National Oilwell Varco 2010 Annual Report Download - page 37

The count of rigs actively drilling in the U.S. as measured by Baker Hughes (a good measure of the level of oilfield activity and spending) peaked
at 2,031 rigs in September 2008, but decreased to a low of 876 in June 2009. U.S. rig count has since increased to 1,739 in early February 2011,
and averaged 1,687 rigs during the fourth quarter of 2010. Many oil and gas operators reliant on external financing to fund their drilling programs
significantly curtailed their drilling activity in 2009, but drilling recovered across North America as gas prices improved and, more recently, as
operators began to drill unconventional shale plays targeting oil, rather than gas. During the fourth quarter of 2010, oil drilling rose to an average
of 43 percent of the total domestic drilling effort, compared to 22 percent in the first half of 2009.
Most international activity is driven by oil exploration and production by national oil companies, which have historically been less susceptible to
short-term commodity price swings. The international rig count has exhibited modest declines nonetheless, falling from its September 2008 peak
of 1,108 to 947 in August 2009, but recently increased to 1,161 in January 2011.
During 2009 the Company saw its Petroleum Services & Supplies and its Distribution Services margins affected most acutely by a drilling
downturn, through both volume and price declines; nevertheless, both of these segments saw pricing stabilize and revenues recover modestly
since the third quarter of 2009. The Companys Rig Technology segment was less impacted owing to its high level of contracted backlog which
it has executed on very well since the economic downturn. Rig Technology posted higher revenues in 2009 than 2008 as a result, but revenues
declined in 2010 as its backlog declined.
The recent economic decline beginning in late 2008 followed an extended period of high drilling activity which fueled strong demand for oilfield
services between 2003 and 2008. Incremental drilling activity through the upswing shifted toward harsh environments, employing increasingly
sophisticated technology to find and produce reserves. Higher utilization of drilling rigs tested the capability of the worlds fleet of rigs, much of
which is old and of limited capability. Technology has advanced significantly since most of the existing rig fleet was built. The industry invested
little during the late 1980s and 1990s on new drilling equipment, but drilling technology progressed steadily nonetheless, as the Company and
its competitors continued to invest in new and better ways of drilling. As a consequence, the safety, reliability, and efficiency of new modern rigs
surpass the performance of most of the older rigs at work today. Drilling rigs are now being pushed to drill deeper wells, more complex wells,
highly deviated wells and horizontal wells; tasks which require larger rigs with more capabilities. The drilling process effectively consumes the
mechanical components of a rig, which wear out and need periodic repair or replacement. This process was accelerated by very high rig
utilization and wellbore complexity. Drilling consumes rigs; more complex and challenging drilling consumes rigs faster.
The industry responded by launching many new rig construction projects since 2005, to: 1) retool the existing fleet of jackup rigs (according to
Offshore Data Services, 71 percent of the existing 459 jackup rigs are more than 25 years old); 2) replace older mechanical and DC electric land
rigs with improved AC power, electronic controls, automatic pipe handling and rapid rigup and rigdown technology; and 3) build out additional
deepwater floating drilling rigs, including semisubmersibles and drillships, employing recent advancements in deepwater drilling to exploit
unexplored deepwater basins. We believe that the newer rigs offer considerably higher efficiency, safety, and capability, and that many will
effectively replace a portion of the existing fleet, and declining dayrates may accelerate the retirement of older rigs.
As a result of these trends the Companys Rig Technology segment grew its backlog of capital equipment orders from $0.9 billion at March 31,
2005, to $11.8 billion at September 30, 2008. However, due to the credit crisis and slowing drilling activity, orders have declined below amounts
flowing out of backlog as revenue, causing the backlog to decline to $4.9 billion by June 30, 2010. The backlog increased modestly through the
second half of 2010 as drillers began ordering more than the Company shipped out of backlog, and finished the year at $5.0 billion.
Approximately $4 billion of contracted backlog is scheduled to flow out as revenue during 2011 and $1 billion is scheduled to flow out as
revenue during 2012. The land rig backlog comprised 14 percent and equipment destined for offshore operations comprised 86 percent of the
total backlog as of December 31, 2010. Equipment destined for international markets totaled 86 percent of the backlog. The Company
experienced relatively minor levels of order cancelations since 2008 (less than four percent), and does not expect additional material cancellation
of contracts or abandonment of major projects; however, there can be no assurance that such discontinuance of projects will not occur.
Segment Performance
The Rig Technology segment generated $7.0 billion in revenues and $2.1 billion in operating profit or 29.6 percent of sales, excluding transaction
charges, during 2010. Compared to the prior year revenues declined 14 percent, and operating profit flow-through or leverage (the change in
operating profit divided by the change in revenue) was 19 percent for the segment. For the fourth quarter of 2010 the segment produced revenues
of $1,757 million, representing a six percent improvement from the third quarter and an 11 percent decline from the fourth quarter of 2009.
Segment operating profit was $500 million and operating margins were 28.5 percent during the fourth quarter. Operating profit flow-through was
19 percent sequentially, and 30 percent year-over-year. Revenues from higher-margin offshore projects declined from the third quarter of 2010 to
the fourth quarter, and lower-margin revenues from land rigs and well intervention equipment increased, resulting in a modestly unfavorable mix
shift that pulled margins down and produced low incremental leverage on the revenue gains for the group. Many of the offshore projects were
contracted at high prices in 2007 and 2008, and are now being manufactured in much lower cost environments, and benefit from greater project
execution experience within the group. Non-backlog revenue, which is predominantly aftermarket spares and services, declined one percent
sequentially and 37