HAL

Halliburton Company (HAL) - Q3 2002 10-Q Summary

Business Context and Reporting Period

This report covers the quarterly period ended September 30, 2002. Halliburton operates in two primary segments: the Energy Services Group (oilfield services and products) and the Engineering and Construction Group (operating as Kellogg Brown & Root, or KBR). The company is currently undergoing a significant reorganization to separate these two groups into distinct operating subsidiary structures. The reporting period reflects a challenging global economic environment, characterized by reduced drilling activity in North America, political instability in key regions (Venezuela, Argentina), and ongoing legal and accounting scrutiny.

Key Financial Metrics

Note: Debt figures are derived from the Balance Sheet (Short-term notes payable + Current maturities of long-term debt + Long-term debt).

Material Changes vs. Prior Period

• Revenue Decline: Consolidated revenues decreased 12% in Q3 2002 and 7% for the first nine months compared to 2001. The Energy Services Group saw a 20% revenue drop in Q3, driven by a 28% decline in North American activity due to lower rig counts and pricing pressure. The Engineering and Construction Group saw a slight 1% revenue increase in Q3.
• Profitability Shift: While Q3 2002 remained profitable ($94M net income), the first nine months of 2002 resulted in a net loss of $382 million, compared to $670 million in net income for the same period in 2001. This swing was primarily due to significant non-recurring charges.
• Major Charges:
  • Asbestos Liability: A $483 million pretax charge was recorded in Q2 2002 (impacting the 9M period) to accrue probable asbestos liabilities ($2.2 billion gross) net of estimated insurance recoveries ($1.6 billion). $330 million was allocated to the Engineering and Construction Group, and $153 million to Discontinued Operations.
  • Project Losses: A $119 million pretax loss was recorded on the Barracuda-Caratinga project in Brazil (Engineering and Construction Group).
  • Restructuring: $78 million in pretax restructuring charges were incurred year-to-date to facilitate the separation of the two business groups.
  • Patent Litigation: A $98 million pretax charge was recorded for a patent infringement judgment against Halliburton Energy Services by BJ Services Company.
• Discontinued Operations: The company recorded a $168 million after-tax loss from discontinued operations in the first nine months of 2002, primarily related to asbestos claims associated with previously disposed businesses (Dresser Equipment Group).

Guidance, Outlook, and Risks

• Outlook: Management expects oilfield services activity to remain essentially flat in the short term due to economic uncertainty, war risk premiums in oil prices, and regional gas price disparities. Drilling activity in the U.S. and Canada is expected to remain constant for the rest of the year, while international activity may decline slightly in Q4. Cost savings from the reorganization are expected to reach $200 million annually in 2003.
• Strategic Shift: Halliburton has decided to no longer pursue lump-sum, fixed-price Engineering, Procurement, Installation, and Commissioning (EPIC) contracts for the offshore oil and gas industry due to unfavorable risk/reward profiles. The company will retain offshore engineering capabilities but through other contracting forms.
• Key Risks & Contingencies:
  • Asbestos Litigation: Approximately 328,000 open asbestos claims. The company is negotiating a global settlement. The outcome of the Harbison-Walker Chapter 11 bankruptcy and the ability to access shared insurance coverage remain critical uncertainties.
  • SEC Inquiry: The SEC has initiated a preliminary inquiry into the company's accounting practices regarding the accrual of revenue from unapproved claims on construction contracts. The company is cooperating fully.
  • Legal Actions: Multiple securities class-action lawsuits and a shareholder derivative action have been filed alleging violations of federal securities laws related to revenue recognition. A patent infringement appeal is pending regarding the BJ Services verdict.
  • Liquidity & Ratings: Credit ratings have been lowered (Moody's Baa2, S&P A-). While still investment grade, further downgrades could trigger collateral requirements on letters of credit and increase borrowing costs. The company has $350 million in committed credit lines contingent on maintaining investment-grade ratings.
  • Geopolitical: Operations are exposed to risks in the Middle East, Venezuela, Argentina, and Nigeria, including strikes, expropriation, and currency controls.

Investor Verification Checklist

• Asbestos Reserve Adequacy: Verify the assumptions used in the $2.2 billion asbestos liability accrual and the $1.6 billion insurance receivable, particularly regarding the solvency of insurers and the outcome of the Harbison-Walker bankruptcy trust negotiations.
• SEC Inquiry Status: Monitor the progress of the SEC's preliminary inquiry into unapproved claims revenue recognition and the potential for restatements or penalties.
• Class Action Litigation: Track the consolidation and discovery phases of the securities class-action lawsuits alleging revenue overstatement.
• Project Performance: Review the status of the Barracuda-Caratinga project in Brazil and the potential for further losses or claim recoveries on other fixed-price contracts.
• Credit Rating Covenants: Assess the risk of further credit rating downgrades and the potential impact on the company's ability to secure letters of credit and maintain liquidity without posting significant cash collateral.
• Restructuring Execution: Confirm the realization of the projected $200 million in annualized cost savings from the separation of the Energy Services and Engineering and Construction groups.