1
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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
--- OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
--- OF THE SECURITIES EXCHANGE ACT OF 1934
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Commission file number 1-9397
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BAKER HUGHES INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware 76-0207995
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
3900 Essex Lane, Houston, Texas 77027
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (713) 439-8600
-----------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at August 1, 1998
----- -------------------------------
Common Stock, $1.00 par value per share 170,534,900 shares
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2
BAKER HUGHES INCORPORATED
INDEX
Page
No.
----
Part I - Financial Information:
Consolidated Condensed Statements of Operations - Three months and
nine months ended June 30, 1998 and 1997 2
Consolidated Condensed Statements of Financial Position
- June 30, 1998 and September 30, 1997 4
Consolidated Condensed Statements of Cash Flows - Nine months
ended June 30, 1998 and 1997 5
Notes to Consolidated Condensed Financial Statements 6
Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Part II - Other Information 21
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PART I. FINANCIAL INFORMATION
BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In millions, except per share amounts)
Three Months Ended Nine Months Ended
June 30, June 30,
1998 1997 1998 1997
-------------------- --------------------
REVENUES:
Sales $ 766.6 $ 600.7 $ 2,332.0 $ 1,705.9
Services and rentals 346.4 316.5 1,071.8 888.2
--------- --------- --------- ---------
Total revenues 1,113.0 917.2 3,403.8 2,594.1
--------- --------- --------- ---------
COSTS AND EXPENSES:
Costs of sales 478.6 380.8 1,448.2 1,077.3
Costs of services and rentals 202.2 174.7 608.6 505.0
Selling, general and
administrative 280.6 239.0 896.5 672.7
Amortization of goodwill
and other intangibles 10.0 7.0 30.7 22.3
--------- --------- --------- ---------
Total costs and expenses 971.4 801.5 2,984.0 2,277.3
--------- --------- --------- ---------
Operating income 141.6 115.7 419.8 316.8
Interest expense (19.7) (12.0) (51.8) (36.0)
Interest income .1 .5 1.9 1.4
--------- --------- --------- ---------
Income before income taxes and
cumulative effect of
accounting change 122.0 104.2 369.9 282.2
Income taxes (40.2) (21.7) (129.5) (90.2)
--------- --------- --------- ---------
Income before cumulative effect
of accounting change 81.8 82.5 240.4 192.0
Cumulative effect of accounting
change - Impairment of long-
lived assets to be disposed of
(net of $6.0 income tax
benefit) (12.1)
--------- --------- --------- ---------
Net income $ 81.8 $ 82.5 $ 240.4 $ 179.9
========= ========= ========= =========
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PART I. FINANCIAL INFORMATION
BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS CONTINUED
(In millions, except per share amounts)
Three Months Ended Nine Months Ended
June 30, June 30,
1998 1997 1998 1997
-------------------- --------------------
Earnings Per Share of Common
Stock - Basic:
Income before cumulative
effect of accounting
change $ .48 $ .56 $ 1.42 $ 1.30
Cumulative effect of
accounting change (.08)
--------- --------- --------- ---------
Net income $ .48 $ .56 $ 1.42 $ 1.22
========= ========= ========= =========
Earnings Per Share of Common
Stock - Diluted:
Income before cumulative
effect of accounting
change $ .46 $ .54 $ 1.38 $ 1.26
Cumulative effect of
accounting change (.08)
--------- --------- --------- ---------
Net income $ .46 $ .54 $ 1.38 $ 1.18
========= ========= ========= =========
Cash dividends per share of
common stock $ .115 $ .115 $ .345 $ .345
========= ========= ========= =========
See accompanying notes to consolidated condensed financial statements.
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BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF FINANCIAL POSITION
(In millions)
ASSETS
June 30, September 30,
1998 1997
---------- -------------
Current Assets:
Cash and cash equivalents $ 11.6 $ 8.6
Receivables - net 1,081.4 1,047.1
Inventories 1,187.7 1,030.5
Deferred income taxes 88.2 83.8
Other current assets 66.8 50.5
---------- -------------
Total current assets 2,435.7 2,220.5
Property - net 1,187.2 982.9
Other assets 504.4 497.5
Excess costs arising from acquisitions - net 1,079.0 1,055.4
---------- -------------
Total assets $ 5,206.3 $ 4,756.3
========== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 390.4 $ 499.7
Short-term borrowings and current portion
of long-term debt 203.7 9.6
Accrued employee compensation and benefits 182.4 223.2
Income taxes payable 55.4 48.6
Other accrued liabilities 180.0 155.2
---------- -------------
Total current liabilities 1,011.9 936.3
---------- -------------
Long-term debt 964.0 771.8
---------- -------------
Deferred income taxes 303.0 275.9
---------- -------------
Other long-term liabilities 167.1 167.7
---------- -------------
Stockholders' Equity:
Common stock 169.8 169.1
Capital in excess of par value 2,249.0 2,236.0
Retained earnings 465.6 283.7
Cumulative foreign currency translation
adjustment (162.7) (144.9)
Unrealized gain on securities available for sale 38.6 60.7
---------- -------------
Total stockholders' equity 2,760.3 2,604.6
---------- -------------
Total liabilities and stockholders' equity $ 5,206.3 $ 4,756.3
========== =============
See accompanying notes to consolidated condensed financial statements.
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BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In millions)
Nine Months Ended
June 30,
1998 1997
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 240.4 $ 179.9
Adjustments to reconcile net income to net cash
flows from operating activities:
Depreciation and amortization of:
Property 141.0 103.6
Other assets and debt discount 38.3 29.7
Deferred income taxes 32.4 20.5
Gain on disposal of assets (32.2) (18.1)
Foreign currency translation gain - net (.2) (4.6)
Cumulative effect of accounting change 12.1
Change in receivables (26.3) (70.7)
Change in inventories (138.9) (105.2)
Change in accounts payable (112.3) 22.2
Changes in other assets and liabilities (63.2) 3.7
-------- --------
Net cash flows from operating activities 79.0 173.1
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Property additions (349.2) (206.1)
Proceeds from disposal of assets 56.4 40.7
Cash obtained in stock acquisition 3.3
Acquisition of businesses, net of cash acquired (119.6)
-------- --------
Net cash flows from investing activities (412.4) (162.1)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings from commercial paper and
revolving credit facilities 381.7 16.6
Proceeds from exercise of stock options 13.5 26.9
Dividends (58.6) (50.1)
-------- --------
Net cash flows from financing activities 336.6 (6.6)
-------- --------
Effect of exchange rate changes on cash (.2) (.6)
-------- --------
Increase in cash and cash equivalents 3.0 3.8
Cash and cash equivalents, beginning of period 8.6 7.7
-------- --------
Cash and cash equivalents, end of period $ 11.6 $ 11.5
======== ========
Income taxes paid $ 82.9 $ 41.0
Interest paid $ 39.4 $ 26.0
See accompanying notes to consolidated condensed financial statements.
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BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
Note 1. General
In the opinion of Baker Hughes Incorporated (the "Company" or "Baker
Hughes"), the unaudited consolidated condensed financial statements include all
adjustments consisting of normal recurring accruals necessary for a fair
presentation of the Company's consolidated financial position as of June 30,
1998, its consolidated results of operations for the three and nine month
periods ended June 30, 1998 and 1997 and its consolidated cash flows for the
nine months ended June 30, 1998 and 1997. Although the Company believes that the
disclosures in these financial statements are adequate to make the information
presented not misleading, certain information and footnote disclosures normally
included in annual financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to the
rules and regulations of the Securities and Exchange Commission (see the
Company's Annual Report on Form 10-K for the year ended September 30, 1997 for
the most recent annual financial statements prepared in accordance with
generally accepted accounting principles). The results of operations for the
three and nine months ended June 30, 1998 are not necessarily indicative of the
results to be expected for the full year. In the Notes to Consolidated Condensed
Financial Statements, all dollar and share amounts in tabulations are in
millions of dollars and shares, respectively, unless otherwise indicated.
Note 2. Inventories
Inventories are comprised of the following:
June 30, September 30,
1998 1997
----------- -------------
Finished goods $ 952.9 $ 832.3
Work in process 117.9 98.3
Raw materials 116.9 99.9
---------- -------------
Total $ 1,187.7 $ 1,030.5
========== =============
Note 3. Acquisitions
On October 24, 1997, the Company acquired Oil Dynamics, Inc. ("ODI")
from Franklin Electric Co. Inc. for $34.4 million. ODI is a manufacturer
of electric submersible pumps used to lift crude oil in producing regions
worldwide and has been added to the operations of Centrilift.
On March 3, 1998, the Company acquired the assets of Western Rock Bit
Company Limited ("WRB"). WRB had been the Company's exclusive licensee and
distributor of bits in Canada and will be operated as a separate division of
Hughes Christensen. The purchase price was $31.4 million.
Other acquisitions were made by the Company during the nine months ended
June 30, 1998, that were not individually nor in the aggregate material to the
consolidated financial statements of the Company.
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BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS CONTINUED
These acquisitions were accounted for using the purchase method of
accounting. Accordingly, the cost of each acquisition has been allocated to
assets acquired and liabilities assumed based on their estimated fair market
values at the date of the acquisition. The operating results of these
acquisitions are included in the consolidated condensed statement of operations
from their respective acquisition date.
Pro forma results of these acquisitions have not been presented as the pro
forma revenue, income before accounting change and earnings per share would not
be materially different from the Company's actual results.
Note 4. Income Per Common Share
The Company adopted Statement of Financial Accounting Standards ("SFAS") No.
128, "Earnings per Share," which establishes new standards for computing and
presenting earnings per share ("EPS"), in the quarter ended December 31, 1997.
Reconciliation of the numerators and denominators of the basic and diluted
EPS computations is as follows:
For the Three Months Ended For the Three Months Ended
June 30, 1998 June 30, 1997
Income Shares Income Shares
(Numerator) (Denominator) (Numerator) (Denominator)
--------- ----------- --------- -----------
Basic EPS $ 81.8 169.7 $ 82.5 148.4
Effect of dilutive
securities:
Stock plans 1.3 1.2
Liquid Yield
Option Notes 1.5 7.2 1.7 7.2
------ ------ ------ ------
Diluted EPS $ 83.3 178.2 $ 84.2 156.8
====== ====== ====== ======
For the Nine Months Ended For the Nine Months Ended
June 30, 1998 June 30, 1997
Income Shares Income Shares
(Numerator) (Denominator) (Numerator) (Denominator)
--------- ----------- --------- -----------
Basic EPS $240.4 169.5 $179.9 148.0
Effect of dilutive
securities:
Stock plans 1.3 1.4
Liquid Yield
Option Notes 5.0 7.2 4.8 7.2
------ ------ ------ ------
Diluted EPS $245.4 178.0 $184.7 156.6
====== ====== ====== ======
Options to purchase 3.2 million shares of common stock were not included in
the computation of diluted EPS for the three months and the
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BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS CONTINUED
nine months ended June 30, 1998 because the options' exercise price of $47.81
was greater than the average market price of the Company's common stock during
the respective periods.
Note 5. Segment Information
Summarized financial information concerning the Company's reportable
segments is shown in the following table:
Three Months Ended Process
June 30, 1998 Oilfield Chemicals Equipment Other Total
- ------------------ ---------- ---------- --------- -------- ----------
Revenues $ 804.4 $ 176.0 $ 127.4 $ 5.2 $ 1,113.0
Segment profit(loss) 113.5 28.1 9.5 (29.1) 122.0
Total assets 3,373.4 1,019.1 445.0 368.8 5,206.3
Three Months Ended
June 30, 1997
- ------------------
Revenues $ 746.3 $ 80.5 $ 85.6 $ 4.8 $ 917.2
Segment profit(loss) 108.5 8.7 7.1 (20.1) 104.2
Total assets 2,774.4 297.4 247.4 312.2 3,631.4
Nine Months Ended
June 30, 1998
- ------------------
Revenues $ 2,474.5 $ 538.0 $ 374.9 $ 16.4 $ 3,403.8
Segment profit(loss) 361.0 73.6 28.5 (93.2) 369.9
Nine Months Ended
June 30, 1997
- ------------------
Revenues $ 2,077.1 $ 240.1 $ 258.7 $ 18.2 $ 2,594.1
Segment profit(loss) 296.2 23.7 22.4 (60.1) 282.2
The following table presents the details of "Other" segment profit (loss):
Three Months Ended Nine Months Ended
June 30, June 30,
1998 1997 1998 1997
------ ------ ------ ------
Corporate expenses $ (9.8) $ (9.1) $(43.3) $(27.5)
Interest expense - net (19.6) (11.5) (49.9) (34.6)
Other .3 .5 2.0
------ ------ ------ ------
Total $(29.1) $(20.1) $(93.2) $(60.1)
====== ====== ====== ======
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BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS CONTINUED
Note 6. Merger with Western Atlas Inc.
On August 10, 1998, Baker Hughes completed the merger with Western Atlas
Inc. ("Western Atlas"). Under the terms of the merger agreement, each
outstanding share of Western Atlas common stock has been converted into the
right to receive 2.7 shares of Baker Hughes common stock. In the aggregate,
Baker Hughes is issuing approximately 148.6 million shares of Baker Hughes
common stock to Western Atlas shareholders. In addition, as part of the merger,
Baker Hughes is issuing up to 7.7 million shares of Baker Hughes common stock in
exchange for certain rights relating to Western Atlas employee stock options.
Western Atlas, the common stock of which was previously publicly traded, is
a leading supplier of oilfield services and reservoir information technologies
for the worldwide oil and gas industry. It specializes in land, marine and
transition-zone seismic data acquisition and processing services; well-logging
and completion services; and reservoir characterization and project management
services.
The following table sets forth certain unaudited pro forma condensed
combined financial information for Baker Hughes giving effect to the merger with
Western Atlas accounted for as a pooling of interests.
Three Months Ended Nine Months Ended
June 30, June 30,
1998 1997 1998 1997
-------- -------- -------- --------
Revenues $1,659.7 $1,335.7 $4,880.7 $3,776.7
Income from continuing
operations 118.0 99.1 342.1 243.5
Net income 118.0 (84.5) 344.9 77.3
Income from continuing
operations per share:
Basic .37 .34 1.08 .83
Diluted .36 .33 1.05 .82
Net income per share:
Basic .37 (.29) 1.09 .26
Diluted .36 (.27) 1.06 .26
June 30, 1998 September 30, 1997
------------- ------------------
Current assets $ 3,075.4 $ 2,813.0
Current liabilities 1,983.5 1,414.6
Total assets 8,157.2 7,087.0
Long-term debt 1,671.1 1,473.3
Shareholders' equity 3,728.1 3,491.5
In May 1997, the Western Atlas Board of Directors approved, in principle, a
plan to distribute (the "Spin-off") to Western Atlas shareholders all of the
outstanding common stock of UNOVA, Inc. ("UNOVA"), a wholly owned subsidiary of
Western Atlas. In connection with the Spin-off, the consolidated financial
statements of Western Atlas were restated
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BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS CONTINUED
to present the operations of UNOVA as discontinued operations. The UNOVA results
of operations for the three and nine months ended June 30, 1997 include a $203.0
million charge related to acquired in-process research and development
activities related to UNOVA's acquisition of United Barcode Industries in April
1997.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") should be read in conjunction with the Company's
Consolidated Condensed Financial Statements and the related notes thereto.
FORWARD-LOOKING STATEMENTS
MD&A includes forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. The words "anticipate," "believe," "expect,"
"plan," "intend," "estimate," "project," "forecasts," "will," "could," "may" and
similar expressions are intended to identify forward-looking statements. No
assurance can be given that actual results may not differ materially from those
in the forward-looking statements herein for reasons including the effect of
competition, the level of petroleum industry exploration and production
expenditures, world economic conditions, prices of, and the demand for, crude
oil and natural gas, drilling activity, weather, the legislative environment in
the United States and other countries, OPEC policy, conflict in the Middle East
and other major petroleum producing or consuming regions, the development of
technology that lowers overall finding and development costs and the condition
of the capital and equity markets.
BUSINESS ENVIRONMENT
Oilfield
Oilfield Operations generated 72% of the Company's consolidated revenues in
the quarter ended June 30, 1998. Oilfield Operations consists of five business
units - Baker Hughes INTEQ, Baker Hughes Solutions, Baker Oil Tools, Centrilift
and Hughes Christensen - that provide products, services and solutions used in
the drilling, completion, production and maintenance of oil and gas wells. The
business environment for Oilfield Operations and its corresponding operating
results are affected significantly by petroleum industry exploration and
production expenditures. These expenditures are influenced strongly by oil
company expectations about the supply and demand for crude oil and natural gas,
energy prices and finding and development costs. Petroleum supply and demand,
pricing and finding and development costs, in turn, are influenced by numerous
factors including, but not limited to, those described above in
"--Forward-Looking Statements".
Four key factors which currently influence the worldwide crude oil market
and therefore current and future expenditures for exploration and development by
our customers are:
1) The degree to which certain large producing countries, in particular
Saudi Arabia, Venezuela, and Mexico, are willing and able to restrict production
and exports of crude oil.
2) The increasing rate of depletion of known hydrocarbon reserves.
Technological advances are resulting in accelerated decline rates and shorter
well lives. In general, accelerated decline rates require additional customer
spending to hold production level.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
3) The economic growth in certain key areas of the world, particularly
developing Asia, where the linkage between energy demand and economic growth is
particularly strong.
4) The amount of crude oil in storage relative to historic levels.
These four factors, together with oil and gas company projections for future
energy price movement, influence overall levels of expenditures for exploration
and development by our customers.
More specifically, two key factors influence the level of exploration and
development spending:
1) Technology: Advances in the design and application of the Company's
products and services allow oil and gas companies to drill fewer wells, place
the wells they drill more precisely in the higher yielding or more easily
produced hydrocarbon zones of the reservoir and allow operators to drill,
complete and operate wells at lower overall costs.
2) Price Volatility: Changes in hydrocarbon markets create uncertainty in
the future price of hydrocarbons and therefore create uncertainty about the
aggregate level of customer spending. Multi-year projects, such as deep-water
exploration and drilling, are the least likely to be impacted by price
volatility. Projects with relatively short payback periods or low profit
margins, such as workover activity or the extraction of heavy oil, are more
likely to be impacted.
Crude oil and natural gas prices and the Baker Hughes rotary rig count are
summarized in the tables below as quarterly averages followed by the Company's
outlook. While reading the Company's outlook set forth below, caution is advised
that the factors described above in "--Forward-Looking Statements" and
"--Business Environment" could negatively impact the Company's expectations for
oil demand, oil and gas prices and drilling activity.
Oil and Gas Prices Three Months Ended Nine Months Ended
June 30, June 30,
1998 1997 1998 1997
- --------------------------------------------------------------------------
WTI ($/bbl) 14.51 19.93 16.77 22.53
U.S. Spot Natural Gas ($/mcf) 2.10 2.04 2.26 2.50
Crude oil prices experienced downward pressure in the third quarter of 1998
due to increased supply from renewed Iraqi exports, increased OPEC production,
higher inventories (particularly in North America) and a simultaneous slowing of
demand growth due to the Asian economic downturn.
U.S. natural gas prices remained strong during most of the quarter ended
June 30, 1998, averaging above $2.00 per mcf, reflecting relatively tight
supply and demand conditions in North America. Since June 30, 1998, gas
prices have averaged below $2.00 per mcf which could impact natural gas
drilling.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
Rotary Rig Count Three Months Ended Nine Months Ended
June 30, June 30,
1998 1997 1998 1997
- --------------------------------------------------------------------------
U.S. - Land 732 811 812 762
U.S. - Offshore 132 122 131 115
Canada 175 253 361 322
- --------------------------------------------------------------------------
North America 1,039 1,186 1,304 1,199
- --------------------------------------------------------------------------
Latin America 261 277 271 279
North Sea 59 60 59 59
Other Europe 45 52 49 57
Africa 83 82 81 82
Middle East 167 158 166 146
Asia Pacific 183 183 180 181
- --------------------------------------------------------------------------
International 798 812 806 804
- --------------------------------------------------------------------------
Worldwide 1,837 1,998 2,110 2,003
- --------------------------------------------------------------------------
U.S. Workover 1,122 1,422 1,282 1,416
Outlook
The Company expects oil prices to trade between $12.00 and $15.50 per barrel
for the remainder of 1998 as production cuts balance the impact of weakened
demand and inventories stabilize. The Company believes that a sustained low
price environment for crude oil may result in a period of slower than expected
customer spending through the end of 1998 and into 1999. In 1999, the
willingness and ability by certain countries, particularly Saudi Arabia,
Venezuela and Mexico, to restrict production and exports, as well as increasing
depletion rates, could result in inventories that approach normal levels and
ultimately rising oil prices. In the long-term, the economic rebound of
developing Asia is expected to result in demand growth approximating the
long-term trend of 2 to 2-1/2% per year.
North America: The Company anticipates that North American activity will
continue to decline through the remainder of the year relative to the prior
year. Offshore activity is expected to weaken temporarily as high day-rate rigs
are recontracted at lower rates.
International: The Company expects that activity in Latin America will
decrease over the remainder of the year as budget cuts in Mexico and Venezuela
impact activity levels. Eastern Hemisphere activity is expected to weaken if
oil prices remain at current depressed levels.
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15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
Chemicals
Baker Petrolite generated 16% of the Company's consolidated revenues in the
quarter ended June 30, 1998. Baker Petrolite is the sole business unit reported
in this segment and is the result of combining Baker Performance Chemicals
Incorporated and Petrolite Corporation ("Petrolite"), acquired in
July 1997.
Operating in all major oil and gas producing regions of the world, Baker
Petrolite manufactures specialty chemicals for inclusion in the sale of
integrated chemical technology solutions for petroleum production,
transportation and refining. In addition to those business environment factors
discussed above for the oilfield segment, the business environment for the
chemicals segment is significantly influenced by the trend of continued
reduction in the total operating cost of the customer base, which includes major
multi-national, independent and national or state-owned oil companies.
Improvements in chemical technology and its application, as well as the expanded
use of alliance relationships, enable Baker Petrolite to reduce overall
production, transportation and refining costs.
Baker Petrolite also provides chemical technology solutions to other
industrial markets throughout the world, including petrochemicals, steel, fuel
additives, plastics, imaging and adhesives. The business environments for these
markets are individually unique but, most are influenced by the general level of
gross domestic product.
Process Equipment
Process Equipment generated 11% of the Company's consolidated revenues in
the quarter ended June 30, 1998. Process Equipment consists of four business
units - EIMCO Process Equipment, Bird Machine Company, Baker Hughes Process
Systems and Baker Hughes Industrial Services - that provide technologies that
separate solids from liquids and liquids from liquids through filtration,
sedimentation, centrifugation and flotation processes. The business environment
for Process Equipment and its corresponding operating results are affected
significantly by spending on large capital projects in the pulp and paper, oil
and gas, industrial, refining, chemical and municipal wastewater treatment
markets. Spending on capital projects is influenced by numerous factors
including, but not limited to, commodity price cycles, especially copper and
pulp, oil and gas, the supply and demand for refined products and chemicals, the
expanding Asian populations and economies, as well as environmental pressures
and legislation. Except for the Asian, pulp and paper, oil and gas and copper
markets, the Company anticipates increased capital project activity in the
refining, chemical and industrial markets. In addition, the Company anticipates
growth from acquisitions and new technology.
ACQUISITIONS
Oil Dynamics, Inc.
On October 24, 1997, the Company acquired Oil Dynamics, Inc. ("ODI")
from Franklin Electric Co. Inc. for $34.4 million. ODI is a manufacturer
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16
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
of electric submersible pumps used to lift crude oil in producing regions
worldwide and will be added to the operations of Centrilift.
On March 3, 1998, the Company acquired the assets of Western Rock Bit
Company Limited ("WRB"). WRB had been the Company's exclusive licensee and
distributor of bits in Canada and will be operated as a separate division of
Hughes Christensen. The purchase price was $31.4 million.
Other acquisitions were made by the Company during the nine months ended
June 30, 1998, that were not individually nor in the aggregate material to the
consolidated financial statements of the Company.
RESULTS OF OPERATIONS
Revenues
Consolidated revenues were up 21% and 31% for the three and nine months
ended June 30, 1998, respectively, as compared to the same periods in 1997.
Sales revenue was up 28% and 37% for the three and nine months ended June
30, 1998, respectively, compared to the corresponding periods in 1997.
Service and rentals revenue was up 9% and 21% for the three and nine
months ended June 30, 1998, respectively, compared to the corresponding
periods in 1997. In the discussion below, the "current quarter" refers to the
three months ended June 30, 1998 and the "nine months" refers to the nine months
ended June 30, 1998.
Oilfield Operations
Revenue for Oilfield Operations increased in most areas of the world in
spite of lower rig count activity as the Company continues to benefit from the
increased use of its technologies in key geographic regions. Outside North
America, revenues increased 12% for the current quarter and 19% for the nine
months compared to the same periods in the prior year, while in North America,
revenues remained flat for the current quarter, but increased 19% for the nine
months compared to the same periods in the prior year. The lower percentage
increases in the current quarter ended June 30, 1998, are reflective of the
recent decline of oilfield activity in several key geographic areas, in
particular North America and Venezuela, resulting from lower customer
spending due to continuing low oil prices.
In North America, U.S. revenues increased 1% in the current quarter compared
to the prior year, while revenues in Canada declined 8% for the current quarter
compared to the prior year. Revenues in Latin America were down 1% in the
current quarter compared to the same quarter in 1997 led by Venezuela where
revenues declined 13%.
In Europe, revenues were up 17% in the current quarter compared to the same
period in the prior year. Revenues in the North Sea increased 20% for the
current quarter as compared to the same period in the prior year led by the
United Kingdom where revenues increased 38%.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
Revenues in Africa were up 3% in the current quarter compared to the same
quarter in 1997. The revenue improvements in Algeria and Gabon were partially
offset by the revenue declines in Nigeria and Cameroon.
In the Middle East revenues were up 12% in the current quarter compared to
the same quarter in the prior year led by Oman where revenues increased 10%.
Revenues in Asia Pacific posted the largest increase of all regions, up 25%
in the current quarter compared to the same period in the prior year. China and
Malaysia were the primary contributors to the revenue growth.
Chemicals
Chemical revenues increased $95.5 million to $176.0 million for the current
quarter and $297.9 million to $538.0 million for the nine months compared to the
same periods in the prior year due to the Petrolite acquisition in July 1997.
Process Equipment
Process Equipment revenues increased 49% and 45% for the current quarter and
nine months, respectively, compared to the same periods in the prior year. The
increases are due to acquisitions offset by activity declines due to the drop in
copper prices and the economic problems in Asia resulting in delays in
customers' capital spending.
Costs and Expenses Applicable to Revenues
Costs of sales and costs of services and rentals have increased from the
prior year periods consistent with the related revenue increases. The gross
margin percentages were 38.8% and 39.4% for the three months ended June
30, 1998 and 1997, respectively. The decline is due primarily to pricing
pressures and less favorable revenue mix in North America and Venezuela. The
gross margin percentages were 39.6% and 39.0% for the nine months ended
June 30, 1998 and 1997, respectively.
Selling, General and Administrative
Selling, general and administrative ("SG&A") expense increased $41.6 million
in the third quarter of 1998 from the third quarter of 1997. As a percent of
consolidated revenues, SG&A expense was 25.2% and 26.1% in the third quarter of
1998 and 1997, respectively. SG&A expense increased $223.8 million for the nine
months ended June 30, 1998 compared to the same period in 1997. As a percent of
consolidated revenues, SG&A expense was 26.3% and 25.9% in the first nine months
of 1998 and 1997, respectively. SG&A increased due to the Petrolite acquisition
and increases in marketing and sales support costs than those incurred in the
prior year periods.
Amortization expense increased $3.0 million and $8.4 million in the three
and nine months ended June 30, 1998, respectively, compared to the
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
same prior year periods due primarily to the Petrolite acquisition in July
1997.
Interest Expense
Interest expense for the three and nine months ended June 30, 1998 increased
compared to the corresponding periods in 1997 due to higher debt levels that
funded acquisitions and increases in working capital and capital expenditures.
Income Taxes
The effective income tax rate for the nine months ended June 30, 1998 was
35.0%, up from 32.0% for the nine months ended June 30, 1997 due to the
settlement with the Internal Revenue Service ("IRS") in 1997, as explained
below.
In the third quarter of 1997, the Company reached an agreement with the IRS
to close the audit of its 1992 and 1993 U.S. consolidated income tax returns.
The principal issue in the examination related to inter-company pricing on the
transfer of goods and services between U.S. and non-U.S. subsidiary companies.
As a result of the agreement, the Company recognized a tax benefit through the
reversal of deferred income taxes previously provided of $11.4 million
(approximately $0.08 per share) in the quarter ended June 30, 1997.
CAPITAL RESOURCES AND LIQUIDITY
Financing Activities
Net cash inflows from financing activities were $336.6 million in the first
nine months of 1998 compared to net cash outflows of $6.6 million for the same
period in 1997. The change from the prior year period is due to increased
borrowings from commercial paper and revolving credit facilities that
funded acquisitions and increases in working capital and capital expenditures.
Total debt outstanding at June 30, 1998 was $1,167.7 million, compared to
$781.4 million at September 30, 1997. The debt to equity ratio was .42 at June
30, 1998, compared to .30 at September 30, 1997.
Cash dividends increased in the first nine months of 1998 compared to the
first nine months of 1997 due to an increase in the number of shares of common
stock outstanding resulting primarily from shares issued in connection with the
1997 acquisitions of Petrolite and Drilex International Inc.
At June 30, 1998, the Company had $889.0 million of credit facilities with
commercial banks, of which $500.0 million was committed. These facilities are
subject to normal banking terms and conditions and do not materially restrict
the Company's activities.
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19
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
Investing Activities
Net cash outflows from investing activities were $412.4 million in the first
nine months of 1998 compared to $162.1 million in the first nine months of 1997.
Property additions increased significantly in the first nine months of 1998
to $349.2 million from $206.1 million in the first nine months of 1997 as the
Company added capacity to meet the increased market demand. The majority of the
capital expenditures have been in Oilfield Operations. Expenditures for rental
tools and machinery and equipment accounted for 39% and 42%, respectively, of
total capital expenditures for the Company for the first nine months of 1998. In
light of the recent activity decline, the Company is reviewing significant
capital projects and expects the rate of capital spending to slow. Funds
provided from operations and outstanding lines of credit are expected to be
adequate to meet future capital expenditure requirements.
The Company used short term borrowings to purchase ODI in October 1997 for a
purchase price, net of cash acquired, of $34.2 million and Western Rock Bit in
March 1998 for $31.4 million. The Company obtained $3.3 million of cash from the
stock for stock acquisition of Drilex in 1997.
Operating Activities
Net cash inflows from operating activities were $79.0 million in the first
nine months of 1998 compared to cash inflows of $173.1 million in the first nine
months of 1997. The primary use of cash by operating activities was to fund
increases in working capital, primarily inventory and the reduction of
liabilities, primarily trade payables.
ACCOUNTING STANDARDS
Impairment of Long-Lived Assets
The Company adopted Statement of Financial Accounting Standards ("SFAS") No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of, effective October 1, 1996. The statement sets forth
guidance as to when to recognize an impairment of long-lived assets, including
goodwill, and how to measure such an impairment. The methodology set forth in
SFAS No. 121 is not significantly different from the Company's current policy
and, therefore, the adoption of SFAS No. 121 does not have a significant impact
on the consolidated financial statements, as it relates to impairment of
long-lived assets used in operations. However, SFAS No. 121 also addresses the
accounting for long-lived assets to be disposed of and requires these assets to
be carried at the lower of cost or fair market value, rather than the lower of
cost or net realizable value, the method that was previously used by the
Company. The Company recognized a charge to income of $12.1 million ($.08 per
share), net of a tax benefit of $6.0 million, as the cumulative effect of a
change in accounting in the first quarter of 1997.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued SFAS No.
130, Reporting Comprehensive Income, which for the Company is effective in
the year ending September 30, 1999. SFAS No. 130 establishes standards for
the reporting and displaying of comprehensive income and its components.
The Company will be analyzing SFAS No. 130 during 1998 to determine what,
if any, additional disclosures will be required.
Derivative and Hedge Accounting
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes accounting and reporting standards for derivative instruments and
hedging activities that require an entity to recognize all derivatives as an
asset or liability measured at its fair value. Depending on the intended use of
the derivative, changes in its fair value will be reported in the period of
change as either a component of earnings or a component of other comprehensive
income.
SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Retroactive application to periods prior to adoption is not
allowed. The Company has not quantified the impact of adoption on its
consolidated financial statements or the date it intends to adopt.
YEAR 2000 ISSUE
The Year 2000 issue is the result of computer programs that use only two
digits to identify a year rather than four. If not corrected, computer
applications could fail or create erroneous results before, during and after the
Year 2000.
The Company is currently assessing the cost and uncertainties related to the
Year 2000 issue using internal and external resources. Based on preliminary
information, the Company currently believes that with certain modifications,
upgrades and, in some instances, converting to new software, the Company will
have substantially addressed the Year 2000 issues with respect to its software,
hardware and products without significant impact on its operating systems. The
estimated costs for the Company to substantially address these Year 2000 issues
are not expected to be material to the Company's financial position, results of
operations or liquidity. Additionally, the Company is not aware of Year 2000
issues of its customers or suppliers that would be material to the Company's
financial position, results of operations or liquidity.
QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURE UPDATE
On May 5, 1998, the interest rate swap agreement for notional amount of
$230.5 million matured. This swap effectively exchanged a fixed interest rate of
3.5% for a variable interest rate equal to 30-day commercial paper rates minus
1.96% on the notional amount.
Except for an insignificant amount, holders of the Company's Liquid Yield
Option Notes ("LYONS") did not redeem the LYONS for cash on May 5, 1998.
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21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS CONTINUED
MERGER WITH WESTERN ATLAS
On August 10, 1998, Baker Hughes completed the merger with Western Atlas
Inc. ("Western Atlas"). Under the terms of the merger agreement, each
outstanding share of Western Atlas common stock has been converted into the
right to receive 2.7 shares of Baker Hughes common stock. In the aggregate,
Baker Hughes is issuing approximately 148.6 million shares of Baker Hughes
common stock to Western Atlas shareholders. In addition, as part of the merger,
Baker Hughes is issuing up to 7.7 million shares of Baker Hughes common stock in
exchange for certain rights relating to Western Atlas employee stock options.
Western Atlas, the common stock of which was previously publicly traded, is
a leading supplier of oilfield services and reservoir information technologies
for the worldwide oil and gas industry. It specializes in land, marine and
transition-zone seismic data acquisition and processing services; well-logging
and completion services; and reservoir characterization and project management
services.
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22
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
(3)(ii) Bylaws as amended on July 22, 1998
(27.1) Financial Data Schedule
(b) Reports on Form 8-K:
A report on Form 8-K was filed with the Commission on May 20, 1998,
reporting that the Company had entered into an agreement and plan of merger with
Western Atlas Inc.
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23
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BAKER HUGHES INCORPORATED
(Registrant)
Date: August 14, 1998 By /s/LAWRENCE O'DONNELL, III
------------------------------------
Lawrence O'Donnell, III
Vice President and General Counsel
Date: August 14, 1998 By /s/JAMES E. BRAUN
------------------------------------
James E. Braun
Vice President and Controller
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INDEX TO EXHIBITS
Exhibits:
(3)(ii) Bylaws as amended on July 22, 1998
(27.1) Financial Data Schedule