SLB N.V. (SLB) Q1 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Schlumberger Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I'd now like to turn the conference over to our host, Vice President, Investor Relations, Mr. Simon Farrant. Please go ahead, sir.

Good morning, good afternoon, and welcome to the Schlumberger Limited First Quarter 2018 Earnings Call. Today's call is being hosted from Moscow, Russia, following the Schlumberger Limited board meeting. Joining us on the call are Paal Kibsgaard, Chairman and Chief Executive Officer; Simon Ayat, Chief Financial Officer; and Patrick Schorn, Executive Vice President, New Ventures. We will, as usual, first go through our prepared remarks, after which, we will open up for questions. For today's agenda, Simon will first present comments on our first quarter financial performance before Patrick reviews our results by geography. Paal will close our remarks with a discussion of our technology portfolio and our updated view of the industry macro. However, before we begin, I'd like to remind the participants that some of the statements we'll be making today are forward-looking. These matters involve risks and uncertainties that could cause our results to differ materially from those projected in these statements. I, therefore, refer you to our latest 10-K filing and other SEC filings. Our comments today may also include non-GAAP financial measures. Additional details and reconciliations to the most directly comparable GAAP financial measures can be found in our first quarter press release, which is on our website. Now, I hand the call over to Simon Ayat.

Thank you, Simon. Ladies and gentlemen, thank you for participating in this conference call. First quarter earnings per share, excluding charges and credits, was $0.38. This represents a decrease of $0.10 sequentially and an increase of $0.13 when compared to the same quarter last year. Our first quarter revenue of $7.8 billion decreased 4% sequentially, largely driven by seasonal declines. Pretax operating margin decreased by 169 basis points to 12%. Highlights by product group were as follows. First quarter reservoir characterization revenue of $1.6 billion decreased 5% sequentially, primarily due to a seasonal decline in Wireline activities and lower SIS software and multi-client license sales following the usual, but muted impact of year end. Margins decreased 224 basis points to 19.7%, driven by the lower contribution from Wireline and SIS software sales. Drilling group revenue of $2.1 billion decreased 2% sequentially, while margins decreased 85 basis points to 13.8%. The strong activity in North America was more than offset by seasonal lower drilling activity in the international areas. Production group revenue of $3 billion decreased 4% sequentially and margins fell by 291 basis points to 7.3%. These results were primarily driven by lower activity in the international markets and transient headwinds that impacted the North America hydraulic fracturing market. Cameron group revenue of $1.3 billion decreased 7% sequentially. This decrease was largely driven by OneSubsea as a result of declining project volumes. Each of Cameron's other product lines also contributed to the decline. Margin decreased 169 basis points to 12.7%, reflecting the lower revenue during the quarter. The book to bill ratio for the Cameron long cycle basis was 0.8. However, the book to bill ratio for the entire group is now at 1, reflecting an increasing backlog of the short cycle businesses. Now turning to Schlumberger as a whole, the effective tax rate, excluding charges and credits, was approximately 18% in the first quarter compared to 19% in the previous quarter. Looking forward, the ETR will be sensitive to the geographic mix of earnings between North America and the rest of the world. With the continued recovery in North America, we anticipate that the ETR will increase next quarter and over the course of the year. We generated $568 million of cash flow from operations. This is despite the consumption of working capital that we typically experience during Q1, which is driven by the annual payment associated with employee compensation. Our net debt increased $800 million during the quarter to $13.9 billion. We ended the quarter with total cash and investments of $4.2 billion. During the quarter, we spent $97 million to repurchase 1.4 million shares at an average price of $69.79. Other significant liquidity events during the quarter included CapEx of approximately $450 million and capitalized costs relating to SPM project of $240 million. During the quarter, we also made $692 million of dividend payments. Full year 2018 CapEx excluding SPM and multi-client investments is still expected to be approximately $2 billion. Now, I will turn the conference call over to Patrick.

Thank you, Simon and good morning everyone. Revenue in the first quarter of 2018 dropped 4% sequentially with pretax operating income decreasing by 16%. In North America, drilling and project activity continued to grow, but our results were negatively impacted by lower than expected pressure pumping activity, together with pricing pressure and supply chain inefficiencies. In the international markets, the underlying business performed as expected for all product lines, including the expected transitory headwinds from the seasonal winter slowdown in the Northern hemisphere and the planned project startup costs associated with recent contract wins. Looking closer at our North America results, revenue increased 1% sequentially with improved land revenue in the US and Canada and stronger offshore activity in the Gulf of Mexico and Alaska, more than offsetting the seasonal drop in Western Geco multi-client sales from the US Gulf of Mexico. Cameron group revenue was lower, following the year end product sales of surface systems and valves and measurement. Onshore in North America, we experienced a slow start to the quarter due to freezing weather and as many shale oil operators took a conservative approach to ramping up activity after the holidays. However with oil prices stabilizing well above $60, both drilling and pressure pumping activity started to ramp up in the second half of the quarter and showed healthy first quarter exit rates. In this market environment, our North America land revenue, excluding Cameron grew 4% year-over-year, matching the increase in rig counts. Growth was driven by higher drilling and project activity with the ramp up of winter drilling activity in Western Canada and continued high demand for rotary steerable systems to drill longer laterals with our two fleet utilization increasing 24% sequentially. In OneStim, we continued to add fleets, but less than planned due to market over capacity that led to lower utilization, inefficiencies, and softer pricing. These headwinds were compounded by inefficiencies and increased costs associated with rail, logistical issues impacting the supply of our sand in parts of our operations. Despite these disruptions on transformation of our logistics control and the vertical integration of our own sand supply successfully ensured strong service quality and overall business continuity for longer operations, which was recognized by our customer base. During the first quarter, we continued to actively deploy our spare fracturing equipment including the first spreads from our newly acquired fleet and the operational performance of these new crudes has already reached the standard of our existing pressure pumping business. Let's now turn to the international areas. Starting with Latin America, revenue decreased 16% sequentially. This was due to lower hydraulic fracturing stage count in Argentina, reduced activity in Brazil as we mobilized for new offshore projects for several international operators and that our cash-based operations in Venezuela declined further. On the positive side, revenue in Mexico grew as onshore workover activity increased and as we continued to monetize our newly acquired Western GECO multi-client seismic library on the back of another successful background for new offshore acreage in Mexico during the quarter. Seasonally lower Cameron group revenue also contributed to the decrease. In Europe, CIS and Africa, revenue decreased 6% sequentially, primarily due to seasonal activity declines in Russia and the Caspian Sea region that impacted all product lines. Activity was seasonally lower as well in the UK and continental Europe GeoMarkets where operations were hit by weather delays and changes in customer drilling plans. In addition, SIS software license and Western GECO multi-client license sales were generally weaker sequentially, despite positive multi-client seismic sales in the Scandinavia GeoMarket related to license sales on the Norwegian continental shelf. Revenue from our Africa GeoMarkets were in line with our expectations as solid performance from new onshore projects in Libya and Chad offset further delays for several integrated projects in Gabon, Nigeria and Ghana. Cameron group revenue during the quarter was higher, particularly in the Russia and Central Asia GeoMarket. Turning next to the Middle East and Asia, revenue decreased 4% sequentially, driven by pricing pressure and lower grilling and hydraulic fracturing activity on land in the Middle East, which was partially offset by stronger drilling activity in Iraq, improved testing services revenue in Qatar and Egypt and solid progress on our long term surface facility project in the region. The move towards more performance based work in the Middle East was further reinforced during the first quarter as we won another IDS contract in Saudi Arabia for 70 long-term turnkey wells which comes in addition to the 274 wells awarded previously, for which we mobilized the first two rigs at the end of the first quarter. In Asia, fourth quarter revenue came in above our expectations, driven by accelerated sale of processing equipment in Thailand and project startups in India, competition encroachment in Australia and increased activity on land in China. Cameron Group was slightly lower with growth in Asia offset by seasonally lower revenue in the Middle East. And with that, let me pass the call over to Paal.

Thank you and good morning, everyone. As described by Simon and Patrick, our first quarter activity was generally in line with expectations, with solid year-over-year growth in Europe, Russia and the Middle East, positive recovery signs in Asia, continued subdued activity in Africa and Latin America, while transient market weakness impacted our business in North America land. During the quarter, we observed mobilization and reactivation costs associated with new projects startups and we also started to reposition our spare capacity in the international market, as we look to maximize our ability to capture profitable growth in the coming quarters and into 2019. So with one quarter of the emerging upturn behind us, let me give you our latest views on how the global oil market, E&P investments and oil selectivity will unfold over the coming year. Looking first at the global oil market, the absence of the normal seasonal stock builds in the first quarter clearly demonstrates that supply and demand is now in balance, which combined with increased geopolitical risk is what has driven oil prices up by more than 10% over the past month. Global crude stocks and days forward coverage is already well below the five year average and bigger growth are expected from the current stock levels in the coming quarters. These anticipated stock growths are underpinned by a continued strong outlook for oil demand with global growth continuing to be projected between 1.5 million and 1.8 million barrels per day in both 2018 and 2019 and with the current US China trade war tension not expected to escalate into lower global growth at this stage. On the supply side, after three consecutive years of dramatic underinvestment in global E&P activity, the worldwide production base has [Technical Difficulty] the expected signs of weakening with noticeable year-over-year production declines appearing in several countries such as Angola, Norway, Mexico, Malaysia, China and Indonesia. This trend is expected to spread and accelerate and impact as the level of new [Technical Difficulty] from prior investments continues to fade into 2019. With Libya and Nigeria producing at near-full capacity, Venezuelan production in free fall, and the potential of new sanctions against Iran, the only major sources of short-term supply growth to address the global production decline and strong worldwide demand growth are Saudi Arabia, Kuwait, UAE, Russia, and the US shale land shale oil operators. At present, the collective spare capacity of the three core OPEC countries is only in the range of 3 million barrels per day. There are also emerging questions around whether the very bullish production growth outlook for US share oil can be fully met, as the industry is coming to face challenges linked to well to well interference as more infill training takes place. Lower production per well as drilling increasingly steps out from tier 1 acreage as operators look to overcome growing infrastructure constraints and as refineries approach current processing capacity for light oil. In spite of these clear signs of a tightening oil market, there has been no upwards revision to 2018 E&P spending with North American and International upstream investments still expected to grow in the range of 20% and 5% respectively. Based on these investment levels and the current supplies, we believe it is increasingly likely that the industry will face growing supply challenges over the coming years and that a significant increase in global E&P investment will be required to minimize the impending production deficit. The key indicator for this evolving trend continues to be global oil inventory level and not US inventories alone, as significant weekly swings in import and export levels often marks the actual evolution of the underlying US supply and demand. Turning next to the oilfield services market, we expect drilling activity in North America land to continue to grow in volume and complexity in the coming quarters as more of our customers move towards longer horizontal lateral. In this market, we continue to be sold out of our differentiated directional and drill bit technologies as we again posted strong growth in the first quarter and we still command a solid pricing premium for our services. In addition to our downhole drilling technology, we are now ready to introduce into the US land market the first complete version of our Rig of the Future as well as our new DELFI enabled drilling software platform that covers the complete drilling process all the way from well design and planning to wellhead execution and total system optimization. We are fully focused on the successful introduction of our new and unique well construction offering into the land market as we aim to provide a step change in drilling performance to our customers. Next, we also see continued growth throughout 2018 in our North America land pressure pumping business, driven by strong underlying activity as well as market share gains, as we deployed a further 1 million horsepower over the course of 2018. With the activity and pricing softness seen in the first quarter as a number of companies added significant new capacity, we expect the market to remain close to being balanced in the coming quarters from an equipment capacity standpoint. This means that frac pricing will likely be range bound and driven by short-term or local supply demand variations and that any upwards pricing movements will likely be limited to passing on people and supply chain cost inflation. In this environment, we have four differentiating factors that will ensure that our frac business meets our financial return expectations, the superior service quality we deliver to our customers, the technology driven efficiency improvement we create at the individual fleet level, the scale advantage we have as to deploy our new capacity and the increasing benefits we are generating from our vertical integration investment program. In the international markets, tendering activity remained high and continues to be very competitive and with a clear move towards performance based contracts for many of our customers. We clearly welcome this trend as it offers [Technical Difficulty] and provides us with a clear financial upside, as we leverage our technology systems, people expertise [Technical Difficulty] capabilities to set new performance benchmarks. In terms of pricing for basic standalone products and services we are yet to see an inflection point and there is still sufficient capacity in the market. However, as the early signs of improving rig rate for land rates, [indiscernible] continues to evolve over the coming quarters, the value proposition of our high end products and services become increasingly attractive compared to the basic performance offered by our competitors and this is where we first expect to see pricing traction in the international market. In terms of geographical trends, our outlook for Russia, the Middle East and the North Sea remains solid and in line with our expectations for the year. While the emerging upside we are seeing in Asia will likely be offset by a somewhat slower growth trajectory in Africa and Latin America, where the start of the activity recovery now seems to be pushed out to the second half of 2018. So overall, the international markets are evolving in line with our expectations for the year and we are excited about the outlook for Schlumberger. We are ready and primed to deliver superior growth, financial returns and free cash flow in the coming years by building on the broader technology offering and expertise in the industry, our unmatched scale and operational efficiency, strong capital discipline and a clear desire to provide industry leading cash returns to our shareholders. Before we open up for questions, I would like to take the opportunity to thank the more than 100,000 women and men that make up the Schlumberger workforce. You are the best team in the industry and I want to thank you for your unwavering commitment to your jobs, to our customers and to the company over the past few years where we together have navigated through very tough market conditions. Now, things are again looking brighter for the industry and for Schlumberger and I look forward to facing the new and more energizing challenges of the growth market together with all of you. Thank you. We will now open up for questions.

[Operator Instructions] First question here will come from Ken Sill with SunTrust Robinson.

This is a good quarter and a tough environment here. One of my first questions is on pressure pumping. You're planning to put 1 million horsepower out. How much did you actually deploy in Q1.

Well, I'm not going to go into the details of exactly how much we deployed. We continue to deploy and I would say that we deployed less than what we planned to, mainly because the overall softness that we experienced in the market. I think, the overall stage count growth market wide was a bit lower than expected and in addition to that, a number of other companies added fairly significant capacity to the market and this had an impact on softening pricing and also it impacted utilization. So we introduced somewhat lower, a lower number of fleets in the first quarter and it was more backend loaded, but we are back on our plan rate of introduction as we enter Q2 and our plan is still to deploy the full 1 million horsepower that we acquired during the course of 2018.

Okay. And then to step to a big picture question, you're very optimistic about the outlook, makes a lot of sense given what we're seeing in inventories. Are you concerned with the Wall Street estimates on timing of the recovery or it seems like international is going to remain slow, North America up 20%. I think some estimate is a little bit higher than that, but it just doesn't seem like people are moving to raise their CapEx budgets very quickly. So I think the trend is very positive, but do you have any concerns about the timing of the growth in activity.

Well, from an operational planning and execution front, from the Schlumberger side, international is unfolding this year as we were expecting. The rate of increase in investment levels is as you note significantly lower than what we see in North America, which was expected. But even with the 5% or plus or minus 5% increase in investment, we can generate I think quite reasonable earnings growth out of that, mainly because we have a much higher market here internationally. Our margins are generally higher and our ability to generate incremental is also much higher internationally than in North America. So even though there is a 4 to 1 ratio on investment growth levels, the [Technical Difficulty] business and our ability to generate earnings. Based on that, I'm quite positive on what we can make out of this growth rate even in 2018. But if you ask me, if the investment levels in the international market is sufficient, I would say no, it isn't. So from a supply ability, I would be concerned whether the international market and the producers there are going to be able to produce sufficient to meet the growth in demand, but there's little I can do about that, but I would just say that international for us is unfolding as expected and I think there is only upside beyond where we are today going forward.

And our next question will come from the line of James West with Evercore ISI.

Thanks and Paal, good early evening to you. Paal, I guess first off, I wanted to ask about the - you had your board meetings in Russia, in Moscow this week. You obviously are still pursuing a transaction there with Eurasia. Could you maybe give us some color around kind of what you and the board saw this week, what you were doing? I mean similar to other major board meetings that you've had in places like Saudi, you picked Moscow for a reason and I love to hear that that reason and why - what you guys are up to in that market, given that it's a very, very large service market.

Yeah. Thanks, James. Yeah. As you know, our board is very much engaged in our business and we dedicate one board meeting a year to go out into our field operations and engage with our employees, with selected customers and also industry experts in the various regions around the world. As you know, in Saudi Arabia, last year had a great visit there and if you look at the largest parts of our business, it is basically in between Saudi Arabia, Russia and the US. So the reason for picking Russia this year is that it is a huge part of our business. It is a business that has shown very good growth and strength over the past three or four years. And it was something that the board wanted to see up close a little bit more. So this week, in addition to the normal board proceeding, the board had the opportunity to interact with a number of selected customers and partners, we engaged with some of the Russian oil industry experts and also the board had the opportunity to lead some of our 11,000 Russian employees. It's been a very productive week. We have provided the board with a broad industry and business update for Russia and we've also detailed our further investment plans in the country. And as to the EDC transaction, Simon, do you want to comment briefly on where we stand on that?

Yeah. Let me give a quick update. Basically since announcing the deal was the EDC shareholders, we've been discussing with the respective authorities, all aspects of the transaction, including the size of our participation and the structure of the entity acquired in this state. As a result, we are very happy to say that we were able to satisfy and address all the concerns raised by the different respective authorities. What is more important that our objective of the deal remain unchanged, which is to deliver the best and most efficient operation to our clients through integration and deployment of technology. Schlumberger would remain the driver behind the operations of EDC as and when the transaction closes.

So James, as to if and when it closes, there is nothing much more we can say than this, other than we do have very good engagement with Eurasian authority. The file is now with them. We need to give them time for them to do their job and we are at their disposal if there is any further follow-up that is required.

Okay. Fair enough. Thanks, Paal. Thanks, Simon. And then a follow-up for me, Paal, on the international side. You announced a number of major key contract awards last quarter and this quarter, but it seems to me there is a lot of stuff going on in the background that has yet to be announced as well as this international recovery really takes hold and gains momentum and understanding that spending activity this year is going to lag I guess the North American spending increase, it seems to me like heading into 19, we're looking at a pretty big inflection point for international. Is that a fair comment?

Yeah. I think that's a fair comment. There is, as you note, significant tendering activity presently. What we are excited about is that a fair bit of these tenders are now shifting towards performance based contracts, which means that even if they're quite competitive the bid, we have a fairly significant financial upside by being able to execute in certain of these performance standards on these activities. So, I would say activity, we expect to continue to ramp during the year, very solid performance and outlook still in Middle East, Russia, North Sea. Asia is surprising a bit to the upside and we're dragging a little bit further on Africa and Latin America. We expect that to start increasing as well in the second half of the year. So I agree with you. I think the outlook for international is strengthening as we go through this year and should be even stronger in 2019.

And our next question comes from the line of Angie Sedita with UBS.

So Paal, a little bit further on the international side, you touched on it in your prepared remarks on pricing and the potential for pricing maybe late 2018, going into 2019. Maybe a little color there and then specifically you highlighted your obvious strengths on the technology side as far as deepwater. So maybe you can go into that a little bit further.

Yeah. In terms of pricing, as I mentioned in the prepared remarks, no inflection point yet when you look at basic products and services. But again the shift towards performance contracts will allow us to increase our effective pricing by performing well on these projects and I think we're very well set up to do that. And the other point which I wanted to mention as well is that as the emerging signs of the rig rate continue to evolve in positive direction and we've seen some encouraging signs in certain land markets for sure on shallow water jackups and even in selected ultra deepwater environment. So when the rig rate starts to come up, the value proposition or our high end technology and services and the value of service quality and execution is going to quickly become increasingly attractive when compared to the basic performance of our competitors. So I think this is where we expect to see pricing to come first and I think it's reasonable to expect that this will start to take shape in the second half of the year.

And then going back to Russia and EDC, what do you think on Eurasia Drilling would bring to Schlumberger. What's the opportunity set by owning that company or a portion of that company and just be opportunistic overall in Russia as we go into 2019?

Well, the opportunity set that are on Eurasia Drilling for us has always been the fact that it will allow us firstly to bring our latest total drilling technology systems to the Russia land market. It is a very drilling intensive market. Today, there is no real integration happening. We have a very strong purpose built downhole offering in Russia, partly through a combination of acquisitions we've made and also organic R&D investment made within the Russia R&D organization. And when we add that to the Rig of the Future where we are working on creating winterized Rig of the Future version for introduction in Russia land as well as the drilling sulfur package, there is huge, I would say, drilling performance upside in Western Siberia by introduction of both software and the rig and this is the whole excitement we have around Eurasia transaction. It is a very well-run company, a company we know very well. We have partnered and worked with them for a number of years, but being present on the ownership side that will allow us to take a stronger position in driving the technology direction and I think that is what creates the excitement.

And the next question will come from the line of Scott Gruber with Citigroup.

I have a question on SPM. You're slowing project sanctioning as you discussed last quarter, given the base business outlook is improving here. I'm curious about the free cash conversion of SPM when you're just spending a maintenance CapEx. CapEx, as a percent of sales, I imagine, is still above your base business, just given the nature of the business, how should we think about the free cash conversion out of net income for that business when you're just spending it in maintenance mode. Is it accretive to the conversion targets for the company or is it dilutive?

Patrick, do you want to comment on that?

Yeah. Maybe I think it's a little bit more general goal. I mean as you are well aware, I mean during the downturn, we've had a significant growth initiative around SPM. As far as this has been a growth avenue that allowed us to get the best returns on our technology. We also announced as we saw the cycle change that we were putting an end to our very strong countercyclical investment program. So with that becomes a very strong discipline around the new project that we are investing in and obviously also with the CapEx that we invest in the ongoing project. Now, this is always a bit of a balance that you're trying to strike between the IBP that you're generating today and the long term value that you're generating in these type of assets. So what we're going to do going forward is that we maintain a very disciplined investment and that we're also looking at monetizing some of these assets and which obviously is one of the biggest ways to start making a significant dent in the cash flow of these assets. So we are looking today at monetizing some of our assets during the turn of 2018, but we want to make sure that we do this at the right time and the most opportune time is when we are having de-risk some of these projects and that we have sufficient value proven that we can obviously then also sell these on as we go along. So we are fully expecting to engage with interesting parties here over the next quarters and we actually are seeing the interest build in this type of transaction. And that is maybe the best that I can give a bit of color around the question that you're asking.

Got it. Patrick, maybe if you could update us on progress on Palliser and the projects in Nigeria and Argentina.

Yes. I certainly can. So we started operation at the end of last year and we concluded a variety of operations, obviously the production operations, we started workover. So as far as drilling new wells, we've had up to four rigs drilling simultaneously up in Canada on the Torxen project. We have added around 56 wells to date. And I think that the key thing to remember is that our investment is fully focused on increasing the oil production from this asset. So we will continue to hook up and put on production these new wells in the months to come and once breakup finishes, we expect to start drilling again in the second half of this year. And quite frankly, we're quite pleased with the progress that the team has made in Canada in a very short time in turning this asset into a very focused organization on oil. When it comes to Nigeria, there, we are going through a lot of fee type work. We're working closely with our partners and here, you would have to think about detailed design around FPSO conversions, the top sites that are needing to be prepared. Everything there is on track. And we're looking to do an FID date here later in the year. So from that, that gives you a bit of an idea of where we are in Nigeria. And the last one, Argentina is doing well. We have drilled a number of wells, the ones that we have at this moment are producing very well, very close to our P10 type of expectation. So, things are looping up when it comes to the performance of the individual wells, but let's be very clear as well I mean, there is no field developed with one or two wells, but we need to make sure that we are drilling many, many very good wells. What we're seeing right now encourages us and that obviously also then helps when you're starting to think about monetization in the future.

And your next question here will come from Kurt Hallead with RBC.

Hey, Paal. I was wondering if you, I guess I'm just still trying to grab my hands around some of the dynamics that are taking place in the US frac market. And you did a great job in trying to walk us through some of these things. I'm just not quite sure if I got a handle on it. So apologize if I'm asking the question that you may have already answered, I'm a little slow on the update. So you mentioned during the first quarter, you've had some challenges around the industry, bringing in some new capacity that led to some softer pricing. Then I heard Patrick talk about things kind of picking up as you go into the end of the first quarter. And then some positive dynamics for the second quarter, yet couched around the prospect for incremental capacity to still kind of creep into the system. So where do we stand? I mean is demand still exceeding available supply in the frac business or are we now at a point where we're kind of going to be stuck in neutral and companies are going to continue to put capacity into the market and print the pricing power as we get into the last three quarters of the year. So, just again if you can give a little more color around that, that would be helpful.

Yeah. So what we said is, from a supply and demand standpoint of frac equipment in Q1, I think it's pretty clear that we had overcapacity as an industry based on the available stages during the first quarter. So we are more or less our capacity today. I think the market going forward when it comes to frac equipment I think is going to also label around being in balance. I think you will probably have local valuations in certain basins. You might have a temporary oversupply, undersupply based on where companies introduce new capacity. But I think the fact that we are now more or less at capacity and we need to accept that it will be in that situation for the duration of this year, I think is pretty clear. And given the fact that the market has been growing steadily now for the second year in a row and also given the fact that we have a very agile service industry and manufacturing industry to support the service industry, it's not a huge surprise that in a fully commoditized market, that supply is going to match demand at some stage and I think we're basically there. So I think from a pricing standpoint, we don't expect any significant tailwinds of kind of net effective pricing. We do expect to continue to be able to pass on additional costs associated with people and supply chain inflation. But beyond that, I think operating margins and profitability is going to have to be driven by how you execute. And from our standpoint, as I mentioned in my prepared remarks, there are four major drivers. One is the service quality and the business continuity that we are able to provide to our customers in any kind of market situation. We also have significant investments into technology that drives individual fleet operating efficiency. As we add another 1 million horse power over the course of 2018, that's going to give us a fairly significant scale advantage and then also what we see is increasing benefits from our vertical integration program, right? So, I think it's going to be a challenging market situation throughout 2018, but we have some levers that we are very much focused on, which makes me confident that we're going to be able to meet our return, I would say, expectations for the investments that we make into this.

The question here will come from the line of James Wicklund with Credit Suisse.

International, I want to drill down a little bit if I could Paal on the performance based contracts. You guys have been pushing this for some time and I know everybody's been a little disappointed at the uptake. But you in your first lumpsum turnkey project in Saudi Arabia and more to come, do you finish your first well on a performance based contract with board drilling in Gabon. The market is concerned that lumpsum turnkey contracts get too competitive, you kind of addressed that, saying that, even though there are big competitive, you have the opportunity to outperform. Can you talk a little bit more about how you do that and is this just a matter of throwing your best technology that the companies, your client themselves might not hire on a regular service basis. Can you talk about how, especially with those two contracts and I realize they're different, how this is going to north of the next couple of years into a much wider performance based type business internationally?

Okay. That's a good question, Jim. So the way we see this contract as you rightfully point out that they are competitively bid as with anything, but with the investments we are making from an R&D standpoint in particular in to our drilling portfolio and with the ultimate focus of creating one drill as a complete revolutionary total billing system, that's where our ability to execute and drive performance on any type of contract to a completely new level that even though we've been - we win the contract at a very competitive pricing, we can over the course of that contract generate very healthy returns to the company. So the way we do this is like I said by having firstly superior individual technology building blocks. Then it's the ability to bring this together to a complete operating and planning software package with drill plan and drill ups is going to do and this is all sitting on our DELFI digital system, which allows every application to share all the data on the information. And then on top of this, it is the domain expertise that we have from the drilling and subsurface as well as our operational execution on the wells that I described. So I can't really point to one thing, but the key with any kind of lumpsum turnkey contract is that you improve the drilling performance over the course of the contract and generally well number ten is drilled significantly faster than wells number one. The key with our system and the whole digital approach is that we ideally - we don't want to start off with the performance of the traditional well number one. We want to start off with well number one matching the traditional performance of well number 10. And if you can do that, you can move up the profitability and the gains you're making and drilling experience from the digital environment that you have deployed on all your operations around the world and this is a major differentiator going forward as to how we can start generating very good returns even in the first wells of the program rather than well 10 or 15 as you get into the second or third year of operation. But this is how we want to set ourselves apart. This is how we are setting ourselves apart and obviously the rigs is going to play an increasingly important part of how we drive performance right and that's why we have a very strong position on rigs with the ADC in Saudi Arabia. This is again linked to our interest in EDC in Russia and then beyond that, we are now actively introducing our Rig of the Future into the US land market as well and these three markets are really the main land drilling markets around the world. And lastly, I would say that this is also why we have made an investment to board drilling. We see performance based contract similar to what I described on land here also to now move in to shallow water and we are very happy and very excited about the partnership and investment we made in board drilling and we see significant opportunities on shallow water together with bore and potential other shallow water drillers to also introduce performance based contracts to this environment.

My follow up if I could, a couple of years ago we were talking about a great deal about the transformational effort that Schlumberger was going through and on the staged basis and I know the downturn kind of interrupted some of the plans. Can you tell us is the transformational effort that was started a couple of years ago, is that done yet, are we getting closer or what phase are we in at this point.

That's a very good question, James. I would say that the downturn in the past three years had an impact on the, what they're trying to mention has grown to our bottom line and it's mainly because it is very difficult to monetize efficiency in an environment where your business continues to shrink quarter after quarter. What we have done during this period of time is that we have ring-fenced the investment in the transformation program and we have continued to evolve it, we have continued to deploy it. We are in the middle of significant deployment as we seek around how we change our workflows, how we introduce new backlog of systems and how we basically conduct all our internal business processes. So this is all progressing and I would say that going forward, the transformation is going to be a critical factor in our ability to generate the incremental margins that we have promised. And I think as soon as you see us now starting to generate a little bit of growth in the international market and we are finished with the pricing concession, that's when I think the impact of the transformation is going to start to become very visible again. We are maintaining, for instance, our CapEx, the investment levels around $2 billion this year, which is as low as it's been throughout the entire downturn and we're doing this because a significant part of the increased activity we are actually going to absorb through increased asset utilization, but this is one way that we are demonstrating what a confirmation can bring. So I would still say that we are in the mid-innings of what the impact of the transformation can bring, but we have continued to advance forward the investments and the deployment of this so that we are very optimistic of what it is going to bring us here as we go forward into 2018 and 2019.

And our next question will come from the line of David Anderson with Barclays.

I just wanted to stick on the LSTK subject here. So Paal, with more of the tendering activity kind of moving towards lumpsum turnkey contracts, I was just wondering if you could just help us conceptually understand how you view the difference between SPM and LSTK, just in terms of say the upside versus the execution risk in both types of contracts. It feels like this is more execution with an LSTK. I was just wondering if you could kind of talk about that of how you look at the two types and whether or not you have a preference for either one of those type of contracts.

Okay. So if you think there's more execution risk on LSTK, I can debunk that pretty firmly. That is obviously not the case. The highest risk profile of any contract type that we take on is on SPM. On LSTK, there is - the performance risk you basically take on there is that you stipulate a fixed price for a well profile that you have seen and as you can study upfront before you submit your bid, we analyze there is - in great detail the global database and experienced base to understand how we can drill these wells and how we can beat the curve basically. And the risk you take on is basically the time it takes to drill the well, because most of the drilling costs are time based. So the risk profile of LSTK is a small fraction of what the risk profile of a SPM project is. And also from a cash standpoint, LSTK is fairly close in terms of payment terms to the base business. It's about - generally you get paid on completing complete wells and this is very close to the payment DSO levels that we're looking at for the base business. So cash exposure, profitability exposure is much more limited than what you see in SPM. And again the ability that I just outlined in the previous question there makes us extremely comfortable with taking on these type of contracts and I would say that generally for all the contracts that we take on, we typically beat the curve and our objective going forward is to continue to beat it by a wider margin.

So is it fair to say that if these contracts are bit fairly competitively that maybe the margins as these contracts start up and I guess in year one are going to, expectations that these are going to improve measurably by year three, is that sort of the idea we should be thinking about that as these come out, maybe a little bit lower profitably today, but the idea is once you start getting these costs and these startup costs all taken care of that the margins all start to uplift, is that sort of how we should be thinking about this.

Yeah. Generally, LSTK contracts have improving profitability over the course of the contract and there are some mobilization prospects. They're not really significant unless they are huge contracts, like for instance the once we are currently mobilizing for in Saudi Arabia. But I would say that the profitability isn't necessarily linked to the mobilization. It's more linked to the fact that your drilling, I would say, curve improves as you build more wells and as I was saying in the earlier question, our goal and what our drilling system is going to enable us to is to basically fast forward on that experience curve. So our well number one isn't going to have the traditional performance level of a graphical well number one. We want to start way down the line, which means that profitability should be much higher in the early parts of these projects as we go forward compared to what they were in the past, but still be able to improve over the course of the project.

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

Paal, I'm just curious, so the expectation for an increase in a 5% with regard international E&P capital spending, you should do a little bit better than that based upon market share. And against that backdrop, what do you think are reasonable expectations for international incremental margins off that mid to high single digit revenue growth for this year.

Yeah. Bill, I think it's a bit too early to make a straight commitment on this, because there are still some forces playing in opposite directions, right, but there are some startup costs, there are some repositioning costs. We've got to work through some of the pricing concessions that we have been giving - given in recent quarters. So I still think it's too early to give you a straight commitment to what sort of sequential incremental margins are going to be in the coming couple of quarters. We stand behind the 65% as we get into steady state growth in the international market. We're going to require some pricing tailwind to get there, but we stand behind that, but I think it's a bit too early to say what the incrementals are going to be, say, into Q2 and Q3. Other than that, they should steadily improve and we have very clear plans in place, enormously getting pricing traction, leveraging performance based contracts and then starting to fully capitalize on the sustained investments we've made in transformation program. So, I think we have all the ingredients there. It's ready to be, I would say, capitalized on, but I'm not going to give you a number say for Q2 and Q3 as of yet.

Okay. And can we speak about the second quarter expectation here, which seems to be a more tangible premise. The Street estimates of $0.48 or thereabouts, high $0.40. You delivered $0.38. Is that a tenable proposition with regard to the realization of that earnings per share?

Yes. I think it is. There is a little bit of color on that. If you look at these, we see solid revenue growth in both drilling and pressure pumping. We're going to work through as usual the kind of a breakup in the second quarter. In the international market, we continue to see the trends that we saw in Q1, strong performance in Middle East, Russia, North Sea. Asia is basically joining that list now and it's slight upside in Asia. But then a bit more limited growth in Africa and Latin America, right. So assuming that the softer pricing and utilization in North America land pressure pumping doesn't really carry into Q2 and at this stage, we don't think it will, then I will say that the current EPS consensus is pretty much in line with how he see.

And our next question will come from the line of Byron Pope with Tudor, Pickering, Holt.

Thanks. I just have one question. Paal, you framed some of the 2018 growth drivers for Schlumberger in terms of GeoMarkets. I was wondering at a high level, could you do the same in terms of which of the groups you think lead the growth. It seems certainly that protection group will be there, just given the frac fleet reactivations, but could you frame at a high level how you think about the growth drivers from a group perspective this year?

Yeah. It's a bit easier to do it, down to the specifics when you look at geography, right. I would say, overall, I see very good growth potential from all four groups. You mentioned production, yes, absolutely. I think with the investments we made in frac capacity and vertical integration and the way we set up in North American land now, I expect that North America will be a strong driver for production group growth, but as well we have obviously a significant business globally as well, strong fracking activity in the Middle East and Argentina as well as other parts of the business that will contribute. Drilling as well, these lumpsum turnkey contracts, our key revenue and bottom line drivers. D&M is obviously the, drilling and measurement is the main driver of the performance of these projects, but all the other drilling segments have a role to play in it as well. So still a very good growth potential for drilling. On the characterization side, our exit out of the Western GECO acquisition business will have an impact on top line progression this year, but from a bottom line side, this should actually be quite accretive to a characterization of operating margins and both wireline and testing is kind of still operating around the close to the bottom of their cycle, mainly because their exposure to the exploration market has not seen any recovery yet, but there are some small signs of improving exploration spend relating to building in 2018, which should enable them to I think to grow as well. And on the Cameron side, we're seeing strong performance from the short cycle businesses and I think we're getting close to the trough of both the booking revenue and margins for the long cycle business. So again, upside there as well. So I think it's a bit more general, what I can say on the technology side, but I would say very good growth potential in all the four groups.

Thank you. So that was the last caller for today. Thank you very much for participating.

Thank you. And that does conclude the conference for today. Thanks for your participation and for using AT&T Executive Teleconference. You may now disconnect.