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 September 30, 2003
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
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 76-0207995
(State or Other Jurisdiction (IRS Employer Identification No.)
of Incorporation or Organization)
3900 ESSEX LANE, SUITE 1200, HOUSTON, TEXAS
(Address of Principal Executive Offices)
77027
(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 by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
YES [X] NO [ ]
--------------------
As of October 31, 2003, the registrant has outstanding 334,846,924
shares of Common Stock, $1 par value.
INDEX
PAGE NO.
--------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Statements of Operations - Three months and nine months ended
September 30, 2003 and 2002 2
Consolidated Condensed Balance Sheets - September 30, 2003 and December 31, 2002 3
Consolidated Condensed Statements of Cash Flows - Nine months ended
September 30, 2003 and 2002 4
Notes to Consolidated Condensed Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 23
Item 4. Controls and Procedures 24
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities and Use of Proceeds 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 27
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
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,
----------------------------- -----------------------------
2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------------------------
Revenues $ 1,338.4 $ 1,251.1 $ 3,853.3 $ 3,639.1
- --------------------------------------------------------------------------------------------------------------------------------
Costs and expenses:
Cost of revenues 976.3 885.1 2,823.1 2,610.6
Selling, general and administrative 194.5 206.2 597.9 617.4
Impairment of investment in affiliate 45.3 - 45.3 -
Restructuring charge reversal (1.1) - (1.1) -
- --------------------------------------------------------------------------------------------------------------------------------
Total 1,215.0 1,091.3 3,465.2 3,228.0
- --------------------------------------------------------------------------------------------------------------------------------
Operating income 123.4 159.8 388.1 411.1
Equity in income (loss) of affiliates (145.9) 1.5 (149.9) 20.5
Interest expense (25.1) (27.2) (77.9) (82.9)
Interest income 0.7 1.5 3.8 3.7
- --------------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
income taxes (46.9) 135.6 164.1 352.4
Income taxes (12.6) (46.8) (90.6) (122.8)
- --------------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations (59.5) 88.8 73.5 229.6
Loss from discontinued operations, net of tax (39.3) (24.1) (40.6) (16.7)
- --------------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of accounting
change (98.8) 64.7 32.9 212.9
Cumulative effect of accounting change, net of tax - - (5.6) (42.5)
- --------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (98.8) $ 64.7 $ 27.3 $ 170.4
================================================================================================================================
Basic earnings per share:
Income (loss) from continuing operations $ (0.18) $ 0.26 $ 0.22 $ 0.68
Loss from discontinued operations (0.12) (0.07) (0.12) (0.05)
Cumulative effect of accounting change - - (0.02) (0.12)
- --------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (0.30) $ 0.19 $ 0.08 $ 0.51
================================================================================================================================
Diluted earnings per share:
Income (loss) from continuing operations $ (0.18) $ 0.26 $ 0.22 $ 0.68
Loss from discontinued operations (0.11) (0.07) (0.12) (0.05)
Cumulative effect of accounting change - - (0.02) (0.13)
- --------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (0.29) $ 0.19 $ 0.08 $ 0.50
================================================================================================================================
Cash dividends per share $ 0.115 $ 0.115 $ 0.345 $ 0.345
================================================================================================================================
See accompanying notes to consolidated condensed financial statements.
2
BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED BALANCE SHEETS
(In millions)
SEPTEMBER 30, DECEMBER 31,
2003 2002
(UNAUDITED) (AUDITED)
- ----------------------------------------------------------------------------------------------------------------------
ASSETS
Current Assets:
Cash and cash equivalents $ 51.4 $ 143.9
Accounts receivable, net 1,163.9 1,101.9
Inventories 1,060.9 996.5
Other current assets 195.5 203.9
Assets of discontinued operations 24.9 122.1
- ----------------------------------------------------------------------------------------------------------------------
Total current assets 2,496.6 2,568.3
- ----------------------------------------------------------------------------------------------------------------------
Investments in affiliates 704.2 872.0
Property, net 1,350.8 1,343.2
Goodwill 1,232.5 1,226.6
Intangible assets, net 141.1 135.5
Other assets 274.2 255.2
- ----------------------------------------------------------------------------------------------------------------------
Total assets $ 6,199.4 $ 6,400.8
======================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 361.4 $ 377.1
Short-term borrowings and current portion of long-term debt - 123.5
Accrued employee compensation 263.9 247.9
Other accrued liabilities 217.1 256.4
Liabilities of discontinued operations 23.2 75.9
- ----------------------------------------------------------------------------------------------------------------------
Total current liabilities 865.6 1,080.8
- ----------------------------------------------------------------------------------------------------------------------
Long-term debt 1,524.2 1,424.3
Deferred income taxes 121.7 166.7
Other long-term liabilities 346.2 331.8
Stockholders' equity:
Common stock 334.8 335.8
Capital in excess of par value 3,078.0 3,111.6
Retained earnings 107.8 196.3
Accumulated other comprehensive loss (178.9) (246.5)
- ----------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 3,341.7 3,397.2
- ----------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 6,199.4 $ 6,400.8
======================================================================================================================
See accompanying notes to consolidated condensed financial statements.
3
BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
2003 2002
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Income from continuing operations $ 73.5 $ 229.6
Adjustments to reconcile income from continuing operations to net cash flows from
operating activities:
Depreciation and amortization 241.6 222.2
Provision (benefit) for deferred income taxes (33.3) 3.2
Gain on disposal of assets (24.3) (42.8)
Impairment of investment in affiliate 45.3 -
Equity in (income) loss of affiliates 149.9 (20.5)
Change in accounts receivable (52.4) 122.4
Change in inventories (57.7) 12.5
Change in accounts payable (14.2) (39.3)
Change in accrued employee compensation and other accrued liabilities (22.6) (47.6)
Change in other long-term liabilities (2.8) 6.4
Changes in other assets and liabilities (11.6) (21.8)
- --------------------------------------------------------------------------------------------------------------------------
Net cash flows from continuing operations 291.4 424.3
Net cash flows from discontinued operations 2.4 83.1
- --------------------------------------------------------------------------------------------------------------------------
Net cash flows from operating activities 293.8 507.4
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Expenditures for capital assets (230.5) (209.8)
Acquisition of businesses, net of cash acquired (9.6) (39.7)
Investment in affiliates (35.4) (15.0)
Proceeds from sale of business 22.0 -
Proceeds from disposal of assets 44.7 63.1
- --------------------------------------------------------------------------------------------------------------------------
Net cash flows from continuing operations (208.8) (201.4)
Net cash flows from discontinued operations - (1.8)
- --------------------------------------------------------------------------------------------------------------------------
Net cash flows from investing activities (208.8) (203.2)
- --------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net borrowings (repayments) of commercial paper and other short-term debt 59.6 (161.6)
Repayment of indebtedness (100.0) -
Proceeds from termination of interest rate swap agreement 15.5 15.8
Proceeds from issuance of common stock 38.1 26.0
Repurchase of common stock (72.9) (25.8)
Dividends (115.8) (116.4)
- --------------------------------------------------------------------------------------------------------------------------
Net cash flows from continuing operations (175.5) (262.0)
Net cash flows from discontinued operations - -
- --------------------------------------------------------------------------------------------------------------------------
Net cash flows from financing activities (175.5) (262.0)
- --------------------------------------------------------------------------------------------------------------------------
Effect of foreign exchange rate changes on cash (2.0) (4.1)
- --------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (92.5) 38.1
Cash and cash equivalents, beginning of period 143.9 38.7
- --------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 51.4 $ 76.8
==========================================================================================================================
Income taxes paid $ 151.4 $ 82.0
Interest paid $ 92.7 $ 88.7
See accompanying notes to consolidated condensed financial statements.
4
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE 1. GENERAL
NATURE OF OPERATIONS
Baker Hughes Incorporated ("Baker Hughes") is engaged in the oilfield
services industry. Baker Hughes is a major supplier of wellbore related
products, technology services and systems to the oil and gas industry on a
worldwide basis and provides products and services for drilling, formation
evaluation, completion and production of oil and gas wells.
BASIS OF PRESENTATION
The unaudited consolidated condensed financial statements of Baker Hughes
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, 2002. 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. DISCONTINUED OPERATIONS
In the third quarter of 2003, the Company's management initiated and the
Board of Directors approved a plan to sell BIRD Machine ("BIRD"), the last
remaining division of the Process segment. In October 2003, the Company signed a
definitive agreement for the sale of BIRD and recorded charges totaling $35.5
million, net of tax of $9.4 million, which consisted of a loss of $13.2 million
on the write-down of BIRD to fair value, $4.1 million of severance and warranty
accruals and a loss of $18.2 million related to the recognition of cumulative
foreign currency translation adjustments into earnings. The sale excludes
certain accounts receivable, inventories and other assets that will be retained
by the Company. The sale is subject to various closing conditions, but is
expected to close no later than January 2004. The Company expects to record
additional pre-tax charges totaling between $5.0 million and $7.0 million in
conjunction with the closing of the transaction.
In December 2002, the Company entered into exclusive negotiations for the
sale of the Company's interest in its oil producing operations in West Africa
and received $10.0 million as a deposit. The transaction was effective as of
January 1, 2003, and resulted in a gain on sale of $4.1 million, net of a tax
benefit of $0.2 million, recorded in the first quarter of 2003. The sales price
was $32.0 million, and the Company received the remaining $22.0 million upon
closing, which occurred in April 2003.
In the third quarter of 2002, the Company signed a letter of intent for the
sale of EIMCO Process Equipment ("EIMCO"), a division of the Process segment,
and recorded a loss on disposal of $21.2 million, net of tax of $0.5 million,
which consisted of a loss of $0.9 million on the write-down to fair value and a
loss of $20.3 million related to the recognition of cumulative foreign currency
translation adjustments into earnings. In November 2002, the Company completed
the sale of EIMCO and received total proceeds of $48.9 million, of which $4.9
million was held in escrow pending completion of final adjustments of the
purchase price. In April 2003, all purchase price adjustments were completed,
resulting in the release of the escrow balance, of which $2.9 million was
returned to the buyer and $2.0 million was received by the Company. In the first
quarter of 2003, the Company also recorded an additional loss on sale due to
purchase price adjustments of $2.5 million, net of tax of $1.3 million.
5
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
The Company has reclassified the consolidated financial statements for all
prior periods presented to reflect these operations as discontinued. Summarized
financial information from discontinued operations is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------
Revenues:
BIRD $ 21.1 $ 29.1 $ 74.2 $ 89.2
Oil producing operations - 7.9 4.2 34.4
EIMCO - 36.1 - 124.2
- ------------------------------------------------------------------------------------------------------------------------
Total $ 21.1 $ 73.1 $ 78.4 $ 247.8
========================================================================================================================
Income (loss) before income taxes:
BIRD $ (5.9) $ (3.1) $ (12.1) $ (5.7)
Oil producing operations - 1.0 1.8 11.6
EIMCO - (2.3) - (0.8)
- ------------------------------------------------------------------------------------------------------------------------
Total (5.9) (4.4) 10.3 5.1
- ------------------------------------------------------------------------------------------------------------------------
Income taxes:
BIRD 2.1 1.0 4.3 2.0
Oil producing operations - (0.2) (0.7) (2.8)
EIMCO - 0.7 - 0.2
- ------------------------------------------------------------------------------------------------------------------------
Total 2.1 1.5 3.6 (0.6)
- ------------------------------------------------------------------------------------------------------------------------
Income (loss) before gain (loss) on disposal:
BIRD (3.8) (2.1) (7.8) (3.7)
Oil producing operations - 0.8 1.1 8.8
EIMCO - (1.6) - (0.6)
- ------------------------------------------------------------------------------------------------------------------------
Total (3.8) (2.9) (6.7) 4.5
- ------------------------------------------------------------------------------------------------------------------------
Gain (loss) on disposal, net of tax:
BIRD (35.5) - (35.5) -
Oil producing operations - - 4.1 -
EIMCO - (21.2) (2.5) (21.2)
- ------------------------------------------------------------------------------------------------------------------------
Total (35.5) (21.2) (33.9) (21.2)
- ------------------------------------------------------------------------------------------------------------------------
Loss from discontinued operations $ (39.3) $ (24.1) $ (40.6) $ (16.7)
========================================================================================================================
Assets and liabilities of discontinued operations are as follows:
SEPTEMBER 30, DECEMBER 31,
2003 2002
- --------------------------------------------------------------------------------------------------
Cash and cash equivalents $ - $ 3.2
Accounts receivable, net 7.1 17.7
Inventories 11.2 37.6
Other current assets 0.4 2.0
Property, net 6.1 60.3
Intangible assets, net 0.1 1.3
- --------------------------------------------------------------------------------------------------
Assets of discontinued operations $ 24.9 $ 122.1
==================================================================================================
Accounts payable $ 10.7 $ 14.9
Accrued employee compensation 4.3 9.0
Other accrued liabilities 6.7 28.1
Deferred income taxes - 20.3
Other long-term liabilities 1.5 3.6
- --------------------------------------------------------------------------------------------------
Liabilities of discontinued operations $ 23.2 $ 75.9
==================================================================================================
6
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3. ACQUISITIONS
In the second quarter of 2003, the Company made an acquisition with a
purchase price of $12.7 million, of which $9.6 million was paid in cash. As a
result of this acquisition, the Company recorded approximately $9.8 million of
intangible assets through September 30, 2003. The purchase price is allocated
based on fair value of the acquisition. Pro forma results of operations have not
been presented because the effect of this acquisition was not material to the
Company's consolidated financial statements.
In the first quarter of 2002, the Company made three acquisitions for an
adjusted aggregate purchase price of $51.7 million. As a result of these
acquisitions, the Company paid $39.7 million in cash and recorded approximately
$31.3 million of goodwill through September 30, 2002. The purchase prices are
allocated based on fair values of the acquisitions. The purchase price of one of
the acquisitions may be subject to change pending the final outcome of
arbitration proceedings. Pro forma results of operations have not been presented
because the effects of these acquisitions were not material to the Company's
consolidated financial statements on either an individual or aggregate basis.
NOTE 4. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) 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 (loss), net of related tax, are
as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (98.8) $ 64.7 $ 27.3 $ 170.4
Other comprehensive income:
Foreign currency translation adjustments:
Translation adjustments during the period 34.0 35.2 85.8 87.5
Reclassifications included in net income due to
sale of BIRD and EIMCO (18.2) (20.3) (18.2) (20.3)
- ------------------------------------------------------------------------------------------------------------------------
Total comprehensive income (loss) $ (83.0) $ 79.6 $ 94.9 $ 237.6
========================================================================================================================
Total accumulated other comprehensive loss consisted of the following:
SEPTEMBER 30, DECEMBER 31,
2003 2002
- -----------------------------------------------------------------------------------------------
Foreign currency translation adjustments $ (135.5) $ (203.1)
Pension adjustment (43.4) (43.4)
- -----------------------------------------------------------------------------------------------
Total accumulated other comprehensive loss $ (178.9) $ (246.5)
===============================================================================================
NOTE 5. STOCK-BASED COMPENSATION
As allowed for under Statement of Financial Accounting Standards ("SFAS")
No. 123, Accounting for Stock-Based Compensation, the Company has elected to
account for its stock-based compensation using the intrinsic value method of
accounting in accordance with Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees. Under this method, no compensation
expense is recognized when the number of shares granted is known and the
exercise price of the stock option is equal to or greater than the market price
of the Company's common stock on the grant date. Reported net income (loss) does
not include any compensation expense associated with stock options but does
include compensation expense associated with restricted stock awards.
7
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
If the Company had recognized compensation expense as if the fair value
based method had been applied to all awards as provided for under SFAS No. 123,
the Company's pro forma net income (loss), earnings per share ("EPS") and
stock-based compensation cost would have been as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------
Net income (loss), as reported $ (98.8) $ 64.7 $ 27.3 $ 170.4
Add: Stock-based compensation for restricted stock
awards included in reported net income (loss), net of tax 0.4 0.7 1.7 1.6
Deduct: Stock-based compensation determined
under the fair value method, net of tax (6.4) (6.3) (18.7) (17.2)
- ------------------------------------------------------------------------------------------------------------------------
Pro forma net income (loss) $ (104.8) $ 59.1 $ 10.3 $ 154.8
========================================================================================================================
Basic EPS
As reported $ (0.30) $ 0.19 $ 0.08 $ 0.51
Pro forma (0.31) 0.17 0.03 0.46
Diluted EPS
As reported $ (0.29) $ 0.19 $ 0.08 $ 0.50
Pro forma (0.31) 0.17 0.03 0.46
These pro forma calculations may not be indicative of future amounts since
additional awards in future years are anticipated.
NOTE 6. FINANCIAL INSTRUMENTS
In April 2003, the Company entered into an interest rate swap agreement for
a notional amount of $325.0 million associated with the Company's 6.25% Notes
due January 2009 that had been designated and had qualified as a fair value
hedging instrument. In June 2003, the Company terminated the interest rate swap
agreement and received proceeds of $15.5 million upon cancellation. This
deferred gain is being amortized as a reduction of interest expense over the
remaining life of the underlying debt security, which matures in January 2009.
At September 30, 2003, the Company has a total of $25.9 million of unamortized
deferred gain included in long-term debt in the consolidated condensed balance
sheet.
In July 2003, the Company entered into an interest rate swap agreement for a
notional amount of $325.0 million associated with the Company's 6.25% Notes due
January 2009. Under this agreement, the Company receives interest at a fixed
rate of 6.25% and pays interest at a floating rate of six-month LIBOR plus a
spread of 2.4425%. The interest rate swap agreement has been designated and
qualifies as a fair value hedging instrument. The interest rate swap agreement
will be fully effective, resulting in no gain or loss recorded in the
consolidated condensed statement of operations. Subsequent to the end of the
third quarter of 2003, the Company terminated this interest rate swap agreement.
At September 30, 2003, the Company had entered into several foreign currency
forward contracts with notional amounts aggregating $84.0 million to hedge
exposure to currency fluctuations in various foreign currencies, including the
British Pound Sterling, the Euro, the Norwegian Krone, the Brazilian Real, the
Argentine Peso and the Indonesian Rupiah. These contracts are designated and
qualify as fair value hedging instruments. Based on quoted market prices as of
September 30, 2003 for contracts with similar terms and maturity dates, the
Company recorded a gain of $1.2 million to adjust these foreign currency forward
contracts to their fair market value. This gain is included in selling, general
and administrative expense in the consolidated condensed statement of
operations. In the unlikely event that the counterparties fail to meet the terms
of the foreign currency forward contracts, the Company's exposure is limited to
the foreign currency rate differential.
8
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. EARNINGS PER SHARE
A reconciliation of the number of shares used for the basic and diluted EPS
calculation is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding for basic EPS 334.7 337.3 335.6 337.1
Effect of dilutive securities - stock plans 1.3 0.8 1.1 1.2
- -----------------------------------------------------------------------------------------------------------------------------
Adjusted weighted average common shares outstanding for diluted EPS 336.0 338.1 336.7 338.3
=============================================================================================================================
Future potentially anti-dilutive shares excluded from diluted EPS:
Options with an option price greater than average market price
for the period 6.9 6.1 6.9 5.0
=============================================================================================================================
NOTE 8. INVENTORIES
Inventories are comprised of the following:
SEPTEMBER 30, DECEMBER 31,
2003 2002
- ---------------------------------------------------------------------------------------
Finished goods $ 872.5 $ 816.5
Work in process 110.2 91.9
Raw materials 78.2 88.1
- ---------------------------------------------------------------------------------------
Total $ 1,060.9 $ 996.5
=======================================================================================
NOTE 9. INVESTMENTS IN AFFILIATES
The Company has investments in affiliates that are accounted for using the
equity method of accounting. The most significant of these affiliates is
WesternGeco, a seismic venture between the Company and Schlumberger Limited
("Schlumberger"). The Company and Schlumberger own 30% and 70% of the venture,
respectively. Included in the caption "Equity in income (loss) of affiliates" in
the Company's consolidated condensed statement of operations for the three and
nine months ended September 30, 2003 is $135.7 million for the Company's share
of $452.0 million of impairment and restructuring charges taken by WesternGeco
in the third quarter of 2003. The charges related to the impairment of
WesternGeco's multiclient seismic library and rationalization of WesternGeco's
marine seismic fleet. In addition, as a result of the continuing weakness in the
seismic industry, the Company evaluated the carrying value of its investment in
WesternGeco and recorded an impairment loss of $45.3 million in the third
quarter of 2003 to write-down the investment to its fair value. The fair value
was determined using a combination of a market value and discounted cash flows
approach.
During the nine months ended September 30, 2003, the Company invested cash
of $35.4 million in affiliates, of which $30.1 million related to the Company's
50% interest in the QuantX Wellbore Instrumentation venture ("QuantX") with
Expro International ("Expro"). The venture is engaged in the permanent in-well
monitoring market and was formed by combining Expro's permanent monitoring
business with one of the Company's product lines. The Company accounts for its
ownership in QuantX using the equity method of accounting.
NOTE 10. GOODWILL AND INTANGIBLE ASSETS
On January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other
Intangible Assets. The adoption of SFAS No. 142 required the Company to cease
amortizing goodwill and to perform a transitional impairment test of goodwill in
each of its reporting units as of January 1, 2002. The Company's reporting units
were based on its organizational and reporting structure. Corporate and other
assets and liabilities were allocated to the reporting units to the extent that
they related to the operations of those reporting units. Valuations of the
reporting units were performed by an independent third party. The goodwill in
both the EIMCO and BIRD operating divisions of the Company's Process segment was
determined to be impaired using a combination of a market value and discounted
cash flows approach to estimate fair value. Accordingly, the Company recognized
transitional impairment losses of $42.5 million, net of tax of $20.4 million.
The transitional impairment losses were recorded in the first quarter of 2002 as
the cumulative effect of accounting change in the consolidated condensed
statement of operations.
9
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
The changes in the carrying amount of goodwill (net of accumulated
amortization) for the nine months ended September 30, 2003 are as follows:
Balance as of December 31, 2002 $ 1,226.6
Translation adjustments and other 5.9
- ----------------------------------------------------------------
Balance as of September 30, 2003 $ 1,232.5
================================================================
The Company has intangible assets which continue to be amortized and are
comprised of the following:
SEPTEMBER 30, 2003 DECEMBER 31, 2002
------------------------------------------ ------------------------------------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION NET AMOUNT AMORTIZATION NET
- --------------------------------------------------------------------------------------------------------------
Technology based $ 178.2 $ (44.3) $ 133.9 $ 167.2 $ (36.5) $ 130.7
Contract based 8.1 (2.7) 5.4 4.7 (2.2) 2.5
Marketing related 5.7 (5.0) 0.7 5.7 (4.8) 0.9
Customer based 0.3 (0.1) 0.2 0.6 (0.1) 0.5
Other 2.4 (1.5) 0.9 2.1 (1.2) 0.9
- --------------------------------------------------------------------------------------------------------------
Total $ 194.7 $ (53.6) $ 141.1 $ 180.3 $ (44.8) $ 135.5
==============================================================================================================
Amortization expense for intangible assets for the three and nine months
ended September 30, 2003 was $3.1 million and $10.3 million, respectively, and
is estimated to be $13.4 million for 2003. Estimated amortization expense for
each of the subsequent five fiscal years is expected to be within the range of
$11.7 million to $13.3 million.
NOTE 11. SEGMENT AND RELATED INFORMATION
The Company's six operating divisions - Baker Atlas, Baker Oil Tools, Baker
Petrolite, Centrilift, Hughes Christensen and INTEQ - have been aggregated into
one reportable segment, "Oilfield", because they have similar economic
characteristics and because the long-term financial performance of these
divisions is affected by similar economic conditions. The consolidated results
are evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance.
These operating divisions manufacture and sell products and provide services
used in the oil and gas industry, including drilling, completion, production and
maintenance of oil and gas wells and in reservoir measurement and evaluation.
They also operate in the same markets and have substantially the same customers.
The principal markets include all major oil and gas producing regions of the
world, including North America, South America, Europe, Africa, the Middle East
and the Far East. Customers include major multi-national, independent and
state-owned oil companies. The Oilfield segment also includes the Company's 30%
interest in WesternGeco and other similar businesses.
The Company evaluates the performance of the Oilfield segment based on
income (loss) from continuing operations before income taxes, accounting
changes, restructuring charges or reversals, impairment of assets and interest
income and expense.
10
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
Summarized financial information is shown in the following table. The
"Corporate and Other" column includes corporate-related items, results of
insignificant operations and, as it relates to segment profit (loss), income and
expense not allocated to the Oilfield segment, including restructuring charges
and reversals and impairment of assets. The "Corporate and Other" column at
September 30, 2003 and December 31, 2002 also includes assets of discontinued
operations.
CORPORATE
OILFIELD AND OTHER TOTAL
- ----------------------------------------------------------------------------------------------
REVENUES
- ----------------------------------------------------------------------------------------------
Three months ended September 30, 2003 $ 1,338.4 $ - $ 1,338.4
Three months ended September 30, 2002 1,251.1 - 1,251.1
Nine months ended September 30, 2003 3,853.3 - 3,853.3
Nine months ended September 30, 2002 3,639.0 0.1 3,639.1
SEGMENT PROFIT (LOSS)
- ----------------------------------------------------------------------------------------------
Three months ended September 30, 2003 $ 193.9 $ (240.8) $ (46.9)
Three months ended September 30, 2002 196.3 (60.7) 135.6
Nine months ended September 30, 2003 526.8 (362.7) 164.1
Nine months ended September 30, 2002 537.7 (185.3) 352.4
TOTAL ASSETS
- ----------------------------------------------------------------------------------------------
As of September 30, 2003 $ 5,619.0 $ 580.4 $ 6,199.4
As of December 31, 2002 5,648.1 752.7 6,400.8
The following table presents the details of "Corporate and Other" segment
loss:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------
Corporate and other expenses $ (36.5) $ (35.0) $ (108.7) $ (106.1)
Interest, net (24.4) (25.7) (74.1) (79.2)
Restructuring charge reversal 1.1 - 1.1 -
Impairment of investment in affiliate (45.3) - (45.3) -
Impairment and restructuring charges
related to an equity method investment (135.7) - (135.7) -
- ---------------------------------------------------------------------------------------------------------------
Total $ (240.8) $ (60.7) $ (362.7) $ (185.3)
===============================================================================================================
NOTE 12. GUARANTEES
In the normal course of business with customers, vendors and others, the
Company is contingently liable for performance under letters of credit and other
bank issued guarantees which totaled approximately $218.4 million at September
30, 2003. In addition, at September 30, 2003, the Company has guaranteed debt
and other obligations of third parties totaling $31.8 million, which declined
significantly from the previous quarter due to the termination of a Company
guarantee related to a lease on a seismic vessel by WesternGeco. WesternGeco
purchased the seismic vessel during the third quarter of 2003.
The Company sells certain of its products to customers with a product
warranty that provides that customers can return a defective product during a
specified warranty period following the purchase in exchange for a replacement
product, repair at no cost to the customer or the issuance of a credit to the
customer. The Company accrues amounts for estimated warranty claims based upon
both current and historical product sales data and warranty costs incurred.
11
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
The changes in the aggregate product warranty liabilities for the nine
months ended September 30, 2003 are as follows:
Balance as of December 31, 2002 $ 7.2
Claims paid (4.6)
Additional warranties issued 5.1
Revisions in estimates for previously issued warranties 0.6
Other 4.0
- ------------------------------------------------------------------------------------------
Balance as of September 30, 2003 $ 12.3
==========================================================================================
NOTE 13. NEW ACCOUNTING STANDARDS
Effective January 1, 2003, the Company adopted SFAS No. 143, Accounting for
Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of long-lived assets.
SFAS No. 143 requires that the fair value of a liability associated with an
asset retirement obligation ("ARO") be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The liability for
the ARO is revised each subsequent period due to the passage of time and changes
in estimates. The associated retirement costs are capitalized as part of the
carrying amount of the long-lived asset and subsequently depreciated over the
estimated useful life of the asset.
The adoption of SFAS No. 143 in the first quarter of 2003 resulted in a
charge of $5.6 million, net of tax of $2.8 million, recorded as the cumulative
effect of accounting change in the consolidated condensed statement of
operations. In conjunction with the adoption, the Company recorded ARO
liabilities of $11.4 million primarily for anticipated costs of obligations
associated with the future disposal of power source units at certain of its
divisions and refurbishment costs associated with certain leased facilities in
Europe and with a fleet of leased railcars and tanks.
In November 2002, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 45 ("FIN 45"), Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others. FIN 45 elaborates on required disclosures by a guarantor in its
financial statements about obligations under certain guarantees that it has
issued and requires a guarantor to recognize, at the inception of certain
guarantees, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The adoption of the provisions of FIN 45 relating to the
initial recognition and measurement of guarantor liabilities, which were
effective for qualifying guarantees entered into or modified after December 31,
2002, did not have an impact on the consolidated condensed financial statements
of the Company. The Company adopted the new disclosure requirements in 2002.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
Consolidation of Variable Interest Entities. An entity is subject to the
consolidation rules of FIN 46 and is referred to as a variable interest entity
if the entity's equity investors lack the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its operations without additional financial support. FIN 46 applies
immediately to variable interest entities created or acquired after January 31,
2003. The Company has no such newly created or acquired entities. FIN 46 applies
after the first interim or annual period ending after December 15, 2003 for
variable interest entities created or acquired prior to February 1, 2003. The
Company is reviewing the provisions of FIN 46 but does not expect the adoption
to have a material impact, if any, on the consolidated condensed financial
statements.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, which amends and clarifies the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS
No. 149 is effective for contracts entered into or modified after June 30, 2003,
with some exceptions for hedging relationships designated after June 30, 2003.
The adoption of SFAS No. 149 on July 1, 2003 did not have an impact on the
consolidated condensed financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, which modifies
the accounting for certain financial instruments. SFAS No. 150 requires that
these financial instruments be classified as liabilities and applies immediately
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. The adoption of SFAS No. 150 on July 1, 2003 did not have
an impact on the consolidated condensed financial statements.
12
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)
NOTE 14. SUBSEQUENT EVENTS
Subsequent to the end of the third quarter of 2003, the Company terminated
the interest rate swap agreement entered into in July 2003. The interest rate
swap agreement was for a notional amount of $325.0 million associated with the
Company's 6.25% Notes due January 2009 and had been designated and had qualified
as a fair value hedging instrument. The Company received proceeds of $6.7
million upon cancellation. This deferred gain is being amortized as a reduction
of interest expense over the remaining life of the underlying debt security,
which matures in January 2009.
In October 2003, the Company entered into an interest rate swap agreement
for a notional amount of $325.0 million associated with the Company's 6.25%
Notes due January 2009. Under this agreement, the Company receives interest at a
fixed rate of 6.25% and pays interest at a floating rate of six-month LIBOR plus
a spread of 2.320%. This interest rate swap will settle semi-annually and
terminates in January 2009. The interest rate swap agreement has been designated
and qualifies as a fair value hedging instrument. The interest rate swap
agreement will be fully effective, resulting in no gain or loss recorded in the
consolidated condensed statement of operations. In the unlikely event that the
counterparty fails to meet the terms of the interest rate swap agreement, the
Company's exposure is limited to the interest rate differential.
Subsequent to the end of the quarter through November 6, 2003, the Company
repurchased 0.8 million shares of its common stock at an average cost of $28.50
per share, for a total of $23.0 million. Upon repurchase, the shares were
retired. The Company has authorization remaining to repurchase up to $130.1
million in common stock.
13
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 and certain statements in the Notes to Consolidated Condensed Financial
Statements include 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," "if," "intend," "estimate," "project,"
"forecasts," "outlook," "will," "could," "would," "may," "likely" and similar
expressions, and the negative thereof, are intended to identify forward-looking
statements. Baker Hughes' expectations about its business outlook, customer
spending, oil and gas prices and the business environment for the Company and
the industry in general are only its forecasts regarding these matters. These
forecasts may be substantially different from actual results, which are affected
by the following risk factors: the level of petroleum industry exploration and
production expenditures; drilling rig and oil and gas industry manpower and
equipment availability; the Company's ability to implement and effect price
increases for its products and services; the Company's ability to control its
costs; the availability of sufficient manufacturing capacity and subcontracting
capacity at forecasted costs to meet the Company's revenue goals; the ability of
the Company to introduce new technology on its forecasted schedule and at its
forecasted cost; the ability of the Company's competitors to capture market
share; the Company's ability to retain or increase its market share; the
Company's successful completion of the pending sale of BIRD Machine; world
economic conditions; the price of, and the demand for, crude oil and natural
gas; drilling activity; weather conditions that affect the demand for energy and
severe weather conditions, such as hurricanes, that affect exploration and
production activities; the legislative and regulatory environment in the U.S.
and other countries in which the Company operates; outcome of government and
internal investigations; Organization of Petroleum Exporting Countries ("OPEC")
policy and the adherence by OPEC nations to their OPEC productions quotas; war,
military action or extended period of international conflict, particularly
involving the U.S., Middle East or other major petroleum-producing or consuming
regions; any future acts of war, armed conflicts or terrorist activities; civil
unrest or in-country security concerns where the Company operates; the
development of technology by Baker Hughes or its competitors that lowers overall
finding and development costs; new laws and regulations that could have a
significant impact on the future operations and conduct of all businesses;
labor-related actions, including strikes, slowdowns and facility occupations;
the condition of the capital and equity markets in general; adverse foreign
exchange fluctuations and adverse changes in the capital markets in
international locations where the Company operates; and the timing of any of the
foregoing. See "Business Environment" for a more detailed discussion of certain
of these risk factors.
Baker Hughes' expectations regarding its level of capital expenditures
described in "Liquidity and Capital Resources" 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's Oilfield segment consists of six operating divisions - Baker
Atlas, Baker Oil Tools, Baker Petrolite, Centrilift, Hughes Christensen and
INTEQ - that manufacture and sell products and provide services used in the oil
and gas industry, including drilling, formation evaluation, completion and
production of oil and gas wells. The Oilfield segment also includes the
Company's 30% interest in WesternGeco, a seismic venture between the Company and
Schlumberger Limited, and other similar businesses.
The business environment for the Company's Oilfield segment and its
corresponding operating results can be significantly affected by the level of
energy industry capital expenditures for the exploration and production ("E&P")
of oil and gas reserves. These expenditures are influenced strongly by
expectations about the supply and demand for crude oil and natural gas products
and by the energy price environment.
The Company does business in approximately 70 countries. According to
Transparency International's annual Corruption Perceptions Index ("CPI") survey,
a high degree of corruption is perceived to exist in many of these countries.
For example, the Company does business in approximately one-half of the 34
countries having the worst scores in Transparency International's CPI survey for
2003. The Company devotes significant resources to the development, maintenance
and enforcement of its Business Code of Conduct policy, its Foreign Corrupt
Practices Act (the "FCPA") policy, its internal control processes and
procedures, as well as other compliance related policies. Notwithstanding the
devotion of such resources, and in part as a consequence thereof, the
14
Company, from time to time, discovers or receives information alleging potential
violations of the FCPA and the Company's policies, processes and procedures. The
Company conducts internal investigations of these potential violations. The
Company anticipates that the devotion of significant resources to compliance
related issues, including the necessity for such internal investigations, will
continue to be an aspect of doing business in a number of the countries in which
oil and gas exploration, development and production take place and the Company
is requested to conduct operations.
Key risk factors currently influencing the worldwide crude oil and gas
markets are:
- - Production control - the degree to which individual OPEC nations and other
large oil and gas producing countries, including, but not limited to,
Mexico, Norway and Russia, are willing and able to control production and
exports of crude oil, to decrease or increase supply and to support their
targeted oil price while meeting their market share objectives. Key measures
of production control include actual production levels compared with target
or quota production levels, oil price compared with targeted oil price and
changes in each country's market share.
- - Global economic growth - particularly the impact of the U.S. and Western
European economies and the economic activity in Japan, China, South Korea
and the developing areas of Asia where the correlation between energy demand
and economic growth is strong. An important factor in the global economic
growth in 2003 and 2004 will be the strength of the U.S. economic recovery.
Key measures include U.S. and global economic activity, global energy demand
and forecasts of future demand by governments and private organizations.
- - Oil and gas storage inventory levels - a measure of the balance between
supply and demand. A key measure of U.S. natural gas inventories is the
storage level reported weekly by the U.S. Department of Energy compared with
historic levels. Key measures for oil inventories include U.S. inventory
levels reported by the U.S. Department of Energy and American Petroleum
Institute and worldwide estimates reported by the International Energy
Agency, again compared with historic levels.
- - Ability to produce natural gas - the amount of natural gas that can be
produced is a function of the number of new wells drilled, completed and
connected to pipelines as well as the rate of reservoir depletion and
production from existing wells. Advanced technologies, such as horizontal
drilling, result in improved total recovery, but also result in a more rapid
production decline. Key measures include government and private surveys of
natural gas production, company reported production, estimates of reservoir
depletion rates and drilling and completion activity.
- - 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, recover more hydrocarbons and to do so at lower cost.
Also key are the overall levels of research and engineering spending and the
pace at which new technology is introduced commercially and accepted by
customers.
- - Maturity of the resource base - of known hydrocarbon reserves in the North
Sea, U.S., Canada and Latin America.
- - Pace of new investment - access to capital and the reinvestment of available
cash flow into existing and emerging markets. Key measures of access to
capital include cash flow, interest rates, dividend policy, analysis of oil
and gas company leverage and equity offering activity. Access to capital is
particularly important for smaller independent oil and gas companies.
- - Energy prices and price volatility - the impact of widely fluctuating
commodity prices on the stability of the market and subsequent impact on
customer spending. Sustained higher energy prices can be an impediment to
economic growth. While current energy prices are important contributors to
positive cash flow at E&P companies, expectations for future prices are
generally more important for determining future E&P spending.
- - Impact of energy prices and price volatility on demand for hydrocarbons -
short-term price changes can result in companies switching to the most
economic sources of fuel or temporary curtailment of demand while long-term
price changes can lead to permanent changes in demand. Key indicators
include hydrocarbon prices on a Btu equivalent basis and indicators of
hydrocarbon demand, such as electricity generation or industrial production.
- - Access to prospects - which are economically attractive to individual oil
and gas companies based on their expectations of required returns,
forecasted energy prices and required investment. Access to prospects may be
limited because host governments do not allow access to the reserves or
because another oil and gas company owns the rights to develop the prospect.
- - Possible supply disruptions - from key oil exporting countries, including,
but not limited to, Iraq, Saudi Arabia or other Middle Eastern countries,
Nigeria and Venezuela, due to political instability, civil unrest or
military activity. In addition, adverse weather such as hurricanes could
impact production facilities, causing supply disruptions.
15
- - Weather - the impact of variations in temperatures as compared with normal
weather patterns and the related effect on demand for oil and natural gas. A
key measure of the impact of weather on energy demand is population-weighted
heating and cooling degree days as reported by the U.S. Department of Energy
and forecasts of warmer than normal or cooler than normal temperatures.
OIL AND GAS PRICES
Generally, customers' expectations about their prospects from oil and gas
sales and customers' 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. West Texas Intermediate ("WTI")
crude oil and U.S. Spot natural gas prices are summarized in the table below as
averages of the daily closing prices during each of the periods indicated.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
WTI crude oil ($/Bbl) $ 30.21 $ 28.30 $ 31.03 $ 25.46
U.S. Spot natural gas ($/MMBtu) 4.88 3.20 5.62 3.05
WTI crude oil prices averaged $30.21/Bbl in the third quarter of 2003. Oil
prices were between $30 and $32/Bbl in July 2003 and August 2003. Prices fell at
the beginning of September 2003 in anticipation of inventory buildups throughout
the winter season, reaching a third-quarter low of $26.93/Bbl on September 23,
2003. On September 24, 2003, OPEC announced plans to cut production by 900,000
barrels per day. If successful, the OPEC quota cut is expected to result in
inventories remaining low throughout the winter season.
During the third quarter of 2003, natural gas prices averaged $4.88/MMBtu.
Natural gas prices trended lower throughout the quarter, falling from a peak in
early July 2003 of $5.54/MMBtu to a low of $4.34/MMBtu in late September. Prices
weakened primarily as a result of strong storage injections that supported
expectations that natural gas storage would reach "normal" levels by the end of
the injection season, traditionally in early November.
RIG COUNTS
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 many of
the products and services provided by the oilfield service industry. The rig
counts act as a leading indicator of consumption of products and services used
in drilling, completing, producing and processing hydrocarbons. 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, generally reflect the relative
strength and stability of energy prices.
The Company has been providing rig counts to the public since 1944. The
Company gathers all relevant data through its field service personnel worldwide
who obtain this information from routine visits to the various rigs, customers,
contractors, or other outside sources. This data is then compiled and
distributed to various wire services and trade associations and is published on
the Company's website. Rig counts are compiled weekly for the U.S. and Canada
and monthly for all international and U.S. workover rigs. North American rigs
are counted as active if the well being drilled has been started and drilling
has not been completed on the day the count is taken. For an international rig
to be counted as active on a monthly basis, drilling operations must comprise at
least 15 days during the month. Published international rig counts do not
include rigs drilling in certain countries, such as Russia and onshore China,
because this information is extremely difficult to obtain. The Company's rig
counts are summarized in the table below as averages for each of the periods
indicated.
16
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ --------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------- --------------------------
U.S. - Land 979 740 896 712
U.S. - Offshore 109 112 109 113
Canada 385 249 358 257
- ------------------------------------------------------------------------------------------------
North America 1,473 1,101 1,363 1,082
- ------------------------------------------------------------------------------------------------
Latin America 253 204 237 211
North Sea 49 46 47 52
Other Europe 39 34 38 37
Africa 50 59 54 57
Middle East 212 203 211 198
Asia Pacific 179 172 177 169
- ------------------------------------------------------------------------------------------------
Outside North America 782 718 764 724
- ------------------------------------------------------------------------------------------------
Worldwide 2,255 1,819 2,127 1,806
================================================================================================
U.S. Workover Rigs 1,164 1,023 1,120 1,003
================================================================================================
INDUSTRY OUTLOOK
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.
Oil - The balance between oil supply and oil demand remained tight as the
fourth quarter of 2003 began. In its September 2003 meeting, OPEC announced
plans to cut production by 900,000 barrels per day to make room in the market
for Iraqi production, maintain tight inventories and keep oil prices at the top
of its targeted range. WTI crude oil prices are expected to remain volatile and
trade between $25/Bbl and $33/Bbl for the balance of 2003. Prices could move to
the bottom of this range if OPEC is unwilling or unable to manage its production
or if certain non-OPEC countries, such as Norway, Mexico and Russia, increase
production and significantly erode OPEC market share.
North American Natural Gas - Prices are expected to trade between
$4.00/MMBtu and $6.00/MMBtu for the remainder of 2003. If these prices are
sustained, it is expected that some industrial demand will be discouraged,
thereby increasing the amount of gas that can be injected into storage before
the start of the 2003/2004 heating season. Storage levels are expected to be at
normal levels at the start of the winter withdrawal season, traditionally in
early November. Gas prices could move to the top of this trading range and spike
above it if cooler than normal weather drives demand higher. Gas prices could
move to the bottom of this range if storage levels are high and demand does not
increase as prices fall or if winter weather is warmer than normal.
Customer Spending - Based upon the Company's discussions with its major
customers, its review of published industry reports and the Company's outlook
for oil and gas prices described above, the anticipated customer spending trends
are as follows:
- North America - Spending in North America, primarily towards developing
natural gas supplies, is expected to increase approximately 10% to 15% in
2003 compared with 2002.
- Outside North America - Customer spending, primarily directed at
developing oil supplies, is expected to be flat to up by 5% in 2003
compared with 2002.
- Total spending is expected to be up 6% to 8% in 2003 compared with 2002.
Drilling Activity - Based upon the Company's outlooks for oil and natural
gas prices and customer spending described above, the Company's outlook for
drilling activity, as measured by the Baker Hughes rig count, is as follows:
- The North American rig count is expected to increase approximately 25% to
30% in 2003 compared with 2002. The U.S. rig count is expected to remain
stable over the remainder of the year.
- Drilling activity outside of North America is expected to increase
modestly over the remainder of the year and is expected to increase as
much as 5% to 7% in 2003 compared with 2002.
17
COMPANY OUTLOOK
The Company expects that 2003 will be stronger than 2002, with revenues
expected to increase by approximately 6% to 8% as compared with 2002, with
related improvements in operating results. The Company expects revenues for the
fourth quarter of 2003 to be up 1% to 3% compared with the third quarter of 2003
due to improving international activity and seasonal increases in Canadian
activity.
In the first quarter of 2003, civil unrest related to electoral issues in
Nigeria resulted in a number of operators curtailing operations in Nigeria in
March 2003 and the delay of several export-direct customer orders for Nigerian
customers. Nigeria held national elections in April 2003 and activity stabilized
in the second quarter. However, the Company's operations in Nigeria remain
susceptible to disruption as a result of the ongoing civil unrest.
Activity in the North Sea, particularly in the U.K. sector, is expected to
be depressed for the next 12 to 18 months. As a result, the Company took steps
in the second quarter of 2003 to reduce its cost structure in the North Sea.
Although activity is expected to increase seasonally, a meaningful increase in
activity levels is dependent upon a large number of assets being sold by the
major oil and gas companies to the independents.
NEW ACCOUNTING STANDARDS
Effective January 1, 2003, the Company adopted SFAS No. 143, Accounting for
Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of long-lived assets.
SFAS No. 143 requires that the fair value of a liability associated with an
asset retirement obligation ("ARO") be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The liability for
the ARO is revised each subsequent period due to the passage of time and changes
in estimates. The associated retirement costs are capitalized as part of the
carrying amount of the long-lived asset and subsequently depreciated over the
estimated useful life of the asset.
The adoption of SFAS No. 143 in the first quarter of 2003 resulted in a
charge of $5.6 million, net of tax of $2.8 million, recorded as the cumulative
effect of accounting change in the consolidated condensed statement of
operations. In conjunction with the adoption, the Company recorded ARO
liabilities of $11.4 million primarily for anticipated costs of obligations
associated with the future disposal of power source units at certain of its
divisions and refurbishment costs associated with certain leased facilities in
Europe and with a fleet of leased railcars and tanks.
In November 2002, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 45 ("FIN 45"), Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others. FIN 45 elaborates on required disclosures by a guarantor in its
financial statements about obligations under certain guarantees that it has
issued and requires a guarantor to recognize, at the inception of certain
guarantees, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The adoption of the provisions of FIN 45 relating to the
initial recognition and measurement of guarantor liabilities, which were
effective for qualifying guarantees entered into or modified after December 31,
2002, did not have an impact on the consolidated condensed financial statements
of the Company. The Company adopted the new disclosure requirements in 2002.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
Consolidation of Variable Interest Entities. An entity is subject to the
consolidation rules of FIN 46 and is referred to as a variable interest entity
if the entity's equity investors lack the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its operations without additional financial support. FIN 46 applies
immediately to variable interest entities created or acquired after January 31,
2003. The Company has no such newly created or acquired entities. FIN 46 applies
after the first interim or annual period ending after December 15, 2003 for
variable interest entities created or acquired prior to February 1, 2003. The
Company is reviewing the provisions of FIN 46 but does not expect the adoption
to have a material impact, if any, on the consolidated condensed financial
statements.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, which amends and clarifies the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS
No. 149 is effective for contracts entered into or modified after June 30, 2003,
with some exceptions for hedging relationships designated after June 30, 2003.
The adoption of SFAS No. 149 on July 1, 2003 did not have an impact on the
consolidated condensed financial statements.
18
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, which modifies
the accounting for certain financial instruments. SFAS No. 150 requires that
these financial instruments be classified as liabilities and applies immediately
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. The adoption of SFAS No. 150 on July 1, 2003 did not have
an impact on the consolidated condensed financial statements.
DISCONTINUED OPERATIONS
In the third quarter of 2003, the Company's management initiated and the
Board of Directors approved a plan to sell BIRD Machine ("BIRD"), the last
remaining division of the Process segment. In October 2003, the Company signed a
definitive agreement for the sale of BIRD and recorded charges totaling $35.5
million, net of tax of $9.4 million, which consisted of a loss of $13.2 million
on the write-down of BIRD to fair value, $4.1 million of severance and warranty
accruals and a loss of $18.2 million related to the recognition of cumulative
foreign currency translation adjustments into earnings. The sale excludes
certain accounts receivable, inventories and other assets that will be retained
by the Company. The sale is subject to various closing conditions, but is
expected to close no later than January 2004. The Company expects to record
additional pre-tax charges totaling between $5.0 million and $7.0 million in
conjunction with the closing of the transaction.
In December 2002, the Company entered into exclusive negotiations for the
sale of the Company's interest in its oil producing operations in West Africa
and received $10.0 million as a deposit. The transaction was effective as of
January 1, 2003, and resulted in a gain on sale of $4.1 million, net of a tax
benefit of $0.2 million, recorded in the first quarter of 2003. The sales price
was $32.0 million, and the Company received the remaining $22.0 million upon
closing, which occurred in April 2003.
In the third quarter of 2002, the Company signed a letter of intent for the
sale of EIMCO Process Equipment ("EIMCO"), a division of the Process segment,
and recorded a loss on disposal of $21.2 million, net of tax of $0.5 million,
which consisted of a loss of $0.9 million on the write-down to fair value and a
loss of $20.3 million related to the recognition of cumulative foreign currency
translation adjustments into earnings. In November 2002, the Company completed
the sale of EIMCO and received total proceeds of $48.9 million, of which $4.9
million was held in escrow pending completion of final adjustments of the
purchase price. In April 2003, all purchase price adjustments were completed,
resulting in the release of the escrow balance, of which $2.9 million was
returned to the buyer and $2.0 million was received by the Company. In the first
quarter of 2003, the Company also recorded an additional loss on sale due to
purchase price adjustments of $2.5 million, net of tax of $1.3 million.
19
The Company has reclassified the consolidated financial statements for all
prior periods presented to reflect these operations as discontinued. Summarized
financial information from discontinued operations is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Revenues:
BIRD $ 21.1 $ 29.1 $ 74.2 $ 89.2
Oil producing operations - 7.9 4.2 34.4
EIMCO - 36.1 - 124.2
- ----------------------------------------------------------------------------------------------------------------------
Total $ 21.1 $ 73.1 $ 78.4 $ 247.8
======================================================================================================================
Income (loss) before income taxes:
BIRD $ (5.9) $ (3.1) $ (12.1) $ (5.7)
Oil producing operations - 1.0 1.8 11.6
EIMCO - (2.3) - (0.8)
- ----------------------------------------------------------------------------------------------------------------------
Total (5.9) (4.4) 10.3 5.1
- ----------------------------------------------------------------------------------------------------------------------
Income taxes:
BIRD 2.1 1.0 4.3 2.0
Oil producing operations - (0.2) (0.7) (2.8)
EIMCO - 0.7 - 0.2
- ----------------------------------------------------------------------------------------------------------------------
Total 2.1 1.5 3.6 (0.6)
- ----------------------------------------------------------------------------------------------------------------------
Income (loss) before gain (loss) on disposal:
BIRD (3.8) (2.1) (7.8) (3.7)
Oil producing operations - 0.8 1.1 8.8
EIMCO - (1.6) - (0.6)
- ----------------------------------------------------------------------------------------------------------------------
Total (3.8) (2.9) (6.7) 4.5
- ----------------------------------------------------------------------------------------------------------------------
Gain (loss) on disposal, net of tax:
BIRD (35.5) - (35.5) -
Oil producing operations - - 4.1 -
EIMCO - (21.2) (2.5) (21.2)
- ----------------------------------------------------------------------------------------------------------------------
Total (35.5) (21.2) (33.9) (21.2)
- ----------------------------------------------------------------------------------------------------------------------
Loss from discontinued operations $ (39.3) $ (24.1) $ (40.6) $ (16.7)
======================================================================================================================
RESULTS OF OPERATIONS
REVENUES
Revenues for the three months ended September 30, 2003 were $1,338.4
million, an increase of 7.0% compared with the three months ended September 30,
2002. Revenues in North America, which account for 42.0% of total revenues,
increased 10.6% for the three months ended September 30, 2003 compared with the
three months ended September 30, 2002. This increase reflects increased activity
in U.S. land operations and Canada, as evidenced by a 33.8% increase in the
North American rig count. Outside North America, revenues increased 4.5% for the
three months ended September 30, 2003 compared with the three months ended
September 30, 2002. This increase reflects the improvement in international
drilling activity, particularly in Latin America, the Middle East and Asia
Pacific, partially offset by price erosion in certain markets and product lines.
Revenues for the nine months ended September 30, 2003 were $3,853.3 million,
an increase of 5.9% compared with the nine months ended September 30, 2002.
Revenues were positively impacted by the increased activity in North America,
Latin America and the Middle East, partially offset by the continued weakness in
the North Sea markets.
COST OF REVENUES
Cost of revenues for the three months ended September 30, 2003 was $976.3
million, an increase of 10.3% compared with the three months ended September 30,
2002. Cost of revenues as a percentage of consolidated revenues was 72.9% and
70.7% for the three months ended September 30, 2003 and 2002, respectively. Cost
of revenues for the nine months ended September 30, 2003 was $2,823.1 million,
an increase of 8.1% compared with the nine months ended September 30, 2002. Cost
of revenues as a percentage of consolidated revenues was 73.3% and 71.7% for the
nine months ended September 30, 2003 and 2002, respectively. The increase is
primarily the result of increased repairs and maintenance for rental tools and
other costs at the Company's INTEQ division, pricing pressures and changes in
the geographic and product mix from the sale of the Company's products and
services.
20
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative ("SG&A") expenses for the three months
ended September 30, 2003 were $194.5 million, a decrease of 5.7% compared with
the three months ended September 30, 2002. SG&A expenses as a percentage of
consolidated revenues for the three months ended September 30, 2003 and 2002
were 14.5% and 16.5%, respectively. SG&A expenses for the nine months ended
September 30, 2003 were $597.9 million, a decrease of 3.2% compared with the
nine months ended September 30, 2002. SG&A expenses as a percentage of
consolidated revenues for the nine months ended September 30, 2003 and 2002 were
15.5% and 17.0%, respectively. These decreases were primarily due to improvement
in the impact of foreign exchange activity. The Company recognized net foreign
exchange gains in 2003 compared with net foreign exchange losses in 2002.
IMPAIRMENT OF INVESTMENT IN AFFILIATE
As a result of the continuing weakness in the seismic industry, the Company
evaluated the carrying value of its investment in WesternGeco and recorded an
impairment loss of $45.3 million in the third quarter of 2003 to write-down the
investment to its fair value. The fair value was determined using a combination
of a market value and discounted cash flows approach.
EQUITY IN INCOME (LOSS) OF AFFILIATES
Equity in income (loss) of affiliates relates to the Company's share of the
income (loss) of affiliates accounted for using the equity method of accounting.
The Company's most significant equity method investment is its 30% interest in
WesternGeco. The operating results of WesternGeco continue to be adversely
affected by the continuing weakness in the seismic industry. As a result of this
weakness, WesternGeco recorded impairment and restructuring charges of $452.0
million in the three months ended September 30, 2003, for impairment of its
multiclient seismic library and rationalization of its marine seismic fleet. The
Company's portion of the charge was $135.7 million and is recorded in equity in
income (loss) of affiliates. Accordingly, equity in income (loss) of affiliates
decreased $147.4 million for the three months ended September 30, 2003 compared
with the three months ended September 30, 2002, and decreased $170.4 million for
the nine months ended September 30, 2003 compared with the nine months ended
September 30, 2002.
INTEREST EXPENSE
Interest expense for the three months ended September 30, 2003 decreased
$2.1 million compared with the three months ended September 30, 2002. The
decrease was primarily due to lower total debt levels resulting from the
repayment of $100.0 million of long-term debt in February 2003 coupled with
amortization of deferred gains related to terminated interest rate swap
agreements.
Interest expense for the nine months ended September 30, 2003 decreased $5.0
million compared with the nine months ended September 30, 2002. The decrease was
primarily due to lower total debt levels, lower average interest rates on the
Company's commercial paper and money market borrowings and the amortization of
deferred gains related to terminated interest rate swap agreements. Total debt
levels decreased due to cash flow from operations and the repayment of $100.0
million of long-term debt in February 2003. The approximate average interest
rate on the Company's commercial paper and money market borrowings was 1.2% for
the nine months ended September 30, 2003 compared with 1.8% for the nine months
ended September 30, 2002.
INCOME TAXES
The Company's effective tax rate for the three and nine months ended
September 30, 2003 differs from the statutory income tax rate of 35% due to the
reduction in the carrying value of the Company's equity investment in
WesternGeco, for which there was no tax benefit, state income taxes, differing
rates of tax on international operations and higher taxes within the WesternGeco
venture that arose due to: (i) the venture being taxed in certain foreign
jurisdictions based on a deemed profit basis, which is a percentage of revenues
rather than profits, and (ii) unbenefitted foreign losses of the venture, which
are operating losses and impairment and restructuring charges in certain foreign
jurisdictions where there was no current tax benefit and where a deferred tax
asset was not recorded due to the uncertainty of its realization.
CUMULATIVE EFFECT OF ACCOUNTING CHANGE
On January 1, 2003, the Company adopted SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of long-lived assets.
SFAS No. 143 requires that the fair value of a liability associated with an
asset retirement obligation ("ARO") be recognized in the period in which it is
incurred if a
21
reasonable estimate of fair value can be made. The liability for the ARO is
revised each subsequent period due to the passage of time and changes in
estimates. The associated retirement costs are capitalized as part of the
carrying amount of the long-lived asset and subsequently depreciated over the
estimated useful life of the asset.
The adoption of SFAS No. 143 in the first quarter of 2003 resulted in a
charge of $5.6 million, net of tax of $2.8 million, recorded as the cumulative
effect of accounting change in the consolidated condensed statement of
operations. In conjunction with the adoption, the Company recorded ARO
liabilities of $11.4 million primarily for anticipated costs of obligations
associated with the future disposal of power source units at certain of its
divisions and refurbishment costs associated with certain leased facilities in
Europe and with a fleet of leased railcars and tanks.
On January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other
Intangible Assets. The adoption of SFAS No. 142 required the Company to cease
amortizing goodwill and to perform a transitional impairment test of goodwill in
each of its reporting units as of January 1, 2002. The Company's reporting units
were based on its organizational and reporting structure. Corporate and other
assets and liabilities were allocated to the reporting units to the extent that
they related to the operations of those reporting units. Valuations of the
reporting units were performed by an independent third party. The goodwill in
both the EIMCO and BIRD operating divisions of the Company's Process segment was
determined to be impaired using a combination of a market value and discounted
cash flows approach to estimate fair value. Accordingly, the Company recognized
transitional impairment losses of $42.5 million, net of tax of $20.4 million.
The transitional impairment losses were recorded in the first quarter of 2002 as
the cumulative effect of accounting change in the consolidated condensed
statement of operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's capital requirements have been principally related to working
capital needs, payment of dividends and long-term debt, repurchase of its common
stock and capital expenditures. These requirements have been met through a
combination of commercial paper borrowings, cash on hand and internally
generated funds.
In the nine months ended September 30, 2003, net cash inflows from operating
activities of continuing operations totaled $291.4 million, a decrease of $132.9
million compared with the nine months ended September 30, 2002. This decrease
was primarily due to increases in working capital related to increased activity.
Expenditures for capital assets totaled $230.5 million and $209.8 million
for the nine months ended September 30, 2003 and 2002, respectively. The
majority of these expenditures were for machinery and equipment and rental
tools. During the nine months ended September 30, 2003 and 2002, the Company
received proceeds of $44.7 million and $63.1 million, respectively, from the
disposal of assets.
During the nine months ended September 30, 2003, the Company made an
acquisition with a purchase price of $12.7 million, of which $9.6 million was
paid in cash. As a result of this acquisition, the Company recorded
approximately $9.8 million of intangible assets through September 30, 2003. The
purchase price is allocated based on fair value of the acquisition. In addition,
during the nine months ended September 30, 2003, the Company invested $35.4
million in affiliates, of which $30.1 million related to the Company's 50%
interest in the QuantX Wellbore Instrumentation venture, which is engaged in the
permanent in-well monitoring market.
In the second quarter of 2003, the Company received the remaining $22.0
million in proceeds from the sale of its interest in its oil producing
operations in West Africa.
During 2002, the Company's Board of Directors authorized the Company to
repurchase up to $275.0 million of its common stock. There were no repurchases
during the third quarter of 2003. The Company has repurchased 2.5 million shares
at an average cost of $28.69 per share, for a total of $72.9 million, during the
nine months ended September 30, 2003. Subsequent to the end of the quarter
through November 6, 2003, the Company repurchased 0.8 million shares at an
average cost of $28.50 per share, for a total of $23.0 million. Upon repurchase,
the shares were retired. The Company has authorization remaining to repurchase
up to $130.1 million in common stock.
In April 2003, the Company entered into an interest rate swap agreement for
a notional amount of $325.0 million associated with the Company's 6.25% Notes
due January 2009 that had been designated and had qualified as a fair value
hedging instrument. In June 2003, the Company terminated the interest rate swap
agreement and received proceeds of $15.5 million. This deferred gain is being
amortized as a reduction of interest expense over the remaining life of the
underlying debt security, which matures in January 2009.
Total debt outstanding at September 30, 2003 was $1,524.2 million, a
decrease of $23.6 million compared with December 31, 2002. The Company repaid
the $100.0 million 5.8% Notes due February 2003. The repayment was funded with
cash
22
on hand, cash flow from operations and the issuance of commercial paper. The
total debt to total capitalization (defined as total debt plus stockholders'
equity) ratio was 0.31 at September 30, 2003 and December 31, 2002.
At September 30, 2003, the Company had $899.9 million of credit facilities
with commercial banks, of which $500.0 million is a three-year committed
revolving credit facility (the "facility") that expires in July 2006. The
facility contains certain covenants which, among other things, require the
maintenance of a funded indebtedness to total capitalization ratio of less than
or equal to 0.50 (the ratio for the Company was 0.31 at September 30, 2003),
limit the amount of subsidiary indebtedness and restrict the sale of significant
assets, defined as 10% or more of total consolidated assets. There were no
direct borrowings under the facility during the nine months ended September 30,
2003; however, to the extent the Company has outstanding commercial paper,
available borrowings under the facility are reduced. At September 30, 2003, the
Company had $40.0 million in commercial paper outstanding with a weighted
average interest rate of 1.1%. At December 31, 2002, the Company had no
outstanding commercial paper. As of September 30, 2003, the Company has
classified all of its commercial paper and $349.6 million of debt due within one
year as long-term debt because the Company has the ability under the facility
and the intent to maintain these obligations for longer than one year.
Cash flows from continuing operations and borrowings from short-term debt
and commercial paper are expected to be the principal sources of liquidity in
2003. The Company believes that cash flow from continuing operations, combined
with its credit facility, will provide the Company with sufficient capital
resources and liquidity to manage its operations, meet debt obligations and fund
projected capital expenditures. The Company currently expects 2003 capital
expenditures to be between $310.0 million and $330.0 million, excluding
acquisitions. The expenditures are expected to be used primarily for normal,
recurring items necessary to support the growth and operations of the Company.
If the Company incurred a reduction in its debt ratings or stock price,
there are no provisions in the Company's debt or lease agreements that would
accelerate their repayment, require collateral or require material changes in
terms. Other than normal operating leases, the Company does not have any
off-balance sheet financing arrangements such as securitization agreements,
liquidity trust vehicles, synthetic leases or special purpose entities. As such,
the Company is not materially exposed to any financing, liquidity, market or
credit risk that could arise if the Company had engaged in such financing
arrangements.
In the normal course of business with customers, vendors and others, the
Company is contingently liable for performance under letters of credit and other
bank issued guarantees which totaled approximately $218.4 million at September
30, 2003. In addition, at September 30, 2003, the Company has guaranteed debt
and other obligations of third parties totaling $31.8 million, which declined
significantly from the previous quarter due to the termination of a Company
guarantee related to a lease on a seismic vessel by WesternGeco. WesternGeco
purchased the seismic vessel during the third quarter of 2003.
The words "believes," "will," "would," "if," "to be," "expected" and
"expects" are intended to identify Forward-Looking Statements in "Liquidity and
Capital Resources". See "Forward-Looking Statements" and "Business Environment"
above for a description of risk factors related to these Forward-Looking
Statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's operations are conducted around the world in a number of
different currencies. The majority of the Company's significant foreign
subsidiaries have designated the local currency as their functional currency. As
such, future earnings are subject to change due to changes in foreign currency
exchange rates when transactions are denominated in currencies other than the
Company's functional currencies. To minimize the need for foreign currency
contracts, the Company's objective is to manage its foreign currency exposure by
maintaining a minimal consolidated net asset or net liability position in a
currency other than the functional currency.
At September 30, 2003, the Company had entered into several foreign currency
forward contracts with notional amounts aggregating $84.0 million to hedge
exposure to currency fluctuations in various foreign currencies, including the
British Pound Sterling, the Euro, the Norwegian Krone, the Brazilian Real, the
Argentine Peso and the Indonesian Rupiah. These contracts are designated and
qualify as fair value hedging instruments. Based on quoted market prices as of
September 30, 2003 for contracts with similar terms and maturity dates, the
Company recorded a gain of $1.2 million to adjust these foreign currency forward
contracts to their fair market value. This gain is included in selling, general
and administrative expense in the consolidated condensed statement of
operations.
The counterparties to the Company's forward contracts are major financial
institutions. The credit ratings and concentration of risk of these financial
institutions are monitored on a continuing basis. In the unlikely event that the
counterparties fail to meet the terms of a foreign currency contract, the
Company's exposure is limited to the foreign currency rate differential.
23
In April 2003, the Company entered into an interest rate swap agreement for
a notional amount of $325.0 million associated with the Company's 6.25% Notes
due January 2009 that had been designated and had qualified as a fair value
hedging instrument. In June 2003, the Company terminated the interest rate swap
agreement and received proceeds of $15.5 million upon cancellation. This
deferred gain is being amortized as a reduction of interest expense over the
remaining life of the underlying debt security, which matures in January 2009.
In July 2003, the Company entered into an interest rate swap agreement for a
notional amount of $325.0 million associated with the Company's 6.25% Notes due
January 2009 that had been designated and had qualified as a fair value hedging
instrument. Subsequent to the end of the third quarter of 2003, the Company
terminated the interest rate swap agreement and received proceeds of $6.7
million. This deferred gain is being amortized as a reduction in interest
expense over the remaining life of the underlying debt security, which matures
in January 2009.
In October 2003, the Company entered into an interest rate swap agreement
for a notional amount of $325.0 million associated with the Company's 6.25%
Notes due January 2009. Under this agreement, the Company receives interest at a
fixed rate of 6.25% and pays interest at a floating rate of six-month LIBOR plus
a spread of 2.320%. This interest rate swap will settle semi-annually and
terminates in January 2009. The interest rate swap agreement has been designated
and qualifies as a fair value hedging instrument. The interest rate swap
agreement will be fully effective, resulting in no gain or loss recorded in the
consolidated condensed statement of operations. In the unlikely event that the
counterparty fails to meet the terms of the interest rate swap agreement, the
Company's exposure is limited to the interest rate differential.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this quarterly report, the Company
has evaluated the effectiveness of the design and operation of its disclosure
controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act
of 1934, as amended (the "Exchange Act"). This evaluation was carried out under
the supervision and with the participation of the Company's management,
including its principal executive officer and principal financial officer. Based
on this evaluation, these officers have concluded that the design and operation
of the Company's disclosure controls and procedures are effective. There has
been no change in the Company's internal controls over financial reporting
during the quarter ended September 30, 2003 that has materially affected, or is
reasonably likely to materially affect, the Company's internal controls over
financial reporting.
Disclosure controls and procedures are the Company's controls and other
procedures that are designed to ensure that information required to be disclosed
by the Company in the reports that the Company files or submits under the
Exchange Act, such as this Quarterly Report, is recorded, processed, summarized
and reported, within the time periods specified in the SEC's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by the
Company in the reports that the Company files under the Exchange Act is
accumulated and communicated to the Company's management, including its
principal executive officer and principal financial officer, as appropriate, to
allow timely decisions regarding required disclosure.
24
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On March 25, 2002, a former employee alleging improper activities relating
to Nigeria filed a civil complaint against the Company in the 281st District
Court in Harris County, Texas, seeking back pay and damages, including future
lost wages. On August 2, 2002, the same former employee filed substantially the
same complaint against the Company in the federal district court for the
Southern District of Texas. The state court case has been stayed pending the
outcome of the federal suit. The Company has reached a proposed settlement
agreement with the former employee. The settlement agreement, which is subject
to final court approval, covers both civil complaints filed in state court and
federal court. The federal court was advised of the proposed settlement and, on
October 4, 2003, issued a standard order allowing the parties sixty days to
finalize the settlement. The Company does not believe the amount of the
settlement is material to the Company.
On March 29, 2002, the Company announced that it had been advised that the
Securities and Exchange Commission ("SEC") and the Department of Justice ("DOJ")
are conducting investigations into allegations of violations of law relating to
Nigeria and other related matters. The SEC has issued a formal order of
investigation into possible violations of provisions under the Foreign Corrupt
Practices Act ("FCPA") regarding anti-bribery, books and records and internal
controls, and the DOJ has asked to interview current and former employees. On
August 6, 2003, the SEC issued a subpoena seeking information about the
Company's operations in Angola and Kazakhstan as part of its ongoing
investigation. The Company is providing documents to and cooperating fully with
the SEC and the DOJ. In addition, the Company is conducting internal
investigations into these matters. There can be no assurance as to the
timeliness of the completion of the investigations or as to the final results
thereof.
The Company's ongoing internal investigation with respect to certain
operations in Nigeria has identified apparent deficiencies in its books and
records and internal controls, and potential liabilities to governmental
authorities in Nigeria. The investigation was substantially completed during the
first quarter of 2003. Based upon current information, the Company does not
expect that any such potential liabilities will have a material adverse effect
on the Company's results of operations or financial condition.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
The Board of Directors of the Company has approved procedures for use under
the Company's Securities Trading and Disclosure Policy to permit the Company's
employees, officers and directors to enter into written trading plans
complying with Rule 10b5-1 under the Securities Exchange Act, as amended. Rule
10b5-1 provides criteria under which such an individual may establish a
prearranged plan to buy or sell a specified number of shares of a company's
stock over a set period of time. Any such plan must be entered into in good
faith at a time when the individual is not in possession of material, nonpublic
information. If an individual establishes a plan satisfying the requirements of
Rule 10b5-1, such individual's subsequent receipt of material, nonpublic
information will not prevent transactions under the plan from being executed.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
Exhibits designated with an"*" are identified as management contracts
or compensatory plans or arrangements.
3.1 Bylaws of Baker Hughes Incorporated, as amended October 22,
2003.
25
10.1* First Amendment to Baker Hughes Incorporated Supplemental
Retirement Plan, effective July 23, 2003.
10.2* Baker Hughes Incorporated 2002 Director and Officer Long-Term
Incentive Plan.
10.3 Interest Rate Swap Confirmation, dated October 16, 2003.
31.1 Certification of Michael E. Wiley, Chief Executive Officer,
dated November 7, 2003, pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934, as amended.
31.2 Certification of G. Stephen Finley, Chief Financial Officer,
dated November 7, 2003, pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934, as amended.
32 Statement of Michael E. Wiley, Chief Executive Officer, and G.
Stephen Finley, Chief Financial Officer, dated November 7, 2003,
furnished pursuant to Rule 13a-14(b) of the Securities Exchange
Act of 1934, as amended.
(b) Reports on Form 8-K:
A Current Report on Form 8-K was filed with the SEC on July 8, 2003, to
report under "Item 5. Other Events and Regulation FD Disclosure" the
issuance of a press release whereby the Company announced that it had
entered into a $500 million three-year revolving credit facility to be
used for commercial paper backup and general corporate purposes.
A Current Report on Form 8-K was filed with the SEC on July 24, 2003,
to furnish under "Item 9. Regulation FD Disclosure" pursuant to "Item
12." the Company's announcement of financial results for the second
quarter of 2003.
A Current Report on Form 8-K was filed with the SEC on September 22,
2003, to furnish under "Item 9. Regulation FD Disclosure" the Company's
announcement of charges and revised outlook for the third quarter of
2003.
A Current Report on Form 8-K was filed with the SEC on October 20,
2003, (a) to report under "Item 5. Other Events and Regulation FD
Disclosure" the issuance of a press release whereby the Company
announced that it had reached a proposed settlement agreement with a
former employee who had made allegations of improper activities
relating to operations in Nigeria and (b) to furnish under "Item 12.
Results of Operations and Financial Condition" the Company's issuance
of a press release whereby the Company announced that it had signed a
definitive agreement for the sale of BIRD Machine.
A Current Report on Form 8-K was filed with the SEC on October 23,
2003, to furnish under "Item 12. Results of Operations and Financial
Condition" the Company's announcement of financial results for the
third quarter of 2003.
A Current Report on Form 8-K was filed with the SEC on October 30,
2003, to report under "Item 5. Other Events and Regulation FD
Disclosure" the issuance of a press release whereby the Company
announced the retirement of its Chief Operating Officer.
26
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 7, 2003 By: /s/ G. STEPHEN FINLEY
--------------------------------------------
G. Stephen Finley
Sr. Vice President - Finance and
Administration and Chief Financial Officer
Date: November 7, 2003 By: /s/ ALAN J. KEIFER
--------------------------------------------
Alan J. Keifer
Vice President and Controller
27
EXHIBIT INDEX
Exhibits designated with an"*" are identified as management contracts
or compensatory plans or arrangements.
3.1 Bylaws of Baker Hughes Incorporated, as amended October 22,
2003.
10.1* First Amendment to Baker Hughes Incorporated Supplemental
Retirement Plan, effective July 23, 2003.
10.2* Baker Hughes Incorporated 2002 Director and Officer Long-Term
Incentive Plan.
10.3 Interest Rate Swap Confirmation, dated October 16, 2003.
31.1 Certification of Michael E. Wiley, Chief Executive Officer,
dated November 7, 2003, pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934, as amended.
31.2 Certification of G. Stephen Finley, Chief Financial Officer,
dated November 7, 2003, pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934, as amended.
32 Statement of Michael E. Wiley, Chief Executive Officer, and G.
Stephen Finley, Chief Financial Officer, dated November 7, 2003,
furnished pursuant to Rule 13a-14(b) of the Securities Exchange
Act of 1934, as amended.