SLB LIMITED quarterly report, Q3 FY2010

Business context and reporting period

Schlumberger Limited (identified in the filing as Schlumberger N.V.) filed this unaudited Form 10-Q for the quarter ended September 30, 2010. The company provides oilfield services and related technologies. Results include Smith International from its August 27, 2010 merger date and Geoservices from its April 23, 2010 acquisition date; Smith contributed approximately one month of third-quarter activity.

Financial performance and position

Amounts are in U.S. dollars; financial statement amounts are in millions unless noted.

• Reported Q3 income includes a $1.27 billion pretax ($1.24 billion after-tax) noncash gain from remeasuring Schlumberger’s previously held M-I SWACO interest upon gaining full ownership. The gain was partly offset by $379 million of after-tax restructuring and merger-related charges. Excluding charges and credits, management reported Q3 net income of $875 million, up 7% sequentially, and nine-month net income of $2.44 billion versus $2.54 billion a year earlier.
• Gross margin was 21.4% in Q3, down from 23.7%, and 22.2% for nine months, down from 24.2%. Management attributed the decline principally to acquired Smith businesses and weaker activity/pricing, particularly in Europe/CIS/Africa; improved North American activity and pricing partly offset this.
• Q3 Oilfield Services revenue was $5.54 billion, up 12% year over year; pretax operating income rose 6% to $1.10 billion, while its pretax margin fell 1.14 percentage points to 19.9%. WesternGeco revenue rose 3% to $478 million, but pretax operating income fell 34% to $40 million.
• At September 30, cash was $1.11 billion, short-term investments $1.51 billion, and held-to-maturity fixed-income investments $600 million. Total debt was approximately $6.7 billion; reported net debt was $3.51 billion, compared with net cash of $126 million at year-end 2009. The change reflects acquisitions, repurchases and other cash uses.
• Capital expenditures were $1.91 billion for nine months, versus $1.72 billion. Full-year 2010 capital spending was expected to approach $3.1 billion. The company repurchased $1.27 billion of shares in the first nine months and paid $756 million of dividends.
• Smith merger accounting added approximately $7.7 billion of goodwill and $4.1 billion of identifiable intangible assets. Acquired inventory fair-value adjustments temporarily burden margins; purchase accounting was expected to reduce annual EPS by approximately $0.05 net.

Material changes versus comparable periods

• Q3 revenue increased 26% year over year, reflecting the Smith and Geoservices acquisitions and stronger North American land activity and pricing. Nine-month revenue increased 8%.
• Reported Q3 net income and EPS rose sharply, but comparison is materially affected by the one-time M-I SWACO gain and restructuring/merger costs. On management’s adjusted basis, Q3 earnings improved year over year; nine-month adjusted earnings declined.
• Operating cash flow decreased to $3.10 billion from $3.34 billion for the first nine months. Receivables and other working-capital movements were significant cash uses.
• Debt and balance-sheet assets increased substantially with the Smith transaction; goodwill rose from $5.31 billion at year-end 2009 to $13.67 billion. Shareholders’ equity increased to $31.12 billion, largely reflecting shares issued for Smith.

Outlook, commentary, risks and contingencies

• Management expected strong North American land activity and continued margin benefit from restructuring in Q4, but no rapid recovery in U.S. Gulf of Mexico deepwater activity despite the moratorium being lifted. New rules, permitting and liability requirements could delay a return.
• Management anticipated some acceleration in overseas recovery, while noting seasonal declines in Russia and uncertainty in Mexico. WesternGeco was expected to improve in Q4 on higher U.S. Gulf of Mexico multiclient sales. Higher oil prices and demand were viewed as supportive, subject to no further deterioration in the world economy; sustained North American gas drilling would require further natural-gas demand growth.
• Liquidity included $2.6 billion of cash and short-term investments and $3.2 billion of unused committed credit facilities. Management said resources were sufficient for at least the next 12 months. It expected to repurchase the remaining $298 million of its 6.50% 2012 notes and approximately $430 million of assumed Smith debt during Q4.
• Disclosed risks include integration and synergy execution, near-term merger-related EPS dilution, customer spending and commodity-market changes, pricing pressure, offshore drilling restrictions, and potential climate and hydraulic-fracturing regulation. The company cited DOJ inquiries concerning freight-forwarding/customs services and operations in sanctioned countries; it was cooperating and could not predict outcomes.
• Legal actions related to the Deepwater Horizon incident named an M-I SWACO entity. Schlumberger was assessing indemnities and insurance and stated that, based on information then known, potential M-I SWACO losses were not expected to be material. Other proceedings’ outcomes and possible losses were not estimable; management did not expect them to be material.
• The filing reports effective disclosure controls and no material change in internal control over financial reporting during the quarter. Management provided no numerical full-year earnings guidance.

Important facts for investors to verify

• How much of reported earnings growth is recurring after excluding the M-I SWACO remeasurement gain and the listed restructuring, merger, impairment and other charges.
• Smith integration progress, realized synergies, purchase-accounting impacts, and the final allocation and valuation of acquired assets, liabilities and goodwill.
• Q4 and subsequent activity, pricing and margins by region, particularly U.S. Gulf of Mexico, North America land, Mexico and Europe/CIS/Africa.
• Cash conversion and working-capital trends, planned capital spending, debt maturities and execution of announced debt repurchases.
• Developments in Deepwater Horizon-related proceedings and indemnity/insurance coverage, as well as the DOJ and sanctions-related inquiries and changes in offshore, climate or hydraulic-fracturing regulation.