Good day ladies and gentlemen and welcome to the National Oilwell Varco third quarter 2018 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. [Operator Instructions]. As a reminder, this conference call 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.

Welcome everyone to National Oilwell Varco's third 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. Reconciliations to the nearest corresponding GAAP measures are in our earnings release available on our website. On a US GAAP basis, for the third quarter of 2018, NOV reported revenues of $2.15 billion and net income of $1 million. 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. Please limit yourself to one question and one follow-up to permit more participation. Now, let me turn the call over to Clay.

Thank you Loren. National Oilwell Varco's revenue in the third quarter of 2018 increased 2% and EBITDA increased $19 million to $245 million or 11.4% of revenue. While the company posted consolidated sequential improvement, our third quarter performance fell short of our expectations. This was due to a combination of market headwinds which arose late in the quarter in North America, a sharper than anticipated falloff or product sales into offshore markets and a couple of self-inflicted execution challenges, which we were focused on fixing. Jose will go into these in more detail in just a few minutes, but generally our completion and production solutions segment saw completion services customers slow deliveries of pressure pumping units, spares and coiled tubing strings in September in North America. Some of these revenues were pushed out into the fourth quarter as deferred units are delivered but nevertheless, we recognize that our North American customers for this equipment are facing lower day rates in pricing. It began slowing acceptance of equipment on order and cutting expenditures to manage their cash flows over the past few weeks. The completion and production solutions segment's offshore products also showed significantly lower sequential sales, which were partially offset by much higher sales of fiberglass pipe and completion tools at good incrementals throughout the third quarter. The wellbore technologies group achieved its expectations for revenue, but with a different mix owing to some tool shipments that didn't make it out by the end of the quarter, which was roughly offset by higher drill pipe and drilling fluid sales. Margins for the group were below expectations due to mix and inflationary forces around labor and steel. We been less successful than we anticipated at passing on higher costs as our customers are pushing back hard on price increases. Rig Technologies…

Thank you Clay. To recap the quarter, NOV's EBITDA improved $19 million to $245 million and operating profit increased by $21 million to $73 million. However net income declined sequentially to $1 million due to higher other expense and a higher tax rate. Other expense increased $17 million, primarily due to FX losses from the continuing devaluation of the Argentine peso against the U.S. dollar. Argentina was designated as a highly inflationary economy requiring us to change our peso currency functional ledgers to U.S. dollar functional during the third quarter, a change that has the unintended effect of amplifying the impact of movements between the Argentine peso and the U.S. dollar on our income statement. Other expense also reflects a small loss associated with a divestiture of a small non-core operation. Pre-tax income totaled $33 million and we reported an income tax provision of $29 million. The outsized income tax expense is primarily the result of valuation allowances, which prevent us from fully recognizing tax credits and other increases in non-deductible expenses. As we previously mentioned, we will continue to have significant volatility in our effective tax rate until we begin reporting higher levels of pre-tax income. One other item on the consolidated P&L worth pointing out is SG&A, which increased $17 million sequentially due to higher employee benefit and workers' compensation costs and an increase in property tax assessments. We expect to report a slight sequential increase in SG&A in the fourth quarter. Looking at our operating segment detail. Lower inter-company sales led to an $11 million sequential decrease in revenue eliminations. This decrease along with lower compensation costs and a reduction in third-party service expense resulted in an $18 million EBITDA improvement at the eliminations and corporate cost line. Most of our business units sell products or services…

[Operator Instructions]. And our first question comes from Mr. James West with Evercore ISI.

Hi. Good morning guys.

Good morning James.

Good morning James.

Clay or Jose, I was wondering if you could kind of bracket for us, we share the bullishness around the offshore markets in the rig reactivations that you are starting to see and what does it cost for, I think these offshore drillers really went to the bottom of the barrel on spares and things like that during the downturn, because they had to. So to reactivate a cold stacked rig today, whether it's a jackup or a floater, can you give us some idea of what that would be in terms of revenue for NOV?

Yes. It's a question we get frequently, James, but it's kind of like asking how long is a piece of rope, hence it depends on a lot of things. First, what condition was that rig in when it was stacked? How hard was it run prior? Secondly, what conditions was it stacked under? And so, were doors welded shut? Were dehumidifiers put onboard? Did you have a crew going around sort of bumping the electronics and cycling through the equipment periodically? And then, thirdly, how long has it been stacked? We believe that after two, three years, the cost of reactivating that rig starts to go up exponentially. So there are a lot of variables here. And what I would tell you is, what we have seen is, it costs across all over the map. Generally though, given how difficult it is to store this complex equipment in salt air and this is equipment that we have been building through the last 10, 15 years, it really wasn't designed to be stacked. None of us really know. So I would generally take the over. We do have one data point of an offshore rig that we are working on now that's basically a $40 million ticket to us. So I think the industry is going to find out as it goes back to work. But there's a lot of work for NOV and our competitors to do to put these rigs back to work.

Okay. But you would say that some of the estimates that have been out there from some of your customer base, generally speaking, do you think the over is probably more likely now? It's not going to matter to really investors, because the rig is going back to work, but those probably are going to be a series of overruns, cost overruns?

Yes. I am not referring to any specific estimate or any specific comment by a customer, but just generally taking equipment off the beach and putting it into a shipyard and really opening the hood and seeing what's under there. Until you do that, none of us really know. And I think even the drilling contractors wouldn't acknowledge this. There's still some uncertainty in that. But nevertheless, I think we continue to move towards a world where more and more rigs are going to get reactivated and we have had several data points in our prepared remarks a few minutes ago around this. And so this is kind of where it starts. We alluded to it last quarter. We kind of saw it build through the third quarter. And so again, we are still a long way from a robust recovery, but it begins with drilling contractors looking at reactivating rigs and we are seeing clear signs that many of them are really thinking hard about it.

And Clay, what's the timeline on a reactivation? When do they need to talk to you about the equipment versus when the rigs is supposed to, it should be back on contract and working?

The sooner, the better.

I am sure.

We are pretty responsive. We certainly have some slack capacity. However it does take a lot of time, a lot of engineering effort that goes into these rigs. And actually in terms of tangibly what we are hearing from our customers, it's more along the lines of that. We are doing more engineering upfront work around these rigs to see what's needed and that's starting to go. But it's not a trivial undertaking. And if history is a guide and I am going way back now, but usually when these stacked rigs go into shipyards and actually do get reactivated out of warm stacking or cold stacking, usually projects tend to run over budget and over time. I would also add that, it's quite ubiquitous, we do have some slack in the capabilities right now, but like virtually anything in our portfolio when things inflect, they tend to inflect pretty sharply and people come through the door at the same time. So one of the things that we are already talking about and worrying about a little bit is a good problem to have when it arises, is how do we expand that capacity, because we are certain that will happen at some point. And things will get tight in a hurry. But we are looking forward to addressing that challenge.

Sure. Got it. Thank guys.

Thanks James.

Thank you. Our next question comes from James Wicklund with Credit Suisse.

Hi Jim.

Hi guys. Good morning. International expectations out there seem to be for either high single-digit or low double-digit growth. The U.S. is expected to recover, you guys note that. Which one do you think in 2019 wins the race in terms of who grows the fastest? And which one is best for NOV? Is it better if international grows by 11% or the U.S. grows by 11%? Which benefits you guys the most?

That's a hard question, Jim.

Well, we don't have the easy ones, Clay. You know that.

No. The good news is, NOV is certainly exposed to both. We are introducing new technologies to both. We have a lot of optionality with respect to both. And so I think that's all good. We are happy. I am happy with growth anywhere and I think that's good for the portfolio. Like I said, we have continued to position ourselves around unconventional technologies that in the past three or four years have clearly been outpacing activity gains in other areas. I think 2019, you are going to continue to see more international customers look at employing these in their respective areas of operation. We are already seeing that in Argentina. We are seeing growing interest in the Middle East. And so, I think that trend is going to steadily kind of move ahead. The other big opportunity for NOV overseas is the fact that the unconventional share revolution in North America started by replacing all of the older rigs with new modern AC rig technology and the Eastern Hemisphere still has a long, long way to go in that respect. And so, I think we are kind of in very early innings of seeing that happen as well. So I can't do it. I don't know which one wins. I hope they both win.

The tie of high numbers.

But NOV really, again, we are positioning for that sort of recovery. And rolling into 2019 with materially higher oil prices than we have had over the past couple of years and a recognition of under-investment across kind of the global oil and gas infrastructure is setting up a pretty good backdrop for 2019.

Okay. That's very helpful. I appreciate it. And when we talk about offshore, the improvement has been somewhat limited really so far to jackups and more shallow rigs. There have been more tenders for deepwater. But going into IOC budget season, some of that has to be just updating at least for budget submission. Can you talk about the scale differences between the work you do on jackups versus floaters? I know floaters are a whole lot more expensive, but just in terms of the workflow we see out there? I know you sell a lot of equipment to the deepwater floaters, but in terms of reactivations and the work you are doing, can you talk about the difference as we transition from jackup and shallow water into floaters over the next couple of years?

Yes. Clearly the floaters are a bigger opportunity around reactivations. There is a lot more sophisticated equipment onboard, but nevertheless we have got good opportunities with jackups as well. In fact, we just introduced a new crane design that is kind of special fit for purpose for jackups that can be retrofitted and kind of improve their capabilities. So the opportunity is in both arenas, but the floaters typically are a little bigger ticket item for us.

Okay. Gentlemen, thank you very much.

Thank you Jim

Thank you. Our next question comes from Byron Pope with Tudor, Pickering, Holt.

Good morning guys.

Good morning Byron.

The continued topline growth for international wellbore technology suggest that you guys are having good success in terms of being that enabler to some of the independent service companies there. But Clay, I was struck by something you touched on with regard, it seems like some of your U.S. customers are purchasing some downhole tools directly as opposed to using it through directional drillers. So is that a sustainable trend and one that's in its early stages? Could you just provide some more color on your thought process there?

Yes. I found it interesting too. We are seeing more components of the bottom hole assembly being accessed directly by the oil and gas companies that were probably previously lumped into kind of a directional drilling tool package. And by the way, we are happy to sell to either. But what it speaks to is that in certain North American markets, customers are disaggregating this a little bit and buying on -- I think, we provide the best drilling motors out there in terms of quality and longevity and value. And I think that's being recognized by some of the E&P companies that are sort of breaking that out of the packages. And so just kind of an interesting trend around disaggregation of the tools away from the service.

Okay. And then just one additional question as it relates to thinking about the steel cost and the impacts there. From the way you guys described in your prepared remarks, it seems as though it's most acute in wellbore technologies? Or is it more broad-based than that? And at some point it seems as though the ability to get through some surcharges would be easier. So how do you think about that in terms of --?

Yes. I think we are dealing with the first full quarter of higher steel costs arising out of the Section 232 tariffs. There are three business units here that are most affected by it, drill pipe, which is in wellbore technologies, but also XL Systems' conductor pipe connections and our coiled tubing string business, quality tubing, which are both in completion and production solutions. All three are kind of having mixed results with regards to passing on steel cost to their customers in terms of higher pricing. But I think we are going to achieve a little higher level of success as we work a little deeper into this and sort of adjust along the way. One of the outcomes of all of this is that irrespective of where the steel actually comes from, we are seeing much higher steel prices across the board. And so it does show up really in all three segments to some degree but I would say those three product lines that I mentioned are most acute. On the positive side, higher steel costs are actually helping our Tuboscope business that provides reclamation services around used tubulars and used sucker rods, because customers are saying, gosh, new sucker rods and new tubulars are so much more expensive. And so there we can inspect and reclaim tubulars and sucker rods coming out of existing wells for reuse and that's become incrementally more attractive. And then likewise, our fiberglass and composite pipe business typically benefits when the cost of steel pipe rises incrementally, demand tends to shift more towards fiberglass and composite tubulars which offer, they are still more expensive, but the benefit is, is that they are not as susceptible to corrosion and so they tend to last much, much longer.

That's really helpful, Clay. I appreciate it. We will see you all soon.

All right. Thank you Byron.

Thank you. Our next question comes from Bill Herbert with Simmons.

Good morning. Notwithstanding the slowdown in Q3 or relative to expectations, cash flow still strong. So you are on your way to becoming overcapitalized and you have mentioned that you are giving a lot of thought with regard to return of cash options. Clay and Jose, can you just give us your latest thinking on that front? Please. Thank you.

Sure, Bill. It's Jose. And I will just say that nothing has really changed on that front except we are inching our way closer, as you described, with a continued healthy cash flow generation from the business. So as we have talked about before, by far the number one priority is making sure that the balance sheet is where it needs to be. It's certainly heading in the right direction and in great condition this quarter on an annualized basis. Net debt-to-EBITDA, 1.45 times, we are very comfortable with that. Gross debt-to-EBITDA is about 2.77, so probably a little tiny, but higher than we wanted to be. But again, everything heading in the right direction. Outside of the balance sheet, it's about investing in compelling organic growth opportunities, which we have obviously ample cash flow to do that. Then we look at, as we sort of exhaust those opportunities that put us into the realm of M&A. We were very active on the M&A front over the last several years with over 30 transactions, about $700 million that we spent on that. As we talked about last quarter, we sort of knew that the M&A environment was going to be a little soft in Q4, but we don't think that that's something that's going to be long-lived. We are pretty optimistic that more and more interesting opportunities are emerging here in Q4 and into early part of 2019. But if they don't emerge and even if they do emerge and we spend at the same pace we have been spending over the last several years, we see ourselves having an excess of capital which we will then look to return to shareholders.

Okay. And two final quick ones from me. First, Clay, you mentioned execution challenges, which should ameliorate in Q4. What were those? And then secondly, Jose, expected revenues out of backlog for rig tech for the foreseeable future? Thank you.

Yes. First, Bill, we had a number of things that we didn't quite get done building frankly by the end of the quarter and they didn't go out. We had some units particularly in the North American in the intervention and stimulation world that our customers really didn't want accept delivery of. So that's really not on us, but we had a few that we didn't quite get done and so a little disappointed in that. But good news is, they are done and should go in Q4. So we are working through those issues.

And Bill, as it relates to revenue out of backlog for the fourth quarter, just for rig, we are looking at just a tiny bit over $280 million.

Thank you.

All right. Thanks Bill.

Thank you. Our next question comes from Sasha Sanwal with UBS.

Thank you guys and good morning.

Good morning.

So just on wellbore, maybe without getting too much into specifics, would it be fair to say that margins for Grant Prideco are still significantly dilutive to overall margins, while maybe bits and downhole are above the average?

Yes. We had some challenges in drill pipe. We had an acquisition earlier this year that was quite large. And so one of the drags on Q3 in drill pipe was the fact that we had some more integration cost flow through in the third quarter. Not big enough really to break out on a consolidated basis, but that was one challenge. The second is that we inherited a lot of backlog there that's at very low margin. And so we have got to kind of work through that and ship that out. And that's a drill pipe that came in at that was diluted to our own drill pipe business. And the third is that a part of the reason was the steel costs up for that business and in particular the raw materials, the green tubes and the tool joints that go into manufacturing that pipe are more expensive than we have in our base business. So the flow through for drill pipe was up as we mentioned, but the flow through was not nearly what it could have been, had we sort of had a more typical mix of our traditional Grant Prideco business. With respect to the downhole tools business and the bits business, we referenced several different technologies in new products that we have been introducing across that business and really pretty strong growth in the third quarter and those businesses have continued to grow now for several quarters, more or less outpacing the rig count. And so really good base of new technologies that are really designed towards delivering wellbores that have lower torch velocity, that are more precisely geosteered into sweet spots of formations and getting some real traction with those. So a lot of things going in the right direction for our downhole tools business.

Thank you. And then just to follow-up, just to maybe touch on pricing briefly as well. So you made the point that it's difficult to kind of push through pricing kind of in this environment. So as we think about what the catalyst might be that might just make those conversations easier, does the Jan, Feb, kind of reset in E&P budgets, does that help? Or are we going to have to maybe wait till the back half of the year before we see a more meaningful turnaround in activity to drive those pricing discussions?

Sasha, I will start and maybe Clay can chime in on this one as well. But one of things that I referred to in my prepared comments is just it's an unusual environment right now, right. We are continuing to see outpaced growth in demand for our drilling related products in our wellbore technologies segment. So that would typically be an environment which we could be very successful in passing on, at least passing on inflationary core cost to our customers. But as I mentioned, it's just very unusual with the decline in pricing that's taking place on the completion side for our E&P contractors. So we think this is a very sort of temporary and transitory thing. As you know, first of all, pressure pumping and other completion services prices are probably approaching stabilization and once that takes place we can be a lot more optimistic and confident in terms of our ability to get those pricing concessions that we think we are deserving of.

Yes. I mean ultimately it's all about scarcity at the risk of oversimplifying most products, most markets in oil field services are highly cyclical and as you are sort of tracing a path to the bottom of the cycle, everyone is focused on price and costs. And as you emerge from that, like a switch flips and everyone begins to become much more focused on time, so much that we provide into development and exploration activities is critical and you kind of have to have it all to spud your well and to develop your wells. And so it feels like we are kind of knocking on the door of transitioning from that first world where everyone is very keenly focused on price into the world where everybody is focused on time. And we had some setbacks in the North American well completion world this quarter. But generally, I think the industry is moving towards that world of more scarcity. Our customers are burning through their stocks of spare parts and inventory that we provide. They are burning through their drill pipe. They are burning through downhole components, through rigs. And so, I think generally we have got a fairly steady tailwind of moving back into a place where we have more pricing leverage and can do a better job overcoming higher steel cost.

Sasha, does that answer your question?

Thank you.

Thank you. Our next question comes from Marshall Adkins with Raymond James.

Good morning gentlemen. And I use that term liberally. Clay, I am going to ask you to speculate a little bit here. I know how much you like doing that. Let's assume oil prices stay roughly in these levels, $70-ish WTI, $80-ish Brent for the next few years. How do you see 2019 playing out generically? I am not asking for specifics on a subgroup in your businesses, but just generically how would you see it playing out in 2019? And then, wouldn't 2020 be meaningfully better than 2019, again assuming oil stays in roughly where it is now?

Yes. First, I am a little more bullish on oil prices generally than the premise of the question. After four years of underspending and all the restraint in capital discipline that's in the space, I think, that that's going to have to turn around to more activity in the oilfield to continue to provide growing demand. But given the premise of your question, I think oil companies are going to have to figure out how to replace reserves. I think they are going to have to get after developing more reserves in the offshore, in particular. I think take away constraints in a couple of the unconventional basins across North America are going to work themselves through in 2019. And I think that sets up, I agree with you, I think 2020 is even better.

But in 2019, is that early 2019 or late 2019?

In terms of improvements?

Yes.

I think early 2019. I mean here in the near term and you have heard this from others, I think a lot of people are kind of running out of 2018 budgets. I think E&P companies don't want to tell Wall Street that they want to up CapEx until they get into 2019 with their 2019 budgets. And so we are facing a little bit of near term pressure here in the fourth quarter around that. But I think once we get into 2019, I do think you are going to see people reload budgets, get back to buying. We have heard this from several different customers for different products that we sell. And so I think once we get into 2019, we are going to get kind of back on the path to more growth.

Okay. My second one, I want to kind of shift gears here. We all kind of know that the U.S. business, I think, we are all pretty bullish on where the oil prices are. But I guess the surprise here is, as you are starting to see a lot of neat things going on in rig tech. So, help paint a picture here on the relative importance between rig reactivations, managed pressure drilling to me seems to be a bigger deal that a lot of people aren't paying attention to and you are in the heart of that and then obviously restocking of aftermarket? So all of those three, maybe some that I forgot or hadn't put in there, how relevant are those in terms of 2019 and 2020 going forward?

Yes. It's really, I think, setting up for a better outlook for rig, although orders were down in the third quarter after three quarters of growth. We did see our mix continue to move upwards with respect to aftermarket, which is a higher margin opportunity for us. In fact, it was a little more than 50% of the rig mix in the third quarter. And we have had our fourth quarter of higher spares bookings with a little more offshore flavor to it in the third quarter, which reflects the fact, I think a lot of the offshore drillers have depleted a lot of their spare parts and they look at putting these rigs back to work. So to kind of sum up the outlook for rig, you have got day rates around $25,000 in North America, which is right at the cusp of justifying new build super spec rigs. You have got some of the larger drillers now upgrading rigs, converting from DC to AC and moving towards the super spec rig category, which is at a very high level of utilization. So you got a lot of financial health across North American drillers. Internationally, we have talked a lot about more modern rigs going into Argentina, opportunities in the Middle East, there's three or four major tenders going on across North Africa, the Middle East and India currently. And so that's picking up. So on the whole, the rig business, I think, is on a much firmer footing both land and offshore. And within the offshore too, I don't know if this will happen in Q4, but we have got a couple of large opportunities in the Eastern Hemisphere, which if they don't show up in Q4, I think we are going to show up early in 2019 that we are feeling better and better about. So on the whole, I feel pretty good about where we are with rigs. Good acceptance of our NOVOS operating system, a good acceptance of our condition-based monitoring, aftermarket equipment maintenance that reduces total cost of ownership, interest in upgrading certain aspects of rigs. So on the whole, I think, we are in as good a position as we have been in for a couple of years here.

Thanks guys.

Thank you Marshall.

Thank you. And, ladies and gentlemen, this concludes our Q&A session for today. I would like to turn the call back to management for any final remarks.

Thank you Carmen and thanks to all of you for joining us. Goodbye.