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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------------
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
--- OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
--- OF THE SECURITIES EXCHANGE ACT OF 1934
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Commission file number 1-9397
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BAKER HUGHES INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware 76-0207995
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
3900 Essex Lane, Houston, Texas 77027
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (713) 439-8600
-----------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at October 31, 1998
----- -------------------------------
Common Stock, $1.00 par value per share 326,933,600 shares
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BAKER HUGHES INCORPORATED
INDEX
Page
No.
----
Part I - Financial Information:
Consolidated Condensed Statements of Operations - Three months and
nine months ended September 30, 1998 and 1997 2
Consolidated Condensed Statements of Financial Position
- September 30, 1998 and December 31, 1997 4
Consolidated Condensed Statements of Cash Flows - Nine months
ended September 30, 1998 and 1997 5
Notes to Consolidated Condensed Financial Statements 7
Management's Discussion and Analysis of Financial Condition and
Results of Operations 15
Part II - Other Information 31
-1-
PART I. FINANCIAL INFORMATION
BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In millions, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
-------------------- --------------------
REVENUES:
Sales $ 737.5 $ 760.8 $ 2,296.1 $ 1,915.0
Services and rentals 847.4 750.6 2,596.6 2,162.4
--------- --------- --------- ---------
Total revenues 1,584.9 1,511.4 4,892.7 4,077.4
--------- --------- --------- ---------
COSTS AND EXPENSES:
Costs of sales 593.4 501.8 1,576.2 1,236.5
Costs of services and rentals 831.4 529.2 2,111.5 1,564.3
Selling, general and
administrative 393.4 309.9 1,017.8 803.1
Unusual charge 175.3 52.1 175.3 52.1
Acquired in-process research
and development 118.0 118.0
--------- --------- --------- ---------
Total costs and expenses 1,993.5 1,511.0 4,880.8 3,774.0
--------- --------- --------- ---------
Operating income(loss) (408.6) .4 11.9 303.4
Interest expense (40.5) (24.8) (108.5) (69.6)
Interest income 1.0 .8 3.0 2.7
Merger related costs (201.9) (201.9)
Spin-off related costs (8.4)
--------- --------- --------- ---------
Income(loss) from continuing
operations before income taxes (650.0) (23.6) (295.5) 228.1
Income taxes 115.5 (32.0) (8.1) (110.5)
--------- --------- --------- ---------
Income(loss) from continuing
operations (534.5) (55.6) (303.6) 117.6
Discontinued operations 14.1 (157.8)
--------- --------- --------- ---------
Net income(loss) $ (534.5)$ (41.5)$ (303.6)$ (40.2)
========= ========= ========= =========
-2-
BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS CONTINUED
(In millions, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
-------------------- --------------------
Basic earnings(loss) per share:
Continuing operations $ (1.65)$ (.18)$ (.95)$ .39
Discontinued operations .05 (.52)
--------- --------- --------- ---------
Total $ (1.65)$ (.13)$ (.95)$ (.13)
========= ========= ========= =========
Diluted earnings(loss) per share:
Continuing operations $ (1.65)$ (.18)$ (.95)$ .39
Discontinued operations .05 (.52)
--------- --------- --------- ---------
Total $ (1.65)$ (.13)$ (.95)$ (.13)
========= ========= ========= =========
Cash dividends per share of
common stock $ .115 $ .115 $ .345 $ .345
========= ========= ========= =========
See accompanying notes to consolidated condensed financial statements.
-3-
BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF FINANCIAL POSITION
(In millions)
(Unaudited)
ASSETS
September 30, December 31,
1998 1997
Current Assets: ---------- ----------
Cash and cash equivalents $ 24.6 $ 41.9
Accounts receivable, net 1,513.5 1,519.4
Inventories 1,082.1 1,145.0
Other current assets 242.6 213.5
---------- ----------
Total current assets 2,862.8 2,919.8
Property, net 2,213.9 1,975.9
Goodwill and other intangibles, net 1,894.6 1,537.2
Multiclient seismic data and other assets 872.6 803.2
---------- ----------
Total assets $ 7,843.9 $ 7,236.1
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Notes payable and current portion of
long-term debt $ 806.4 $ 177.4
Accounts payable 584.1 601.5
Payroll and related expenses 300.2 287.0
Other current liabilities 390.1 351.3
---------- ----------
Total current liabilities 2,080.8 1,417.2
---------- ----------
Long-term debt 1,883.4 1,610.7
---------- ----------
Deferred income taxes 226.9 283.8
---------- ----------
Deferred revenue and other long-term liabilities 417.6 405.4
---------- ----------
Stockholders' Equity:
Common stock 326.8 316.8
Capital in excess of par value 2,921.1 2,834.0
Retained earnings 131.9 494.1
Foreign currency translation adjustment (146.7) (160.5)
Unrealized gain on securities available for sale 5.6 38.1
Pension liability adjustments (3.5) (3.5)
---------- ----------
Total stockholders' equity 3,235.2 3,519.0
---------- ----------
Total liabilities and stockholders' equity $ 7,843.9 $ 7,236.1
========== ==========
See accompanying notes to consolidated condensed financial statements.
-4-
BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
Nine Months Ended
September 30,
1998 1997
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income(loss) from continuing operations $ (303.6) $ 117.6
Adjustments to reconcile net income(loss) from
continuing operations to net cash flows from
operating activities:
Depreciation, depletion and amortization 556.9 428.8
Provision(benefit) for deferred income taxes 38.7 (14.0)
Noncash portion of nonrecurring charges 494.9 32.7
Acquired in-process research and development 118.0
Gain on disposal of assets (31.9) (11.4)
Change in receivables 5.7 (134.5)
Change in inventories (56.6) (70.4)
Change in accounts payable (54.1) 50.2
Changes in other assets and liabilities (148.6) 6.5
-------- --------
Net cash flows from continuing operations 501.4 523.5
Net operating activities from discontinued
operations 1.6
-------- --------
Net cash flows from operating activities 501.4 525.1
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for capital assets and multiclient
seismic data (973.7) (804.7)
Proceeds from disposal of assets 74.6 45.1
Cash obtained in stock acquisition 65.4
Acquisition of businesses, net of cash acquired (426.7) (97.6)
Proceeds from sale of investments 48.5
-------- --------
Net cash flows from continuing operations (1,325.8) (743.3)
Net investing activities from discontinued
operations (405.7)
-------- --------
Net cash flows from investing activities (1,325.8) (1,149.0)
-------- --------
-5-
BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS CONTINUED
(In millions)
(Unaudited)
Nine Months Ended
September 30,
1998 1997
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings from commercial paper and
revolving credit facilities 931.2 639.7
Repayment of indebtedness (103.5) (107.2)
Proceeds from issuance of common stock 35.8 59.4
Dividends (58.7) (52.9)
Increase in UNOVA, Inc. receivable (120.4)
-------- --------
Net cash flows from continuing operations 804.8 418.6
Net financing activities from discontinued
operations 197.2
-------- --------
Net cash flows from financing activities 804.8 615.8
Effect of exchange rate changes on cash 2.3 (2.3)
-------- --------
Decrease in cash and cash equivalents (17.3) (10.4)
Cash and cash equivalents, beginning of period 41.9 35.2
-------- --------
Cash and cash equivalents, end of period $ 24.6 $ 24.8
======== ========
Income taxes paid $ 121.8 $ 119.1
Interest paid $ 109.6 $ 61.5
See accompanying notes to consolidated condensed financial statements.
-6-
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
Note 1. Basis of Presentation
General
In the opinion of Baker Hughes Incorporated ("Baker Hughes" or the
"Company"), the unaudited consolidated condensed financial statements
include all adjustments consisting of normal recurring accruals necessary
for a fair presentation of the Company's consolidated financial position as
of September 30, 1998, its consolidated results of operations for the three
and nine months ended September 30, 1998 and 1997 and its consolidated cash
flows for the nine months ended September 30, 1998 and 1997. Although the
Company believes that the disclosures in these financial statements are
adequate to make the information presented not misleading, certain
information and footnote disclosures normally included in annual financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission (see the Company's
Annual Report on Form 10-K for the year ended September 30, 1997 for the
most recent annual financial statements prepared in accordance with
generally accepted accounting principles). The results of operations for
the three and nine months ended September 30, 1998 are not necessarily
indicative of the results to be expected for the full year.
In the notes to consolidated condensed financial statements, all dollar
and share amounts in tabulations are in millions of dollars and shares,
respectively, unless otherwise indicated.
Merger
On August 10, 1998, Baker Hughes completed a merger with Western Atlas
Inc. ("Western Atlas") by issuing 148.6 million shares of the Company's
common stock for all of the outstanding common stock of Western Atlas (the
"Merger"). Each share of Western Atlas common stock was exchanged for 2.7
shares of Baker Hughes common stock. Western Atlas, the common stock of
which was previously publicly traded, is a leading supplier of oilfield
services and reservoir information technologies for the worldwide oil and
gas industry. It specializes in land, marine and transition-zone seismic
data acquisition and processing services, well-logging and completion
services and reservoir characterization and project management services.
The Merger was accounted for as a pooling of interests and,
accordingly, all prior period consolidated financial statements of Baker
Hughes have been restated to include the results of operations, financial
position and cash flows of Western Atlas. Information concerning common
stock, employee stock plans and per share data has been restated on an
equivalent share basis.
-7-
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS CONTINUED
The following is a reconciliation of revenues, income(loss) from
continuing operations and net income(loss) of Baker Hughes and Western
Atlas for the periods prior to the combination.
Three Months Ended Nine Months Ended
September 30, 1997 September 30, 1997
------------------ ------------------
Revenues:
Baker Hughes $ 1,091.2 $ 2,858.7
Western Atlas 420.2 1,218.7
-------- --------
Combined $ 1,511.4 $ 4,077.4
========= ========
Income(loss) from continuing operations:
Baker Hughes $ (82.9) $ 57.6
Western Atlas 27.3 60.0
-------- --------
Combined $ (55.6) $ 117.6
========= ========
Net income(loss):
Baker Hughes $ (82.9) $ 57.6
Western Atlas 41.4 (97.8)
-------- --------
Combined $ (41.5) $ (40.2)
========= ========
There were no material adjustments required to conform the accounting
policies of the two companies. Certain amounts have been reclassified to
conform reporting practices.
In connection with the Merger, the Company recorded merger related
costs of $201.9 million which consisted of the following:
Transaction costs $ 51.5
Employee costs 130.7
Other costs 19.7
-------
Total $ 201.9
=======
The transaction costs include banking and legal fees, printing and
other costs directly related to the Merger.
The employee related costs consist of payments made to certain officers
of Western Atlas and Baker Hughes pursuant to change in control provisions
of employment contracts and other employee benefit plans, severance
benefits paid to terminated employees whose responsibilities were redundant
as a result of the Merger and a noncash charge of $45.3 million related to
the triggering of change in control rights contained in certain Western
Atlas employee stock option plans which occurred as a result of the Merger.
-8-
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS CONTINUED
Other costs include merger integration costs that were incurred during
the three months ended September 30, 1998. The Company expects that
additional merger related expenses will be incurred in future quarters,
primarily for items that did not qualify for recognition in the three
months ended September 30, 1998.
Change in Year End
On August 27, 1998, the Board of Directors of the Company approved a
change in the Company's fiscal year end from September 30 to December 31,
effective with the calendar year beginning January 1, 1998. A three-month
transition period from October 1, 1997 through December 31, 1997 preceded
the start of the new fiscal year.
Changes in Accounting Principles
The Company adopted Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income," effective January 1,
1998. The statement establishes standards for the reporting and displaying
of comprehensive income and its components. Comprehensive income includes
all changes in equity during a period except those resulting from
investments by and distributions to owners.
The Company's total comprehensive income(loss) is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
-------- ------- --------- ------
Net income(loss) $ (534.5) $ (41.5) $ (303.6) $ (40.2)
Other comprehensive income(loss) (17.1) 29.5 (18.7) 11.8
-------- ------- --------- ------
Total comprehensive income(loss) $ (551.6) $ (12.0) $ (322.3) $ (28.4)
======== ======= ========= ======
Note 2. Discontinued Operations
On October 31, 1997, Western Atlas distributed all the shares of UNOVA,
Inc. ("UNOVA"), its then wholly owned industrial automation systems
subsidiary, as a stock dividend to it's shareholders (the "Spin-off"). The
operations of UNOVA for the three and nine months ended September 30, 1997
are classified as discontinued operations in the Company's consolidated
condensed financial statements. For periods prior to the Spin-off, cash,
debt, and the related net interest expense were allocated based on the
capital needs of UNOVA's operations. All corporate general and
administrative costs of the Company are included in continuing operations,
and no allocation was made to UNOVA for any of the periods presented.
-9-
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS CONTINUED
Discontinued operations of UNOVA are as follows:
Three Months Nine Months
Ended Ended
September 30, September 30,
1997 1997
------------ ------------
Net revenue $ 361.8 $ 1,094.1
Allocated interest expense 6.5 15.7
Allocated interest income .8 3.0
Income (loss) before income taxes $ 23.5 $ (127.4)
Provision for income taxes (9.4) (30.4)
-------- --------
Discontinued operations $ 14.1 $ (157.8)
======== ========
The UNOVA results of operations for the nine months ended September 30,
1997 include a $203.0 million charge related to acquired in-process
research and development activities related to it's acquisition of United
Barcode Industries in April 1997.
Note 3. Acquisitions
In addition to the acquisitions discussed below, during the nine months
ended September 30, 1998, the Company made five acquisitions with an
aggregate purchase price of $91.8 million. These acquisitions were
accounted for using the purchase method of accounting. Accordingly, the
cost of each acquisition has been allocated to assets acquired and
liabilities assumed based on their estimated fair market values at the date
of the acquisition. The operating results of these acquisitions are
included in the consolidated statement of operations from their respective
acquisition date. Pro forma results of these acquisitions have not been
presented as the pro forma revenue, net income and earnings per share would
not be materially different from the Company's actual results.
WEDGE DIA-LOG and 3-D Geophysical
In April 1998, the Company acquired all the outstanding stock of WEDGE
DIA-LOG, Inc. ("WEDGE") for $218.5 million in cash. WEDGE specializes in
cased-hole logging and pipe recovery services. Also in April 1998, the
Company acquired 3-D Geophysical, Inc. ("3-D") for $117.5 million in cash.
3-D is a supplier of primarily land-based seismic data acquisition
services. The purchase method of accounting was used to record both of
these acquisitions. The operating results of these acquisitions are
included in the consolidated statement of operations from their respective
acquisition date. Pro forma results of these two acquisitions have not
been presented as the pro forma revenue, net income and earnings per share
would not be materially different from the Company's actual results.
-10-
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS CONTINUED
Petrolite
In July 1997, the Company acquired Petrolite Corporation ("Petrolite")
and Wm. S. Barnickel & Company ("Barnickel"), the holder of 47.1% of
Petrolite's common stock, for 19.3 million shares of the Company's common
stock having a value of $730.2 million in a three-way business combination
accounted for using the purchase method of accounting. Additionally, the
Company assumed Petrolite's outstanding vested and unvested employee stock
options which were converted into the right to acquire 1.0 million shares
of the Company's common stock. Such assumption of Petrolite options by the
Company had a fair market value of $21.0 million resulting in total
consideration in the acquisitions of $751.2 million.
The purchase price was allocated to the assets purchased and the
liabilities assumed based on their estimated fair market values at the date
of acquisition. In accordance with generally accepted accounting
principles, the amount allocated to in-process research and development,
which was determined by an independent valuation, was recorded as a charge
in the three months ended September 30, 1997 because its technological
feasibility had not been established and it had no alternative future use.
Note 4. Unusual Charge
1998
During the three months ended September 30, 1998, the Company
recognized a $175.3 million unusual charge consisting of the following:
Impairment of oil & gas properties $ 72.3
Restructurings:
Severance for 3,400 employees under existing benefit plans 41.8
Abandoned leases and other contractual obligations 30.7
Write down of property and other assets 30.5
-------
Total $ 175.3
=======
During the three months ended September 30, 1998, the Company decided
to significantly reduce the scope and level of its start-up oil and gas
operations in light of the capital required and risks associated with oil
and gas exploration. As a result, the Company recorded a noncash charge of
$72.3 million for the impairment of oil and gas properties and a write off
of previously capitalized costs related to countries in which the Company
has decided to no longer pursue oil and gas activity.
The Company restructured and downsized its operations to the current
and expected market conditions, which resulted in a charge of $103.0
million in the three months ended September 30, 1998. The charge included
restructuring and downsizing at most of the Company's operating divisions.
Cash provisions of the unusual charge totaled $72.5 million. The Company
spent $16.3 million in the three months ended September 30, 1998 and
-11-
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS CONTINUED
expects to spend substantially all of the remaining $56.2 million in the
remainder of 1998 and 1999.
1997
During the three months ended September 30, 1997, the Company
recognized a $52.1 million unusual charge consisting of the following:
Baker Petrolite:
Severance for 140 employees under
existing benefit plans $ 2.2
Relocation of people and equipment 3.4
Integration costs 9.3
Inventory write-down 11.3
Write-down of other assets 9.3
Drilex:
Write-down of property and other assets 4.1
Banking and legal fees 3.0
Discontinued product lines:
Severance for 50 employees 1.5
Write-down of inventory, property and other assets 8.0
----
Total $ 52.1
=====
In connection with the acquisitions of Petrolite, accounted for as a
purchase, and Drilex, accounted for as a pooling of interests, the Company
recorded unusual charges of $35.5 million and $7.1 million, respectively,
to combine the acquired operations with those of the Company. The charges
include the cost of closing redundant facilities, eliminating or relocating
redundant personnel and equipment and rationalizing inventories which
require disposal at amounts less than their cost. A $9.5 million charge
was recorded as a result of the decision to discontinue a low margin,
oilfield product line in Latin America and to sell the Tracor Europa
subsidiary, a computer peripherals distributor, which resulted in a write-
down of the investment to net realizable value. Cash provisions of the
unusual charge totaled $19.4 million. The Company spent $5.5 million in
the three months ended September 30, 1997 and spent substantially all of
the remaining $13.9 million in the remainder of 1997 and 1998.
-12-
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS CONTINUED
Note 5. Inventories
Inventories are comprised of the following:
September 30, December 31,
1998 1997
----------- ------------
Finished goods $ 854.5 $ 911.5
Work in process 109.3 138.2
Raw materials 118.3 95.3
---------- -----------
Total $ 1,082.1 $ 1,145.0
========== ===========
Note 6. Earnings per Share ("EPS")
Weighted average shares used in computing EPS for the three months
ended September 30, 1998 and 1997 are 323.0 million shares and 313.8
million shares, respectively. There were no adjustments in determining
diluted EPS for the three months ended September 30, 1998 and 1997.
Reconciliation of the numerators and denominators of the basic and diluted
EPS computations for the nine month periods is as follows:
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
Income Shares Income Shares
------- ------ ------- ------
Income(loss) from continuing
operations $(303.6) 319.4 $ 117.6 300.2
Effect of dilutive
securities:
Stock plans 4.0
------ ------ ------- -----
Diluted EPS $(303.6) 319.4 $ 117.6 304.2
====== ====== ======= =====
Options to purchase 6.9 million shares of common stock were not
included in the computation of diluted EPS for the three months and the
nine months ended September 30, 1998 because their inclusion would be anti-
dilutive.
Note 7. Other Charges
During the three months ended September 30, 1998, the demand for the
Company's products and services declined sharply as the price of oil and
natural gas fell. This sharp decline in customer demand materialized
quickly from high growth levels experienced in the last several years and
that had continued into the early part of 1998. The Company wrote down
excess and obsolete inventory and rental tools and equipment brought about
by these changing market conditions. In the three months ended September
30, 1998, the Company provided reserves and recorded write-downs of
-13-
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS CONTINUED
$114.5 million reflected in costs of sales and $149.0 million reflected in
costs of services and rentals. In addition, the Company increased its
environmental remediation liability by a charge to income of $8.8 million,
which is reflected in costs of sales. Other charges of $18.2 million were
recorded in selling, general and administrative expenses, that relate
primarily to litigation accruals and a loss on the sale of Tracor Europa.
The Company owns a 50% interest in Petroalliance Services Company
Limited ("PAS"), which provides seismic, well-logging and reservoir
characterization services in the former Soviet Union, including Russia.
The financial statements of PAS have been included in the consolidated
financial statements of the Company because the Company has provided all
the financial and operational support for PAS. Beginning in early 1998,
economic conditions in Russia deteriorated significantly, causing PAS to
become unprofitable and jeopardizing its relationship with its Russian
customers. As a result, the Company began exploring its options with
respect to its investment in PAS. In August 1998, the Company entered into
an agreement to sell its 50% interest in PAS, however, it was subsequently
advised by the prospective buyer that it would be unable to consummate the
transaction. As a result of the continuing deterioration of the operating
environment in Russia and the Company's decisions to divest or suspend its
participation in PAS, the Company has recorded charges totaling $83.2
million in the three months ended September 30, 1998 for the write-down of
assets related to PAS. Of this amount, $50.5 million is included in
selling, general and administrative expense and $32.7 million is included
in cost of services and rentals.
-14-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results
of Operations ("MD&A") should be read in conjunction with the Company's
consolidated condensed financial statements and the related notes thereto.
FORWARD-LOOKING STATEMENTS
MD&A includes forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The words "anticipate,"
"believe," "expect," "plan," "intend," "estimate," "project," "forecasts,"
"will," "could," "may" and similar expressions are intended to identify
forward-looking statements. No assurance can be given that actual results
may not differ materially from those in the forward-looking statements
herein for reasons including the effect of competition, the level of
petroleum industry exploration and production expenditures, world economic
conditions, prices of, and the demand for, crude oil and natural gas,
drilling activity, weather, the legislative environment in the United
States and other countries, OPEC policy, conflict in the Middle East and
other major petroleum producing or consuming regions, the development of
technology that lowers overall finding and development costs and the
condition of the capital and equity markets.
MERGER
On August 10, 1998, Baker Hughes Incorporated ("Baker Hughes" or the
"Company") completed a merger with Western Atlas Inc. ("Western Atlas") by
issuing 148.6 million shares of its common stock for all of the outstanding
common stock of Western Atlas (the "Merger"). Each share of Western Atlas
common stock was exchanged for 2.7 shares of Baker Hughes common stock.
Western Atlas is a leading supplier of oilfield services and reservoir
information technologies for the worldwide oil and gas industry. It
specializes in land, marine and transition-zone seismic data acquisition
and processing services, well-logging and completion services and reservoir
characterization and project management services. The Merger was accounted
for as a pooling of interests and, accordingly, all prior period
consolidated financial statements of Baker Hughes have been restated to
include the results of operations, financial position and cash flows of
Western Atlas.
CHANGE IN YEAR END
On August 27, 1998, the Board of Directors of the Company approved a
change in the Company's fiscal year end from September 30 to December 31,
effective with the calendar year beginning January 1, 1998. A three-month
transition period from October 1, 1997 through December 31, 1997 preceded
the start of the new fiscal year.
BUSINESS ENVIRONMENT
The Company is primarily engaged in the oilfield service industry.
It's oilfield operations generated 92% of the Company's consolidated
revenues in both the three and nine months ended September 30, 1998 and
-15-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
consist of eight business units - Western Geophysical, Baker Atlas, Baker
Hughes INTEQ, E&P Solutions, Baker Oil Tools, Baker Petrolite, Centrilift
and Hughes Christensen - that manufacture and sell equipment and provide
services and solutions used in the drilling, completion, production and
maintenance of oil and gas wells and in reservoir measurement and
evaluation. The business environment for the Company and its corresponding
operating results are affected significantly by the petroleum industry
exploration and production expenditures. These expenditures are influenced
strongly by oil company expectations about the supply and demand for crude
oil and natural gas, energy prices and finding and development costs.
Petroleum supply and demand, pricing and finding and development costs, in
turn, are influenced by numerous factors including, but not limited to,
those described above in "--Forward-Looking Statements".
Four key factors which currently influence the worldwide crude oil
market and therefore current and future expenditures for exploration and
development by our customers are:
1) The degree to which certain large producing countries, in particular
Saudi Arabia, Venezuela, and Mexico, are willing and able to restrict
production and exports of crude oil.
2) The increasing rate of depletion of known hydrocarbon reserves.
Technological advances are resulting in accelerated decline rates and
shorter well lives. In general, accelerated decline rates require
additional customer spending to hold production levels.
3) The economic growth in certain key areas of the world, particularly
developing Asia, where the correlation between energy demand and economic
growth is particularly strong.
4) The amount of crude oil in storage relative to historic levels.
These four factors, together with oil and gas company projections for
future commodity price movement, influence overall levels of expenditures
for exploration and development by the Company's customers.
More specifically, two key factors influence the level of exploration
and development spending:
1) Technology: Advances in the design and application of more
technologically advanced products and services allow oil and gas companies
to drill fewer wells, place the wells they drill more precisely in the
higher yielding or more easily produced hydrocarbon zones of the reservoir
and allow operators to drill, complete and operate wells at lower overall
costs.
2) Price Volatility: Changes in hydrocarbon markets create uncertainty
in the future price of hydrocarbons and therefore create uncertainty about
the aggregate level of customer spending. Multi-year projects, such as
deep-water exploration and drilling, are the least likely to be impacted by
price volatility. Projects with relatively short payback periods or low
profit margins, such as workover activity or the extraction of heavy oil,
are more likely to be impacted.
-16-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
Crude oil and natural gas prices and the Baker Hughes rotary rig count
are summarized in the tables below as quarterly averages followed by the
Company's outlook. While reading the Company's outlook set forth below,
caution is advised that the factors described above in "--Forward-Looking
Statements" and "--Business Environment" could negatively impact the
Company's expectations for oil demand, oil and gas prices and drilling
activity.
Oil and Gas Prices Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
- --------------------------------------------------------------------------
WTI ($/bbl) 14.08 19.73 14.91 20.89
U.S. Spot Natural Gas ($/mcf) 1.93 2.39 2.06 2.30
Crude oil prices were weaker compared to the same periods in 1997 due
to a slowing of worldwide demand growth, the Asian economic downturn, and
increases in OPEC and non-OPEC production in prior quarters that has
resulted in higher inventories (particularly in North America).
U.S. natural gas prices weakened during the three months ended
September 30, 1998. Prices greater than $1.80 are expected to support
natural gas drilling activity at near current levels.
Rotary Rig Count Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
- --------------------------------------------------------------------------
U.S. - Land 676 865 747 805
U.S. - Offshore 119 126 129 121
Canada 206 399 280 349
- --------------------------------------------------------------------------
North America 1,001 1,390 1,156 1,275
- --------------------------------------------------------------------------
Latin America 229 270 254 276
North Sea 48 55 54 59
Other Europe 45 52 47 54
Africa 65 78 77 81
Middle East 170 170 167 157
Asia Pacific 169 184 179 182
- --------------------------------------------------------------------------
International 726 809 778 809
- --------------------------------------------------------------------------
Worldwide 1,727 2,199 1,934 2,084
- --------------------------------------------------------------------------
U.S. Workover 1,000 1,411 1,140 1,420
Outlook
The Company expects oil prices to trade between $12.00 and $15.50 per
barrel for the remainder of 1998 as production cuts balance the impact of
weakened demand and inventories stabilize. The Company believes that a
-17-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
sustained low price environment for crude oil may result in a period of
slower than expected customer spending through the end of 1998 and into
1999. In 1999, the willingness and ability of certain countries,
particularly Saudi Arabia, Venezuela and Mexico, to continue to restrict
production and exports, as well as increasing depletion rates, could result
in inventories that approach normal levels and ultimately lead to rising
oil prices. Growth in customer upstream spending is dependent upon
expectations for growth in worldwide hydrocarbon demand. In the long-term,
the economic rebound of developing Asia is expected to result in demand
growth approximating the long-term trend of 2 to 2-1/2% per year.
North America: The Company anticipates that North American activity
will continue to decline through the remainder of the year relative to the
prior year. Offshore activity is expected to weaken temporarily as high
day-rate rigs are recontracted at lower rates.
International: The Company expects that activity in Latin America will
decrease over the remainder of the year as budget cuts in Mexico and
Venezuela impact activity levels. Eastern Hemisphere activity is expected
to weaken further unless oil prices rise above current levels.
DISCONTINUED OPERATIONS
On October 31, 1997, Western Atlas distributed all the shares of UNOVA,
Inc. ("UNOVA"), its then wholly owned industrial automation systems
subsidiary, as a stock dividend to it's shareholders (the "Spin-off"). The
operations of UNOVA for the three and nine months ended September 30, 1997
are classified as discontinued operations in the Company's consolidated
condensed financial statements. For periods prior to the Spin-off, cash,
debt, and the related net interest expense were allocated based on the
capital needs of UNOVA's operations. All corporate general and
administrative costs of the Company are included in continuing operations
and no allocation was made to UNOVA for any of the periods presented.
The UNOVA results of operations for the nine months ended September 30,
1997 include a $203.0 million charge related to acquired in-process
research and development activities related to its acquisition of United
Barcode Industries in April 1997.
ACQUISITIONS
In April 1998, the Company acquired all the outstanding stock of WEDGE
DIA-LOG, Inc. ("WEDGE") for $218.5 million in cash. WEDGE specializes in
cased-hole logging and pipe recovery services. Also in April 1998, the
Company acquired 3-D Geophysical, Inc. ("3-D") for $117.5 million in cash.
3-D is a supplier of primarily land-based seismic data acquisition
services. The purchase method of accounting was used to record both of
these acquisitions. The operating results of these acquisitions are
included in the consolidated statement of operations from their respective
acquisition date.
-18-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
Other acquisitions were made during the nine months ended September 30,
1998, that were not individually, nor in the aggregate, material to the
consolidated financial statements of the Company.
In July 1997, the Company acquired Petrolite Corporation ("Petrolite")
and Wm. S. Barnickel & Company ("Barnickel"), the holder of 47.1% of
Petrolite's common stock, for 19.3 million shares of the Company's common
stock having a value of $730.2 million in a three-way business combination
accounted for using the purchase method of accounting. Additionally, the
Company assumed Petrolite's outstanding vested and unvested employee stock
options which were converted into the right to acquire 1.0 million shares
of the Company's common stock. Such assumption of Petrolite options by the
Company had a fair market value of $21.0 million resulting in total
consideration in the acquisitions of $751.2 million.
PETROALLIANCE SERVICES COMPANY LIMITED
The Company owns a 50% interest in Petroalliance Services Company
Limited ("PAS"), which provides seismic, well-logging and reservoir
characterization services in the former Soviet Union, including Russia.
The financial statements of PAS have been included in the consolidated
financial statements of the Company because the Company has provided all
the financial and operational support for PAS. Beginning in early 1998,
economic conditions in Russia deteriorated significantly, causing PAS to
become unprofitable and jeopardizing its relationship with its Russian
customers. As a result, the Company began exploring its options with
respect to its investment in PAS. In August 1998, the Company entered into
an agreement to sell its 50% interest in PAS, however, it was subsequently
advised by the prospective buyer that it would be unable to consummate the
transaction. As a result of the continuing deterioration of the operating
environment in Russia and the Company's decisions to divest or suspend its
participation in PAS, the Company has recorded charges totaling $83.2
million in the three months ended September 30, 1998 for the write-down of
assets related to PAS.
RESULTS OF OPERATIONS
Revenues
Consolidated revenues were up $73.5 million and $815.3 million for the
three and nine months ended September 30, 1998, respectively, as compared
to the same periods in 1997. Sales revenue was down 3% and up 20% for the
three and nine months ended September 30, 1998, respectively, as compared
to the corresponding periods in 1997. Service and rentals revenue was up
13% and 20% for the three and nine months ended September 30, 1998,
respectively, as compared to the corresponding periods in 1997.
Consolidated revenues for the three and nine months ended September 30,
1998 were approximately $64.0 million and $382.0 million, respectively,
higher than the same periods in 1997 due to the various acquisitions made
by the Company in 1997 and 1998. Activity levels were lower in most areas
of the world, but the impact on the Company's business was most dramatic in
-19-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
North America land based activity and in Venezuela where the lower oil and
gas prices reduced demand for the Company's products and services.
Excluding acquisitions, Western Geophysical is the only division that
reported a revenue increase for the three months ended September 30, 1998
as compared to the same period in 1997 as it benefited from strong
licensing sales of multiclient data where customer spending is impacted
less by fluctuations in oil prices in the short term. The Company expects
consolidated revenues for the three months ending December 31, 1998 to be
lower than the consolidated revenues for the three months ended September
30, 1998.
Costs and Expenses Applicable to Revenues
Costs of sales and costs of services and rentals have increased from
the prior year periods due primarily to the recording of various charges as
described below. Excluding the impact of these items from the 1998 periods
and the impact of a $21.9 million nonrecurring item in the 1997 periods
related to the Petrolite acquisition, the gross margin percentages were
29.3% and 33.2% for the three months ended September 30, 1998 and 1997,
respectively, and 30.9% and 31.8% for the nine months ended September 30,
1998 and 1997, respectively. The decline is due primarily to pricing
pressures and lower activity levels in North America and Venezuela.
During the three months ended September 30, 1998, the demand for the
Company's products and services declined sharply as the price of oil and
natural gas fell. This sharp decline in customer demand materialized
quickly from high growth levels experienced in the last several years and
continued into the early part of 1998. As a result, the Company wrote down
excess and obsolete inventory and rental tools and equipment brought about
by these changing market conditions. In the three months ended September
30, 1998, the Company provided reserves and recorded write-downs of $114.5
million reflected in costs of sales and $149.0 million reflected in costs
of service and rentals. In addition, the Company increased its
environmental remediation liability during the three months ended September
30, 1998 by a charge to income of $8.8 million, which is reflected in costs
of sales.
Additionally, the Company has written off the goodwill arising from its
investment in PAS and property, plant and equipment of PAS in the amount of
$21.8 million and $10.9 million, respectively, during the three months
ended September 30, 1998. Such charges are included in costs of services
and rentals.
Selling, General and Administrative
Selling, general and administrative ("SG&A") expense increased $83.5
million in the three months ended September 30, 1998 from the same period
in 1997. Charges totaling $68.7 million were recorded during the three
months ended September 30, 1998 that relate primarily to additional PAS
reserves, litigation accruals and a loss on the sale of Tracor Europa.
Excluding these nonrecurring items, SG&A expense as a percent of
consolidated revenues was 20.5% in both the three months ended September
-20-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
30, 1998 and 1997 and 19.4% and 19.7% in the nine months ended September
30, 1998 and 1997, respectively.
Unusual Charge
1998
During the three months ended September 30, 1998, the Company
recognized a $175.3 million unusual charge consisting of the following
(in millions):
Impairment of oil & gas properties $ 72.3
Restructurings:
Severance for 3,400 employees under existing benefit plans 41.8
Abandoned leases and other contractual obligations 30.7
Write down of property and other assets 30.5
-------
Total $ 175.3
=======
During the three months ended September 30, 1998, the Company decided
to significantly reduce the scope and level of its start-up oil and gas
operations in light of the capital required and risks associated with oil
and gas exploration. As a result, the Company recorded a noncash charge of
$72.3 million for the impairment of oil and gas properties and a write off
of previously capitalized costs related to countries in which the Company
has decided to no longer pursue oil and gas activity.
The Company restructured and downsized its operations to the current
and expected market conditions which resulted in a charge of $103.0 million
in the three months ended September 30, 1998. The charge included
restructuring and downsizing at most of the Company's operating divisions
and is expected to reduce future operating costs in an attempt to offset
expected lower future revenues. Cash provisions of the unusual charge
totaled $72.5 million. The Company spent $16.3 million in the three months
ended September 30, 1998 and expects to spend substantially all of the
remaining $56.2 million in the remainder of 1998 and 1999.
-21-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
1997
During the three months ended September 30, 1997, the Company
recognized a $52.1 million unusual charge consisting of the following
(in millions):
Baker Petrolite:
Severance for 140 employees under
existing benefit plans $ 2.2
Relocation of people and equipment 3.4
Integration costs 9.3
Inventory write-down 11.3
Write-down of other assets 9.3
Drilex:
Write-down of property and other assets 4.1
Banking and legal fees 3.0
Discontinued product lines:
Severance for 50 employees 1.5
Write-down of inventory, property and other assets 8.0
----
Total $ 52.1
=====
In connection with the acquisitions of Petrolite, accounted for as a
purchase, and Drilex, accounted for as a pooling of interests, the Company
recorded unusual charges of $35.5 million and $7.1 million, respectively,
to combine the acquired operations with those of the Company. The charges
include the cost of closing redundant facilities, eliminating or relocating
redundant personnel and equipment and rationalizing inventories which
require disposal at amounts less than their cost. A $9.5 million charge
was recorded as a result of the decision to discontinue a low margin,
oilfield product line in Latin America and to sell the Tracor Europa
subsidiary, a computer peripherals operation, which resulted in a write-
down of the investment to net realizable value. Cash provisions of the
unusual charge totaled $19.4 million. The Company spent $5.5 million in
the three months ended September 30, 1997 and spent substantially all of
the remaining $13.9 million in the remainder of 1997 and 1998.
Acquired In-process Research and Development
In the Petrolite acquisition, the Company allocated $118.0 million of
the purchase price to in-process research and development. In accordance
with generally accepted accounting principles, the Company recorded the
acquired in-process research and development as a charge to expense because
its technological feasibility had not been established and it had no
alternative future use at the date of acquisition.
Interest Expense
Interest expense for the three and nine months ended September 30, 1998
increased $15.7 million and $38.9 million, respectively, compared to the
-22-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
corresponding periods in 1997 due to higher debt levels that funded
acquisitions, capital expenditures and increases in working capital.
Merger Related Costs
In connection with the Merger, the Company recorded merger related
costs of $201.9 million during the three months ended September 30, 1998
which consisted of the following (in millions):
Transaction costs $ 51.5
Employee costs 130.7
Other costs 19.7
-------
Total $ 201.9
=======
The transaction costs include banking and legal fees, printing and
other costs directly related to the Merger.
The employee related costs consist of payments made to certain officers
of Western Atlas and Baker Hughes pursuant to change in control provisions
of employment contracts and other employee benefit plans, severance
benefits paid to terminated employees whose responsibilities were redundant
as a result of the Merger and a noncash charge of $45.3 million related to
the triggering of change in control rights contained in certain Western
Atlas employee stock option plans which occurred as a result of the Merger.
Other costs include merger integration costs that were incurred during
the three months ended September 30, 1998. The Company expects that
additional merger related expenses will be incurred in future quarters,
primarily for items that did not qualify for recognition in the three
months ended September 30, 1998.
Spin-off Related Costs
Costs related to the spin-off of UNOVA of $8.4 million were charged to
continuing operations during the three months ended September 30, 1997.
Income Taxes
The effective income tax rate for the three and nine months ended
September 30, 1998 differs from the statutory rate due to the
nondeductibility of certain unusual, merger and other nonrecurring charges
recorded in those periods.
CAPITAL RESOURCES AND LIQUIDITY
Financing Activities
Net cash inflows from continuing operations' financing activities were
$804.8 million in the nine months ended September 30, 1998 compared to
$418.6 million for the same period in 1997. Total debt outstanding at
September 30, 1998 was $2,689.8 million, compared to $1,788.1 million at
-23-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
December 31, 1997. The change from the prior year period is primarily due
to increased borrowings from commercial paper and revolving credit
facilities that funded acquisitions, capital expenditures and increases in
working capital. The debt to equity ratio was .83 at September 30, 1998,
compared to .51 at December 31, 1997.
Cash dividends increased in the nine months ended September 30, 1998
compared to the same nine months of 1997 due to an increase in the number
of shares of common stock outstanding resulting primarily from the issuance
of shares in connection with the 1997 acquisition of Petrolite. On an
annualized basis, the cash dividend of $.46 per share of common stock, will
require approximately $150.0 million of cash which compares to an annual
requirement of approximately $78.0 million before the merger with Western
Atlas.
At September 30, 1998, the Company had $2,063.4 million of credit
facilities with commercial banks, of which $1,000.0 million was committed.
These facilities are subject to normal banking terms and conditions and do
not materially restrict the Company's activities. At September 30, 1998,
the Company had borrowed $1,640.8 million against the credit facilities.
Investing Activities
Net cash outflows from continuing operations' investing activities were
$1,325.8 million in the nine months ended September 30, 1998 compared to
$743.3 million in the same period in 1997.
Property additions increased in the nine months ended September 30,
1998 to $973.7 million from $804.7 million in the nine months ended
September 30, 1997 as the Company added capacity to meet increased market
demand and due to an increase in the acquisition of multiclient seismic
data. In light of the recent activity decline, the Company is reviewing
significant capital projects and expects the rate of capital spending to
slow. Funds provided from operations and outstanding lines of credit are
expected to be adequate to meet future capital expenditure requirements.
During the nine months ended September 30, 1998, the Company used
short-term borrowings to purchase various businesses including WEDGE for
$218.5 million, net of cash acquired; 3-D for $117.5 million; and Western
Rock Bit for $31.4 million.
Proceeds from the disposal of assets generated $74.6 million and $45.1
million in the nine months ended September 30, 1998 and 1997, respectively.
The Company obtained $65.4 million of cash from the acquisition of
Petrolite in July 1997. In July 1997, the Company sold all of the
marketable securities obtained in the Barnickel acquisition for $48.5
million.
Operating Activities
Net cash inflows from continuing operations' operating activities were
$501.4 million in the first nine months of 1998 compared to $523.5 million
in the first nine months of 1997.
-24-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
ACCOUNTING STANDARDS
Derivative and Hedge Accounting
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133 establishes
accounting and reporting standards for derivative instruments and hedging
activities that require an entity to recognize all derivatives as an asset
or liability measured at its fair value. Depending on the intended use of
the derivative, changes in its fair value will be reported in the period of
change as either a component of earnings or a component of other
comprehensive income.
SFAS No. 133 is effective for all quarters of fiscal years beginning
after June 15, 1999. Retroactive application to periods prior to adoption
is not allowed. The Company has not quantified the impact of the adoption
of SFAS No. 133 on its consolidated financial statements.
QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURE UPDATE
At September 30, 1998, the Company had Norwegian Krone denominated
commitments of $82.7 million to purchase two seismic vessels in 1999 and
Australian dollar denominated commitments of $36.2 million to purchase
seismic vessel equipment at various times through February 2000. The
Company has entered into forward exchange contracts to purchase the
required amount of Norwegian Krone and Australian dollars for $88.9 million
and $35.7 million, respectively.
YEAR 2000 ISSUE
Forward-Looking Statements Regarding the Year 2000 Issue
"Year 2000 Issue" contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. The words
"expect", "believe", "will" and similar expressions are intended to
identify forward-looking statements. Although the Company expects that it
will complete various phases of its Year 2000 Program Plan as described
below, including (without limitation) the specific remedial and corrective
aspects of the program or the contingency plans described below, there can
be no assurance that the Company will be successful in completing each and
every aspect of the Program Plan and, if successful, within the expected
schedules described below. Factors that could affect the Company's
implementation of its Year 2000 Program Plan include unforeseen
difficulties in remediating a specific problem due to the complexity of
hardware and software, the inability of third parties to adequately address
their own year 2000 issues, including vendors, contractors, financial
institutions, U.S. and foreign governments and customers, the delay in
completion of a phase of the Program Plan necessary to begin a latter
phase, the discovery of a greater number of hardware and software systems
or technologies with material year 2000 issues than the Company presently
anticipates and the lack of alternatives that the Company previously
believed existed.
-25-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
Overview
Many computer hardware and software products have not been engineered
with internal calendars or date-processing logic capable of accommodating
dates after December 31, 1999. In most cases, the problem is due to the
hardware or software application storing the year as a two-digit field. In
applications where this year 2000 ("Y2K") problem exists, the year 2000
will appear as 00, and current applications could interpret the year as
1900 rather than 2000. The same problem exists for years later than 2000
because the application cannot distinguish which century the date
represents. This could cause errors when dates are used in comparisons,
sorting, calculations and other forms of processing. These errors and
problems could negatively affect the Company's business application
systems, manufacturing, engineering and process control systems, products
sold to customers, equipment used in providing services, facilities and
information technology ("IT") infrastructure such as local and wide area
networks and communications systems. Additionally, Y2K issues impacting
suppliers and customers could have an indirect negative impact on the
Company.
The Company has organized a Year 2000 Program Team, reporting to a
Senior Vice President of the Company, to oversee the Company's activities
to identify, assess and correct the Company's Y2K problems. An Advisory
Team has also been organized to serve as a steering committee for the
Company's Y2K effort. The Advisory Team includes the coordinators from
each of the Company's operating divisions and representatives from the
Company's corporate office including the legal, contracts, finance, risk
management and internal audit functions. Each operating division has
organized a team with representatives from manufacturing, engineering,
management information systems, procurement, contracts, legal, finance and
marketing. The operating divisions are responsible for the specific Y2K
activities at their respective division while the Year 2000 Program Team
coordinates the activities that are common to all operating divisions.
Both internal and external resources are being utilized to identify, assess
and correct the Company's Y2K problems.
Year 2000 Program Plan
Baker Hughes has developed a Year 2000 Program Plan (the "Program
Plan") for identifying, assessing and correcting its Y2K problems. This
Program Plan sets forth the Company's overall plan to identify, assess and
correct its Y2K problems and provides direction to the operating division
teams to ensure consistency and quality in their approach. The Program
Plan addresses the following phases to identify, assess and correct the
Company's Y2K issues: program management, inventory and risk assessment,
remediation, testing and implementation, contingency planning and quality
assurance. Each phase is described as follows:
Program Management
The program management phase consists of the Year 2000 Program Team's
ongoing management of the Company's Y2K effort, establishing and promoting
awareness of Y2K issues within the Company, communicating the Company's Y2K
-26-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
efforts to customers, vendors and other outside parties and establishing
guidelines for the Company's operating divisions to develop a consistent
approach to resolving Y2K issues and to oversee quality in testing and
validating that remedial action has corrected an identified Y2K problem.
Inventory and Risk Assessment
The objective of the inventory and risk assessment phase is to complete
and document an inventory of all hardware and software systems and
technologies that the Company utilizes, determine whether the inventoried
items have Y2K problems and, if such problems exist, assess the risks
associated with the problem. To date, the inventory and risk assessment
phase has been conducted and documented on an informal, ad hoc basis and
has focused on business application systems, IT infrastructure, products
sold to customers and equipment that the Company uses in providing services
to its customers. To a lesser degree, inventory and risk assessment has
been conducted for the Company's suppliers and vendors. The Company has
not actively conducted an inventory and risk assessment to date with
respect to its facilities and customers.
The lack of a formal inventory make it difficult to quantitatively
measure the progress in completing the inventory and risk assessment phase.
To address this difficulty, the Company purchased a database management
tool designed specifically for Y2K inventory and risk assessment in the
third quarter of 1998 to be used to document the inventory, assist in the
business impact analysis and risk assessment and measure the Company's
progress in addressing Y2K compliance. The multiple hardware and software
systems and technologies that the Company utilizes also make it difficult
to measure this progress. Assuming that the Company does not identify more
hardware and software systems and technologies in the areas of the Company
that it has not inventoried compared to those areas that it has
inventoried, the Company expects to complete the formalized inventory and
risk assessment phase by January 1999. The Company estimates that it has
assessed the risk for approximately 30-40% of the hardware and software
systems and technologies that the Company has inventoried to date.
Remediation
Baker Hughes has adopted the British Standards Institute Year 2000
Conformity Guidelines for determining whether software and hardware are not
materially affected by Y2K problems. When meeting these guidelines, the
Company has deemed that hardware or software is not materially affected by
Y2K problems and, thus, is "in Y2K compliance". The Company believes that
this standard is a reasonable standard to determine when hardware and
software is not materially affected by Y2K problems.
The Company's remediation efforts include the correction or replacement
of noncompliant hardware and software and are scheduled to be completed by
mid to late 1999 for all material noncompliant hardware and software that
the Company has identified to date. Both Company employees and outside
vendors and contractors are conducting remediation activities for the
Company. In some cases, the purchase of new hardware and software
-27-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
equipment has been accelerated to replace equipment that is not Y2K
compliant.
Testing and Validation
Baker Hughes expects to perform testing and validation of the
compliance status for critical hardware and software as remediation is
completed. Hardware and software that is not critical may not be tested
and validated. The Company expects that Company employees will conduct
substantially all of the testing and validation work and that it will, in
large part, not utilize independent contractors for testing and validation.
Contingency Planning
The Company's operations personnel have identified contingency
scenarios, but the Company has not yet developed formal contingency plans.
The Company expects to develop contingency plans for the areas that
represent the highest business risk and for areas that are expected to take
the longest time to remediate. The Company expects this effort to begin in
January 1999.
Quality Assurance
The Year 2000 Program Team is also implementing a quality assurance
program. The Company expects to utilize external resources to evaluate its
program management and assess the completeness and adequacy of its risk
assessment and testing and validation of compliance. The Company expects
the quality assurance effort to begin in January 1999.
Year 2000 Program Costs
Baker Hughes has approximately 80 full time equivalent employees
("FTEs") involved in the Y2K effort, which the Company estimates has an
associated annual cost of approximately $5.6 million. Generally, these
FTEs are full time employees who are devoting some portion of their
schedule to the Y2K effort. With few exceptions, the Company has not hired
employees to work exclusively and specifically on the Y2K issue.
In addition to the payroll and payroll related costs of these
approximately 80 FTEs, Baker Hughes estimates spending approximately $45.0
million in the Y2K compliance effort, of which approximately $35.0 million
would be capitalized as replacement hardware and software equipment. Of
the $45.0 million, the Company has spent approximately $20 million through
September 30, 1998. The Company has funded, and expects to continue to
fund, these expenditures from cash that it generates from operating
activities or existing credit facilities. These cost estimates could
change materially based upon the completion of the inventory and risk
assessment phase of the Program Plan.
-28-
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
Third Party Issues
The failure of third parties with which the Company has a material
relationship to address their Y2K problems could negatively and materially
impact the Company. To address this risk, the Year 2000 Program Team is
currently assessing the effect of Y2K on key vendor and contractor
relationships and expects to do the same with respect to key customer
relationships. This assessment includes key relationships with parties
with which the Company interfaces electronically and with which the Company
has entered into strategic alliances.
The Year 2000 Program Team is evaluating vendors that the Company
believes are material to its operations and assessing the business risk of
Y2K noncompliance on their part. Based upon this assessment, the Company
is seeking to obtain written confirmation from key vendors and contractors
that they are adequately addressing their Y2K issues. Additionally, the
Company seeks to review the Y2K statements of these vendors and contractors
to the extent they exist. Where the Company cannot obtain satisfactory
confirmation from these vendors, the purchasing departments of each
operating division of the Company will identify alternate sources, if
available, for vendors if those sources are needed because of an inability
to perform due to Y2K noncompliance. The Company expects to complete this
assessment by April 1999.
Known Material Y2K Noncompliant Systems and Technologies
The Company's INTEQ operating division identified Y2K noncompliance in
one of its surface data acquisition systems, which includes both hardware
and software components. This personal computer-based system serves as the
data acquisition platform for INTEQ's well site services. The software is
in the process of being remediated. The noncompliant PC hardware cannot be
economically remediated, and the purchase of new, higher grade personal
computers is required to replace the noncompliant equipment. This
remediation began in 1997 with the replacement of personal computers being
phased in and is expected to be completed by late 1999. The Company
estimates that as of September 30, 1998, it was 60% complete in the
replacement of the noncompliant personal computer hardware and software for
the surface data acquisition system.
The Company's Baker Process operating division is implementing a new
business application system to replace its existing systems, which are not
Y2K compliant. The Company expects the implementation of the new system
will be completed by the end of 1999.
The Company's Western Geophysical operating division relies heavily
upon Global Positioning System ("GPS") equipment that the U.S. Navy
operates. Western Geophysical uses GPS to obtain accurate longitude and
latitude information for the purposes of providing its seismic services.
The Company's GPS receivers are substantially compliant but the government
controlled system, Navstar, is not compliant. This system is utilized to
process information that Western Geophysical GPS receivers use. Navstar's
non-compliance is a known problem outside the control of the Company that
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
affects other businesses, the government, the military services and
individuals that rely upon GPS services, including most of the Company's
competitors. Based upon information obtained from the U.S. government, the
Company believes that the government is adequately addressing Navstar's Y2K
noncompliance problem. However, there can be no assurance that Navstar's
Y2K noncompliance, or any other Y2K noncompliance with respect to the
government's GPS equipment or the equipment of its contractors and
subcontractors will be corrected on schedule. The Company is not aware of
any contingency system that its GPS receivers can utilize if Navstar is not
made Y2K compliant. A failure to correct the Y2K problems of this
equipment could have a material adverse impact on the Company's results of
operations.
The Company is unable to reasonably estimate the absolute dollar effect
on the Company's results of operation, liquidity or financial condition if
its remediation efforts are unsuccessful, although the Company believes the
effect would be material. Additionally, contingency plans have not been
developed for these known material noncompliant systems and technologies
because the Company believes that the remediation efforts will be
successful and does not anticipate a problem with the roll-out of the
compliant systems. However, the Company may develop contingency plans as
appropriate during 1999.
As the Company completes its inventory and risk assessment phase,
additional material, noncompliant systems and technologies may be
identified.
Potential Material Noncompliant Systems and Technologies
The Company's Baker Process operating division provides mechanical
equipment that, in some cases, has been customized at the request of the
customer to include control panels and circuit boards. The Company
obtained these control panels and circuit boards from third-party vendors
at the request of various customers. The Company is researching the Y2K
compliance status of these boards. This status is often dependent upon the
purchase date and serial number of the product. The warranties from the
Company or its subcontractors have, in many instances, lapsed with respect
to these panels and circuit boards. The Company expects to have completed
its investigation of these systems by mid 1999.
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PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
A Special Meeting of Stockholders was held on August 10, 1998, to
vote upon a proposal to issue shares of Baker Hughes common stock in
connection with the Merger. The number of affirmative votes, the number of
negative votes, the number of abstentions and the number of broker nonvotes
with respect to the approval of the issuance of shares in connection with
the Merger were as follows:
Number of Affirmative Votes 120,484,740
Number of Negative Votes 7,364,589
Number of Abstentions 600,301
Number of Broker Nonvotes 41,316,039
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
(3)(ii) Bylaws as amended on October 28, 1998
(27.1) Financial Data Schedule
(b) Reports on Form 8-K:
A report on Form 8-K was filed with the Commission on August 14,
1998, reporting that the Company had completed the acquisition of Western
Atlas Inc. pursuant to the Agreement and Plan of Merger dated as of May 10,
1998 and amended on July 22, 1998.
A report on Form 8-K was filed with the Commission on September 11,
1998, reporting that the Company changed its fiscal year end from September
30 to December 31, effective the calendar year beginning January 1, 1998.
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SIGNATURES
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 thereunto duly authorized.
BAKER HUGHES INCORPORATED
(Registrant)
Date: November 16, 1998 By /s/LAWRENCE O'DONNELL, III
------------------------------------
Lawrence O'Donnell, III
Vice President and General Counsel
Date: November 16, 1998 By /s/JAMES E. BRAUN
------------------------------------
James E. Braun
Vice President and Controller
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