UNITED STATES 
SECURITIES AND EXCHANGE COMMISSION 
Washington, D.C. 20549
 
FORM 8-K
 
CURRENT REPORT 
Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934
 
Date of Report (Date of earliest event reported): December 4, 2017
 
BAKER HUGHES, A GE COMPANY
BAKER HUGHES, A GE COMPANY, LLC

(Exact name of registrant as specified in its charter)
 
Delaware
1-38143
81-4403168
Delaware
1-09397
76-0207995
(State of Incorporation)
(Commission File No.)
(I.R.S. Employer
Identification No.)
(State of Incorporation)
(Commission File No.)
(I.R.S. Employer
Identification No.)
 
17021 Aldine Westfield Road
Houston, Texas 77073
  
Registrant’s telephone number, including area code: (713) 439-8600
 
(former name or former address, if changed since last report)
 
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:
 
 
Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)
 
Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)
 
Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))
 
Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))
 
Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 (§230.405 of this chapter) or Rule 12b-2 of the Securities Exchange Act of 1934 (§240.12b-2 of this chapter).
 
Emerging growth company
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
 

 

Item 7.01. Regulation FD Disclosure

On December 4, 2017, Baker Hughes, a GE company, LLC, a Delaware limited liability company (the “Company,” “we” or “our”) distributed a confidential preliminary offering memorandum relating to a proposed offering of new senior notes to be offered and sold only to persons reasonably believed to be qualified institutional buyers pursuant to Rule 144A under the U.S. Securities Act of 1933, as amended (the “Securities Act”), and to certain non-U.S. persons pursuant to Regulation S under the Securities Act.  The new senior notes will not be registered under the Securities Act, or the securities laws of any state or other jurisdiction, and, unless so registered, may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements of the Securities Act and applicable state securities laws.

This Current Report on Form 8-K (“Current Report”) does not constitute an offer to sell or the solicitation of an offer to buy any securities and shall not constitute an offer, solicitation or sale in any state or jurisdiction in which, or to any person to whom, such offer, solicitation or sale is unlawful.

As provided in General Instruction B.2 of Form 8-K, the information in this Item 7.01 shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, nor shall they be deemed to be incorporated by reference in any filing under the Securities Act of 1933, as amended, except as shall be expressly set forth by specific reference in such a filing.

Item 8.01. Other Events

On July 3, 2017, we closed our previously announced business combination (the “Transactions”) to combine the oil and gas business (“GE O&G”) of General Electric Company (“GE”) and Baker Hughes Incorporated (“BHI”), creating a fullstream oilfield technology provider that has a unique mix of integrated oilfield products, services and digital solutions.  In connection with the Transactions, we entered into and are governed by an Amended & Restated Operating Agreement, dated as of July 3, 2017 (the “Agreement”).  Under the Agreement, EHHC Newco, LLC (“EHHC”), a wholly owned subsidiary of Baker Hughes, a GE company (“BHGE”), is our sole managing member and BHGE is the sole managing member of EHHC and the holding company of the combined businesses.  The Transactions were executed using a partnership structure, pursuant to which GE O&G and BHI each contributed their operating assets to the Company.  GE holds an approximate 62.5% controlling interest in us and former BHI shareholders hold an approximate 37.5% interest through the ownership of 100% of the Class A Common Stock of BHGE.  GE’s interest is held through a voting interest of Class B Common Stock in BHGE and its economic interest through a corresponding number of our Common Units.  The Transactions were treated as a “reverse acquisition” for accounting purposes and, as such, the historical financial statements of the accounting acquirer, GE O&G, are the historical financial statements of the Company.

Following the Transactions, we revised our segment structure and began to manage and report our operating results through four operating segments as defined below.

·
Oilfield Services:  Oilfield Services provides equipment and services ranging from well evaluation to decommissioning.  Products and services include diamond and tri-cone drill bits, drilling services (including directional drilling technology, measurement while drilling & logging while drilling), downhole completion tools and systems, wellbore intervention tools and services, wireline services, drilling and completions fluids, oilfield and industrial chemicals, pressure pumping, and artificial lift technologies (including electrical submersible pumps).
 
·
Oilfield Equipment:  Oilfield Equipment provides a broad portfolio of products and services required to facilitate the safe and reliable flow of hydrocarbons from the subsea wellhead to the surface.  Products and services include pressure control equipment and services, subsea production systems and services, drilling equipment, and flexible pipeline systems.  Oilfield Equipment operation designs and manufactures onshore and offshore drilling and production systems and equipment for floating production platforms and provides a full range of services related to onshore and offshore drilling activities.
 
·
Turbomachinery & Process Solutions:  Turbomachinery & Process Solutions provides equipment and related services for mechanical-drive, compression and power-generation applications across the oil and gas industry as well as products and services to serve the downstream segments of the industry including refining, petrochemical, distributed gas, flow and process control and other industrial applications.  The Turbomachinery & Process Solutions portfolio includes drivers (aeroderivative gas turbines, heavy-duty gas turbines and synchronous and induction electric motors), compressors (centrifugal and axial, direct drive high speed, integrated, subsea compressors, turbo expanders and reciprocating), turn-key solutions (industrial modules and waste heat recovery), pumps, valves, and compressed natural gas (CNG) and small-scale liquefied natural gas (LNG) solutions used primarily for shale oil and gas field development.
 

 
·
Digital Solutions:  Digital Solutions provides equipment and services for a wide range of industries, including oil & gas, power generation, aerospace, metals, and transportation.  The offerings include sensor-based measurement, nondestructive testing and inspection, turbine, generator and plant controls and condition monitoring, as well as pipeline integrity solutions.
 
In addition, following the Transactions, we changed the presentation of the statement of income (loss) and statement of cash flows in our financial statements as we believe that the new presentation is a more appropriate presentation of the combined businesses.

The exhibits included as Exhibit 99.1, Exhibit 99.2 and Exhibit 99.3 hereto revise the following information included in the BHI definitive proxy statement/prospectus (“Proxy Statement/Prospectus”) filed on May 30, 2017 with the Securities and Exchange Commission (“SEC”) to reflect the change in segment reporting and new presentation of the statement of income (loss) and statement of cash flows:

·
“Business— GE O&G Business,”
·
“Management’s Discussion and Analysis of Financial Condition and Results of Operations of GE O&G”; and
·
“Audited Combined Financial Statements of GE Oil and Gas for the years ended December 31, 2016, 2015, and 2014.”

The presentation of the historical financial information and related disclosure in this Current Report is consistent with the segment reporting structure and new income statement and cash flow presentations set forth in the Company’s Quarterly Report on Form 10-Q filed for the quarterly period ended September 30, 2017.

The information included in Exhibits 99.1, 99.2 and 99.3 has been revised only to reflect the reporting and presentation changes described above and has not otherwise been updated or revised to reflect events or changes occurring after the date of the Proxy Statement/Prospectus.  This information should be read in conjunction with our other SEC filings.

The Company is also filing with this Current Report as Exhibit 99.4 unaudited pro forma condensed combined statements of income (loss) of Baker Hughes, a GE company, LLC for the nine-month period ended September 30, 2017 and for the year ended December 31, 2016.  Exhibit 99.4 hereto updates the unaudited pro forma condensed combined statements of income (loss) for Baker Hughes, a GE company, LLC previously filed by the Company with the SEC on September 19, 2017 as Exhibit 99.1 to the Company’s Current Report on Form 8-K/A.  Exhibit 99.4 hereto includes updates to the total purchase consideration and the estimates of fair value of assets acquired and liabilities assumed.  In addition, the unaudited pro forma condensed combined statement of income (loss) of the Company for the year ended December 31, 2016 included in Exhibit 99.4 hereto has been updated to reflect the new income statement presentation and more recent available information.  Exhibit 99.4 does not update the previously filed unaudited pro forma financial statements of Baker Hughes, a GE company.

Item 9.01. Financial Statements and Exhibits.
 
     (d) Exhibits.
 
 
 
 
 
Exhibit No.
 
Description
Exhibit 99.1
 
Revised Description of GE O&G Business
Exhibit 99.2
 
Revised Management’s Discussion and Analysis of Financial Condition and Results of Operations of GE O&G
Exhibit 99.3
 
Revised Audited Combined Financial Statements of GE Oil and Gas for the years ended December 31, 2016, 2015, and 2014
Exhibit 99.4
 
Unaudited pro forma condensed combined statements of income (loss) of for the nine-month period ended September 30, 2017 and for the fiscal year ended December 31, 2016.

 

 
Signature
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
 
 
 
 
 
 
BAKER HUGHES, A GE COMPANY
 
 
 
 
 
 
 
 
Dated:  December 4, 2017
By:
/s/ Lee Whitley  
 
 
Lee Whitley
Corporate Secretary
 
 
 
 
 
       
 
BAKER HUGHES, A GE COMPANY, LLC
 
 
 
 
 
 
 
 
Dated:  December 4, 2017
By:
/s/ Lee Whitley  
 
 
Lee Whitley
Corporate Secretary
 
 
 
 

 
EXHIBIT INDEX
 
 
 
 
Exhibit No.
 
Description
 
 
 
 
 
 

 
Exhibit 99.1

GE O&G Business

Baker Hughes, a GE company, LLC, a Delaware limited liability company (the Company, BHGE LLC, we, us, or our) and the successor to Baker Hughes Incorporated, a Delaware corporation (Baker Hughes) is a fullstream oilfield technology provider that has a unique mix of equipment and service capabilities. On July 3, 2017, we closed our previously announced business combination (the Transactions) to combine the oil and gas business (GE O&G) of General Electric Company (GE) and Baker Hughes. In connection with the Transactions, we entered into and are governed by an Amended & Restated Operating Agreement, dated as of July 3, 2017 (the BHGE LLC Agreement). Under the BHGE LLC Agreement, EHHC Newco, LLC (EHHC), a wholly owned subsidiary of Baker Hughes, a GE company (BHGE), is our sole managing member and BHGE is the sole managing member of EHHC. As our managing member, EHHC conducts, directs and exercises full control over all our activities, including our day-to-day business affairs and decision-making, without the approval of any other member. As such, EHHC is responsible for all our operational and administrative decisions and the day-to-day management of our business. GE owns approximately 62.5% of our common units and BHGE owns approximately 37.5% of our common units indirectly through two wholly owned subsidiaries.
The Transactions were treated as a “reverse acquisition” for accounting purposes and, as such, the historical financial statements of the accounting acquirer, GE O&G, are the historical financial statements of the Company.  The Company’s financial statements have been prepared on a consolidated basis, effective July 3, 2017. For all periods prior to July 3, 2017, the Company’s financial statements were prepared on a combined basis. The combined financial statements included in Exhibit 99.3 to this Current Report on Form 8-K combine certain accounts of GE and its subsidiaries that were historically managed as part of its Oil & Gas business. The historical financial results in the combined financial statements presented may not be indicative of the results that would have been achieved had GE O&G operated as a separate, stand-alone entity during those periods. The GE O&G numbers in the combined statements of income (loss) and statements of cash flows have been reclassified to conform to the presentation included in BHGE LLC’s Quarterly Report on Form 10-Q for the period ended September 30, 2017. We believe that the reclassified presentation is a more appropriate presentation of the combined businesses.
The following description of GE O&G was included in the definitive proxy statement/prospectus (Proxy Statement/Prospectus) filed by Baker Hughes on May 30, 2017 and has been recast to reflect a change in segment reporting following the Transactions.  The description below is limited to GE O&G’s business as of the date of the Proxy Statement/Prospectus and does not include disclosure on Baker Hughes, except as specifically noted.  The information included below has been revised only to reflect the reporting changes described above and has not otherwise been updated or revised to reflect events or changes occurring after the date of the Proxy Statement/Prospectus. This information should be read in conjunction with BHGE LLC’s SEC filings. Following the Transactions, the majority of the legacy Baker Hughes business is included in the Oilfield Services segment, with a small component included in the Digital Services segment.

GE O&G offers its customers a leading portfolio of advanced technology and optimization support. GE O&G is active in all segments of the oil and gas industry: upstream to downstream, greenfield to brownfield, and onshore and offshore segments. GE O&G also delivers pipeline integrity solutions, a wide range of sensing, inspection and monitoring technologies and industrial power generation and compression solutions for the midstream liquefied natural gas and pipeline segments and the downstream refining and petro-chemical segments. GE O&G endeavors to continuously improve oil and gas industry performance, output and productivity.
GE O&G offers its solutions through four segments: Oilfield Services (OFS); Oilfield Equipment (OES); Turbomachinery & Process Solutions (TPS); and Digital Solutions (DS). GE O&G also offers its solutions through joint ventures where localization provides a competitive advantage or where local law so requires.

 GE O&G is a global business with consolidated 2016 revenue of $13,269 million. GE O&G generates its revenue and orders from a combination of equipment sales and services. In 2016, 46.0% of revenue was generated from equipment sales and 54.0% from services, while 32.5% of orders were for equipment and 67.5% for services. Due to the nature of GE O&G’s business, including the time required to manufacture equipment and the long-term nature of many of its service contracts, there is a backlog of unfilled customer orders for equipment sales and services, which as of December 31, 2016 totalled $21,697 million. The following charts show the split between equipment sales and services for GE O&G’s 2016 and 2015 revenues, and 2016, 2015 and 2014 orders and year end backlog.
 
 
1

 
 
     
Equipment/Services Revenues
 
   
Orders
  
Backlog
 
 
 
  
 
Product services and backlog of product services

GE O&G’s Statement of Earnings displays sales and costs of sales in accordance with SEC regulations under which “goods” is required to include all sales of tangible products and “services” must include all other sales, including other services activities. For the amounts shown above, as well as in the orders and backlog charts included in this Business section and the Management’s Discussion and Analysis of Financial Condition and Results of Operations of GE O&G included in Exhibit 99.2 to this Current Report on Form 8-K, GE O&G distinguishes between “equipment” and “product services,” where product services refers to sales under product services agreements, including sales of both goods (such as spare parts and equipment upgrades) and related services (such as monitoring, maintenance and repairs), which is an important part of its operations. GE O&G refers to “product services” simply as “services” within this Business section and the Management’s Discussion and Analysis of Financial Condition and Results of Operations of GE O&G included in Exhibit 99.2 to this Current Report on Form 8-K.

Backlog is defined as unfilled customer orders for products and services believed to be firm. For product services, an amount is included for the expected life of the contract.
 
2

 
Products and Services

Oilfield Services

The Oilfield Services (OFS) segment provides equipment and services ranging from well evaluation to decommissioning. OFS provides equipment and related services for onshore and shallow water oil and gas wells.  OFS’ product lines design, manufacture and sell artificial lift equipment, including dry trees, surface wellheads, electric submersible pumps, rod lift systems, actuators, progressive cavity pumps, and distribute gas lift systems for extracting crude oil and other fluids from wells.  Products and services also include diamond and tri-cone drill bits, drilling services (including directional drilling technology, measurement while drilling & logging while drilling), downhole completion tools and systems, wellbore intervention tools and services, wireline services, drilling and completions fluids and oilfield and industrial chemicals.  OFS’ products and services are used by international, national, and independent oil companies and oilfield service companies. The OFS portfolio includes the Lufkin® and Sondex® brands

OFS product lines’ core technologies enable stable, precise and accurate wellbore placement for high quality drilling that supports higher utilization rates by reducing the need for calibrations and repairs. Using data-enabled services, including equipment baseline modeling, condition-based maintenance, rig-based re-certification, and digitized asset history, OFS systems and services are able to increase reliability and reduce downtime.
OFS revenues represented approximately 6% of total GE O&G revenue and generated a loss of $204 million in 2016.
OFS revenues represented approximately 8% of total GE O&G revenue and generated a loss of $79 million in 2015.
Following the Transactions, a majority of the legacy Baker Hughes business operations are included in the OFS segment.


Oilfield Equipment

The Oilfield Equipment (OFE) segment provides a broad portfolio of products and services required to facilitate the safe and reliable flow of hydrocarbons from the subsea wellhead to the surface production facilities. The OFE operation designs and manufactures onshore and offshore drilling and production systems and equipment for floating production platforms and provides a full range of services related to onshore and offshore drilling activities.

The OFE portfolio includes deepwater drilling equipment, subsea production systems (SPS), flexible pipe systems, surface pressure control, and related service solutions. The OFE drilling product line offers blowout preventers, control systems, marine drilling risers, wellhead connectors, diverters and related services. OFE offers SPS, including trees, control systems, manifolds, connections, wellheads, specialty connectors, installation and decommissioning solutions, and related services. OFE also provides advanced flexible composite pipes for deepwater production riser applications and flowlines for use with floating production, storage, and offloading vessels, in a range of extreme operating environments.   OFE also offers a range of comprehensive, worldwide services for installation, technical support, well access through subsea intervention systems, operating resources and tools, offshore products and brownfield asset integrity solutions. The OFE portfolio includes the Hydril™, Vetco® Gray, Wellstream®, and Advantec™ brands.
OFE  customers are oil and gas field developers, drilling and oil companies seeking to undertake new subsea projects, mid-life upgrades and maintenance, well interventions and workover campaigns. OFE differentiates itself in SPS and deepwater drilling systems. OFE’s key competitive areas are large-bore gas fields, deepwater oilfields and fields with long tieback distances. In addition to a robust presence in other subsea areas, including high-pressure high-temperature (HPHT) fields, OFE’s product lines’ production systems are among the industry’s most reliable, with uptime of the critical control system exceeding 99.8%.
 
3

 
OFE revenues represented approximately 27% of total GE O&G revenue and 19% of GE O&G segment profit in 2016.
OFE revenues represented approximately 30% of total GE O&G revenue and 25% of 2015 GE O&G segment profit.
 

Turbomachinery & Process Solutions

The Turbomachinery & Process Solutions (TPS) segment provides equipment and related services for mechanical-drive, compression and power-generation applications across the oil and gas industry as well as products and services to serve the downstream segments of the industry including refining, petrochemical, distributed gas, flow and process control and other industrial applications. TPS segment is a leader in designing, manufacturing, maintaining and upgrading rotating equipment across the oil and gas, petro-chemical and industrial sectors.

The TPS portfolio includes drivers, driven equipment, flow control and turnkey solutions. Drivers comprise aero-derivative gas turbines, heavy-duty gas turbines, small- to medium-sized steam turbines, and synchronous and induction electric motors. TPS’ driven equipment consists of electric generators, reciprocating, centrifugal, axial, direct-drive high speed, integrated and subsea compressors, and turbo-expanders. TPS’ flow control includes pumps, valves, regulators, control systems and other flow and process control technologies. As part of its turnkey solutions, GE O&G TPS offers power generation modules, waste heat/energy recovery, energy storage, modularized small and large liquefaction plants, carbon capture and storage/use facilities. TPS also offers a variety of system upgrades and conversion solutions, from a single machine to full plant debottlenecking and modernization. The TPS portfolio includes the NuovoPignone®, Salof™, Dresser™ and Thermodyn® brands.
TPS’ products enable customers to increase upstream oil and gas production, liquefy natural gas, compress gas for transport via pipelines, generate electricity, store gas and energy, refine oil and gas and produce petro-chemicals, while minimizing both operational and environmental risks in the most extreme service conditions. TPS’ customers are upstream, midstream and downstream, onshore and offshore, and small to large scale. Midstream and downstream customers include liquefied natural gas plants, pipelines, storage facilities, refineries and a wide range of industrial and engineering, procurement and construction (EPC) companies.
TPS’ value proposition is founded on its turbomachinery and flow control technology, a unique competence to integrate gas turbine and compressors in the most critical natural gas applications, best-in-class manufacturing and testing capabilities, reliable maintenance and service operations, and innovative real-time diagnostics and control systems, enabling condition-based maintenance and increasing overall productivity, availability, efficiency and reliability for oil and gas assets. TPS differentiates itself from competitors with its expertise in technology and project management, local presence and partnerships, as well as the deep industry know-how of its teams to provide fully integrated equipment and services solutions with state-of-art technology from design and manufacture through to operations.
 
TPS revenues represented approximately 52% of GE O&G revenue and 73% of GE O&G segment profit in 2016.

TPS revenues represented approximately 48% of total GE O&G revenue and 63% of GE O&G segment profit in 2015.

Digital Solutions

The Digital Solutions (DS) segment provides a diverse portfolio of hardware, software, industrial control systems, inspection solutions, sensor and measurement instruments and advisory services to improve machinery health and productivity of industrial assets.

The DS portfolio includes condition monitoring, inspection technologies, measurement and sensing and pipeline inspections. The DS condition monitoring product line, which includes the Bently Nevada® and System 1® brands, provides rack-based vibration monitoring equipment, sensors, software cybersecurity solutions and industrial controls for power generation and oil and gas operations. The DS inspection technologies product line includes a broad portfolio of non-destructive testing (NDT) technology, software, and services, including industrial radiography, ultrasonic sensors, testing machines and gauges, NDT film, and remote visual inspection.
 
4

 
The  DS measurement and sensing product line, which includes the Panametrics®, Druck®, Reuter Stokes™, Presens™ and Naxys™ brands,provides instrumentation including flow meters, moisture, humidity and oxygen analyzers, pressure sensors, controllers, calibrators, leak detection systems, radiation monitoring, flame sensors, and neutron scattering technology. The  DS pipeline inspections product line, operating under the PII™ brand, provides services to assess metal loss, identify deformation and abnormal geometry, detect cracks and assess overall pipeline integrity.
The DS segment helps companies optimize industrial assets by providing solutions such as performance management, condition and asset health monitoring, enabling customers to mitigate risk, boost safety, meet regulatory requirements, reduce maintenance costs, and improve equipment reliability, uptime, and efficiency. It also provides customers with the first step of their digital transformation, using sensors, services and inspections to connect industrial assets to the industrial internet via GE’s Predix cloud-based platform. Deployed on machines, onsite, or in the cloud, Predix handles big data on an industrial scale and with industrial-strength security, giving customers the power to innovate and make faster, more confident decisions. Predix provides the insights that transform asset performance and operations, allowing customers to enhance the safety, productivity and life of assets.
DS revenues represented approximately 16% of GE O&G revenue and 21% of GE O&G segment profit in 2016.
DS revenues represented approximately 13% of total GE O&G revenue and 15% of GE O&G segment profit in 2015.

Raw Materials and Suppliers

The principal raw materials used by GE O&G include steel alloys, chromium, nickel, titanium, barite, beryllium, copper, lead, tungsten carbide, synthetic and natural diamonds, gels, sand and other proppants, printed circuit boards and other electronic components and hydrocarbon-based chemical feed stocks. Raw materials that are essential to GE O&G’s business are normally readily available from multiple sources, but may be subject to price volatility. Market conditions can trigger constraints in the supply of certain raw materials, and GE O&G is always seeking ways to ensure the availability and manage the cost of raw materials. GE O&G’s procurement department uses its size and buying power to enhance its access to key materials at competitive prices.

In addition to raw materials, GE O&G also uses the products and services of metal fabricators, machine shops, foundries, forge shops, assembly operations, contract manufacturers, logistics providers, packagers, indirect material providers, and others in order to produce and deliver products to its customers. These materials and services are generally available from multiple sources.

Intellectual Property

GE O&G’s technology, brands and other intellectual property rights are important elements of its business. GE O&G relies on patent, trademark, copyright and trade secret laws, as well as non-disclosure and employee invention assignment agreements to protect its intellectual property rights. Many of the patents and patent applications in GE O&G’s portfolio are owned by GE O&G, while other patents and patent applications in GE O&G’s portfolio are licensed to GE O&G by GE and third parties. GE O&G does not consider any individual patent, trademark or copyright to be material to its business operations.

In connection with the Transactions, GE entered into a IP cross-license agreement (the IP Cross-License Agreement) with BHGE LLC. GE  agreed to license to BHGE LLC the right to use certain intellectual property owned or controlled by GE (other than GE Digital) pursuant to the terms of the IP Cross-License Agreement. BHGE LLC agreed to license to GE the right to use certain intellectual property rights pursuant to the terms of the IP Cross-License Agreement. This license allows BHGE LLC to have continued rights to use some of GE’s intellectual property so that they can be leveraged pursuant to the terms of the IP Cross-License Agreement. Any improvements to such intellectual property made or developed by BHGE LLC will be owned by BHGE LLC and licensed back to GE pursuant to the terms of the IP Cross-License Agreement and any improvements to such intellectual property made or developed by GE will be owned by GE and licensed to BHGE LLC. See “Item 1.01 Entry into a Material Definitive Agreement—Commercial Agreements—IP Cross-License Agreement” in BHGE LLC’s Current Report on Form 8-K filed on July 3, 2017 for more information.
 
5

 
GE O&G follows a policy of seeking patent and trademark protection in numerous countries and regions throughout the world for products and methods that appear to have commercial significance and in regions where GE O&G has, or desires to have, a business presence. GE O&G has over 8,500 issued patents and pending patent applications worldwide, of which more than 2,000 are in the United States. GE O&G believes that protection of its patents, trademarks, and other intellectual property rights is central to the conduct of its business, and enforces its intellectual property rights against infringement worldwide as it deems appropriate to protect its business. Additionally, GE O&G considers the quality and timely delivery of its products, the services it provides to its customers and the technical knowledge and skills of its personnel to be other important components of the portfolio of capabilities and assets that support its ability to compete.

Customers and Sales

GE O&G’s sales efforts are organized around the constantly evolving needs of its customers and markets. GE O&G provides products and solutions to international, national, and independent oil companies and oilfield service companies in the upstream offshore, upstream onshore, pipeline and storage, refinery and petro-chemical, liquefied natural gas, industrial power generation and drilling segments. GE O&G’s customers also include EPC companies that perform projects using GE O&G products and services, as well as other industrial companies, including participants in the automotive, mining, aviation, aerospace and food and beverages sectors. No single customer accounted for 10% or more of GE O&G’s revenues in any of the past three fiscal years.

GE O&G sells to its customers through direct and indirect channels. Its primary sales channel is through its direct sales force, which has a strong regional focus with local teams close to the customer, who are able to draw support from centers of excellence in each of GE O&G’s major product lines. GE O&G’s sales force also uses its application engineers, field application engineers, service engineers, commercial and sales managers, and account executives to help deliver and provide customers with the best product and service solutions which GE O&G can offer.
In indirect channels, GE O&G relies upon its channel partners who act as buy/resell distributors, agents, or third-party sales representatives and provide GE O&G products, generally on a non-exclusive basis. Other indirect sales channels include original equipment manufacturers (OEMs) who incorporate GE O&G products and services as part of their design package and product offerings, and GE entities outside of GE O&G that incorporate GE O&G products and services in their offerings.
GE O&G’s marketing strategy spans traditional and digital media and includes exhibiting expertise through white papers, presentations and engineering focused publications, tradeshow and event marketing. Central to this strategy is engaging customers to understand the core challenges they face and how GE O&G can co-create innovative solutions to address these needs.

Certain non-U.S. GE O&G entities have received purchase orders for the sale of goods pursuant to General License H issued in January 2016 by the U.S. Department of Treasury’s Office of Foreign Assets Control that could potentially enhance Iran’s ability to develop petroleum resources. The first of these non-U.S. entities received four purchase orders during the fourth quarter of 2016 and two sets of purchase orders during the first quarter of 2017 covering the sale of spare parts for gas turbine equipment for ultimate end use by an Iranian company in gas production projects in Iran and have a total value of €33.6 million ($35.4 million). The non-U.S. affiliate also booked a modification of a previously reported contract to add additional scope valued at €2.0 million ($2.2 million). As of March 31, 2017 this non-U.S. GE O&G entity has not recognized any revenue, but has incurred €2.7 million ($2.9 million) in costs. A second non-U.S. GE O&G entity received a purchase order pursuant to General License H valued at €0.2 million ($0.2 million) during the fourth quarter of 2016 and a second purchase order during the first quarter of 2017 valued at €0.3 million ($0.3 million) for the sale of services associated with the commissioning of gas compressors in Iran. As of March 31, 2017, gross revenues attributable to this purchase order was €0.3 million ($0.3 million), and net profits attributable to this purchase order was €0.2 million ($0.2 million). A third non-U.S. affiliate of GE’s Oil & Gas business received purchase orders pursuant to General License H valued at €0.3 million ($0.3 million) during the first quarter of 2017 for the sale of production logging equipment and spare parts to an Iranian customer. As of March 31, 2017, the non-US affiliate has not yet recognized revenue or profit associated with this transaction. The non-U.S. GE O&G entities intend to continue this activity pursuant to General License H.
 
 
 
6

 

Contracts

GE O&G conducts its business under various types of contracts, including fixed-fee or turnkey contracts, transactional agreements for products and/or services across upstream, midstream and downstream segments and long-term aftermarket service agreements.

GE O&G enjoys stable relationships with many of its customers based on long-term project contracts. Several of those contracts require GE O&G to commit to a fixed price based on the customer’s technical specifications with little or no legal relief due to changes in circumstances, such as changes in local laws or industry or geopolitical events. In some cases, failure to deliver products or perform services within contractual commitments may lead to liquidated damages claims. In other cases, delivery of products or services ahead of contractual commitments can result in bonuses. GE O&G seeks to mitigate these exposures through close collaboration with its customers during work phases.  See “Risk Factors—Risk Factors Related to the Business of New Baker Hughes—Some of our customers require bids in the form of long-term, fixed pricing contracts” included in the Proxy Statement/Prospectus for further detail.
Consistent with industry practice, customers typically indemnify GE O&G for certain claims arising from the injury or death of their employees and their other contractors, the loss of or damage to their equipment and that of their other contractors, damage to the well or reservoir and pollution or clean-up originating from the customer’s equipment or from the reservoir, including uncontained oil flow from a reservoir, and claims arising from catastrophic events, such as a well blowout, fire, explosion and from pollution below the surface. Conversely, GE O&G typically indemnifies its customers for certain claims arising from the injury or death of its employees, the loss of or damage to its equipment (other than equipment lost in the hole) or pollution originating from GE O&G equipment in GE O&G care, custody or control, above the surface of the earth or water.
Subject to limited exceptions, GE O&G’s general practice is to include a limitation of liability clause to limit the overall risk associated with work performed under a contract. It is also GE O&G’s general practice to include a limitation of liability for consequential loss, including loss of profits and loss of revenue.
GE O&G’s indemnity structure may not protect it in every case. Often GE O&G contracts with customers that are not the end user of its products. It is GE O&G’s practice to seek to obtain an indemnity from its customer for any end-user claims but this is not always possible. Similarly, government agencies and other third parties may make claims in respect of which GE O&G is not indemnified and for which responsibility is assessed proportionate to fault. In all cases, deviations from GE O&G’s standard contracting practices are examined through an established risk deviation process.

Research and Development

GE O&G maintains an active research and development program, some of which is conducted using the research and development resources of GE. GE O&G engages in research and development activities directed primarily toward the development of new products, services, technology and other solutions, as well as the improvement of existing products and services and the design of specialized products to meet specific customer needs. GE O&G has technology centers located in many locations relevant to the global oil and gas industry.

In connection with the Transactions, GE agreed to provide BHGE LLC with access to certain of GE’s technological developments, enhancements and software, including tailored technology research and development services related to BHGE LLC’s operations. In addition, BHGE LLC agreed to provide GE with certain access to GE O&G’s technological developments, enhancements and software. See “Item 1.01 Entry into a Material Definitive Agreement—Commercial Agreements—IP Cross-License Agreement” in BHGE LLC’s Current Report on Form 8-K filed on July 3, 2017 for more information.
 
7

 
GE O&G’s expenditures for research and development activities were approximately $352 million in 2016, approximately $408 million in 2015, and approximately $420 million in 2014.
In the TPS product line, GE O&G continues to invest in product improvement of reciprocating and centrifugal compressors, using advanced fluid dynamic simulation and advanced aeromechanics to improve capability, operability and efficiency of its centrifugal compressors family.
GE O&G OFE continues to invest in products to develop capability, improve performance and reduce costs. In SPS, the recent focus has been to expand capability into deeper water, longer offsets and at higher pressures. Subsea Power and Processing is also an area in which GE O&G is investing, covering both pumping and compression.
On the surface, OFS invested in a new and cutting-edge line of hydraulic actuators that offer customers improvements in reliability, efficiency and maintainability.
GE O&G DS continues to invest in advanced digital solutions designed to improve the efficiency, reliability and safety of oil and gas production operations. These systems integrate operational data from producing oil and gas facilities to deliver notifications and analytical reports to engineers so they can identify operational performance issues before they become significant, thus helping to prevent unplanned downtime and improve facility reliability.

Regulatory and Environmental

GE O&G’s operations, including its products and services, are subject to U.S. and non-U.S. laws and regulations relating to the protection of the environment and human health, including laws and regulations governing the investigation and remediation of soil and water contamination, including groundwater, surface water and marine waters, the payment for damages to natural resources, air emissions, water discharges, the use and handling of petroleum products and hazardous materials, and the disposal of petroleum wastes and hazardous wastes. Compliance with these laws and regulations requires obtaining and complying with the terms and conditions of permits, authorizations and other standards. Compliance also requires the installation of equipment, and the carrying out of periodic maintenance, in order to control and limit emissions and discharges, and to decrease the chances of unauthorized releases to the environment. These laws and regulations differ from jurisdiction to jurisdiction, continually change, and tend to become more stringent over time.
 
The laws and regulations governing the investigation and remediation of soil and water have required and may in the future require GE O&G to remediate contamination at both its current and former properties, and potentially at other properties and locations impacted by its operations. These laws and regulations may also require GE O&G to contribute to the costs of investigating and remediating contamination at third-party sites to which GE O&G sent hazardous and petroleum wastes for disposal, notwithstanding that the original disposal activity accorded with all legal and regulatory requirements. These laws and regulations are often no fault, and can require GE O&G to clean up contamination that stems from historic releases into the environment even though the releases may not have violated any then-existing requirements, as well as contamination caused by third parties such as former owners and operators of GE O&G’s current properties. Moreover, these laws and regulations are often joint and several, and GE O&G can be held responsible for the payment of the full amount of an environmental liability even if there are other responsible parties that will not or cannot satisfy their share of the liability. See “Risk Factors—Risk Factors Related to the Business of New Baker Hughes—Compliance with, and rulings and litigation in connection with, environmental regulations and the environmental impacts of our or our customers’ operations may adversely affect our business and operating results” in the Proxy Statement/Prospectus for further detail.

GE O&G has incurred and will continue to incur liabilities, and operating and capital costs, to maintain and achieve compliance with environmental, health and safety laws and regulations.

Competition

GE O&G’s products and services are sold in highly competitive markets and the competitive environment varies by product line, as discussed below:
 
 
8

 

Oilfield Services (OFS)

In OFS, competitors include Schlumberger (including Cameron), Halliburton, Weatherford International, TechnipFMC, Weir Oil & Gas, Cactus and Summit.

Oilfield Equipment (OFE)

OFE believes that the principal competitive factors in the industries and markets it serves are product and service quality, reliability and on time delivery, health, safety and environmental standards, technical proficiency, availability of spare parts and price. Its strong track record of innovation enables OFE to enter into long-term, performance-based service agreements with its customers.

In the SPS product line, the primary competitors of OFE include OneSubsea (part of Schlumberger), TechnipFMC, Aker Solutions ASA, Proserv and Dril-Quip Inc. In the flexible pipe product line, competitors include TechnipFMC, NOV, Airborne, and Magma. In the drilling sub-product line, competitors include NOV and Schlumberger.

Turbomachinery & Process Solutions (TPS)

TPS believes that the principal competitive factors in the industries and markets it serves are product range (or power range measured in Megawatts) coverage, efficiency, product reliability and availability, service capabilities, packages, references, emissions and price.

In upstream and midstream applications, TPS’ primary equipment competitors include Siemens (Power and Gas business unit), Solar (a Caterpillar company), MAN Turbo and Mitsubishi Heavy Industries. In downstream applications, TPS primarily competes with OEMs and independent service providers, including Flowserve, Pentair, Emerson, Siemens, Hitachi, Solar (a Caterpillar company), Ariel, MAN Turbo, Burckhardt, Elliott Ebara and Mitsubishi Heavy Industries.
TPS’ aftermarket equipment product line competes with smaller independent local providers such as Masaood John Brown, Sulzer, MTU, Trans Canada Turbine, Chromalloy and Ethos Energy (a joint venture of Siemens and the Wood Group).

Digital Solutions (DS)

DS believes that the principal competitive factors in the industries and markets it serves are superior product technology, service, quality, and reliability, as well as its ability to utilize the GE Store.

DS competes across a wide range of industries, including Oil & Gas, Power Generation, Aerospace, and Light and Heavy Industrials. The products and services are sold in a diversified, fragmented arena with a broad range of competitors.
Although no single company competes directly with DS across all its product lines, various companies compete in one or more products. Primary competitors include Emerson, ABB, Schneider Electric, Fortive, Olympus, Comet Group, Honeywell Process Solutions, Roper Technology, Siemens, Spectris, Aspentech and OSISoft.

Employees

As of December 31, 2016, GE O&G had approximately 34,000 employees. A small portion of GE O&G’s employees is represented under collective bargaining agreements or similar labor arrangements. GE O&G believes that its employee relations are generally favorable.
 
9

 

Properties

GE O&G owns or leases numerous properties in domestic and foreign locations. Generally, GE O&G leases office space, with less than 5% of such space being owned, while it owns approximately 80% of its manufacturing locations. Its principal properties include manufacturing facilities, light industrial sites, service shops, research and development laboratories, technology centers, and corporate offices. GE O&G also has numerous smaller facilities that include sales, project, and support offices and bulk storage facilities throughout the world. All of GE O&G’s owned properties are unencumbered.
 
As of January 1, 2017, GE O&G had access to the following principal properties, either owned or leased.
             
Location
  
Region
  
Purpose
  
Legal Status
GE O&G
  
 
  
 
  
 
London, United Kingdom
  
Europe
  
Office
  
Leased
Houston, Texas
 
NAM
 
Office
 
Leased
Oilfield Services
           
Comodoro, Argentina
  
LATAM
  
Manufacturing
  
Owned
Lufkin, Texas
  
NAM
  
Manufacturing and Overhaul & Repair
  
Owned
Ploiesti, Romania
  
Europe
  
Manufacturing
  
Owned
Oklahoma City, Oklahoma
  
NAM
  
Manufacturing and Overhaul & Repair
  
Owned
Shawnee, Oklahoma
  
NAM
  
Manufacturing
  
Owned
Dammam, Saudi Arabia
  
MENAT
  
Manufacturing
  
Leased
Monterrey, Mexico
  
LATAM
  
Manufacturing
  
Leased
Comodoro, Argentina
  
LATAM
  
Manufacturing
  
Owned
Oilfield Equipment
  
 
  
 
  
 
Bristol, United Kingdom
  
Europe
  
Office
  
Leased
Aberdeen, United Kingdom
  
Europe
  
Office and Manufacturing
  
Owned
Newcastle, United Kingdom
  
Europe
  
Office and Manufacturing
  
Owned
Montrose, United Kingdom
  
Europe
  
Manufacturing
  
Leased
Houston, Texas (NHR)
  
NAM
  
Manufacturing and services
  
Owned
Houston, Texas (Hydril)
  
NAM
  
Office and Manufacturing
  
Owned
Niteroi, Brazil
  
LATAM
  
Manufacturing
  
Leased
Singapore
  
ASEAN
  
Manufacturing
  
Owned
Turbomachinery & Process Solutions
  
 
  
 
  
 
Florence, Italy
  
Europe
  
Office and Manufacturing
  
Owned/Leased
Avenza, Italy
  
Europe
  
Spare parts distribution
  
Leased
Massa, Italy
  
Europe
  
Manufacturing and string test
  
Owned
Jacksonville, Florida
  
NAM
  
Manufacturing
  
Leased
Lufkin, Texas
  
NAM
  
Manufacturing
  
Owned
Schertz, Texas
  
NAM
  
Manufacturing
  
Owned
Houston, Texas (Port NW)
  
NAM
  
Manufacturing
  
Leased
Houston, Texas (HSC)
  
NAM
  
Overhaul & Repair
  
Owned
Digital Solutions
  
 
  
 
  
 
San Ramon, California
  
NAM
  
Office
  
Leased
Hurth, Germany
  
Europe
  
Manufacturing
  
Owned
Minden, Nevada
  
NAM
  
Manufacturing
  
Owned
Billerica, Massachusetts
  
NAM
  
Office and Manufacturing
  
Leased
Ahrensburg, Germany
  
Europe
  
Manufacturing
  
Leased
Cramlington, United Kingdom
  
Europe
  
Office and Manufacturing
  
Owned
Longmont, Colorado
  
NAM
  
Manufacturing
  
Leased
Groby, United Kingdom
  
Europe
  
Manufacturing
  
Owned
Wunstorf, Germany
  
Europe
  
Manufacturing
  
Owned
       
GE O&G believes all properties that it currently occupies are suitable for their intended use.
 
  
Legal Proceedings

GE O&G is subject to litigation and other risks posed under the different regimes in all parts of the world where the company operates or buys or sells its equipment and services. GE O&G has adopted appropriate risk management and compliance programs to address these and other matters that may arise from time to time. Yet the global and diverse nature of GE O&G’s business, and the changing enforcement environments in which it operates, means the nature and outcome of existing or potential legal proceedings and enforcement actions cannot be predicted with certainty. GE O&G believes, based on its review or the probable outcome of the proceedings to which it is a party, that any unrecorded liability that may result will not have a material adverse effect on its liquidity, financial condition or results of operations.
 


10
 
Exhibit 99.2


MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS OF GE O&G

Baker Hughes, a GE company, LLC, a Delaware limited liability company (the Company, BHGE LLC, we, us, or our ) and the successor to Baker Hughes Incorporated, a Delaware corporation (Baker Hughes) is a fullstream oilfield technology provider that has a unique mix of equipment and service capabilities. On July 3, 2017, we closed our previously announced business combination (the Transactions) to combine the oil and gas business (GE O&G) of General Electric Company (GE) and Baker Hughes.  In connection with the Transactions, we entered into and are governed by an Amended & Restated Operating Agreement, dated as of July 3, 2017 (the BHGE LLC Agreement). Under the BHGE LLC Agreement, EHHC Newco, LLC (EHHC), a wholly owned subsidiary of Baker Hughes, a GE company (BHGE), is our sole managing member and BHGE is the sole managing member of EHHC. As our managing member, EHHC conducts, directs and exercises full control over all our activities, including our day-to-day business affairs and decision-making, without the approval of any other member. As such, EHHC is responsible for all our operational and administrative decisions and the day-to-day management of our business. GE owns approximately 62.5% of our common units and BHGE owns approximately 37.5% of our common units indirectly through two wholly owned subsidiaries.
 
The Transactions were treated as a “reverse acquisition” for accounting purposes and, as such, the historical financial statements of the accounting acquirer, GE O&G, are the historical financial statements of the Company.  The Company’s financial statements have been prepared on a consolidated basis, effective July 3, 2017. For all periods prior to July 3, 2017, the Company’s financial statements were prepared on a combined basis. The combined financial statements included in Exhibit 99.3 to this Current Report on Form 8-K combine certain accounts of GE and its subsidiaries that were historically managed as part of its Oil & Gas business. The historical financial results in the combined financial statements presented may not be indicative of the results that would have been achieved had GE O&G operated as a separate, stand-alone entity during those periods.  The GE O&G numbers in the combined statements of income (loss) and the combined statements of cash flows have been reclassified to conform to the presentation included in BHGE LLC’s Quarterly Report on Form 10-Q for the period ended September 30, 2017. We believe that the reclassified presentation is a more appropriate presentation of the combined businesses.
 
The following management’s discussion and analysis of financial condition and results of operations of GE O&G was included in the definitive proxy statement/prospectus (Proxy Statement/Prospectus) filed by Baker Hughes on May 30, 2017 and has been recast to reflect a change in segment reporting following the Transactions and the reclassified presentation of the statements of income (loss) and the statements of cash flows.  The discussion below is limited to the fiscal years ended December 31, 2016, 2015 and 2014 for GE O&G and does not include financial information for Baker Hughes. The information included in this section has been revised only to reflect the reporting changes described above and has not otherwise been updated or revised to reflect events or changes occurring after the date of the Proxy Statement/Prospectus. This information should be read in conjunction with BHGE LLC’s SEC filings. Following the Transactions, the majority of the legacy Baker Hughes business is included in the Oilfield Services segment, with a small component included in the Digital Services segment.
 
The following discussion and analysis summarizes the significant factors affecting the results of operations, financial condition and liquidity position of GE O&G as of and for the years ended December 31, 2016, 2015 and 2014, and should be read in conjunction with the combined financial statements and related notes of GE O&G included in Exhibit 99.3 to this Current Report on Form 8-K. Neither the following discussion and analysis nor the combined financial statements of GE O&G represent the financial position or results of operations of the Oil & Gas operating segment of GE. The following discussion and analysis of the financial condition and results of operations of GE O&G covers periods prior to the consummation of the Transactions and does not reflect its effect on future periods. The following discussion and analysis contain forward-looking statements that reflect GE O&G’s plans, estimates and beliefs. Actual results could differ materially from those discussed in the forward-looking statements. See “Cautionary Note Regarding Forward-Looking Statements” included in the Proxy Statement/Prospectus. Factors that could cause or contribute to these differences include those discussed below and in the section titled “Risk Factors” included in the Proxy Statement/Prospectus.
 

1



Presentation

The sum of the components reported in millions may not be equal to the total amount reported due to rounding. Percentages presented are calculated from the numbers in millions.
 
Executive Summary

GE O&G operates in more than 120 countries, offering its customers a leading portfolio of advanced technology and optimization support. GE O&G is active in all segments of the oil and gas industry; upstream to downstream, greenfield to brownfield, onshore and offshore. GE O&G also delivers pipeline integrity solutions, a wide range of sensing, inspection and monitoring technologies and industrial power generation and compression solutions for the midstream liquefied natural gas and pipeline segments and downstream refining and petro-chemical segments. GE O&G endeavors to continuously improve oil and gas industry performance, output and productivity.

GE O&G principally provides equipment and services to the oil and natural gas exploration and production industry, both on land and offshore, through its four business segments: Oilfield Services (OFS); Oilfield Equipment (OFE); Turbomachinery & Process Solutions (TPS); and Digital Solutions (DS), which are described below:
              
Oilfield Services provides equipment and services ranging from well evaluation to decommissioning. Products and services include diamond and tri-cone drill bits, drilling services (including directional drilling technology, measurement while drilling & logging while drilling), downhole completion tools and systems, wellbore intervention tools and services, wireline services, drilling and completions fluids, oilfield and industrial chemicals, pressure pumping, and artificial lift technologies (including electrical submersible pumps).

Oilfield Equipment provides a broad portfolio of products and services required to facilitate the safe and reliable flow of hydrocarbons from the subsea wellhead to the surface. Products and services include pressure control equipment and services, Subsea production systems and services, drilling equipment, and flexible pipeline systems. Oilfield Equipment operation designs and manufactures onshore and offshore drilling and production systems and equipment for floating production platforms and provides a full range of services related to onshore and offshore drilling activities.

Turbomachinery & Process Solutions provides equipment and related services for mechanical-drive, compression and power-generation applications across the oil and gas industry as well as products and services to serve the downstream segments of the industry including refining, petrochemical, distributed gas, flow and process control and other industrial applications.  The Turbomachinery & Process Solutions portfolio includes drivers (aero-derivative gas turbines, heavy-duty gas turbines and synchronous and induction electric motors), compressors (centrifugal and axial, direct drive high speed, integrated, subsea compressors, turbo expanders and reciprocating), turn-key solutions (industrial modules and waste heat recovery), pumps, valves, and compressed natural gas (CNG) and small-scale liquefied natural gas (LNG) solutions used primarily for shale oil and gas field development.

Digital Solutions provides equipment and services for a wide range of industries, including oil & gas, power generation, aerospace, metals, and transportation. The offerings include sensor-based measurement, non-destructive testing and inspection, turbine, generator and plant controls and condition monitoring, as well as pipeline integrity solutions.

The years ended December 31, 2016 and 2015 were a challenging period for the oil and gas industry, primarily due to uncertainty and volatility in oil and gas prices. While there have been indications of positive trends in oil and gas prices, the industry generally continues to focus on cost rationalization and capital spending reductions to align its cost structure with current economic conditions. The challenging period continues and has led to lower capital spending across the oil and gas industry, which adversely affected GE O&G’s financial performance in 2016 and in 2015 as it experienced a reduction in volume and pricing pressure across most of its product lines.
 
 
2


 
The Transactions

On October 30, 2016, GE and Baker Hughes entered into the Transaction Agreement and Plan of Merger, as amended by the Amendment to the Transaction Agreement and Plan of Merger, dated as of March 27, 2017, which provided for the combination of GE O&G and Baker Hughes as described above. The combined product portfolio of GE O&G and Baker Hughes in drilling, completions, production and midstream/downstream equipment and services created a leading equipment, technology, and service provider in the oil and gas industry operating in more than 120 countries.
 
Factors Affecting Results of Operations

Oil and Gas Prices

The sharp decline experienced in oil and gas prices since 2014 and the prospect of a continuation of prevailing low oil and gas prices has caused GE O&G’s business to experience declines in orders, some project commencement delays and pricing pressures as capital spending by customers has been diminished, deferred or cancelled. Outside North America, customer spending is most heavily influenced by Brent oil prices and by regional or oil-linked natural gas prices, while in North America, customer spending is highly driven by WTI oil prices and natural gas prices, as measured by the Henry Hub Natural Gas Spot Price. In response to this uncertain industry outlook, GE O&G continues to realize cost saving actions with an increased focus on execution and productivity.

The following table sets forth average oil prices for the years indicated.
             
 
Average Daily Price
 
Year Ended
WTI Crude
 
Brent Crude
 
Henry Hub
Natural Gas
 
December 31, 2016
$
43.29
 
$
43.67
 
$
2.52
 
December 31, 2015
 
48.66
   
52.32
   
2.62
 
December 31, 2014
 
93.17
   
98.97
   
4.37
 
(1)
Source: U.S. Energy Information Administration (EIA). As of May 19, 2017, WTI crude, Brent crude and natural gas traded at approximately $48.86 per barrel, $51.29 per barrel and $3.26 per mmBtu, respectively.
 

 
Rig Counts and Contract Awards

The number of customer contracts awarded across key product lines in the calendar year is a key business barometer for GE O&G, as it is an indicator of the overall health of the oil and gas business. The number of contracts awarded is generally determined by the capital spending of our customers, which is directly influenced by oil and gas prices. The awards represent the amount of new business that was available for open bid within the industry and is a good indicator of customer spending over the period. These awards should not be the sole factor considered as there may be other conditions that impact the customer’s overall spending, particularly with respect to services. Rig counts are also a business barometer for GE O&G. When drilling rigs are active, they consume products and services. Rig count trends are governed by exploration and development spending by our customers, which in turn is influenced by current and future price expectations for oil and gas. Therefore, the counts may be reflective of the relative strength and stability of energy prices and overall market activity.

The following table sets forth rig counts and contract awards for the years indicated.
             
 
Calendar year ending
December 31,
 
 
2016
 
2015
 
2014
 
LNG awards(1)
 
4
   
23
   
38
 
Offshore blowout preventer awards(2)
 
-
   
-
   
8
 
Subsea tree awards(3)
 
75
   
156
   
239
 
U.S. onshore rigs(4)
 
490
   
948
   
1,804
 
International onshore rigs(4)(5)
 
855
   
1,072
   
1,385
 
 
(1)
Source: Internal GE database of publicly announced awards in million tons per annum.
(2)
Source: IHS Petrodata April 2017.
(3)
Source: WoodMac April 2017.
(4)
Source: Baker Hughes Rig Count, www.bakerhughes.com.
(5)
Does not include Russia, China or Central Asia.
 
3


 
Key Performance Indicators ($ millions)

Product services and backlog of product services

GE O&G’s Statement of Earnings displays sales and costs of sales in accordance with SEC regulations under which “goods” is required to include all sales of tangible products and “services” must include all other sales, including other service activities. For the amounts shown below, as well as in the orders and backlog charts included in the Business section in Exhibit 99.1 to this Current Report on Form 8-K and this Management’s Discussion and Analysis section, GE O&G distinguishes between “equipment” and “product services”, where product services refers to sales under product services agreements, including sales of both goods (such as spare parts and equipment upgrades) and related services (such as monitoring, maintenance and repairs), which is an important part of its operations. GE O&G refers to “product services” simply as “services” within the Business section in Exhibit 99.1 to this Current Report on Form 8-K and this Management’s Discussion and Analysis section.

Backlog is defined as unfilled customer orders for products and services believed to be firm. For product services, an amount is included for the expected life of the contract.
 
Historical orders and backlog by fiscal year ($ millions)
 
     
Orders
 
Backlog
   
 

Orders: In 2016, GE O&G recognized orders of $11,273 million, a decrease of $4,112 million from 2015. Driven by broader market conditions, GE O&G continued to see delays in final investment decisions on projects and pricing pressure.
 
Backlog: GE O&G’s backlog represents unfilled customer orders for products and services, with the value being defined as the expected life of contract sales for product services. In 2016, GE O&G’s backlog was $21,697 million, a decrease of $2,244 million from 2015 primarily driven by the decrease in equipment backlog of 32% as well as the strengthening of the U.S. dollar, which accounted for a decrease of $309 million. GE O&G’s services backlog increased by 5% to $15,223 million. Backlog remains relatively strong and provides an indication of long term revenues within GE O&G.
 
GE O&G’s book-to-bill ratio utilized to analyze the relationship between orders received and revenue recognized. Due to the market conditions, our book-to-bill ratio was 0.8:1 and 0.9:1 for the years ending December 31, 2016 and 2015, respectively. These ratios and the resulting reduction in backlog were primarily driven by the long-cycle nature of our equipment businesses and the aforementioned market conditions. Based on improving industry conditions, GE O&G expects this trend to stabilize, specifically in the equipment businesses, and as a result we do not expect it to have a material effect on our operations. GE O&G continues to monitor conditions and act accordingly, as an example, executing further restructuring and product cost-out efforts. GE O&G expects approximately 30% of the total $21,697 million December  31, 2016 year-end backlog to be fulfilled within the following fiscal year with the remainder expected to be completed in future years.
 
 
4

 

 
Results of Operations ($ millions)

The results of operations of GE O&G are evaluated by the chief executive officer of GE O&G on a combined and consolidated basis as well as at the segment level.

Revenue includes revenues related to the segment. Segment operating income is determined based on the internal performance measures used by the chief executive officer of GE O&G to assess the performance of each segment in a financial period. In assessing each segment’s performance, the chief executive officer of GE O&G may exclude certain items from the segment and include these items in the corporate items and eliminations line. The performance of our operating segments is evaluated based on segment operating income (loss), which is defined as income (loss) before income taxes and equity in loss of affiliate and before the following: net interest expense, net other non operating income (loss), corporate expenses, restructuring, impairment and other charges, inventory impairments, goodwill impairments, merger and related costs, and certain gains and losses not allocated to the operating segments.
            
In evaluating the segment performance, the chief executive officer of GE O&G uses the following metrics:
          
Volume & Price: Volume is the increase or decrease in products and/or services sold period-over-period excluding the impact of foreign exchange and price. The volume impact on profit is calculated by multiplying the prior period profit rate by the change in revenue volume between the current and prior period. Price is defined as the change in sales price for a comparable product or service period-over-period and is calculated as the period-over-period change in sales prices of comparable products and services.
                   
Foreign Exchange (“FX”): FX measures the translational foreign exchange impact, or the translation impact of the period-over-period change on sales and costs directly attributable to change in the foreign exchange rate compared to the U.S. dollar. FX impact is calculated by multiplying the functional currency amounts (revenue or profit) with the period-over-period FX rate variance, using the average exchange rate for the respective period.
                       
(Inflation)/Deflation: (Inflation)/deflation is defined as the increase or decrease in direct and indirect costs of the same type for an equal amount of volume. It is calculated as the year-over-year change in cost (i.e., price paid) of direct material, compensation & benefits and overhead costs.
                          
Productivity: Productivity is measured by the remaining variance in profit, after adjusting for the period-over-period impact of volume & price, foreign exchange and (inflation)/deflation as defined above. Improved or lower period-over-period cost productivity is the result of cost efficiencies or inefficiencies, such as cost decreasing or increasing more than volume, or cost increasing or decreasing less than volume, or changes in sales mix among segments. This also includes the period-over-period variance of transactional foreign exchange, aside from those foreign currency devaluations that are reported separately for business evaluation purposes.
 
 
5


 
Revenue and Segment Operating Income (Loss) Before Tax

Revenue and segment operating income (loss) for each of our four operating segments is provided below. 

   
GE O&G
Fiscal Year Ending December 31,
 
(in millions)
 
2016
   
2015
   
2014
 
Revenue
                 
Oilfield Services
   
799
     
1,411
     
2,232
 
Oilfield Equipment
   
3,547
     
5,060
     
5,927
 
Turbomachinery & Process Solutions
   
6,837
     
7,985
     
8,647
 
Digital Solutions
   
2,086
     
2,232
     
2,385
 
Total segment revenue
   
13,269
     
16,688
     
19,191
 
Segment operating income (loss)
                       
Oilfield Services
   
(204
)
   
(79
)
   
10
 
Oilfield Equipment
   
320
     
677
     
764
 
Turbomachinery & Process Solutions
   
1,255
     
1,684
     
1,562
 
Digital Solutions
   
355
     
409
     
483
 
Total segment operating income (loss)
   
1,726
     
2,691
     
2,819
 
Corporate
   
(380
)
   
(260
)
   
(164
)
Inventory impairment
   
(138
)
   
(51
)
   
(8
)
Impairment of goodwill
   
-
     
(2,080
)
   
-
 
Restructuring, impairment and other
   
(516
)
   
(411
)
   
(189
)
Merger and related costs
   
(33
)
   
(27
)
   
(67
)
Operating income (loss)
   
659
     
(138
)
   
2,391
 
Other non operating income (loss), net
   
27
     
100
     
124
 
Interest expense, net
   
(102
)
   
(120
)
   
(179
)
Income (loss) before income taxes
   
584
     
(158
)
   
2,336
 
Provision for Income Taxes
   
(250
)
   
(473
)
   
(484
)
Net income (loss)
   
334
     
(631
)
   
1,852
 
 
 
 
6


 

The following charts show historical segment revenues and segment operating income for each of our reportable segments for the years ended December 31, 2016, 2015 and 2014 as well as our revenues by geographic region for the year ended December 31, 2016:

Historical Segment Revenues and Segment Operating Income ($ millions)
 
     
Segment Revenues
 
Segment Operating Income
   
 

2016 Geographic Revenues ($13,269 million)
 



Fiscal Year 2016 to Fiscal Year 2015 Consolidated Performance

Revenue in 2016 was $13,269 million, a decrease of $3,419 million, or 20%, from 2015. This decrease was primarily due to the continued decline in customer activity across all product lines due to the continued weakness in oil prices. Oilfield Equipment decreased $1,513 million, Turbomachinery & Process Solutions decreased $1,148 million, Oilfield Services decreased $612 million, and Digital Solutions decreased $146 million.
                 
Total segment operating income in 2016 was $1,726 million, a decrease of $965 million, or 36%, from 2015. This decrease was primarily driven by the combined impact of lower volume and pricing headwinds. Turbomachinery & Process Solutions decreased $429 million, Oilfield Equipment decreased $357 million, Oilfield Services decreased $125 million, and Digital Solutions decreased $54 million.
 
 
 
7

 

Oilfield Services

Oilfield Services 2016 revenue was $799 million, a decrease of $612 million, or 43%, from 2015. This decline was primarily driven by the impact of lower oil prices on customer purchasing decisions throughout the year.
                     
Oilfield Services 2016 segment operating loss was $204 million, compared to a loss of $79 million in 2015. This decline in profitability was mainly due to lower cost productivity, partially offset by cost deflation.
               
Oilfield Equipment

Oilfield Equipment 2016 revenue was $3,547 million, a decrease of $1,513 million, or 30%, from 2015. This decline was primarily due to customers’ activity reductions, and to a lesser extent the strengthening of the U.S. dollar.
                    
Oilfield Equipment 2016 segment operating income was $320 million, compared to $677 million in 2015. This decline in profitability was the result of lower revenues and negative pricing, as well as lower cost productivity, partially offset by deflation savings.

Turbomachinery & Process Solutions

Turbomachinery & Process Solutions 2016 revenue was $6,837 million, a decrease of $1,148 million, or 14%, from 2015. The decline was primarily attributable to decreases in volume and price driven by uncertainty in the broader market, and delays in equipment contracts.
                 
Turbomachinery & Process Solutions 2016 segment operating income was $1,255 million, compared to $1,684 million in 2015. This decline in profitability was primarily due to the impact of lower volume and negative pricing.
           
Digital Solutions

Digital Solutions 2016 revenue was $2,086 million, a decrease of $146 million, or 7%, from 2015. This decline was due to lower sales volume driven by the delay of capital spending projects in the oil and gas sector.
                  
Digital Solutions 2016 segment operating income was $355 million, compared to $409 million in 2015. This decline in profitability was driven by lower cost productivity and weaker sales volume.
          
Corporate

In 2016, Corporate expenses were $380 million, an increase of $120 million compared to 2015. This was primarily due to selective increases in R&D program investments and lower cost productivity.
            
Restructuring, Impairment and Other

In 2016, GE O&G recognized $516 million in restructuring and other charges, an increase of $105 million compared to 2015. This increase was driven by continued focus on cost rationalization to better align GE O&G’s operating structure to market conditions and significant currency devaluations in Angola and Nigeria.
 
Merger and Related Costs

GE O&G recorded $33 million of merger and related costs in 2016, an increase of $6 million from the prior year, primarily related to the acquisition of Baker Hughes.
        
Interest Expense, Net

In 2016, GE O&G incurred net interest expenses of $102 million, a decrease of $18 million from the prior year, primarily related to the factoring of accounts receivable, mainly with GE Capital.
 
 
8

 

Income Tax

In 2016, GE O&G income tax expense decreased by $223 million, to $250 million from $473 million in 2015. This decrease was primarily due to a decline in profit excluding the impairment of non-deductible goodwill of $453 million, partially offset by a decrease in the benefit from global operations including foreign tax credit benefits of $132 million. The 2015 effective tax rate was unfavorably impacted by this goodwill impairment, which was non-deductible for tax purposes and increased the tax provision by $713 million relative to income tax expense had it been deductible.
                 
Fiscal Year 2015 to Fiscal Year 2014

Consolidated Performance

Revenue in 2015 was $16,688 million, a decrease of $2,503 million, or 13%, from 2014. This decrease was primarily due to the negative impact of the strengthening of the U.S. dollar on all segments along with lower volume due to weakness in oil prices. Oilfield Equipment decreased $867 million, Oilfield Services decreased $821 million, Turbomachinery & Process Solutions decreased by $662 million, and Digital Solutions decreased $153 million.
                               
Total segment operating income in 2015 was $2,691 million, a decrease of $128 million, or 5%, from 2014. This decline was primarily driven by the strengthening of the U.S. dollar in comparison to other currencies and the impact of lower volumes. Oilfield Services decreased $89 million, Oilfield Equipment decreased $87 million and Digital Solutions decreased $74 million, partially offset by an increase in Turbomachinery & Process Solutions of $122 million.
         
Oilfield Services

Oilfield Services 2015 revenue was $1,411 million, a decrease of $821 million, or 37%, compared to 2014. This decrease was primarily driven by lower volumes and weaker price on equipment and services product lines due to the decline in oil prices throughout the year.
                    
Oilfield Services 2015 segment operating loss was $79 million, compared to segment operating income of $10 million in 2014. This decline in profitability was mainly due to volume and price-related decreases.
               
Oilfield Equipment

Oilfield Equipment 2015 revenue was $5,060 million, a decrease of $867 million, or 15%, from 2014. The decrease was mainly attributable to the strengthening of the U.S. dollar.
                        
Oilfield Equipment 2015 segment operating income was $677 million, a decrease of $87 million from 2014. This decline in profitability was mainly due to the strengthening of the U.S. dollar and weaker volumes, partially offset by cost deflation and cost productivity.

Turbomachinery & Process Solutions

Turbomachinery & Process Solutions 2015 revenue was $7,985 million, a decrease of $662 million, or 8%, from 2014. The decrease was driven by the negative impact of the strengthening of the U.S. dollar, which offset volume and price-related increases.
                        
Turbomachinery & Process Solutions 2015 segment operating income was $1,684 million, an increase of $122 million from 2014. This increase in profitability was driven by strong cost productivity, volume and price increases and cost deflation.
         
Digital Solutions

Digital Solutions 2015 revenue was $2,232 million, a decrease of $153 million, or 6%, compared to 2014. This decrease was primarily driven by the impact of a stronger U.S. dollar and partially offset by an increase in volume.
                                  
 
9

 
 
Digital Solutions 2015 segment operating income was $409 million, compared to $483 million in 2014. The decline in profitability was mainly driven by the negative impact of the strengthening U.S. dollar, which more than offset strong cost productivity.
 
Corporate

In 2015, Corporate expenses were $260 million an increase of $96 million, compared to 2014. This increase was primarily due to selective increases in R&D program investments and localization efforts.
                  
Restructuring, Impairment and Other

In 2015, GE O&G implemented various restructuring programs designed to better align its cost structure to the change in economic conditions driven by a significant decline in oil prices. This combined with significant currency devaluations in Angola and Nigeria, resulted in restructuring and other charges of $411 million, an increase of $222 million compared to 2014.
 
Merger and Related Costs

GE O&G recorded $27 million of merger and related costs in 2015, a decrease of $40 million from the prior year. This reduction was primarily related to non-recurring trailing costs related to the acquisition of Lufkin Industries in 2014.
                  
Interest Expense, Net

In 2015, GE O&G incurred net interest expenses of $120 million, a decrease of $59 million from the prior year. This decrease was driven by an increase in interest income and a decrease in factoring expenses.
             
Income Tax

In 2015, GE O&G income tax expense decreased by $11 million, to $473 million from $484 million in 2014. This decrease was primarily due to a decrease in the benefit from global operations including foreign tax credit benefits of $174 million, partially offset by a decline in profit excluding the impairment of non-deductible goodwill of $160 million. The 2015 effective tax rate was unfavorably impacted by this goodwill impairment which was non-deductible for tax purposes and increased the tax provision by $713 million relative to income tax expense had it been deductible.
            
Financial Resources and Liquidity

GE O&G’s objective is to maintain sufficient liquidity and financial flexibility to fund its business operations. As of December 31, 2016, GE O&G had $981 million of cash and equivalents, compared to $1,432 million at December 31, 2015. As of December 31, 2016, approximately $878 million of the $981 million of cash and equivalents was held by GE O&G’s foreign subsidiaries and would be subject to United States tax if repatriated. GE O&G’s intent is to permanently reinvest these funds outside of the United States and current plans do not suggest a need to repatriate such funds to fund GE O&G’s United States operations.

GE O&G mainly generates its cash from its operating activities. Historically GE O&G has participated in GE’s cash pooling arrangements to access liquidity and fund its operations, the effect of which is treated as net parent investment for carve out financial statement purposes. GE O&G has accessed third party bank debt when needed to fill its short-term cash needs. GE O&G has not borrowed material amounts from third party banks or the capital markets to fund its operations.

GE O&G has committed credit lines of $200 million that have been extended to it by three banks as of December 31, 2016. As of December 31, 2016, $128 million of these credit facilities remained available for use.
 
 
10


 
GE O&G has undertaken certain transactions with related parties, primarily GE Capital, through which it can monetize its accounts receivable through the sale of these receivable to GE Capital’s Working Capital Solutions. GE O&G monetizes receivables, as and when needed, to generate liquidity without the use of the capital markets. GE O&G pays commission and servicing fees to GE Capital’s Working Capital Solutions for these transactions when they are consummated.

GE O&G believes that cash on hand, cash flows generated from operations and the available credit facility will provide sufficient liquidity to manage its global cash needs.

As of December 31, 2016, $752 million of cash and equivalents were held in bank accounts and cannot be released, transferred or otherwise converted into a currency that is regularly transacted internationally, due to lack of market liquidity, capital controls or similar monetary or exchange limitations limiting the flow of capital out of the jurisdiction.
                     
Cash Flows

The following table summarizes cash flows generated from (used in) each type of activity for each period (in millions):
                   
 
GE O&G Fiscal Year Ending
December 31,
 
 
2016
 
2015
 
2014
 
Operating activities
 
$
262
   
$
1,277
   
$
1,887
 
Investing activities
   
(472
)
   
(466
)
   
(836
)
Financing activities
   
(102
)
   
(515
)
   
(388
)
 
 
Operating Activities

GE O&G’s largest source of operating cash is payments from customers, of which the largest component is collecting cash related to product or services sales including advance payments or progress collections for work to be performed. The primary use of operating cash is to pay GE O&G’s suppliers, employees, tax authorities and others for a wide range of material and services.

Cash flows from operating activities generated $262 million and $1,277 million for the years ended December 31, 2016 and 2015, respectively. Cash flows from operating activities decreased $1,015 million in 2016 primarily due to the decrease in net income, partially offset by improvements in other working capital categories, due to improvements in the collection of past due receivables, improved inventory management and restructuring.
                        
Cash flows from operating activities generated $1,277 million and $1,887 million for the years ended December 31, 2015 and 2014, respectively. Cash flows from operating activities decreased $610 million in 2015 primarily due to a decrease in progress collections driven by market conditions. This was offset by an improvement in the other working capital categories, primarily receivables and inventory, due to an improvement in collections of past due receivables, improved inventory management and restructuring efforts.
           
Investing Activities

Cash flows from investing activities used $472 million and $466 million for the years ended December 31, 2016 and 2015, respectively. GE O&G’s principal recurring investing activity is the funding of capital expenditures, including property plant and equipment and software, to support operations. Expenditures for capital assets were $424 million in 2016 and $607 million in 2015. There were no material acquisitions or dispositions in 2016; however, in 2015 GE O&G generated approximately $181 million from business dispositions and utilized $86 million cash in business acquisitions.
                            
Cash flows from investing activities used $466 million and $836 million for the years ended December 31, 2015 and 2014, respectively. Expenditures for capital assets were $607 million and $686 million in 2015 and 2014, respectively. The decline in capital expenditures in 2015 is a result of GE O&G’s rationalization of investments aligned to the lower market activity. In 2014, $592 million was utilized to acquire businesses, primarily Cameron’s Reciprocating Compression division for $550 million. In addition, GE O&G recognized proceeds from the sale of assets of $441 million, primarily from the sale of the Wayne Fueling Systems business of $485 million.
 
 
11

 

 
Financing Activities
 
Cash utilized in financing activities for 2016 was $102 million, a decrease of $413 million compared to 2015. This was primarily driven by a net contribution to GE as part of the cash pooling activity that is included in the net transfer (to)/from parent component on the Statement of Cash Flows.

Cash utilized in financing activities for 2015 was $515 million, an increase of $127 million compared to 2014. This was primarily driven by a net transfer to GE as part of the cash pooling activity that is included in the net transfer (to)/from parent component on the Statement of Cash Flows $960 million, partially offset by a change in borrowings of $797 million.
            
Contractual Obligations

The following table summarizes GE O&G’s significant contractual obligations and other long-term liabilities as of December 31, 2016 (in millions): 
                               
 
 
Total
   
Less than
1 year
   
2-3 years
   
4-5 years
   
More than
5 years
 
Long-Term Debt(a)
 
$
156
   
$
118
   
$
35
   
$
1
   
$
2
 
Operating leases(b)
   
516
     
94
     
159
     
109
     
154
 
Purchase obligations(c)
   
489
     
479
     
10
     
     
 
Other long term liabilities(d)
   
540
     
48
     
44
     
28
     
420
 
(a)
Represents principal amount of long-term debt, including current maturities. The interest on this debt is between $1-2 million per year and reflected in the table above in long-term debt.
(b)
Amounts represent the future minimum payments under noncancelable operating leases with an initial term of one year or more. GE O&G does not include options unless exercise of that option is anticipated.
(c)
Represents purchase orders for goods and services utilized in the normal course of business.
(d)
Includes capital lease obligations, capital expenditures and pension funding obligations. The following non-current liabilities are excluded from the table above: derivatives, deferred revenue and other miscellaneous items. For further information on certain of these items, see Note 11, Borrowings, Note 13, All Other Liabilities, and Note 19, Commitments and Product Warranties to the GE O&G combined financial statements included in Exhibit 99.3 to this Current Report on Form 8-K. See Note 14, Income Taxes, to the GE O&G combined financial statements included in Exhibit 99.3 to this Current Report on Form 8-K for disclosures surrounding uncertain income tax positions. Additionally, liabilities for uncertain tax positions totaling $149 million, including interest and penalties, are not included in the table because the timing of their resolution cannot be estimated.
           
 
Other Factors Affecting Liquidity

Customer receivables: In line with industry practice, GE O&G may bill its customers for services provided in arrears dependent upon contractual terms. In a challenging economic environment, GE O&G may experience delays in the payment of its invoices due to customers’ lower cash flow from operations or their more limited access to credit markets. While historically there have not been material non-payment events, GE O&G attempts to mitigate this risk through the sale of its receivables in monetization programs or working with its customers to restructure their debts; however, not all countries and programs allow monetization on a non-recourse basis. A customer’s failure or delay in payment could have a material adverse effect on GE O&G’s short-term liquidity and results from operations. As of December 31, 2016, GE O&G has no customer balances which exceed 10% of GE O&G’s net customer receivables.
 
 
12


 
International operations: GE O&G’s cash that is held outside the United States, which comprised 90% of the total cash balance as of December 31, 2016, is in certain circumstances subject to exchange or cash controls that could make it challenging to quickly access. As a result, GE O&G’s cash balance may not represent its ability to quickly and efficiently use this cash.
 
Off Balance Sheet Commitments

In addition to the above-referenced contractual obligations, GE O&G has additional contractual commitments and other commitments that are not necessarily reflected in GE O&G’s consolidated balance sheet. Such commitments as of December 31, 2016 are as follows:
 
Guarantees Related to Operating Activities

Commitments relate mainly to guarantees or counter-guarantees given by banks and insurance companies to various customers in connection with ongoing contracts to secure due and proper performance of the contracts or following the payment of retention guarantees and advance billings of $48 million as of December 31, 2016.
 
Quantitative and Qualitative Disclosures about Market Risk

Cash Flow Hedges

GE O&G’s business involves buying, manufacturing and selling components and products across global markets. These activities expose GE O&G to changes in foreign currency exchange rates, commodity prices and interest rates which can adversely affect revenues earned and costs of its operating businesses. When the currency in which equipment is sold differs from the primary currency of the legal entity and the exchange rate fluctuates, it will affect the revenue earned on the sale. These sales and purchase transactions also create receivables and payables denominated in foreign currencies and exposure to foreign currency gains and losses based on changes in exchange rates. Changes in the price of raw materials used in manufacturing can affect the cost of manufacturing. GE O&G uses derivatives to mitigate or eliminate these exposures, where appropriate.

GE O&G uses cash flow hedging primarily to reduce or eliminate the effects of foreign currency exchange rate changes on purchase and sale contracts. Accordingly, most derivative activity in this category consists of currency exchange contracts. GE O&G had outstanding foreign currency forward contracts with notional amounts aggregating $6,430 million and $8,017 million to hedge exposure to currency fluctuations in various foreign currencies at December 31, 2016 and 2015, respectively. Based on quoted market prices as of December 31, 2016 or 2015 for forward contracts with similar terms and maturity dates, GE O&G recorded losses, both realized and unrealized in nature, of $273 million and $117 million, respectively, to adjust these forward contracts to their fair market value. As at December 31, 2016 GE O&G estimates that a 1% appreciation or depreciation in the U.S. dollar would result in impact of approximately $10 million to the financial results of GE O&G, as GE O&G is generally able to mitigate its foreign exchange exposure, where there are liquid financial markets, through use of foreign currency derivative transactions.
 
Changes in and Disagreements with Accountants and Financial Disclosure

None.
 
Critical Accounting Estimates

Accounting estimates and assumptions discussed in this section are those considered to be the most critical to an understanding of GE O&G’s financial statements because they involve significant judgments and uncertainties. Many of these estimates include determining fair value. These estimates reflect GE O&G’s best judgment about current, and for some estimates future, economic and market conditions and their potential effects based on information available as of the date of these financial statements. If these conditions change from those expected, it is reasonably possible that the judgments and estimates described below could change, which may result in future impairments of goodwill, intangibles and long-lived assets, increases in reserves for contingencies, establishment of valuation allowances on deferred tax assets and increased tax liabilities, among other effects. Also, see Note 2, Accounting Policies to the consolidated financial statements, which discusses GE O&G’s most significant accounting policies.
 
 
13

 

 
Revenue Recognition on Long-Term Product Services Agreements

Revenue recognition on long-term product services agreements requires estimates of profits over the multiple-year terms of such agreements, considering factors such as the frequency and extent of future monitoring, maintenance and overhaul events, the amount of personnel, spare parts and other resources required to perform the services, and future billing rate, cost changes and customers’ utilization of assets. GE O&G routinely reviews estimates under product services agreements and regularly revises them to adjust for changes in the outlook for revenue recognition.

GE O&G also regularly assesses customer credit risk inherent in the carrying amounts of receivables, contract costs and estimated earnings, including the risk that contractual penalties may not be sufficient to offset its accumulated investment in the event of customer termination. GE O&G gains insight into future utilization and cost trends, as well as credit risk, through its knowledge of the installed base of equipment and the close interaction with its customers that comes with supplying critical services and parts over extended periods. Revisions, after applying the cumulative catch-up basis of accounting, may affect a product services agreement’s total estimated profitability, resulting in an adjustment of earnings; such adjustments increased earnings by $293 million, $256 million and $145 million in the years ending December 31, 2016, 2015 and 2014, respectively. GE O&G provides for probable losses when they become evident. GE O&G continues to evaluate the provisions of ASC 605-35, Revenue from Contracts with Customers, and the assessment of the impact, on GE O&G’s combined financial statements and related disclosures. Also, see Note 2 to the consolidated financial statements for additional information and disclosure.
 
Goodwill and Other Identified Intangible Assets

GE O&G tests goodwill for impairment annually using data as of July 1 of that year. The impairment test consists of two different steps: in step one, the carrying value of the reporting unit is compared with its fair value; in step two, which is applied when the carrying value is more than its fair value, the amount of goodwill impairment, if any, is derived by deducting the fair value of the reporting unit’s assets and liabilities from the fair value of its equity and comparing that amount with the carrying amount of goodwill. GE O&G determines fair values of each of the reporting units using the market approach, when available and appropriate, or the income approach, or a combination of both. GE O&G assesses the valuation methodology based upon the relevance and availability of the data at the time the valuation is performed.
 
Pension Assumptions

Pension benefits are calculated using significant inputs to the actuarial models that measure pension benefit obligations and related effects on operations. Two assumptions, discount rate and expected return on assets, are important elements of plan expense and asset/liability measurement. GE O&G evaluates these critical assumptions at least annually on a plan- and country-specific basis. GE O&G periodically evaluates other assumptions involving demographic factors such as retirement age, mortality and turnover, and updates them to reflect its experience and expectations for the future. Actual results in any given year will often differ from actuarial assumptions because of economic and other factors.

Projected benefit obligations are measured as the present value of expected payments discounted using the weighted average of market-observed yields for high-quality fixed-income securities with maturities that correspond to the payment of benefits; lower discount rates increase present values and subsequent-year pension expense and higher discount rates decrease present values and subsequent-year pension expense.
                           
GE O&G’s discount rates for principal pension plans at December 31, 2016, 2015 and 2014 were 3.41%, 3.83% and 3.69%, respectively, reflecting market interest rates. GE O&G’s expected return on assets at December 31, 2016, 2015 and 2014 were 6.86%, 6.91%, and 6.66%, respectively. The discount rate and expected return on assets have not changed significantly from our December 31, 2016 assumptions.
 
 
14

 

 
Income Taxes

We operate in more than 120 countries and our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in these various jurisdictions. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Our income tax rate is impacted by the tax rate on our global operations. In addition to local country tax laws and regulations, this rate depends on the extent earnings are indefinitely reinvested outside the United States. Indefinite reinvestment is determined by future operations of the Business. At December 31, 2016 and 2015, approximately $11,936 million and $11,204 million of earnings, respectively, have been indefinitely reinvested outside the United States. Most of these earnings have been reinvested in active non-U.S. business operations, and we do not intend to repatriate these earnings to fund U.S. operations. Because of the availability of U.S. foreign tax credits, it is not practicable to determine the U.S. federal income tax liability that would be payable if such earnings were not reinvested indefinitely.

Deferred income tax assets represent amounts available to reduce income taxes payable in future years. We evaluate the recoverability of these future deductions and credits by assessing the adequacy of future taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. These sources of income rely heavily on estimates. We use our historical experience and short- and long-range business forecasts to provide insight. Further, our global business gives us the opportunity to employ various prudent and feasible tax planning strategies to facilitate the recoverability of future deductions.
                                                           
Our tax filings routinely are subject to audit by the tax authorities in the jurisdictions where we conduct business. These audits may result in assessments of additional taxes that are resolved with the tax authorities or through the courts. We have provided for the amounts we believe will ultimately result from these proceedings, but settlements of issues raised in these audits may affect our tax rate.
                                                           
GE O&G has $94 million of gross unrecognized tax benefits at December 31, 2016, of which an immaterial amount may require a cash payment. GE O&G is not able to reasonably estimate in which future periods these amounts ultimately will be settled and paid.
 
Derivatives and Hedging

GE O&G operates in more than 120 countries and are subject to market risks primarily associated with changes in foreign currency exchange rates. GE O&G maintains a foreign-currency risk management strategy that uses derivative instruments to protect its interests from unanticipated fluctuations in earnings and cash flows caused by volatility in currency exchange rates. Foreign currency forward contracts provide a hedge against currency fluctuations on monetary assets/liabilities and future committed cash flows denominated in other than a functional currency.

GE O&G had outstanding foreign currency forward contracts with notional amounts aggregating $6,430 million and $8,017 million to hedge exposure to currency fluctuations in various foreign currencies at December 31, 2016 and 2015, respectively. Based on quoted market prices as of December 31, 2016, 2015 and 2014, for forward contracts with similar terms and maturity dates, GE O&G records losses of $273 million, $117 million and $109 million, respectively, to adjust these forward contracts to their fair market value. Also, see Note 18, Derivatives to the consolidated financial statements, which has additional details on GE O&G’s strategy.
 
Other Loss Contingencies

Other loss contingencies are uncertain and unresolved matters that arise in the ordinary course of business and result from events or actions by others that have the potential to result in a future loss. Such contingencies include, but are not limited to, environmental obligations, litigation, regulatory proceedings, product quality and losses resulting from other events and developments.

When a loss is considered probable and reasonably estimable, a liability is recorded in the amount of GE O&G’s best estimate for the ultimate loss. When there appears to be a range of possible costs with equal likelihood, liabilities are based on the low end of such range. However, the likelihood of a loss, with respect to a contingency, is often difficult to predict and determining a meaningful estimate of the loss or a range of loss may not be practicable based on the information available and the potential effect of future events and decisions by third parties that will determine the ultimate resolution of the contingency.
 
 
15

 
 
Moreover, it is not uncommon for such matters to be resolved over many years, during which time relevant developments and new information must be continuously evaluated to determine both the likelihood of potential loss and whether it is possible to reasonably estimate a range of possible loss. When a loss is probable but a reasonable estimate cannot be made, disclosure is provided.
                       
Disclosure is also provided when it is reasonably possible that a loss will be incurred or when it is reasonably possible that the amount of a loss will exceed the recorded provision. GE O&G regularly reviews all contingencies to determine whether the likelihood of loss has changed and to assess whether a reasonable estimate of the loss, or range of loss, can be made. As discussed above, development of a meaningful estimate of loss or a range of potential loss is complex when the outcome is directly dependent on negotiations with, or decisions by, third parties, such as regulatory agencies, the court system and other interested parties. Such factors bear directly on whether it is possible to reasonably estimate a range of potential loss and boundaries of high and low estimates.
 

 
 
 
 
 
 
 
 
 
 
16
 
Exhibit 99.3

 
INDEX TO FINANCIAL STATEMENTS

CONTENTS
 
 
     
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
3
     
COMBINED STATEMENT OF INCOME (LOSS)
4
     
COMBINED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
5
     
COMBINED STATEMENT OF CHANGES IN EQUITY
6
     
COMBINED STATEMENT OF FINANCIAL POSITION
7
     
COMBINED STATEMENT OF CASH FLOWS
8
     
NOTES TO THE COMBINED FINANCIAL STATEMENTS
9
 
     
NOTE 1
DESCRIPTION OF THE BUSINESS
9
     
NOTE 2
BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
9
     
NOTE 3
ACQUISITIONS AND DISPOSITIONS
23
     
NOTE 4
CURRENT RECEIVABLES
23
     
NOTE 5
INVENTORIES
24
     
NOTE 6
PROPERTY, PLANT AND EQUIPMENT
24
     
NOTE 7
GOODWILL
25
     
NOTE 8
OTHER INTANGIBLE ASSETS
26
     
NOTE 9
CONTRACT ASSETS
27
     
NOTE 10
ACCOUNTS PAYABLE
27
     
NOTE 11
BORROWINGS
28
     
NOTE 12
POSTRETIREMENT BENEFIT PLANS
29
     
NOTE 13
ALL OTHER LIABILITIES
37
     
NOTE 14
INCOME TAXES
38
     
NOTE 15
EQUITY
42
     
NOTE 16
EQUITY-ACCOUNTED INVESTMENTS
45
     
 
1    GE O&G Annual FS

 
 
     
     
NOTE 17
FAIR VALUE MEASUREMENTS
46
     
NOTE 18
DERIVATIVES
47
     
NOTE 19
COMMITMENTS, CONTINGENCIES AND PRODUCT WARRANTIES
51
     
NOTE 20
RELATED PARTIES
52
     
NOTE 21
SEGMENT INFORMATION
54
     
NOTE 22
STOCK BASED COMPENSATION
56
     
NOTE 23
RESTRUCTURING, IMPAIRMENT AND OTHER
60
     
NOTE 24
SUBSEQUENT EVENTS
61

 
 
 
 
 
 
 
 
 
 

2    GE O&G Annual FS



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Report of Independent Registered Public Accounting Firm

The Board of Directors of General Electric Company:

We have audited the accompanying combined statement of financial position of GE Oil & Gas (the “Company”, a business within General Electric Company) as of December 31, 2016 and 2015, and the related combined statements of income (loss), comprehensive income (loss), changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2016. These combined financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these combined financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States) and in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the combined financial statements referred to above present fairly, in all material respects, the combined financial position of the Company as of December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles.

/s/ KPMG S.p.A. Florence, Italy
March 16, 2017, except as to Note 21
which is as of December 4, 2017
 
 
 
 
 
 
 
3    GE O&G Annual FS


 
COMBINED STATEMENT OF INCOME (LOSS)
For the years ended December 31 (In millions)
 
2016
   
2015
   
2014
 
Revenues
                 
Sales of goods
 
$
9,488
   
$
12,353
   
$
14,464
 
Sales of services
   
3,781
     
4,335
     
4,727
 
  Total revenues
   
13,269
     
16,688
     
19,191
 
                         
Costs and expenses
                       
Cost of goods sold
   
7,816
     
9,271
     
10,508
 
Cost of services sold
   
2,307
     
2,922
     
3,748
 
Selling, general and administrative expenses
   
1,938
     
2,115
     
2,288
 
Impairment of goodwill
   
-
     
2,080
     
-
 
Restructuring, impairment and other
   
516
     
411
     
189
 
Merger and related costs
   
33
     
27
     
67
 
  Total costs and expenses
   
12,610
     
16,826
     
16,800
 
Operating income (loss)
   
659
     
(138
)
   
2,391
 
Other non operating income (loss), net
   
27
     
100
     
124
 
Interest expense, net
   
(102
)
   
(120
)
   
(179
)
Income (loss) before income taxes
   
584
     
(158
)
   
2,336
 
                         
Provision for income taxes
   
(250
)
   
(473
)
   
(484
)
Net income (loss)
   
334
     
(631
)
   
1,852
 
                         
Less net income (loss) attributable to noncontrolling interests
   
(69
)
   
(25
)
   
12
 
Net income (loss) attributable to parent
 
$
403
   
$
(606
)
 
$
1,840
 

See Notes to the Combined Financial Statements
 
4    GE O&G Annual FS


 
COMBINED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
For the years ended December 31 (In millions)
 
2016
   
2015
   
2014
 
Net income (loss)
 
$
334
   
$
(631
)
 
$
1,852
 
Less net income (loss) attributable to noncontrolling interests
   
(69
)
   
(25
)
   
12
 
Net income (loss) attributable to parent
   
403
     
(606
)
   
1,840
 
 
                       
Other comprehensive income (loss)
                       
    Currency translation adjustments
   
(422
)
   
(617
)
   
(129
)
    Cash flow hedges
   
(8
)
   
(2
)
   
-
 
    Benefit plans
   
54
     
40
     
(94
)
Other comprehensive (loss)
   
(376
)
   
(579
)
   
(223
)
Less other comprehensive (loss) attributable to noncontrolling interests
   
(14
)
   
(11
)
   
(8
)
Other comprehensive (loss) attributable to parent
   
(362
)
   
(568
)
   
(215
)
 
                       
Comprehensive income (loss)
   
(42
)
   
(1,210
)
   
1,629
 
Less comprehensive income (loss) attributable to noncontrolling interests
   
(83
)
   
(36
)
   
4
 
Comprehensive income (loss) attributable to parent
 
$
41
   
$
(1,174
)
 
$
1,625
 

Amounts presented net of taxes. See Note 15 for further information about other comprehensive income (loss) and noncontrolling interests.

See Notes to the Combined Financial Statements
 
5    GE O&G Annual FS
 


 
COMBINED STATEMENT OF CHANGES IN EQUITY
(In millions)
 
2016
   
2015
   
2014
 
Equity balance at January 1
 
$
14,388
   
$
16,205
   
$
14,689
 
Net income (loss) attributable to parent
   
403
     
(606
)
   
1,840
 
Other comprehensive (loss) attributable to parent
   
(362
)
   
(568
)
   
(215
)
Net transfers (to) / from parent
   
259
     
(643
)
   
(109
)
Ending balance at December 31
   
14,688
     
14,388
     
16,205
 
Noncontrolling interests
   
167
     
157
     
181
 
Total equity balance at December 31
 
$
14,855
   
$
14,545
   
$
16,386
 

See Notes to the Combined Financial Statements
 
 
 
6    GE O&G Annual FS


 
COMBINED STATEMENT OF FINANCIAL POSITION
December 31 (In millions)
 
2016
   
2015
 
Current assets
           
Cash and equivalents
 
$
981
   
$
1,432
 
Current receivables (Note 4)
   
2,563
     
2,818
 
Inventories (Note 5)
   
3,224
     
3,671
 
Other current assets
   
633
     
488
 
Total current assets
   
7,401
     
8,409
 
                 
Property, plant & equipment-net (Note 6)
   
2,325
     
2,554
 
Goodwill (Note 7)
   
6,680
     
6,867
 
Other intangible assets - net (Note 8)
   
2,449
     
2,676
 
Contract assets (Note 9)
   
1,967
     
1,666
 
All other assets
   
573
     
627
 
Deferred income taxes (Note 14)
   
326
     
334
 
Total assets
 
$
21,721
   
$
23,133
 
 
               
Current liabilities
               
Short-term borrowings (Note 11)
   
239
     
384
 
Accounts payable, principally trade accounts (Note 10)
   
1,898
     
2,222
 
Current compensation and benefits
   
10
     
10
 
Progress collections
   
1,596
     
2,310
 
All other current liabilities (Note 13)
   
1,191
     
1,631
 
Total current liabilities
   
4,934
     
6,557
 
                 
Long-term borrowings (Note 11)
   
38
     
13
 
Non-current compensation and benefits
   
519
     
641
 
All other non-current  liabilities (Note 13)
   
495
     
523
 
Deferred income taxes (Note 14)
   
880
     
854
 
Total liabilities
 
$
6,866
   
$
8,588
 
 Equity
               
Accumulated other comprehensive (loss) – net attributable to parent (Note 15)
               
   Currency translation adjustments
   
(1,801
)
   
(1,384
)
   Cash flow hedges
   
(10
)
   
(2
)
   Benefit plans
   
(83
)
   
(146
)
Net parent investment
   
16,582
     
15,920
 
Total equity attributable to parent
   
14,688
     
14,388
 
Noncontrolling interests (a)
   
167
     
157
 
Total equity
   
14,855
     
14,545
 
Total liabilities and equity
 
$
21,721
   
$
23,133
 

(a) Included AOCI attributable to noncontrolling interests of $(51) million and $(37) million at December 31, 2016 and December 31, 2015, respectively.

See Notes to the Combined Financial Statements
 
7    GE O&G Annual FS

 
COMBINED STATEMENT OF CASH FLOWS
For the years ended December 31 (In millions)
 
2016
   
2015
   
2014
 
Cash flows - operating activities
                 
Net income (loss)
 
$
334
   
$
(631
)
 
$
1,852
 
Less net income (loss) attributable to noncontrolling interests
   
(69
)
   
(25
)
   
12
 
Net income (loss) attributable to parent
   
403
     
(606
)
   
1,840
 
Adjustments to reconcile net income (loss) attributable to parent to cash
                       
   provided by operating activities:
                       
   Depreciation and amortization
   
550
     
530
     
443
 
   Goodwill impairment
   
-
     
2,080
     
-
 
   Deferred income taxes
   
39
     
(96
)
   
(246
)
   Decrease (increase) in current receivables
   
278
     
469
     
(102
)
   Decrease (increase) in inventories
   
345
     
442
     
(231
)
   (Decrease) in accounts payable
   
(256
)
   
(450
)
   
(131
)
   Increase (decrease) in progress collections
   
(714
)
   
(867
)
   
(18
)
   Deferred charges
   
(292
)
   
(87
)
   
(46
)
   All other operating activities
   
(91
)
   
(138
)
   
378
 
Cash from operating activities
   
262
     
1,277
     
1,887
 
Cash flows - investing activities
                       
Expenditure for capital assets
   
(424
)
   
(607
)
   
(686
)
Proceeds from disposal of assets
   
20
     
30
     
26
 
Proceeds from principal business dispositions
   
-
     
181
     
441
 
Net cash from (payments for) principal businesses purchased
   
(1
)
   
(86
)
   
(592
)
All other investing activities
   
(67
)
   
16
     
(25
)
Cash (used for) investing activities
   
(472
)
   
(466
)
   
(836
)
Cash flows - financing activities
                       
Net increase (decrease) in borrowings (maturities of 90 days or less)
   
(78
)
   
105
     
(606
)
Repayments and other reductions (maturities longer than 90 days)
   
(235
)
   
(18
)
   
(107
)
Newly issued debt (maturities longer than 90 days)
   
157
     
90
     
93
 
Net transfer (to) / from parent
   
191
     
(708
)
   
252
 
All other financing activities
   
(137
)
   
16
     
(20
)
Cash (used for) financing activities
   
(102
)
   
(515
)
   
(388
)
Effect of currency exchange rate changes on cash and equivalents
   
(139
)
   
(254
)
   
(53
)
Increase (decrease) in cash and equivalents
   
(451
)
   
42
     
610
 
Cash and equivalents at beginning of year
   
1,432
     
1,390
     
780
 
Cash and equivalents at end of year
 
$
981
   
$
1,432
   
$
1,390
 
Supplemental disclosure of cash flow information
                       
Cash paid during the year for interest
 
$
55
   
$
52
   
$
68
 
Cash paid for taxes
   
317
     
264
     
205
 

See Notes to the Combined Financial Statements
 
8    GE O&G Annual FS
 


 
NOTES TO THE COMBINED FINANCIAL STATEMENTS
NOTE 1
DESCRIPTION OF THE BUSINESS
GE Oil and Gas (the “Business,” “GE O&G,” “we,” “our,” or “us”) offers its customers a leading portfolio of advanced technology and optimization support across the oil and gas value chain.  With its operational headquarters in London, United Kingdom, the Business is comprised of assets, liabilities, and results of operations of certain dedicated legal entities within General Electric Company (“GE”), a U.S. listed company, as well as certain non-GE O&G legal entities, which are shared legal entities within GE.
We have global operations with a presence in North America, Europe, Asia, Africa, Australia and Latin America and generate approximately 76% of our revenue from outside of the United States of America. The Business has approximately 34,500 employees in more than 120 countries and has four operating segments: Oilfield Services (OFS), Oilfield Equipment (OFE), Turbomachinery & Process Solutions (TPS) and Digital Solutions (DS).
 
NOTE 2
BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
     
BASIS OF PRESENTATION
These combined financial statements were prepared on a stand-alone basis derived from the consolidated financial statements and accounting records of GE. These combined financial statements as of December 31, 2016 and 2015 and for each of the years ended December 31, 2016, 2015 and 2014 are presented as carve-out financial statements and reflect the combined historical results of operations, financial position and cash flows of GE O&G, in conformity with U.S. generally accepted accounting principles (“GAAP”).

All significant intercompany balances and transactions within the Business have been eliminated in these combined financial statements. As described in Note 20, certain transactions between the Business and GE have been included in the combined financial statements.

The combined financial statements reflect the attribution of the specifically identifiable assets and liabilities of the Business, including goodwill and other identifiable intangible assets arising from the historical acquisitions of businesses comprising GE O&G. Where a business included within the scope of GE O&G as of December 31, 2016 was historically acquired and operated within another GE business unit, the combined financial statements reflect the assets, liabilities and results of operations of those businesses on a fully retrospective basis (in accordance with the guidance applicable to transactions between entities under common control) based on their carrying values, as reflected in the accounting records of GE.

GE uses a centralized approach to cash management and financing of its operations. This arrangement is not reflective of the manner in which the Business would have financed its operations had it been a stand-alone business separate from GE during the periods presented. Long-term intercompany financing, including strategic financing, and cash pooling arrangements, which are used to fund expansion or certain working capital needs, are excluded from the asset and liability balances in the Combined Statement of Financial Position. These amounts have instead been reported as “Net parent investment” as a component of equity.

GE and its affiliates provide a variety of services to the Business. Certain services, such as employee payroll, administering employee benefits plans and paying related claims, provision of voice and data networking, facility rent, outsourcing of certain functions, and other corporate services and overhead (including costs for executive compensation and stock options), are charged to the Business. In circumstances where charges were not historically billed to the Business by GE (or charges billed were not reflective of the full costs of doing business), those charges have been allocated to the Business and are reflected as Selling, general and administrative expenses in the Combined Statement of Income (Loss). Where specific identification of charges was not practicable, a reasonable method of allocation was applied to those charges based on either a proportional share of operating revenues, headcount, personnel costs, or estimates of use and the resulting allocation to the Business is recorded in Selling, general and administrative expenses in the Combined Statement of Income (Loss).
 
 
9    GE O&G Annual FS

 
The Business believes the allocations of these amounts were determined on a reasonable basis and the methods were applied consistently for the periods presented and reflect all of the costs of GE O&G. These allocated amounts, however, are not necessarily indicative of the actual amounts that might have been incurred or realized had GE O&G operated as a separate stand-alone entity during the periods presented. Consequently, the combined financial statements do not necessarily represent the results the Business would have achieved if the Business had operated as a separate stand-alone entity during the periods presented.

Certain columns and rows may not add due to the use of rounded numbers.

ACCOUNTING POLICIES
FOREIGN CURRENCY
Assets and liabilities of non-U.S. operations with a functional currency other than the U.S. dollar have been translated into U.S. dollars at the quarterly exchange rates, and revenues, expenses, and cash flows have been translated at average rates for the respective periods.  Any resulting translation gains and losses are included in Other comprehensive income (loss).

Gains and losses from foreign currency transactions, such as those resulting from the settlement of receivables or payables in the non-functional currency and those resulting from remeasurements of monetary items, are included in the Combined Statement of Income (Loss). A loss of $40 million and gains of $26 million, and $68 million were incurred for each of the years ended December 31, 2016, 2015 and 2014, respectively.

USE OF ESTIMATES

The preparation of combined financial statements in conformity with GAAP requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, disclosure of any contingent assets or liabilities at the date of the combined financial statements and the reported amounts of revenue and expenses during the reporting period. We base our estimates and judgments on historical experience and on various other assumptions and information that we believe to be reasonable under the circumstances. Estimates and assumptions about future events and their effects cannot be perceived with certainty, and accordingly, these estimates may change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes. While the Business believes that the estimates and assumptions used in the preparation of the combined financial statements are appropriate, actual results could differ from those estimates. Estimates are used for, but are not limited to, determining the following: allowance for doubtful accounts and inventory valuation reserves; recoverability of long-lived assets, including revenue recognition on long term contracts, valuation of goodwill; useful lives used in depreciation and amortization; income taxes and related valuation allowances; accruals for contingencies; actuarial assumptions to determine costs and liabilities related to employee benefit plans; stock-based compensation expense, valuation of derivatives and the fair value of assets acquired and liabilities assumed in acquisitions.

COST AND EQUITY-ACCOUNTED INVESTMENTS

Investments in privately held companies in which we do not have the ability to exercise significant influence, most often because we hold a voting interest of 0% to 20% are accounted for using the cost method. The carrying values of these investments as of December 31, 2016 and 2015 are $53 million and $13 million.

Associated companies are entities in which we do not have a controlling financial interest, but over which we have significant influence, most often because we hold a voting interest of 20% to 50%. Associated companies are accounted for as equity method investments. Results of associated companies are presented on a one-line basis. Investments in, and advances to, associated companies are presented on a one-line basis in the caption “All other assets” in our Combined Statement of Financial Position. See Note 16 for additional information.
 
 
10    GE O&G Annual FS

 


RESTRUCTURING COSTS

Costs of restructuring are accounted for according to FASB Accounting Standards Codification (“ASC”) 420, Exit or Disposal Cost Obligations, and other related pronouncements. ASC 420 requires that a liability for costs associated with an exit or disposal activity be recognized when the liability is incurred.

SEGMENT REPORTING

We conduct our operations through several business segments, which are organized based on the nature of markets and customers. Pursuant to ASC 280, Segment Reporting, operating segments represent components of an enterprise for which separate financial information is available that is regularly evaluated by the chief operating decision maker in determining how to allocate resources and in assessing performance. The chief operating decision maker uses a variety of measures to assess the performance of the Business as a whole, depending on the nature of the activity. Operating activities are managed through four operating segments: Oilfield Services (OFS), Oilfield Equipment (OFE), Turbomachinery & Process Solutions (TPS) and Digital Solutions (DS). The performance of these four segments is principally measured based on revenues and operating profit.

SALES OF GOODS AND SERVICES

We record all sales of goods and services only when a firm sales agreement is in place, delivery has occurred or services have been rendered and collectability of the fixed or determinable sales price is reasonably assured.

Except for goods sold under long-term construction type contracts and service agreements, we recognize sales of goods under the provisions of U.S. Securities and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) 104, Revenue Recognition.  In situations where arrangements include customer acceptance provisions based on seller or customer-specified objective criteria, we recognize revenue when we have reliably demonstrated that all specified acceptance criteria have been met or when formal acceptance occurs, respectively. We do not provide for anticipated losses before we record sales.

We recognize revenue on larger construction and equipment contracts using long-term construction accounting. We estimate total long-term contract revenue net of price concessions as well as total contract costs. For larger construction and equipment contracts, we recognize sales based on our progress toward contract completion measured by actual costs incurred in relation to our estimate of total expected costs. We routinely update our estimates of future costs for agreements in process and report any cumulative effects of such adjustments in current operations. We provide for any loss that we expect to incur on these agreements when that loss is probable.

We sell product services under long-term product maintenance agreements, where costs of performing services are incurred on other than a straight-line basis. We recognize related sales based on the extent of our progress toward completion measured by actual costs incurred in relation to our estimate of total expected costs. We routinely update our estimates of future costs for agreements in process and report any cumulative effects of such adjustments in current operations.

For our long term product maintenance agreements, we regularly assess customer credit risk inherent in the carrying amounts of receivables and contract costs and estimated earnings, including the risk that contractual penalties may not be sufficient to offset our accumulated investment in the event of customer termination. We gain insight into future utilization and cost trends, as well as credit risk, through our knowledge of the installed base of equipment and the close interaction with our customers that comes with supplying critical services and parts over extended periods. Revisions, after applying the cumulative catch up basis of accounting, may affect a product services agreement’s total estimated profitability resulting in an adjustment of earnings; such adjustments increased earnings by $293 million, $256 million and $145 million in 2016, 2015 and 2014, respectively. We provide for probable losses when they become evident.
 
 
11    GE O&G Annual FS


 
Arrangements for the sale of goods and services sometimes include multiple components. Our arrangements with multiple components usually involve an upfront deliverable of equipment and future service deliverables such as installation, commissioning, training or the future delivery of ancillary products. In most cases, the relative values of the undelivered components are not significant to the overall arrangement and are typically delivered within three to six months after the core product has been delivered. In such agreements, selling price is determined for each component and any difference between the total of the separate selling prices and total contract consideration (i.e., discount) is allocated pro rata across each of the components in the arrangement. The value assigned to each component is objectively determined and obtained primarily from sources such as the separate selling price for that or a similar item or from competitor prices for similar items. If such evidence is not available, we use our best estimate of selling price, which is established consistent with the pricing strategy of the Business and considers product configuration, geography, customer type, and other market specific factors

RESEARCH AND DEVELOPMENT

Research and development expenses are expensed as incurred and relate to the research and development of new products and services. These costs amounted to $352 million, $408 million and $420 million for the years ended December 31, 2016, 2015 and 2014, respectively.

SHIPPING AND HANDLING COSTS

Shipping and handling costs are presented gross. Amounts billed to a customer in a sale transaction related to shipping and handling, if any, represent revenues earned for the goods provided and the respective costs are expensed as incurred. These costs amounted to $182 million, $277 million, and $290 million in 2016, 2015 and 2014, respectively.

CASH AND EQUIVALENTS

Money market instruments with original maturities of three months or less are included in cash equivalents unless designated as available-for-sale and classified as investment securities.

As of December 31, 2016, $752 million of cash and equivalents were held in bank accounts and cannot be released, transferred or otherwise converted into a currency that is regularly transacted internationally, due to lack of market liquidity, capital controls or similar monetary or exchange limitations limiting the flow of capital out of the jurisdiction.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

We establish an allowance for doubtful accounts based on various factors including the payment history and financial condition of our debtors and the economic environment. Provisions for doubtful accounts are recorded based on the aging status of the debtor accounts or when it becomes evident that the debtor will not make the required payments at either contractual due dates or in the future. The provision for doubtful accounts recorded was equal to $119 million, $102 million and $65 million for the years ended December 31, 2016, 2015 and 2014, respectively.

CONCENTRATION OF CREDIT RISK

We grant credit to our customers who primarily operate in the oil and natural gas industry. Although this concentration affects our overall exposure to credit risk, our current receivables are spread over a diverse group of customers across many countries, which mitigates this risk. We perform periodic credit evaluations of our customers’ financial conditions, including monitoring our customers’ payment history and current credit worthiness to manage this risk. We do not generally require collateral in support of our current receivables, but we may require payment in advance or security in the form of a letter of credit or a bank guarantee. As of December 31, 2016 and 2015, GE O&G had no customer balances that exceed 10% of GE O&G net customer receivables.
 
 
12    GE O&G Annual FS

 

INVENTORIES

All inventories are stated at the lower of cost or realizable values and they are measured on a first-in, first-out (FIFO) basis. As necessary, we record provisions and maintain reserves for excess, slow moving and obsolete inventory. To determine these reserve amounts, we regularly review inventory quantities on hand and compare them to estimates of future product demand, market conditions, production requirements and technological developments.

PROPERTY, PLANT AND EQUIPMENT (PP&E)

Property, plant and equipment is initially stated at cost and is depreciated over its estimated economic life. Subsequently, property, plant and equipment is measured at cost less accumulated depreciation and impairment losses. In 2015, we changed the method of depreciating our U.S. assets from an accelerated method based on a sum-of-the-years digits formula to a straight-line basis in order to align and harmonize our methodology for manufacturing plant and equipment. This change in estimate was made prospectively as of October 1, 2015, and had an immaterial impact for 2015. Since this date, our manufacturing plant and equipment is generally depreciated on a straight-line basis.

OTHER INTANGIBLE ASSETS

We amortize the cost of other intangible assets over their estimated useful lives unless such lives are deemed indefinite. The cost of intangible assets is generally amortized on a straight-line basis over the asset’s estimated economic life. Amortizable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable. In these circumstances, they are tested for impairment based on undiscounted cash flows and, if impaired, written down to fair value based on either discounted cash flows or appraised values. Intangible assets with indefinite lives are tested annually for impairment and written down to fair value as required. Refer to the Impairment of Goodwill and Other Long-Lived Assets accounting policy.

IMPAIRMENT OF GOODWILL AND OTHER LONG-LIVED ASSETS

We perform an annual impairment test of goodwill on a qualitative or quantitative basis for each of our reporting units as of July 1 of each year, or more frequently when circumstances indicate an impairment may exist at the reporting unit level. When performing the annual impairment test we have the option of performing a qualitative or quantitative assessment to determine if an impairment has occurred. If a qualitative assessment indicates that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then we perform a quantitative impairment test for goodwill.

The quantitative impairment test consists of two different steps: in step one, the carrying value of the reporting unit is compared with its fair value; in step two, which is applied when the carrying value is more than its fair value, the amount of goodwill impairment, if any, is derived by deducting the fair value of the reporting unit’s assets and liabilities from the fair value of its equity, and comparing that amount with the carrying amount of goodwill. We determine fair values of each of the reporting units using the market approach, when available and appropriate, or the income approach, or a combination of both. We assess the valuation methodology based upon the relevance and availability of the data at the time we perform the valuation.

Valuations using the market approach are derived from metrics of publicly-traded companies or historically completed transactions of comparable businesses. The selection of comparable businesses is based on the markets in which the reporting units operate considering risk profiles, size, geography, and diversity of products and services.
 
 
13    GE O&G Annual FS

 

Under the income approach, fair value is determined based on the present value of estimated future cash flows, discounted at an appropriate risk-adjusted rate. We use our internal forecasts to estimate future cash flows and include an estimate of long-term future growth rate based on our most recent views of the long-term outlook for each business. Actual results may differ from those assumed in our forecasts. We derive our discount rates using a capital asset pricing model and analyzing published rates for industries relevant to our reporting units to estimate the cost of equity financing. We use discount rates that are commensurate with the risk and uncertainty inherent in the respective reporting units and in our internally developed forecast. 

We review PP&E, intangible assets and certain other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable and at least annually for indefinite-lived intangible assets. When testing for impairment, we group our long-lived assets with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities (or asset group). The determination of recoverability is made based upon the estimated undiscounted future net cash flows. The amount of impairment loss, if any, is determined by comparing the fair value, as determined by a discounted cash flow analysis, with the carrying value of the related assets.

FINANCIAL INSTRUMENTS

Our financial instruments include cash and equivalents, current receivables, investments, trade payables, short and long-term debt, and derivative financial instruments. Except for long-term debt, the estimated fair value of our financial instruments at December 31, 2016 and 2015 approximates their carrying value as reflected in our Combined Statement of Financial Position. For further information on the fair value of our debt, see Note 17.

We monitor our exposure to various business risks including commodity prices and foreign currency exchange rates and we regularly use derivative financial instruments to manage these risks. Although GE policies do not permit the use of derivative financial instruments for speculative purposes, derivative financial instruments may be classified as trading for accounting purposes. At the inception of a new derivative, we designate the derivative as a hedge or we determine the derivative to be undesignated as a hedging instrument. We document the relationships between the hedging instruments and the hedged items, as well as our risk management objectives and strategy for undertaking various hedge transactions. We assess whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of the hedged item at both the inception of the hedge and on an ongoing basis.

We have a program that utilizes foreign currency forward contracts to reduce the risks associated with the effects of certain foreign currency exposures. Under this program, our strategy is to have gains or losses on the foreign currency forward contracts mitigate the foreign currency transaction and translation gains or losses to the extent practical. These foreign currency exposures typically arise from changes in the value of assets (for example, current receivables) and liabilities (for example, current payables) which are denominated in currencies other than the functional currency. We record all derivatives as of the end of our reporting period in our Combined Statement of Financial Position at fair value. For the forward contracts held as undesignated hedging instruments, we record the changes in fair value of the forward contracts in our Combined Statements of Income along with the change in the fair value, related to foreign exchange movements, of the hedged item. Changes in the fair value of forward contracts designated as cash flow hedging instruments are recognized in other comprehensive income (loss) until the hedged item is recognized in earnings. If derivatives designated as a cash flow hedge are determined to be ineffective, the ineffective portion of that derivative’s change in fair value is recognized in earnings.

We had outstanding foreign currency forward contracts with notional amounts aggregating $6,430 million and $8,017 million at December 31, 2016 and 2015, respectively, to hedge exposure to currency fluctuation in various foreign currencies. We also have embedded derivatives with notional amounts aggregating $620 million and $891 million at December 31, 2016 and December 2015, respectively. Based on quoted market prices as of December 31, 2016, 2015 and 2014 for forward contracts with similar terms and maturity dates, we recorded losses, both realized and unrealized, of $273 million, $117 million and $109 million, respectively, to adjust these forward contracts to their fair market value. The impact of commodity forward contracts on earnings was immaterial for the years ended December 31, 2016, 2015 and 2014.
 
 
14    GE O&G Annual FS

 

FAIR VALUE MEASUREMENTS

The following sections describe the valuation methodologies we use to measure financial instruments and non-financial instruments within pension plans accounted for at fair value.

For financial assets and liabilities measured at fair value on a recurring basis, fair value is the price we would receive to sell an asset or pay to transfer a liability in an orderly transaction with a market participant at the measurement date. In the absence of active markets for the identical assets or liabilities, such measurements involve developing assumptions based on market observable data and, in the absence of such data, internal information that is consistent with what market participants would use in a hypothetical transaction that occurs at the measurement date.

Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. Preference is given to observable inputs. These two types of inputs create the following fair value hierarchy:

 
Level 1 -
Quoted prices for identical instruments in active markets.

 
Level 2 -
Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

 
Level 3 -
Significant inputs to the valuation model are unobservable.

We maintain policies and procedures to value instruments using the best and most relevant data available. In addition, we perform reviews to assess the reasonableness of the valuations. With regard to Level 3 valuations (including instruments valued by third parties), we perform a variety of procedures to assess the reasonableness of the valuations. Such reviews include an evaluation of instruments whose fair value change exceeds predefined thresholds (and/or does not change) and consider the current interest rate, currency and credit environment, as well as other published data, such as rating agency market reports and current appraisals. These reviews are performed by risk manager. A detailed review of methodologies and assumptions is performed by individuals independent of the business for individual measurements with a fair value exceeding predefined thresholds. This detailed review may include the use of a third-party valuation firm.

RECURRING FAIR VALUE MEASUREMENTS

The following sections describe the valuation methodologies we use to measure different financial instruments at fair value on a recurring basis.

Investments in Debt and Equity Securities within Pension Plan Assets

When available, we use quoted market prices to determine the fair value of investment securities, which form part of our pension plan assets, and they are included in Level 1. Level 1 securities primarily include publicly traded equity securities.

For large numbers of investment securities for which market prices are observable for identical or similar investment securities but not readily accessible for each of those investments individually (that is, it is difficult to obtain pricing information for each individual investment security at the measurement date), we obtain pricing information from our independent pricing vendors. The independent pricing vendors use various pricing models for each asset class that are consistent with what other market participants would use. The inputs and assumptions to the model of the pricing vendors are derived from market observable sources including: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers, and other market-related data. Since many fixed income securities do not trade on a daily basis, the methodology of the pricing vendors use available information as applicable such as benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. The pricing vendors consider available market observable inputs in determining the evaluation for a security. Thus, certain securities may not be priced using quoted prices, but rather determined from market observable information. These investments are included in Level 2 and primarily comprise our portfolio of corporate fixed income, and government, mortgage and asset-backed securities. In infrequent circumstances, an independent pricing vendor may provide us with valuations that are based on significant unobservable inputs, and in those circumstances we classify the investment securities in Level 3.
 
 
15    GE O&G Annual FS

 

Annually, we conduct reviews of independent pricing vendors to validate that the inputs used in that vendor’s pricing process are deemed to be market observable as defined in the applicable standard. While we are not provided access to proprietary models of the vendor, our reviews have included on-site walk-throughs of the pricing process, methodologies and control procedures for each asset class and level for which prices are provided. Our reviews also include an examination of the underlying inputs and assumptions for a sample of individual securities across asset classes, credit rating levels and various durations. In addition, the pricing vendors have an established challenge process in place for all security valuations, which facilitates identification and resolution of potentially erroneous prices. We believe that the prices received from pricing vendors are representative of prices that would be received to sell the assets at the measurement date (exit prices) and are classified appropriately in the hierarchy.

We use non-binding broker quotes and other third-party pricing services as our primary basis for valuation when there is limited, or no, relevant market activity for a specific instrument or for other instruments that share similar characteristics. We have not adjusted the prices we have obtained. Investment securities priced using non-binding broker quotes and other third-party pricing services are included in Level 3. As is the case with the independent pricing vendor, third-party brokers and other third-party pricing services do not provide access to their proprietary valuation models, inputs and assumptions. Accordingly, our risk management personnel conduct reviews of vendors, as applicable, similar to the reviews performed of the independent pricing vendor. In addition, we conduct internal reviews of pricing for all such investment securities quarterly to ensure reasonableness of valuations used in our combined financial statements. These reviews are designed to identify prices that appear stale, those that have changed significantly from prior valuations, and other anomalies that may indicate that a price may not be accurate. Based on the information available, we believe that the fair values provided by the brokers and other third-party pricing services are representative of prices that would be received to sell the assets at the measurement date (exit prices).

Investments in private equity, real estate and collective funds held within our pension plans, are generally valued using the net asset value (NAV) per share as a practical expedient for fair value provided certain criteria are met. The NAVs are determined based on the fair values of the underlying investments in the funds. On January 1, 2016, we adopted guidance whereby investments that are measured at fair value using the NAV practical expedient are no longer classified in the fair value hierarchy.

Derivatives

We use closing prices for derivatives included in Level 1, which are traded either on exchanges or liquid over-the-counter markets.

The majority of our derivatives are valued using internal models. The models maximize the use of market observable inputs including interest rate curves and both forward and spot prices for currencies and commodities. Derivative assets and liabilities included in Level 2 primarily represent foreign currency and commodity forward contracts for the Business.

NON-RECURRING FAIR VALUE MEASUREMENTS

Certain assets are measured at fair value on a non-recurring basis within the pension plans. These assets are not measured at fair value on an ongoing basis, but are subject to fair value adjustments only in certain circumstances. These assets can include long-lived assets that have been reduced to fair value when they are held for sale, cost and equity method investments and long-lived assets that are written down to fair value when they are impaired and the remeasurement of retained investments in formerly consolidated subsidiaries upon a change in control that results in deconsolidation of a subsidiary, if we sell a controlling interest and retain a noncontrolling stake in the entity. Assets that are written down to fair value when impaired and retained investments are not subsequently adjusted to fair value unless further impairment occurs.
 
 
16    GE O&G Annual FS

 

Cost and Equity Method Investments

Cost and equity method investments are valued using market observable data such as quoted prices when available. When market observable data is unavailable, investments are valued using a discounted cash flow model, comparative market multiples or a combination of both approaches as appropriate and other third-party pricing sources.

Long-lived Assets

Fair values of long-lived assets, including real estate, are primarily derived internally and are based on observed sales transactions for similar assets. In other instances, for example, collateral types for which we do not have comparable observed sales transaction data, collateral values are developed internally and corroborated by external appraisal information. Adjustments to third-party valuations may be performed in circumstances where market comparables are not specific to the attributes of the specific collateral or appraisal information may not be reflective of current market conditions due to the passage of time and the occurrence of market events since receipt of the information.

INCOME TAXES

The Business is included in the consolidated U.S. federal, foreign and state income tax returns of GE, where allowable by law. The Business determines its current and deferred taxes based on the separate return method (i.e., as if the Business were a taxpayer separate from GE). All income taxes due to or due from the Business’ parent that have not been settled or recovered by the end of the period are reflected in Note 14 as such balances will be maintained and settled. Any differences between actual amounts paid or received by the Business and taxes accrued under the separate return method have been reflected in the GE net investment account.
The Business accounts for taxes under the asset and liability method. Under this method, deferred income taxes are recognized for temporary differences between the financial statement and tax return bases of assets and liabilities as well as from net operating losses and tax credit carryforwards, based on enacted tax rates expected to be in effect when taxes actually are paid or recovered and other provisions of the tax law. The effect of a change in tax laws or rates on deferred tax assets and liabilities is recognized in income in the period in which such change is enacted. Future tax benefits are recognized to the extent that realization of such benefits is more likely than not, and a valuation allowance is established for any portion of a deferred tax asset that management believes may not be realized.
We currently intend to indefinitely reinvest substantially all earnings of our foreign subsidiaries with operations outside the U.S. and, accordingly, have not provided U.S. income tax on such income.
Significant judgment is required in determining our tax expense and in evaluating our tax positions, including evaluating uncertainties. We operate in more than 120 countries and our tax filings are subject to audit by the tax authorities in the jurisdictions where we conduct business. These audits may result in assessments of additional taxes that are resolved with the tax authorities or through the courts. We have provided for the amounts we believe will ultimately result from these proceedings. The Business recognizes uncertain tax positions that are “more likely than not” to be sustained if the relevant tax authority were to audit the position with full knowledge of all the relevant facts and other information. For those tax positions that meet this threshold, the Business measures the amount of tax benefit based on the largest amount of tax benefit that the Business has a greater than 50% chance of realizing in a final settlement with the relevant authority. The Business classifies interest and penalties associated with uncertain tax positions as interest expense and provision for income taxes, respectively, on the Combined Statement of Income (Loss). The effects of tax adjustments and settlements from taxing authorities are presented in the combined financial statements in the period they are recorded.
POSTRETIREMENT BENEFITS

Certain employees and retirees of the Business participate in postretirement benefit plans, sponsored by either the Business or GE:
 
 
17    GE O&G Annual FS


 
Multiemployer Plans (sponsored by GE)

These plans are accounted in accordance with ASC Subtopic 715-80 Compensation—Retirement Benefits—Multiemployer Plans (see Note 12).

Pension Benefits (sponsored by the Business)

These plans are accounted for under the provisions of ASC Subtopic 715-20, Compensation Retirement Benefits: Defined Benefit Plans (see Note 12). In accordance with ASC 715-20, management categorizes plan assets for disclosure purposes in accordance with the fair value hierarchy as set forth in ASC 820, Fair Value Measurements and Disclosures.


Pension benefits are calculated using significant inputs to the actuarial models that measure pension benefit obligations and related effects on operations. Two assumptions, discount rate and expected return on assets, are important elements of plan expense and asset/liability measurement. We evaluate these critical assumptions at least annually on a plan and country-specific basis. We periodically evaluate other assumptions involving demographic factors such as retirement age, mortality and turnover, and update them to reflect our experience and expectations for the future. Actual results in any given year will often differ from actuarial assumptions because of economic and other factors.
Projected benefit obligations are measured as the present value of expected payments. We discount those cash payments using the weighted average of market-observed yields for high-quality fixed-income securities with maturities that correspond to the payment of benefits. Lower discount rates increase present values and generally subsequent-year pension expense; higher discount rates decrease present values and generally subsequent-year pension expense.
The weighted average discount rates for our pension plans at December 31, 2016, 2015 and 2014 were equal to 3.41%, 3.83% and 3.69%, respectively, reflecting market interest rates.
To determine the expected long-term rate of return on pension plan assets, we consider current and target asset allocations, as well as historical and expected returns on various categories of plan assets. In developing future long-term return expectations for our principal benefit plans’ assets, we formulate views on the future economic environment, both in the US and abroad. We evaluate general market trends and historical relationships among a number of key variables that impact asset class returns such as expected earnings growth, inflation, valuations, yields and spreads, using both internal and external sources. We also take into account expected volatility by asset class and diversification across classes to determine expected overall portfolio results given current and target allocations.
Based on our analysis of future expectations of asset performance, past return results, and our current and target asset allocations, we have assumed a weighted average 6.98% long-term expected return on those assets for cost recognition in 2017 compared to 6.86% in 2016 and 6.91% in 2015.
Changes in key assumptions for our pension plans would have the following effects:
·
Discount rate - A 25 basis point increase in discount rate would decrease pension cost in the following year by $2 million and would decrease the pension benefit obligation at year-end by about $30 million.

·
Expected return on assets - A 50 basis point decrease in the expected return on assets would increase pension cost in the following year by $3 million.
 
 
18    GE O&G Annual FS

 
 
ACCOUNTING CHANGES
 
On September 30, 2016, we adopted ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which was intended to simplify several aspects of the accounting for employee share-based payment transactions including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the Combined Statement of Cash Flows.  Application of the requirements from January 1, 2016 resulted in an immaterial impact to the combined financial statements.

On January 1, 2016, we adopted ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes, which amends existing guidance on income taxes to require the classification of all deferred tax assets and liabilities as non-current on the statement of financial positionThe adoption of ASU 2015-17 did not result in an impact to the combined financial statements.

On January 1, 2016, we adopted ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments, which eliminated the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. See Note 3 for further discussion of the purchase accounting effects of recent acquisitions.
 
On January 1, 2016, we adopted ASU 2015-02, Amendments to the Consolidation Analysis. The ASU amended the consolidation guidance for VIEs and general partners’ investment in limited partnerships and modified the evaluation of whether limited partnerships and similar legal entities are VIEs or voting interest entities. The adoption of ASU 2015-02 did not result in an impact to the combined financial statements.

In the second quarter of 2014, the Business adopted Accounting Standards Update (ASU) 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which raised the threshold for a disposal to qualify as a discontinued operation and expanded the disclosure requirements for those transactions that meet the new criteria to be classified as discontinued operations. To be classified as a discontinued operation, the disposal of a component or group of components must represent a strategic shift that has, or will have, a major effect on an entity’s operations and financial results. The ASU also expands the disclosure requirements for those transactions that meet the new criteria to be classified as discontinued operations. The revised accounting guidance applies prospectively to all disposals (or classifications as held for sale) of components of an entity and for businesses that, upon acquisition, are classified as held for sale on or after adoption. Early adoption is permitted for disposals (or classifications as held for sale) that have not been previously reported in financial statements. The effects of applying the revised guidance will vary based upon the nature and size of future disposal transactions.
 
On January 1, 2014, we adopted ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. Under the new guidance, an unrecognized tax benefit is required to be presented as a reduction to a deferred tax asset if the disallowance of the tax position would reduce the available tax loss or tax credit carryforward instead of resulting in a cash tax liability. The adoption of ASU 2013-11 resulted in an immaterial impact to the combined financial statements.

On January 1, 2014, we adopted ASU 2013-05, Foreign Currency Matters (Topic 830): Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity. Under the revised guidance, the entire amount of the cumulative translation adjustment associated with the foreign entity will be released into income in the following circumstances: (a) the sale of a subsidiary or group of net assets within a foreign entity that represents a complete or substantially complete liquidation of that entity, (b) the loss of a controlling financial interest in an investment in a foreign entity, or (c) when the accounting for an investment in a foreign entity changes from the equity method to full consolidation. The revised guidance applies prospectively to transactions or events occurring on or after January 1, 2014.
 
 
19    GE O&G Annual FS

 

NEW ACCOUNTING STANDARDS UPDATE

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers.  The ASU will supersede most of the existing revenue recognition requirements in U.S. GAAP and will require entities to recognize revenue at an amount that reflects the consideration to which the Company expects to be entitled in exchange for transferring goods or services to a customer.  The new standard also requires significantly expanded disclosures regarding the qualitative and quantitative information of an entity’s nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.  The pronouncement is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period.

The standard permits either a full retrospective method of adoption, in which the standard is applied to all the periods presented, or a modified retrospective method of adoption, in which the standard is applied only to the current period with a cumulative-effect adjustment reflected in retained earnings.  We will adopt the standard on January 1, 2018, will apply it retrospectively to all periods presented, and will elect the practical expedient for contract modifications.
The new standard requires companies to identify contractual performance obligations and determine whether revenue should be recognized at a point in time or over time based on when control of goods and services transfer to a customer.  As a result, we expect changes in the presentation of our financial statements, including: (1) timing of revenue recognition, and (2) changes in classification between revenue and costs.  The new standard will have no cash impact and, as such, does not affect the economics of our underlying customer contracts.  The effect of applying the new guidance to our existing book of contracts will result in lower reported earnings in 2018 (and comparative periods previously reported) and in the early years after adoption.  However, we expect to experience an increase in reported earnings, on that existing book of contracts, as they mature.

We expect that the timing of revenue recognition on our long-term product service agreements will be significantly affected.  Although we expect to continue to recognize revenue over time on these contracts, we also expect that there will be changes to how contract modifications, termination clauses and purchase options are accounted for by us.  In particular, under our existing processes, the cumulative impact from a contract modification on revenue already recorded is recognized in the period in which the modification is agreed.  Under the new standard, we expect the impact from certain types of modifications to be recognized over the remaining life of the contract.
         
In February 2016, the FASB issued ASU No. 2016-02, Leases.  The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months.  Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition.  Similarly, lessors will be required to classify leases as sales-type, finance or operating, with classification affecting the pattern of income recognition.  Classification for both lessees and lessors will be based on an assessment of whether risks and rewards as well as substantive control have been transferred through a lease contract.  The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted.  A modified retrospective transition approach is required for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.  While we continue to evaluate the effect of the standard on our ongoing financial reporting, we anticipate that the adoption of the ASU may materially affect our consolidated and combined financial statements.
 
 
20    GE O&G Annual FS

 
 
In October 2016, the FASB issued ASU No. 2016-16, Accounting for Income Taxes: Intra-Entity Asset Transfers of Assets Other than Inventory.  The ASU eliminates the deferral of tax effects of intra-entity asset transfers other than inventory.  As a result, the tax expense from the intercompany sale of assets, other than inventory, and associated changes to deferred taxes will be recognized when the sale occurs even though the pre-tax effects of the transaction have not been recognized. The new standard is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods. The effect of the adoption of the standard will depend on the nature and amount of future transactions but is currently expected as an increase to retained earnings of approximately $300 million.  Future earnings will be reduced in total by this amount.  The effect of the change on future transactions will depend on the nature and amount of future transactions as it will affect the timing of recognition of both tax expenses and tax benefits, with no change in the associated cash flows.
In March 2017, the FASB issued ASU No. 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which changes the income statement presentation of net periodic benefit cost by requiring separation between the service cost component and all other components.  The service cost component is required to be presented as an operating expense with other similar compensation costs arising for services rendered by the pertinent employees during the period.  The non-operating components must be presented outside of income from operations.  This pronouncement is effective for annual reporting periods beginning after December 15, 2017, and the presentation disclosure should be applied using a retrospective approach.  Early adoption is permitted.  We will adopt this standard on January 1, 2018.

All other new accounting pronouncements that have been issued but not yet effective are currently being evaluated and at this time are not expected to have a material impact on our financial position or results of operations.

 
 
 
 
 
 

21    GE O&G Annual FS



NOTE 3
ACQUISITIONS AND DISPOSITIONS
ACQUISITIONS
On June 2, 2014, we acquired 100% ownership of Cameron’s Reciprocating Compression division (“Cameron”) for $550 million. Cameron provides reciprocating compression equipment and aftermarket services for oil and gas production, gas processing, gas distribution and independent power industries. Cameron is included in our TPS segment. The purchase price allocation resulted in goodwill of $280 million and amortizable intangible assets of $95 million.

DISPOSITIONS
On June 30, 2015, we completed the sale of the Industrial Air & Gas Technology (“IAGT”) business for a selling price of $185 million and a pre-tax gain of $71 million. IAGT primarily sells to the industrial space focused on the movement of liquids/hydrocarbons through pipe either through blower or compression equipment. IAGT was included in our TPS segment.

On June 20, 2014, we completed the sale of the Wayne Fueling Systems (“Wayne”) business, a manufacturer of retail fuel dispensers, payment devices, forecourt control systems and peripheral equipment for a selling price of $485 million, recording a pre-tax gain of $53 million. Wayne Fueling Systems was included in our DS segment.

The pre-tax gains from the sale of these businesses have been recognized as part of “Other expenses / (income), net” in the Combined Statement of Income (Loss).
NOTE 4
CURRENT RECEIVABLES

December 31 (In millions)
 
2016
   
2015
 
Customer receivables
 
$
1,699
   
$
2,011
 
Related parties
   
236
     
233
 
Sundry receivables
   
814
     
751
 
 
   
2,749
     
2,995
 
Less allowance for losses
   
(186
)
   
(177
)
Total
 
$
2,563
   
$
2,818
 

Customer receivables are recorded at the invoiced amount less an allowance for doubtful accounts. Beyond factoring activities with related parties (as described in Note 20), the Business also sells certain current receivables externally, which are accounted for in accordance with ASC 860, Transfers and Servicing.  Sundry receivables primarily consist of advance payments to suppliers and value added tax receivables.

December 31 (In millions)
 
2016
   
2015
 
Receivables syndicated externally
 
$
257
   
$
330
 

 
22    GE O&G Annual FS


 
NOTE 5
INVENTORIES
Inventories, net of reserves of $260 million and $274 million in 2016 and 2015, respectively, are comprised of the following at December 31:

December 31 (In millions)
 
2016
   
2015
 
             
Raw materials and work in process
 
$
1,639
   
$
1,978
 
Finished goods
   
1,585
     
1,693
 
Total
 
$
3,224
   
$
3,671
 
                 
NOTE 6
PROPERTY, PLANT AND EQUIPMENT
                  
   
Depreciable lives
(in years)
   
Original Cost
   
Net Carrying Value
 
December 31 (Dollars in millions)
       
2016
   
2015
   
2016
   
2015
 
                               
Land and improvements
   
8(a
)
 
$
130
   
$
164
   
$
125
   
$
160
 
Buildings, structures and related equipment
   
8-40
     
995
     
526
     
878
     
462
 
Machinery and equipment
   
4-20
     
2,916
     
3,266
     
1,054
     
1,414
 
Leasehold costs and manufacturing plant under construction
   
1-10
     
349
     
581
     
268
     
518
 
Total
         
$
4,390
   
$
4,537
   
$
2,325
   
$
2,554
 
(a) Depreciable lives exclude land.
 
 
23    GE O&G Annual FS

 

NOTE 7
GOODWILL
After initial recognition, goodwill is measured net of any accumulated impairment losses. Changes in the carrying amount of goodwill for the fiscal year ended December 31, 2016 and December 31, 2015, by operating segment, are as follows:

(In millions)
 
OFS
   
OFE
   
TPS
   
DS
   
Total
 
Balance at December 31, 2014 - gross
 
$
2,907
   
$
3,947
   
$
1,891
   
$
2,166
   
$
10,911
 
Accumulated impairments at December 31, 2014
   
(553
)
   
(867
)
   
-
     
(254
)
   
(1,674
)
Balance at December 31, 2014
 
$
2,354
   
$
3,080
   
$
1,891
   
$
1,912
   
$
9,237
 
Acquisitions and purchase accounting adjustments
   
-
     
22
     
32
     
-
     
54
 
Dispositions
   
-
     
-
     
(42
)
   
-
     
(42
)
Currency translation
   
(22
)
   
(129
)
   
(28
)
   
(123
)
   
(302
)
Impairments
   
(2,080
)
   
-
     
-
     
-
     
(2,080
)
Balance at December 31, 2015
   
252
     
2,973
   
$
1,853
   
$
1,789
   
$
6,867
 
Acquisitions and purchase accounting adjustments
   
-
     
19
     
(1
)
   
-
     
18
 
Currency translation
   
(106
)
   
(7
)
   
(38
)
   
(54
)
   
(205
)
Balance at December 31, 2016
 
$
146
   
$
2,985
   
$
1,814
   
$
1,735
   
$
6,680
 

In performing the annual impairment test for goodwill in the third quarter of 2015 using data as of July 1 of that year, we determined that a step two test was required for a reporting unit within our OFS operating segment. As a consequence of the continued pressure on oil prices, the revised expected cash flows for this reporting unit resulted in a goodwill impairment charge of $2,080 million. The impairment charge has been included as part of “Impairment of goodwill” in the Combined Statement of Income (Loss).  As of December 31, 2016, we believe that the goodwill is recoverable for all of the reporting units; however, there can be no assurance that the goodwill will not be impaired in future periods.
 
 
 
24    GE O&G Annual FS

 


NOTE 8
OTHER INTANGIBLE ASSETS
DEFINITE LIVES INTANGIBLES
   
2016
   
2015
 
December 31
(Dollars in millions)
 
Useful life (in years)
   
Gross carrying amount
   
Accumulated amortization
   
Net
   
Gross carrying amount
   
Accumulated amortization
   
Net
 
                                           
Customer-related
   
15-25
   
$
1,920
   
$
(660
)
 
$
1,260
   
$
1,959
   
$
(585
)
 
$
1,374
 
Patents & technology
   
14-25
     
596
     
(371
)
   
225
     
634
     
(348
)
   
286
 
Capitalized software
   
4-5
     
896
     
(535
)
   
361
     
804
     
(432
)
   
372
 
Trademarks
   
18-30
     
681
     
(130
)
   
551
     
698
     
(108
)
   
590
 
Other
           
1
     
(1
)
   
-
     
3
     
(1
)
   
2
 
Total
         
$
4,094
   
$
(1,697
)
 
$
2,397
   
$
4,098
   
$
(1,474
)
 
$
2,624
 

During 2016 and 2015, we recorded additions to intangible assets subject to amortization of $153 million and $226 million, respectively, primarily driven by capitalized software.

Oil & Gas amortization expense related to intangible assets subject to amortization amounted to $272 million, $245 million and $251 million in 2016, 2015 and 2014, respectively.

Estimated amortization expense for each of the subsequent five fiscal years is expected to be as follows:

(In millions)
 
2017
   
2018
   
2019
   
2020
   
2021
 
Estimated amortization expense
 
$
234
   
$
225
   
$
200
   
$
164
   
$
148
 

INDEFINITE LIVED INTANGIBLES
2016
 
2015
 
December 31 (In millions)
Gross carrying amount
 
Gross carrying amount
 
Indefinite lived intangible assets
 
$
52
   
$
52
 

Indefinite-lived intangible assets as of December 31, 2016 and 2015 comprise trademarks acquired in previous years (Vetco and Bently Nevada trademarks for $42 million and $10 million, respectively).
 
 
 
25    GE O&G Annual FS

 

NOTE 9
CONTRACT ASSETS

December 31 (In millions)
 
2016
   
2015
 
   Long-term product service agreements (a)
 
$
1,046
   
$
928
 
   Long-term equipment contract revenue (b)
   
703
     
502
 
Total revenue in excess of billings
   
1,749
     
1,430
 
   Deferred inventory costs (c)
   
218
     
236
 
Contract Assets
 
$
1,967
   
$
1,666
 

(a) Reflects revenues earned in excess of billings on our long-term product service agreements.
(b) Reflects revenues earned in excess of billings on our long-term contracts to construct technically complex equipment.
(c) Represents cost deferral for shipped goods and other costs for which the criteria for revenue recognition has not yet been met.

NOTE 10
ACCOUNTS PAYABLE

December 31 (In millions)
 
2016
   
2015
 
Trade payables
 
$
1,368
   
$
1,583
 
Related parties (a)
   
530
     
639
 
Total
 
$
1,898
   
$
2,222
 

(a) Refer to Note 20 for further information.
 
 
 
26    GE O&G Annual FS

 

NOTE 11
BORROWINGS
December 31 (Dollars in millions)
     
2016
   
2015
 
Short-term borrowings
     
Amount
   
Weighted
Average Rate(a)
   
Amount
   
Weighted
Average Rate(a)
 
Short-term bank borrowings
       
$
79
     
9.1
%
 
$
237
     
16.8
%
Intercompany borrowings (b)
         
121
             
134
         
Current portion of long term borrowings
         
34
     
1.3
     
2
     
1.1
 
Other
         
5
     
1.3
     
11
     
2.7
 
Total short-term borrowings
       
$
239
           
$
384
         
                                       
Long-term borrowings
 
Maturities
 
Amount
   
Weighted
Average Rate(a)
   
Amount
   
Weighted
Average Rate(a)
 
Long-term bank borrowings
   
2018-2024
   
$
2
     
4.1
%
 
$
3
     
2.9
%
Capital leases
           
1
     
4.5
     
2
     
4.5
 
Notes payable
           
35
     
1.0
     
8
     
4.8
 
Total long-term borrowings
         
$
38
           
$
13
         

(a)
Based on year-end balances and year-end local currency effective interest rates, including the effects from hedging.
(b)
Refer to Note 20 for further information.

The estimated fair value of the bank borrowings at December 31, 2016 and 2015 was equal to $183 million and $254 million, respectively. We estimate fair values based on valuation methodologies using current market interest rate data that are comparable to market quotes adjusted for our non-performance risk.

Liquidity is affected by debt maturities and our ability to repay or refinance such debt. External debt maturities, which include bank borrowings and notes payable, over the next five years follows:

(In millions)
 
2017
   
2018
   
2019
   
2020
   
2021
 
External debt maturities
 
$
113
   
$
6
   
$
24
   
$
-
   
$
-
 
 
 
 
 

27    GE O&G Annual FS


 
NOTE 12
POSTRETIREMENT BENEFIT PLANS
Certain U.S. employees are covered under various U.S. GE employee benefit plans, including GE’s retirement plans (pension, retiree health and life insurance, and savings benefit plans). In addition, certain UK employees participate in the GE UK Pension Plan.
We are allocated relevant participation costs for these GE employee benefit plans. As such, we have not recorded any liabilities associated with our participation in these plans in our Combined Statement of Financial Position as of December 31, 2016 and 2015. Expenses associated with our employees’ participation in the U.S. GE postretirement benefit plans were equal to $133 million, $134 million, $160 million for the years ended December 31, 2016, 2015 and 2014, respectively.

During 2016, two UK pension plans sponsored by the Business, the 1987 Vetco Gray Hughes Pension Plan and the UK Dresser Pension Scheme, were merged into the GE UK Pension Plan. The Business has agreed to pay deficit contributions for the next 10 years. The estimated present value of these payments is $32 million and is recorded in the Combined Statement of Financial Position in “All other liabilities.” Subsequent to that merger, plan participants in these respective plans participate in the GE UK Pension Plan. In addition, certain other business employees also participate in the GE UK Pension Plan. Expenses associated with our employees’ participation in the GE UK Pension Plan were equal to $7 million, $14 million, and $15 million for the years ended December 31, 2016, 2015 and 2014, respectively.

PENSION PLANS

In addition to these GE plans, certain of our employees are also covered by pension plans sponsored by the Business. Our pension plans in 2016 included eight U.S. and non-U.S. pension plans with pension assets or obligations greater than $20 million. We use a December 31 measurement date for these plans. These defined benefit plans generally provide benefits to employees based on formulas recognizing length of service and earnings.

PENSION PLAN PARTICIPANTS AS OF DECEMBER 31, 2016
       
Active employees
   
2,210
 
Vested former employees
   
2,710
 
Retirees and beneficiaries
   
4,515
 
Total
   
9,435
 

The amount we report in our income as pension cost consists of the following components:
·
Service cost - the cost of benefits earned by active employees who participate in the plan.
·
Prior service cost amortization – the cost of changes to our benefit plans (plan amendments) related to prior service performed.
·
Expected return on plan assets – the return we expect to earn on plan investments used to pay future benefits.
·
Interest cost – the accrual of interest on the pension obligations due to the passage of time.
·
Net actuarial loss (gain) amortization – differences between our estimates (for example, discount rate, expected return on plan assets) and our actual experience which are initially recorded in equity and amortized into income.
·
Curtailment gain/loss – income effects of amounts previously deferred that have been accelerated because of an event that shortens future service or eliminates future benefits (for example, a sale of a business).
 
 
 

28    GE O&G Annual FS


COST OF PENSION PLANS

(In millions)
 
2016
 
2015
     
2014
 
Service cost for benefits earned
 
$
18
 
 
 
$
24
     
$
21
 
Expected return on plan assets
   
(46
)
     
(65
)
     
(61
)
Interest cost on benefit obligations
   
34
       
49
       
55
 
Net actuarial loss amortization
   
14
       
21
       
9
 
Net settlement / curtailment loss (gain)
   
(26
)
(b)
   
4
 
(a)
   
-
 
Pension cost
 
$
(6
)
 
 
$
33
     
$
24
 

(a) Primarily associated with two facility closures and accelerated vesting for certain participants.
(b) Primarily associated with two UK plans merging into the GE UK Pension Plan.

ASSUMPTIONS USED IN PENSION CALCULATION

Accounting requirements necessitate the use of assumptions to reflect the uncertainties and the length of time over which the pension obligations will be paid. The actual amount of future benefit payments will depend upon when participants retire, the amount of their benefit at retirement and how long they live. To reflect the obligation in today’s dollars, we discount the future payments using a rate that matches the time frame over which the payments will be made. We also need to assume a long-term rate of return that will be earned on investments used to fund these payments.

The assumptions at December 31 used to measure the year-end benefit obligations and pension cost follow.

Assumptions used to measure pension benefit obligations:

December 31
 
2016
   
2015
   
2014
 
Discount rate
   
3.41
%
   
3.83
%
   
3.69
%
Compensation increases
   
4.09
     
4.36
     
4.36
 

Assumptions used to measure pension cost

December 31
 
2016
   
2015
   
2014
 
Discount rate
   
3.83
%
   
3.69
%
   
4.51
%
Expected return on assets
   
6.86
     
6.91
     
6.66
 

We evaluate these assumptions annually. We evaluate other assumptions periodically, such as retirement age, mortality and turnover, and update them as necessary to reflect our actual experience and expectations for the future.

We determine the discount rate using the weighted average yields on high-quality fixed-income securities that have maturities consistent with the timing of benefit payments. Lower discount rates increase the size of the benefit obligations and pension expense in the following year; higher discount rates reduce the size of the benefit obligation and subsequent-year pension expense.

The expected return on plan assets is the estimated long-term rate of return that will be earned on the investments used to fund the pension obligations. To determine this rate, we consider the current and target composition of plan investments, our historical returns earned, and our expectations about the future.
 
 
29    GE O&G Annual FS

 

The compensation assumption is used to estimate the annual rate at which pay of plan participants will grow. If the rate of growth assumed increases, the size of the pension obligations will increase, as will the amount recorded in equity attributable to parent and amortized to income in subsequent periods.
We amortize experience gains and losses, as well as the effects of changes in actuarial assumptions and plan provisions, over a period no longer than the average future service of employees.

FUNDING POLICY

The funding policy for our pension plans is to contribute amounts sufficient to meet minimum funding requirements as set forth in employee benefit and tax laws plus such additional amounts as we may determine to be appropriate. We expect to contribute approximately $41 million to our pension plans in 2017. In 2016, we contributed $50 million.

BENEFIT OBLIGATIONS

Benefit obligations are described in the following tables. Accumulated and projected benefit obligations (ABO and PBO) represent the obligations of a pension plan for past service as of the measurement date. ABO is the present value of benefits earned to date with benefits computed based on current compensation levels. PBO is ABO increased to reflect expected future compensation.

PROJECTED BENEFIT OBLIGATIONS (PBO)

(In millions)
 
2016
     
2015
 
Balance at January 1
 
$
1,290
     
$
1,400
 
Service cost for benefits earned