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CAMERON INTERNATIONAL CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) In addition to the historical data contained herein, this document includes forward-looking statements regarding future market strength, customer spending and order levels, revenues and earnings of the Company, as well as expectations regarding equipment deliveries, margins, profitability, the ability to control and reduce raw material, overhead and operating costs, cash generated from operations, capital expenditures and the use of existing cash balances and future anticipated cash flows made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The Company's actual results may differ materially from those described in any forward-looking statements. Any such statements are based on current expectations of the Company's performance and are subject to a variety of factors, some of which are not under the control of the Company, which can affect the Company's results of operations, liquidity or financial condition. Such factors may include overall demand for, and pricing of, the Company's products; the size and timing of orders; the Company's ability to successfully execute large subsea and drilling projects it has been awarded; the possibility of cancellations of orders in backlog; the Company's ability to convert backlog into revenues on a timely and profitable basis; the impact of acquisitions the Company has made or may make; changes in the price of (and demand for) oil and gas in both domestic and international markets; raw material costs and availability; political and social issues affecting the countries in which the Company does business; fluctuations in currency markets worldwide; and variations in global economic activity. In particular, current and projected oil and gas prices historically have generally directly affected customers' spending levels and their related purchases of the Company's products and services. As a result, changes in oil and gas price expectations may impact the demand for the Company's products and services and the Company's financial results due to changes in cost structure, staffing and spending levels the Company makes in response thereto. See additional factors discussed in "Factors That May Affect Financial Condition and Future Results" contained herein. Because the information herein is based solely on data currently available, it is subject to change as a result of, among other things, changes in conditions over which the Company has no control or influence, and should not therefore be viewed as assurance regarding the Company's future performance. Additionally, the Company is not obligated to make public disclosure of such changes unless required under applicable disclosure rules and regulations. 19-------------------------------------------------------------------------------- Table of Contents THIRD QUARTER 2014 COMPARED TO THIRD QUARTER 2013 Market Conditions Information related to drilling activity and certain commodity spot and futures prices during each quarter and the number of deepwater floaters and semi-submersibles under contract at the end of each period follows: Three Months Ended September 30, Increase (Decrease) 2014 2013 Amount % Drilling activity (average number of working rigs during period)(1): United States 1,903 1,769 134 7.6 % Canada 385 349 36 10.3 % Rest of world 1,348 1,285 63 4.9 % Global average rig count 3,636 3,403 233 6.8 % Commodity prices (average of daily U.S. dollar prices per unit during period)(2): West Texas Intermediate Cushing, OK crude spot price per barrel in U.S. dollars $ 97.60 $ 105.82 $ (8.22 ) (7.8 )% Henry Hub natural gas spot price per MMBtu in U.S. dollars $ 3.93 $ 3.56 $ 0.37 10.4 % Twelve-month futures strip price (U.S. dollar amount at period end)(2): West Texas Intermediate Cushing, OK crude oil contract (per barrel) $ 88.68 $ 97.81 $ (9.13 ) (9.3 )% Henry Hub natural gas contract (per MMBtu) $ 4.01 $ 3.80 $ 0.21 5.5 % Contracted drillships and semi-submersibles by location at period-end(3): U.S. Gulf of Mexico 48 41 7 17.1 % Central and South America 66 81 (15 ) (18.5 )% Northwestern Europe 44 45 (1 ) (2.2 )% West Africa 46 40 6 15.0 % Southeast Asia and Australia 28 24 4 16.7 % Other 51 49 2 4.1 % Total 283 280 3 1.1 % (1) Based on average monthly rig count data from Baker Hughes (2) Source: Bloomberg (3) Source: ODS-Petrodata Ltd. The increase in average worldwide operating rigs during the third quarter of 2014 as compared to the third quarter of 2013 was primarily due to an increase in North American rigs drilling for oil and higher activity levels in the Middle East and Asia Pacific regions. Crude oil prices (West Texas Intermediate, Cushing, OK) trended downward most of the quarter after reaching a high of $107.62 in late July before closing the period at $91.16 per barrel. On average, crude oil prices were almost 8% lower during the third quarter of 2014 as compared to the third quarter of 2013. The twelve month futures price for crude oil at September 30, 2014 was slightly lower than spot prices near the end of the quarter. Oil prices have continued to decline into the low-to-mid $80 range on the New York Mercantile Exchange during the first half of October 2014. This decline, if continuing, could affect exploration and production activity levels and, therefore, demand for the Company's products and services. 20-------------------------------------------------------------------------------- Table of Contents Natural gas (Henry Hub) prices were fairly consistent throughout the third quarter of 2014, averaging $3.93 per MMBtu, which is a 10% increase as compared to the same period in 2013. The 12-month futures strip price for natural gas at September 30, 2014 was $4.01 per MMBtu, which is comparable to the spot price at September 30, 2014. The total number of drillships and semi-submersibles available for contract and under contract were generally consistent with the same period of prior year with some redeployment occurring away from Central and South America to the U.S. Gulf of Mexico and certain other regions of the world. Consolidated Results Consolidated net income for the third quarter of 2014 totaled $238 million, compared to $192 million for the third quarter of 2013. These amounts included $3 million and $14 million, respectively, of net income from discontinued operations for the third quarters of 2014 and 2013. Discontinued operations include the Company's Reciprocating Compression business sold in June 2014 and the Centrifugal Compression business in which the Company entered into a definitive agreement in August 2014 to sell (see Note 2 of the Notes to Consolidated Condensed Financial Statements for further information). Consolidated net income also includes $13 million and $3 million, respectively, of net income attributable to noncontrolling interests for the third quarters of 2014 and 2013. Net income attributable to Cameron stockholders for the third quarter of 2014 totaled $225 million, compared to $189 million for the third quarter of 2013. Earnings from continuing operations per diluted share totaled $1.10 for the third quarter of 2014, compared to $0.72 per diluted share for the third quarter of 2013. Included in the third quarter 2014 results were certain costs, totaling $0.07 per diluted share, primarily associated with: • a loss on disposal of non-core assets, • costs associated with the early retirement of Senior Notes originally due in April 2015, and • severance, restructuring and certain other costs. The results for the third quarter of 2013 included after-tax charges of $0.03 per share, primarily related to the integration of OneSubsea and certain other acquisitions. Absent these costs, diluted earnings from continuing operations per share would have increased approximately 56% in the third quarter of 2014 as compared to the third quarter of 2013. Total revenues for the Company increased $361 million, or 15.6%, during the three months ended September 30, 2014 as compared to the three months ended September 30, 2013. Nearly 94% of the increase was attributable to higher revenues in the Drilling & Production Systems (DPS) segment, reflecting improved performance across each major product line. Revenues in the Valves & Measurement (V&M) segment were up 10% compared to the same period last year, mainly as a result of increased sales of engineered and distributed valves, while PCS segment revenues, excluding discontinued operations, were down nearly 15%. As a percent of revenues, cost of sales (exclusive of depreciation and amortization) increased from 71.2% during the third quarter of 2013 to 71.5% for the third quarter of 2014, mainly as a result of lower product margins in the V&M and PCS segments as described further below under "Segment Results". Selling and administrative expenses decreased $5 million, or 1.5%, during the three months ended September 30, 2014 as compared to the three months ended September 30, 2013. Selling and administrative expenses were 11.9% of revenues for the third quarter of 2014, down from 14.0% for the third quarter of 2013, reflecting the impact of cost control efforts. Depreciation and amortization expense totaled $83 million for the third quarter of 2014 as compared to $79 million during the third quarter of 2013, an increase of $4 million. The increase was due primarily to higher depreciation expense as a result of recent increased levels of capital spending, mainly in the Surface Systems and OneSubsea divisions, partially offset by a nearly $7 million decrease in intangible asset amortization in Drilling Systems. 21-------------------------------------------------------------------------------- Table of Contents Net interest increased $13 million, from $23 million during the third quarter of 2013 to $36 million during the third quarter of 2014, mainly resulting from additional interest associated with (i) $750 million of new senior notes issued by the Company in December 2013, (ii) $500 million of new senior notes issued in June 2014, and (iii) increased interest associated with certain tax contingencies. Other costs totaled $19 million for the three months ended September 30, 2014 as compared to costs of $14 million for the three months ended September 30, 2013. See Note 3 of the Notes to Consolidated Condensed Financial Statements for further information on the nature of these items. The Company's effective tax rate on income from continuing operations for the third quarter of 2014 was 23.0% compared to 21.5% for the third quarter of 2013. The components of the effective tax rates for both periods were as follows (dollars in millions): Three Months Ended September 30, 2014 2013 Tax Provision Tax Rate Tax Provision Tax Rate Forecasted tax expense by jurisdiction $ 66 21.6 % $ 55 24.1 % Adjustments to income tax provision: Finalization of prior year returns 4 1.3 (4 ) (1.8 ) Changes in valuation allowances 3 1.0 - - Accrual adjustments and other (3 ) (0.9 ) (2 ) (0.8 ) Tax provision $ 70 23.0 % $ 49 21.5 % Segment Results DPS Segment - Three Months Ended September 30, Increase (Decrease) ($ in millions) 2014 2013 $ % Revenues $ 1,975 $ 1,637 $ 338 20.6 % Income from continuing operations before income taxes $ 295 $ 216 $ 79 36.6 % Income from continuing operations before income taxes as a percent of revenues 14.9 % 13.2 % N/A 1.7 % Orders $ 1,874 $ 2,205 $ (331 ) (15.0 )% Backlog (at period-end) $ 8,996 $ 9,162 $ (166 ) (1.8 )% Revenues Increased shipments and higher manufacturing activity associated with high beginning-of-the-period backlog levels, as well as higher aftermarket revenues resulting from an increasing base of installed equipment, led to a 36% increase in drilling equipment revenues and a 15% increase in subsea equipment revenues during the third quarter of 2014 as compared to the third quarter of 2013. Also contributing to the improvement in segment revenues was an 8% increase in surface equipment revenues, largely as a result of higher activity levels in the unconventional resource regions of North America. 22-------------------------------------------------------------------------------- Table of Contents Income from continuing operations before income taxes as a percent of revenues The increase in the ratio of income from continuing operations before income taxes as a percent of revenues was primarily due to: • a 0.4 percentage-point decrease in the ratio of cost of sales to revenues resulting mainly from improved margins in the drilling equipment product line, largely related to growth in higher-margin land and jackup BOP activity and aftermarket business, as well as better cost recovery on rig projects, • a 0.4 percentage-point decrease in the ratio of depreciation and amortization expense to revenues due mainly a decline of nearly $7 million in intangible asset amortization expense in Drilling Systems, and • a 1.0 percentage-point decrease in the ratio of selling and administrative expense to revenues as a result of the effects of cost control efforts in relation to the growth in revenues. Orders The decrease in orders was due to: • a 40% decline in subsea equipment orders, largely associated with a third quarter 2013 award, totaling more than $500 million, that was received from Chevron for the Rosebank project in the UK North Sea, with no similar-size large project award received in the third quarter of 2014 as customers continued to evaluate project economics and field layout designs which has had an impact on the timing of new awards, and • a 9% decrease in drilling equipment orders, mainly resulting from a softening in the market for newbuild jackup rigs and floaters. These decreases were partially offset by a 37% increase in surface equipment orders reflecting continued high demand for new equipment, including rental equipment and other aftermarket parts and services, largely as a result of continued strong activity levels in the unconventional resource regions of North America and increased activity in the Middle East, particularly in Saudi Arabia and Oman. Backlog (at period-end) The decline in backlog at September 30, 2014 as compared to September 30, 2013 was due mainly to: • a 7% decrease in drilling equipment backlog largely resulting from (i) the reversal of nearly $243 million in backlog in the first quarter of 2014 as the result of a customer cancellation of a large drilling project award issued in 2012, and (ii) a softening in the market for newbuild jackup rigs and floaters, as well as • a 4% decrease in subsea equipment backlog, due mainly to the slower pace of large new project awards over the course of the first three quarters of 2014. Partially offsetting these declines was a 28% increase in surface equipment backlog due to recent high order rates largely resulting from continued strong activity levels in the unconventional resource regions of North America and increased activity in recent periods in the Middle East, particularly in Saudi Arabia and Oman. 23-------------------------------------------------------------------------------- Table of Contents V&M Segment - Three Months Ended September 30, Increase/(Decrease) ($ in millions) 2014 2013 $ % Revenues $ 552 $ 502 $ 50 10.0 % Income from continuing operations before income taxes $ 103 $ 98 $ 5 5.1 % Income from continuing operations before income taxes as a percent of revenues 18.7 % 19.5 % N/A (0.8 )% Orders $ 529 $ 497 $ 32 6.4 % Backlog (at period-end) $ 954 $ 1,058 $ (104 ) (9.8 )% Revenues Favorable North American market conditions and the impact of businesses acquired in the last twelve months contributed to an increase of 15% in sales of distributed valves. Engineered valve sales increased 18% during the third quarter of 2014 as compared to the third quarter of 2013, due primarily to weak market conditions during the third quarter of 2013 which negatively impacted shipments during that period. Income from continuing operations before income taxes as a percent of revenues Income from continuing operations before income taxes as a percent of revenues decreased primarily due to (i) a 1.6 percentage-point decrease in margins resulting from pricing pressures and the impact of higher costs, primarily for engineered valves, and (ii) a 0.3 percentage-point increase in the ratio of depreciation and amortization expense to revenues due to higher depreciation from recent increased levels of capital spending, mainly in the engineered valve product line, and the impact of businesses acquired during the last twelve months. Offsetting these cost increases was a 1.0 percentage-point decrease in the ratio of selling and administrative expenses to revenues as a result of the effects of cost control efforts in relation to the growth in revenues. Orders Overall, total segment orders increased slightly when compared to the same period last year. Distributed valve orders increased 23% reflecting higher activity levels in North America while certain large orders for metering equipment in the current period led to a 13% increase in demand for measurement products. Partially offsetting these increases was a 13% decline in engineered valve orders due mainly to project timing delays. Backlog (at period-end) Backlog levels for the V&M segment decreased approximately 10% from September 30, 2013, as recent order rates for new engineered and process valves have not kept pace with recent deliveries. These decreases were partially offset by strong demand for distributed valves and measurement products reflecting continued strength in the North American market. 24-------------------------------------------------------------------------------- Table of Contents PCS Segment - Three Months Ended September 30, Increase (Decrease) ($ in millions) 2014(1) 2013(1) $ % Revenues $ 151 $ 178 $ (27 ) (15.2 )% Income from continuing operations before income taxes $ 9 $ 13 $ (4 ) (30.8 )% Income from continuing operations before income taxes as a percent of revenues 6.0 % 7.3 % N/A (1.3 )% Orders $ 178 $ 206 $ (28 ) (13.6 )% Backlog (at period-end) $ 634 $ 499 $ 135 27.1 % (1) Excluding discontinued operations Revenues The revenue decrease in the PCS segment was due primarily to the timing of manufacturing activity on large custom engineered processing equipment projects, particularly in Canada and the Asia Pacific region, and weaker demand from North American customers for midstream processing applications. Income from continuing operations before income taxes as a percent of revenues The decrease in the ratio of income from continuing operations before income taxes as a percent of revenues was due primarily to: • lower product margins of 1.4 percentage-points, mainly due to low volumes and underabsorption of costs in the wellhead and midstream processing product line, and • a 0.9 percentage-point increase in the ratio of depreciation and amortization expense to revenues as a result of higher depreciation and amortization expense during the third quarter of 2014 in relation to lower revenues as compared to the same period last year. Partially offsetting these cost increases was a 1.2 percentage-point decrease in the ratio of selling and administrative expenses to revenues as a result of the effects of cost control efforts. Orders The decrease in segment orders was due mainly to a large award received in the third quarter of 2013 for a CO2 separation system for a floating production storage and offloading (FPSO) vessel to be located offshore Brazil, with no similar-size custom engineered project award received during the third quarter of 2014, partially offset by a large award during the third quarter of 2014 for a new cryogenic gas processing system. Backlog (at period-end) Overall segment backlog was up 27% at September 30, 2014 as compared to September 30, 2013, largely as the result of a $250 million award received in the fourth quarter of 2013 for equipment to be provided for a gas processing facility in Malaysia. 25-------------------------------------------------------------------------------- Table of Contents Corporate Segment - The loss from continuing operations before income taxes in the Corporate segment increased $2 million from $100 million in the third quarter of 2013 to $102 million in the third quarter of 2014. This increase was due largely to: • a $13 million increase in net interest, as described further in "Consolidated Results" above, and • a $5 million increase in other costs, as described further in Note 3 of the Notes to Consolidated Condensed Financial Statements. Mostly offsetting these increases was a $16 million reduction in selling and administrative costs as a result of the effects of cost control efforts. NINE MONTHS ENDED SEPTEMBER 30, 2014 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2013 Market Conditions Information related to drilling activity and certain commodity spot prices during the first nine months of each period follows: Nine Months Ended September 30, Increase 2014 2013 Amount % Drilling activity (average number of working rigs during period)(1): United States 1,845 1,763 82 4.7 % Canada 371 347 24 6.9 % Rest of world 1,344 1,288 56 4.3 % Global average rig count 3,560 3,398 162 4.8 % Commodity prices (average of daily U.S. dollar prices per unit during period)(2): West Texas Intermediate Cushing, OK crude spot price per barrel in U.S. dollars $ 99.77 $ 98.17 $ 1.60 1.6 % Henry Hub natural gas spot price per MMBtu in U.S. dollars $ 4.57 $ 3.70 $ 0.87 23.5 % (1) Based on average monthly rig count data from Baker Hughes (2) Source: Bloomberg The increase in average worldwide operating rigs during the first nine months of 2014 as compared to the first nine months of 2013 was driven primarily by higher North American oil drilling activity and higher activity levels in the Middle East and Asia Pacific regions and in Africa. Despite the improvement in natural gas pricing, the challenging economics associated with horizontal shale development drilling at current prices continues to constrain the overall rig market. The average number of rigs drilling for gas was down slightly in North America in the first nine months of 2014 as compared to the first nine months of 2013. Crude oil prices (West Texas Intermediate, Cushing, OK) were relatively consistent throughout much of the first nine months of 2014 reaching a high of $107.62 per barrel in late July before closing the period at its lowest level since May 2013 of $91.16 per barrel. On average, crude oil prices were relatively flat during the first nine months of 2014 as compared to the first nine months of 2013. Oil prices have continued to decline into the low-to-mid $80 range on the New York Mercantile Exchange during the first half of October 2014. This decline, if continuing, could affect exploration and production activity levels and, therefore, demand for the Company's products and services. 26-------------------------------------------------------------------------------- Table of Contents In early February 2014, natural gas (Henry Hub) prices reached their highest levels since September 2011, before leveling off to close at $4.02 per MMBtu at September 30, 2014. On average, prices during the first nine months of 2014 were up almost 24% as compared to the same period in 2013. Consolidated Results Consolidated net income for the first nine months of 2014 totaled $587 million, compared to $481 million for the first nine months of 2013. These amounts included $31 million and $42 million, respectively, of net income from discontinued operations for the nine months ended September 30, 2014 and 2013. Consolidated net income also includes $29 million and $3 million, respectively, of net income attributable to noncontrolling interests for the first nine months of 2014 and 2013. Net income attributable to Cameron stockholders for the nine months ended September 30, 2014 totaled $558 million, compared to $478 million for the first nine months of 2013. Earnings from continuing operations per diluted share totaled $2.53 for the first nine months of 2014, compared to $1.77 per diluted share for the same period in 2013. Included in the results for the nine months ended September 30, 2014 were charges, net of certain gains, totaling $0.26 per diluted share, primarily associated with: • a goodwill impairment charge related to the PSE business and an impairment of certain intangible assets, • a loss on disposal of non-core assets, • costs associated with the early retirement of Senior Notes originally due in April 2015, • a gain from remeasurement of a prior interest in an equity method investment, and • severance, restructuring, and certain other costs. The results for the first nine months of 2013 included after-tax charges of $0.36 per share, primarily related to formation costs for OneSubsea, including additional income tax expense incurred in connection with the formation, as well as currency devaluation, severance, restructuring and other costs. Absent these costs in both periods, diluted earnings from continuing operations per share would have increased nearly 31% as compared to the first nine months of 2013. Total revenues for the Company increased nearly $1.2 billion, or 18.3%, during the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. Nearly 24% of the increase was attributable to businesses acquired since the beginning of 2013 with the remaining increase reflecting higher revenues in each major product line in the DPS segment. Revenues in the V&M segment were up modestly compared to the same period last year while PCS segment revenues, excluding discontinued operations, were down 18%. As a percent of revenues, cost of sales (exclusive of depreciation and amortization) were 72.0% for the first nine months of 2014 as compared to 71.0% for the first nine months of 2013. The increase was mainly the result of higher costs in relation to revenues in each segment as described further below under "Segment Results". Selling and administrative expenses increased $50 million, or 5.4%, during the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013. This increase was primarily due to higher business activity levels in the DPS segment, along with the impact of additional costs from newly acquired businesses. Selling and administrative expenses were 12.8% of revenues for the first nine months of 2014, down from 14.4% for the same period in 2013, reflecting the impact of cost control efforts in relation to the growth in revenues. 27-------------------------------------------------------------------------------- Table of Contents Depreciation and amortization expense totaled $256 million for the nine months ended September 30, 2014 as compared to $211 million for the nine months ended September 30, 2013, an increase of $45 million. The increase was due mainly to higher depreciation expense as a result of recent increased levels of capital spending, primarily in the DPS segment, and the impact of additional depreciation and acquired intangible amortization expense associated mainly with businesses acquired from Schlumberger in connection with the formation of OneSubsea, partially offset by a $7 million decrease in intangible asset amortization in Drilling Systems. Net interest increased $24 million, from $74 million during the first nine months of 2013 to $98 million during the first nine months of 2014, mainly resulting from additional interest associated with (i) $750 million of new senior notes issued by the Company in December 2013 and (ii) $500 million of new senior notes issued in June 2014. Other costs, net of credits, totaled $62 million for the nine months ended September 30, 2014 as compared to $80 million for the nine months ended September 30, 2013, a decrease of $18 million. See Note 3 of the Notes to Consolidated Condensed Financial Statements for further information on the nature of these items. The effective income tax rate for the first nine months of 2014 was 24.4% as compared to 23.7% for the first nine months of 2013. The components of the effective tax rates for both periods were as follows (dollars in millions): Nine Months Ended September 30, 2014 2013 Tax Provision Tax Rate Tax Provision Tax Rate Forecasted tax expense by jurisdiction $ 167 22.7 % $ 134 23.3 % Adjustments to income tax provision: Tax effect of goodwill impairment 9 1.3 - - Finalization of prior year returns 4 0.5 6 1.0 Tax effects of changes in legislation - - (9 ) (1.6 ) Changes in valuation allowances 3 0.4 5 1.0 Accrual adjustments and other (4 ) (0.5 ) - - Tax provision $ 179 24.4 % $ 136 23.7 % Segment Results DPS Segment - Nine Months Ended September 30, Increase (Decrease) ($ in millions) 2014 2013 $ % Revenues $ 5,583 $ 4,344 $ 1,239 28.5 % Income from continuing operations before income taxes $ 713 $ 566 $ 147 26.0 % Income from continuing operations before income taxes as a percent of revenues 12.8 % 13.0 % N/A (0.2 )% Orders $ 5,323 $ 6,451 $ (1,128 ) (17.5 )% Revenues Businesses acquired since the beginning of 2013 accounted for 21% of the revenue increase for the segment. Absent this impact, increased shipments and higher manufacturing activity associated with high beginning-of-the-year backlog levels, as well as higher aftermarket revenues resulting from an increasing base of installed equipment, led to a 37% increase in drilling equipment revenues and a 19% increase in subsea equipment revenues during the first nine months of 2014 as compared to the first nine months of 2013. 28-------------------------------------------------------------------------------- Table of Contents Also contributing to the improvement in segment revenues was a 10% increase in surface equipment revenues, largely as a result of higher activity levels in the unconventional resource regions of North America as well as increased deliveries to customers operating in the North Sea. Income from continuing operations before income taxes as a percent of revenues The decrease in the ratio of income from continuing operations before income taxes as a percent of revenues was due primarily to a 0.6 percentage-point increase in the ratio of cost of sales to revenues resulting mainly from: • a mix shift to a higher proportion of subsea project revenues, which inherently carry lower margins than surface equipment revenues, and • lower margins in the drilling equipment product line due to higher project costs, as well as higher warranty and inventory obsolescence costs during the first nine months of 2014 as compared to the first nine months of 2013. Mostly offsetting this was a net reduction of 0.4 percentage-points in the combined ratios of depreciation and amortization expense and selling and administrative expenses to revenues, mainly as a result of the effects of cost controls on selling and administrative expenses in relation to the growth in revenues. Orders The decrease in total segment orders was primarily due to a 47% decrease in subsea orders, mainly as a result of certain large project awards received during the first nine months of 2013, with no similar-sized large awards received during the first nine months of 2014, including (i) an award received from Petrobras for subsea trees and associated equipment for use in Pre- and Post-Salt basins offshore Brazil, (ii) a large booking to supply subsea production systems to a project offshore Nigeria, and (iii) an award received from Chevron for the Rosebank project in the UK North Sea. During 2014, customers have continued to evaluate project economics and field layout designs which have had an impact on the timing of new awards. Partially offsetting the decline in subsea orders was: • an 8% increase in orders for surface equipment, primarily related to continued strength in activity levels in the unconventional resource regions in North America, and • a 3% increase in orders for drilling equipment reflecting several large rig project awards received early in 2014 and increased demand for aftermarket parts and services. V&M Segment - Nine Months Ended September 30, Decrease ($ in millions) 2014 2013 $ % Revenues $ 1,580 $ 1,558 $ 22 1.4 % Income from continuing operations before income taxes $ 304 $ 320 $ (16 ) (5.0 )% Income from continuing operations before income taxes as a percent of revenues 19.2 % 20.5 % N/A (1.3 )% Orders $ 1,582 $ 1,560 $ 22 1.4 % Revenues Overall, segment revenues for the nine months ended September 30, 2014 were relatively flat when compared to the same period last year. Sales of distributed valves and measurement products increased 10% and 15%, respectively, mainly as a result of continued strength in the North American market. Largely offsetting these increases were sales declines of 5% and 9% for engineered valves and process valves, respectively, due largely to project slippage, recent order weakness and delayed timing of valve deliveries due to various customer changes. 29-------------------------------------------------------------------------------- Table of Contents Income before income taxes as a percent of revenues The decrease in the ratio of income from continuing operations before income taxes as a percent of revenues was primarily attributable to: • a 0.7 percentage-point increase in the ratio of cost of sales to revenues due mainly to pricing pressures and the impact of higher costs, primarily in engineered and process valves, • a 0.4 percentage-point increase in the ratio of depreciation and amortization expense to revenues due to higher depreciation from recent capital spending, mainly in the engineered valve product line and the impact of businesses acquired during the last twelve months, and • a 0.2 percentage-point increase in the ratio of selling and administrative costs to revenues, due mainly to higher employee-related costs in relation to revenues. Orders Overall, total segment orders were relatively flat when compared to the same period last year. Distributed valve orders increased 19% as a result of higher North American activity levels. This was largely offset by declines of approximately 11% and 15% in both engineered and process valve orders, respectively, due mainly to project slippage and lower new pipeline project activity levels in North America. PCS Segment - Nine Months Ended September 30, Decrease ($ in millions) 2014(1) 2013(1) $ % Revenues $ 414 $ 505 $ (91 ) (18.0 )% Income from continuing operations before income taxes $ 9 $ 18 $ (9 ) (50.0 )% Income from continuing operations before income taxes as a percent of revenues 2.2 % 3.6 % N/A (1.4 )% Orders $ 465 $ 533 $ (68 ) (12.8 )% (1) Excluding discontinued operations Revenues The revenue decrease in the PCS segment was due primarily to the timing of manufacturing activity on large international custom engineered processing equipment projects and weaker demand from North American customers for wellhead and midstream processing applications. 30-------------------------------------------------------------------------------- Table of Contents Income from continuing operations before income taxes as a percent of revenues The decrease in the ratio of income from continuing operations before income taxes as a percent of revenues was due primarily to: • a 1.7 percentage-point increase in the ratio of cost of sales to revenues resulting mainly from lower margins in the wellhead and midstream processing product line due mainly to low volumes and underabsorption of costs, and • a 1.2 percentage-point increase in the ratio of depreciation and amortization expense to revenues as a result of higher depreciation and amortization expense during the first nine months of 2014 in relation to lower revenues as compared to the same period last year. This was partially offset by a decrease of 1.6 percentage-points in the ratio of selling and administrative expenses to revenues as a result of cost reduction programs and cost control efforts, including the shutting down of certain facilities during the last twelve months. Orders The decrease in segment orders was due mainly to a large award received in the first nine months of 2013 for a CO2 separation system for a floating production storage and offloading (FPSO) vessel to be located offshore Brazil, with no similar-size custom engineered project award received during the first nine months of 2014. Corporate Segment - The loss from continuing operations before income taxes in the Corporate segment decreased $38 million from $329 million in the first nine months of 2013 to $291 million in the first nine months of 2014. This decrease was due largely to: • a combined $48 million decline in depreciation and amortization expense and in selling and administrative expenses, mainly reflecting the effects of cost control efforts which have lowered employee-related costs, including travel, information technology and other facility costs, and • an $18 million decrease in other costs, as described further in Note 3 of the Notes to Consolidated Condensed Financial Statements. Partially offsetting these reductions was a $24 million increase in net interest, as described further in "Consolidated Results" above. Liquidity and Capital Resources Consolidated Condensed Statements of Cash Flows During the first nine months of 2014, net cash provided by operations totaled $255 million, an increase of $49 million from the $206 million of cash provided by operations during the first nine months of 2013. The 2014 amount was negatively impacted by approximately $95 million of tax payments made during the third quarter associated with the pre-tax gain recognized on the sale of the Reciprocating Compression business. Cash totaling $532 million was used for working capital during the first nine months of 2014 compared to $464 million during the first nine months of 2013, an increase of $68 million. During the first nine months of 2014, approximately $283 million of cash was used to build inventory levels, primarily in the DPS segment, in order to meet the demands from the high backlog and activity levels in that business segment. The timing of payments to third parties and annual employee incentive payouts, as well as lower advances received from customers, during the first nine months of 2014 also contributed to a use of cash totaling $291 million for the period. Cash provided by investing activities was $218 million for the first nine months of 2014. In June 2014, the Company received $547 million of cash, net of transaction costs, from the sale of the Reciprocating Compression business to General Electric. Additionally, capital spending during the first nine months of 2014 totaled $259 million. Capital needs in the Surface Systems and OneSubsea divisions of the DPS segment, along with continued development of the Company's enhanced business information systems, accounted for almost three-quarters of the 2014 capital spending. 31-------------------------------------------------------------------------------- Table of Contents Net cash used for financing activities totaled approximately $1.2 billion for the first nine months of 2014. Approximately $1.6 billion of cash was used to acquire nearly 25 million shares of treasury stock during the first nine months of 2014. In 2014, the Board of Directors authorized the Company to initiate a commercial paper program with authority to issue up to $500 million in short-term debt. Under this program, the Company issued commercial paper totaling $350 million in principal amount for use in funding the treasury stock purchases referred to above and for other corporate needs. The average term of the outstanding commercial paper as of September 30, 2014 was approximately 26 days. The Company currently anticipates being able to continue to issue new commercial paper to fund or extend outstanding commercial paper as it comes due for payment. During June 2014, the Company repaid $250 million of floating rate notes upon maturity and issued a total of $500 million of new senior notes split equally between 3- and 10-year maturities. Additionally, the Company in July 2014, spent $253 million, which included a make-whole premium plus accrued interest, to redeem early $250 million principal amount of 1.6% Senior Notes. Also, in July 2014, OneSubsea paid a dividend of €75 million with Cameron's non-U.S. partnership receiving €45 million and Schlumberger receiving €30 million (approximately $40 million). Future liquidity requirements At September 30, 2014, the Company had nearly $1.2 billion of cash, cash equivalents and short-term investments. Approximately $479 million of the Company's cash, cash equivalents and short-term investments at September 30, 2014 were in the OneSubsea venture. Dividends of available cash from OneSubsea to the venture partners, 40% of which would go to Schlumberger, require approval of the OneSubsea Board of Directors prior to payment. Of the remaining cash, cash equivalents and short-term investments not held by OneSubsea, $184 million was located in the United States. Total debt at September 30, 2014 was nearly $3.2 billion, most of which was in the United States. Excluding capital leases, approximately $890 million of the debt obligations have maturities within the next three-year period. The remainder of the Company's long-term debt is due in varying amounts between 2018 and 2043. Excluding discontinued operations, the Company's backlog decreased approximately 4% from December 31, 2013, mainly due to the cancellation of a large drilling project award in the first quarter of 2014 totaling nearly $243 million, as well as weakness in current year-to-date order rates. Orders during the first nine months of 2014 were down nearly 14% from the same period in 2013 due mainly to certain large subsea project awards received in the first nine months of 2013 that did not repeat during the first nine months of 2014. The timing of such large project awards are inconsistent period-over-period. The Company views its backlog of unfilled orders, current order rates, current rig count levels and current and future expected oil and gas prices to be, in varying degrees, leading indicators of and factors in determining its estimates of future revenues, cash flows and profitability levels. Information regarding actual 2014 and 2013 average rig count and commodity price levels and forward-looking twelve-month market-traded futures prices for crude oil and natural gas are shown in more detail under the captions "Market Conditions" above. A more detailed discussion of third quarter and year-to-date orders and September 30 backlog levels by segment may be found under "Segment Results" for each period above. The Company also expects full year capital spending on new equipment and facilities to be approximately $425 million for 2014, down from $520 million during 2013. The Company believes, based on its current financial condition, existing backlog levels, which are still at historically high levels, and current expectations for future market conditions, that it will be able to meet its short- and longer-term liquidity needs with existing cash, cash equivalents and short-term investments on hand, expected cash flow from future operating activities and amounts available for borrowing under its $835 million five-year multi-currency Revolving Credit Facility, which matures on June 6, 2016, and its new three-year $750 million Revolving Credit Facility, described further in Note 8 of the Notes to Consolidated Condensed Financial Statements. Up to $200 million of this new facility may be used for letters of credit. The Company also has a bi-lateral $40 million facility with a third-party bank, expiring on February 2, 2015. At September 30, 2014, no amounts had been borrowed under the $835 million facility. The Company had issued letters of credit totaling $72 million under the new $750 million Revolving Credit Facility and $25 million under the $40 million bi-lateral facility, leaving $678 million and $15 million, respectively, available for future use. The Company also believes, based on its existing current credit standing, that it will be able to continue to refinance existing debt upon maturity, if desired. 32-------------------------------------------------------------------------------- Table of Contents The Company has an authorized stock repurchase program whereby the Company may purchase shares directly or indirectly by way of open market transactions or structured programs, including the use of derivatives, for the Company's own account or through commercial banks or financial institutions. The program, initiated in October 2011, has had a series of authorizations by the Board of Directors totaling $3.8 billion since inception. At September 30, 2014, the Company had remaining authority for future stock purchases totaling approximately $665 million. Critical Accounting Policies Goodwill - During the first quarter of each annual period, the Company reviews the carrying value of goodwill in accordance with accounting rules on impairment of goodwill, which require that the Company estimate the fair value of each of its reporting units annually, or when impairment indicators exist, and compare such amounts to their respective carrying values to determine if an impairment of goodwill is required. The estimated fair value of each reporting unit is determined using discounted future expected cash flow models (level 3 unobservable inputs) consistent with the accounting guidance for fair value measurements. Certain estimates and judgments are required in the application of the discounted cash flow models, including, but not limited to, estimates of future cash flows and the selection of a discount rate. As described further in Note 2 of the Notes to Consolidated Condensed Financial Statements, effective June 1, 2014, the Company completed the previously announced sale of its Reciprocating Compression business, a division of the Process and Compression Systems (PCS) segment, to General Electric for cash consideration of approximately $547 million, net of transaction costs. Reciprocating Compression had previously been included with the Process Systems and Equipment (PSE) business in the Process Systems & Reciprocating Compression reporting unit for goodwill impairment evaluation purposes. As a result of the classification of Reciprocating Compression as a discontinued operation in the first quarter of 2014 when a definitive agreement to sell the business was entered into, total reporting unit goodwill was allocated between the two businesses. Following this, the PSE business was evaluated as a separate reporting unit in connection with the Company's annual goodwill impairment review conducted during the first quarter of 2014. As a result of this review, the PSE goodwill amount, totaling approximately $40 million, was fully impaired at that time. Factors That May Affect Financial Condition and Future Results Downturns in the oil and gas industry have had, and will likely in the future have, a negative effect on the Company's sales and profitability. Demand for most of the Company's products and services, and therefore its revenue, depends to a large extent upon the level of capital expenditures related to oil and gas exploration, development, production, processing and transmission. Declines, as well as anticipated declines, in oil and gas prices could negatively affect the level of these activities, or could result in the cancellation, modification or rescheduling of existing orders. As examples, oil prices began declining during the third quarter of 2014 and have continued to decline into the low-to-mid $80 range on the New York Mercantile Exchange during the first half of October 2014. This decline, if continuing, could affect exploration and production activity levels and, therefore, demand for the Company's products and services. Additionally, natural gas spot prices in the United States declined during the first half of 2012 to less than $2 per MMBtu, the lowest level in the last decade. Although natural gas prices have subsequently increased, current rig count levels associated with dry gas extraction activities have not fully recovered to previous levels. This price decline negatively impacted 2012 order levels by certain of the Company's customers which affected the Company's 2012 and 2013 revenues and profitability. See also the discussion in "Market Conditions" above. 33-------------------------------------------------------------------------------- Table of Contents The inability of the Company to deliver its backlog or future orders on time could affect the Company's future sales and profitability and its relationships with its customers. At September 30, 2014, the Company's backlog was approximately $10.6 billion, excluding discontinued operations. The ability to meet customer delivery schedules for this backlog, as well as future orders, is dependent on a number of factors including, but not limited to, access to the raw materials required for production, an adequately trained and capable workforce, project engineering expertise for large subsea projects, sufficient manufacturing plant capacity and appropriate planning and scheduling of manufacturing resources. Many of the contracts the Company enters into with its customers require long manufacturing lead times and contain penalty clauses relating to on-time delivery. A failure by the Company to deliver in accordance with customer expectations could subject the Company to financial penalties or loss of financial incentives and may result in damage to existing customer relationships. Additionally, the Company bases its earnings guidance to the financial markets on expectations regarding future order rates and the timing of delivery of product currently in backlog. Failure to deliver equipment in accordance with expectations could negatively impact the market price performance of the Company's common stock and other publicly-traded financial instruments. Expansion of the Company's offerings in the drilling market creates additional risks not previously present. The Company's acquisitions of LeTourneau Technologies Drilling Systems, Inc. and the TTS Energy Division of TTS Group ASA (TTS) expanded the Company's portfolio of products and services available to customers involved in oil and gas drilling activities. These acquisitions brought large drilling rig construction projects not previously offered and a record backlog at that time. As a result of both, the complexity of execution within this business has increased from that of the past. Also, the Company had previously struggled to increase production capacity to deliver this backlog. Large drilling rig projects are accounted for using accounting rules for production-type and construction-type contracts. In accordance with this guidance, the Company estimates the expected margin on these projects and recognizes this margin as units are completed. These projects (i) require significantly more engineering and project management expertise than are needed for projects involving the supply of drilling stacks and associated equipment to customers, (ii) are larger in financial scope and (iii) require longer lead times than many other projects involving the Company's Drilling Systems business. Additionally, unplanned difficulties in engineering and managing the construction of such major projects could result in cost overruns and financial penalties which could negatively impact the Company's margins and cash flow. Similar to subsea systems projects described below, a reduction in expected margins on these projects from such unplanned events would result in a cumulative adjustment to reduce margins previously recognized in the period a change in estimate is determined. Execution of subsea systems projects exposes the Company to risks not present in its other businesses. Cameron, through OneSubsea, is a significant participant in the subsea systems projects market. This market is different from most of the Company's other markets since subsea systems projects are larger in scope and complexity, in terms of both technical and logistical requirements. Subsea projects typically (i) involve long lead times, (ii) are larger in financial scope, (iii) require substantial engineering resources to meet the technical requirements of the project and (iv) often involve the application of existing technology to new environments and, in some cases, may require the development of new technology. The Company's OneSubsea business has a backlog of approximately $3.2 billion for subsea systems projects at September 30, 2014. To the extent the Company experiences unplanned difficulties in meeting the technical and/or delivery requirements of the projects, the Company's earnings or liquidity could be negatively impacted. The Company accounts for its subsea projects, as it does its separation and drilling projects, using accounting rules for construction-type and production type contracts. Factors that may affect future project costs and margins include the ability to properly execute the engineering and design phases consistent with our customers' expectations, production efficiencies obtained, and the availability and costs of labor, materials and subcomponents. These factors can impact the accuracy of the Company's estimates and materially impact the Company's future period earnings. If the Company experiences cost overruns, the expected margin could decline. Were this to occur, in accordance with the accounting guidance, the Company would record a cumulative adjustment to reduce the margin previously recorded on the related project in the period a change in estimate is determined. Subsea systems projects accounted for approximately 5.7% of total revenues in the first nine months of 2014. 34-------------------------------------------------------------------------------- Table of Contents As a designer, manufacturer, installer and servicer of oil and gas pressure control equipment, the Company may be subject to liability, personal injury, property damage and environmental contamination should such equipment fail to perform to specifications. Cameron provides products and systems to customers involved in oil and gas exploration, development and production, as well as in certain other industrial markets. Some of the Company's equipment is designed to operate in high-temperature and/or high-pressure environments on land, on offshore platforms and on the seabed and some equipment is designed for use in hydraulic fracturing operations. Cameron also provides aftermarket parts and repair services at numerous facilities located around the world or at customer sites for this and other equipment. Because of applications to which the Company's products and services are put, particularly those involving the high temperature and/or pressure environments, a failure of such equipment, or a failure of our customer to maintain or operate the equipment properly, could cause damage to the equipment, damage to the property of customers and others, personal injury and environmental contamination, onshore or offshore, leading to claims against Cameron. The implementation of an upgraded business information system may disrupt the Company's operations or its system of internal controls. The Company has a project underway to upgrade its SAP business information systems worldwide. The first stage of this multi-year effort was completed at the beginning of the third quarter of 2011 with the deployment of the upgraded system for certain businesses within the Company's PCS segment. Since then, other businesses and business functions have been migrated in stages. Effective October 1, 2014, nearly all businesses within the V&M segment, the Surface Systems division, the Company's worldwide engineering and human resource functions, as well as other corporate office activities are now operating in the upgraded system. The Drilling Systems division is scheduled to be migrated in 2015 and OneSubsea in 2016. The Drilling Systems division and OneSubsea are major contributors to the Company's consolidated revenues and income before income taxes. As this system continues to be deployed throughout the Company, delays or difficulties may be encountered in effectively and efficiently processing transactions and conducting business operations until such time as personnel are familiar with all appropriate aspects and capabilities of the upgraded systems. The Company's operations and information systems are subject to cybersecurity risks. Cameron continues to increase its dependence on digital technologies to conduct its operations. Many of the Company's files are digitized and more employees are working in almost paperless environments. Additionally, the hardware, network and software environments to operate SAP, the Company's main enterprise-wide operating system, have been outsourced to third parties. Other key software products used by the Company to conduct its operations either reside on servers in remote locations or are operated by the software vendors or other third parties for the Company's use as "Cloud-based" or "Web-based" applications. The Company has also outsourced certain information technology development, maintenance and support functions. As a result, the Company is exposed to potentially severe cyber incidents at both its internal locations and outside vendor locations that could result in a theft of intellectual property and/or disruption of its operations for an extended period of time resulting in the loss of critical data and in higher costs to correct and remedy the effects of such incidents, although no such material incidents have occurred to date to the Company's knowledge. Fluctuations in currency markets can impact the Company's profitability. The Company has established multiple "Centers of Excellence" facilities for manufacturing such products as subsea trees, subsea chokes, subsea production controls and blowout preventers. These production facilities are located in the United Kingdom, Brazil, Romania, Italy, Norway and other European and Asian countries. To the extent the Company sells these products in U.S. dollars, the Company's profitability is eroded when the U.S. dollar weakens against the British pound, the euro, the Brazilian real and certain Asian currencies, including the Singapore dollar. Alternatively, profitability is enhanced when the U.S. dollar strengthens against these same currencies. For further information on the use of derivatives to mitigate certain currency exposures, see Item 3, "Quantitative and Qualitative Disclosures about Market Risk" below and Note 14 of the Notes to Consolidated Condensed Financial Statements. 35-------------------------------------------------------------------------------- Table of Contents The Company's operations expose it to risks of non-compliance with numerous countries' import and export laws and regulations, and with various nations' trade regulations including U.S. sanctions. The Company's operations expose it to trade and import and export regulations in multiple jurisdictions. In addition to using "Centers of Excellence" for manufacturing products to be delivered around the world, the Company imports raw materials, semi-finished goods and finished products into many countries for use in country or for manufacturing and/or finishing for re-export and import into another country for use or further integration into equipment or systems. Most movement of raw materials, semi-finished or finished products by the Company involves exports and imports. As a result, compliance with multiple trade sanctions and embargoes and import and export laws and regulations poses a constant challenge and risk to the Company. The Company has received a number of inquiries from U.S. governmental agencies, including the U.S. Securities and Exchange Commission and the Office of Foreign Assets Control, regarding compliance with U.S. trade sanction and export control laws, the most recent of which was received in December 2012 and replied to by the Company in January 2013. The Company has undergone and will likely continue to undergo governmental audits to determine compliance with export and customs laws and regulations. The United States and the European Union (EU) also recently imposed sanctions on various sectors of the Russian economy and on transactions with certain Russian nationals and entities. These sanctions may severely limit the amount of future business the Company does with customers involved in activities in Russia. As of September 30, 2014, approximately 1% of the Company's backlog from continuing operations related to future deliveries to customers doing business in Russia. For the nine months ended September 30, 2014, customer sales by the Company's continuing operations into Russia totaled less than 1% of the Company's sales during that period. In addition, the sanctions of the U.S. and the EU are inconsistent and neither is, as yet, well defined, both of which factors increase the risk of an unintended violation. The Company's operations expose it to political and economic risks and instability due to changes in economic conditions, civil unrest, foreign currency fluctuations, and other risks, such as local content requirements, inherent to international businesses. The political and economic risks of doing business on a worldwide basis include the following: • volatility in general economic, social and political conditions; • the effects of civil unrest and, in some cases, military action on the Company's business operations, customers and employees, such as that recently occurring in several countries in the Middle East, in Ukraine and in Venezuela; • exchange controls or other similar measures which result in restrictions on repatriation of capital and/or income, such as those involving the currencies of, and the Company's operations in, Angola and Nigeria; and • reductions in the number or capacity of qualified personnel. In recent months, civil unrest and military action have increased in Iraq which may impact the ability of that country to continue to produce and export oil at current levels. Such unrest may also jeopardize the Company's in-country investments and on-going business activities supporting Iraq's oil and gas production infrastructure. At September 30, 2014, less than 1% of the Company's backlog related to future deliveries to customers doing business in Iraq. Additionally, less than 1% of the Company's property, plant and equipment were located in Iraq. The Company is also evaluating its options under the force majeure clauses of each of the major contracts with its customers doing business in Iraq in the event the current situation in that country continues to deteriorate. Cameron also has manufacturing and service operations that are essential parts of its business in other developing countries and volatile areas in Africa, Latin America and other countries that were part of the Former Soviet Union, the Middle East, and Central and South East Asia. Recent increases in activity levels in certain of these regions have increased the Company's risk of identifying and hiring sufficient numbers of qualified personnel to meet increased customer demand in selected locations. The Company also purchases a large portion of its raw materials and components from a relatively small number of foreign suppliers in China, India and other developing countries. The ability of these suppliers to meet the Company's demand could be adversely affected by the factors described above. 36-------------------------------------------------------------------------------- Table of Contents In addition, customers in countries such as Angola and Nigeria increasingly are requiring the Company to accept payments in the local currencies of these countries. These currencies do not currently trade actively in the world's foreign exchange markets. The Company also has various manufacturing and aftermarket operations in Venezuela that contributed $54 million in revenues during the first nine months of 2014. The economy in Venezuela is highly inflationary. As a result, the Company's operations in Venezuela are accounted for as U.S. dollar functional currency entities and the Company considers its earnings in Venezuela to be permanently reinvested. Since the 2013 devaluation of the Venezuelan bolivar, the Company has used the official rate of 6.3 bolivars to the U.S. dollar to remeasure non-functional currency transactions in its financial statements. During 2014, the Venezuelan government began using other auction rates (SICAD rates) for activities involving the exchange of bolivars and dollars. At September 30, 2014, the published SICAD I rate was 12.0 bolivars to the U.S. dollar and the published SICAD II rate was approximately 49.99 bolivars to the U.S. dollar. The Company does not currently expect a material loss or a material decline in operating cash flows to occur should these expanded auction rates result in a change in the payment practices of its primary customer or in a further devaluation of the Venezuelan currency. These factors however, along with recent civil unrest, create political and economic uncertainty with regard to their impact on the Company's continued operations in this country. Increasingly, some of the Company's customers, particularly the national oil companies, have required a certain percentage, or an increased percentage, of local content in the products they buy directly or indirectly from the Company. This requires the Company to add to or expand manufacturing capabilities in certain countries that are presently without the necessary infrastructure or human resources in place to conduct business in a manner as typically done by Cameron. This increases the risk of untimely deliveries, cost overruns and defective products. The Company's operations expose it to risks resulting from differing and/or increasing tax rates. Economic conditions around the world have resulted in decreased tax revenues for many governments, which have led and could continue to lead to changes in tax laws in countries where the Company does business, including further changes in the United States. Changes in tax laws could have a negative impact on the Company's future results. The Company's operations require it to deal with a variety of cultures, as well as agents and other intermediaries, exposing it to anti-corruption compliance risks. Doing business on a worldwide basis necessarily involves exposing the Company and its operations to risks inherent in complying with the laws and regulations of a number of different nations. These laws and regulations include various anti-bribery and anti-corruption laws. The Company does business and has operations in a number of developing countries that have relatively underdeveloped legal and regulatory systems compared to more developed countries. Several of these countries are generally perceived as presenting a higher than normal risk of corruption, or as having a culture in which requests for improper payments are not discouraged. Maintaining and administering an effective anti-bribery compliance program under the U.S. Foreign Corrupt Practices Act (FCPA), the United Kingdom's Bribery Act of 2010, and similar statutes of other nations, in these environments presents greater challenges to the Company than is the case in other, more developed countries. Additionally, the Company's business involves the use of agents and other intermediaries, such as customs clearance brokers, in these countries as well as others. As a result, the risk to the Company of compliance violations is increased because actions taken by any of them when attempting to conduct business on our behalf could be imputed to us by law enforcement authorities. The Company is subject to environmental, health and safety laws and regulations that expose the Company to potential liability and proposed new regulations that would restrict activities to which the Company currently provides equipment and services. The Company's operations are subject to a variety of national and state, provincial and local laws and regulations, including laws and regulations relating to the protection of the environment. The Company is required to invest financial and managerial resources to comply with these laws and expects to continue to do so in the future. To date, the cost of complying with governmental regulation has not been material, but the fact that such laws or regulations are frequently changed makes it impossible for the Company to predict the cost or impact of such laws and regulations on the Company's future operations. The modification of existing laws or regulations or the adoption of new laws or regulations imposing more stringent environmental restrictions could adversely affect the Company. 37-------------------------------------------------------------------------------- Table of Contents The Company provides equipment and services to companies employing hydraulic fracturing or "fracking" and could be adversely impacted by additional regulations of this enhanced recovery technique. Environmental concerns have been raised regarding the potential impact on underground water supplies of hydraulic fracturing which involves the pumping of water and certain chemicals under pressure into a well to break apart shale and other rock formations in order to increase the flow of oil and gas embedded in these formations. Recently, a number of U.S. states have proposed regulations regarding disclosure of chemicals used in fracking operations or have temporarily suspended issuance of permits for such operations. Additionally, the United States Environmental Protection Agency (EPA) issued rules, which become effective in January 2015, that are designed to limit the release of volatile organic compounds, or pollutants, from natural gas wells that are hydraulically fractured. The EPA has published draft permitting guidance for oil and gas hydraulic fracturing activities using diesel fuels and is continuing to study whether the fracking process has any negative impact on underground water supplies. A draft of the final report on the results of the study is expected in 2014. Should these regulations, or additional regulations, restrict or curtail hydraulic fracturing activities, the Company's revenues and earnings could be negatively impacted. Enacted and proposed climate protection regulations and legislation may impact the Company's operations or those of its customers. The EPA has made a finding under the United States Clean Air Act that greenhouse gas emissions endanger public health and welfare and the EPA has enacted regulations requiring monitoring and reporting by certain facilities and companies of greenhouse gas emissions. In June 2014, the U.S. Supreme Court prohibited the EPA from being able to require limits on carbon dioxide and other heat trapping gases from sources that would otherwise not need an air pollution permit. Also, in June 2014, the EPA, acting under President Obama's Climate Action Plan, proposed its Clean Power Plan, which would set U.S. state-by-state guidelines for power plants to meet by 2030 to cut their carbon emissions by 30% nationwide from 2005 levels. The guidelines are also intended to cut pollution, nitrogen oxides and sulfur dioxide by more than 25% during the same period. Under the Clean Power Plan, states are to develop plans to meet state-specific goals to reduce carbon pollution and submit those plans to the EPA by June 2016, with a later deadline provided under certain circumstances. While these proposed rules may hasten the switch from coal to cleaner burning fuels such as natural gas, the overall long-term economic impact of the plan is uncertain at this point. Carbon emission reporting and reduction programs have also expanded in recent years at the state, regional and national levels with certain countries having already implemented various types of cap-and-trade programs aimed at reducing carbon emissions from companies that currently emit greenhouse gases. To the extent the Company's customers are subject to these or other similar proposed or newly enacted laws and regulations, the Company is exposed to risks that the additional costs by customers to comply with such laws and regulations could impact their ability or desire to continue to operate at current or anticipated levels in certain jurisdictions, which could negatively impact their demand for the Company's products and services. To the extent Cameron becomes subject to any of these or other similar proposed or newly enacted laws and regulations, the Company expects that its efforts to monitor, report and comply with such laws and regulations, and any related taxes imposed on companies by such programs, will increase the Company's cost of doing business in certain jurisdictions, including the United States, and may require expenditures on a number of its facilities and possibly on modifications of certain of its products. The Company could also be impacted by new laws and regulations establishing cap-and-trade and those that might favor the increased use of non-fossil fuels, including nuclear, wind, solar and bio-fuels or that are designed to increase energy efficiency. If the proposed or newly executed laws have the effect of dampening demand for oil and gas production, they could lower spending by customers for the Company's products and services. 38-------------------------------------------------------------------------------- Table of Contents Environmental Remediation The Company's worldwide operations are subject to domestic and international regulations with regard to air, soil and water quality as well as other environmental matters. The Company, through its environmental management system and active third-party audit program, believes it is in substantial compliance with these regulations. The Company is heir to a number of older manufacturing plants that conducted operations in accordance with the standards of the time, but which have since changed. The Company has undertaken clean-up efforts at these sites and now conducts its business in accordance with today's standards. The Company's clean-up efforts have yielded limited releases of liability from regulators in some instances, and have allowed sites with no current operations to be sold. The Company conducts environmental due diligence prior to all new site acquisitions. For further information, refer to Note 13 of the Notes to Consolidated Condensed Financial Statements. Environmental Sustainability The Company has pursued environmental sustainability in a number of ways. Processes are monitored in an attempt to produce the least amount of waste. All of the waste disposal firms used by the Company are carefully selected in an attempt to prevent any future Superfund involvements. Actions are taken in an attempt to minimize the generation of hazardous wastes and to minimize air emissions. Recycling of process water is a common practice. Best management practices are used in an effort to prevent contamination of soil and ground water on the Company's sites. Cameron has implemented a corporate "HSE Management System" based on the principles of ISO 14001 and OHSAS 18001. The HSE Management System contains a set of corporate standards that are required to be implemented and verified by each business unit. Cameron has also implemented a corporate regulatory compliance audit program to verify facility compliance with environmental, health and safety laws and regulations. The compliance program employs or uses independent third-party auditors to audit facilities on a regular basis specific to country, region, and local legal requirements. Audit reports are circulated to the senior management of the Company and to the appropriate business unit. The compliance program requires corrective and preventative actions be taken by a facility to remedy all findings of non-compliance which are tracked on the corporate HSE data base. |