primarily consisted of pressure control systems and other replacement equipment. For the third straight quarter, we received no new rig orders. Near-term demand for offshore remains almost nonexistent outside of replacement equipment. Discussions continue regarding midterm opportunities, which include one-off specialized 20-K drill ships and speculative mid-water semi-submersibles. However, we do not anticipate these orders materializing in 2016. The land markets appear much more promising as conversations with customers in North America, the Middle East, and certain other international markets are increasing regarding equipment upgrades and new field opportunities. More and more, operators are demanding modern, pad optimal, Tier 1 AC rigs for potential upcoming projects, and contractors are seeking to upgrade and expand their capabilities in order to position themselves to capture incremental market opportunities. While offshore opportunities will remain limited for the foreseeable future, we believe our land business will bottom in Q3 and begin to recover as we enter 2017. We continue to work diligently on restructuring and resizing the business for anticipated future volumes. Our focus is on standardizing processes, optimizing structures, and eliminating all redundancies in our global operations. This focus is designed to ensure the flexibility and agility needed to respond to recovery of significantly reduced costs in lead times. We anticipate revenue out of backlog will fall another $81 million in the third quarter to $360 million and anticipate an 18% to 20% falloff in total segment revenue, as we continue to work off our backlog on existing projects. Decremental margins should be in the low 20% range as we expect normal decrementals to be partially offset by $15 million in cost savings, resulting from more efforts to cut costs and improve efficiencies as we restructure the business. Our Rig Aftermarket segment generated $643 million in revenue during the second quarter of 2016, down 7% from $391 million in Q1 of 2016 and down 45% from $657 million in the second quarter of 2015. EBITDA for the segment was $73 million or 20.1% of sales, down 11% sequentially and down 55% from the prior year. EBITDA decremental leverage was limited to 33% as cost controls were able to partially offset the decline in total revenue and an unfavorable mix shift as sales of spare parts continue to decline, while lower margin service and repair work began to improve. Operating profit, excluding other items, was $67 million or 18.4% of sales. Spare parts sales continued to decline during the second quarter; however, bookings on spares began to solidify as we entered the third quarter. Customers have depleted existing inventories and are now getting to the point to where they must order new parts in order to support their existing operations. Service and repair work rebounded during the second quarter as reactivations in the U.S. began to take place and the number of special periodic survey projects increased by 30%. While the number of projects and associated revenue are increasing, strained customers continue to reduce the scope of projects and associated purchases as much as possible. Our condition-based monitoring services continue to gain traction and deliver value for our customers. Our RIGSENTRY service, which was introduced last quarter, identified potential failures of subsea BOPs before they occurred on four separate occasions, potentially saving our customers millions of dollars in unplanned downtime. Operational success is driving commercial success as our monitoring service revenues increased by over 50% during the quarter. We expect the pace of stacking offshore rigs will continue to accelerate, a difficult process which will ultimately help rebalance an oversupplied market. In the current environment, rig aftermarket remains focused on providing industry-leading OEM parts, service, and support that we have delivered over the years to take care of our customers' operating needs anywhere in the world. We also continue to partner with our customers to develop innovative solutions for their most pressing needs. Today, our customers cannot afford extra downtime and need to be optimally positioned to capitalize on any new opportunities. As previously noted, we are seeing strong demand for our condition-based monitoring solutions, which allow contractors to predict failures and address problems before they occur. We are also seeing growing demand for other recently introduced offerings designed to address the stress our customers are under in the current environment. Some of these offerings include in-field certification services, for which we travel to rigs anywhere in the world to provide required certifications on active locations, resulting in substantially reduced downtime, rig performance services in which we assess and review a customer's equipment to identify opportunities for improving operational efficiencies and minimizing downtime, and storage preservation and reactivation services, which lowers the cost of stacking equipment and enables faster reactivation of rigs, creating a competitive advantage for contractors in securing new contracts. Notwithstanding the remaining challenges in the offshore space, conversations with our customers leave us cautiously optimistic that we are at or near a bottom for our rig aftermarket business. While we anticipate a tepid near-term recovery, driven by reactivation-related business in the U.S. and pent-up demand for offshore parts, service, and repair work, we could still see revenue decline in the third quarter by a couple hundred basis points. We also anticipate realizing roughly $5 million in cost savings during the third quarter, which should more than offset decrementals associated with the revenue decline. Our Wellbore Technologies segment generated $511 million in revenue during the second quarter, down 19% sequentially from $631 million and down 47% sequentially from the $956 million in the second quarter of 2015. Revenue mix by destination was 43% North America and 57% international. North America revenue declined 24% compared to the 35% decline in rig count, and international revenue fell 13%, exceeding the decline in the international rig count as drilling activity in the Middle East registered its sharpest decline since this down cycle began. EBITDA was $1 million, down $42 million from the previous quarter and $156 million from the prior year. Sequential EBITDA decrementals were 35%. The segment reported an operating loss, excluding other items, of $96 million for the quarter Throughout this cycle, we have been intensely focused on what we can control. We aggressively pursued the declining number of business opportunities that were available and continued to invest in and drive innovation with our customers' interests at heart, meaning our focus is on improving oil field efficiencies by reducing time and costs while improving well productivity. We have also been relentlessly focused on resizing the organization, lowering our cost structure, and optimizing our processes. Additionally, we have repositioned our people and operations to focus on the customers and basins around the world which we believe will be the most active throughout the next cycle. These actions have taken place across all four of our operating segments and all 15 business units. But today I will highlight a few representative examples from within our Wellbore Technologies segment. In our dynamic drilling solutions business, we have streamlined our operations, enhanced relationships with old and new customers, and we continue to execute well with our legacy offerings. We recently displaced a primary competitor across the fleet of one of the largest private rig contractors in North America with our data acquisition and information management systems. Additionally, we have continued investing in delivering innovative solutions to better serve the current needs of our customers, including, one, building out capabilities and executing revenue generating contracts associated with real-time drilling data acquisition, visualization, and optimization technologies; two, delivering substantial drilling improvements for customers with our eVolve optimization and closed-loop drilling automation services; three, introducing a new MWD tool; and, four, introducing our geo gas analyzer, the first patented Fourier transform infrared spectrometer, specifically designed to provide real-time gas ratio analysis for formation hydrocarbon identification. In our drilling and intervention business, in addition to launching a number of literally groundbreaking technologies such as our rotary steerable tool, and multiple innovative new drill bits and motors, we have substantially improved our product development and manufacturing capabilities. Investments made in streamlining processes, leading edge manufacturing equipment, and repositioning operations have us well positioned for the future. Changes implemented in our drill bit business have reduced the time it takes to take a new drill bit design from concept to finished product down to six weeks from over 16 weeks as recently as a year ago. These changes will also allow us to reach prior peak volumes with a 25% lower head count and will allow us to maintain substantially lower inventory levels, reducing working capital and the potential for obsolescence. In our field service-related operations, we have numerous examples of how we have repositioned our assets and our personnel to become much more intimate with our customers, focused on regions that will be the most active in the future. Our Wellsite Services Business has added to the capabilities in Argentina, which positions us well for the anticipated long-term ramp in activity within the Vaca Muerta field. Here recently an operator utilized our Wellsite Service Business Unit's PETROS fluid system and solids control services in addition to a myriad of other NOV products and equipment to drill the deepest horizontal well yet in the Loma Campana block of the Vaca Muerta field. Circling back to our drilling and intervention business, we have reduced the average turnaround time for repairing bits and redressing motors in certain key basins around the world, including the Permian, from three weeks to one week, by expanding our field service and repair facilities. This type of improvement significantly enhances our ability to take care of our customers and reduces inventory requirements. As you can tell, we haven't simply reacted to a sharply deteriorating market over the past six quarters. We have and will continue to play offense. In May, the U.S. land rig count was down 80% from the prior peak, and the past two quarters have had successive declines of approximately 20%, but it appears things have begun to stabilize, at least within the North American marketplace. While there is cautious optimism about rigs getting back to work, the extent of declines have induced a level of trauma that likely delays a meaningful recovery until next year. For the third quarter, we expect our Wellbore Technologies segment's top line to increase a couple hundred basis points with mid-30% incremental EBITDA margins. We also expect to realize an additional $15 million benefit in Q3 due to our ongoing cost-cutting and operational efficiency initiatives. Our Completion and Production Solutions segment generated $538 million in revenue during the second quarter, down 4% sequentially from $558 million, and down 38% from $873 million recognized in the second quarter of 2015. EBITDA was $57 million or 10.6% of sales, an increase of $9 million from the previous quarter, but down $91 million from the prior year. The segment reported operating profit, excluding other items, of $5 million for the quarter. EBITDA improved on lower revenue, due to cost-cutting initiatives, operational efficiencies, and strong improvements in our subsea business as the operation benefited from high absorption in both of its manufacturing facilities and executed well on existing orders. We took in $269 million of new orders, down $59 million sequentially, and shipped $333 million in revenue from backlog, resulting in an 81% book-to-bill. The segment ended the quarter with a backlog balance of $947 million, $47 million lower than the prior period. While our subsea business had strong levels of activity this quarter and our plants should remain busy through at least year-end, the outlook for offshore-related projects remains challenging and pricing pressures persist. These challenges extend into other offshore-oriented businesses, including our floating production operations, where there is limited visibility into additional projects outside of our existing backlog for the remainder of the year. We do, however, remain optimistic regarding midterm prospects as we continue to have strong dialogue regarding FPSO opportunities with customers. And our new relationship with GE is contributing towards rapidly advancing our efforts to engineer and offer integrated topside solutions with standardized interfaces, which should materially improve the economics of deepwater production development. With the average price for WTI still hovering below $50 a barrel during the quarter, new order intake remains soft. While certain operators have slightly increased activity related to working down the inventory of drilled but uncompleted wells in the U.S., it has not yet translated into an increase in activity for our well intervention and stimulation business and other completion-related offerings. But conversations regarding the plans to step up activity have increased. Additionally, we are seeing slight increases in production and infrastructure-related offerings, something we see as a good indication operators are preparing to get back to work as they cannot complete wells without having the production infrastructure in place. For the third quarter, we expect revenue to increase around 10% as we execute on certain large projects booked earlier in the year and see continued improvement in our production-related businesses. We should see 30% incrementals on the increase in revenue, and we expect to realize an additional $10 million benefit from the ongoing cost savings and efficiency enhancing initiatives which are occurring across the segment. While market conditions have proved challenging through the first half of 2016, we have been able to generate cash flow from operations of approximately $750 million, more than twice the amount produced during the first half of 2015. With a current cash balance of $1.7 billion and an undrawn capacity on our credit facility of $4.4 billion, we have total liquidity in excess of $6 billion. So from a financial standpoint, NOV is very well-positioned. We hope our commentary this morning also provided you with insights into how well NOV is positioned from an operational and strategic standpoint. We are working hard to continue our long history of pioneering the critical technologies which drive the oil and gas industry, and the entire team at NOV remains laser focused on reducing our cost structure and fine-tuning our ability to execute more efficiently, regardless of the market environment. And with that, Michelle, we'll open it up to questions.

[Operator:]

Thank you. Our first question comes from the line of Kurt Hallead with RBC. Your line is open. Please go ahead.

[Kurt Hallead:]

Hi, good morning.

[Clay C. Williams:]

Hey, Kurt. Good morning.

[Kurt Hallead:]

So I wanted to focus a little bit more on the rig aftermarket. You mentioned that you are starting to see some pickup in inquiries. And I just wanted to make sure I heard you correctly. Was most of the inquiries coming from the land business or is there some mix of land and offshore?

[Clay C. Williams:]

I think we're really seeing a mix of both, Kurt. It's certainly active dialogue and action related to reactivations and re-mobilizations in the U.S. land market, as well as more dialogue and more action related to service and repair-related activities offshore, as well as some reactivations that have been taken place in the Gulf.

[Kurt Hallead:]

Okay. Great. And then I was also wondering, as you guys are always very active in potential M&A, do you feel like we are at an inflection point where deals could start to get done and bid-ask spreads have kind of narrowed?

[Clay C. Williams:]

Yeah, we do, Kurt. In 2015, we had a lot of conversations underway, but not many closings as valuations continued to move downward. I think as we entered 2016 we're starting to see, I think, counterparties that are really coming to grips with the very, very tough market we all find ourselves in. And so that's helped in driving bids and asks together. And so I am actually very encouraged with the number of conversations that we have underway. We had about, I don't know, seven or eight closings, I think, so far this year, and lots of other conversations that are under way. And, as you've seen, many that we referred to in our comments on this call and in the preceding call, a lot of really interesting technologies that I think will have a lot of leverage in an up cycle.

[Kurt Hallead:]

Great. And then one more follow-up, maybe for you, Clay, is a lot of discussion in the marketplace, given the – it looks like the dearth of offshore drilling orders that are going to take place over potentially a multi-year period, that there's some viewpoint out in the marketplace that NOV is going to feel pressured to do a deal to kind of offset that business segment and potentially get into something a little bit different than just the manufacturing element. I was wondering if you might be able to provide some insights on how you're thinking about the longer-term review and whether or not NOV needs to get involved in something else other than manufacturing?

[Clay C. Williams:]

Well, first, I would say that we don't disagree. I mean, you go back to our comments and we're kind of hunkering down for a much lower level of building in the offshore. And certainly that's been a big business for NOV over the preceding 12-plus years. And but that's also nothing new. That narrative has been out there for a year and a half, and frankly we, since the downturn began, have been kind of preparing for a near term future that looks that way. And in view of that, we haven't jumped out there and done a great big deal. What I would tell you is I think we can get more impact from our capital by continuing to knock out these sort of bolt-on transactions that are little bit smaller. When we examine the portfolio of acquisitions that we 've made over the preceding 20 years, we find consistently that the smaller transactions carry higher returns and lower risk. The specific examples that we've done here in the last six months have been really interesting technologies, have brought on really, really good people. The Trican team, for instance, who came in with the completion tools business, is very experienced in that space and can help us grow and build the business. If you look back at our history over the preceding 20 years, we've done a couple of large deals, but the business units that we have today, that are mostly market leaders around the globe, were really built kind of transaction by transaction, smaller acquisitions bringing in really high quality businesses and products and technology and management teams and kind of brick by brick. And to me that's a more efficient, more workmanlike and more effective way to kind of build out global leading franchises. And so if we see a terrific opportunity that's much larger, certainly we'll act on it. But realistically I think we can do and will do a lot of good by continuing to deploy capital through the down cycle and a lot of smaller, interesting, high-value acquisition targets.

[Kurt Hallead:]

That's great color. Thanks, Clay.

[Clay C. Williams:]

You bet. Thank you.

[Operator:]

Thank you. And our next question comes from the line of Sean Meakim with JPMorgan. Your line is open. Please go ahead.

[Sean C. Meakim:]

Hey, good morning.

[Clay C. Williams:]

Hi, Sean.

[Sean C. Meakim:]

So Clay, I was hoping that maybe you could talk a little bit more about the GE partnership. There's just – seems like a lot of potential there. Is there any way you can help us size some of that potential? Maybe just a couple of different ways to think about it could be you're starting with brownfield opportunities, which makes sense, but what the cost savings could look like for the customer or time savings to first oil, things that can really drive the value on greenfield projects. And what's the potential for you all?

[Clay C. Williams:]

Yeah. Sean, we – a few years ago when we sort of began to invest in the FPSO opportunity, we did a little study or actually had an industry expert do a study around the FPSO construction results for the industry. And they looked at, I want to say, a dozen or more vessels. And on average they're 35% or more over budget and more than a year late. And when you talk about delaying production that much, when we talk about those sorts of cost overrun, that's a huge inefficiency in the space. And so in terms of the savings that this may carry, I think, realistically bring a more industrialized sort of supply chain, standardization in the design, kind of the partnership that we're forging with GE. I think, it's going to materially move the needle. Though the size of each individual project for the two of us is going to vary a lot, given the size and capabilities of the FPSO. But it can easily range well over $200 million per vessel for the larger FPSOs and beyond. And so that is exciting. But more specifically, in terms of the near-term opportunities, the brownfield focuses, the idea here is that we can develop families of small FPSOs that really target one, two, four, five wells and make those smaller accumulations more economic. What's interesting is, you look statistically across deepwater basins, there's a lot more smaller fields than there are giant fields. And so it's a larger opportunity set, a way that a new technology, new sort of industrialized system that enables the many, many, many more smaller fields to be produced will enable GE and NOV and our shipyard partners to get up the learning curve on making these vessels. And so it seems that it will sort of grow on itself, and so we're pretty excited about that. The other kind of element to the strategy I would also point out, is that a lot of these larger fields, some of the inefficiencies around FPSO construction stem from the fact that the view of the field changes over time. And so the forecast on production profiles and the like changes over time. So part of our idea is if we can take one of our small FPSOs and put it in a larger field and put that field under production for a year or two, the owner of that field gets a lot smarter. And it enables all parties to sort of optimize the design of the larger FPSO that might come in later and produce the field through many more wells. So on the whole very excited about the partnership. I think GE is going to be a great partner and bring a lot to the mix.

[Sean C. Meakim:]

Got it. Thank you for all that detail. And then I guess I wanted to touch on rig systems also. Throughput has been coming in generally below expectations. Of course then that just pushes right into the right, but can you give us some more detail on what's driving that confidence stabilization exiting 2016?

[Clay C. Williams:]

Sean, so yeah. We're seeing – it's obviously a very challenging environment today. There is a lot of stress and strain on the systems. We're continuing to progress all of these contracts forward and are maintaining really good relationships with both the shipyards and the drilling contractors as well. But there's certainly a tremendous amount of tension between the drilling contractors and the shipyards, and to some degree we're helping facilitate those discussions. And so while those pressures are in place, things tend to – customers tend to want to put off acceptance of rigs, particularly for the rigs that don't have contracts in place. We still feel really good about the overall position, but, as you know, we are very cautious about making sure that we don't get over the tips of our skis in terms of the balance of sort of where we are in terms of progress payments and the amount that we have at risk. So trying to keep the overall portfolio in a positive position, and that's how we're managing the business.

[Loren Singletary:]

Yeah. We also see, I think, as you move into 2017, I think – and Jose had this in his prepared remarks – our outlook for the land side of the business is improving, and so – and the number of conversations we have under way. Part of what we saw in the second quarter were reactivations of land rigs in North America. And we've got others, drilling contractors interested in not pulling the trigger yet on purchase orders, but interested in talking about new rigs. And then in many international markets around the globe also. So I think you're going to see our mix shift in the future – in the coming quarters a little more towards land.

[Sean C. Meakim:]

Okay. Got it. Yes. Thank you very much for the time.

[Operator:]

Thank you. And our next question comes from the line of Marshall Adkins with Raymond James. Your line is open please go ahead.

[J. Marshall Adkins:]

Morning, guys, a lot of great detail there. Appreciate that. A couple of just conflicting things, and you probably reconciled them but I just missed it. Clay, you started out saying you're not really willing to call a bottom yet, but it sounds like in a lot of your businesses you are at a bottom, probably saw it in Q2. So I just want to get a little more color. That we all know the offshore rig systems is going to be challenged for a while, but outside of that you said you were at or near bottom of rig aftermarket. Wellbore tech and completions seem like they're there, too. Am I missing something?

[Clay C. Williams:]

Well, Marshall, I'll stress what was also in my opening remarks, which is we are seeing businesses within those segments continuing to decline, and we're seeing pricing pressures continuing to mount, particularly overseas generally. And so, again, kind of at or near bottom, a lot of crosscurrents, a lot of moving pieces. What I can tell you with a great deal of certainty, though, is that we are definitely taking costs out of these businesses, continuing to do that. And so, yeah, I hope you're right. I hope we are at bottom and maybe even have bottom in the rearview mirror on the company's business units, but not ready to jump out there and say that emphatically.

[J. Marshall Adkins:]

Okay. Unrelated follow-up, clearly you have capacity to expand in upturn, which we're looking for. What are going to be the bottlenecks on the way up? Is labor going to be an issue, or is there something else? I know you guys have spent a lot of time thinking about this. Is there something else we should be watching in terms of bottlenecks on the way back up?

[Clay C. Williams:]

Yeah, I would say our external supply chain, which we have talked a lot about insourcing over the last year and a half and have done a lot of that, when I think back to the ramp up from 2006 onward, a lot of time and effort went into qualifying our vendors and kind of developing a supply chain that supports our operations. And, honestly, in terms of cost cutting in 2015 that was kind of the first actions that we took, was to insource more and try to keep our factories loaded. So kind of building out our supply chain once again will be challenging. Labor will be a challenge certainly. Obviously a very painful time for this industry and for this company to lose so many talented people, and attracting those folks back or folks that can come in and kind of grow with us is going to be challenged. But look, this is nothing new in the oil field. This is a cyclical business, and I think we've said in prior calls, one of the critical skill sets you got to have the ability to both reduce quickly in markets like this, but also the ability to grow quickly when it goes the other way. And so, frankly, we're looking forward to solving the challenges that the upturn are going to bring to us.

[J. Marshall Adkins:]

Pretty sure we're all looking forward to that. Thanks.

[Loren Singletary:]

Amen.

[Operator:]

Thank you. And our next question comes from the line of Tom Curran with FBR Capital Markets. Your line is open. Please go ahead.

[Tom P. Curran:]

Good morning, guys.

[Loren Singletary:]

Hey, Tom.

[Clay C. Williams:]

Good morning.

[Tom P. Curran:]

When it comes to the continued uptrend, the secular uptrend in completion demand intensity, the focus, understandably, tends to be on the implications for hydraulic fracturing, horsepower, and proppant consumption, primarily sand. And yet on Dover's Q2 call, they rightly reminded us that it has implications for other offerings, such as rod lift and the amount of rod consumption you'll see as average lateral lengths continue to increase. Could you give us an update on all those different offerings for you, or maybe just highlight a few where you're seeing the greatest impact of the continued uptrend in demand intensity?

[Jose A. Bayardo:]

Sure, Tom. Hey, it's Jose. I will start off on this, and then Clay can take you back. But it's a good question and I think there's – people sometimes have some misperceptions about our portfolio and product offering. But really as we see the trend that is moving forward across not just North America but all markets, that trend is related to more product-consumptive wells, more service intensive and product-consumptive wells. It's not just impacting specifically completion, what you think of as traditionally completion-related items. It really impacts the entire well construction process. So even though we are drilling much more efficiently and the rate of penetration is much, much higher, on a per footage basis the amount of tubing, bits, motors, et cetera, that you consume is remaining essentially the same on a per foot basis. Additionally, when you are putting in the volumes of sand and proppant and all these other items, you think about the flow-back type operations, you think about production chokes and things of that nature, that's an area where we're seeing a lot of demand for our products. And I think earlier Clay touched on rod lift and the rods, where we are seeing a lot of demand and attention put on that product offering. So across our Wellbore Technologies segment, as well as some large components of our Completion Solutions segment, we're going to see a good impact from the trends that are taking place.

[Clay C. Williams:]

Yes. Specific on artificial lift, we did see a pick-up in the second quarter on rod guide application, and we did a little bit of that. Robbins & Myers brought a lot more to our Tuboscope unit within Wellbore Technologies, and we saw a pick-up in the second quarter. A lot of these shale wells are going on rod lift pretty quickly. And those products are in addition to downhole progressing cavity pumps, rotating heads, other artificial lift products that we have. And those are in addition to, as Jose just mentioned, production chokes, our dynamic oil recovery system for produced water. We have a lot of production and a growing portfolio of production equipment and processing and treatment equipment, centrifugal pumps, LACT units, those sorts of things. So NOV, we've been quietly investing more in that area and kind of growing out that portfolio. And we would absolutely echo Dover's comments that it's not just the horsepower. It's everything else that goes with that that will benefit.

[Tom P. Curran:]

All right. Thank you for that, guys. Returning to the M&A line of questioning, if you were to consider a more sizable transaction, given your current expectations with regard to the timing and the strength of the recovery, what is the highest you would be willing to take your leverage exiting that transaction?

[Clay C. Williams:]

I am actually going to beg off answering that specifically. We have looked at larger transactions. I think my earlier answer kind of gave you a feel that it would have to be very, very compelling, and I think we would have to look at the actual opportunity and the proximity to the upturn to make the call on kind of what we would think would be an appropriate balance sheet profile going into that. So that is all very, very speculative. But, just to state it more bluntly, I think we are mostly interested today, as we look out across a big and growing portfolio of potential M&A opportunities, in pursuing a lot of smaller critical technologies, bolt-on sort of adds that we really think are going to create the most shareholder value for our shareholders in the upturn. And again, I can't stress this enough. This is sort of how we really did build the business over the last 20-plus years, and having now moved into much more of a buyer's market, that sort of roll up your sleeves and get out there in a lot of conversations and look for opportunities to add on smaller acquisitions, I think, is the best application of capital. Conversely, to go out there and to make one larger bet on one larger transaction and sort of say, well, that's it, it's just far less appealing.

[Tom P. Curran:]

All right. I appreciate the thoughts, guys.

[Operator:]

Thank you. Our last question will come from the line of Byron Pope with Tudor, Pickering, Holt. Your line is open. Please go ahead.

[Byron K. Pope:]

Good morning.

[Clay C. Williams:]

Good morning.

[Loren Singletary:]

Hi, Byron.

[Byron K. Pope:]

I had a question about Completion and Production Solutions, and with regard to the Q3 guidance and top line being up sequentially. I would think that that would be elements of well intervention and onshore production that would lead the way, but I was just wondering, maybe Jose, if you can provide some color on what's driving that? And if you spoke to it earlier, I apologize.

[Jose A. Bayardo:]

No problem, Byron. It's a combination of factors. One of the items driving it is a large anticipated shipment from – related to an order in our well intervention and stimulation business. But as we also talked a little bit about, we're seeing some pretty good orders coming in and discussions related to more production-oriented equipment. So that's the primary factor associated with the pickup in revenue.

[Clay C. Williams:]

Yeah. We've also seen pretty good demand on flexible pipe for Brazil as well.

[Byron K. Pope:]

Okay. And then, Clay, one question for you, just sticking with completion and production solutions, it seemed as though, I guess, when you all had your Analyst Day, it seems as though one of the long-term goals for that segment was this notion of integration. And it seemed as though E&P operators weren't necessarily standardizing on surface production and processing equipment. Is it your sense that during this downturn and maybe coming out of this downturn, more appropriately, E&P reception to that more standardized integrated model on the surface production side might be gaining some traction?

[Clay C. Williams:]

Yeah. If you're talking about FPSOs certainly, and I think our customers recognize their model is broken, and so there's a lot of receptivity to doing things differently there. With regards to onshore, it remains fairly fragmented. Volumes are down and so our customers, I think, are more open to buying – assembling their own packages. However, there are benefits to our customers through acquiring a little broader package of equipment when it comes to putting in processing equipment for land wells as well.

[Byron K. Pope:]

Okay. Thanks, guys. I appreciate it.

[Jose A. Bayardo:]

Thanks, Byron.

[Byron K. Pope:]

Thank you.

[Operator:]

Thank you. And this does conclude today's Q&A session. And I would like to turn the conference back over to Mr. Clay Williams for any closing remarks.

[Clay C. Williams:]

Thank you, Michelle, and thank you all for joining us. We look forward to speaking to you next quarter.

[Operator:]

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