Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
EXECUTIVE OVERVIEW
Organization
We are a leading provider of services and products to the energy industry. We serve the upstream oil and natural gas industry throughout the lifecycle of the reservoir, from locating hydrocarbons and managing geological data, to drilling and formation evaluation, well construction and completion, and optimizing production through the life of the field. Activity levels within our operations are significantly impacted by spending on upstream exploration, development, and production programs by major, national, and independent oil and natural gas companies. We report our results under two segments, the Completion and Production segment and the Drilling and Evaluation segment:
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our Completion and Production segment delivers cementing, stimulation, intervention, pressure control, specialty chemicals, artificial lift, and completion products and services. The segment consists of Production Enhancement, Cementing, Completion Tools, Production Solutions, Pipeline and Process Services, Multi-Chem, and Artificial Lift.
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our Drilling and Evaluation segment provides field and reservoir modeling, drilling, evaluation, and precise wellbore placement solutions that enable customers to model, measure, drill, and optimize their well construction activities. The segment consists of Baroid, Sperry Drilling, Wireline and Perforating, Drill Bits and Services, Landmark Software and Services, Testing and Subsea, and Consulting and Project Management.
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The business operations of our segments are organized around four geographic regions: North America, Latin America, Europe/Africa/CIS and Middle East/Asia. We have significant manufacturing operations in various locations, including the United States, Canada, China, Malaysia, Singapore and the United Kingdom. With approximately
50,000
employees, we operate in approximately
70
countries around the world, and our corporate headquarters are in Houston, Texas and Dubai, United Arab Emirates.
Termination of Baker Hughes acquisition
In November 2014, we entered into a merger agreement with Baker Hughes to acquire all outstanding shares of Baker Hughes in a stock and cash transaction. On April 30, 2016, primarily because of the challenges in obtaining remaining regulatory approvals and general industry conditions that severely damaged deal economics, we and Baker Hughes mutually terminated our merger agreement. As a result, we paid Baker Hughes a termination fee of $3.5 billion and recognized the tax-deductible expense in the second quarter of 2016. In addition, we mandatorily redeemed $2.5 billion of senior notes during the second quarter of 2016. See Note 2 to the condensed consolidated financial statements for further information.
Financial results
Market conditions continued to negatively impact our business during the third quarter of 2016 marked by lower activity levels and continued pricing pressure around the globe. The North America market continues to face activity and pricing challenges, with the United States land rig count at September 30, 2016 having declined over 70% from the peak in November 2014, which resulted in our recognition of third quarter operating losses in the region. However, crude prices have increased significantly since the low point in February 2016 and the North American rig count has shown improvement since a low point in May 2016, signaling that we may have hit the bottom of the industry downturn and can begin to look ahead for a potential market recovery. The third quarter average United States rig count increased 14% compared to the second quarter.
We generated $3.8 billion of revenue during the third quarter of 2016, a 31% decrease from the $5.6 billion of revenue generated in the third quarter of 2015. This decrease resulted from activity and pricing reductions in all of our product services lines, most notably stimulation activity in the United States land market. We reported operating income of $128 million in the third quarter of 2016, with a mix of positive operating results in our international business partially offset by operating losses in North America. This compares to operating income of $43 million in the third quarter of 2015, which included $381 million of company-wide impairments and other charges and $82 million of Baker Hughes related costs.
We generated $11.9 billion of revenue during the first nine months of 2016, a 36% decline from the $18.6 billion of revenue generated in the first nine months of 2015. Additionally, we recognized $6.8 billion of operating losses during the first nine months of 2016 compared to $251 million of operating losses during the first nine months of 2015. These results were negatively impacted by global activity and pricing reductions, combined with $3.2 billion and $1.9 billion of impairments and other charges recorded in the first nine months of 2016 and 2015, respectively. Additionally, operating results were negatively impacted by Baker Hughes related costs, which were $4.1 billion during the first nine months of 2016 and included a $3.5 billion merger termination fee along with charges resulting from our reversal of assets held for sale accounting, compared to $203 million of Baker Hughes-related costs during the first nine months of 2015.
The impact of our structural global cost savings initiatives are taking shape, and our operating results are beginning to benefit from cost reductions that have been implemented during the current market downturn. We were required to reduce our global workforce in an effort to address deteriorating market conditions and better align our workforce with anticipated activity levels in the near-term. Personnel expense is one of the largest cost categories for us, and therefore, we implemented cost containment measures as they related to employees and their work locations. We reduced our global headcount by approximately 13,000 during the first nine months of 2016 and by approximately 40% since the beginning of 2015 to help mitigate the industry downturn. See Note 3 to the condensed consolidated financial statements for further information about our impairments and other charges.
Business outlook
The past several years have continued to be extremely challenging for us, as the impact of reduced commodity prices created widespread pricing pressure and activity reductions on a global basis. We have taken actions since late 2014 to help mitigate the effect on our business from the downturn in the energy market, and we will continue to evaluate our cost structure and make further adjustments as required. However, with commodity price improvements from first quarter lows and the recent uptick in North America rig count, there are signs of optimism in the industry for a potential market recovery, which we believe we are well positioned to benefit from given our delivery platform and cost containment strategies.
In North America, we continued to experience substantial pricing pressure, which has deteriorated our margins across all of our product service lines. Revenue in North America declined 33% in the third quarter of 2016 as compared to the third quarter of 2015, outperforming a 43% decline in the average North America rig count year over year. During this down cycle, we have made structural changes to our delivery platform, eliminating management layers and consolidating roles and locations. The rig count has shown recent improvement, with the average third quarter United States rig count increasing 14% when compared to the second quarter. As a result of this recent uptick in rig count and increased asset utilization in the United States land sector, our North America revenue grew sequentially for the first time in seven quarters and margins are beginning to see an improvement now that our cost savings initiatives are taking effect. Despite uncertainty surrounding customer activity around the upcoming holiday season, we anticipate our North America revenue will perform in-line with changes in the rig count in the fourth quarter. While the supply and demand balance for United States onshore services appears to be heading in the right direction, we are still in an over-supplied equipment market. Our customers remain focused on cost and producing more barrels of oil equivalent. We believe we are well positioned as we continue to collaborate with customers to engineer solutions that deliver the lowest cost per barrel of oil equivalent. We will continue to take advantage of the growing rig count by focusing on increasing equipment utilization, managing costs and expanding our surface efficiency model.
The international markets have been more resilient than North America throughout the downturn, but we experienced further activity and pricing headwinds during the third quarter, with revenue declines compared to the second quarter in all three international regions with margins remaining challenged. We have continued to work with customers during this downturn to improve project economics through technology and improved operating efficiency. We believe the typical seasonal uptick in year-end software and product sales will be minimal this year as customer budgets are exhausted and seasonal sales may not fully offset continued pricing and activity pressures. As such, we expect margins and revenues to be flat in the fourth quarter, as compared to the third quarter, while the international markets take a little more time to rebound. In Latin America, rig activity remains low across the region, while Venezuela continues to experience significant political and economic turmoil. We expect to see a bottoming of the international rig count in the first half of 2017, driven by both cyclical and traditional seasonal impacts.
We have adjusted to market conditions and reduced our capital expenditures to $625 million in first nine months of 2016, a reduction of over 60% from the first nine months of 2015. As a result of the actions we have taken over the past few years, we believe we are well positioned for the potential market recovery and will scale up our delivery platform by addressing our product service lines one step at a time through a combination of organic growth, investment, and selective acquisitions. We are continuing to execute the following strategies in
2016
:
- directing capital and resources into strategic growth markets, including unconventional plays, mature fields, and deepwater;
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leveraging our broad technology offerings to provide value to our customers and enabling them to more efficiently drill and complete their wells;
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exploring additional opportunities for acquisitions that will enhance or augment our current portfolio of services and products, including those with unique technologies or distribution networks in areas where we do not already have significant operations;
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investing in technology that will help our customers reduce reservoir uncertainty and increase operational efficiency;
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improving working capital, and managing our balance sheet to maximize our financial flexibility;
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continuing to seek ways to be one of the most cost efficient service providers in the industry by maintaining capital discipline and leveraging our scale and breadth of operations; and
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- collaborating with our customers to maximize production at the lowest cost per barrel of oil equivalent.
Our operating performance and business outlook are described in more detail in “Business Environment and Results of Operations.”
Financial markets, liquidity, and capital resources
We believe we have invested our cash balances conservatively and secured sufficient financing to help mitigate any near-term negative impact on our operations from adverse market conditions. During the second quarter of 2016, in conjunction with the termination of the Baker Hughes transaction, we paid a $3.5 billion termination fee and mandatorily redeemed $2.5 billion of debt that we issued in late 2015. In the third quarter of 2016, we paid off an additional $600 million of senior notes that matured in August, closing the quarter at $3.3 billion of cash and equivalents. This represents a $6.8 billion reduction in our cash position since December 31, 2015, but a cash improvement since June 30, 2016. This quarterly growth was driven by working capital improvements, including a reduction in our days sales outstanding, along with the receipt of a series of tax refunds. We remain committed to operating within our cash flows and continue to execute capital discipline during the current market environment. We also have $3.0 billion available under our revolving credit facility which, with our cash balance, we believe provides us with sufficient liquidity to address the challenges and opportunities of the current market. For additional information on market conditions, see “Liquidity and Capital Resources” and “Business Environment and Results of Operations.”
LIQUIDITY AND CAPITAL RESOURCES
As of
September 30, 2016
, we had $3.3 billion of cash and equivalents, compared to $10.1 billion at December 31, 2015. Additionally, we held
$96 million
of investments in fixed income securities at
September 30, 2016
and
December 31, 2015
. These securities are reflected in "Other current assets" and "Other assets" in our condensed consolidated balance sheets. Approximately
$1.9 billion
of our total cash position as of
September 30, 2016
was held by our foreign subsidiaries, a substantial portion of which is available to be repatriated into the United States to fund our U.S. operations or for general corporate purposes, with a portion subject to certain country-specific restrictions. We have provided for U.S. federal income taxes on cumulative undistributed foreign earnings where we have determined that such earnings are not indefinitely reinvested.
Significant sources and uses of cash
- Operating cash flows was a negative
$2.8 billion
during the first
nine
months of
2016
, driven primarily by the $3.5 billion termination fee paid to Baker Hughes during the second quarter.
- We mandatorily redeemed $2.5 billion of senior notes in the second quarter and repaid $600 million of senior notes that matured during the third quarter.
- Capital expenditures were
$625 million
in the first
nine
months of
2016
, a reduction of over 60% from the first nine months of 2015, as we continue to adapt to market conditions. These capital expenditures were predominantly made in our
Production Enhancement
,
Sperry Drilling
,
Cementing
,
Baroid
, and Production Solutions product service lines.
- During the first
nine
months of
2016
, our primary components of working capital (receivables, inventories, and accounts payable) decreased by a net
$609 million
, primarily due to decreased business activity driven by current market conditions.
- We paid
$465 million
in dividends to our shareholders during the first
nine
months of
2016
.
- We received a series of United States tax refunds aggregating $430 million during the third quarter of 2016, primarily related to the carryback of our net operating losses recognized in 2015. This was partially offset by tax payments for normal business operations in various foreign jurisdictions.
Future sources and uses of cash
We manufacture our own equipment, which allows us flexibility to increase or decrease our capital expenditures based on market conditions. Capital spending for the full year
2016
is currently expected to be approximately
$850 million
, a reduction of over 60% from the $2.2 billion of capital expenditures in 2015, which demonstrates our commitment to live within our cash flows during this challenging period for the industry. The capital expenditures plan for the remainder of the year is primarily directed toward our
Production Enhancement
,
Sperry Drilling
,
Production Solutions
,
Wireline and Perforating
and
Cementing
product service lines.
During 2014, we reached an agreement, subject to court approval, to settle a substantial portion of the plaintiffs' claims asserted against us relating to the Macondo well incident. In the second quarter of 2016, we made a $33 million payment in accordance with our MDL Settlement. Our total Macondo-related loss contingency liability as of
September 30, 2016
was $413 million, of which $369 million is expected to be paid in the first quarter of 2017. See Note 8 to the condensed consolidated financial statements for further information.
Currently, our quarterly dividend rate is $0.18 per common share, or approximately
$155 million
. Subject to the approval of our Board of Directors, our intention is to continue paying dividends at our current rate.
Our Board of Directors has authorized a program to repurchase our common stock from time to time. Approximately
$5.7 billion
remains authorized for repurchases as of
September 30, 2016
and may be used for open market and other share purchases. There were no repurchases made under the program during the nine months ended September 30, 2016.
Other factors affecting liquidity
Financial position in current market.
As of
September 30, 2016
, we had
$3.3 billion
of cash and equivalents,
$96 million
in fixed income investments, and
$3.0 billion
of available committed bank credit under our revolving credit facility. Furthermore, we have no financial covenants or material adverse change provisions in our bank agreements, and our debt maturities extend over a long period of time. We believe our cash on hand, cash flows generated from operations and our available credit facility will provide sufficient liquidity to address the challenges and opportunities of the current market and manage our global cash needs for the remainder of 2016, including capital expenditures, scheduled debt maturities, working capital investments, dividends, if any, and contingent liabilities.
Guarantee agreements.
In the normal course of business, we have agreements with financial institutions under which approximately
$1.9 billion
of letters of credit, bank guarantees, or surety bonds were outstanding as of
September 30, 2016
. Some of the outstanding letters of credit have triggering events that would entitle a bank to require cash collateralization.
Credit ratings.
During the third quarter of 2016, in conjunction with the termination of our merger agreement with Baker Hughes earlier in the year and as a result of general market conditions, Standard & Poor’s (S&P) changed our long-term credit rating from A- to BBB+ and changed our outlook from negative to stable. The credit ratings on our short-term debt remain A-2 with S&P. Our credit ratings with Moody’s Investors Service (Moody's) remain Baa1 for our long-term debt and P-2 for our short-term debt with a negative outlook.
Customer receivables
. In line with industry practice, we bill our customers for our services in arrears and are, therefore, subject to our customers delaying or failing to pay our invoices. In weak economic environments, we may experience increased delays and failures to pay our invoices due to, among other reasons, a reduction in our customers’ cash flow from operations and their access to the credit markets as well as unsettled political conditions. If our customers delay paying or fail to pay us a significant amount of our outstanding receivables, it could have a material adverse effect on our liquidity, consolidated results of operations and consolidated financial condition. See “Business Environment and Results of Operations – International operations – Venezuela” for further discussion related to receivables from our primary customer in Venezuela.
BUSINESS ENVIRONMENT AND RESULTS OF OPERATIONS
We operate in approximately
70
countries throughout the world to provide a comprehensive range of discrete and integrated services and products to the energy industry related to the exploration, development, and production of oil and natural gas. A significant amount of our consolidated revenue is derived from the sale of services and products to major, national, and independent oil and natural gas companies worldwide. The industry we serve is highly competitive with many substantial competitors in each segment of our business. During the first
nine
months of
2016
, based upon the location of the services provided and products sold, 40% of our consolidated revenue was from the United States, compared to 45% of consolidated revenue from the United States in the first
nine
months of 2015. This decline reflects the impact our North America operations are experiencing from the downturn in the energy market. No other country accounted for more than 10% of our revenue during these periods.
Operations in some countries may be adversely affected by unsettled political conditions, acts of terrorism, civil unrest, force majeure, war or other armed conflict, sanctions, expropriation or other governmental actions, inflation, changes in foreign currency exchange rates, foreign currency exchange restrictions and highly inflationary currencies, as well as other geopolitical factors. We believe the geographic diversification of our business activities reduces the risk that loss of operations in any one country, other than the United States, would be materially adverse to our consolidated results of operations.
Activity within our business segments is significantly impacted by spending on upstream exploration, development, and production programs by our customers. Also impacting our activity is the status of the global economy, which impacts oil and natural gas consumption.
Some of the more significant determinants of current and future spending levels of our customers are oil and natural gas prices, global oil supply, the world economy, the availability of credit, government regulation, and global stability, which together drive worldwide drilling activity. Lower oil and natural gas prices usually translate into lower exploration and production budgets. Our financial performance is significantly affected by well count in North America, as well as oil and natural gas prices and worldwide rig activity, which are summarized in the tables below.
The following table shows the average oil and natural gas prices for West Texas Intermediate (WTI), United Kingdom Brent crude oil, and Henry Hub natural gas:
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Three Months Ended
September 30
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Year Ended
December 31
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2016
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2015
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2015
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Oil price - WTI
(1)
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$
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44.84
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$
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46.42
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$
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48.69
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Oil price - Brent
(1)
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45.79
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50.25
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52.36
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Natural gas price - Henry Hub
(2)
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2.88
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2.76
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2.63
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(1)
Oil price measured in dollars per barrel
(2)
Natural gas price measured in dollars per million British thermal units (Btu), or MMBtu
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The historical average rig counts based on the weekly Baker Hughes Incorporated rig count information were as follows:
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Three Months Ended
September 30
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Nine Months Ended
September 30
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Land vs. Offshore
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2016
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2015
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2016
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2015
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United States:
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Land
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461
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833
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459
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1,021
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Offshore (incl. Gulf of Mexico)
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18
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33
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23
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38
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Total
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479
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866
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482
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1,059
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Canada:
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Land
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119
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187
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110
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197
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Offshore
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2
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3
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2
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|
3
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Total
|
121
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190
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|
112
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|
200
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International (excluding Canada):
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Land
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711
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865
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740
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896
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Offshore
|
225
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267
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|
225
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|
291
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Total
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936
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1,132
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965
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|
1,187
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Worldwide total
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1,536
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2,188
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1,559
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2,446
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Land total
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1,291
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1,885
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1,309
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|
2,114
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Offshore total
|
245
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|
303
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|
250
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|
332
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Three Months Ended
September 30
|
Nine Months Ended
September 30
|
Oil vs. Natural Gas
|
2016
|
2015
|
2016
|
2015
|
United States (incl. Gulf of Mexico):
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Oil
|
391
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658
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388
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817
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Natural gas
|
88
|
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208
|
|
94
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|
242
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Total
|
479
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866
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482
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1,059
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Canada:
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Oil
|
64
|
|
88
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|
54
|
|
90
|
|
Natural gas
|
57
|
|
102
|
|
58
|
|
110
|
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Total
|
121
|
|
190
|
|
112
|
|
200
|
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International (excluding Canada):
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|
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Oil
|
709
|
|
885
|
|
733
|
|
935
|
|
Natural gas
|
227
|
|
247
|
|
232
|
|
252
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Total
|
936
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|
1,132
|
|
965
|
|
1,187
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Worldwide total
|
1,536
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|
2,188
|
|
1,559
|
|
2,446
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Oil total
|
1,164
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1,631
|
|
1,175
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|
1,842
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Natural gas total
|
372
|
|
557
|
|
384
|
|
604
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Three Months Ended
September 30
|
Nine Months Ended
September 30
|
Drilling Type
|
2016
|
2015
|
2016
|
2015
|
United States (incl. Gulf of Mexico):
|
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Horizontal
|
373
|
|
659
|
|
376
|
|
805
|
|
Vertical
|
61
|
|
123
|
|
58
|
|
152
|
|
Directional
|
45
|
|
84
|
|
48
|
|
102
|
|
Total
|
479
|
|
866
|
|
482
|
|
1,059
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Crude oil prices have been extremely volatile during the past few years. WTI oil spot prices declined significantly towards the second half of 2014 with a peak price of $108 per barrel in June 2014, and continued to decline throughout 2015, ranging from a high of $61 per barrel in June 2015 to a low of $35 per barrel in December 2015. WTI oil spot prices declined further into February 2016 to a low of $26 per barrel, a level which had not been experienced since 2002. Brent crude oil spot prices declined from a high of $115 per barrel in June 2014, and continued to decline throughout 2015, ranging from a high of $66 per barrel in May 2015 to a low of $35 per barrel in December 2015, and declined further to $26 per barrel in January 2016. Commodity prices have increased from the low point experienced in early 2016 to highs of $51 per barrel in June 2016 for WTI and $52 per barrel in October 2016 for Brent, although prices have continued to fluctuate significantly. We believe this price improvement could signal the beginning of a turning point in the market. Although crude oil prices continue to be lower than their 2014 and 2015 highs, growing domestic and global consumption has contributed to rising prices.
WTI and Brent crude oil spot prices had a monthly average in September 2016 of $45 per barrel and $47 per barrel, respectively. In September 2016, the partial closure of the Colonial Pipeline system led to rising stockpiles and falling prices, which contributed to decreases from the monthly average of $48 per barrel in June 2016. However, prices are expected to remain relatively unchanged for the remainder of 2016 as significant economic and geopolitical events are expected to affect market participants' expectations and demand growth. Crude oil production in the United States is projected to average 8.7 million barrels per day for the remainder of 2016.
In the United States Energy Information Administration (EIA) October 2016 "Short Term Energy Outlook," the EIA projects that Brent prices will average $48 per barrel in the fourth quarter of 2016, while WTI prices will average about $1 less per barrel. The EIA also notes that price projections are highly uncertain due to the current values of futures and options contracts. During the third quarter of 2016, in an effort to speed the market's rebalancing, the Organization of the Petroleum Exporting Countries (OPEC) tentatively agreed to cut production. This would be the group’s first deal to reduce supply in eight years. Details, including individual country targets, are expected to be finalized at a scheduled meeting in the fourth quarter. The International Energy Agency's (IEA) October 2016 "Oil Market Report" forecasts the 2016 global demand to average approximately 96.3 million barrels per day, which is up 1% from 2015, driven by an increase in the Asia Pacific region, while all other regions remain approximately the same.
For the third quarter of 2016, the average Henry Hub natural gas price in the United States increased approximately 4% from the third quarter of 2015.
The Henry Hub natural gas spot price averaged $2.99 per MMBtu in September 2016, an increase of $0.40 per MMBtu, or 15%, from June 2016. Production decline and increased demand for natural gas to fuel electricity generation contributed to higher natural gas prices. The EIA October 2016 “Short Term Energy Outlook” projects Henry Hub natural gas prices to average $3.04 per MMBtu in the fourth quarter of 2016. Over the long term, the EIA expects natural gas consumption to increase primarily in the electric power sector and to a lesser extent in the industrial sector as new fertilizer and chemical projects become available.
North America operations
During the third quarter of 2016, North America oil directed rig count declined 291 rigs, or 39%, from the third quarter of 2015, while the natural gas-directed rig count in North America decreased 165 rigs, or 53%, during the same period. In the United States land market during the third quarter of 2016, there was a decline of 45% in the average rig count compared to the third quarter of 2015.
The United States land rig count has dropped 73% since its peak in November 2014. Price erosion for our services continued during the third quarter of 2016, specifically in North America, and we believe pricing pressure will continue until activity stabilizes. However, the rig count has begun to show improvement since its low point in May 2016 with a 14% increase in the average third quarter United States rig count when compared to the second quarter, and is expected to continue improving for the remainder of the year. As a result of the structural changes to our delivery platform we made during this down cycle, we believe North America margins can begin to recover going forward, and we anticipate our North America revenue for the fourth quarter to perform in-line with changes in the rig count, despite uncertainty surrounding customer activity around the upcoming holiday season. In the long run, we believe the shift to unconventional oil and liquids-rich basins in the United States land market will continue to drive increased service intensity and will create higher demand in fluid chemistry and other technologies required for these complex reservoirs, which will have positive implications for our operations when the energy market ultimately recovers.
In the Gulf of Mexico, the average offshore rig count for the third quarter of 2016 was down 45% compared to the third quarter of 2015. Activity in the Gulf of Mexico is dependent on, among the factors described above and other things, governmental approvals for permits, our customers' actions, and the entry and exit of deepwater rigs in the market.
International operations
The average international rig count for the third quarter of 2016 decreased by 17% compared to the third quarter of 2015. Depressed crude oil prices have caused many of our customers to reduce their budgets and defer several new projects; however, we have continued to work with our customers to improve project economics through technology and improved operating efficiency. In Latin America, the rig count is at a 15-year low across the region, and Venezuela continues to experience significant political and economic turmoil. Latin America is expected to remain our most challenged region throughout the international down cycle, and we do not expect to see a fundamental improvement for the remainder of 2016. For our overall international business, we believe the typical seasonal uptick in year-end sales will be minimal this year as customer budgets are exhausted and seasonal sales may not fully offset continued pricing and activity pressures.
Venezuela.
In February 2015, the Venezuelan government created a three-tier foreign exchange rate system, which included the National Center of Foreign Commerce official rate of 6.3 Bolívares per United States dollar, the SICAD, and the SIMADI. During the first quarter of 2015, we began utilizing the SIMADI floating rate mechanism to remeasure our net monetary assets denominated in Bolívares, with an initial market rate of 192 Bolívares per United States dollar, resulting in a foreign currency loss of $199 million recorded during the first quarter of 2015.
In February 2016, the Venezuelan government revised the three-tier exchange rate system to a new dual-rate system designed to streamline access to dollars for production and essential imports as well as combat inflation. The dual-rate exchange mechanisms are as follows: (i) the DIPRO, which replaced and devalued the official rate from 6.3 to 10.0 Bolívares per United States dollar, and represents a protected rate made available for vital imports such as food, medicine, and raw materials for production; and (ii) the DICOM, which replaces the SIMADI and which is intended to be a free floating system that will fluctuate according to market supply and demand. The DICOM had a market rate of 276 Bolívares per United States dollar at March 31, 2016 and 654 Bolívares per United States dollar at
September 30, 2016
. We are utilizing the DICOM to remeasure our net monetary assets denominated in Bolívares, and the revised system and continued devaluation did not materially affect our financial statements for the
three and nine
months ended
September 30, 2016
.
As of
September 30, 2016
, our total net investment in Venezuela was approximately
$745 million
, with only $1 million of net monetary assets denominated in Bolívares, and we had an additional
$36 million
of surety bond guarantees outstanding relating to our Venezuelan operations.
We have continued to experience delays in collecting payments on our receivables from our primary customer in Venezuela. These receivables are not disputed, and we have not historically had material write-offs relating to this customer. Additionally, we routinely monitor the financial stability of our customers. During the second quarter of 2016, we executed a financing agreement with our primary customer in Venezuela in an effort to actively manage these customer receivables, resulting in an exchange of $200 million of outstanding trade receivables for an interest-bearing promissory note. We recorded the note at its fair market value at the date of exchange, which resulted in a
$148 million
pre-tax loss on exchange in the second quarter. This instrument provides a more defined schedule around the timing of payments, while generating a return while we await payment. We are using an effective interest method to accrete the carrying amount to its par value as it matures. We received our first interest payment on this promissory note during the third quarter, and the carrying amount of the note was
$60 million
as of September 30, 2016. In October 2016, we agreed to exchange this promissory note for a new note with the same maturity and coupon, but which is expected to be tradeable in a more liquid market. We intend to hold the new note to maturity.
Our total outstanding net trade receivables in Venezuela were
$564 million
as of
September 30, 2016
, excluding the promissory note receivable discussed above, compared to
$704 million
as of
December 31, 2015
, which represents
13%
and
14%
of total company trade receivables for the respective periods. The majority of our Venezuela receivables are United States dollar-denominated receivables. Of the
$564 million
receivables in Venezuela as of
September 30, 2016
,
$138 million
has been classified as long-term and included within “Other assets” on our condensed consolidated balance sheets. As a result of current conditions in Venezuela and the continued delays in collecting payments on our receivables in the country, we began curtailing activity in Venezuela during the first quarter of 2016.
For additional information, see Part I, Item 1(a), “Risk Factors” in our
2015
Annual Report on Form 10-K.
RESULTS OF OPERATIONS IN
2016
COMPARED TO
2015
Three Months Ended
September 30, 2016
Compared with
Three Months Ended
September 30, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
REVENUE:
|
Three Months Ended
September 30
|
Favorable
|
Percentage
|
Millions of dollars
|
2016
|
2015
|
(Unfavorable)
|
Change
|
Completion and Production
|
$
|
2,176
|
|
$
|
3,200
|
|
$
|
(1,024
|
)
|
(32
|
)%
|
Drilling and Evaluation
|
1,657
|
|
2,382
|
|
(725
|
)
|
(30
|
)
|
Total revenue
|
$
|
3,833
|
|
$
|
5,582
|
|
$
|
(1,749
|
)
|
(31
|
)%
|
|
|
|
|
|
By geographic region:
|
|
|
|
|
North America
|
$
|
1,658
|
|
$
|
2,488
|
|
$
|
(830
|
)
|
(33
|
)%
|
Latin America
|
415
|
|
739
|
|
(324
|
)
|
(44
|
)
|
Europe/Africa/CIS
|
744
|
|
1,021
|
|
(277
|
)
|
(27
|
)
|
Middle East/Asia
|
1,016
|
|
1,334
|
|
(318
|
)
|
(24
|
)
|
Total revenue
|
$
|
3,833
|
|
$
|
5,582
|
|
$
|
(1,749
|
)
|
(31
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING INCOME:
|
Three Months Ended
September 30
|
Favorable
|
Percentage
|
Millions of dollars
|
2016
|
2015
|
(Unfavorable)
|
Change
|
Completion and Production
|
$
|
24
|
|
$
|
163
|
|
$
|
(139
|
)
|
(85
|
)%
|
Drilling and Evaluation
|
151
|
|
401
|
|
(250
|
)
|
(62
|
)
|
Total
|
175
|
|
564
|
|
(389
|
)
|
(69
|
)
|
Corporate and other
|
(47
|
)
|
(140
|
)
|
93
|
|
66
|
|
Impairments and other charges
|
—
|
|
(381
|
)
|
381
|
|
100
|
|
Total operating income
|
$
|
128
|
|
$
|
43
|
|
$
|
85
|
|
198
|
%
|
|
|
|
|
|
By geographic region:
|
|
|
|
|
North America
|
$
|
(66
|
)
|
$
|
8
|
|
$
|
(74
|
)
|
—
|
|
Latin America
|
11
|
|
108
|
|
(97
|
)
|
(90
|
)%
|
Europe/Africa/CIS
|
76
|
|
150
|
|
(74
|
)
|
(49
|
)
|
Middle East/Asia
|
154
|
|
298
|
|
(144
|
)
|
(48
|
)
|
Total
|
$
|
175
|
|
$
|
564
|
|
$
|
(389
|
)
|
(69
|
)%
|
Consolidated revenue was
$3.8 billion
in the
third
quarter of
2016
, a decrease of
$1.7 billion
, or 31%, as compared to the
third
quarter of 2015, associated with widespread pricing pressure and activity reductions on a global basis, including significant reductions in North America pressure pumping. Revenue outside of North America was
57%
of consolidated revenue in the
third
quarter of
2016
, compared to
55%
of consolidated revenue in the
third
quarter of 2015, which reflects the greater impact our North America operations are experiencing as it relates to the downturn in the energy market.
Consolidated operating income was
$128 million
during the
third
quarter of
2016
compared to operating income of
$43 million
in the
third
quarter of
2015
. Operating results were impacted by declines in drilling activity, logging services and direct sales in our international operations as a result of the global downturn in the energy market. Our operating results for the three months ended September 30, 2015 were also negatively impacted by $381 million of impairments and other charges. See Note 3 to the condensed consolidated financial statements for further information about impairments and other charges.
OPERATING SEGMENTS
Completion and Production
Completion and Production (C&P) revenue in the
third
quarter of 2016 was
$2.2 billion
, a decrease of $1.0 billion, or 32%, from the
third
quarter of 2015, due to a decline in activity and pricing in all
of our product services lines, particularly North America pressure pumping services which drove the majority of the C&P revenue decline. International revenue also declined as a result of reduced pressure pumping services and completion tool sales.
C&P operating income in the
third
quarter of 2016 was
$24 million
, a decrease of $139 million, or 85%, compared to the
third
quarter of 2015, with decreased profitability across all regions as a result of global activity and pricing reductions, primarily pressure pumping services and completion tool sales in our international operations.
Drilling and Evaluation
Drilling and Evaluation (D&E) revenue in the
third
quarter of 2016 was $
1.7 billion
, a decrease of $725 million, or 30%, from the
third
quarter of 2015. Reductions were seen across all product service lines due to the low rig count, lower pricing and customer budget constraints worldwide. Drilling, fluid and logging activity drove the declines.
D&E operating income in the
third
quarter of 2016 was
$151 million
, a decrease of $250 million, or 62%, compared to the
third
quarter of 2015, driven by a decline in activity and pricing across all regions, particularly drilling activity in the United States, Saudi Arabia and Nigeria. Third quarter of 2016 results were also impacted by depreciation expense from assets previously classified as held for sale in the third quarter of 2015.
GEOGRAPHIC REGIONS
North America
North America revenue in the
third
quarter of 2016 was $1.7 billion, a 33% decline compared to the
third
quarter of 2015, relative to a 43% decline in average North America rig count. We had an operating loss of $66 million compared to $8 million of operating income in the
third
quarter of 2015. These declines were driven by reduced activity and pricing pressure throughout the United States land market.
Latin America
Latin America revenue in the
third
quarter of 2016 was $415 million, a 44% reduction compared to the
third
quarter of 2015, with operating income of $11 million, a 90% decline from the
third
quarter of 2015, primarily as a result of reduced activity in Mexico, Brazil and Argentina, as well as our decision to curtail activity in Venezuela. From a product service line perspective, pressure pumping services, drilling activity and logging experienced the largest declines in both revenue and operating income.
Europe/Africa/CIS
Europe/Africa/CIS revenue in the
third
quarter of 2016 was $744 million, a decline of 27% compared to the
third
quarter of 2015, with operating income of $76 million, a 49% decrease compared to the
third
quarter of 2015. The decreases during the quarter were driven by a sharp reduction of activity in the North Sea, Angola and Nigeria, along with lower drilling activity, pressure pumping services
and completion tools sales throughout the region.
Middle East/Asia
Middle East/Asia revenue in the
third
quarter of 2016 was $1.0 billion, a reduction of 24% compared to the
third
quarter of 2015, with operating income of $154 million, a 48% decrease from the
third
quarter of 2015. This was the result of reduced activity in Indonesia, Iraq and Australia, along with lower drilling activity, direct sales and logging throughout the region.
OTHER OPERATING ITEMS
Corporate and other
expenses decreased to $47 million in the
third
quarter of
2016
, compared to $
140 million
of expenses in the
third
quarter of
2015
. This decrease was primarily due to $82 million of Baker Hughes related costs in the third quarter of 2015, as well as various legal and environmental reserve adjustments in the third quarter of 2016, including a $28 million downward revision of our Macondo loss contingency liability.
Impairments and other charges.
We recorded a total of approximately $381 million in company-wide charges during the
third
quarter of 2015, primarily related to fixed asset impairments and write-offs and severance costs. There were
no
impairments and other charges recorded during the third quarter of 2016. See
Note 3
to the condensed consolidated financial statements for further information.
NONOPERATING ITEMS
Interest expense, net
increased $42 million in the
third
quarter of 2016, compared to the
third
quarter of 2015, primarily due to additional interest resulting from the senior notes issued in November 2015.
Effective tax rate
. During the three months ended
September 30, 2016
, we recorded a total income tax benefit of $59 million on pre-tax losses of $52 million, resulting in an effective tax rate of 114.3%. During the three months ended September 30, 2015, we recorded a total income tax benefit $37 million on pre-tax losses of $90 million, resulting in an effective tax rate of 40.8%. See Note 5 to the condensed consolidated financial statements for significant drivers of these effective tax rates.
Nine Months Ended
September 30, 2016
Compared with
Nine Months Ended
September 30, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
REVENUE:
|
Nine Months Ended
September 30
|
Favorable
|
Percentage
|
Millions of dollars
|
2016
|
2015
|
(Unfavorable)
|
Change
|
Completion and Production
|
$
|
6,614
|
|
$
|
10,890
|
|
$
|
(4,276
|
)
|
(39
|
)%
|
Drilling and Evaluation
|
5,252
|
|
7,661
|
|
(2,409
|
)
|
(31
|
)
|
Total revenue
|
$
|
11,866
|
|
$
|
18,551
|
|
$
|
(6,685
|
)
|
(36
|
)%
|
|
|
|
|
|
By geographic region:
|
|
|
|
|
North America
|
$
|
4,968
|
|
$
|
8,701
|
|
$
|
(3,733
|
)
|
(43
|
)%
|
Latin America
|
1,432
|
|
2,455
|
|
(1,023
|
)
|
(42
|
)
|
Europe/Africa/CIS
|
2,317
|
|
3,213
|
|
(896
|
)
|
(28
|
)
|
Middle East/Asia
|
3,149
|
|
4,182
|
|
(1,033
|
)
|
(25
|
)
|
Total revenue
|
$
|
11,866
|
|
$
|
18,551
|
|
$
|
(6,685
|
)
|
(36
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING INCOME:
|
Nine Months Ended
September 30
|
Favorable
|
Percentage
|
Millions of dollars
|
2016
|
2015
|
(Unfavorable)
|
Change
|
Completion and Production
|
$
|
22
|
|
$
|
938
|
|
$
|
(916
|
)
|
(98
|
)%
|
Drilling and Evaluation
|
546
|
|
1,107
|
|
(561
|
)
|
(51
|
)
|
Total
|
568
|
|
2,045
|
|
(1,477
|
)
|
(72
|
)
|
Corporate and other
|
(4,210
|
)
|
(401
|
)
|
(3,809
|
)
|
—
|
|
Impairments and other charges
|
(3,189
|
)
|
(1,895
|
)
|
(1,294
|
)
|
(68
|
)
|
Total operating loss
|
$
|
(6,831
|
)
|
$
|
(251
|
)
|
$
|
(6,580
|
)
|
—
|
|
|
|
|
|
|
By geographic region:
|
|
|
|
|
North America
|
$
|
(229
|
)
|
$
|
417
|
|
$
|
(646
|
)
|
(155
|
)%
|
Latin America
|
81
|
|
342
|
|
(261
|
)
|
(76
|
)
|
Europe/Africa/CIS
|
197
|
|
400
|
|
(203
|
)
|
(51
|
)
|
Middle East/Asia
|
519
|
|
886
|
|
(367
|
)
|
(41
|
)
|
Total
|
$
|
568
|
|
$
|
2,045
|
|
$
|
(1,477
|
)
|
(72
|
)%
|
Consolidated revenue was
$11.9 billion
in the first
nine
months of
2016
, a decrease of
$6.7 billion
, or
36%
, as compared to the first
nine
months of
2015
, associated with pricing declines and activity reductions on a global basis,
including significant reductions in North America pressure pumping.
Revenue outside of North America was 58% of consolidated revenue in the first
nine
months of
2016
, compared to 53% of consolidated revenue in the first
nine
months of
2015
, which reflects the greater impact our North America operations are experiencing as it relates to the downturn in the energy market.
Consolidated operating loss was
$6.8 billion
in the first
nine
months of
2016
compared to an operating loss of
$251 million
during the first
nine
months of
2015
. Operating results were negatively impacted by
$3.2 billion
and
$1.9 billion
of impairments and other charges recorded in the
nine
months ended September 30, 2016 and 2015, respectively.
Additionally, we incurred
$4.1 billion
of Baker Hughes related costs during the first
nine
months
of 2016, primarily due to the $3.5 billion
termination fee and $464 million of charges resulting from our reversal of assets held for sale accounting, compared to
$203 million
of Baker Hughes related costs during the first
nine
months of 2015. Also contributing to these operating results were significant declines in pressure pumping activity and pricing declines in North America as a result of the global downturn in the energy market.
See Note 2 to the condensed consolidated financial statements for further discussion of the Baker Hughes transaction and financial statement impact of terminating our merger agreement and Note 3 to the condensed consolidated financial statements for further information about impairments and other charges.
OPERATING SEGMENTS
Completion and Production
Completion and Production (C&P) revenue in the first
nine
months of 2016 was
$6.6 billion
, a decrease of
$4.3 billion
, or
39%
, from the first
nine
months of 2015, due to a decline in activity and pricing in most of our product services lines, particularly North America pressure pumping services which drove the majority of the C&P revenue decline. International revenue declined as a result of reductions in pressure pumping activity and well completion services in all regions.
C&P operating income in the first
nine
months of 2016 was
$22 million
, compared to
$938 million
of operating income in the first
nine
months of 2015, with decreased profitability across all regions as a result of global activity and pricing reductions, primarily in North America pressure pumping services.
Drilling and Evaluation
Drilling and Evaluation (D&E) revenue in the first
nine
months of 2016 was
$5.3 billion
, a decrease of
$2.4 billion
, or
31%
, from the first
nine
months of 2015. Reductions were seen across all product service lines due to the low rig count, lower pricing and customer budget constraints worldwide.
D&E operating income in the first
nine
months of 2016 was
$546 million
, a decrease of
$561 million
, or
51%
, compared to the first
nine
months of 2015, driven by a decline in activity and pricing across all regions, particularly drilling and logging activity in North America, as well as reduced drilling activity in Latin America, decreased drilling activity in the Europe/Africa/CIS region, and lower drilling and logging activity in the Middle East/Asia region.
GEOGRAPHIC REGIONS
North America
North America revenue in the first
nine
months of 2016 was
$5.0 billion
, a
43%
decline compared to the first
nine
months of 2015, relative to a 53% decline in average North America rig count.
We had an operating loss of
$229 million
, a substantial reduction from the
$417 million
of operating income reported in the first
nine
months of 2015. These declines were driven by reduced activity and pricing pressure throughout the United States land market, specifically relating to pressure pumping services and drilling activity.
Latin America
Latin America revenue in the first
nine
months of 2016 was
$1.4 billion
, a
42%
reduction compared to the first
nine
months of 2015, with operating income of
$81 million
, a
76%
decline from the first
nine
months of 2015. These reductions were primarily related to our decision to curtail activity in Venezuela and currency weakness in the country, reduced activity across all product service lines in Mexico, and lower drilling activity in Brazil and Colombia.
Europe/Africa/CIS
Europe/Africa/CIS revenue in the first
nine
months of 2016 was
$2.3 billion
, a decline of
28%
compared to the first
nine
months of 2015, with operating income of
$197 million
, a
51%
decrease compared to the first
nine
months of 2015. These decreases were driven by a sharp reduction of activity in the North Sea, Angola, Nigeria and Congo, along with lower drilling activity, pressure pumping services
and completion tools sales throughout the region.
Middle East/Asia
Middle East/Asia revenue in the first
nine
months of 2016 was
$3.1 billion
, a reduction of
25%
compared to the first
nine
months of 2015, with operating income of
$519 million
, a
41%
decrease from the first
nine
months of 2015. This was the result of pricing concessions across the region, along with reduced activity for pressure pumping services in Saudi Arabia and Australia, a decline in drilling and logging activity in Indonesia and Malaysia, and lower project management activity in India, Iraq, and Australia.
OTHER OPERATING ITEMS
Corporate and other
expenses were
$4.2 billion
in the first
nine
months of
2016
compared to
$401 million
in the first
nine
months of
2015
, primarily driven by Baker Hughes related costs. During the first
nine
months
of 2016, we incurred a $3.5 billion
termination fee and $464 million of charges resulting from our reversal of assets held for sale accounting, as compared to $203 million of Baker Hughes related costs during the first nine months of 2015. See Note 2 to the condensed consolidated financial statements for further discussion of the Baker Hughes transaction and the financial statement impact of terminating our merger agreement.
Impairments and other charges.
Primarily as a result of the downturn in the energy market and its corresponding impact on the company’s business outlook, we recorded a total of approximately
$3.2 billion
in company-wide charges during the first nine months of 2016, which consisted of fixed asset impairments and write-offs, inventory write-downs, impairments of intangible assets, severance costs, facility closures, a loss on exchange for a promissory note in Venezuela, and other charges. This compares to
$1.9 billion
of impairments and other charges recorded in the first
nine
months of 2015 which consisted of fixed asset impairments and write-offs, inventory write-downs, impairments of intangible assets, severance costs, facility closures, and other charges. See
Note 3
to the condensed consolidated financial statements for further information.
NONOPERATING ITEMS
Interest expense, net
increased $191 million in the first
nine
months of 2016, as compared to the first
nine
months of 2015. This was primarily due to additional interest resulting from the senior notes issued in November 2015, coupled with $41 million of redemption fees and associated costs related to the $2.5 billion debt mandatorily redeemed during the second quarter of 2016, which was recorded through interest expense.
Other, net
was a $117 million loss in the first
nine
months of 2016, as compared to a $281 million loss in the first
nine
months of 2015, driven by foreign currency exchange losses in various countries. The primary driver for the decrease was in Venezuela, where we recognized a $199 million foreign currency exchange loss during the first quarter of 2015 as a result of utilizing the new currency exchange mechanism to remeasure net monetary assets in the country. See "Business Environment and Results of Operations" for further information.
ENVIRONMENTAL MATTERS
We are subject to numerous environmental, legal and regulatory requirements related to our operations worldwide. For information related to environmental matters, see
Note 8
to the condensed consolidated financial statements.
FORWARD-LOOKING INFORMATION
The Private Securities Litigation Reform Act of 1995 provides safe harbor provisions for forward-looking information. Forward-looking information is based on projections and estimates, not historical information. Some statements in this Form 10-Q are forward-looking and use words like “may,” “may not,” “believe,” “do not believe,” “plan,” “estimate,” “intend,” “expect,” “do not expect,” “anticipate,” “do not anticipate,” “should,” “likely” and other expressions. We may also provide oral or written forward-looking information in other materials we release to the public. Forward-looking information involves risk and uncertainties and reflects our best judgment based on current information. Our results of operations can be affected by inaccurate assumptions we make or by known or unknown risks and uncertainties. In addition, other factors may affect the accuracy of our forward-looking information. As a result, no forward-looking information can be guaranteed. Actual events and the results of our operations may vary materially.
We do not assume any responsibility to publicly update any of our forward-looking statements regardless of whether factors change as a result of new information, future events or for any other reason. You should review any additional disclosures we make in our press releases and Forms 10-K, 10-Q and 8-K filed with or furnished to the SEC. We also suggest that you listen to our quarterly earnings release conference calls with financial analysts.