Halliburton Company
Q3 2005 Earnings Call Transcript

Published: 29 Nov 2005

[Operator:]

Good day and welcome to today's Halliburton Company Third Quarter 2005 Results Conference Call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Ms. Evelyn Angelle. Please go ahead.

[Evelyn Angelle:]

Good morning, and welcome to Halliburton's third quarter 2005 earnings release conference call. Today's call is being webcast and a replay will be available on our website for seven days. Joining me today are Dave Lesar, Chairman, President, and CEO; Chris Gaut, Executive Vice President and CFO; and Andy Lane, Executive Vice President and COO. The press release announcing our third quarter results is available on our website at www.halliburton.com. It estimates the impact the Gulf of Mexico hurricanes had on different parts of our business. Overall the hurricanes negatively impacted our third quarter net income by $0.05 per diluted share. We have tentatively scheduled our 2005 fourth quarter earnings release conference call, Friday, January 27, 2006, at 9

[Dave Lesar:]

Thank you, Evelyn, and good morning everyone. I'm pleased to record another quarter of solid financial performance at Halliburton. Despite the Gulf of Mexico's pretax impact from the hurricanes of proximately $33 million, we achieved record consolidated operating income of $690 million. While the situation in the Gulf has claimed everyone's attention, in reality the hurricanes are only a small part of the news we will share with you this morning. First of all, regardless of what you may read in the papers, we did not do any work for FEMA. In fact, as of today, KBR's hurricane-related work is less than $200 million and is being done under the competitively bid CONCAP contract. In the ESG, I'm happy to report that not only did we achieve record revenues in operating income, but we also posted an operating income margin of 21.8%. Part of this is attributable to the price increases we have implemented in the past. I also announced in September additional price increases beginning this month. These will range from 6 to 18% depending on the product line and Andy will give you more details on those in a moment. We also continue to benefit from our strong focus on return on capital. This is being demonstrated by our fixed or exit strategy, where we are focusing our attention on our lowest performing areas in order to continue driving up our margins and returns by getting better terms from our customers or by exiting the market and taking that equipment to areas where we see higher returns. This has a short-term impact on a region's revenue and cost as we demobilize and remobilize that equipment, but I believe that it is in ESG's best interest in the long run and Andy will give you more details on that in a moment. At KBR, revenue is strong, margins have improved and we have landed some exciting new contracts, including new awards for LNG, and gas-to-liquid products that are strengthening our backlog and portfolio. This quarter also, as expected, we had successful resolution of some of our fuel issues under the Rio contracts. We have settled six of the ten task orders under review with no decrease in the amount of costs we will be reimbursed by the government. We have also monetized an investment we had in a toll road we constructed a number of years ago. Our only disappointment this quarter at KBR were some losses incurred in our E&C operations in Algeria. You will hear more about those in a moment. I would also like to mention that we have and continue to make, strategic investments in the U.S. to take advantage of this strong market, just as we said we would. This has strengthened our returns and is helping us build for growth in the rest of the world. It now seems even the skeptics have changed their view of the continued strength of the North American market. Now, let's turn to Chris for the financial highlights and then Andy will come in with some more operational details.

[Chris Gaut:]

Thanks, Dave and good morning. I will comment on the overall company and individual segment results. I will summarize the change in revenue and then operating income for each of our six segments and then discuss our liquidity and other financial matters. In my remarks, I will be comparing third quarter of 2005 results sequentially to the second quarter of 2005. Halliburton Company revenue was $5.1 billion in Q3, essentially flat from the prior quarter. Energy service group revenue was up $126 million, or 5% sequentially with three of the four ESG divisions setting new revenue records. KBR revenue went down 7% sequentially primarily due to reduced activity on the competitively bid LogCAP contract in Iraq. On a consolidated basis, international revenue was 72% of the total. Halliburton achieved record operating income of $690 million for the third quarter. Overall, ESG operating income increased by $44 million reflecting a 70 basis point operating margin increase. This was driven by higher natural gas drilling activity and continued pricing strength for our services, particularly in North America, where the market continues to be exceptionally strong. KBR operating income increased 23% in the third quarter to $150 million, operating margins rose by 150 basis points to 6%, with the sale of an interest in the U.S. toll road contributing $85 million to operating income, partially offset by losses and project joint ventures in Algeria. Now, I will highlight the ESG segment results. Beginning with production optimization, where revenues increased $61 million or 6% compared to the second quarter of 2005. Production enhancement led the segment with a 14% increase due to high demand in U.S. land for stimulation services and a strong rebound in Canada. Completion tools revenue decreased 10% due to effects of the hurricanes in the Gulf of Mexico, the large second quarter sales into Asia, and the completion of a large project in Mortania last quarter. Production optimization operating income increased sequentially 7% or $18 million with a 40 basis point improvement in margins. In production enhancement, operating income grew 22% and margins continued to benefit from improved pricing and increased equipment utilization in the U.S. and Canada and lower cost due to a change in mix in Algeria. However, completion tools operating income decreased 26%, largely reflecting the negative impact of the hurricanes and lower sales for the quarter. In the fluid systems segment, revenue increased $32 million or 5% over the second quarter of 2005. Cementing revenue increased 4% primarily driven by better pricing in the U.S., land, and strengthened activity in Canada. Third quarter results were negatively impacted by the hurricanes in the Gulf Coast, and decreased activity in Mexico. Baroid revenue increase by 5% reflecting activity and pricing increases in Western Africa and in the U.S. In addition, the rebound from the Canadian spring breakup contributed to Baroid revenue improvement. The hurricanes damaged or temporarily halted operations at several of our cementing and Baroid facilities in Louisiana many of which have already come back online. Fluid systems operating income was up $4 million or 3% sequentially with continued margin strength. Cementing services operating income increased 3% and Baroid operating income increased 2% due to the same factors that drove revenue. Our drilling information evaluation segment had a revenue increase of $22 million or 4% sequentially of which 59% came from international operations. Sperry Drilling Services grew revenue by 7% due to a robust Canadian market and strong activity in the U.S., the Middle East, and the North Sea. Security DBS increased revenue 13%, driven primarily by Canada, the U.S. and the North Sea. The logging services revenue declined sequentially due to higher direct sales in Asia in the prior quarter. Partially offsetting this decline was increased activity in the U.S., and Latin America in logging. Drilling information evaluation operating income increased $3 million or 2% over the second quarter. Sperry Drilling Services operating income increased 6% mainly due to increased activity in Canada, the U.S., and the Middle East. Security DBS drill bits operating income increased 46%, driven by the strength in rig count in Canada, as well as increased activity in the U.S. and Europe/Africa. Logging operating income decreased 16% due to the decline in direct sales in Asia. Drilling information evaluation margins remained essentially flat from the prior quarter despite the impact of the hurricanes which halted or delayed activity in operations and manufacturing facilities along the Gulf Coast. Digital and consulting solutions segment revenue was up 7% compared to the second quarter of 2005, primarily due to sales in North Africa. Digital and consulting solutions operating income increased $19 million or 119% compared to the second quarter of 2005. The second quarter included a $15 million charge for the integrated solutions projects in Mexico. Now let's turn to the two KBR segments. Government and infrastructure revenue for the third quarter of 2005 was $1.9 billion, compared to 2 billion in the second quarter. The decrease resulted from lower activities and the LogCAP contract and at the DML shipyard in the UK. Government infrastructures operating income for the third quarter was $149 million, up $76 million or 104% over the second quarter. The increase is primarily the result of $85 million in operating income on the sale of our interest in the toll road we built in the '90s outside Washington D.C. As part of our plans to develop various projects, we occasionally take an ownership interest in the constructed asset, such as a toll road or a railroad. Our strategy is to monetize that ownership interest once the operation matures and the asset increases in value and this is what happened in the case of this toll road. This quarter, KBR revenue related to Iraq activities was $1.9 billion, operating income was $45 million resulting in an operating margin of 3.7%. We recognized $24 million in income related to the favorable settlement of various Iraq-related audit issues, particularly fuel. The second quarter included $29 million in Iraq-related award fees granted on definitized past quarters. Nonetheless our cumulative operating margin on the Iraq-related activities over the past two and a half years is less than 2% of revenue. In the energy and chemical segment, revenue for the third quarter of 2005 was $614 million, compared to $653 million for the second quarter. Operating income for the third quarter of 2005 was $1 million versus $49 million in the second quarter. Operating income declined primarily as a result of a total of $70 million in losses on various projects in Algeria. Approximately $47 million related to charges we took on an unconsolidated Algerian joint venture. About half of this amount related to project losses and the other half was a write-down of our carrying value of the venture. Separately, from this joint venture we recognized 23 million in additional losses on a gas project in Algeria. Outside of Algeria, E&C continued to have very strong results with the commencement of the new LNG and GTL projects, continued good performance on reimbursable oil gas production facilities and the completion of our work scope on the Belanak FPSO project in Indonesia. Now let's review other financial items. General corporate expenses were 26 million in the third quarter, compared to 37 million in the second quarter of 2005. The decrease was mainly due to reduced outside professional fees. Our effective tax rate this quarter was 20% which is lower than the 28% estimate we provided you last quarter. The reason for the decline is similar to what we have seen during the first and second quarters of this year, the improving profitability of our domestic operations is causing our estimates of U.S. taxable income for 2005 to increase. This allows us to use more of our tax losses and foreign tax credits than we previously estimated. Utilization of these tax benefits has a direct positive impact on our cash flow. We are now estimating a 26% effective tax rate for 2005, compared to our estimate of 29% last quarter. We had to adjust our third quarter tax rate down to get to a 26% tax rate for the nine month results. And we expect about a 26% rate for the fourth quarter. However, this may change as we now are in our budgeting and planning process for future years. If as a result of this process, our estimate of U.S. taxable income for future years increases significantly, we may record a large one-time favorable adjustment to our valuation allowance during the fourth quarter of 2005 which could result in a large reversal of income tax expense and a large positive income contribution. Essentially this would be recognized in the tax deductions for the asbestos settlement that we were not able to benefit previously. In 2006, and thereafter, we continue to believe our effective tax rate will be back at our normal range of 36 to 38%. I would also like to point out that our diluted weighted average shares outstanding increased to 525 million shares this quarter. This caused additional dilution to our EPS of approximately $0.02. The dilution was attributable to the significant increase of our stock price in the third quarter, the impact this had on our convertible notes, and employee stock options in the diluted EPS calculation. Generally, at this level, a $5 increase in our quarterly average stock price results in 1.6 million additional diluted shares. As you know, we plan to adopt a new accounting standard on expensing employee stock options effective January 1 of 2006. We expect this will result in $0.02 of additional ongoing quarterly expense starting next year. Now, let's turn to liquidity. Cash and marketable securities were $2.1 billion at September 30, which is an increase of approximately $550 million from June 30, 2005. Our debt-to-total capitalization ratio was 39% as of September 30, and last week we paid off the $300 million variable rate senior notes that matures this month. Our September 30, 2005, debt-to-total capitalization ratio would have been 37%, including this debt reduction in October. We also had further improvement to our return on capital employed during Q3, which is now running at an annual rate of 25.3%, and that's a 260 basis point improvement from last quarter, and that includes 70 basis points related to income from the toll road sale. We calculate return on capital employed differently from some other companies as we do not deduct our significant cash balance from capital employed. During Q3 our capital spending increased to meet the higher level of activity due to our customers' increase in E&P spending up about 25% versus the run rate in the first half. We expect our CapEx to be in its higher range of 180 to $200 million per quarter into next year. We are confident that we have planned for the appropriate level investment in 2006. Before turning it over to Andy, I will give you an update about the separation of KBR; as we announced in January, we believe it is necessary for KBR to deliver solid operating performance for a number of quarters to build KBR's backlog and to reduce uncertainty around the various disputes and investigations under way in order to maximize KBR's value for our shareholders. We have made progress in these areas but no time line has been set for a separation of KBR. In pursuing the potential operation of KBR, we will consider an initial public offering of KBR as well as private transactions. Andy?

[Andy Lane:]

Thanks, Chris. Good morning, everyone. ESG turned in another record-setting quarter. reflecting continued robust activity in the market. The management team we have in place at the ESG is doing an excellent job in capitalizing on the current opportunities. Our employees are working very hard and we continue to add direct resources to meet the improved demand. If you look at the first nine months of 2005, compared to this same period in 2004, we've had top line growth of over $1.4 billion, or 24%, and we've improved the operating income by over $700 million. Our September ESG year-to-date margins were 22%. We are proud of our management and our dedicated hard-working employees who delivered these great results. I will talk about each region in a moment but first I wanted to describe how the hurricanes in the Gulf of Mexico prevented us from having an even greater quarter. Halliburton was relatively fortunate; nevertheless, we sustained heavy damages to both our Baroid and cementing Louisiana facilities in Cameron, Bennett and Intercoastal City. We have shifted our activity to other facilities while those are being repaired and we are now ready to continue operations at the pre hurricane levels. As you know, some of our customers' platforms and rigs were damaged or lost and it will take them a while to reestablish pre hurricane activity levels. We do expect customers to resume the activities that were curtailed by the storms throughout the end of the year, and into the first half of 2006. Our Gulf of Mexico activity is about 70% of pre hurricane levels. Meanwhile, we have deployed a number of our Gulf of Mexico personnel to higher utilization areas until activity levels resume. The third quarter ESG hurricane impact of $0.04 per share is based on a mix of lower operational activity and temporary declines in manufacturing productivity. Looking forward to the fourth quarter of 2005, we expect a similar financial impact as seen in the third quarter, primarily due to lower operational activities, and the number of offshore rigs that are out of service. I would like to thank all of our employees on the Gulf Coast to helping to secure our facilities, ensure the safety of our workers, and return our business to normal operations. I also appreciate our employees worldwide who very generously helped take care of people who were displaced by the storms, by contributing to a Halliburton matching assistance fund. A positive contributor to this quarter's performance was improved pricing. Since May of 2004, we have had three U.S. price book increases ranging from 8 to 15%. We have announced an additional price increase effective October 15, in three divisions. The increases are as follows

[Dave Lesar:]

Thank you, Andy. You can see we remain very bullish and optimistic about where the industry is, and the future in terms of customer spending. Our company has obviously endured a lot of challenges in the past year, including resolving asbestos, getting the election behind us, and our learning experience on Barricuda. But that's behind us now. Today we're going about our daily business of focusing on higher profits and returns for our shareholders. And we are moving forward with quarter after quarter of financial improvements. I think that the management team feels good to get back to some semblance of life being normal. Now we'll take your questions. We ask you to limit to one question, and one follow-up per caller. Thank you.