Weatherford International plc (WFRD) Q2 2016 Earnings Report, Transcript and Summary

Good morning. My name is Kim, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Weatherford International Second Quarter 2016 Earnings Conference Call. [Operator Instructions] As a reminder, ladies and gentlemen, today's call is being recorded. Thank you. I would now like to turn the conference over to Ms. Karen David-Green, Vice President of Investor Relations, Corporate Marketing and Communications. You may begin your conference.

Thank you, Kim. Good morning, and welcome to the Weatherford International Second Quarter Conference call. I'd like to thank everyone for accommodating the earlier start to this conference call. As you know, we wanted to avoid an overlap of our call with one of our peers. With me on today's call, we have Bernard Duroc-Danner, Chairman, President and Chief Executive Officer; and Krishna Shivram, Executive Vice President and Chief Financial Officer. Today's call is being webcast, and a replay will be available on Weatherford's website for 10 days. Before we begin with our opening comments, I'd like to remind our audience that some of today's comments may include forward-looking statements and non-GAAP financial measures. Please refer to our second quarter press release, which can be found on our website, for the customary caution on forward-looking statements and a reconciliation of non-GAAP to GAAP financial measures. We welcome your questions after the prepared statements. And now, I'd like to hand over the call to Krishna.

Thank you, Karen, and good morning, everyone. Let me start with a recap of our operating performance in the second quarter. Overall, our revenue of $1.4 billion declined 11% or by $183 million sequentially, while our operating income before R&D and corporate expenses reduced only marginally by $11 million, reflecting the beneficial impact of the large cost reduction actions taken this year. Sequential operating income margins deteriorated by 168 basis points to reach negative 8.3%. Sequential decrementals were excellent at 6%. Loss per share for the quarter before charges and credits was $0.28, which was $0.01 better than the first quarter, while EBITDA was flat with the first quarter at $58 million. North America revenue declined 26%, outperforming a 35% reduction in average rig count and continued pricing headwinds. Seasonal activity reductions due to the spring breakup in Canada coupled with pressure-pumping activity hitting new lows with 2 fewer crews operating at the end of the quarter compared to the start of the quarter. Having said that, operating losses reduced substantially by $27 million with the aggressive cost actions taken this year, resulting in resilient margins albeit negative of minus 25.2% and sequential incrementals of 19%. Internationally, our revenue declined 3% on a sequential rig count reduction of 7%. Latin America bore the brunt of the decline with sequential revenue dropping 18% due to steep customer spending cuts in Argentina, Mexico, Brazil and Colombia. Operating income margins also fell sharply, as cost-reduction actions that were taken late in the quarter, while benefiting future quarters, were not enough to mitigate the drop in revenue. Operating income margins dropped to just 1%, but with the recent cost actions, this should improve going forward. Eastern Hemisphere revenue increased by 4% sequentially. In the Europe/Caspian/Russia/Sub-Sahara Africa region, sharp activity reductions in offshore West Africa were only partly mitigated by a seasonal recovery in Russia, resulting in a sequential revenue reduction of 5%, while operating margins improved to make the region profitable again. In the Middle East/North Africa/Asia Pacific region, the sequential revenue increase of 11% reflected the final contract settlement of the Zubair product and higher activity in Algeria, more than offsetting declines across several Asia Pacific operations. Operating income margins declined 180 basis points to essentially a break-even level, reflecting the full impact of pricing concessions given to customers in prior quarters. The revenue for the land rigs business declined 9% with lower sequential utilization rates. However, strong cost-reduction actions which are structural and enduring in nature allowed us to improve the operating income by $9 million. On the cost side, as of last week, we have completed 97% of the previously announced reduction in force exercise of 8,000. This means that we have reduced our total payroll by 42% over the last 18 months, since the first of January 2015. Given the current market context and the anticipated increase in activity levels, we have chosen to preserve capability to address the upcoming growth which are in excess of the requirements of current activity levels. Such additional costs, included in our quarterly results, amount to $50 million, representing 350 basis points of margin and $0.05 in EPS terms. I want to be clear on the cost reductions front. Should the industry environment abruptly change back to February levels and persist at those levels, we can eliminate this additional annualized retained cost of $200 million, and furthermore, collapse our operating structure materially to save even more costs. Such steps would be extreme and would impair our capability to grow in the future without additional investments. Below operating margins, R&D costs reduced by $5 million, sequentially, while corporate costs were down $8 million, reflecting spending cuts in line with the reduced budgets. These levels are sustainable going forward. The tax benefit recorded in the second quarter of 21% reflected the tax benefit on the losses, primarily in the U.S., partly offset by tax provisions internationally. The tax rate for 2016 will be dependent on the geographical mix of earnings and will be heavily weighted by results in the U.S., but could swing widely as a percentage rate as the levels of income are quite low. The second quarter results also included net after-tax charges of $312 million. Let me go to the key charges. We took a charge of $101 million in litigation charges, mainly related to advancement in negotiations with the SEC regarding our income tax restatements from previous years. A charge of $84 million was taken to reflect the fair market value adjustment of a note receivable from a customer in Venezuela, while we intend to hold this note to maturity and collect on the entire face value and the associated interest. Accounting rules mandate the write-down on this note to reflect its current market value. Over time, this value should continue to increase as commodity prices recover and maturity dates get nearer. We took a charge of $69 million from bond tender premiums that were paid related to the repurchase of a senior note; a charge of $62 million, primarily from write-downs in inventory and other assets as we continued to resize the business; a charge of $41 million in severance and restructuring charges; and finally, a credit of $45 million of income relating to the Zubair legacy contract, reflecting the favorable terms of settlement reached with our customer. The good news is that as of this print, the construction phase of this contract has been completed and is now in the routine operations and maintenance phase, where we hand over the project to our customer while training them to operate the facilities. So it's quite routine now. So from now onwards, you will never again hear us talking about the Zubair contract. Moving on to the near-term outlook. We expect a modest recovery in activity levels in the U.S., which has already seen a 7% quarter-to-date increase on rig count on land, augmented by the post break-up seasonal recovery in Canada. Signs of increasing activity are already manifesting in the U.S., with 2 additional pressure pumping crews being deployed in July. In fact, we made 77 job offers last week to manage the staffing of these crews. It takes about 3 weeks, currently, to re-equip a stack fleet with minimal CapEx, but it takes up to 6 weeks to restock the fleet crew. Already, there are signs of a tightening labor market in the U.S. with many laid-off workers having left the oilfield workforce permanently to move to other sectors of the economy. While the initial recruitment will comprise experienced oilfield hands, beyond a point, retraining will be needed. All of this is going to reverse the pricing trend in the U.S., albeit gradually, as operators will have to pay more to access high-quality service capability. Additionally, with customers working through their DUC, or drilled but uncompleted, inventory, our completion in artificial lift activity levels will get a disproportionate boost on U.S. land. Internationally, we expect to see some flattening in Latin America, modest growth in the Europe/Caspian/Russia/Sub-Sahara Africa region with a continued seasonal recovery into the summer in both Russia and, but to a lesser extent, in Europe, aided further by market share gains in the Middle East and in some Asian markets. Pricing will not deteriorate any further from second quarter levels, but costs will continue to trend downwards. Based on this, we expect to see a gradual improvement in our second half results, although on an overall basis, we do not expect to break even by year-end. Bernard will comment in more detail on the operating results, contract activity and wins and the outlook later on in this call. Moving on to cash flow and net debt. Free cash flow in the second quarter was a disappointing negative $160 million while still improving on the first quarter's free cash flow by $56 million. The shortfall can be explained quite simply. Customers in general, but particularly national oil companies, have begun to manage their cash flows actively, thereby delaying payments to contractors. We missed about $150 million in specific projected collections reflected in the 9-day increase in our DSO this quarter. Obviously, these customers have solid credit, and recoverability is not in question. Just the timing is delayed. As our customers will benefit from better oil prices going forward, we expect them to improve their payment cycle in the second half of the year and into next year. Secondly, with the reduction in product sales, we could not hit our inventory reduction targets in the second quarter, and while we did reduce inventory levels in the quarter, we fell short by $50 million. Thirdly, the tender offer we made on our 2017, '18, '19 and 2020 bonds resulted in a settlement on June 30, accelerating payment of accrued interest of $27 million, which would otherwise have been paid in the third quarter. And lastly, we also accelerated the reduction in force program and incurred an additional $28 million in cash severance payments. These factors impacted our second quarter free cash flow by about $250 million. Our current forecast for free cash flow for the year is in the range of a positive $100 million to $150 million. This implies a seasonal recovery in our cash flow generation in the second half of the year, which is normal for our industry. Our second half cash flow will be bolstered by improved results, stronger customer collections, lower inventory levels, much lower severance cash costs, absence of employee annual bonus payments and continued discipline in capital spending. CapEx is now targeted to be $200 million for the year, down another $50 million from the previous guidance. This low level of CapEx should not alarm anyone. Our CapEx is divided into 3 buckets: the manufacturing capacity, infrastructure capacity and technical equipment for our services business. In terms of manufacturing capacity, we are currently running at just over 1/3 of available capacity. In terms of service infrastructure, we are well built out globally and are materially underutilized currently. And finally, on the technical equipment front, we have objective utilization metrics for each product line in place, be it drilling services, wireline logging or pressure pumping, and based on detailed analyses, we believe we can support about 2.5x the current levels of activity without adding any meaningful higher CapEx. As we grow into the up cycle, we can and we will maintain a tight lid on CapEx. Net debt increased by $187 million in the quarter to reach $6.8 billion. In the second quarter, we successfully upsized and issued $1.27 billion of convertible notes and $1.5 billion in 5-year and 7-year senior debt at very good interest rates. A big part of these proceeds totaling $1.9 billion were used to buy back debt maturing in 2017, 2018, 2019 and 2020, pursuant to the tender offer, and the rest of the proceeds were used to pay down the revolver. As a result of these transactions, our maturity profile has changed substantially, derisking the liquidity profile of the company materially. Prior to these transactions, we had $2.1 billion of maturities over the next 3 years. Today, this number is a mere $639 million, with only $88 million due in 2017 and only $66 million due in 2018. The success of these transactions reflects investor confidence both in the recovery of the sector as a whole and in Weatherford's strong performance in the backdrop of such a sectoral recovery. We are grateful for our investors' faith in us, and we expect to exceed their expectations. One point of particular note here is that the springing maturity clause in our revolver links to reducing the 2019 $1 billion bond maturity to less than $500 million by the fourth quarter of 2018 has already been neutralized, as the outstanding amount on the 2019 bond is now only $485 million. This means that the revolver now extends out to July of 2019 with no problems. Another noteworthy item is that all of our banks recently unanimously approved an amendment to our revolver agreement to iron out kinks and to ease certain restrictions that make it easier for Weatherford to operate. Additionally, an accordion feature of up to $250 million was added to the agreement to allow existing and new lenders to extend more capacity to the company going forward. All of these changes are positive for Weatherford and demonstrate the continuing support from our banking group. Our long-term net debt will trend down. Our current intention is that in 2021, when the convertible debt becomes due, we expect to issue shares to our debt holders in exchange. This will structurally reduce our debt by $1.27 billion. Additionally, positive free cash flow from operations and the proceeds from the eventual sale of the land rigs business will also reduce net debt materially. All of this goes to further delever and derisk the company. Longer term, we continue to target a 25% to 30% debt-to-cap ratio and recover our investment-grade credit ratings. As of June 30, available liquidity was $1.8 billion, including $1.3 billion of revolver capacity and $452 million of cash balances. Operating EBITDA for the quarter was flat with Q1 at $58 million. As to specified EBITDA, as defined in our revolver agreement, it came in at $130 million for the quarter. The key specified debt to specified EBITDA ratio at June 30 was 1.0x versus a covenant of 3.0x, meaning we have ample headroom on the covenant. The same ratio including LCs [ph] was 2.04x, which is also well below the covenant of 4.0x. Our projections for the rest of the year suggest that we maintained the substantial headroom on the covenant. In conclusion, Weatherford is now materially derisked from a liquidity standpoint, has a clear achievable plan to delever over the next several years, and the company is now at the take-off point as the market recovers, with industry-leading earnings and cash flow incrementals. With that, I will now turn the call over to Bernard.

Thank you, Krishna. Good morning, everyone. Few comments on Q2. The second quarter evolved as we expected. We thought NAM would trough, and it did. Despite of a devastated Canada [ph] in Q2 making a severe activity drop that much worse for NAM, operating income actually improved, improved significantly. This is entirely due to cost management and excellent operating execution. We thought the Eastern Hemisphere would not deteriorate further in Q2, and this was correct. We have crossed currents in Q2 of the Eastern Hemisphere. Pricing concession given out in prior quarters impacted the quarter. This conflicted with some early startups and powerful cost cuts. The end result was marginal declines in overall revenues and flat profitability. We viewed Latin America as having a very weak prognosis. This proved also, and unfortunately, correct. Mexico, Colombia, our largest market, Brazil and even Argentina, all weakened further, in some instances dramatically. By way of an illustration, our largest client in our largest national market, Colombia, moved their drilling activity in late '14 from 30 rigs within plan for over 40 to 0 in this second quarter. In the course of the quarter, the client went actually down to 0 drilling rigs. Q2 showed exemplary decremental of 6% on 11% decline in sequential revenues. We expect these will be industry-leading decrementals. They reflect, above all, the very aggressive cost actions taken from day 1 of the down cycle. We have had the best, as in lowest, decrementals consistently. Lastly, Q2 was to be the last quarter with ongoing -- the ongoing Zubair project, and it was. Zubair is completed. You won't hear of Zubair anymore. It is a closed issue. On cash flow, a long-term focus and objective, profitability, CapEx, inventory and cash payment of the 15 operating bonuses traditionally paid in Q2 all were by and large as planned. We had 2 unexpected events, accelerated Q3 payments into Q2 and delayed receivables collection. The acceleration of payments for severance execution was 1 of the 2 accelerations. Almost all of the Q3 was pushed into Q2 as we accelerated our payroll cuts to end the layoff program earlier. The acceleration of prepayments of Q3 interest expense, in addition to Q2's scheduled interest payments. It was a byproduct of the debt tender offer. Delayed receivables collection. As Krishna mentioned, the delays are all -- well, they're all NOCs and few IOCs too. This isn't a credit or a collection issue. This is an industry phenomenon. Why did large clients slow down payments? Because they could. In Q2's extremely depressed environment, it was possible. The net result was a significant shortfall in scheduled collections at quarter's end. All this added up to $200 million, $250 million swing in our free cash flow. The swing isn't lost. It will benefit the second half of '16. Q2 synthesis and forward views. Looking at Q2, a few conclusions are clear to us. NAM profit in Q1 profitability wise and Q2 revenue wise. NAM is now turning; however slowly, but turning it is. Eastern Hemisphere troughed in Q2. Same observation, Eastern Hemisphere as a whole is turning; however slowly, but turning it is. Latin America will continue to remain challenged. We don't see it turning, not in '16. More details on forward views. These comments apply to Weatherford, they incorporate market trends but with idiosyncratic specificity. We are a little different from the others. Only half our product lines overlap the Big 3, essentially completion and formation evaluation, and our recent market share history is also different. First half of this year reflected the psychology of a $25 oil market, which is essentially a forced liquidation of the industry's capabilities. Volume activity worldwide and pricing conditions reached levels unseen in any management's lifetime, including this one. Second half of this year will reflect a $40, $45 oil market psychology, which will make it the beginnings of a recovery, albeit from extraordinarily low levels. The oil field will slowly pull out the extreme operating conditions it was placed under. Progress will occur but step-by-step, and not everywhere. Oil bears need not fret. The recovery will be short of the minimum activity levels required to sustain, let alone grow, a flat worldwide oil production capacity. This means, on the whole, our clients in the second half will continue to lower their oil production, overall, and de facto capacity. In effect, second half of this year, we won't be able to overcome decline rates either. Worldwide oil production capacity will be lower at year-end than it was at the end of Q2. Geographically, activity gains will be predominantly land and concentrated in 3 regions: North America, MENA and Russia. The rest will, by and large, flatten out. NAM will slowly rise activity with all segments benefiting. Completion and lift will be the strongest first beneficiaries as will pressure pumping. The capacity overhang in that segment limits the near-term potential. Completion -- our completion is seeing for the first time in many quarters an increase in orders and activity on a number of U.S. land plays. On lift, we have seen recent improvements in orders and new equipment, suggesting both the end of our client destocking and some activity increases. Lift prognosis matters for us in NAM. It is a very large and normally very profitable product line with low beta. But when conditions deteriorate to an extreme, as they recently have lift our lift, becomes much higher beta than understood. Let me explain further. We are the largest player worldwide, including North America, in all forms of lift, except ESPs. Normally, lift is an island of resilience and stability. With the unprecedented collapse of North American activity, lift experienced high beta with major client destocking of new and parts inventory as well as severe curtailment of the new well markets. This deterioration was much worse in ESP segment because the types of wells ESPs address keep their low beta. As a correlation, our lift and our non-ESP lift peers have much more to recover with a turn in the market. De facto, in this particular cycle, our NAM lift product line has become high beta. Eastern Hemisphere orders [ph] has declined volume wise and experienced a modest recovery. Expect the first manifest rise in activity late in Q3 and squarely in Q4. This will not apply to the entire hemisphere. Russia and MENA will show, by far, the most improvements, both the combination of activity increases and market share gains in our case. The Gulf countries, Saudi Arabia, Kuwait and the Emirates, are the prime movers for us. Middle East will be an island of strength in the second half. There are also some Eastern Hemisphere markets that will lag, but at the minimum, these markets will stabilize with no further declines. Latin America on the whole will start second half weak. It will flatten before year-end. The activity declines will arrest. But it will not experience much of any recovery, not this year. There will be shifts in national markets and clients, but overall, the prognosis of the market is for a soft followed by flat outlook for the second half. That makes Latin America the laggard. Two targets we'll strive for. We may reach break-even profitability, operating income, in North America by first half of next year, first half of '17. On the back of high expected volume incrementals and the full effect of cost cuts, we assume in this respect very little improvements in pricing in that turnaround time frame. Two, Eastern Hemisphere may return to double-digit operating income margin albeit just low end of the double digit. In Q4, this is -- therefore, Q4 of this year, Q4 '16, on the back of high expected incrementals. And again, much of the strong incrementals expected after the credit of the cost revolution at Weatherford, which brings me to costs and organizational change. I want to touch on a number of operational issues because I believe we are at the turning point in the cycle, the turning point of 2-year cost and operating transformation, and I believe it portends a strong performance at Weatherford. The first half of the year, we have reduced our global employee count by another 7,800. Our total employee count stands today at just 32,000, down from 55,300 on January 1, '15, 18 months ago. This is a 42% contraction of our total payroll in 18 months. The organization has been delayered on average by 1/3. The support ratio indirect to direct labor dropped further to 37.8%. Early in '14, it stood at near 60%. No other statistic tells the story like the support ratio. It’s almost cutting in half was accomplished in the midst of a very sharp decline in direct headcount. That is extremely difficult to get done. Simply said, we have step-changed as in made efficient our support structure. We did this in addition to direct cost action, even though direct labor was hammered very hard. This is important because future incrementals will benefit immensely when activity turns. Our low support ratio will drive powerful absorption with volume increases. Responsibility and accountability has been pushed to the sand face as close to the field as possible, which means less Dubai, Singapore, Moscow, Houston, et cetera, more Dharhan, Sakhalin, U.K. and Midland, et cetera. Supply chain as in the manufacturing, procurement, logistics have been restructured with efficiency gains at all levels. We made large gains in procurement and logistics already. Manufacturing is still in the process of being restructured but metrics for work center rates and time to delivery have already improved. Operating and financial management have been upgraded thoroughly from the leadership through the ranks. It is self-evident at the leadership level. They run deep through the ranks. HR has been empowered at all levels of the organization with an emphasis on training and career development. Operational compensation is geared towards free cash flow returns, quality and safety, with the turn/return metrics become increasingly important as will quality. Q3, but even more so Q4, will capture the full benefit of all the cost actions taken, which brings me to forward operating priorities. Other than a few local exceptions, people and delayering cost reductions are completed. We're calling for an end to the payroll-related cost drive. There will not be any further contraction. The current level of 32,000 worldwide employees will be our low point. We are also calling for an end to all price discounting. This is a company-wide formal decision and process. No tender or bid submission will be priced lower than Q2 levels effective now. This is the first step towards price recovery. Over time, price recovery will be a powerful driver of financial results. Pricing worldwide, not just North America, reached levels which we have never experienced before, not by a wide margin. Pricing levels are unsustainable long term for our industry. We are not banking on pricing alone to drive margin improvements. The level of support cost ratio at the end of Q2 of 38.8% is so far from its historical levels a few years ago, in our view is very high incremental when high activity comes through, view it as a particularly powerful absorption booster of high business volume. On the cost side, we will be left as work in process our ongoing 2-year productivity and efficiency internal projects centered around supply chain, maintenance cycles and invoicing processes with powerful structural cost and cash flow efficiency implications. This will benefit '17 and later years. You will notice we started to add a few operating news in our quarterly results, be they contract wins we view as directionally important or particular agreements such as the joint effort with IBM. We spent much of the last 2 years talking about layoffs, shutdowns and curtailments. When we didn't, we talked about liquidity, banking facilities and balance sheet constraints. Today, our capitalization is structurally safe with actions taken in June. We have ample liquidity and time. This doesn't change our financial priorities. The company's culture, compensation and focus is on the free cash flow generation and returns as key metrics of performance. It is set. It is ingrained in our DNA, and it won't change. Also, legacy issues, whether administrative, legal and contractual, are closed, and our cost structure is at an unprecedented low level, of which much is perennial. With all this achieved and all behind us, it is time we focus on clients, technology, product development and the impact we as a company can make on the industry. With our specialization and unique toolbox and technology capabilities we have, we have much to offer. By year-end, Weatherford's maturation process, at least in our opinion, will be essentially completed. The company had years of extremely aggressive growth and development in its formative years. It had then many years of success, but also paid a high administrative and operational price with speed and rate of growth. Even if all issues are closed, the lesson is learnt. Along the way, our industry's unprecedented depression in depth and longevity allowed us to step-change faster and further of what needed to be changed. That includes our cost structure. We focus on strengths, product line infrastructure and selected market share opportunities to the exclusion of all else. So it allowed us to adopt cash generation and return metric for financial objectives throughout the organization and change our culture. With the overly aggressive earlier stages of the company, part of our history, buried and gone, all that Weatherford focus is on financial priorities and operating performance. The market is turning. It feels slow, hesitant, frail, worrisome. But made no mistake, it is as frustrating as will be powerful when some time has run. The oil field service industry, our industry is a coiled spring, and within the industry, Weatherford is especially tightly coiled. With that, I'll turn the call back to the operator for the Q&A session.

[Operator Instructions] And your first question comes from the line of Jim Wicklund with Crédit Suisse.

Bernard, operationally, it looked like a decent quarter, especially in North America. Internationally, you mentioned that the Middle East and Russia will show improvement in the second half, and you specifically mentioned contract wins. Can you tell us what product lines, what areas that you're winning contracts in, in the International markets, especially in the Middle East these days?

Saudi Arabia, Kuwait, Abu Dhabi, Oman, would be essentially it. And in terms of product lines, it would be essentially drilling-related, drilling and with some completion add-ons.

Okay. And Latin America, you know that's going to continue to lag. Obviously Mexico, Baker had of big blow-up in Ecuador. I mean, everything seems to be stalled. Do you see Latin America coming back in '17? Or is this going to be a longer-term endemic issue?

I think that places like Colombia, Argentina, and, to a more limited degree, Mexico, will have an awakening in '17, nothing extravagant, of course it depends on oil, et cetera. I think Brazil will take a bit longer. And I cannot speak for Venezuela because there are financing issues there. So it's an unknown.

And your next question comes from the line of Bill Herbert with Simmons.

Bernard, could you expand on the recovery path for Eastern Hemisphere margins by year-end? I mean, we're going effectively from breakeven to low double digits by year-end. Is that -- I mean, are those basically costs that have already been taken out of the system that didn't necessarily manifest themselves on the P&L in the second quarter and should begin to blossom in Q3 and Q4?

I think, when you look at the margin expansion we're planning to get, which I agree is a big number if we are to achieve our targets. You will see that about a large 1/3 of it is driven by simply the incorporation of the cost actions we took through the P&L. It's not so much that we acted later throughout the Eastern Hemisphere. It just takes longer simply because of regulations and culture in those places. So our assessment is we're pretty good on the cost metrics, on figuring out what will happen. Our assessment, again, is that it is take just about full effect in Q4 and most of the effect in Q3. So Q3 already benefit, Q4 in full on the cost side and then drives a large 1/3 of the margin improvements that we're hoping to see in dollar terms. The balance of 2/3, or small 2/3, is really nothing more but a measurement of the activity that we see as very, well not only likely, but planned for, we are increasing volume of activity in a number of Middle Eastern markets. It's not in a -- it's not a large number, but it's in a number of markets. We could measure what that means. We know the profitability of the contracts, and we can measure it. And if you add all of that, it provides us with the just a certain dollar margin for the fourth quarter, which, combined with the costs, brings us to somewhere between 10% to 11%, very specifically, operating income margins for MENAP, because Asia Pacific is combined with it. Asia will not change very much. A little bit of cost benefits, will not change very much. So it's all driven by MENAP, and so we see that will still allows us to say that we can see that particular part of our business being driven to double-digit results.

Okay. So to be clear, the double-digit aspiration is for MENAP and not necessarily Eastern Hemisphere?

No, it's for Eastern Hemisphere. I just covered the part of it that. Directly, it's seasonal in the case of Russia, which is very powerful, and then also cost cuts. I mean, cost cuts are seasonal. The European side doesn't move that much in terms of activities, just cost. So the one that was more granular was MENAP. Forgive me.

Okay. And the second line of inquiry here is, I think, Krishna referenced putting 2 fleets back to work in North America in July, and I just want to drill down a little bit on your frac fleet in North America. I think you have something along in the order of kind of 900,000 horsepower in North America. And first, how much of that is working? Second, what's the health of the fleet? And I'm just kind of wondering about how much of your idle capacity can go back to work in short order with a minimal amount of CapEx?

I'll cover some of the aspects and Krishna fill in the blanks. We have originally 23 spreads, and we would calibrate the spread at just about 50,000 horsepower a piece. It's a bit more than 900,000 horsepower in the U.S. However, we feel today we only have 20 that realistically. Out of the 20 spreads, it will be 1 million horsepower rather than the prime number. We have 10 which is hot-stacked -- 10 marketed and also hot-stacked and 10 which is cold-stacked. Of the 10 that are hot-stacked, we went all the way down for 5 operating as recently as Q2 and the 5 becomes 7. So if you will, 7 out of 10 are active, 7 actually under contract, and 3 which are ready to go, assuming we can find the crews. The other 10 cold-stacked are being minimally maintained. They're not just being -- they're not being dilapidated. They're not being sort of cannibalized and the rest of it. There is a CapEx involved for the other 10, which Krishna will cover.

Thanks, Bernard. So yes, first of all, to bring the 3 hot-stacked fleets back on there’s minimal, absolutely we're talking 3 weeks’ time to bring those fleets back to work with very, very minimal expenditure. The cold-stacked fleets will roughly take about $5 million to $7 million each with about a 4-week turnaround time to bring each fleet back. So we could work on all those fleets concurrently, of course. So really the CapEx needed, additional CapEx needed to bring the 10 cold-stacked fleet back to work is actually quite minimal for a company of our size. And we are very cognizant of the market, working closely with our customers, and we should be able to react quite quickly to any kind of upswing in the market.

To put it in a perspective, Bill, I think, on cold-stacked, which is half of our fleet, now the 10 out of the 20, about $150 a horsepower on average to bring them back to the market. They have been, again, minimally maintained. They have not been cannibalized.

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

So just looking to expand on that discussion on the pumping fleet. As you think about more -- the restart of the activity and the impact of pricing, I think you noted in the prepared remarks some tightening of labor, just curious, as you think about pricing progression, do you expect to see some concessions from your customers on pass-through costs first before you can get toward the net pricing? Just curious how that dynamic will play out as activity were to pick up.

So, Sean, you are absolutely right on that. It is a utilization story. In North America, the way the recovery unfolds, which you know very well, is you start getting more fleets back to work. The overall utilization of the U.S. fleet, not just our fleet but industry fleet, has to reach a certain threshold before we then start gradually renegotiating terms and conditions, which include pass-throughs, et cetera. That's how the pricing improvement starts manifesting. And eventually at some point, when the market picks up to a certain threshold, then you start having a little bit tightness in both in equipment and in labor in terms of shortage, and that's when you start getting a little bit more pricing power. But we don't envisage anything in our assumptions on pricing for the rest of this year.

Sean, also be careful that -- be careful, be mindful more so than careful that in the breadth of the product lines, lift completion, well construction and so forth, you’ve had absolutely also terrible pricing and you're probably a bit more likely to see pricing, I wouldn't say strong pricing, no, but some pricing move in the other products and service lines rather than pressure pumping. Pressure pumping will really be initially by our assessment, utilization gain, for quite some time, until you get to a level of utilization where it's more natural to get some pricing relief.

No, I think that's fair. And then just to circle back on the updated free cash flow guidance, there is some moving parts. I was just hoping you could give us a little bit more detail. Particularly I was thinking around the working capital, how you -- how that component is going to help you achieve those targets for the second half?

Right. So first of all, receivables, we should -- I have mentioned that NOCs are managing the cash flow actively. This is an industry thing. It's not a Weatherford thing. And we expect that to continue through the second half. We think NOCs worldwide are going to continue to manage their cash flow quite actively through the end of the year. So the DSO will stay where it is, but obviously, the collections in the second half will exceed that on a prorated basis what we saw in the second quarter. Inventory levels initially for the first, like I would say, 6 to 9 months starting now, will actually dip because there will be a step-up in activity. That's our assumption based on what we are seeing in the marketplace. So you'll see inventory levels dip a little bit before we need to start restocking. Restocking will start some time mid-next year. So in terms of working capital, we expect to see some inventory declines. We expect to see an increase -- marginal increase in receivable balances, and payables will go with the business. If business goes up, payables will increase as we go forward, allowing us to manage the receivables from a liquidity perspective. So it'll be a little bit of a mixed bag, I would say, kind of flattish working capital for the next 6 to 9 months and then gradual increase after that, as the business picks up to a new level.

And your next question comes from the line of Marshall Adkins with Raymond James.

I want to drill down on the -- your ability to respond in an upturn. I think, Krishna, you mentioned that the activity could -- would need to improve 2.5x before you need meaningful CapEx. First of all, did I hear that right? And how does that apply by product line and by geographic areas? Is North America going to be the same? For example, 2.5x where we are today is 1,100 rigs before you really need to spend any CapEx.

I'll give some element of comments, Marshall, and then Krishna will add. It's actually a little bit, even a bit more than that. The manufacturing capabilities can accommodate 3x more volume, not 2.5. The infrastructure, which is a bit of on artificial measurement, the roof line that we developed over the years is so wide and actually is. So it give up a much higher volume. It can also accommodate throughput of 3x the volume that we presently have easily. The 2.5x concerns the tools deployed in the field. Whether it's completion service tools, whether it's LWD kits to both ends of the spectrum, that's what Krishna was referring to. And all of these numbers are absolutely correct. We actually do not need to expand manufacturing or infrastructure period in the foreseeable future, because 3x the volume, even in the recovery, it's a lot. In terms of the service tools that I just mentioned and all the formation evaluation tools, as you can tell also, 2.5x is a vast number. In addition to which I will tell you, we are improving really by a large measure the intensity of usable tools, which if anything will tend to make the 2.5x the bigger number and/or last longer, if you will. As volumes come in, we'll still have that kind of ability to accommodate more business. So CapEx, we're not starving the business, not the business which is being deprived of anything. The reality is we have very long assets. So we can use assets. We are using assets. We've learned how to do that intelligently. And although CapEx as activity, obviously, will grow, you will be surprised by how modest it is. And it's not we’re suppressing our capabilities at all. It’s just that we spent much in past years and it has not been wasted. That's really all. Krishna, you want to add to?

Yes, I'd like to add just to give some context here as well. In the last 2 years or so, we have immensely strengthened the management of our product lines. People in the field -- the product line people in the field, they have asset-sharing objectives, and that culture change has happened nicely over the last 2 years. So today, they all carry a global CapEx objective by product line. Every product line has got utilization metrics which are now embedded. People understand them. And sharing of tools is one aspect of it. The other aspect of it is to localize repairs and maintenance. So we have opened up R&M centers locally in many geographies in the last 2 years. What this does is that when a tool goes down after using them in a job, it gets now maintained and repaired locally and it's redeployed immediately back in the field from where it came as opposed to the past when it would have to come back to Houston or go back to the U.K., it would take months and months of turnaround time, which means you had to have a huge number of backup tools in every country to cope with that R&M kind of facility that we had -- in a centralized facility that we had. Now having localized everything, we have much more confident in telling you that we don't need that many backup tools as before. This is part of the transformation of Weatherford, just the way we're managing our fleet, global fleet of tools, the way we're managing the deployment of tools, and the repair and maintenance of tools. So all of this goes into the kind of statistic that I was talking about, 2.5x.

We managed our costs down. We've talked a lot about it, because it's easy to measure people. What we don't talk much about is the quality of the people and the priorities they have, the operating guidelines they have, the culture change. We also don't talk as much either as to the work we done on and around the assets, understanding the asset base we have, understanding how to use it more efficiently. There's an enormous amounts of headroom in us doing that. But we've done all 3 at the same time. We just put the emphasis on just the raw numbers of people leaving and the cost measurement because it's just easier to get your hands around it. So really our ability to manage the upswing in terms of physical tools and CapEx is actually very, very strong, without meaningfully adding to CapEx and eroding our cash flow going forward.

And in closing, that doesn't have anything to do with the availability of capital. It has to do with returns. That was returns-driven initiative.

That was a surprisingly high number and that's a good color and helps me -- help me understanding how you get there. The other surprising thing that I heard was, I think, Krishna, you mentioned that you're already starting to see a little bit of a tightening in the labor side and maybe 6 weeks to re-staff a frac crew today. If activity is, let's say, 30%, 50% higher than today, how long do you think that’d take you to hire out and train a crew?

We are not alone in this. Our peers are also recruiting hand over fist right now or to start some few additional crews that they're putting out there. So I think, frankly, as an industry, the first, I would say -- there's no empirical verification of this, of course, but I would say the first 25%, 30%, 40% increased physical activity, it'll be fairly straightforward to recruit back some of the labor that have been laid off. After that, it'll get really tight. So when I would say up to 600 oil rigs, it should be fairly easy. After that, it gets tighter. So we'll reach a situation where we tell the customers we have the equipment but we have less people, we don't have people to run it. And that's what I was talking about in the prepared comments that the crunch will come on people first, then it'll come on equipment much later.

Marshall, at the end of the day, what he means is the elasticity, a response of North America on the oil side, meaning on the production, on the capacity side, is overstated for a simple reason that -- forget the reservoir issues and what are others zones we can go after, production is the one that we are after and blah, blah, blah, forget that. That's one issue. But the other issue is just the shareability for the industry to bounce back. Of course, it will. It will take much longer. It is not a normal depression we went through. It lasted much longer, much, much, much longer. It’s already twice as long as '09 and deeper, and there are consequences. And the consequences is measured with the elasticity of response.

And presumably, that's on pricing that was hyperbolic when you started to have running in those bottlenecks?

Yes, that's not what we want. I mean, as an industry, that's correct. We don't make the rules.

And your next question comes from the line of the Waqar Syed with Goldman Sachs.

Just quickly on the Zubair. I guess, last time around the $150 million of settlement, have you received proceeds for that? Or when do you expect them, if not already?

So we signed a settlement agreement with them, Waqar, and really they're following the settlement agreement to the letter. So we received $60 million in the second quarter, and offsetting that was operating expenses because we had operations, which have not finished, in the second quarter. But the rest of the money, most of it'll come in the third quarter, as negotiated and agreed. And that's part of our second half cash flow forecast.

And your next question comes from the line of Kurt Hallead with RBC.

So I just wanted to follow up on 2 things. First, focus on the cash flow dynamics you guys outlined, what do you expect for the full year cash flow generation. Just wondering how you guys are risk-assessing getting to that cash flow number in the context -- in that context and maybe what percentage of working capital is going to represent that cash flow.

So obviously there is a number of elements in our second half cash flow guidance, right? We see an improvement in earnings, as Bernard mentioned in his comments, right, with the growth both in North America and Eastern Hemisphere, excluding Latin America. Latin America has not yet grown. And there is also, of course, a working capital relief, both mainly from inventories, really, and some amount of receivables as well just flowing through from the Q2. And I think from a risk assessment standpoint, these are the main assumptions we have because the rest of it, the severance is going to go down because we've accelerated much of it into the second quarter. Interest payments actually will go down as well in cash terms because -- again, because of acceleration into second quarter. And the Zubair contract will be cash positive more so in the second half, much more so than in the first half. So when you aggregate all of the moving pieces, these are the things most of it should happen as planned. I think from a risk standpoint, commodity prices, activity levels, et cetera, those are the elements of it. But I'd like to mention that no matter what the numbers are, the implications are completely dampened now because from a liquidity and capital structure standpoint, as we mentioned earlier, and the covenant management, there is no issue at all.

So to summarize, Kurt, I mean, I’ll add a couple of things also if you wanted to get more comfort, which is that we always have a large operating bonus payment in Q2, every Q2 of every year. It's in the range of $18 million. It occurs in one quarter, in Q2. It isn't a routine, thus far, but it won't occur in Q3, Q4. So there you are. The other thing also as you take a look, for no particular reason out of the individual agreements, payables were taken down quite a lot in Q2 also. I mean, these are all obvious things you'll see, find. So I have mentioned also -- so that's one set of factors. And Krishna is right, it is not -- we are not a company which is -- have any issues of either liquidity or anything like that. We have now the kind of capital structure that we want, and we do feel that we can take the net debt number down to, if you analyze the numbers to $4 billion as a matter of 3 different events, which is free cash flow, and the sale of assets, which is rigs, and also in our minds we believe the conversion of the convertible into equity takes you down, just mechanically, very easily, to $4 billion, and from there on we’ll take it down further. It's all very clear. Do not assume, though -- because we believe that the measurement of free cash flow is not the critical or only measurement that matters at Weatherford anymore, don't presume that we don't have within the organization ingrained in everyone's metrics the importance of free cash. That won't change precisely because we intend to make generous free cash flow in the years ahead, not just in the second half of the year. This is perennial. So don't assume because we say this that we don't view free cash flow generation as critical when you run the company. This is actually the measurements of success long term of any company.

Okay, that's great. And then my follow-up is, so you mentioned breakeven in a couple of different context, one on operating income. I think that was related specifically to North America. And then Krishna, I think, your reference to breakeven was on an earnings per share basis. Can you guys clarify?

What I put forth is what we see internally, which is we see a path towards North America going from what was $100 million negative operating profit in Q2, which was better than Q1, to being breakeven. That's one. And we see that occurring in the first half of next year, Q1 or Q2. There are number of reasons for that. And of course, it depends also on oil being reasonable and so forth and so on. But a lot of it are things we control. This is one thing. What Krishna mentioned severances distinct is simply the fact that he doesn't see, and he's right, how we can predictively be able to make enough of a progress to be able to be breakeven this year. It's doesn't mean numbers will not get better. Everybody is saying they will get better. The question is, can we go from where we are $0.28 negative to a breakeven, which is, I think, urgently needed. We'll get there. We don't think we'll get there by Q4, unfortunately, but the numbers will be better. That's what Krishna was conveying. And I think, thank you very much. I think we have to close the Q&A session. We have -- there's a lot of calls today from our peers. And just to allow people to attend the other calls, we're just closing here. Thank you very much, everyone, for your time.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.