Good day, ladies and gentlemen, and welcome to the Baker Hughes Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I'd now like to introduce your host for today's conference Ms. Alondra De Oteyza, Director of Investor Relations. Ma'am, you may begin.

Thank you, Bridgette. Good morning, everyone, and welcome to the Baker Hughes second quarter 2016 earnings conference call. Here with me today is our Chairman and CEO, Martin Craighead; and Kimberly Ross, Senior Vice President and Chief Financial Officer. Today's presentation and the earnings release that was issued earlier today can be found on our website at bakerhughes.com. As a reminder, during the course of this conference call, we will provide predictions, forecasts and other forward-looking statements. Although they reflect our current expectations, these statements are not guarantees of future performance and involve a number of risks and assumptions. We advise you to review our SEC filings for a discussion of some of the factors that could cause actual results to differ materially. Also, reconciliation of operating profit and non-GAAP measures to GAAP results can be found on our earnings release and on our website at bakerhughes.com under the Investor Relations section. And with that, I'll turn the call over to Martin Craighead. Martin?

Good morning, everyone, and thanks for joining us today. When we last spoke to you on May 3, we told you that we were focused on three objectives this year. First, we said we would reduce $500 million in costs by year-end by simplifying our organizational structure and rationalizing our operational footprint. Second, we said that we would focus on our core strengths and product innovation while building broader sales channels for our products and technology. And third, we announced plans to optimize our capital structure by paying down debt and buying back shares, while ensuring we maintain financial flexibility. In less than three months, we've moved with urgency and have made tremendous progress on all fronts. We restructured the company to remove significant costs and create a more nimble, efficient organization. Today, we are firmly on track to reach our savings targets. We redesigned the customer facing areas of our business to better support our strategy of taking more new products to market faster and more efficiently. We fortified our full service business with enhancements to our operations and sales organization and we've laid the groundwork to build new sales channels for direct sales. As Kimberly will describe, we've also made enormous progress on our capital structure in all three areas of focus. Today, I'll share more details about what we've accomplished so far, how we are executing in the market to better position the company for success and our view of the industry outlook including the opportunities we see for Baker Hughes. But first I'd like to give you an overview of our second quarter financial results. Our performance in the quarter was impacted by continued reductions in customer spending and activity, trends driven not only by the price of oil, but the volatility of those prices and…

Thanks, Martin and good morning, everyone. As Martin mentioned, today we reported revenue for the second quarter of $2.4 billion, down 10% sequentially as a result of additional activity reductions and pricing pressures across all our geographic segments. On a GAAP basis, the net loss for the quarter was $911 million or $2.08 per share. The adjusted net loss for the second quarter was $392 million or $0.90 per share. Adjusted net loss excludes $519 million of after-tax adjusting items or $1.18 per share. These items on a pre-tax basis are: goodwill impairment of $1.8 billion of which $1.5 billion related to North America and $311 million to our Industrial Services segment. Impairments and restructuring charges of $1.1 billion primarily related to impairments of fixed assets and intangibles, workforce reductions and contract terminations. Inventory adjustments of $621 million related to writing off inventory. A charge for early extinguishment of debt of a $142 million related primarily to the premium on the bonds we repurchased. Merger and related costs of $78 million and $262 million for income taxes on these items. These charges were partially offset by the collection of the merger termination fee of $3.5 billion and the reversal of a loss on firm purchase commitments of $51 million as a result of reaching a settlement this quarter. On the other hand, non-adjusted from our results are before tax charges related to provisions for doubtful accounts of a $166 million, primarily in Ecuador and valuation allowances on indirect taxes of $45 million, largely in Africa. These charges reflect the ongoing challenges our industry is facing and the restructuring actions we have implemented to align our business to these market conditions. These actions are expected to result in an estimated $450 million of annualized cost savings with approximately two-thirds coming from…

Thank you, Kimberly. At this point, I would like to ask the operator to open the lines for your questions. To give everyone a fair chance to ask questions, we ask that you limit yourselves to a single question and one related follow-up question. With that being said, Bridgette, could I have the first question please?

Thank you. [Operator Instructions] And our first question is from Jud Bailey with Wells Fargo. Your line is open.

Thank you. Good morning.

Good morning, Jud.

A question on the cost reductions, Alondra, you laid out kind of the source of the cost reduction on your way in terms of meeting your plan. How much did you recognize in terms of cost savings in the second quarter, and how do we think about margins in the back half of the year, how quickly do you realize those savings and how do we think about margins progressing and where do we see the biggest impact from those cost savings?

So, Jud, this is Kimberly. So, we got about one month of benefit in quarter two. So, obviously, we do expect to have further benefit coming through in quarter three and quarter four. And therefore, we would expect to see some margin improvements in the second half of the year due to the cost reductions that have taken place.

Okay.

Additionally, we'll continue to focus on some additional cost reductions, we still have some more that we're going to do in quarter three and some of those take a little bit of time, so they won't necessarily be a full quarter of it, but then we'd expect to start seeing more cost savings in quarter four from that initiative and we'll update you on that next quarter.

Okay. So, would we expect by the fourth quarter that all that cost savings effectively will be in the results by the fourth quarter or would you still have a little bit of a lag there?

No. We're on target. Well, we would not expect to see necessarily a full quarter's savings, but by the end of the year, we will see a run rate for the following year, the $500 million savings that we targeted.

Okay. Great. And then my follow-up, just kind of staying with that topic and Martin to think about what your commentary was on North America. I think you said your expectation was for a grind higher in the back half of the year. With that as a backdrop for potential activity levels, how do we think about North American margins, I would imagine you should see a pretty notable step up in margins with some of the cost reductions and the volume increases should help? Can you help us think about how you could perhaps exit your North America margins under that scenario?

I would say Jud that, yes, we expect the margins to finish strong in North America driven by strong incrementals given the cost reductions that are taking place. Of course, the biggest driver in North America is going to be activity levels which will drive our pricing environment. But putting those aside, if you just want to look at our - of what we can control, so to speak, it's the cost removals driving some strong incrementals. So, we expect the margins to be much more improved than they are right now.

Do you think you can get close to breakeven?

You tell me what oil prices are, what the rig count is, and I can give you - I can land the plane, but I can't - I am not going to go there right now.

Great. Thank you. I'll turn it back.

Our next question is from Kurt Hallead with RBC. Your line is open.

Hey, good morning.

Good morning, Kurt.

Hey. I just wanted to follow up, you referenced 60 new products coming in the back half of the year and I just want to try to gauge what you think that could potentially generate from a revenue standpoint, maybe as a percentage of total revenue and maybe, kind of give us some kind of historical perspective on what new products generally represented from a revenue standpoint?

That's a great question. If you remember Kurt in 2014 at the Analyst Conference, we put a $1 billion bogey out there. Obviously, it was a different environment in 2014 and we hit that. Last year, we didn't share with you, I don't think specifically, but a dramatically different market. And the revenue from new products hung in very, very well as a percentage of total revenue. I would put these 60 products in the remaining part of the year, an incremental revenue associated with those products, north of $0.25 billion I think, is a safe call depending on the product, the mix, where we are launching it, and the margin contribution on all of those is generally accretive.

That $0.25 billion would be within the first year of launch, is that a fair way to look at it?

Yes, that is exactly right.

Okay. And then, my follow up is you mentioned based on your new strategy of focusing on only profitable areas where that might have an impact of like 5% on the revenue base. And at the same time you are talking about direct sales and selling into some local competition? I'm assuming Martin, and maybe you can kind of clarify this, that whatever you're going to sell into these local players will more than offset that 5% revenue drop?

Yeah. That's the plan. I can tell you one thing, it will sure as hell more than offset the margin drop and there is a timing issue. We're in the process of weaving through that portfolio, we're engaged with that emerging customer set, I like where we are in the process in terms of laying the groundwork, staffing the teams, and we're having serious discussions with this emerging customer group in terms of what's the scope of their needs. This is a new opportunity for them as well. We're building this business from the ground up. There's no rulebook on this, no one else is doing it like we plan to do it. I think the thing to keep in mind that this is a broader set of new customers in this space and we have every intension of having every one of them be a customer of Baker Hughes.

Right. Awesome, that's great and great to have you back on the conference call circuit.

Great to be here, thanks.

All right.

Our next question is from Angie Sedita with UBS. Your line is open.

Good morning, Angie.

Thanks. Good morning, guys. So, to go along with that prior question that Kurt just asked on the rationalizing of products cross certain countries and the 5% of revenues. Can you talk about where you are in that process, is that still in the early stages or maybe even midway and talk about the timeline on that a little bit? And then, obviously there are some opportunities besides local oil service providers, can you talk about where you think, your other new channels could be for sales op?

Yeah. So, timing-wise, Angie, I mean, we've just left home plate and I think, that's the best way to frame it. But as I've said, the interest levels, the type of dialogue, the enthusiasm confirms that we're on the right path. And I'm sorry, the second part of your question?

And then, as far as where you - how many other opportunities do you think you see in new sales channels besides the local oil service providers?

Well, I think that pretty much sums up the - when we're talking about these new channels that is the category that I think they all fall underneath. But there's a whole different kind of mixture in that group. And at the same time, let's remember that as I said in my prepared comments, our core business continues to be the biggest growth opportunity in so many ways, depending on what part of the world we're in. The new products, the new organization, the new teams being able to peel out, if you will, some of the underperforming assets and double down on more of the stronger assets, we expect to see pretty strong uplift in the core business concurrent with these new market channels.

Perfect. Okay. Good color. And then, as a unrelated follow up, maybe if you could talk a little bit about your thoughts on pressure pumping in frac regards to Baker and the industry overall and maybe walk us through, if you can, how much of Baker's equipment is cold stack versus warm stack, the CapEx to bring it back and just thoughts on overall frac attrition for the U.S.?

Some of that's skating on the edge of competitive information, but let me put it this way. Of our total fleet, we probably have 20% active and then you could go through the various forms of cold stack, warm stack, hot stack. The hot stack equipment could mobilize in days, you know the cold stacked, you're talking a lot longer period, months, very little money in terms of the hot stack to bring it back, but the cold stack you're well north of $150 million. So, it's a lot of capital and this is one of the issues that we have with that business.

And then thoughts on overall attrition in the industry? How much that come back fairly easy versus how much would need in total CapEx to come back?

Well, that's a great question. It's hard to speculate Angie. If I look at the size and the scope of our franchise, our franchise in North America, I think it probably reflects the industry average. Given the cash-strapped nature of a lot of the independent players, they maybe cannibalizing a little bit more and not maintaining to the same level. So, you could maybe make some of the numbers I gave you a little bit more bleak as an industry whole. But what it is to-date, does it really matter because there could be a lot more to come.

All right. Great. Thanks. I'll turn it over.

Our next question is from Sean Meakim with JPMorgan. Your line is open.

Hi, good morning.

Good morning, Sean.

So just not to focus too much on less than 5% of revenue. But I just was curious, we talked about businesses that don't meet your hurdles for profit and returns today.

Yeah.

Just curious if that contribution looked materially different during normalized activity, say 2013 or 2014?

That's a good question and I can tell you that the decisions we're making today are based on the analysis work through different time periods. I don't want to be specific because I think that what we're doing is some really, really good rigorous evaluation. But we looked at the businesses at the sharpest end of the stick under a variety of market conditions. We looked at a variety of risk factors. I mean a real portfolio of risk factors financially as well as operationally as well as commercially. We looked at collectability, we looked at cash flows. We've got a real insight to these businesses that was the opportunity we had, while we were kind of in that purgatory time. So these are the decisions now that are on the - this is the information that is now on the table and this is the decision set that Belgacem and Derek, and Art and the team, all of us, Kimberly are working through.

So it'll be fair to say then as you think about normalized activity next cycle, having gone through the analysis, you'd expect that there's going to be, not necessarily just today, but in a normalized period of activity, improvement to the overall in terms of profitability and return.

That's the objective.

That's the idea.

That's exactly right. And remember as well, remember as well, Sean that the decisions to exit or to take something out is generally very small as I said in my comments, but it's converted into something with somebody else. And that's going to not only drive our margins, it's going to drive the number one driver we have as a management team which is return on invested capital. Full stop.

Very helpful. And then I was hoping to touch on working capital. So, it looks like your DSOs got better in the quarter, but of course we had the big provisions for doubtful accounts. I was hoping maybe Kimberly could give us a little more on the moving pieces and then in particular if you're seeing anything in terms of shifts in receivable collections from some of your large international customers?

Yeah. So, as we said, obviously we had a bit moment both in receivables as well as in inventory and those were largely attributed to the write-offs or the reserves that we took on both of those. We did overall, we had nine days improvement of which seven days was essentially bad debt on the receivable side. So we've continued to make progress on collecting the receivable. This is an area that we started last year being very focused on because at the end of the day, I would say a sale is not a sale if you don't collect on it, it's a gift and we're really not in the business of gifting.

Right.

So, we've really increased the discipline and having proactive discussions with our customers about collections. So, obviously there are many countries, especially when they're very dependent on oil that are struggling in today's environment. We look at those, in some cases the future will look better when oil prices get better, in other cases we see that they might continue to have struggles. And so, what I can say is even right down to myself is people are out talking to our customers and having a good sense about where they are and we obviously try to work with them as much as possible. But in some cases, we end up having to take provisions and our policy is based on a timeframe. So, when we haven't been paid after a certain timeframe, then we take provisions on those receivables. So, not getting any easier right now, but I think we have a pretty good full-court pressed on it from our side. And even if we have taken a provision I should say, we will continue to work on collecting those funds. So, it's not like it's been written off, we continue to work to collect.

Of course. Yeah, fair enough. Thanks a lot for the detail.

Our next question is from Jim Wicklund with Credit Suisse. Your line is open.

Good morning, guys.

Good morning, Jim.

Martin, I remember when the geo market structure was first being introduced at Baker Hughes and the comment was it was going to take a long time, measured in years, similar to what Schlumberger had gone through in adapting their geo market structure, you talk about the new design of your current structure and the implementation. How long should it take to implement the change in management structure, design and population of the appropriate spots? How long should we expect it to be before you have the new organization, if you would, up and running?

Well, let me look at my watch here. It's done. It's done. We've moved with...

Okay. So, we're not going to have to go through four years of every quarter gone is it done yet, it's already done. So, that's good.

It's done. Full stop, truly.

And...

The team moved with great speed. Sorry, didn't mean to interrupt you. The team moved with great speed. We knew who we wanted, who we didn't. We knew where we wanted them, an enormous feeling of excitement with the organization, to stand things up in a different way, focus on winning and what we're winning with, to compete on our strengths, not defend our weaknesses and people are pretty charged up. So there's no timeframe on this one, we're locked and loaded.

Okay. And Kimberly on that note, how long before - what quarter do you think we start to see the actual - not the cost savings you'll do the rest of this year, but sometime in 2017 and 2018 where we see the full benefit of that new management structure impacting the financial statements?

Well, I'd like to think it's already starting, quite frankly with the streamlined organization that with my perspective on this is that we're making decisions very quickly. And we're able to push them down through the organization very quickly also. This helps us with regards to standardization in some areas and obviously that helps get cost out as well as it helps us move faster and it takes risk out, right also if you can move faster and things are less complex. So I'd like to think that we're going to be seeing that sooner rather than later. Obviously the full impact, we wouldn't expect to see this year, but I'm already seeing just how we're making decisions quicker and able to move up and down and through the organization a lot faster. Even from my perspective, I now don't have to go out and try to change something with four different geo heads now I go straight to Belgacem or Art or we all get together, we make a decision and we can start communicating to the organization very quickly in a standardized fashion.

Okay. That's very helpful. And my follow-up, if I could. Over the last couple of years and going back probably two years or three years or four years now, Baker had gone on an expansion effort of building out infrastructure in international markets, so they could compete more on a variable cost basis against some of the bigger players. And I just wonder now, if some of those might be considered stranded assets with the change in business model and is that true. And if so, I think you're pursuing an asset light model anyway. So it wouldn't be a surprise, but is that the case. Are you going to have some redundant infrastructure in the international markets that you added just four years ago, five years ago?

Well, yeah. Again, we're maintaining obviously a global footprint. But with that said, even within countries, we believe and we're seeing that there's some opportunities for optimization and obviously the business is strong also. So, we have been taking actions and shutting down facilities last year as well as this year. We will continue to have some taking place in quarter three and then additionally what we'll be looking at next year is looking at some of the footprint around supply chain also. So, I think this is one of those things that one should look at on a regular basis, but definitely right now considering the downturn and some of the changes that have taken place, really taking a close look at that. And again, this goes to our analysis on return on invested capital also and really putting the rigor into, okay, how do we maximize the value of the assets that we have, where we want to exit, but then also how do we make sure that we have the least amount of bricks and motors to service the business in an optimal way.

Okay. Thank you all very much. I appreciate it.

Welcome Jim.

Our next question is from James West with Evercore. Your line is open.

Hey, good morning Martin, good morning Kimberly.

Good morning James.

Hi, James.

Martin, you talked about the new sales channels for direct sales. And I'm curious, I guess, to one, have you had to add staff or is this a reallocation of staff? Two, is this the part of your sales force test or do they have the right tools to attack this new market? And how quickly can they ramp up the conversations with the new third-party competitors that are going to compete with your larger competitors in these markets where you are choosing to not be I guess, boots on the ground?

I like the way these questions are starting to go because you can see, there is a learning curve for everybody in this industry as to the model that we are building here. There is a skill-set that's different from looking after the large NOC or an independent in North America. But that's a skill-set that we're growing our self. I think it's going to be a competency that as this category emerges, we are going to have a competency that's very much oriented to this sector. It's a very technical but also very, very operations driven customer base. Unlike a traditional customer James, like a Statoil or a Petrobras or a Devon, these are us, these are folks that have generally been in our industry. And so the conversations are much more about partnerships, it's about what their challenges are themselves in terms it could be anything around compliance, HSE, maintenance schedules. So, you would see our sales people in this category be former types of heavy lifters within our operations. The timeframe on these is much longer than a transactional or tender type of thing. These are probably six month timeframes once the discussion start and these guys get our folks and get our equipment in place. So I don't know if I answered your question or not, but that's kind of the color I can provide.

Okay. That's very helpful. And then, Martin obviously, you over the last couple of months have had, I'm sure not tons of customer conversations around, you're describing both a new strategy and then in more recent weeks probably with oil prices coming back down, has made perhaps some changed conversations or maybe not. So I'm curious how those conversations on your strategy are going and also if there has been any change in the last couple of weeks with oil prices coming down in terms of your customer outlooks for the back half of this year?

Okay. Let's take the first one, what are the customers saying. So you have a customer that says wait. You mean, I can have a Baker Hughes product, perhaps more opportunities to buy some of the best products and technology in my respective, the country I operate in or the basin I operate in. I mean customers love it. As to the activity levels that I'm hearing from our customers, it's kind of as I said James, in the commentary. It depends where they are, it depends on the strength of the customer, the quality of their acreage and so forth. I think, as Kimberly said internationally, it's a concerning environment, it's the cash flow, CapEx issue much more, it's a longer cycle nature of projects. I think until the view is more constructive, these guys are just going to - just sit tight. Now, I think the Middle East is maybe a little bit different than that. It should be, at worst, flat to slightly up. And we have a large, very large OPEC customer there that just announced a very ambitious plan, to grow their production 30% by 2020. So, that aside, as far as North America, I don't subscribe to the whole full commentary that I think, gets thrown around a lot by your community. And I think that the customers are going to need something that's coming and vectoring in on around $60 or high $50s just because certain costs on our side are going to go up. And I just would feel a lot more confident that we see some stability well north of $55 before there is a lot of motivation for us to be bringing back capital into North America.

Okay. Very helpful. Thank you, Martin.

Okay. Thank you, everyone. We will take now one final question. Bridgette?

Thank you. And our next question is from Byron Pope with Tudor, Pickering, Holt. Your line is open.

Good morning.

Good morning, Byron.

Just got one question here, a lot of moving pieces in the Q2 results. And so, I'm just trying to think about base line operating margins for the three international regions in the context of the cost savings benefits that will kick-in in the back half of the year. So, as it relates to the three international regions, is it reasonable to think that as we step through the back half of the year, that those operating margins for each of those three regions should trend higher sequentially as you move through the back half of the year just given the benefit of the cost reductions?

Yeah. I mean, obviously we expect to continue to have some price pressures in some activities, but we have focused on the cost reductions. And therefore we do expect to see sequential improvement. In some parts of international markets it takes a bit longer to get costs out due especially if it involves people because of some of the labor processes. And so, we'll continue to focus on that but the answer to your question is yes, we do expect to see sequential improvement in the margin as a result of cost savings.

Thanks, Kimberly.

Thank you. And I'm not showing any further questions. I'll now turn the call back over to Mr. Martin for closing remarks.

Thanks, Bridgette. Everybody listen before I sign off I want to leave you with a few key points to sum up what we discussed today. Number one, less than three months ago we made a series of very clear commitments to our stakeholders, including you. And today's update strongly demonstrates that we're making very good progress on every one of them with decisiveness and speed. Two, in the second quarter we made significant progress to both strengthen our competitive position and financial performance in our core full service business and we expect that that momentum to build as customer confidence in the market returns. And three, while we see the market remaining challenging for the rest of this year and for the reasons that we outlined, with our strength and innovation, focus on operational performance and flexibility of our broader go to market's model, unique to Baker Hughes, makes us very well positioned for the opportunities that are available today and when the market around the world begins to recover. So, with that folks I want to thank all of you for joining this morning. And Bridgette, you can now close the call.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program and you may now disconnect. Everyone have a great day.