1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-9397
BAKER HUGHES INCORPORATED
(a Delaware Corporation)
76-0207995
3900 Essex Lane
Houston, Texas 77027
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 August 4, 2001
Common Stock, $1.00 par value per share 335,760,824 shares
2
INDEX
<Table>
<Caption>
PAGE NO.
--------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Statements of Operations - Three months and six months ended
June 30, 2001 and 2000 2
Consolidated Condensed Balance Sheets - June 30, 2001 and December 31, 2000 3
Consolidated Condensed Statements of Cash Flows - Six months ended
June 30, 2001 and 2000 4
Notes to Consolidated Condensed Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 17
PART II - OTHER INFORMATION 18
</Table>
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In millions, except per share amounts)
(Unaudited)
<Table>
<Caption>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
Revenues $ 1,342.0 $ 1,255.5 $ 2,570.5 $ 2,496.3
---------- ---------- ---------- ----------
Costs and expenses:
Cost of revenues 961.8 968.6 1,851.8 1,957.3
Selling, general and administrative 198.7 185.6 401.9 377.8
Unusual charge (credit), net -- (23.7) 7.0 (23.7)
---------- ---------- ---------- ----------
Total 1,160.5 1,130.5 2,260.7 2,311.4
---------- ---------- ---------- ----------
Operating income 181.5 125.0 309.8 184.9
Equity in income of affiliates 8.8 1.3 19.3 1.3
Interest expense (32.3) (44.0) (66.4) (88.2)
Interest income 0.4 0.5 1.8 1.0
Gain on trading securities -- 10.1 -- 17.2
---------- ---------- ---------- ----------
Income before income taxes, extraordinary loss 158.4 92.9 264.5 116.2
and cumulative effect of accounting change
Income taxes (53.1) (30.2) (88.9) (38.1)
---------- ---------- ---------- ----------
Income before extraordinary loss and cumulative 105.3 62.7 175.6 78.1
effect of accounting change
Extraordinary loss (net of $0.8 income tax benefit) (1.5) -- (1.5) --
Cumulative effect of accounting change (net of $0.5
income tax expense) -- -- 0.8 --
---------- ---------- ---------- ----------
Net income $ 103.8 $ 62.7 $ 174.9 $ 78.1
========== ========== ========== ==========
Basic and diluted earnings per share:
Income before extraordinary loss and cumulative $ 0.31 $ 0.19 $ 0.52 $ 0.24
effect of accounting change
Extraordinary loss -- -- -- --
Cumulative effect of accounting change -- -- -- --
---------- ---------- ---------- ----------
Net income $ 0.31 $ 0.19 $ 0.52 $ 0.24
========== ========== ========== ==========
Cash dividends per share $ 0.115 $ 0.115 $ 0.23 $ 0.23
========== ========== ========== ==========
</Table>
See accompanying notes to consolidated condensed financial statements.
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BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED BALANCE SHEETS
(In millions)
(Unaudited)
<Table>
<Caption>
June 30, December 31,
2001 2000
---------- ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 42.2 $ 34.6
Accounts receivable, net 1,315.6 1,310.4
Inventories 1,014.4 898.5
Other current assets 245.8 243.1
---------- ----------
Total current assets 2,618.0 2,486.6
---------- ----------
Investment in affiliates 883.6 869.3
Property, net 1,355.5 1,378.7
Goodwill and other intangibles, net 1,469.2 1,498.1
Other assets 243.0 220.0
---------- ----------
Total assets $ 6,569.3 $ 6,452.7
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 521.4 $ 469.3
Short-term borrowings and current portion of long-term debt 14.3 13.3
Accrued employee compensation 212.4 250.6
Other current liabilities 338.2 254.6
---------- ----------
Total current liabilities 1,086.3 987.8
---------- ----------
Long-term debt 1,949.6 2,049.6
Deferred income taxes 173.7 158.6
Other long-term liabilities 210.1 210.0
Stockholders' equity:
Common stock 335.7 333.7
Capital in excess of par value 3,108.1 3,065.7
Accumulated deficit (3.5) (101.3)
Accumulated other comprehensive loss (290.7) (251.4)
---------- ----------
Total stockholders' equity 3,149.6 3,046.7
---------- ----------
Total liabilities and stockholders' equity $ 6,569.3 $ 6,452.7
========== ==========
</Table>
See accompanying notes to consolidated condensed financial statements.
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5
BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
<Table>
<Caption>
Six Months Ended
June 30,
--------------------------
2001 2000
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 174.9 $ 78.1
Adjustments to reconcile net income to net cash flow from operating
activities:
Depreciation, depletion and amortization 167.0 311.7
Provision for deferred income taxes 2.8 34.4
Loss on extinguishment of debt 2.3 --
Gain on disposal of assets (8.5) (26.4)
(Gain) loss on sale of product lines 1.1 (11.2)
Gain on trading securities -- (17.2)
Equity in income of affiliates (19.3) (1.3)
Change in accounts receivable (14.6) (1.8)
Change in inventories (120.6) (33.2)
Change in accounts payable 52.0 (72.8)
Change in accrued employee compensation and other current liabilities 47.7 (41.2)
Change in deferred revenue and other long-term liabilities 0.5 (6.0)
Changes in other assets and liabilities (40.3) (25.1)
---------- ----------
Net cash flows from operating activities 245.0 188.0
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for capital assets and multiclient seismic data (136.3) (318.1)
Proceeds from disposal of assets 31.2 69.8
Proceeds from sale of product lines 1.4 31.4
Proceeds from sale of trading securities -- 58.6
---------- ----------
Net cash flows from investing activities (103.7) (158.3)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings from commercial paper and short-term debt 202.7 70.7
Repayment of indebtedness (301.8) --
Proceeds from issuance of common stock 44.6 15.1
Dividends (77.1) (75.9)
---------- ----------
Net cash flows from financing activities (131.6) 9.9
---------- ----------
Effect of foreign exchange rate changes on cash (2.1) (2.3)
---------- ----------
Increase in cash and cash equivalents 7.6 37.3
Cash and cash equivalents, beginning of period 34.6 15.6
---------- ----------
Cash and cash equivalents, end of period $ 42.2 $ 52.9
========== ==========
Income taxes paid $ 35.8 $ 86.0
Interest paid $ 61.5 $ 74.7
</Table>
See accompanying notes to consolidated condensed financial statements.
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BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The unaudited consolidated condensed financial statements of Baker Hughes
Incorporated and its subsidiaries (the "Company") included herein have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Accordingly, certain information and disclosures normally included
in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted. The Company believes that
the presentations and disclosures herein are adequate to make the information
not misleading. The unaudited consolidated condensed financial statements
reflect all adjustments (consisting of normal recurring adjustments) necessary
for a fair presentation of the interim periods. These unaudited consolidated
condensed financial statements should be read in conjunction with the Company's
audited consolidated financial statements included in its Annual Report on Form
10-K for the year ended December 31, 2000. The results of operations for the
interim periods are not necessarily indicative of the results of operations to
be expected for the full year.
In the notes to the unaudited consolidated condensed financial statements,
all dollar and share amounts in tabulations are in millions of dollars and
shares, respectively, unless otherwise indicated.
NOTE 2. DERIVATIVE INSTRUMENTS
On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging
Activities, as amended by SFAS No. 137 and SFAS No. 138. 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 fair value. Depending on the intended use of the
derivative and its effectiveness, 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. The adoption of SFAS No. 133 on January 1, 2001 resulted
in a gain of $0.8 million, net of tax, recorded as the cumulative effect of an
accounting change in the consolidated condensed statement of operations and a
gain of $1.2 million, net of tax, recorded in accumulated other comprehensive
income.
The Company monitors its exposure to various business risks including
commodity price, foreign exchange rate and interest rate risks and occasionally
uses derivative financial instruments to manage the impact of certain of these
risks. The Company's policies do not permit the use of derivative financial
instruments for speculative purposes. The Company uses forward exchange
contracts and currency swaps to hedge certain firm commitments and transactions
denominated in foreign currencies. The Company uses interest rate swaps to
manage interest rate risk. The Company also uses crude oil swaps and collars to
hedge price risk associated with the Company's crude oil production.
At the inception of any new derivatives, the Company designates the
derivative as a cash flow hedge or fair value hedge. The Company documents all
relationships between hedging instruments and the hedged items, as well as its
risk management objectives and strategy for undertaking various hedge
transactions. The Company assesses 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.
To qualify for hedge accounting, the derivative must qualify either as a
fair value hedge, cash flow hedge or a hedge of the net investment in foreign
operations. A fair value hedge is a hedge of a recognized asset or liability on
an unrecognized firm commitment. Both the effective and ineffective portions of
the changes in the fair value of the derivative, along with the gain or loss on
the hedged item, are recorded in earnings and reported in the consolidated
condensed statements of operations on the same line as the hedged item. A cash
flow hedge is a hedge of a forecasted transaction or the variability of cash
flows to be received or paid in the future related to a recognized asset or
liability. The effective portion of the changes in the fair value of the
derivative is recorded in accumulated other comprehensive income. When the
hedged item is realized, the gain or loss included in accumulated other
comprehensive income is reported on the same line in the consolidated condensed
statements of operations as the hedged item. In addition, both the fair value
changes excluded from the Company's effectiveness assessments and the
ineffective portion of the changes in the fair value of derivatives used as cash
flow hedges are immediately recognized in earnings. The Company is not currently
hedging any of its net investments in foreign operations.
During the three months ended June 30, 2001, the Company had two interest
rate swaps that qualified as fair value hedges. They were fully effective,
resulting in no net gain or loss recorded in the consolidated condensed
statement of operations.
During the three months ended June 30, 2001, the Company had one crude oil
contract (costless collar), which matured June 30, 2001, and several foreign
currency forward contracts. These contracts qualified as cash flow hedges.
During the three months ended June 30, 2001, the Company recorded a loss of $0.5
million ($0.4 million after tax) in revenue in the consolidated condensed
statement of operations to recognize the ineffective portion of its cash flow
hedges.
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BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3. COMPREHENSIVE INCOME
Comprehensive income includes all changes in equity during a period except
those resulting from investments by and distributions to owners. The components
of the Company's comprehensive income, net of related tax, are as follows:
<Table>
<Caption>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
Net income $ 103.8 $ 62.7 $ 174.9 $ 78.1
Other comprehensive loss:
Foreign currency translation adjustments (6.7) (26.9) (39.3) (42.8)
Adoption of SFAS 133 -- -- 1.2 --
Loss on derivative instruments (0.2) -- (1.2) --
---------- ---------- ---------- ----------
Total comprehensive income $ 96.9 $ 35.8 $ 135.6 $ 35.3
========== ========== ========== ==========
</Table>
Total accumulated other comprehensive loss consisted of the following:
<Table>
<Caption>
June 30, December 31,
2001 2000
---------- ------------
Foreign currency translation adjustments $ (284.4) $ (245.1)
Pension adjustment (6.3) (6.3)
---------- ----------
Total accumulated other comprehensive loss $ (290.7) $ (251.4)
========== ==========
</Table>
NOTE 4. UNUSUAL ITEMS
During the first quarter of 2001, the Company recorded an unusual charge of
$7.0 million. The cash portion of the charge was $6.0 million and consisted of
severance for approximately 100 employees relating to the restructuring of the
Baker Process operations in Germany. No payments were made during the first
quarter of 2001, and $0.3 million was paid during the second quarter of 2001.
Based on current estimates, the Company expects that the majority of the accrued
severance will be paid during 2001 as the employees leave the Company.
During the second quarter of 2000, the Company recognized a pre-tax gain of
$11.2 million on the sale of two product lines. The Company received net
proceeds of $31.4 million that were used to repay outstanding indebtedness. The
Company also recorded an unusual credit of $12.5 million as net reductions to
unusual charge accruals recorded in 1999 and prior years to reflect the current
estimates of remaining expenditures. The net reductions primarily related to
severance accruals and accruals for lease obligations. These items are reflected
as unusual credits in the consolidated condensed statement of operations.
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BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
During the three and six months ended June 30, 2000, the Company recorded
pre-tax gains of $10.1 million and $17.2 million, respectively, including $7.9
million and $10.6 million of unrealized gains, respectively, related to its
holdings in Varco International, Inc.
NOTE 5. EXTRAORDINARY LOSS
On May 28, 2001, the Company redeemed its outstanding Liquid Yield Options
Notes ("LYONS") at a redemption price of $786.13 per $1,000 principal amount,
for a total of $301.8 million. The redemption was funded through the issuance of
commercial paper. In connection with the early extinguishment of debt, the
Company recorded an extraordinary loss of $2.3 million ($1.5 million after tax)
which represents the write-off of the remaining debt issuance costs.
NOTE 6. EARNINGS PER SHARE ("EPS")
A reconciliation of the number of shares used for the basic and diluted EPS
calculation is as follows:
<Table>
<Caption>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
Weighted average common shares outstanding for basic
EPS 335.7 330.5 335.3 330.2
Effect of dilutive securities - stock plans 1.9 2.3 2.3 1.5
---------- ---------- ---------- ----------
Adjusted weighted average common shares outstanding for
diluted EPS 337.6 332.8 337.6 331.7
========== ========== ========== ==========
Future potentially anti-dilutive shares excluded from
diluted EPS:
Options with option price greater than market price 4.6 3.3 4.1 3.4
LYONS convertible into common stock -- 7.2 -- 7.2
</Table>
NOTE 7. INVENTORIES
Inventories are comprised of the following:
<Table>
<Caption>
June 30, December 31,
2001 2000
---------- ------------
Finished goods $ 808.7 $ 706.0
Work in process 86.5 82.0
Raw materials 119.2 110.5
---------- ----------
Total $ 1,014.4 $ 898.5
========== ==========
</Table>
NOTE 8. SEGMENT AND RELATED INFORMATION
The Company has eight divisions that have separate management teams and
infrastructures that offer different products and services. The divisions have
been aggregated into two reportable segments, "Oilfield" and "Process".
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BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
The Oilfield segment consists of six divisions - Baker Atlas, Baker Hughes
INTEQ, Baker Oil Tools, Baker Petrolite, Centrilift and Hughes Christensen -
that manufacture and sell equipment and provide services used in the drilling,
completion, production and maintenance of oil and gas wells and in reservoir
measurement and evaluation. They have been aggregated because the long-term
financial performance of these divisions is affected by similar economic
conditions and the consolidated results are evaluated regularly by the chief
operating decision makers in deciding how to allocate resources and in assessing
performance. The principal markets for this segment include all major oil and
gas producing regions of the world including North America, Latin America,
Europe, Africa, the Middle East and the Far East. Customers include major
multi-national, independent and national oil companies. The Oilfield segment
also includes the Company's interest in an oil and gas property in Nigeria and
its investments in affiliates.
The Process segment consists of two divisions - Bird Machine Company and
EIMCO Process Equipment - that manufacture and sell process equipment for
separating solids from liquids and liquids from liquids through filtration,
sedimentation, centrifugation and flotation processes. The principal markets for
this segment include all regions of the world where there are significant
industrial, chemical, and municipal wastewater applications and base metals
activity. Customers include municipalities, contractors, engineering companies
and pulp and paper, minerals, industrial and oil and gas producers. The Process
segment also includes a refining and production product line.
The Company evaluates the performance of its segments based on income before
income taxes, accounting changes, unusual items and interest income and expense.
Intersegment sales and transfers are not significant.
Summarized segment financial information is shown in the following table.
The "Other" column includes corporate-related items, net interest expense and,
as it relates to segment profit (loss), income and expense items not allocated
to reportable segments.
<Table>
<Caption>
Oilfield Process Other Total
---------- ---------- ---------- ----------
REVENUES
Three months ended June 30, 2001 $ 1,257.8 $ 84.2 $ -- $ 1,342.0
Three months ended June 30, 2000 $ 1,174.4 $ 81.1 $ -- $ 1,255.5
Six months ended June 30, 2001 $ 2,414.0 $ 156.5 $ -- $ 2,570.5
Six months ended June 30, 2000 $ 2,331.8 $ 164.5 $ -- $ 2,496.3
SEGMENT PROFIT (LOSS)
Three months ended June 30, 2001 $ 223.5 $ (1.9) $ (63.2) $ 158.4
Three months ended June 30, 2000 $ 129.1 $ (0.4) $ (35.8) $ 92.9
Six months ended June 30, 2001 $ 406.6 $ (7.3) $ (134.8) $ 264.5
Six months ended June 30, 2000 $ 220.8 $ (2.9) $ (101.7) $ 116.2
TOTAL ASSETS
As of June 30, 2001 $ 5,743.9 $ 317.4 $ 508.0 $ 6,569.3
As of December 31, 2000 $ 5,597.9 $ 332.3 $ 522.5 $ 6,452.7
</Table>
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BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
The following table presents the details of "Other" segment loss:
<Table>
<Caption>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
Corporate expenses $ (31.3) $ (26.1) $ (63.2) $ (55.4)
Interest, net (31.9) (43.5) (64.6) (87.2)
Unusual charge (credit), net -- 23.7 (7.0) 23.7
Gain on trading securities -- 10.1 -- 17.2
---------- ---------- ---------- ----------
Total $ (63.2) $ (35.8) $ (134.8) $ (101.7)
========== ========== ========== ==========
</Table>
NOTE 9. NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, Business Combinations. SFAS No. 141 requires that all business
combinations initiated after June 30, 2001 be accounted for under the purchase
method and addresses the initial recognition and measurement of goodwill and
other intangible assets acquired in a business combination. Business
combinations accounted for under the pooling of interest method prior to June
30, 2001 will not be changed. The adoption of SFAS No. 141 by the Company will
not have an impact on the balance sheet, statement of operations or cash flows
of the Company.
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 142 addresses the initial recognition and measurement of
intangible assets acquired in a business combination and the accounting for
goodwill and other intangible assets subsequent to their acquisition. SFAS No.
142 provides that intangible assets with finite useful lives be amortized and
that goodwill and intangible assets with indefinite lives not be amortized, but
rather be tested at least annually for impairment. SFAS No. 142 requires that a
transitional impairment test be performed within six months of adoption. Any
transitional impairment loss will be recognized as a change in accounting
principle. The Company has not completed its analysis of the impact of the
adoption of SFAS No. 142 on its consolidated financial statements. The Company
will adopt SFAS No. 142 for its fiscal year beginning January 1, 2002.
9
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ITEM 2. 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 (each a "Forward-Looking Statement"). The words
"anticipate," "believe," "expect," "plan," "intend," "estimate," "project,"
"forecasts," "will," "could," "may" and similar expressions, and the negative
thereof, 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 effects 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. See "-Business Environment" for a more
detailed discussion of certain of these factors.
Baker Hughes' expectations regarding its level of capital expenditures
described in "-Capital Resources and Liquidity - Investing Activities" below are
only its forecasts regarding these matters. In addition to the factors described
in the previous paragraph and in "-Business Environment," these forecasts may be
substantially different from actual results, which are affected by the following
factors: the accuracy of the Company's estimates regarding its spending
requirements; regulatory, legal and contractual impediments to spending
reduction measures; the occurrence of any unanticipated acquisition or research
and development opportunities; changes in the Company's strategic direction; and
the need to replace any unanticipated losses in capital assets.
BUSINESS ENVIRONMENT
The Company has eight divisions each with separate management teams and
infrastructures that offer different products and services. The divisions have
been aggregated into two reportable segments - "Oilfield" and "Process".
The Oilfield segment currently consists of six divisions - Baker Atlas,
Baker Hughes INTEQ, Baker Oil Tools, Baker Petrolite, Centrilift and Hughes
Christensen - that manufacture and sell equipment and provide related services
used in exploring for, developing and producing hydrocarbon reserves. The
Oilfield segment also includes the Company's interest in an oil and gas property
in Nigeria.
The Process segment consists of two divisions - Bird Machine Company and
EIMCO Process Equipment - that manufacture and sell process equipment for
separating solids from liquids and liquids from liquids through filtration,
sedimentation, centrifugation and flotation processes. The Process segment also
includes a refining and production product line.
The business environment for the Company's Oilfield segment and its
corresponding operating results can be significantly affected by the level of
industry capital expenditures for the exploration and production of oil and gas
reserves. These expenditures are influenced strongly by oil company expectations
about the supply and demand for crude oil and natural gas products and by the
energy price environment that results from supply and demand imbalances.
Key factors currently influencing the worldwide crude oil and gas markets
are:
o Production control: the degree to which OPEC nations and other large
producing countries are willing and able to control production and exports
of crude oil.
o Global economic growth: particularly the impact of the U.S. economy and
economic activity in Japan, China, South Korea and the developing areas of
Asia where the correlation between energy demand and economic growth is
strong.
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o Oil and gas storage inventories: relative to historic levels.
o Technological progress: in the design and application of new products that
allow oil and gas companies to drill fewer wells and to drill, complete and
produce wells faster and at lower cost.
o Maturity of the resource base: of known hydrocarbon reserves in the maturing
provinces of the North Sea, U.S., Canada and Latin America.
o The pace of new investment: access to capital and the reinvestment of
available cash flow into existing and emerging markets.
o Price volatility: the impact of widely fluctuating commodity prices on the
stability of the market and subsequent impact on customer spending.
o Weather: the impact of variations in temperatures as compared with normal
weather patterns and the related effect on demand for oil and natural gas.
OIL AND GAS PRICES
Generally, customer expectations about their prospects from oil and gas
sales and customer expenditures to explore for or produce oil and gas rise or
fall with corresponding changes in the prices of oil or gas. Accordingly,
changes in these expenditures will normally result in increased or decreased
demand for the Company's products and services in its Oilfield segment. Crude
oil and natural gas prices are summarized in the table below as averages of the
daily closing prices during each of the periods indicated. 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 and gas demand, oil and gas
prices and drilling activity.
<Table>
<Caption>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
Crude Oil, US Spot Prices, WTI, Cushing ($/Bbl) $ 27.88 $ 28.93 $ 28.31 $ 28.89
Natural Gas, US Spot Prices, Henry Hub ($/MMBtu) $ 4.35 $ 3.58 $ 5.32 $ 3.06
</Table>
During the three months ended June 30, 2001, oil prices averaged $27.88 per
barrel, ranging from a low of $25.06 per barrel to a high of $29.98 per barrel.
Oil prices remained relatively stable in the three and six months ended June 30,
2001 compared with the three and six months ended June 30, 2000. Slower economic
growth and increases in OPEC production contributed to an increase in
inventories. Although inventories have increased, they remain relatively low in
terms of forward supply. Interruptions in exports from Iraq and uncertainty
regarding the resumption of exports from Iraq also provided price support.
U.S. natural gas prices increased in the three months ended June 30, 2001
compared with the three months ended June 30, 2000, averaging $4.35/MMBtu.
Prices during the second quarter of 2001 fell from a high in early April of
$5.56/MMBtu to a low in late June of $2.98/MMBtu as a result of slowing US
economic growth, conservation efforts driven by the sustained high prices
experienced last winter and increases in natural gas production. With record
natural gas storage injections in May and June, confidence has increased that
target storage levels for the beginning of the winter 2001/2002 withdrawal
season will be met.
ROTARY RIG COUNT
The Company is engaged in the oilfield service industry providing products
and services that are used in exploring for, developing and producing oil and
gas reservoirs. When drilling or workover rigs are active, they consume the
products and services produced by the oilfield service industry. The active rig
count acts as a leading indicator of consumption of products and services used
in drilling, completing, producing and processing hydrocarbons.
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Rig count trends are governed by the exploration and development spending by
oil and gas companies, which in turn is influenced by current and future price
expectations for oil and natural gas. Rig counts therefore reflect the relative
strength and stability of energy prices. The Company's rotary rig counts are
summarized in the table below as averages for each of the periods indicated and
are based on weekly rig counts for the U.S. and Canada and monthly rig counts
for all other areas.
<Table>
<Caption>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
U.S. - Land 1,108 694 1,023 679
U.S. - Offshore 167 131 167 129
Canada 256 265 383 344
---------- ---------- ---------- ----------
North America 1,531 1,090 1,573 1,152
---------- ---------- ---------- ----------
Latin America 268 213 265 201
North Sea 56 44 54 40
Other Europe 39 38 38 37
Africa 57 45 55 43
Middle East 174 156 173 150
Asia Pacific 157 133 153 131
---------- ---------- ---------- ----------
Outside North America 751 629 738 602
---------- ---------- ---------- ----------
Worldwide 2,282 1,719 2,311 1,754
========== ========== ========== ==========
U.S. Workover Rigs 1,227 1,075 1,209 1,037
========== ========== ========== ==========
</Table>
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 - Through the balance of 2001, oil prices are expected to be influenced
primarily by expectations for U.S. economic growth and OPEC's willingness and
ability to control production to achieve its price targets. Other factors that
could influence prices include worldwide economic growth, changes in non-OPEC
oil supply, exports of oil from Iraq and weather. Oil prices are expected to
decrease slightly throughout the year, trading between $25 and $28/Bbl. If OPEC
is willing and able to act aggressively to maintain prices, oil prices could be
sustained between $27 and $31/Bbl for the balance of the year. On the other
hand, if OPEC experiences difficulty in controlling production, oil prices could
fall to $22/Bbl by the end of 2001.
Natural Gas - Through the balance of 2001, U. S. natural gas prices are
expected to average between $3.00/MMBtu and $3.50/MMBtu with price spikes above
this range caused by weather driven demand. Although prices are expected to be
lower than the winter of 2000/2001, they are expected to remain strong enough to
support an active North American drilling program. Prices are expected to be
influenced by U.S. economic activity, particularly in those industrial segments
of the U.S. economy that consume natural gas, increases in North American
natural gas production, the strength of storage injections through the summer,
storage levels at the beginning of the winter 2001/2002 withdrawal season,
demand for natural gas for electricity and weather.
Customer Spending - Based upon the Company's discussions with its major
customers and review of published industry surveys and reports, anticipated
customer spending trends are as follows:
o North America - customer spending directed at developing natural gas is
expected to increase 15-18% in 2001 as compared with 2000, but is likely
to be limited by the availability of drilling rigs, crews and oilfield
services in North America.
o Outside North America - customer spending directed at developing oil
supplies is expected to increase 18-20% in 2001 compared with 2000.
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RESULTS OF OPERATIONS
REVENUES
Revenues for the three months ended June 30, 2001 increased 6.9% to $1,342.0
million compared with revenues of $1,255.5 million for the three months ended
June 30, 2000. Excluding revenues from Western Geophysical, the Company's
seismic division that was contributed to a venture in November 2000, revenues
increased 24.9% for the three months ended June 30, 2001 compared with the three
months ended June 30, 2000.
Oilfield revenues, excluding Western Geophysical, increased 26.7% to
$1,257.8 million for the three months ended June 30, 2001 compared with revenues
of $993.0 million for the three months ended June 30, 2000. Geographically,
Oilfield revenues in North America, which account for 44.9% of total Oilfield
revenues, increased 37.4% for the three months ended June 30, 2001 compared with
the three months ended June 30, 2000. This increase reflects the increased
drilling activity in this area, as evidenced by a 40.5% increase in the North
American rig count, and improved pricing for the Company's products and
services. Outside North America, Oilfield revenues increased 19.1% for the three
months ended June 30, 2001 compared with the three months ended June 30, 2000.
This increase reflects the ongoing improvement in international drilling
activity, particularly in Latin America, the North Sea, the Middle East and Asia
Pacific.
Revenues for the six months ended June 30, 2001 increased 3.0% to $2,570.5
million compared with revenues of $2,496.3 million for the six months ended June
30, 2001. Excluding revenues from Western Geophysical, revenues increased 22.4%
for the six months ended June 30, 2001 compared with the six months ended June
30, 2000. Revenues were impacted by significantly higher drilling activity
levels worldwide and improved pricing for the Company's products and services.
GROSS MARGIN
Gross margin for the three months ended June 30, 2001 and 2000 was 28.3% and
22.9%, respectively. Excluding Western Geophysical, gross margin for the three
months ended June 30, 2001 and 2000 was 28.3% and 24.5%, respectively. Gross
margin for the six months ended June 30, 2001 and 2000 was 28.0% and 21.6%,
respectively. Excluding Western Geophysical, gross margin for the six months
ended June 30, 2001 and 2000 was 28.0% and 24.3%, respectively. The improvements
in gross margin are the result of pricing improvements for the Company's
products and services, primarily in North America, productivity gains at every
Oilfield division, continued cost management measures throughout the Company and
higher utilization of the Company's assets.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative ("SG&A") expense as a percentage of
consolidated revenues was 14.8% for each of the three month periods ended June
30, 2001 and 2000. Excluding Western Geophysical, SG&A expense as a percentage
of consolidated revenues for the three months ended June 30, 2001 and 2000 was
14.8% and 16.4%, respectively. SG&A expense as a percentage of consolidated
revenues for the six months ended June 30, 2001 and 2000 was 15.6% and 15.1%,
respectively. Excluding Western Geophysical, SG&A expense as a percentage of
consolidated revenues for the six months ended June 30, 2001 and 2000 was 15.6%
and 17.4%, respectively. These decreases in SG&A expense as a percentage of
consolidated revenues is primarily due to a higher revenue base and the fact
that SG&A expenses are generally more fixed in nature.
UNUSUAL CHARGES
2001
During the first quarter of 2001, the Company recorded an unusual charge of
$7.0 million. The cash provision of the charge totaled $6.0 million and
consisted of severance costs for approximately 100 employees relating to the
restructuring of the Baker Process operations in Germany. No payments were made
during the first quarter of 2001, and $0.3 million was paid in the second
quarter of 2001. Based on current estimates, the Company expects that the
majority of the accrued severance will be paid during 2001 as the employees
leave the Company.
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15
2000
In October 2000, the Company's Board of Directors approved the Company's
plan to substantially exit the oil and gas exploration business, resulting in an
unusual charge of $105.0 million. The cash provision of the charge totaled $13.3
million and consisted of $5.5 million of severance costs for approximately 50
employees and $7.8 million for other contractual obligations. Of the total cash
charge of $13.3 million, $0.6 million was paid as of December 31, 2000. No
payments were made during the first quarter of 2001 and $4.6 million was paid in
the second quarter of 2001. Based on current estimates, the Company expects that
$4.5 million of the remaining accrual will be paid in 2001.
INTEREST EXPENSE
Interest expense for the three and six months ended June 30, 2001 decreased
$11.7 million and $21.8 million, respectively, compared with the three and six
months ended June 30, 2000. These decreases were primarily due to lower debt
levels. Average commercial paper and money market borrowings for the three and
six months ended June 30, 2001 were $295.0 million and $242.1 million,
respectively, compared with average commercial paper and money market borrowings
for the three and six months ended June 30, 2000 of $1,056.6 million and
$1,069.3 million, respectively. The reduction in commercial paper and money
market borrowings from corresponding prior year periods was primarily due to the
cash proceeds received from the formation of Western GECO in November 2000 and
cash flow from operations.
GAIN ON TRADING SECURITIES
In the fourth quarter of 1999, the Company announced its intention to sell
its holdings of Varco International, Inc. ("Varco"), and reclassified these
holdings from available for sale securities to trading securities. During the
three and six months ended June 30, 2000, the Company recorded pre-tax gains of
$10.1 million and $17.2 million, respectively, including unrealized gains of
$7.9 million and $10.6 million, respectively, related to these holdings.
INCOME TAXES
The effective income tax rate for the three months ended June 30, 2001 and
2000 was 33.5%, and 32.5%, respectively. The effective income tax rate for the
six months ended June 30, 2001 and 2000 was 33.6% and 32.8%, respectively. These
rates differ from the statutory income tax rate of 35.0% due to lower taxes from
international operations partially offset by the non-deductibility of certain
goodwill amortization.
CAPITAL RESOURCES AND LIQUIDITY
OPERATING ACTIVITIES
Net cash inflows from operating activities were $245.0 million and $188.0
million for the six months ended June 30, 2001 and 2000, respectively. The
increase in cash flow is primarily due to increased profitability and improved
balance sheet management.
INVESTING ACTIVITIES
Net cash outflows from investing activities were $103.7 million and $158.3
million for the six months ended June 30, 2001 and 2000, respectively.
Expenditures for capital assets totaled $136.3 million and $318.1 million
for the six months ended June 30, 2001 and 2000, respectively. Excluding Western
Geophysical, expenditures for capital assets were $136.3 million and $149.5
million for the six months ended June 30, 2001 and 2000, respectively. The
decrease is primarily due to reduced expenditures for oil and gas properties as
a result of the Company's decision in 2000 to substantially exit the oil and gas
exploration business. The Company currently expects 2001 capital expenditures to
be between $300.0 million to $360.0 million excluding any acquisitions. Funds
provided from operations and outstanding lines of credit are expected to be
adequate to meet future capital expenditure requirements.
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16
Proceeds from the disposal of assets and the sale of product lines generated
$32.6 million and $101.2 million for the six months ended June 30, 2001 and
2000, respectively. Proceeds from the sale of the Company's Varco holdings
generated $58.6 million in the six months ended June 30, 2000.
The words "expected" and "expects" are intended to identify Forward-Looking
Statements in "Investing Activities". See "-Forward-Looking Statements" and
"-Business Environment" above for a description of risk factors related to these
Forward-Looking Statements.
FINANCING ACTIVITIES
Net cash (outflows) inflows from financing activities were ($131.6) million
and $9.9 million for the six months ended June 30, 2001 and 2000, respectively.
On May 28, 2001, the Company redeemed its outstanding Liquid Yield Options
Notes ("LYONS") at a redemption price of $786.13 per $1,000 principal amount,
for a total of $301.8 million. The redemption was funded through the issuance of
commercial paper. The Company anticipates that the redemption will have no
significant impact on interest expense in future periods.
Total debt outstanding at June 30, 2001 was $1,963.9 million compared with
$2,062.9 million at December 31, 2000. Debt was repaid using cash flow from
operations and $32.6 million in proceeds from the disposal of assets and the
sale of product lines. The debt to equity ratio was 0.62 at June 30, 2001
compared with 0.68 at December 31, 2000.
At June 30, 2001, the Company had $1,241.1 million of credit facilities with
commercial banks, of which $750.5 million was committed. These facilities are
subject to normal banking terms and conditions that do not significantly
restrict the Company's activities.
DERIVATIVE AND HEDGE ACCOUNTING
On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging
Activities, as amended by SFAS No. 137 and SFAS No. 138. 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 fair value. Depending on the intended use of the
derivative and its effectiveness, 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. The adoption of SFAS No. 133 on January 1, 2001 resulted
in a gain of $0.8 million, net of tax, recorded as the cumulative effect of an
accounting change in the consolidated condensed statement of operations and a
gain of $1.2 million, net of tax, recorded in accumulated other comprehensive
income.
EURO CONVERSION
A single European currency (the "Euro") was introduced on January 1, 1999,
at which time the conversion rates between the old, or legacy, currencies and
the Euro were set for participating member countries. However, the legacy
currencies in those countries will continue to be used as legal tender through
December 31, 2001. Thereafter, the legacy currencies will be canceled, and Euro
bills and coins will be used in the participating countries.
Most of the Company's products and services are essentially priced with
reference to the U.S. dollar. As a result, the Company does not believe that it
will be subject to a significant increase in pricing transparency due to the
introduction of the Euro. The Company's customers may require billing in two or
more currencies. Until the Company's financial computer systems are modified or
replaced to handle Euro-denominated transactions, the Company will, in most
cases, need to apply a methodology whereby legacy currencies are first converted
into Euros according to a legally prescribed fixed exchange ratio and then, when
the customer requires, converted from Euros to a second national currency. The
Company does not believe that this conversion will materially affect its
contracts. Most of the Company's contracts are either bids in response to
requests for tenders or purchase orders, both of which are short term in nature.
Longer term contracts are sufficiently flexible to permit pricing in multiple
currencies. The Euro conversion period is longer than most of the pricing
features of these contracts, thus permitting a pricing conversion to the Euro as
new orders are issued. The same is true with most of the Company's contracts
with vendors.
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17
During 1997, the Company began a multi-year initiative designed to develop
and implement an enterprise-wide software system. The initiative, named "Project
Renaissance," utilizes SAP R/3 as its software platform across all significant
operations of the Company. SAP R/3 is programmed to process in Euros for most of
the Company's accounting, financial and operational functions, and the Company
expects that the implementation of this system will address its Euro issues in
these areas. Because the Company has engaged in this implementation for
operational purposes and not solely to address Euro issues, the Company has not
separately determined the cost of converting these systems for use with the
Euro. These Euro conversion costs are embedded in the cost of Project
Renaissance and are not susceptible to separate quantification. The Company has
scheduled implementation of SAP R/3 in its major European operations prior to
December 31, 2001. Alternatively, the Company may make certain modifications to
its legacy computer systems, or replace them, to address certain Euro conversion
issues, pending full implementation of SAP R/3. The Company began converting
certain legacy currency based financial records to the Euro beginning in January
2001 with all significant records expected to be converted by October 31, 2001.
The Company continues to assess the impact of the Euro on its operations and
financial, accounting and operational systems. The Company does not presently
anticipate that the transition to the Euro will have a significant impact on its
results of operations, financial position or cash flows.
The words "anticipate", "will", "may", and "expects" are intended to
identify a Forward-Looking Statement in " - Euro Conversion." The Company's
anticipation regarding the lack of significance of the Euro introduction on the
Company's operations is only its forecast regarding this matter. This forecast
may be substantially different from actual results, which are affected by
factors such as the following: unforeseen difficulties in remediating specific
computer systems to accommodate the Euro due to the complexity of hardware and
software, the failure of the Company to implement SAP R/3 or another Euro
compliant computer system in a geographic location that prices in Euros, the
inability of third parties to adequately address their own Euro systems issues,
including vendors, contractors, financial institutions, U.S. and foreign
governments and customers, the delay in completion of a phase of the Company's
remediation of a computer system to accommodate the Euro necessary to begin a
later phase, the discovery of a greater number of hardware and software systems
or technologies with material Euro issues than the Company presently
anticipates, and the lack of alternatives that the Company previously believed
existed.
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ITEM 3. QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURES
On June 15, 2001, the Company entered into an interest rate swap agreement
for a notional amount of $100.0 million. The Company receives interest at a rate
of 7.875% and pays interest at a rate equal to three-month LIBOR plus a 2.7625%
spread. The interest rate swap settles quarterly and terminates in June 2004. At
June 30, 2001, the fair market value of this swap agreement was a $0.6 million
liability.
At June 30, 2001, the Company had entered into foreign currency forward
contracts with notional amounts of $0.4 million and $0.8 million to hedge
exposure to currency fluctuations in the Euro and Indonesian Rupiah,
respectively. At June 30, 2001, the fair market value of these forward
contracts, based on quoted market prices for contracts with similar terms and
maturity dates, was a $0.1 million liability.
Certain borrowings of the Company are denominated in currencies other than
its functional currency. At June 30, 2001, these nonfunctional currency
borrowings totaled $7.9 million with exposures between the U.S. Dollar and the
Euro, the Saudi Riyal and the United Arab Emirates Dirham. A 10% appreciation of
the U.S. Dollar against these currencies would not have a significant effect on
the future earnings of the Company.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has been named as a defendant in a number of shareholder class
action securities fraud suits that purported stockholders of the Company filed
shortly after the Company's announcement on December 8, 1999 regarding the
accounting issues that the Company discovered at its Baker Hughes INTEQ
division. These suits were consolidated into one lawsuit in the federal district
court for the Southern District of Texas pursuant to the Private Securities
Litigation Reform Act of 1995. The court has dismissed this suit, and the
plaintiffs have filed a notice of appeal with respect to the dismissal in the
Fifth Circuit Court of Appeals. The Company believes the allegations in this
suit are without merit and that the plaintiffs will be unsuccessful in their
appeal. The Company intends to vigorously contest the appeal and defend the suit
if the plaintiffs are successful on appeal. Even so, an adverse outcome on
appeal and in any subsequent litigation could have an adverse impact on the
Company's results of operations or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on April 25, 2001 (1)
to elect four Class I members of the Board of Directors to serve for three-year
terms (2) to reapprove the 1995 Employee Annual Incentive Compensation Plan, as
amended and restated, (3) to consider a stockholder proposal to implement the
MacBride Principle with respect to the Company's operations in Northern Ireland
and (4) to consider a stockholder proposal requesting that the Board of
Directors be declassified.
The four Class I directors who were so elected are Edward P. Djerejian, H.
John Riley, Jr., Charles L. Watson and Michael E. Wiley. The number of
affirmative votes and the number of votes withheld for the directors so elected
were:
<Table>
<Caption>
Number of Number of
Names Affirmation Votes Withheld
----- ----------------- ------------
Edward Pl Djerejian 244,464,234 48,002,453
H. John Riley, Jr 243,979,964 48,486,723
Charles L. Watson 239,906,051 52,560,636
Michael E. Wiley 243,990,036 48,476,651
</Table>
The number of affirmative votes, the number of negative votes, the number of
abstentions and the number of broker no-votes with respect to the reapproval of
the 1995 Employee Annual Incentive Compensation Plan, as amended and restated
were as follows:
<Table>
<Caption>
Number of Number of
Affirmative Votes Negative Votes Abstentions Broker No-Votes
----------------- -------------- ----------- ---------------
286,594,786 4,409,214 1,462,687 0
</Table>
The number of affirmative votes, the number of negative votes, the number of
abstentions and the number of broker no-votes with respect to the approval of
the stockholder proposals were as follows:
<Table>
<Caption>
Number of Number of
Affirmative Negative Broker
Votes Votes Abstentions No-votes
------------ ------------ ------------ ------------
Proposal regarding Northern
Ireland 40,962,223 219,324,200 12,484,373 19,695,891
Proposal regarding classified
Board 203,116,238 63,979,045 5,675,509 19,695,891
</Table>
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
None.
(b) Reports on Form 8-K:
A Current Report on Form 8-K was filed with the Commission on May 8,
2001, reporting the results of the Company's Annual Meeting of Stockholders
election of certain members of the Board of Directors and stockholder
proposals.
A Current Report on Form 8-K was filed with the Commission on July 6,
2001, reporting that the Company had offered to consent to the entry of a
cease-and-desist order with the United States Security and Exchange
Commission.
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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: August 9, 2001 By: /s/ G. STEPHEN FINLEY
-------------------------------
Sr. Vice President - Finance and
Administration and Chief Financial
Officer
Date: August 9, 2001 By: /s/ ALAN J. KEIFER
-------------------------------
Vice President and Controller
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