哈里伯頓 (HAL) 2003 Q3 法說會逐字稿

Good day, and welcome to today's Halliburton Company third quarter 2003 results conference call. Today's 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, Mr. Cedric Burgher. Please go ahead, sir.

Thank you. Good morning and welcome to Halliburton's third quarter 2003 earnings conference call. Today's call is being webcast and a replay will be available on our website. Joining me today on the call are Dave Lesar, our Chairman, President and Chief Executive Officer, John Gibson, Chief Executive Officer of Energy Services Group, and Chris Gaut, Executive Vice President and Chief Financial Officer. On today's call Chris and John will discuss our operating performance and update you on the progress of our asbestos settlement and a few other important matters for the company. Following that, Dave will provide a few remarks before opening up the call for questions. We'll limit each caller to one question in order to maximize participation in the time we've allowed.

I expect by now most of you have seen this morning's press release with our third quarter results. If you don't have a copy of our press release, you can obtain it from our website, www.Halliburton.com. Today's press release includes tables with the expanded segment and geographic information that we set out last quarter. These tables provide operating results for each of our five segments and energy services group geographical details for the third quarter and first nine months of 2002 and 2003.

Also, the footnote tables detail significant items that are included in the operating results such as gains and losses on sales of businesses, restructuring costs, litigation, asbestos charges, et cetera. Our objective in providing this additional information is to increase transparency in our reporting and to give you greater insight into our financial performance. We hope you are pleased with the leadership position that we've taken in increasing transparency and disclosure in our industry.

Before turning the call over to Chris, I would like to remind our audience that some of today's comments may include forward-looking statements reflecting the company's view about future events and their potential impact on financial performance. These matters involve risks and uncertainties that could impact the company's operations and financial results and cause our actual results to differ from our forward-looking statements. These risks are discussed in Halliburton's Form 10-K for the year ended December 31, 2002, and the June 30, 2003 Form 10-Q. With that I'll turn the call over to Chris Gaut. Chris?

Thanks, Cedric, and good morning. My comments today will include updates on company and segment results, liquidity and other financial items, guidance for the fourth quarter, and an update on asbestos. I will be comparing third quarter 2003 results from continuing operations sequentially to our second quarter for the duration of this call. Now moving to our operating results. Total company revenues for the quarter were up 15% sequentially, primarily due to Government services work in Iraq. International revenues were 74% of the total in the third quarter. That's up from 67% in the second quarter of 2003, again primarily due to Government services work in Iraq.

Our operating income increased $133 million sequentially, primarily due to the $173 million dollar charge on the Barracuda Carachinga in the second quarter and increased results from Government services in the third quarter offset by the charge related to the Angelo Dutch litigation. Let me explain the Angelo-Dutch charge. Last Friday, October 24th, a Harris County, Texas civil court jury returned a verdict holding that one of our subsidiary companies, Halliburton Energy Services, Inc. is liable for breaching confidentiality agreements entered into 1996 and '97. The jury verdict against Halliburton plus attorneys' fees amount to $77 million dollars. Plaintiffs had claimed in excess of $600 million in damages. The plaintiffs in the case, Anglo Dutch Petroleum International, Inc. and Anglo-Dutch Tangguh LLC alleged that Halliburton was liable for damages sustained when entities unrelated to do Halliburton succeeded in acquiring certain interests in the Tangguh oil and gas field in Kazakhstan. The plaintiffs claim that, but for Halliburton's disclosure of certain confidential information violation of the confidentiality agreement, the plaintiffs would have acquired the interest themselves.

Under Texas law, a verdict is not a judgment unless and until approved by the judge. We intend to file post-trial motions to seek a reduction or elimination of the award. If the verdict becomes a judgment, we intend to appeal the case. We have recorded a charge of $77 million dollars related to this case in the third quarter of 2003. That charge amounts to $47 million after tax, or 11 cents per diluted share. Although the verdict was rendered in the fourth quarter, this is the type of subsequent event that causes us to update our view of the liability as of the end of the third quarter. When we issued the revised earnings guide on October 9th for the third quarter, we expected large legal fees on this case, but we expected to win the case. For the third quarter, our income from continuing operations was $92 million dollars, or 21 cents per diluted share as compared to $42 million, or 9 cents per diluted share for the second quarter.

Third quarter results include the 11 cent per share charge for the Anglo-Dutch litigation and foreign currency losses of 2 cents per share. Second quarter results included a gain of 3 cents per share on the sale of Halliburton Measurement Systems, or HMS, as I'll refer to it, and a loss of 24 cents per share on the Barracuda KaraChinga project. Now I'll review our segment operating results. The energy services group, ESG, revenue of $1.8 billioin which was a 1% increase from the second quarter. ESG operating income totaled $170 million. That's a decrease of $65 million compared to the second quarter of 2003.

The sequential change as impacted by the $24 million gain on the sale of HMS in the second quarter, as well as the $77 million Anglo-Dutch litigation costs in the third quarter. Excluding these two events which totaled $101 millioin, ESG's ongoing operation showed good sequential improvement. Results for the ESG segments are as follows: Drilling information evaluation segment revenues increased $19 million with increases in each of its sub-businesses. Sperry Sun revenue increased by 1% with improved activity in the United States and Canada, offset by decreases in Norway and Russia due to declines in activity there. Logging revenues improved 9% due to higher land rig counts in the United States, higher direct sales to the Far East and Africa, and in Brazil due to the award of a new offshore contract.

And for drill bits, Security DBS' revenues increased 15% primarily due to increased activity in the United States, Canada, and the Middle East. Drilling information evaluation operating income decreased $4 million. That was driven primarily by reduced earnings in Sperry Sun. At Sperry Sun, operating income declined 19% due to slower activity in Norway and in Russia. Logging continued to perform well as margins improved with increased activity in the United States and Mexico and direct sales in Vietnam and Africa.

Although revenue was up in our drill bit segment, we did have relocation costs associated with the consolidation of our drill bit manufacturing facilities in Woodland, Texas which reduced operating income from drill bits by about $3 million dollars. Fluid segment revenue was down $8 million compared to the second quarter as improved activity in cementing was offset by reduced activity in Baroid. Cementing revenue was up 3% due to higher land rig counts and pricing improvements in the United States and Canada. And Baroid revenue decreased 7% with declines in the Gulf of Mexico due to reduced deep water activity as well as reduced activity in the U.K. North Sea, and in Africa. Fluid segment operating income was down $13 million, primarily due to results in Europe and Africa region.

Cementing operating income decreased 4%. Increase in the United States and Canada land activity was offset by lower activity in the Europe and Africa area, and at Baroid, the reduced activity I just mentioned in the Gulf of Mexico and North Sea and Africa cut Baroid's operating income in half compared to the second quarter. Production optimization segment revenue increased $37 million sequentially with improvements in production enhancement and tools and testing, reduced by lower operating results for our Subsea 7 joint venture. Tools and testing revenue increased 9% with Mexico, Brazil, Canada, the Middle East and the North Sea all accounting for most of the increase and production enhancement revenue was up 8%, primarily in the United States and Canada.

Production optimization was our star performer in ESG this quarter. Operating income increased $9 million even though the segment's second quarter operating income included that $24 million dollar HMS gain. Production enhancement operating income improved 32% due to higher North American land rig counts, some pricing improvement, and a more favorable mix of services. Completion products operating income nearly doubled sequentially, mainly due to inventory adjustments in the second quarter which did not repeat in the third quarter, plus improved activity in Nigeria and in Norway.

Tools and testing operating income was up $10 million dollars due to higher international activity and Subsea 7's $6 million dollar decrease in operating income as compared to the second quarter reflects their lower utilization in higher repair and dry-docking costs for that joint venture. Landmark and other energy services revenues decreased $23 million, primarily due to a $14 million dollar lower revenues from other surface and Subsea operations, but Landmark Graphics revenue was up 2%, due primarily to revenue growth in the Middle East. Landmark and other energy services' operating income was down $57 million dollars due to that $77 million charge for Anglo-Dutch litigation, offset by higher operating income in Landmark Graphics.

On a geographic basis for the energy services group, sequential revenues were up in all regions except Europe/Africa. This region was down due to declines in the North Sea. North America revenues were up 4%, primarily due to a $31 million dollar seasonal increase in Canada. Middle East Asia revenues increased 4%, mainly on direct sales in China and Qatar. Revenue was up 8% in Latin America, as we saw continued increase in Mexico and improvement in Brazil from all four segments. ESG's Brazil's revenue increased 20% quarter over quarter.

Geographically, ESG North American operating income was up $41 million dollars due to higher activity, but the $24 million dollar HMS gain recorded in the second quarter and the $77 million dollars Anglo-Dutch charge in the third quarter resulted in a net reduction of $60 million dollars in ESG North American operating income. Latin American margins improved with increases in Mexico and Brazil. Decreased directional drilling activity in the North Sea impacted margins negatively in Europe and Africa. In Middle East Asia, operating income increased 20% on improved activity.

Now let's move to our engineering construction segment, KBR, and here we're comparing third quarter of 2003 sequentially to the second quarter of this year. Revenues for KBR increased 29% sequentially to approximately $2.3 billion dollars. The increase was primarily from Government services work in the Middle East for the United States government and the United Kingdom Ministry of Defense. We added $2.2 billion to KBR backlog in the third quarter, which that represents over 95% of revenue for the quarter. Net of workoff, backlog at the end of September was $9.8 billion dollars.

KBR's operating income was $49 million, which was a $197 million improvement over the second quarter, primarily due to a loss in the Barracuda project of $173 million dollars in the second quarter; and increased Government services work in the Middle East. Partially offsetting this increase in operating income in the third quarter were losses on projects in Europe, the Middle East, and offshore Asia-Pacific. As previously announced, we are exiting the offshore fixed price EPIC contract area. On Barracuda, as mentioned last quarter, KBR signed a nonbinding heads of agreement with the project owner that would resolve a number of disputed issues and refer remaining issues to arbitration.

Negotiations have been underway to execute definitive, enforceable agreements. Substantial progress has been made in that regard, and we believe we now have reached agreement, subject to board approval of the parties. The project is 78% complete, and there is $308 million dollars in backlog associated with this project. There was no significant P&L impact from Barracuda in the third quarter and the Barracuda vessel has arrived in Brazil from Singapore. The Bellenek project in Indonesia is currently 84% complete with $177 million dollars in backlog. Our liquefied natural gas projects continued to realize good job performance and make good financial contributions.

The Alice Springs to Darwin rail project in Australia is in the final phase of construction and is expected to be completed in the fourth quarter, ahead of schedule and on budget. KBR's work for the United States and United Kingdom governments in the Middle East continues to be strong. Iraq-related work for Halliburton as a whole contributed approximately $34 million dollars in operating income for the third quarter on $900,000 dollars of revenue. That's a 3.8% margin before corporate costs and before taxes.

This represents about 12% of our third quarter consolidated operating income before the Anglo-Dutch charge. The Iraq-related work for KBR and ESG contributed just under 5 cents in after-tax earnings per share. Now turning from segment operating results to our financial -- to other financial items, general corporate expenses were $15 million in the third quarter compared to $16 million dollars in the second quarter of this year. We expect general corporate expenses to be approximately $17 to $19 million in the fourth quarter. Interest expense was $33 million in the third quarter compared to $25 million in the prior quarter. The increase is due to the issuance of the $1.2 billion dollars in convertible notes at the end of the second quarter. We expect interest expense to increase to approximately $45 million in the fourth quarter due to our recent $1.05 billion dollar issuance of additional senior notes.

In the third quarter, we had a foreign currency loss of $17 million dollars, primarily related to the pound sterling. This compares to $19 million of exchange gains in the second quarter. Our effective tax rate on continuing operations for the quarter was 39%, which is about the rate we anticipated for the fourth quarter, excluding the impacts of any proposed asbestos settlement. Capital expenditures totaled $142 million for the quarter. That's up $14 million sequentially, but we expect our full year capital spending to be down year-over-year to approximately $575 million dollars, which is a further reduction from our previous guidance. Depreciation, depletion, and amortization expense was $132 million for the quarter.

We expect fourth quarter DD&A to be at about this level. The third quarter net loss from discontinued operations was $34 million after tax, or 8 cents per diluted share, reflecting a reserve for uncollectible receivables at a portion of the insurance receivables that we purchased from Harbison-Walker. Also included in the cost of discontinued operations are professional fees associated with the due diligence, printing, and the distribution costs of the disclosure statement and other aspects of the proposed settlement for asbestos and silica liabilities. Now I would like to take a minute to update you on our debt and liquidity. Total debt of the September 30 balance sheet was $2.4 billion. That's down from $2.6 billion on June 30 due to maturity of the $150 million in medium term notes. Our debt-to-cap ratio at the end of the quarter decreased to 40% due to the modest decrease in debt.

Our net debt-to-cap ratio, taking into account $1.2 billion of cash, is 25%. We continue to maintain our investment rate credit ratings. Subsequent to quarter end, we issued $1.05 billion in senior notes including $750 million in seven-year notes at a fixed rate of 5.5% and $300 million of two-year notes at a floating rate equal to three month LIBOR plus 1.5%. We ended the quarter with $1.2 billion in cash. That's up slightly from $1.1 billion at the end of 2002. This increase is due to the second quarter $1.2 billion convertible debt issuance which was partially offset by increased working capital requirements, capital expenditures, dividend payments, approximately $290 million in debt maturity during the quarter, and the $180 million reduction of our accounts receivable securitization facility.

Our networking capital position was $3.4 billion at the end of the quarter, with much of the increase this year due to government receivables related to Iraq. We continue to have $350 million in availability under our unused committed credit lines that expire in mid-2006. Our head count was approximately 103,000 at the end of the quarter which is up 7,000 sequentially due to increases in activities related to Iraq. In general, oil foot industry activity and pricing levels in the third quarter show little improvement compared to the prior quarter. At this point, we believe activity and pricing will be relatively flat in the fourth quarter.

We expect earnings per share from continuing operations to be at least 30 cents per share in the fourth quarter, excluding any impact from the proposed asbestos settlement. In keeping with best practices in corporate governance beginning in 2004, we will no longer provide earnings per share guidance. As you know, we have provided expanded segment and geographic information on the table with our earnings release and we will strive to improve the transparency of our reporting. With respect to the SEC investigation, we are cooperating with the staff, we are providing additional documents, and the SEC has conducted additional interviews.

To our knowledge generally the scope of the investigation has not changed and relates to the accrual of revenue associated with cost overruns and unapproved claims for long-term engineering and construction projects. Turning to an asbestos update. First let me give you statistics here. During the third quarter an estimated 10,000 new claims were filed compared to 37,000 new claims last quarter.

We continue to believe that in most cases the single claimants are filing against multiple Halliburton entities and therefore, the actual number of additional claimants is about half that number. Less than 100 cases were settled during the third quarter as this activity has, for the most part, been on hold awaiting the outcome of our proposed settlement. This leaves us with a total number of claims of about 435,000. For the purpose of the proposed settlement, the number we focus on is the total number of claimants because the law requires approval of 75% of the present claimants in order to establish the 524-G trust. We have settlement agreements with about 345,000 claimants which we believe is more than 95% of all present claimants.

The difference in our estimates of the number of claims and the number of claimants is due in part to a number of claimants filing multiple claims which would be resolved on a per-claimant basis under the proposed settlement. As a result of an increase in the estimated number of current asbestos claims, the cash required to fund the settlement may modestly exceed $2.775 billion. As stated in the disclosure statement, our estimate of the aggregate value of all claims before due diligence considerations is $3.05 billion dollars.

Subject to the final due diligence results, we may need to reach agreement with the claimants' representatives to adjust the settlement matrix to reduce the overall amounts or we would need to increase the amounts we would be willing to pay to resolve the asbestos and silica liabilities which resulted in an additional condition to the Chapter 11 filing. Discussions with the claimants' representatives have commenced on these matters. We are continuing our due diligence review of current asbestos claims to be included in the proposed settlement. We have received in excess of 80% of the necessary files related to medical evidence, and we have reviewed substantially all the information provided. Product ID due diligence has not moved as rapidly as the medical due diligence. However, we continue to review medical and product ID information, and although there are no guarantees, we expect as the time for filing approaches, the interest of the claimants in consummating the settlement will result in us receiving information necessary to proceed.

In September, DII, KBR, and affected subsidiaries began the solicitation process in connection with the planned asbestos and silica settlement. A disclosure statement which describes the Chapter 11 plan of reorganization and trust distribution procedures has been mailed to asbestos and silica claimants for the purpose of soliciting votes to approve the plan of reorganization prior to filing a Chapter 11 proceeding. The deadline to vote to accept or reject the proposed plan of reorganization is November 5th, 2003.

In the event we elect to adjust the settlement matrix to adjust the amounts per claim, a supplemental disclosure statement may be required, and if so, the claimants potentially adversely affected by the adjustment may have an opportunity to change their votes. The additional time to make such supplemental disclosure and opportunity to change votes may delay the Chapter 11 filing. We have not yet received a significant number of ballots from the claimants in connection with the plan of reorganization. It's customary for ballots not to be returned until the end of the solicitation period. Most claimants' representatives will await resolution of the cash amount before returning their ballot.

Should remaining conditions be timely satisfied without amending the proposed plan of reorganization, DII, KBR, and affected subsidiaries could be in a position to make the prepackaged Chapter 11 filing in late November. But if we are required to amend the proposed plan and make supplemental disclosures to claimants, a December filing is more likely. We are nearing completion on our financing commitments and documentation for the funding of the proposed settlement, and as part of this effort, we completed the debt offering earlier in October that added another $1 billion dollars of funds that would be available as part of the cash necessary for the settlement.

When and if the currently proposed settlement becomes probable, we would increase our accrual for probable and reasonably estimated liabilities for current and future asbestos claims up to approximately $4.4 billion dollars, reflecting the amount in cash and notes we would pay to fund the settlement, combined with the value of 59 1/2 million shares of Halliburton common stock. Using our recent stock price of $24 dollars, the share component of the charge would be approximately $1.4 billion dollars pretax. As a result, we would record at such time, which may be in the fourth quarter if things fall into place here as we described, an additional pretax charge would occur of approximately $1 billion dollars. The tax benefit from this charge will be relatively small as we will set up a valuation allowance for much of the loss carried forward.

We may enter into agreements with all or some of our insurance carriers to negotiate an overall accelerated payment of anticipated insurance proceeds. The temporary restraining order relating to more than 200,000 pending Harbison-Walker asbestos claims against DI industries expired on September 30th, 2003.

Discovery in the claims that have previously been stayed may begin as early as November 1st, and the trials on any of the claims that have previously been stayed may commence as early as January 1st, 2004. Notwithstanding expiration of the stay, asbestos and silica claims against DI industries will automatically be stayed upon a Chapter 11 filing. Now I would like to turn the call over to John for his remarks on the energy services environment and outlook.

Thanks, Chris.

John?

I'm sure y'all know that ray activity has continued to rise both in North America and internationally, and this is underpinned our results this quarter, but rather than discuss rig activity for which there's much third-party information, what I would like to do is discuss today three elements of our improved performance. First, we've seen evidence that our global design for growth is gaining traction by delivering higher customer value, accelerated technical innovation, as well as added efficiency and effectiveness within our operations overall.

All four new divisions are actively managing operating costs and working capital, improving service quality for our customers, and taking steps to avoid low margin work in favor of improved performance of our portfolio. In addition, we've strengthened alignment and governance of our joint venture investments within the respective divisions and are focusing on ways to improve their financial impact on the company. Secondly, the revenues secured through new technology in the first nine months of this year are essentially the same as those for 2002 as a whole.

Landmark Graphics and our well dynamics joint venture have recently received two of the 11 major 2003 world oil awards, and we have announced new product launches in all four divisions. With a robust pipeline of new research and technological developments, we're already finalizing our go-to-market plans and priority products for 2004, much as we did in 2003, and this is all backed up by an IT capability which, for the second year running, has been voted number one in the industry -- in the energy industry by Information Week. Very proud of that accomplishment.

Finally, I would like to turn to health, safety, and the environment, and in particular, the 500 million miles we recently reached without an employee fatality, roughly equivalent to three round trips to the sun. We think this is a remarkable achievement and so do our customers. In fact, the reaction has been quite outstanding with many invitations to share lessons we have learned. What is less well known is what we've achieved in our manufacturing plants. In the last two years, we have reduced our incident rates by over 50%.

In using the measures endorsed by the Occupational Safety and Health Administration as published by the Bureau of Labor and Statistics, our year-to-year date rate of 1.72 now compares to a U.S.-wide manufacturing rate of 8.1. I'm very proud of what we've achieved and what we are doing globally, and none of this would be possible without our staff.

The strong accountability and alignment with our new divisions and regions, the delivery of high value, new products and our outstanding achievements in health, safety, and environment. Now I would like to turn the call over to Dave who will make some closing comments. Dave?

Thank you, John, and hello, everyone. As you could tell from the prior comments, overall, I'm very pleased with our operating performance this quarter as our broad portfolio of businesses combine to deliver both revenue growth and improved profitability. We were able to achieve this with little help from pricing or activity increases and also by overcoming the Anglo-Dutch litigation expense.

Both the energy services group and KBR continue to focus on increasing profitability and capital discipline. I have said for some time over the past calls that I thought pricing and activity in the oil field would improve more in the second half of this year. Unfortunately the pricing improvement we have experienced so far has been modest. And activity in the important Gulf of Mexico market for Halliburton has not yet picked up, and competition in our sector remained very fierce in the third quarter. Our customer spending continues to be held back due to continuing economic and political uncertainties, and their view that commodity prices may not stay at these high levels.

However, these high commodity prices have allowed our customers to significantly improve their balance sheet and position them for growing their reserves and production, and I believe that this bodes well for a longer term recovery in our business. Chris gave you the information with respect to our work in Iraq, and there have been a lot of politically motivated allegations against our company which we do not believe should go unanswered. As most of you know, we believe that the criticism has come away is inaccurate, unfounded, and misleading. Fortunately, our employees and customers know that.

Our people and our customers have told us that they understand that what we are doing in Iraq is important and they appreciate our work there, both in supporting the troops and improving the lives of the Iraqi people. Frankly, when I see the allegations repeated day after day in the press, I'm offended. I know that a lot of people feel the same way, but as you know, these attacks are less about Halliburton and more about external political issues, and it is obvious that these attacks are unwarranted and not based on realities that our company faces in Iraq.

I would say that regardless of your individual political views or opinions about U.S. foreign policy, our troops are there, and they need to be supported, and the Iraqi people need to be supported. For our part, we will continue to present the facts, and we are confident that in the long run, facts will prevail over fiction. And most importantly, we are committed to staying the course.

As a company uniquely qualified to take on this difficult assignment, we will continue to bring all of our global resources to bear at this critical time in the Middle East. We have served the military for over 50 years and have no intention of backing down at this point. In short, we're extremely proud of the work that we're doing there. This concludes the remarks that Chris and John and I had, and we'll now turn it open for a series of questions.

Thank you. Thank you, sir. If you would like to ask a question, please do so by pressing the star key followed by the digit 1 on your touchtone telephone. If you are on a speakerphone, please be sure that your mute function is turned off to allow your signal to reach our equipment. In the interest of time, we do ask that each participant ask one question only. Once again, please press star,1 on your touchtone telephone to ask a question, and we'll pause for just a moment to give everyone an opportunity to signal for questions. And we'll take the first question from Jim Wicklund of Banc of America Securities. Please go ahead.

Good morning, everybody. Guys, asbestos is going to get talked about, and John talked about the operations. KBR, it's well understood that there's some intention by Halliburton to trim down KBR over the next year. What would you keep and why?

Well, Jim, I think what we said on KBR is that the offshore EPIC business is one that we will cut back on. We don't intend to compete there. The other parts of KBR we feel are integral to KBR as a whole and have not said anything about any other plans in that regard. We were pleased with KBR's improvement this quarter. There, you know, are still some things that KBR's working through, primarily in the offshore EPIC area, but they seem to be making good progress.

And we'll take our next question from Geof Kieburtz of Smith Barney. Please go ahead.

Thanks very much. I would like to explore the fourth quarter guidance a little bit further. I understand your comments, Dave, regarding the fact that activity and pricing haven't improved quite as well as you had maybe previously anticipated, but can you help us understand a little bit the outlook for potential sequential decline, and what, if anything, that might indicate about your current outlook for '04?

Geoff, our guidance for the fourth quarter is at least 30 cents. We've said that the environment generally is flat. We're not seeing much help on the price. As you know, there are areas where there is some seasonality in the fourth quarter. You know, North Sea, for instance. So, you know, that all kind of gets baked into our outlook here for the fourth quarter. Next year, you know, our expectation is that there will be some modest increases in certain areas but, you know, overall, those are -- that improvement is expected to be fairly modest, and we'll provide a better update on the fourth quarter, on 2004 rather, as we look at the trends in our next call. But, you know, on the whole, the market looks kind of, in general, flat with certain international pockets being good. Certain areas where we can see some price improvement, but also other areas that seem to be well supplied with a good bit of price competition and some seasonality and activity. Anything you would like to add to that, John?

I would say that we are consistent with what we had said last quarter in that pricing is difficult. We have seen in the North American market for production optimization that we have gotten a price increase that we've been able to hold, but we still -- and many of the areas are in very competitive environment. We don't see that changing, and we're going to work hard on choosing specific geographies and product lines where we think it's possible as we go forward and take advantage of it, but otherwise it's going to be a very competitive market as we go forward.

And, Geof, we did point out, too, that our interest expense will be up in the fourth quarter with the additional debt that we issued here during the quarter.

And we'll take our next question from Terry Darling of Goldman Sachs. Please go ahead.

Thanks. A question on the profitability of the ESG business overall, I guess two-parter here. First, do we view the margins in production optimization and Landmark and other as sustainable; and then, John, perhaps you could comment on where you see opportunities to improve the margin performance at Sperry Sun and Baroid where I presume you are a little disappointed?

Well, let's take a look at it overall, first with Landmark. I would really look at our new technologies, and as I look at the new technologies, I see that we're releasing products like decision space with atomic meshing and we think that will really change fundamentally how people do modeling of reservoirs. We have a new release of Geo Probe for Sun workstations which we think will meet many, many of our customers' needs as we go forward. Pro magic and seismic processing, there are just a lot of new products at Landmark, and the typical growth in Landmark results from new innovation, new products in the market, and we're very strong there. As we look at the production optimization, we just have a tremendous team there.

We saw growth in all aspects of that. This past quarter, the completion products group, very focused, as well as tools and testing and production optimization within that group. As people move into the gas markets and focus on the production of gas, that entire business unit benefits greatly from that. We turn to the fluids group with Baroid and cementing. Cementing had a good quarter, and Baroid is where the weakness exists. That weakness is related primarily to our African results and the Gulf of Mexico, and in truth, as we go forward, I'm quite pleased with what I saw happen in Baroid in the last quarter in that we began to move a lot of our revenue internationally, and we have to improve our international focus for fluids.

Baroid had a very strong market position in North America, and we have to learn how to increase that market position on a global basis and not be as dependent on the Gulf of Mexico. Our design for growth and which we focus on the international markets I think will benefit Baroid as we go forward. We do have new products there, and accolade in particular. We had 61% growth in our new product revenue year-to-year for our Baroid division, and so we're quite pleased with the new product revenue and we just need to move internationally.

If we look finally at Sperry, we did have some slowdowns in the area of the more complicated drilling.

So the deep water Gulf of Mexico, some of the activities in the Norway, and so as we move away from those, it causes us to be in sort of the lower margin environment overall for directional drilling, but we do see that as we go forward that that should pick back up and we're very well positioned there with new technology as well on our full drift drilling suite of which a component of that is Geo Pilot, we're up 74% year to year in that particular area for new technology. So I think all of the new technologies we're bringing online are going to make a difference there, and we're going to have to focus on the Baroid division to make sure that we get the international growth.

And we'll take our next question from Paul McCray of Wellington Management. Please go ahead.

Good morning. Actually me question was also on Baroid. Seemed like a stunning decline relative to expectations. Could you just go a little further, John? Have you lost any market share there, and normally wouldn't seasonally Baroid do better in the North Sea in the third quarter than the second quarter which makes that -- I believe you said there was a 50% decline in earnings versus the second quarter, all the more surprising.

Baroid is the most disappointing of the results that we have, and it principally is related to some activities in the Gulf of Mexico. We had fairly significant cost of centrifuging our waste during Q3. We had some severance cost in the Gulf of Mexico as well. As the activity level there has gone down, we've had to also reduce our cost in the Gulf of Mexico on Baroid, and we've done that in Q3 and we incurred some small severance there.

We've also had some inventory issues in the Europe/Africa market, and we're working on those. So we have a lot of efficiency to improve there, and as we extend internationally, I think that's going to make up the difference. Our accolade product line is extremely strong, and we're investing more into synthetics, and we think that the new technologies, combined with the focus internationally, will make the difference. But we just, we need to work on it. And our Gulf of Mexico dependence has to be reduced.

We'll take our next question from Ken Sill of CS First Boston. Please go ahead.

Yeah, good morning, gentlemen. I wanted to get back to KBR and dig into the L&G business. You've cited that as an area of, you know, some sequential improvement. Could you talk about how much L&G backlog is there at KBR and how you expect that to evolve over the next one to two years? Because I think this is pretty long lead time stuff.

Yeah, Ken, we don't break out L&G backlog per se, but our on-shore backlog, we're working off, you know, some significant projects, but we still have a, you know, very large backlog in that area. You know, approaching $2 billion dollars of backlog in the on-shore sector of KBR and, as you know, there are many projects in the discussion stage at this point and, you know, we're very pleased with the market position that we have in that sector. But that's about, you know, the extent of the information we can provide on L&G.

And we'll go next to Jamie Stone of UBS. Please go ahead.

I just wanted to follow up a little bit more on the guidance. Can you give us a sense as to what your expectations are for KBR and the Iraqi revenue and profitability in the fourth quarter? Are you anticipating that you'll continue to run at a similar rate as the third quarter, or are you kind of just saying maybe, you know, we don't have any visibility to that, so we're not really including that in our forecast?

Yeah, Jamie, we're in a responsive mode there, of course. That's the primary nature of the contract we have, but the revenue level that we're at in the third quarter is probably going to, you know, be at that level in the fourth quarter or maybe a bit more. That's where we're running at this point in time, but, you know, we are ramped up pretty well here at this point in time and don't see a huge amount of additional growth. We think a large part of the growth has occurred at this point.

And we'll go next to Kevin Simpson of Miller Taback. Please go ahead.

Good morning. My question is on KBR as well. Chris, you know, you talked about losses in some of the, I guess three specific areas, and I guess one of them was Asia Pacific. I'm wondering if you could tell us the size of those losses, and is one of them the, you know, the contract in offshore Indonesia?

Yes, Kevin, I mentioned three or four different projects in KBR in which they did record losses. That's, you know, not unusual when you have as many projects as they have. Many are profitable and some do incur losses as we look at that. In particular on the Bellenek project, we did take a charge there between $5 and $10 million dollars, and most of the other ones that I had mentioned were in that general range as well. An individual basis in that $5 to $10 million dollar range.

And we'll go next to Mike Urban of Deutsche Bank. Please go ahead.

Thanks. Good morning. You've talked about some of the business lines that had some issues in the Gulf of Mexico, and that was part of what was behind it. I was wondering if you were able to quantify kind of in the aggregate what the sequential impact of the Gulf of Mexico was and maybe how much of that was kind of one time in nature, be it storms or currents or whatever the issue may be.

Let's see, on the Gulf of Mexico, it's really dependent upon the deep water Gulf of Mexico, and we had a large reduction in the activity in the deep water where the really high margin, high value, high-tech component of our portfolio is focused, including the Baroid accolade technology that's our higher end drilling fluids. And so as you reduce the deep water activity, it reduces our use of those drilling fluids. We had a couple of storms associated with the Gulf of Mexico this past quarter.

We had currents that affected some of the activity in Q3. We also have just seen a general slowdown in the Gulf of Mexico by operators and shifts to other areas of the country, shifts up into the Rockies and the Rockies picked up quite nicely. So we're seeing some movement in terms of where our customers are spending their capital.

As we go forward, I think the Gulf of Mexico, we really plan on it being flat and, as a result, we've focused very hard on our costs in the Gulf of Mexico. As we see it out in the long term, we think that the activity levels there are not going to be ones that you can count on increasing, and we just need to focus on running a very efficient operation.

And we'll go next to Scott Gill of Simmons & Company. Please go ahead.

Yes, good morning, gentlemen. Chris, I guess this question is directed to you. Back in early October in your preannouncement for the quarter, you talked about kind of a 5-cent decrease in contributions and earnings from operations. I was wondering if you could reconcile that 5-cent differs to what got reported today and then particularly address, in that press release you talked about shortcomings in the joint ventures as well as legal fees. Can you help us determine where those numbers are in this press release?

Well, Scott, of course, when we were talking about the guidance and the revisions to guidance, we were talking about changes versus expectations for the third quarter, and what we've been speaking about here today are comparisons against prior periods. So, you know, we're comparing against different reference points, if you will. In the guidance, revised guidance that we issued on October 9th, we -- I mentioned legal fees, and the largest part there would have been legal fees that we anticipated in connection with the Anglo-Dutch case.

As I said earlier, the legal fees on that case were large, and we expected to win the case, but we did expect that we would record a large amount of legal fees in connection with that. Also we said that joint ventures were down from our expectations for the third quarter, and they are, in particular, Subsea 7 which I mentioned was down fairly significant given the size of that operation from the second quarter, but down even more so from our expectations for the quarter.

And we'll take our next question from Rob McKenzie of Friedman, Billings, Ramsey. Please go ahead.

Good morning. It's Brad Suddarth. Hello?

Good morning.

Good morning, it's Brad Suddarth. A quick question on Landmark. Just wanted to get back to. It looks like revenues were pretty flat sequentially and year over year, modest changes. Yet operating income was up significantly. You've mentioned new technology and something about the Middle East. What specifically drove the strong improvement in operating income? For Landmark?

We've had excellent focus over the last year in improving our efficiency and particularly in integrating some of the activities between the core part of Halliburton for the back office and so gains and efficiency have really improved our margins there to where we've seen excellent margin improvement from the Landmark division as we're going forward from their focus on that. We're very pleased with that.

We have time for one more question.

And we'll take our next question from Bill Sanchez of Howard Weil. Please go ahead.

Good morning. Chris, you did a good job of walking through the uses of cash during the quarter. I just wanted to focus on the comment as it relates to Government receivables relating to Iraq up again sequentially. Do we expect the receivables to continue to build here as we move through the balance of the year on when should we expect perhaps to see those receivables come in at some point?

Good question, Bill, and we have seen a very large build there. But as I think we mentioned in connection with Jamie's question, we're expecting that we're reaching a steady state here as the level of activity has built and as we achieve that steady state, we would expect also to see a leveling off in the receivables and in the working capital investment that we have here.

Okay. I would like to thank you for joining us on today's call. A replay will be available on our website. Again it's www.Halliburton.com.

And that does conclude today's conference. We thank you for your participation and you may disconnect at this time.