1
EXHIBIT 13.1
BAKER HUGHES INCORPORATED
SELECTED FINANCIAL DATA
Year Ended Three Months Ended Year Ended September 30,
December 31, December 31, ----------------------------------------------
(In millions, except per share amounts) 1998 1997 1997 1996 1995 1994
------------ ---------- --------- --------- ---------- --------
Revenues $ 6,311.9 $ 1,572.9 $ 5,343.6 $ 4,445.8 $ 3,920.4 $3,699.3
------------ ---------- --------- --------- ---------- --------
Costs and expenses:
Costs of revenues 4,710.9 1,045.7 3,676.9 3,062.8 2,711.4 2,551.5
Selling, general and administrative 1,301.8 324.6 1,036.1 889.2 818.2 831.9
Merger related costs 219.1
Unusual charge 215.8 52.1 39.6 31.8
Acquired in-process research and development 118.0
Operating income of business sold (10.5)
------------ ---------- --------- --------- ---------- --------
Total 6,447.6 1,370.3 4,883.1 3,991.6 3,529.6 3,404.7
------------ ---------- --------- --------- ---------- --------
Operating income (loss) (135.7) 202.6 460.5 454.2 390.8 294.6
Interest expense (149.0) (24.5) (91.4) (87.9) (89.1) (106.4)
Interest income 3.6 1.1 3.6 4.9 6.6 5.2
Spin-off related costs (8.4)
Gain on sale of Varco stock 44.3
Gain on sale of Pumpsystems 101.0
------------ ---------- --------- --------- ---------- --------
Income (loss) from continuing operations before
income taxes, extraordinary loss and cumulative
effect of accounting changes (281.1) 179.2 364.3 415.5 308.3 294.4
Income taxes (16.3) (68.0) (163.4) (169.1) (126.9) (123.5)
------------ ---------- --------- --------- ---------- --------
Income (loss) from continuing operations before
extraordinary loss and cumulative effect of
accounting changes (297.4) 111.2 200.9 246.4 181.4 170.9
Extraordinary loss (44.3)
Cumulative effect of accounting changes (12.1) (14.6) (44.2)
------------ ---------- --------- --------- ---------- --------
Income (loss) from continuing operations (297.4) 111.2 188.8 246.4 166.8 82.4
Discontinued operations, net of tax 2.8 (154.9) 55.7 38.4 38.0
------------ ---------- --------- --------- ---------- --------
Net income (loss) $ (297.4) $ 114.0 $ 33.9 $ 302.1 $ 205.2 $ 120.4
============ ========== ========= ========= ========== ========
Per share of common stock:
Income (loss) from continuing operations
before extraordinary loss and cumulative
effect of accounting changes:
Basic $ (.92) $ .35 $ .67 $ .86 $ .55 $ .59
Diluted (.92) .34 .66 .85 .54 .58
Dividends .46 .12 .46 .46 .46 .46
Financial position:
Working capital $ 1,414.6 $ 1,502.7 $ 1,398.4 $ 1,856.1 $ 1,812.2 $1,584.4
Total assets 7,810.8 7,230.6 7,087.0 5,796.6 5,435.2 5,141.3
Long-term debt 2,726.3 1,605.3 1,473.3 1,124.2 1,295.3 1,128.0
Stockholders' equity 3,199.4 3,519.0 3,491.5 3,190.9 2,870.3 2,886.8
See Notes 1 and 2 of Notes to Consolidated Financial Statements for a
discussion of the Merger with Western Atlas Inc. and the adoption of new
accounting standards in 1997. In 1995, the Company adopted a new accounting
standard related to the accounting for postemployment benefits. In 1994, the
Company adopted new accounting standards related to accounting for income taxes
and employers accounting for post retirement benefits other than pensions. See
Note 7 of Notes to Consolidated Financial Statements for a discussion of
acquisitions made in 1998, the Transition Period, 1997 and 1996. The Company
sold EnviroTech Pumpsystems and EnviroTech Measurements and Controls in 1994.
See Note 8 of Notes to Consolidated Financial Statements for a description of
the unusual and other nonrecurring charges in 1998, 1997 and 1996. The unusual
charge in 1994 consisted of the restructuring and reorganization of certain
Oilfield divisions and the discontinuance of an MWD product line, offset by an
insurance recovery. The Company repurchased or defeased debt in 1994 resulting
in an extraordinary loss.
2
BAKER HUGHES INCORPORATED
MANAGEMENT REPORT OF FINANCIAL RESPONSIBILITIES
The management of Baker Hughes Incorporated is responsible for the preparation
and integrity of the accompanying consolidated financial statements and all
other information contained in this Annual Report. The consolidated financial
statements have been prepared in conformity with generally accepted accounting
principles and include amounts that are based on management's informed judgments
and estimates.
In fulfilling its responsibilities for the integrity of financial
information, management maintains and relies on the Company's system of internal
control. This system includes written policies, an organizational structure
providing division of responsibilities, the selection and training of qualified
personnel and a program of financial and operational reviews by a professional
staff of corporate auditors. The system is designed to provide reasonable
assurance that assets are safeguarded, transactions are executed in accordance
with management's authorization and accounting records are reliable as a basis
for the preparation of the consolidated financial statements. Management
believes that, as of December 31, 1998, the Company's internal control system
provides reasonable assurance that material errors or irregularities will be
prevented or detected within a timely period and is cost effective.
Management recognizes its responsibility for fostering a strong ethical
climate so that the Company's affairs are conducted according to the highest
standards of personal and corporate conduct. This responsibility is
characterized and reflected in the Company's Standards of Conduct which is
distributed throughout the Company. Management maintains a systematic program to
assess compliance with the policies included in the code.
The Board of Directors, through its Audit/Ethics Committee composed solely
of nonemployee directors, reviews the Company's financial reporting, accounting
and ethical practices. The Audit/Ethics Committee recommends to the Board of
Directors the selection of independent public accountants and reviews their fee
arrangement. It meets periodically with the independent public accountants,
management, and the corporate auditors to review the work of each and the
propriety of the discharge of their responsibilities. The independent public
accountants and the corporate auditors have full and free access to the
Audit/Ethics Committee, without management present, to discuss auditing and
financial reporting matters.
/s/ MAX L. LUKENS /s/ ERIC L. MATTSON /s/ JAMES W. HARRIS
Max L. Lukens Eric L. Mattson James W. Harris
Chairman, President Senior Vice President Vice President-Tax and Controller
and Chief Executive Officer and Chief Financial Officer
1
3
BAKER HUGHES INCORPORATED
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 consolidated
financial statements of Baker Hughes Incorporated ("Baker Hughes" or the
"Company") for the year ended December 31, 1998, the three months ended
December 31, 1997 and for the years ended September 30, 1997 and 1996 and the
related notes to consolidated financial statements.
FORWARD-LOOKING STATEMENTS
MD&A includes forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, (each a "Forward-Looking Statement"). The
words "anticipate," "believe," "expect," "plan," "intend," "estimate,"
"project," "forecasts," "will," "could," "may" and similar expressions are
intended to identify forward-looking statements. No assurance can be given that
actual results may not differ materially from those in the forward-looking
statements herein for reasons including the effects of competition, the level
of petroleum industry exploration and production expenditures, world economic
conditions, prices of, and the demand for, crude oil and natural gas, drilling
activity, weather, the legislative environment in the United States and other
countries,OPEC policy, conflict in the Middle East and other major petroleum
producing or consuming regions, the development of technology that lowers
overall finding and development costs and the condition of the capital and
equity markets.
Baker Hughes' expectations regarding its level of capital expenditures and
its capital expenditures on Project Renaissance described in "Investing
Activities" below are only its forecasts regarding these matters. In addition to
the factors described in the previous paragraph and in "Business Environment,"
these forecasts may be substantially different from actual results, which are
affected by the following factors: the accuracy of the Company's estimates
regarding its spending requirements, regulatory, legal and contractual
impediments to spending reduction measures; the occurrence of any unanticipated
acquisition or research and development opportunities; changes in the Company's
strategic direction; and the need to replace any unanticipated losses in capital
assets.
CHANGE IN YEAR-END
On August 27, 1998, the Board of Directors of Baker Hughes approved a change in
the fiscal year end of the Company from September 30 to December 31, effective
with the calendar year beginning January 1, 1998. A three-month transition
period from October 1, 1997 through December 31, 1997 (the "Transition Period")
precedes the start of the 1998 fiscal year. "1997" and "1996" refer to the
respective years ended September 30, the Transition Period refers to the three
months ended December 31, 1997, and "1998" refers to the twelve months ended
December 31, 1998.
MERGER
On August 10, 1998, Baker Hughes completed a merger ("the Merger") with Western
Atlas Inc. ("Western Atlas") by issuing 148.6 million shares of its common
stock for all of the outstanding common stock of Western Atlas. Each share of
Western Atlas common stock was exchanged for 2.7 shares of Baker Hughes common
stock. Western Atlas is a leading supplier of oilfield services and reservoir
information technologies for the worldwide oil and gas industry. It specializes
in land, marine and transition-zone seismic data acquisition and processing
services, well-logging and completion services and reservoir characterization
and project management services.
The Merger was accounted for as a pooling of interests and, accordingly,
all prior period consolidated financial statements of Baker Hughes have been
restated to include the results of operations, financial position and cash flows
of Western Atlas. Information concerning common stock, employee stock plans and
per share data has been restated on an equivalent share basis. The consolidated
financial statements as of September 30, 1997 and for each of the two years in
the period ended September 30, 1997 include Baker Hughes' previous September 30
fiscal year amounts and Western Atlas' December 31 calendar year amounts for the
respective fiscal years of Baker Hughes. Consolidated financial statements for
the three months ended December 31, 1997 include amounts for Baker Hughes and
Western Atlas for the three months ended December 31, 1997. As a result, Western
Atlas' results of operations for the three
2
4
BAKER HUGHES INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
months ended December 31, 1997 are included in both the consolidated financial
statements for the year ended September 30, 1997 and for the three months ended
December 31, 1997.
BUSINESS ENVIRONMENT
The Company is primarily engaged in the oilfield service industry. Oilfield
operations generated more than 90 percent of the Company's consolidated
revenues in 1998, the Transition Period, 1997 and 1996 and currently consists
of eight business units- Baker Atlas, Baker Hughes INTEQ, Baker Oil Tools,
Baker Petrolite, Centrilift, E&P Solutions, Hughes Christensen and Western
Geophysical - that manufacture and sell equipment and provide related services
used in the drilling, completion, production, and maintenance of oil and gas
wells and in reservoir measurement and evaluation. The business environment for
the Company and its corresponding operating results are affected significantly
by the petroleum industry exploration and production expenditures. These
expenditures are influenced strongly by oil company expectations about the
supply and demand for crude oil and natural gas, energy prices, and finding and
development costs. Petroleum supply and demand, pricing, and finding and
development costs, in turn, are influenced by numerous factors including, but
not limited to, those described above in "Forward-Looking Statements."
Four key factors that currently influence the worldwide crude oil market
and therefore current and future expenditures for exploration and development by
our customers are:
o The degree to which certain large producing countries, in particular
Saudi Arabia and Venezuela, are willing and able to restrict production and
exports of crude oil.
o The increasing rate of depletion of known hydrocarbon reserves.
Technological advances are resulting in accelerated decline rates and shorter
well lives. In general, accelerated decline rates require additional customer
spending to hold production levels.
o The level of economic growth in certain key areas of the world,
particularly developing Asia, where the correlation between energy demand and
economic growth is particularly strong.
o The amount of crude oil in storage relative to historic levels.
These four factors, together with oil and gas company projections for
future commodity price movement, influence overall levels of expenditures for
exploration and development by the Company's customers.
More specifically, two key factors influence the level of exploration and
development spending:
Technology: Advances in the design and application of more technologically
advanced products and services allow oil and gas companies to drill fewer wells,
place the wells they drill more precisely in the higher yielding or more easily
produced hydrocarbon zones of the reservoir, and allow operators to drill,
complete, and operate wells at lower overall costs.
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. Multiyear projects, such as deepwater
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 averages for the periods indicated and are
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
Transition
1998 Period 1997 1996
------ ----------- ------ ------
West Texas Intermediate
Crude ($/bbl) 14.41 20.02 21.83 20.51
U. S. Spot
Natural Gas ($/mcf) 2.01 2.72 2.47 2.21
3
5
Crude oil prices experienced record low levels in 1998, trading below $15/bbl
for most of the year and averaging only $14.41/bbl - the lowest yearly average
recorded since 1983 and down over 30 percent from year-ago levels. Prices were
lower due to increased supply from renewed Iraqi exports, increased OPEC and
non-OPEC production, higher inventories (particularly in North America) and a
simultaneous slowing of demand growth due to the Asian economic downturn and a
generally warmer than normal winter. U.S. natural gas weakened in 1998 compared
to the prior year periods, also due to the abnormally warm winter weather.
ROTARY RIG COUNT
Transition
1998 Period 1997 1996
------ ---------- ------ ------
U.S.-Land 703 873 788 652
U.S.-Offshore 123 125 118 107
Canada 259 448 340 247
----- ----- ----- -----
North America 1,085 1,446 1,246 1,006
----- ----- ----- -----
Latin America 243 280 277 279
North Sea 52 55 58 53
Other Europe 46 56 57 69
Africa 74 75 80 76
Middle East 166 165 150 138
Asia Pacific 173 173 181 173
----- ----- ----- -----
International 754 804 803 788
----- ----- ----- -----
Worldwide 1,839 2,250 2,049 1,794
----- ----- ----- -----
U.S. Workover 1,088 1,427 1,412 1,306
OUTLOOK
The factors discussed above resulted in historically high inventory levels and
lower oil prices by the end of 1998. Oil prices that had ranged from
$18-$26/bbl in 1997 fell to $15-$18/bbl in the first part of 1998. At the end
of 1998 oil prices were trading between $10-$13/bbl. In response to lower oil
prices and expectations for continued low oil prices in 1999, oil companies cut
upstream capital spending particularly in the second half of 1998.
Baker Hughes expects oil prices to remain at relatively low levels
throughout 1999, strengthening modestly from current levels towards the latter
part of 1999. As a result, 1999 oil company capital spending is expected to
decline approximately 25-30 percent from 1998 spending levels. Cuts in upstream
capital spending were more significant in North and South America than in the
Eastern Hemisphere in 1998. The Company expects customer spending in the Eastern
Hemisphere to be reduced more significantly in 1999. Customer spending is
expected to decline sequentially during the first two quarters of 1999 before
stabilizing in the second half of the year.
DISCONTINUED OPERATIONS
On October 31, 1997, Western Atlas distributed all the shares of UNOVA, Inc.
("UNOVA"), its then wholly owned industrial automation systems subsidiary, as a
stock dividend to its shareholders (the "Spin-off"). The operations of UNOVA
for the Transition Period, 1997 and 1996 are classified as discontinued
operations in the Company's consolidated financial statements. For periods
prior to the Spin-off, cash, debt, and the related net interest expense were
allocated based on the capital needs of UNOVA's operations. All corporate
general and administrative costs of the Company are included in continuing
operations and no allocation was made to UNOVA for any of the periods
presented.
The UNOVA results of operations for 1997 include a $203.0 million charge
for acquired in-process research and development activities related to UNOVA's
acquisition of Norand Corporation and United Barcode Industries in April 1997.
ACQUISITIONS
In addition to the acquisitions discussed below, the Company made several
acquisitions to expand its technology base and to increase its presence in key
geographic areas. None of these acquisitions individually or in the aggregate
are material to the Company's consolidated financial statements.
1998
In April 1998, the Company acquired all the outstanding stock of WEDGE DIA-Log,
Inc. ("WEDGE") for $218.5 million in cash. WEDGE specializes in cased-hole
logging and pipe recovery services. Also in April 1998, the Company acquired
3-D Geophysical, Inc. ("3-D") for $117.5 million in cash. 3-D is a supplier of
primarily land-based seismic data acquisition services. The purchase method of
accounting was used to record both of these acquisitions. The operating results
of these acquisitions are included in the consolidated statement of operations
from their respective acquisition date.
4
6
BAKER HUGHES INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
1997
In July 1997, the Company completed the acquisition of Petrolite Corporation
("Petrolite"). Baker Hughes issued 19.3 million shares of its common stock
having an aggregate value of $730.2 million. Additionally, the Company assumed
Petrolite's outstanding vested and unvested employee stock options which had a
fair market value of $21.0 million, resulting in total consideration of $751.2
million. The Company recorded an unusual charge of $35.5 million related to the
combination of Petrolite with Baker Performance Chemicals, the Company's
existing oilfield and industrial chemicals operations, forming Baker Petrolite,
a leading provider of oilfield chemicals in the major oilfield markets.
Also in July 1997, the Company acquired Drilex International Inc.
("Drilex"), a provider of products and services used in the directional and
horizontal drilling and workover of oil and gas wells, for 2.7 million shares of
the Company's common stock. The acquisition of Drilex, which has been combined
with the operations of Baker Hughes INTEQ, provides the Company with an
increased presence in the U.S. land directional and horizontal drilling market.
In connection with the acquisition of Drilex, the Company recorded an unusual
charge of $7.1 million related to transaction and other one-time costs.
RESULTS OF OPERATIONS
REVENUES
Revenues for 1998 were $6,311.9 million, an increase of 18.1 percent over 1997
revenues of $5,343.6 million. The increase was due, in part, to acquisitions in
1998 and in the latter part of 1997, offset by activity level declines as rig
counts in 1998 fell 12.9 percent in North America and 6.1 percent outside North
America when compared to 1997. These activity declines were brought about by
the significant drop in the price of oil and natural gas in the second half of
1998 and the resultant decrease in customer spending. Approximately 65 percent
of the Company's revenues were derived from international activities in 1998
and 1997.
Quarterly revenues peaked in the June 1998 quarter at $1,659.7 million and
declined $240.5 million, or 14.5 percent, to $1,419.2 million by the December
1998 quarter. The impact on the Company's business was most dramatic in North
America land-based activity and in Venezuela. Excluding acquisitions, Western
Geophysical is the only division that reported revenue increases in the second
half of 1998 as it benefited from strong licensing sales of multiclient seismic
data, where customer spending has been less impacted by fluctuations in oil
prices. The Company expects revenues in the March 1999 quarter to be lower than
the revenues reported for the December 1998 quarter.
Revenues for the three months ended December 31, 1997 were $1,572.9
million, an increase of 30.4 percent over revenues for the three months ended
December 31, 1996 of $1,206.7 million. The revenue improvement resulted from
higher activity levels as the worldwide rig count increased 14.7 percent.
Revenues for 1997 were $5,343.6 million, an increase of 20.2 percent over
1996 revenues of $4,445.8 million. Revenue from 1997 acquisitions contributed
$218.7 million of the revenue improvement in 1997. Revenue growth in 1997
outpaced the 14.2 percent increase in the worldwide rig count. In particular,
revenues in Venezuela increased $136.2 million, or 55.2 percent in 1997 when
compared to 1996, as that country continued to work towards its then-stated goal
of significantly increasing production.
GROSS MARGIN
Gross margins for 1998, the Transition Period, 1997 and 1996, were 25.4
percent, 33.5 percent, 31.2 percent and 31.1 percent, respectively. The
decrease in 1998 is due primarily to other nonrecurring charges recorded in
costs of revenues of $305.0 million as discussed in "Unusual and Other
Nonrecurring Charges," manufacturing under-absorption and pricing pressure
experienced during the last half of 1998. The increases in the Transition
Period, 1997 and 1996 resulted primarily from higher incremental gross profit on
increasing revenues, changes in the revenue mix and continued emphasis on
productivity and cost improvements.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative ("SG&A") expense as a percent of
consolidated revenues for 1998, the Transition Period, 1997
5
7
and 1996, were 20.6 percent, 20.6 percent, 19.4 percent and 20.0 percent,
respectively. In 1998, other nonrecurring charges totaling $68.7 million were
recorded in SG&A, offset by cost reduction efforts taken in the September and
December 1998 quarters. In 1997, SG&A expense as a percent of consolidated
revenues declined compared to 1996 due to foreign exchange gains incurred in
1997 compared to foreign exchange losses incurred in 1996 offset by higher
marketing costs due to increased activity levels.
MERGER RELATED CHARGES
In connection with the Merger, in 1998 the Company recorded Merger related
costs of $219.1 million. The categories of costs incurred, the actual cash
payments made in 1998 and the accrued balances at December 31, 1998 are
summarized below:
Accrued
Amounts Balance at
paid in December 31,
Total 1998 1998
------- ------- ------
Cash costs
Transaction costs $ 51.5 $ 46.9 $ 4.6
Employee costs 87.7 66.7 21.0
Other Merger
integration costs 21.7 9.8 11.9
------- ------- ------
Subtotal cash cost 160.9 $ 123.4 $ 37.5
======= ======
Noncash 58.2
-------
Total $ 219.1
=======
Transaction costs of $51.5 million include banking, legal and printing fees and
other costs directly related to the Merger. The Company had contracted for and
incurred most of the cost of the services for the remaining accrual; however,
such amounts had not been paid. The Company expects that all amounts accrued
for transaction costs will be paid by June 30, 1999.
Employee-related costs of $87.7 million consist of payments made to certain
officers of Western Atlas and Baker Hughes pursuant to change in control
provisions and severance benefits paid to terminated employees whose
responsibilities were deemed redundant as a result of the Merger. Accrued
employee costs, other than retirement benefits, at December 31, 1998 of $12.8
million are scheduled to be paid to the employees upon leaving the Company
during the first quarter of 1999. The remaining accrued employee costs at
December 31, 1998 of $8.2 million represent retirement benefits of certain
employees that will be paid, in accordance with the terms of the agreements,
over the lives of the covered employees.
Other integration costs include the costs of changing legal registrations
in various jurisdictions, terminating a joint venture as a result of the Merger,
changing signs and logos at the Company's major facilities around the world, and
other integration costs. The Company expects that the remaining balance of $11.9
million for other integration costs will be paid by June 30, 1999.
The noncash charge of $58.2 million consists of a charge of $45.3 million
related to the triggering of change of control rights contained in certain
Western Atlas employee stock option plans that were not converted to Baker
Hughes options concurrent with the Merger; a charge of $3.9 million for the
issuance of the Company's common stock pursuant to certain stock plans as a
result of the change in control; and a $9.0 million charge recorded to write-off
the carrying value of a product line that was discontinued as a result of the
Merger.
UNUSUAL AND OTHER NONRECURRING CHARGES
1998
The Company had experienced high growth levels for its products and services
from 1994 through the second quarter of 1998. During the third and fourth
quarters of 1998, the Company experienced a decline in demand for its products
and services as a result of a significant decrease in the price of oil and
natural gas. The decline in customer demand materialized quickly from the
previous high growth rates. As a result of this sharp decline in demand and to
adjust to the lower level of activity, the Company assessed its overall
operations and recorded charges of $549.0 million in the September quarter and
$40.5 million in the December quarter as summarized below:
6
8
BAKER HUGHES INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Accrued
Amounts Balance at
paid in December 31,
Total 1998 1998
------- ------- -------
Cash charges:
Severance for
approximately
5,300 employees $ 64.3 $ 26.6 $ 37.7
Integration costs, abandoned
leases and other
contractual obligations 40.0 14.7 25.3
Environmental reserves 8.8 4.3 4.5
Other cash costs (includes
litigation reserves) 21.4 4.7 16.7
------- ------- -------
Subtotal cash charges 134.5 $ 50.3 $ 84.2
======= ======= =======
Noncash charges - write-down of:
Inventory and rental tools 173.2
PetroAlliance Services
Company Limited 83.2
Property and other assets 80.1
Oil and gas properties (ceiling-test) 69.3
Intangible assets 21.5
Real estate held for sale 17.0
Investments in affiliates 10.7
-------
Subtotal noncash charges 455.0
-------
Total cash and noncash charges $ 589.5
=======
The above charges were reflected in the following captions of the
consolidated statement of operations:
Total
--------
Costs of revenues $ 305.0
Selling, general and administrative 68.7
Unusual charge 215.8
--------
Total $ 589.5
========
The amount accrued for severance is based upon the Company's written
severance policy and the positions eliminated. The accrued severance does not
include any portion of the employees' salaries through their severance dates.
Based upon current severance dates, the Company expects that of the accrued
severance remaining at December 31, 1998, $27.0 million will be paid during the
first quarter of 1999 and the remaining $10.7 million will be paid during the
second quarter of 1999 when the employees leave the Company.
The Company accrued $40.0 million to combine operations and consolidate
facilities. Such accrual includes costs to settle leases on idled facilities
based upon lease agreements; to shut-down oil and gas operations in certain
countries based upon management's decision to abandon operations; to terminate a
rig contract based upon the terms of the agreement; and other collocation costs
based upon the estimated exit costs for approved plans. The accrual does not
include any portion of the costs before actual abandonment of the facilities or
ceasing of the operations. The Company expects to spend approximately $9.4
million of the accrued balance as of December 31, 1998 during the first quarter
of 1999 and, except for amounts payable under terms of leases and other
contracts, the remaining amounts accrued will be paid during the remainder of
1999.
The impairment of inventory and rental tool assets of $173.2 million
impacted virtually all operating divisions and was due to advances in technology
that have obsoleted certain product lines, as well as a decline in market demand
that has resulted in an excess supply of certain products. The product lines
most affected were completion products, drilling and evaluation systems and
tools, tricone and diamond drill bits, and filtration systems. Much of the
obsolete and excess inventory will be scrapped and has been written off
completely. The remaining assets have been written down to their estimated value
based on the Company's inventory and rental tool obsolescence policy.
In the third quarter of 1998, the Company recorded an $83.2 million
write-down of PetroAlliance Services Company Limited ("PAS"), a former
consolidated joint venture operating in the former Soviet Union. The write-down
of the joint venture was based upon the Company's estimated value of assets
ultimately received in consideration of the sale of the PAS investment in
November 1998. The Company received as consideration for the sale of PAS a
seismic vessel, other seismic and well-logging assets, certain PAS assets in
Kazakhstan and Turkmenistan, certain customer receivables and a $33.0 million
note from the purchasers. The write-down included $10.7 million for equipment,
$22.0 million of goodwill, and $50.5 million of net current assets.
The impairment of property and other assets of $80.1 million includes an
$18.1 million write-down to reduce the carrying value of a portion of the
Company's drilling equipment; a $12.6 million write-off of obsolete solid and
oil-filled streamer sections used on seismic vessels; a $14.9 million write-down
of surplus well-logging equipment; a $9.5 million write-off of prepaid
royalties
7
9
on an abandoned product line; and $25.0 million of assets written down to fair
market value. The write-down of these assets was determined based on internally
developed valuations using a variety of methods.
A $69.3 million charge results from the application of the ceiling test
prescribed for oil and gas properties accounted for under the full cost method.
With the sharp decline in price of both oil and natural gas, the carrying value
of the Company's oil and gas interests were required to be written down.
The write-off of intangible assets of $21.5 million includes $2.7 million
for capitalized software costs for product lines abandoned as a result of recent
acquisitions; $5.3 million for capitalized development costs for software
systems that are being replaced by the Company's implementation of SAP R/3; and
$13.5 million for goodwill associated with a discontinued business and a
subsidiary held for sale.
The write-down of real estate held for sale of $17.0 million is for a
specific property and the charge reduces the carrying value to the property's
appraised value.
The $10.7 million charge is to write-off investments in joint ventures in
both Russia and Indonesia and also includes a loss on the sale of Tracor Europa,
a discontinued subsidiary.
1997
During 1997, the Company recorded unusual charges of $52.1 million. This
included charges in connection with the acquisitions of Petrolite and Drilex of
$35.5 million and $7.1 million, respectively, to combine the acquired
operations with those of the Company. An additional $9.5 million charge was
recorded as a result of the decision to discontinue a low margin, oilfield
product line in Latin America and to sell the Tracor Europa subsidiary, a
computer peripherals operation. This resulted in a write-down of the investment
in Tracor Europa to net realizable value. Cash provisions of the unusual charge
totaled $19.4 million. The Company spent $5.5 million during 1997 and $1.6
million during the Transition Period. The Company spent substantially all of
the remaining $12.3 million in 1998. Such expenditures relate to specific plans
and clearly defined actions and were funded from operations and available
credit facilities.
1996
During 1996, the Company recorded an unusual charge of $39.6 million. The
charge consisted of the write-off of $8.5 million of oilfield operations
patents that no longer protected commercially significant technology, a $5.0
million impairment of a Latin America joint venture due to changing market
conditions in the region in which it operates, restructuring charges totaling
$24.1 million, and $2.0 million of other charges. The restructuring charges
included the downsizing of Baker Hughes INTEQ's Singapore and Paris operations,
a reorganization of EIMCO Process Equipment's Italian operations, and the
consolidation of certain Baker Oil Tools manufacturing operations. Noncash
provisions of the charge totaled $25.3 million and consisted primarily of the
write-down of assets to net realizable value. The remaining $14.3 million of
the charge represents expected cash expenditures related to severance under
existing benefit arrangements, abandoned leases, and the relocation of people
and equipment. The Company spent $4.2 million of the cash during 1996, $6.3
million during 1997 and the remaining $3.8 million during the Transition
Period.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT
The acquisition of Petrolite in 1997 was accounted for as a purchase.
Accordingly, the purchase price was allocated to the assets acquired and the
liabilities assumed based on their estimated fair market values at the date of
the acquisition. In accordance with generally accepted accounting principles,
the $118.0 million allocated to in-process research and development has been
recorded as a charge in the consolidated statement of operations as of the
acquisition date because the technological feasibility of the projects
in-process had not been established and there was no alternative future use at
that date.
There were 26 individual research and development projects that were in
development at the time of the acquisition that were classified as in-process
research and development. The products under development were valued using a
discounted cash flow analysis at a 14 percent discount factor. The cash flows
were projected for a 20-year period and included additional research and
development and capital expenditures required to
8
10
BAKER HUGHES INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
complete the projects. The gross margins used for these products were generally
consistent with those of other chemical products sold by the Company. The 14
percent discount factor used considered the time value of money, inflation and
the risk inherent in the projects under development. In aggregate, the
remaining completion costs for these products were projected to exceed $7.2
million with completion periods varying from 90 days to two years. Significant
cash inflows from these products in total were expected to commence during 1999.
During 1998, 16 of these products generated commercial sales, five had product
sales on a trial basis only, and five were determined not to be viable
products.
INTEREST EXPENSE
Interest expense in 1998 increased $57.6 million compared to 1997. Interest
expense in 1997 increased $3.5 million compared to 1996. These increases were
due to higher debt levels that funded acquisitions, capital expenditures, and
working capital.
SPIN-OFF RELATED COSTS
Costs related to the Spin-off of UNOVA of $8.4 million were charged to
continuing operations during 1997.
GAIN ON SALE OF VARCO STOCK
In May 1996, the Company sold 6.3 million shares of Varco International, Inc.
("Varco") common stock, representing its entire investment in Varco. The
Company received net proceeds of $95.5 million and recognized a pretax gain of
$44.3 million. The Company's investment in Varco was accounted for using the
equity method. Equity income included in the Consolidated Statement of
Operations for 1996 was $1.8 million.
INCOME TAXES
A significant portion of the Merger related costs and the unusual and other
nonrecurring charges recorded in 1998 are not deductible for tax purposes in
any jurisdiction. In addition, the Company operates in certain jurisdictions
that assess tax on a deemed profit or turnover basis. As a result, the Company
provided $16.3 million of income taxes on the net loss of $297.4 million in
1998. The effective tax rates before Merger and acquisition related costs, Spin-
off related costs, unusual, and other nonrecurring items were 35.5 percent,
37.9 percent, 35.2 percent and 40.0 percent for the periods ended December 31,
1998, December 31, 1997, September 30, 1997 and September 30, 1996,
respectively.
CAPITAL RESOURCES AND LIQUIDITY
OPERATING ACTIVITIES
Net cash inflows from operating activities of continuing operations were $809.7
million, $141.1 million, $713.5 million and $636.6 million in 1998, the
Transition Period, 1997 and 1996, respectively. The increase in operating cash
flow in each successive period resulted from the increasing business levels
from period to period.
INVESTING ACTIVITIES
Net cash outflows from investing activities of continuing operations were
$1,675.8 million in 1998, $319.2 million in the Transition Period, $971.8
million in 1997 and $485.4 million in 1996.
Property additions in 1998 increased as the Company added capacity to meet
increased market demand and due to an increase in the acquisition of multiclient
seismic data. In light of the more recent activity decline, the Company reviewed
significant capital projects and currently expects 1999 capital expenditures to
be approximately $600.0 million (excluding acquisitions), a significant
reduction from 1998 capital spending. Funds provided from operations and
outstanding lines of credit are expected to be adequate to meet future capital
expenditure requirements.
Proceeds from the disposal of assets generated $100.0 million in 1998,
$20.5 million in the Transition Period, $66.3 million in 1997 and $98.3 million
in 1996.
The Company obtained $68.7 million of cash from the two stock acquisitions
of Petrolite Corporation and Drilex that occurred in 1997. In July 1997, the
Company sold all of the marketable securities it obtained from Wm. S. Barnickel
& Company in association with the Petrolite acquisition for $48.5 million. In
May 1996, the Company sold its entire investment in Varco receiving net proceeds
of $95.5 million.
In 1998 the Company used short-term borrowings to purchase various
businesses including WEDGE for $218.4 million, net of
9
11
cash acquired, 3-D for $117.5 million and Western Rock Bit for $31.4 million.
In the Transition Period, the Company used short-term borrowings to purchase
various businesses, including Oilfield Dynamics Inc. for $34.2 million. In
1997, the Company used existing cash on hand and short-term borrowings to
purchase various businesses, including Environmental Technology Divisions of
Deutz AG for $52.2 million, net of cash acquired. In 1996, the Company acquired
Vortoil Separation Systems and KTM Process Equipment Inc. for a total of $32.7
million, net of cash acquired.
During the June 1997 quarter, the Company began a multi-year initiative
designed to develop and implement an enterprise- wide software system. The
initiative, named "Project Renaissance," will utilize SAP R/3 as its software
platform across the entire Company and is expected to cost in excess of $300
million over a four-year period.
The words "expected" and "expects" are intended to identify Forward-Looking
Statements in "Investing Activities." See "Forward-Looking Statements" and
"Business Environment" above for a description of risk factors related to these
Forward-Looking Statements.
FINANCING ACTIVITIES
Net cash inflows (outflows) from financing activities of continuing operations
were $838.6 million, $173.7 million, $462.3 million and ($133.9) million in
1998, the Transition Period, 1997 and 1996, respectively.
Total debt outstanding at December 31, 1998 was $2,770.7 million, compared
to $1,782.6 million at December 31, 1997 and $1,589.5 million and $1,179.1
million at September 30, 1997 and 1996, respectively. The increase in debt is
primarily due to increased borrowings from commercial paper and revolving credit
facilities that funded acquisitions, capital expenditures and increases in
working capital. The debt-to-equity ratio was 0.87 at December 31, 1998 compared
to 0.51 at December 31, 1997.
Cash dividends in 1998 increased due to the increase in the number of
shares of common stock outstanding. On an annualized basis the cash dividend of
$0.46 per share of common stock will require approximately $150.0 million of
cash which compares to an annual requirement of approximately $80.0 million
before the Merger.
At December 31, 1998, the Company had $2,237.4 million of credit facilities
with commercial banks, of which $1,000.0 million was committed. These facilities
are subject to normal banking terms and conditions that do not significantly
restrict the Company's activities.
Subsequent to December 31, 1998, the Company issued $400 million of 6.875
percent Notes due January 2029, $325 million of 6.25 percent Notes due January
2009, $200 million 6.0 percent Notes due February 2009 and $100 million of 5.8
percent Notes due 2003 with effective interest rates of 7.07 percent, 6.36
percent, 6.09 percent and 6.01 percent, respectively. The proceeds were used to
repay current portions of long-term debt, commercial paper, and other short-term
borrowings.
ACCOUNTING STANDARDS
DERIVATIVE AND HEDGE ACCOUNTING
In June 1998, the FASB 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 quarters of fiscal years beginning after
June 15, 1999. Retroactive application to periods prior to adoption is not
allowed. The Company will adopt the standard in the first quarter of 2000. The
Company has not quantified the impact of the adoption of SFAS No. 133 on its
consolidated financial statements.
QUANTITATIVE AND QUALITATIVE MARKET RISK DISCLOSURES
The Company is exposed to certain market risks that are inherent in the
Company's financial instruments arising from transactions that are entered into
in the normal course of business. The Company may enter into derivative
financial instrument transactions to manage or reduce market risk; that is, the
Company does not enter into derivative financial instrument transactions for
speculative
10
12
BAKER HUGHES INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
purposes. A discussion of the Company's primary market risk exposure in
financial instruments is presented below.
LONG-TERM DEBT
The Company is subject to interest rate risk on its long-term fixed interest
rate debt. Commercial paper borrowings, other short-term borrowings and
variable rate long-term debt do not give rise to significant interest rate risk
because these borrowings have maturities of less than three months or have
variable interest rates. All other things being equal, the fair market value of
debt with a fixed interest rate will increase, and the amount required to
retire the debt today will increase, as interest rates fall and the fair
market value will decrease as interest rates rise. This exposure to interest
rate risk is managed by borrowing money that has a variable interest rate or
using interest rate swaps to change fixed interest rate borrowings to variable
interest rate borrowings. Generally, the Company desires to maintain between 45
percent and 65 percent of total borrowings at variable interest rates.
The following table sets forth, as of December 31, 1998 and 1997, the
Company's principal cash flows for its long-term debt obligations, which bear a
fixed rate of interest and are denominated in U.S. dollars, and the related
weighted average interest rates by expected maturity dates. Additionally, the
table sets forth the notional amounts and weighted average interest rates of the
Company's interest rate swaps by expected maturity.
1998 1999 2000 2001 2002 2003 Thereafter Total
As of
December 31, 1998:
Long-term debt (4) $ 152.0 $ 95.1 $ 1.5 $ 9.2 $ 885.1(1) $ 1,142.9
Weighted average
interest rates 7.61% 8.55% 6.77% 6.77% 6.10% 6.51%
Fixed to variable swaps (5) $ 93.0
Pay rate 7.76%(2)
Receive rate 8.59%
As of
December 31, 1997:
Long-term debt (4) $ 49.1 $ 150.0 $ 93.0 $ 890.6(1) $ 1,182.7
Weighted average
interest rates 5.65% 7.73% 8.59% 6.11% 6.48%
Fixed to variable swaps (5) $ 230.5 $ 93.0
Pay rate 3.55%(3) 7.82%(2)
Receive rate 3.50% 8.59%
(1) Includes a zero-coupon instrument with an accreted value of $275.5 million
and $265.7 million at December 31, 1998 and 1997, respectively.
(2) Six-month LIBOR plus 2 percent settled semi-annually, maturing in January
2000.
(3) 30-day commercial paper minus 1.96 percent settled at maturity in May 1998.
(4) Fair value of long-term debt is $1,114.8 million and $1,257.9 million at
December 31, 1998 and 1997, respectively.
(5) Fair value of the interest rate swaps is $1.6 million and $2.8 million at
December 31, 1998 and 1997, respectively.
Included in the table above in the "Thereafter" column is the Company's
Liquid Yield Option Notes ("LYONS") which are convertible into Company common
stock at the option of the holder. As such, the fair value of the LYONS is
determined, in addition to changes in interest rates, by changes in the market
price of the Company's common stock. Holding interest rates constant, a 20
percent decline in the market price of the Company's common stock would not
cause the fair value of the LYONS at December 31, 1998 to decrease by a
comparable percentage amount because the LYONS currently trade more like a debt
instrument than an equity instrument. This occurs because the market price of
the Company's common stock at December 31, 1998 of $17.625 was significantly
below the LYONS conversion price of $38.88.
INVESTMENTS
The Company's investment in common stock and common stock warrants of
Tuboscope, Inc. ("Tuboscope") is subject to equity price risk as the common
stock of Tuboscope is traded on the New York Stock Exchange. Warrants to buy
shares of Tuboscope common stock derive their value, in part, from the market
value of Tuboscope common stock. This investment is classified as available for
sale and, consequently, is reflected in the consolidated statement of financial
position at fair value with unrealized gains and losses reported as a separate
component of comprehensive income within stockholders' equity. The Company has
no current intention of acquiring more shares of, or disposing of its interest
in, Tuboscope; however, the Company's intentions may change in light of facts
and circumstances that may arise in future dealings in the marketplace or other
events affecting Tuboscope or the Company.
11
13
At December 31, 1998 and 1997, the fair value of the Company's investment
in common stock and common stock warrants of Tuboscope was $26.9 million and
$91.4 million, respectively. The Tuboscope common stock was valued at the
closing price at December 31, 1998 and 1997, as reported on the New York Stock
Exchange, and the warrants were valued using the Black-Scholes option-pricing
model. No actions have been taken by the Company to hedge this market risk
exposure. A 20 percent decline in the market price of Tuboscope common stock
would cause the fair value of the investment in common stock and common stock
warrants of Tuboscope to decrease $5.9 million at December 31, 1998.
FOREIGN CURRENCY
The Company's operations are conducted around the world in a number of
different currencies. As such, there is exposure to future earnings due to
changes in foreign currency exchange rates when transactions are denominated in
currencies other than the Company's functional currencies, which are the
primary currencies in which the Company conducts its business in various
jurisdictions. As a general rule, the Company hedges all or part of the future
earnings exposure when it believes the risk of loss is greater than the cost of
the associated hedge.
At December 31, 1998 and 1997, the Company had Norwegian Krone denominated
commitments of $81.4 million and $84.0 million, respectively, to purchase two
seismic vessels. The Company entered into forward exchange contracts with
notional amounts of $88.9 million as of December 31, 1998 and 1997 to hedge
these commitments. At December 31, 1998, the fair market value of these
contracts was $80.8 million resulting in an unrealized loss of $8.1 million. At
December 31, 1997, the unrealized loss was not significant. Also at December 31,
1998, the Company had Australian Dollar denominated commitments of $32.6 million
primarily related to a long-term equipment purchase commitment for which the
Company entered into forward exchange contracts with notional amounts of $29.1
million to hedge the majority of this commitment. At December 31, 1998, the fair
market value of these contracts was $30.2 million resulting in an unrealized
gain of $1.1 million. The notional amounts are used to express the volume of
these transactions and do not represent exposure to loss. The fair market value
of these contracts was based on year end quoted market prices for contracts with
similar terms and maturity dates. The carrying value of the contracts was not
significant. Foreign currency gains and losses for such purchases are deferred
and become part of the bases of the assets. 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 and, in management's opinion, present no significant credit
risk to the Company. 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 spot rate differential.
Certain borrowings of the Company are denominated in currencies other than
its functional currency. At December 31, 1998, these nonfunctional currency
borrowings totaled $28.5 million where the primary exposure was between the U.S.
Dollar and the British Pound. At December 31, 1997, the Company's nonfunctional
currency short-term borrowings totaled $8.7 million where the primary exposure
was between the U.S. Dollar and the French Franc. A 10 percent appreciation of
the U.S. Dollar against these currencies would not have a significant effect on
the future earnings of the Company.
YEAR 2000 ISSUE
Forward-Looking Statements Regarding the Year 2000 Issue The words "expect,"
"believe," "will," "estimate," "target" and similar expressions are intended to
identify Forward-Looking Statements in "Year 2000 Issue." Although the Company
expects that it will complete various phases of its Year 2000 Program Plan (the
"Program Plan") as described below, including (without limitation) the specific
remedial and corrective aspects of the program or the contingency plans
described below, there can be no assurance that the Company will be successful
in completing each and every aspect of the Program Plan and, if successful,
within the expected schedules described below. Factors that could affect the
Company's implementation of its Program Plan include unforeseen difficulties in
remediating a
12
14
BAKER HUGHES INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
specific problem due to the complexity of hardware and software, the inability
of third parties to adequately address their own year 2000 issues, including
vendors, contractors, financial institutions, U.S. and foreign governments and
customers, the delay in completion of a phase of the Program Plan necessary to
begin a later phase, the discovery of a greater number of hardware and software
systems or technologies with material year 2000 issues than the Company
presently anticipates, and the lack of alternatives that the Company previously
believed existed.
OVERVIEW
Many computer hardware and software products have not been engineered with
internal calendars or date-processing logic capable of accommodating dates
after December 31, 1999. In most cases, the problem is due to the hardware or
software application storing the year as a two-digit field. In applications
where this year 2000 ("Y2K") problem exists, the year 2000 will appear as 00,
and current applications could interpret the year as 1900 or some other date
rather than 2000. The same error may exist for years later than 2000 because
the application cannot distinguish which century the date represents. These
errors could negatively affect the Company's business application systems,
manufacturing, engineering and process control systems, products sold to
customers, equipment used in providing services, facilities equipment and
information technology ("IT") infrastructure. Additionally, Y2K issues
impacting suppliers and customers could have an indirect negative impact on the
Company.
YEAR 2000 PROGRAM PLAN
Baker Hughes has developed a Year 2000 Program Plan for identifying, assessing
and correcting its Y2K problems. This Program Plan strives to achieve a
consistent approach to the Y2K issue throughout the Company. The Program Plan
has the following aspects: program management, inventory and risk assessment,
remediation, testing and implementation, contingency planning, and quality
assurance.
The Company is currently completing an inventory of all hardware and
software that the Company incorporates in its products or utilizes to support
its operations or provide services to its customers. The Company is also
determining whether the inventoried items have Y2K problems. If a Y2K problem
exists, the Company will assess the risks associated with the problem.
At December 31, 1998, the Company had inventoried well over half of its
hardware and software. All inventories and assessments are in progress and
expected to be substantially complete by mid-March. Since the inventory and
assessment phase is still in progress, the Company could identify additional
hardware and software that has Y2K problems.
Baker Hughes has adopted the British Standards Institute Year 2000
Conformity Guidelines as a reasonable standard for determining whether software
and hardware are not materially affected by Y2K problems. When meeting these
guidelines, the Company has deemed that hardware and software are not materially
affected by Y2K problems and, thus, are "in Y2K compliance."
The Company's remediation efforts include the correction or replacement of
noncompliant hardware and software and are scheduled to be completed by mid to
late 1999 for all material noncompliant hardware and software that the Company
has identified to date. Both the Company's employees and outside vendors are
performing this work. The Company has established a target date of June 30, 1999
for the completion of the work on a majority of its material noncompliant
systems and technologies. The Company expects to complete its development of
contingency plans prior to the end of 1999 for any material systems and
technologies not remediated by June 1999.
The Company is unable to reasonably estimate the absolute dollar effect on
the Company's results of operation, liquidity or financial condition if its
remediation efforts are unsuccessful, although the Company believes the effect
would be material.
Baker Hughes has performed testing and validation of the compliance status
for all critical hardware and software as the Company has completed each
remediation project. Hardware and software that is not critical may not be
tested and validated. The Company is currently testing and validating, among
other hardware and software, its seismic data acquisition and analysis systems,
surface data acquisition and logging systems, wireline logging systems, certain
filtration and separation equipment that has been customized with program logic
controllers, and certain motor controllers that include embedded chips and
internal clocks. The
13
15
Company's employees and, in some cases, third-party contractors have performed
the testing and validation work. Near the completion of the inventory and risk
assessment phase, the Company expects to use external resources to evaluate the
Company's program management and the adequacy and completeness of its risk
assessment, testing and validation.
YEAR 2000 PROGRAM PLAN COSTS
Baker Hughes has approximately 80 full-time equivalent employees ("FTEs")
involved in the Y2K effort, which the Company estimates has an associated
annual cost of approximately $5.6 million. Generally, these FTEs are full-time
employees who are devoting some portion of their schedule to the Y2K effort.
In addition to the payroll and payroll-related costs, Baker Hughes
estimates spending approximately $48.0 million in the Y2K compliance effort, of
which approximately $35.0 million would be capitalized as replacement hardware
and software equipment. Of the $48.0 million, the Company has spent
approximately $26 million through December 31, 1998. The Company has funded, and
expects to continue to fund, these expenditures from cash that it generates from
operating activities or existing credit facilities. These cost estimates could
change materially based upon the completion of the inventory and risk assessment
phase of the Program Plan.
THIRD-PARTY ISSUES
The failure of third-parties, which have a material relationship with the
Company, to address their Y2K problems could negatively and materially impact
the Company. To address this risk, the Company is assessing the effect of Y2K
on key vendor and contractor relationships and has begun to do the same with
respect to key customer relationships. This assessment includes key
relationships with parties with which the Company interfaces electronically and
with which the Company has entered into strategic alliances.
The Company is evaluating vendors that the Company believes are material to
its operations and assessing the business risk of Y2K noncompliance on their
part. Based upon this assessment, the Company is seeking to obtain written
confirmation from key vendors and contractors that they are adequately
addressing their Y2K issues. Additionally, the Company seeks to review the Y2K
statements of these vendors and contractors to the extent they exist. Where the
Company cannot obtain satisfactory confirmation from these vendors, the
purchasing departments of each operating division of the Company intend to
identify alternate sources, if available, for vendors if those sources are
needed because of an inability to perform due to Y2K noncompliance. The Company
expects to complete this assessment by May 1999.
KNOWN MATERIAL Y2K NONCOMPLIANT HARDWARE AND SOFTWARE
INTEQ and Baker Oil Tools are implementing SAP R/3 for domestic operations
during 1999. INTEQ has delayed remediation of its existing payroll system, and
Baker Oil Tools has delayed remediation for certain other business applications,
in each case, pending the implementation of SAP R/3. Contingencies for these
operational areas are being evaluated, and the Company expects to implement a
contingency plan if the SAP implementation is not timely.
Older versions of INTEQ's PC-based surface data acquisition systems are not
Y2K compliant. The software is in the process of being remediated. The
noncompliant PC hardware cannot be economically remediated, and the purchase of
new, higher grade personal computers is required to replace the noncompliant
equipment. This remediation began in 1997 with the replacement of personal
computers being phased in and is expected to be completed by late 1999. The
Company estimates that as of December 31, 1998, it was 60 percent complete in
the replacement of the noncompliant personal computer hardware and software for
the surface data acquisition systems.
Baker Atlas is rewriting its bonded inventory control module that tracks
assets that are used in international waters that may be exempt from import
duties. The upgrade is expected to be in place by June 1999.
The Company's Western Geophysical operating division relies heavily upon
Global Positioning System ("GPS") equipment that the U.S. Navy operates. The
noncompliance of this equipment is a known problem outside the control of the
Company that affects other businesses, the government, the military services and
individuals that rely upon GPS services, including most of the
14
16
BAKER HUGHES INCORPORATED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Company's seismic business competitors. Based upon information obtained from
the U.S. government, the Company believes that the government is
adequately addressing its GPS Y2K noncompliance problem and expects this system
to be compliant in early 1999. However, there can be no assurance that any Y2K
noncompliance with respect to the government's GPS equipment or the equipment
of its contractors and subcontractors will be corrected on schedule. The Company
is not aware of any contingency system that its GPS receivers can utilize if
the government's GPS equipment is not made Y2K compliant. A failure to correct
the Y2K problems of this equipment could have a material adverse impact on the
Company's results of operations.
Western Geophysical uses a seismic acquisition synchronizer as part of its
marine seismic acquisition services. This product is not Y2K compliant, and its
noncompliance would have a material impact on the Company's marine seismic
acquisition revenues if not corrected. The Company is discussing the issue with
the manufacturer to complete an upgrade remediation plan. Western Geophysical
anticipates that this software will be Y2K compliant by June 1999. A seismic
acquisition system that Western Geophysical uses is also not Y2K compliant. The
manufacturer has informed Western Geophysical that it intends to make the system
Y2K compliant in the first quarter of 1999. Finally, Western Geophysical has a
prospect data logger software system that is not Y2K compliant. Western
Geophysical is internally generating software upgrades for this system.
Baker Process is implementing a new business application system to replace
its existing systems, which are not Y2K compliant. This system includes
financial, purchasing, inventory management and manufacturing functionality. The
Company expects Baker Process to complete the implementation of the new system
by late 1999.
The Baker Process operating division provides mechanical equipment that, in
some cases, has been customized at the request of the customer to include
control panels and circuit boards. The Company obtained these control panels and
circuit boards from third-party vendors at the request of various customers. The
Company is researching the Y2K compliance status of these boards. This status is
often dependent upon the purchase date and serial number of the product. The
warranties from the Company or its subcontractors have, in many instances,
lapsed with respect to these panels and circuit boards. The Company expects to
have completed its investigation of these systems by mid 1999. Pending the
results of this evaluation, there could be a material noncompliance issue with
these products.
EURO CONVERSION
A single European currency ("the Euro") was introduced on January 1, 1999, at
which time the conversion rates between legacy currencies and the Euro were set
for 11 participating member countries. However, the legacy currencies in those
countries will continue to be used as legal tender through January 1, 2002.
Thereafter, the legacy currencies will be canceled, and Euro bills and coins
will be used in the eleven participating countries.
Transition to the Euro creates a number of issues for the Company. Business
issues that must be addressed include pricing policies and ensuring the
continuity of business and financial contracts. Finance and accounting issues
include the conversion of accounting systems, statutory records, tax books and
payroll systems to the Euro, as well as conversion of bank accounts and other
treasury and cash management activities.
The Company is assessing and addressing these transition issues. The
Company does not presently anticipate that the transition to the Euro will have
a significant impact on its results of operations, financial position or cash
flows. The word "anticipate" is intended to identify a Forward-Looking Statement
in "Euro Conversion." Baker Hughes' anticipation regarding the lack of
significance of the Euro introduction on Baker Hughes' operations is only its
forecast regarding this matter. This forecast may be substantially different
from actual results, which are affected by factors substantially similar to
those described in "Year 2000 Issue - Forward-Looking Statements Regarding the
Year 2000 Issue" above.
15
17
BAKER HUGHES INCORPORATED
INDEPENDENT AUDITORS' REPORT
STOCKHOLDERS OF BAKER HUGHES INCORPORATED:
We have audited the accompanying consolidated statements of financial position
of Baker Hughes Incorporated and its subsidiaries as of December 31, 1998 and
1997, and the related consolidated statements of operations, stockholders'
equity and cash flows for the year ended December 31, 1998, the three month
period ended December 31, 1997 and for each of the two years in the period
ended September 30, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Baker Hughes Incorporated and its
subsidiaries at December 31, 1998 and 1997, and the results of their operations
and their cash flows for the year ended December 31, 1998, the three month
period ended December 31, 1997 and for each of the two years in the period
ended September 30, 1997 in conformity with generally accepted accounting
principles.
As discussed in Note 2 to the consolidated financial statements, the Company
changed its method of accounting for impairment of long-lived assets to be
disposed of effective October 1, 1996 to conform with Statement of Financial
Accounting Standards No. 121.
/s/ DELOITTE & TOUCHE LLP
February 17, 1999
Houston, Texas
16
18
BAKER HUGHES INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended Three Months Ended Year Ended September 30,
(In millions, except per share amounts) December 31, 1998 December 31, 1997 1997 1996
----------------- ----------------- --------- ---------
Revenues $ 6,311.9 $ 1,572.9 $ 5,343.6 $ 4,445.8
--------- --------- --------- ---------
Costs and expenses:
Costs of revenues 4,710.9 1,045.7 3,676.9 3,062.8
Selling, general and administrative 1,301.8 324.6 1,036.1 889.2
Merger related costs 219.1
Unusual charge 215.8 52.1 39.6
Acquired in-process research and development 118.0
--------- --------- --------- ---------
Total 6,447.6 1,370.3 4,883.1 3,991.6
--------- --------- --------- ---------
Operating income (loss) (135.7) 202.6 460.5 454.2
Interest expense (149.0) (24.5) (91.4) (87.9)
Interest income 3.6 1.1 3.6 4.9
Spin-off related costs (8.4)
Gain on sale of Varco stock 44.3
--------- --------- --------- ---------
Income (loss) from continuing operations before income
taxes and cumulative effect of accounting change (281.1) 179.2 364.3 415.5
Income taxes (16.3) (68.0) (163.4) (169.1)
--------- --------- --------- ---------
Income (loss) from continuing operations before cumulative
effect of accounting change (297.4) 111.2 200.9 246.4
Cumulative effect of accounting change:
Impairment of long-lived assets to be disposed of
(net of $6.0 income tax benefit) (12.1)
--------- --------- --------- ---------
Income (loss) from continuing operations (297.4) 111.2 188.8 246.4
Discontinued operations, net of tax 2.8 (154.9) 55.7
--------- --------- --------- ---------
Net income (loss) $ (297.4) $ 114.0 $ 33.9 $ 302.1
========= ========= ========= =========
Basic earnings per share:
Income (loss) from continuing operations before cumulative
effect of accounting change $ (0.92) $ 0.35 $ 0.67 $ 0.86
Cumulative effect of accounting change (0.04)
Discontinued operations 0.01 (0.52) 0.19
--------- --------- --------- ---------
Net income (loss) $ (0.92) $ 0.36 $ 0.11 $ 1.05
--------- --------- --------- ---------
Diluted earnings per share:
Income (loss) from continuing operations before cumulative
effect of accounting change $ (0.92) $ 0.34 $ 0.66 $ 0.85
Cumulative effect of accounting change (0.04)
Discontinued operations 0.01 (0.51) 0.19
--------- --------- --------- ---------
Net income (loss) $ (0.92) $ 0.35 $ 0.11 $ 1.04
========= ========= ========= =========
See Notes to Consolidated Financial Statements
17
19
BAKER HUGHES INCORPORATED
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(In millions, except par value) December 31, 1998 December 31, 1997
----------------- -----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 16.6 $ 41.9
Receivables-less allowance for doubtful accounts:
December 31, 1998, $50.1; December 31, 1997, $54.4 1,422.3 1,519.4
Inventories 1,065.7 1,145.0
Other current assets 219.9 213.5
---------- ----------
Total current assets 2,724.5 2,919.8
Property-net 2,292.3 1,979.0
Goodwill and other intangibles - less accumulated amortization:
December 31, 1998, $285.5; December 31, 1997, $238.4 1,898.4 1,537.2
Multiclient seismic data and other assets 895.6 794.6
---------- ----------
Total assets $ 7,810.8 $ 7,230.6
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 560.5 $ 601.5
Short-term borrowings and current portion of long-term debt 44.4 177.3
Accrued employee compensation 284.3 287.0
Other accrued liabilities 420.7 351.3
---------- ----------
Total current liabilities 1,309.9 1,417.1
---------- ----------
Long-term debt 2,726.3 1,605.3
---------- ----------
Deferred income taxes 156.5 283.8
---------- ----------
Deferred revenue and other long-term liabilities 418.7 405.4
---------- ----------
Commitments and contingencies
Stockholders' equity:
Common stock, $1 par value (shares authorized - 400.0; outstanding -
327.1 at December 31, 1998 and 316.8 at December 31, 1997) 327.1 316.8
Capital in excess of par value 2,931.8 2,834.0
Retained earnings 100.4 494.1
Cumulative foreign currency translation adjustment (155.4) (160.5)
Unrealized gain (loss) on securities available for sale (0.1) 38.1
Pension liability adjustment (4.4) (3.5)
---------- ----------
Total stockholders' equity 3,199.4 3,519.0
---------- ----------
Total liabilities and stockholders' equity $ 7,810.8 $ 7,230.6
========== ==========
See Notes to Consolidated Financial Statements
18
20
BAKER HUGHES INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated Other Comprehensive Income
--------------------------------------
Unrealized
Capital Foreign Gain (Loss)
In Excess Currency on Securities Pension
Common of Retained Translation Available Liability Treasury
(In millions, except per share amounts) Stock Par Value Earnings Adjustment for Sale Adjustment Stock Total
------ --------- -------- ----------- ------------- ---------- -------- ---------
BALANCE, SEPTEMBER 30, 1995 $142.2 $ 1,342.3 $ 140.1 $ (107.7) $ (3.4) $ -- $ -- $ 1,513.5
as previously reported
Western Atlas pooling of interests 143.6 1,039.0 165.8 8.4 1,356.8
------ --------- -------- ----------- ------------- ---------- -------- ---------
BALANCE, SEPTEMBER 30, 1995 285.8 2,381.3 305.9 (99.3) (3.4) -- -- 2,870.3
Comprehensive income
Net income 302.1
Other comprehensive income:
Foreign currency translation
adjustment, net of $.5 tax (7.0)
Unrealized gain adjustment,
net of $12.2 tax 22.7
Total comprehensive income 317.8
Cash dividends on common
stock ($.46 per share) (65.9) (65.9)
Stock issued pursuant to
employee stock plans 3.7 67.1 70.8
Treasury stock purchase (2.1) (2.1)
------ --------- -------- ----------- ------------- ---------- -------- ---------
BALANCE, SEPTEMBER 30, 1996 289.5 2,448.4 542.1 (106.3) 19.3 -- (2.1) 3,190.9
Comprehensive income
Net income 33.9
Other comprehensive income:
Foreign currency translation
adjustment, net of $1.1 tax (29.8)
Unrealized gain adjustment,
net of $22.3 tax 41.4
Pension adjustment, net of $1.9 tax (3.5)
Total comprehensive income 42.0
Drilex pooling of interests 2.7 46.9 5.7 55.3
Spin-off of UNOVA (See Note 3) (513.1) (77.9) (8.8) (599.8)
Cash dividends on common
stock ($.46 per share) (69.6) (69.6)
Petrolite and other acquisitions 20.2 758.4 778.6
Stock issued pursuant to
employee stock plans 4.1 87.9 13.5 105.5
Treasury stock purchase (11.4) (11.4)
------ --------- -------- ----------- ------------- ---------- -------- ---------
BALANCE, SEPTEMBER 30, 1997 316.5 2,828.5 434.2 (144.9) 60.7 (3.5) -- 3,491.5
Comprehensive income
Net income 114.0
Other comprehensive income:
Foreign currency translation
adjustment, net of $1.6 tax (15.6)
Unrealized gain adjustment,
net of $10.3 tax (22.6)
Total comprehensive income 75.8
Cash dividends on common
stock ($.115 per share) (19.5) (19.5)
Stock issued pursuant to
employee stock plans 0.3 5.5 5.8
Adjustment for change in year end (34.6) (34.6)
------ --------- -------- ----------- ------------- ---------- -------- ---------
BALANCE, DECEMBER 31, 1997 316.8 2,834.0 494.1 (160.5) 38.1 (3.5) -- 3,519.0
Comprehensive income
Net loss (297.4)
Other comprehensive income:
Foreign currency translation
adjustment, net of $.5 tax 5.1
Unrealized loss adjustment,
net of $22.5 tax (38.2)
Pension adjustment, net of $.5 tax (.9)
Total comprehensive income (331.4)
Cash dividends on common
stock ($.46 per share) (96.3) (96.3)
Stock issued pursuant to
employee stock plans 10.3 97.8 108.1
------ --------- -------- ----------- ------------- ---------- -------- ---------
BALANCE, DECEMBER 31, 1998 $327.1 $ 2,931.8 $ 100.4 $ (155.4) $ (0.1) $ (4.4) $ -- $ 3,199.4
====== ========= ======== =========== ============= ========== ======== =========
See Notes to Consolidated Financial Statements
19
21
BAKER HUGHES INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended Three Months Ended Year Ended September 30,
(In millions) December 31, 1998 December 31, 1997 1997 1996
----------------- ------------------ ------------------------
Cash flows from operating activities:
Income (loss) from continuing operations $ (297.4) $ 111.2 $ 188.8 $ 246.4
Adjustments to reconcile income (loss) from
continuing operations to net cash flows from
operating activities:
Depreciation, depletion and amortization 758.3 141.7 554.9 465.0
Provision (benefit) for deferred income taxes (107.0) (4.2) (3.9) 28.6
Noncash portion of nonrecurring charges 513.2 32.7 25.3
Acquired in-process research and development 118.0
Gain on sale of Varco stock (44.3)
Gain on disposal of assets (32.0) (12.0) (20.7) (38.0)
Cumulative effect of accounting changes 12.1
Change in receivables 99.5 (84.4) (209.2) (132.1)
Change in inventories (39.5) (58.2) (110.1) (79.4)
Change in accounts payable (59.8) 8.5 82.9 43.6
Change in other assets and liabilities (25.6) 38.5 68.0 121.5
---------- ---------- ---------- ----------
Net cash flows from continuing operations 809.7 141.1 713.5 636.6
Net cash flows from discontinued operations 10.5 12.1 22.3
---------- ---------- ---------- ----------
Net cash flows from operating activities 809.7 151.6 725.6 658.9
---------- ---------- ---------- ----------
Cash flows from investing activities:
Expenditures for capital assets and multiclient
seismic data (1,318.2) (296.6) (1,047.7) (657.7)
Proceeds from disposal of assets 100.0 20.5 66.3 98.3
Cash obtained in stock acquisitions 68.7
Proceeds from sale of businesses 12.1
Acquisition of businesses, net of cash acquired (457.6) (43.1) (107.6) (33.6)
Proceeds from sale of investments 48.5 95.5
---------- ---------- ---------- ----------
Net cash flows from continuing operations (1,675.8) (319.2) (971.8) (485.4)
Net cash flows from discontinued operations (0.6) (406.3) 9.6
---------- ---------- ---------- ----------
Net cash flows from investing activities (1,675.8) (319.8) (1,378.1) (475.8)
---------- ---------- ---------- ----------
Cash flows from financing activities:
Net borrowings (payments) from commercial
paper and revolving credit facilities 977.3 (29.0) 471.0 (19.4)
Repayment of indebtedness (69.5) (21.4) (128.7) (111.6)
Proceeds from issuance of common stock 27.1 13.6 80.0 60.1
Dividends (96.3) (19.5) (69.6) (65.9)
Payment from UNOVA, Inc. 230.0 109.6 2.9
---------- ---------- ---------- ----------
Net cash flows from continuing operations 838.6 173.7 462.3 (133.9)
Net cash flows from discontinued operations 13.1 210.4 (44.5)
---------- ---------- ---------- ----------
Net cash flows from financing activities 838.6 186.8 672.7 (178.4)
Adjustment for change in year end (17.3)
Effect of foreign exchange rate changes on cash 2.2 (1.5) (2.1) (0.7)
---------- ---------- ---------- ----------
Increase (decrease) in cash and cash equivalents (25.3) (0.2) 18.1 4.0
Cash and cash equivalents, beginning of year 41.9 42.1 24.0 20.0
---------- ---------- ---------- ----------
Cash and cash equivalents, end of year $ 16.6 $ 41.9 $ 42.1 $ 24.0
========== ========== ========== ==========
See Notes to Consolidated Financial Statements
20
22
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Baker Hughes
Incorporated and all majority-owned subsidiaries (the "Company" or "Baker
Hughes"). In the Notes to Consolidated Financial Statements, all dollar amounts
in tabulations are in millions of dollars unless otherwise indicated.
CHANGE IN YEAR-END
On August 27, 1998, the Board of Directors of Baker Hughes approved a change in
the fiscal year-end of the Company from September 30 to December 31, effective
with the calendar year beginning January 1, 1998. A three-month transition
period from October 1, 1997 through December 31, 1997 (the "Transition Period")
precedes the start of the 1998 fiscal year. "1997" and "1996" refer to the
respective years ended September 30, the Transition Period refers to the three
months ended December 31, 1997 and "1998" refers to the twelve months ended
December 31, 1998.
MERGER
On August 10, 1998, Baker Hughes completed a merger (the "Merger") with Western
Atlas Inc. ("Western Atlas") by issuing 148.6 million shares of Baker Hughes
common stock for all of the outstanding common stock of Western Atlas. Each
share of Western Atlas common stock was exchanged for 2.7 shares of Baker
Hughes common stock. Western Atlas, the common stock of which was previously
publicly traded, is a leading supplier of oilfield services and reservoir
information technologies for the worldwide oil and gas industry. It specializes
in land, marine and transition-zone seismic data acquisition and processing
services, well-logging and completion services, and reservoir characterization
and project management services.
The Merger was accounted for as a pooling of interests and, accordingly,
all prior period consolidated financial statements of Baker Hughes have been
restated to include the results of operations, financial position and cash flows
of Western Atlas. Information concerning common stock, employee stock plans and
per share data has been restated on an equivalent share basis. The consolidated
financial statements as of September 30, 1997 and for each of the two years in
the period ended September 30, 1997 include Baker Hughes' previous September 30
fiscal year amounts and Western Atlas' December 31 calendar year amounts for the
corresponding fiscal years of Baker Hughes. Consolidated financial statements
for the three months ended December 31, 1997 include amounts for Baker Hughes
and Western Atlas for the three months ended December 31, 1997. As a result,
Western Atlas' results of operations for the three months ended December 31,
1997 are included in both the consolidated financial statements for the year
ended September 30, 1997 and for the Transition Period. Included in the
consolidated statement of stockholders' equity is a $34.6 million adjustment for
the change in year end which represents Western Atlas' results of operations for
the three months ended December 31, 1997 that is included in both 1997 and the
Transition Period.
The reconciliations of revenue, income from continuing operations and net
income (loss) of Baker Hughes and Western Atlas for the periods prior to the
combination are as follows:
Three Months Ended Year Ended September 30,
December 31, 1997 1997 1996
------------------ -------- --------
Revenues:
Baker Hughes $ 1,133.4 $3,685.4 $3,027.7
Western Atlas 439.5 1,658.2 1,418.1
--------- -------- --------
Combined $ 1,572.9 $5,343.6 $4,445.8
========= ======== ========
Income from continuing
operations:
Baker Hughes $ 79.4 $ 97.0 $ 176.4
Western Atlas 31.8 91.8 70.0
--------- -------- --------
Combined $ 111.2 $ 188.8 $ 246.4
========= ======== ========
Net income (loss):
Baker Hughes $ 79.4 $ 97.0 $ 176.4
Western Atlas 34.6 (63.1) 125.7
--------- -------- --------
Combined $ 114.0 $ 33.9 $ 302.1
========= ======== ========
There were no material adjustments required to conform the accounting
policies of the two companies. Certain amounts of Western Atlas have been
reclassified to conform to the reporting practices of Baker Hughes.
In connection with the Merger, in 1998 the Company recorded merger related
costs of $219.1 million. The categories of costs
21
23
incurred, the actual cash payments made in 1998 and the accrued balances at
December 31, 1998 are summarized below:
Accrued
Amounts Balance at
paid in December 31,
Total 1998 1998
------- ------- ------------
Cash costs:
Transaction costs $ 51.5 $ 46.9 $ 4.6
Employee costs 87.7 66.7 21.0
Other Merger
integration costs 21.7 9.8 11.9
------- ------- ------------
Subtotal cash cost 160.9 $ 123.4 $ 37.5
------- ======= ============
Noncash 58.2
-------
Total $ 219.1
=======
Transaction costs of $51.5 million include banking, legal and printing fees
and other costs directly related to the Merger. The Company had contracted for
and incurred most of the cost of the services for the remaining accrual,
however, such amounts had not been paid. The Company expects that all amounts
accrued for transaction costs will be paid by June 30, 1999.
Employee related costs of $87.7 million consist of payments made to certain
officers of Western Atlas and Baker Hughes pursuant to change in control
provisions and severance benefits paid to terminated employees whose
responsibilities were deemed redundant as a result of the Merger. Accrued
employee costs, other than retirement benefits, at December 31, 1998 of $12.8
million are scheduled to be paid to the employees upon leaving the Company
during the first quarter of 1999. The remaining accrued employee costs at
December 31, 1998 of $8.2 million represent retirement benefits of certain
employees that will be paid, in accordance with the terms of the agreements,
over the lives of the covered employees.
Other integration costs include the costs of changing legal registrations
in various jurisdictions, terminating a joint venture as a result of the Merger,
changing signs and logos at the Company's major facilities around the world and
other integration costs. The Company expects that the remaining balance of $11.9
million for other integration costs will be paid by June 30, 1999.
The noncash charge of $58.2 million consists of a charge of $45.3 million
related to the triggering of change of control rights contained in certain
Western Atlas employee stock option plans that were not converted to Baker
Hughes options concurrent with the Merger; a charge of $3.9 million for the
issuance of the Company's common stock pursuant to certain stock plans as a
result of the change in control; and a $9.0 million charge recorded to write-off
the carrying value of a product line that was discontinued as a result of the
Merger.
NOTE 2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation: The consolidated financial statements include
those of the Company and all majority owned subsidiaries. Investments in which
the Company owns 20 percent to 50 percent and exercises significant influence
over operating and financial policies are accounted for using the equity
method. All significant intercompany accounts and transactions have been
eliminated in consolidation.
Use of estimates: The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Revenue recognition: Revenue from product sales are recognized upon
delivery of products to the customer. Revenue from services and rentals are
recorded when such services are rendered.
Cash equivalents: The Company considers all highly liquid investments with
an original maturity of three months or less at the time of purchase to be cash
equivalents.
Inventories: Inventories are stated primarily at the lower of average cost
or market.
Property: Property is stated principally at cost less accumulated
depreciation, which is generally provided by using the straight-line method over
the estimated useful lives of individual items. The Company manufactures a
substantial portion of its rental tools and equipment, and the cost of these
items includes direct and indirect manufacturing costs.
The Company is developing and implementing SAP R/3 as an enterprise-wide
software system. External direct costs of con-
22
24
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
sulting services and payroll related cost of employees who work full-time on
implementation of the enterprise-wide software system are capitalized. Costs
associated with business process reengineering are expensed as incurred.
The Company uses the full-cost method of accounting for its investment in
oil and gas properties. Under this method, the Company capitalizes all
acquisition, exploration, and development costs incurred for the purpose of
finding oil and gas reserves. Depreciation, depletion, and amortization of oil
and gas properties is computed using the unit-of-production method based upon
production and estimates of proved reserves. Due to ceiling test limitations,
the Company had write-downs of $69.3 million, $12.5 million and $7.0 million
during 1998, 1997 and 1996, respectively.
Multiclient Seismic Data: Costs incurred in the creation of Company-owned
multiclient seismic data are capitalized and amortized over the estimated
revenue that the Company expects to receive from the licensing of such data.
Cash prepayments received from customers for specific contracts are included in
deferred revenue until earned.
Impairment of 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 prior policy and, therefore, the adoption of SFAS No. 121 did not
have a significant impact on the consolidated financial statements as it relates
to impairment of long-lived assets used in operations. The accounting for
long-lived assets to be disposed of requires these assets to be carried at the
lower of cost or fair market value as determined by a discounted cash flow
analysis, 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
$12.1 million ($.04 per share-diluted), net of a tax benefit of $6.0 million, in
1997 as the cumulative effect of a change in accounting.
Investments: Investments in debt and equity securities, other than those
accounted for by the equity method, are classified as available for sale and
reported at fair value with unrealized gains or losses, net of tax, recorded as
a separate component of comprehensive income within stockholders' equity.
Goodwill: Goodwill arising from acquisitions is amortized on the
straight-line method over the lesser of its expected useful life or 40 years.
Income taxes: Deferred income taxes are determined utilizing an asset and
liability approach. This method gives consideration to the future tax
consequences associated with differences between the financial accounting and
tax bases of assets and liabilities.
Environmental matters: Remediation costs are accrued based on estimates of
known environmental remediation exposure. Such accruals are recorded even if
significant uncertainties exist over the ultimate cost of the remediation.
Ongoing environmental compliance costs, including maintenance and monitoring
costs, are expensed as incurred. Where the Company has been identified as a
potentially responsible party in a Federal Superfund site, the Company accrues
its share of the estimated remediation costs of the site based on the ratio that
the estimated volume of waste contributed to the site by the Company bears to
the total volume of waste at the site.
Stock-based compensation: The intrinsic value method of accounting is used
for stock-based employee compensation whereby no compensation expense is
recognized when the exercise price of an employee stock option is equal to, or
greater than, the market price of the Company's common stock on the grant date.
Foreign currency translation: Gains and losses resulting from balance sheet
translation of foreign operations where a foreign currency is the functional
currency are included as a separate component of comprehensive income within
stockholders' equity. Gains and losses resulting from balance sheet translation
of foreign operations where the U.S. Dollar is the functional currency are
included in the consolidated statements of operations.
Financial instruments: The Company uses forward exchange contracts and
currency swaps to hedge certain firm commitments and transactions denominated
in foreign currencies. Gains and losses on forward contracts are deferred and
offset against foreign exchange gains or losses on the underlying hedged item.
The
23
25
Company uses interest rate swaps to manage interest rate risk. The interest
differentials from interest rate swaps are recognized as an adjustment to
interest expense. The Company's policies do not permit financial instrument
transactions for speculative purposes.
NOTE 3.
DISCONTINUED OPERATIONS
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, organized to conduct Western Atlas' industrial automation
systems business. Pursuant to the Spin-off, on October 31, 1997 each Western
Atlas shareholder received an equivalent number of shares of UNOVA common stock
in a tax-free transaction. As explained in Note 1, the fiscal year financial
information for Baker Hughes for the year ended September 30, 1997 includes
Western Atlas' results for calendar year 1997. Hence, on the statements of
consolidated stockholders' equity, the Spin-off of UNOVA is included in the
year ended September 30, 1997.
Income (loss) from discontinued operations includes interest expense
allocated on the basis of debt levels assumed in the Spinoff. Corporate, general
and administrative costs of Western Atlas were not allocated to UNOVA for any of
the periods presented. Concurrent with the Spin-off, UNOVA repaid Western Atlas
for intercompany indebtedness totaling $230.0 million.
Discontinued operations of UNOVA are as follows:
Three Months Ended Year Ended September 30,
December 31, 1997 1997 1996
------------------ --------- -----------
Revenue $107.0 $ 1,201.1 $ 1,164.7
Allocated interest expense 1.7 17.2 11.5
Allocated interest income 2.7 4.4
Income (loss) before income taxes 4.7 (122.7) 92.9
Provision for income taxes (1.9) (32.2) (37.2)
------ --------- --------
Discontinued operations $ 2.8 $ (154.9) $ 55.7
====== ========= ========
The UNOVA results of operations in 1997 include a $203.0 million charge for
acquired in-process research and development activities related to UNOVA's
acquisition of Norand Corporation and United Barcode Industries in 1997.
The net assets of UNOVA as of the distribution date were as follows:
Current assets $ 752.7
Noncurrent assets 586.9
---------------
Total assets 1,339.6
---------------
Current liabilities (652.2)
Noncurrent liabilities (87.6)
---------------
Total liabilities (739.8)
---------------
Net assets of UNOVA $ 599.8
===============
NOTE 4.
EARNINGS PER SHARE
The Company adopted SFAS No. 128, "Earnings per Share," in the Transition
Period. SFAS No. 128 establishes new standards for computing and presenting
earnings per share ("EPS"), and requires all prior periods to be restated.
Reconciliation of the numerators and denominators of the basic and diluted EPS
computations for income from continuing operations is as follows:
Year Ended Year Ended
September 30, 1997 September 30, 1996
---------------------- ---------------------
(Loss) Shares Income Shares
-------- -------- -------- --------
Basic $ (297.4) 321.7 $ 111.2 316.2
Effect of dilutive securities,
net of tax:
Stock plans 6.2
Liquid Yield Option Notes 1.7 7.2
-------- -------- -------- --------
Diluted $ (297.4) 321.7 $ 112.9 329.6
======== ======== ======== ========
Year Ended Year Ended
September 30, 1997 September 30, 1996
---------------------- ---------------------
Income Shares Income Shares
-------- -------- -------- --------
Basic $ 200.9 299.5 $ 246.4 287.7
Effect of dilutive securities,
net of tax:
Stock plans 5.2 2.9
Liquid Yield Option Notes 6.0 7.2
-------- -------- -------- --------
Diluted $ 200.9 304.7 $ 252.4 297.8
======== ======== ======== ========
Securities excluded from the computation of diluted EPS for the year ended
December 31, 1998 that could potentially dilute basic EPS in the future were
options to purchase 13.3 million shares, Liquid Yield Option Notes convertible
into 7.2 million shares and 1.6 million shares estimated to be issued under the
Company's employee stock purchase plan. Since the Company incurred a loss for
1998, such dilutive securities were excluded as they would be anti-dilutive to
basic EPS.
24
26
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5.
INVENTORIES
Inventories are comprised of the following:
December 31, 1998 December 31, 1997
----------------- -----------------
Finished goods $ 855.2 $ 911.5
Work in process 83.2 138.2
Raw materials 127.3 95.3
---------- ----------
Total $ 1,065.7 $ 1,145.0
========== ==========
NOTE 6.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment is comprised of the following:
December 31, 1998 December 31, 1997
----------------- -----------------
Land $ 86.0 $ 73.0
Buildings 613.3 534.3
Machinery and equipment 2,313.6 1,983.6
Rental tools and equipment 906.5 820.0
Oil and gas properties,
full cost method 225.1 114.8
---------- ----------
Total property 4,144.5 3,525.7
Accumulated depreciation
and depletion 1,852.2 1,546.7
---------- ----------
Property-net $ 2,292.3 $ 1,979.0
========== ==========
NOTE 7.
ACQUISITIONS AND DISPOSITIONS
In addition to the acquisitions discussed separately below, the Company made
several smaller acquisitions in each respective year with an aggregate purchase
price of $119.2 million during 1998, $74.3 million during the Transition
Period, $98.4 million in 1997 and $32.9 million in 1996. 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 statements 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.
1998
WEDGE and 3-D
In April 1998, the Company acquired all the outstanding stock of WEDGE DIA-Log,
Inc. ("WEDGE") for $218.5 million in cash. WEDGE specializes in cased-hole
logging and pipe recovery services. Also in April 1998, the Company acquired
3-D Geophysical, Inc. ("3-D") for $117.5 million in cash. 3-D is a supplier of
primarily land-based seismic data acquisition services. The purchase method of
accounting was used to record both of these acquisitions. Pro forma results of
these two acquisitions have not been presented as the pro forma revenue, net
income, and earnings per share would not be materially different from the
Company's actual results.
1997
PETROLITE
In July 1997, the Company acquired Petrolite Corporation ("Petrolite") and Wm.
S. Barnickel & Company ("Barnickel"), the holder of 47.1 percent of Petrolite's
common stock, for 19.3 million shares of the Company's common stock having a
value of $730.2 million in a three-way business combination. The purchase
method of accounting was used to record these acquisitions. Additionally, the
Company assumed Petrolite's outstanding vested and unvested employee stock
options which were converted into the right to acquire 1.0 million shares of
the Company's common stock. Such assumption of Petrolite options by the Company
had a fair market value of $21.0 million resulting in total consideration in
the acquisitions of $751.2 million. Petrolite, the shares of which were
previously publicly traded, is a manufacturer and marketer of specialty
chemicals used in the petroleum and process industries. Barnickel was a
privately held company that owned marketable securities, which were sold after
the acquisition, in addition to its investment in Petrolite.
The acquisition of Petrolite in 1997 was accounted for as a purchase.
Accordingly, the purchase price was allocated to the assets acquired and the
liabilities assumed based on their estimated fair market values at the date of
the acquisition. In accordance with generally accepted accounting principles,
the $118.0 million
25
27
allocated to in-process research and development has been recorded as a charge
in the consolidated statement of operations as of the acquisition date because
the technological feasibility of the projects in-process had not been
established and there was no alternative future use at that date.
There were 26 individual research and development projects that were in
development at the time of the acquisition that were classified as in-process
research and development. The products under development were valued using a
discounted cash flow analysis at a 14 percent discount factor. The cash flows
were projected for a 20-year period and included additional research and
development and capital expenditures required to complete the projects. The
gross margins used for these products were generally consistent with those of
other chemical products sold by the Company. The 14 percent discount factor used
considered the time value of money, inflation, and the risk inherent in the
projects under development. In aggregate, the remaining completion costs for
these products were projected to exceed $7.2 million with completion periods
varying from 90 days to two years. Significant cash inflows from these products
in total were expected to commence during 1999. During 1998, 16 of these
products generated commercial sales, five had product sales on a trial basis
only, and five were determined not to be viable products.
The Company incurred certain liabilities as part of the plan to combine the
operations of Petrolite with those of the Company. These liabilities relate to
the Petrolite operations and include severance of $13.8 million for redundant
marketing, manufacturing, and administrative personnel, relocation of $5.8
million for moving equipment and transferring marketing and technology
personnel, primarily from St. Louis to Houston, and environmental remediation of
$16.5 million for redundant properties and facilities that were to be sold. Cash
spent during 1998, the Transition Period, and 1997 totaled $12.9 million, $2.1
million and $7.7 million, respectively.
DRILEX
In July 1997, the Company acquired Drilex International Inc. ("Drilex"), a
provider of products and services used in the directional and horizontal
drilling and workover of oil and gas wells, for 2.7 million shares of the
Company's common stock. The acquisition was accounted for using the pooling of
interests method of accounting. Under this method of accounting, the historical
cost bases of the assets and liabilities of the Company and Drilex are combined
at recorded amounts and the results of operations of the combined companies for
1997 are included in the 1997 consolidated statement of operations. The
historical results of the separate companies for years prior to 1997 are not
combined because the retained earnings and results of operations of Drilex are
not material to the consolidated financial statements of the Company.
NORAND AND UNITED BARCODE INDUSTRIES
The Company acquired Norand Corporation ("Norand") on March 3, 1997, and United
Barcode Industries ("UBI") on April 4, 1997. These companies were integrated
into the Company's industrial automation systems operations and included in the
Spin-off of UNOVA. The purchase method of accounting was used to record these
acquisitions; and, accordingly, the acquisition costs of $280.0 million and
$107.0 million for Norand and UBI, respectively, were allocated to the net
assets acquired based upon their relative fair values. In accordance with
generally accepted accounting principles, such allocation assigned a combined
value for the two acquisitions of $203.0 million to in-process research and
development activities, which was expensed in 1997 because its technological
feasibility had not been established and it had no alternative future use at
the date of acquisition.
1996
In May 1996, the Company sold 6.3 million shares of Varco International, Inc.
("Varco") common stock, representing its entire investment in Varco. The
Company received net proceeds of $95.5 million and recognized a pretax gain of
$44.3 million. The Company's investment in Varco was accounted for using the
equity method. Equity income included in the consolidated statement of
operations for 1996 was $1.8 million.
26
28
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8.
UNUSUAL AND OTHER NONRECURRING CHARGES
1998
The Company had experienced high growth levels for its products and services
from 1994 through the second quarter of 1998. During the third and fourth
quarters of 1998, the Company experienced a decline in demand for its products
and services as a result of a significant decrease in the price of oil and
natural gas. The decline in customer demand materialized quickly from the
previous high growth rates. As a result of this sharp decline in demand and to
adjust to the lower level of activity, the Company assessed its overall
operations and recorded charges of $549.0 million in the September quarter and
$40.5 million in the December quarter as summarized below:
Accrued
Amounts Balance at
paid in December 31,
Total 1998 1998
------------ ------------ ------------
Cash charges:
Severance for
approximately
5,300 employees $ 64.3 $ 26.6 $ 37.7
Integration costs, abandoned
leases and other
contractual obligations 40.0 14.7 25.3
Environmental reserves 8.8 4.3 4.5
Other cash costs (includes
litigation reserves) 21.4 4.7 16.7
------------ ------------ ------------
Subtotal cash charges 134.5 $ 50.3 $ 84.2
------------ ============ ============
Noncash charges - write-down of:
Inventory and rental tools 173.2
PetroAlliance Services
Company Limited 83.2
Property and other assets 80.1
Oil and gas properties (ceiling-test) 69.3
Intangible assets 21.5
Real estate held for sale 17.0
Investments in affiliates 10.7
------------
Subtotal noncash charges 455.0
------------
Total cash and noncash charges $ 589.5
============
The above charges were reflected in the following captions of the
consolidated statement of operations:
Costs of revenues $ 305.0
Selling, general and administrative 68.7
Unusual charge 215.8
------------
Total $ 589.5
============
The amount accrued for severance is based upon the Company's written
severance policy and the positions eliminated. The accrued severance does not
include any portion of the employees' salaries through their severance dates.
Based upon current severance dates, the Company expects that of the accrued
severance remaining at December 31, 1998, $27.0 million will be paid during the
first quarter of 1999 and the remaining $10.7 million will be paid during the
second quarter of 1999 when the employees leave the Company.
The Company accrued $40.0 million to combine operations and consolidate
facilities. Such accrual includes costs to settle leases on idled facilities
based upon lease agreements; to shut-down oil and gas operations in certain
countries based upon management's decision to abandon operations; to terminate a
rig contract based upon the terms of the agreement; and other collocation costs
based upon the estimated exit costs for approved plans. The accrual does not
include any portion of the costs before actual abandonment of the facilities or
ceasing of the operations. The Company expects to spend approximately $9.4
million of the accrued balance as of December 31, 1998 during the first quarter
of 1999 and, except for amounts payable under terms of leases and other
contracts, the remaining amounts accrued will be paid during the remainder of
1999.
The impairment of inventory and rental tool assets of $173.2 million
impacted virtually all operating divisions and was due to advances in technology
that have obsoleted certain product lines, as well as a decline in market demand
that has resulted in an excess supply of certain products. The product lines
most affected were completion products, drilling and evaluation systems and
tools, tricone and diamond drill bits, and filtration systems. Much of the
obsolete and excess inventory will be scrapped and has been written off
completely. The remaining assets have been written down to their estimated value
based on the Company's inventory and rental tool obsolescence policy.
In the third quarter of 1998, the Company recorded an $83.2 million
write-down of PetroAlliance Services Company Limited ("PAS"), a former
consolidated joint venture operating in the former Soviet Union. The write-down
of the joint venture was based upon the Company's estimated value of assets
ultimately received in consideration of the sale of the PAS investment in
November 1998. The Company received as consideration for the
27
29
sale of PAS a seismic vessel, other seismic and well-logging assets, certain PAS
assets in Kazakhstan and Turkmenistan, certain customer receivables and a $33.0
million note from the purchasers. The write-down included $10.7 million for
equipment, $22.0 million of goodwill, and $50.5 million of net current assets.
The impairment of property and other assets of $80.1 million includes an
$18.1 million write-down to reduce the carrying value of a portion of the
Company's drilling equipment; a $12.6 million write-off of obsolete solid and
oil-filled streamer sections used on seismic vessels; a $14.9 million write-down
of surplus well-logging equipment; a $9.5 million write-off of prepaid royalties
on an abandoned product line; and $25.0 million of assets written down to fair
market value. The write-down of these assets was determined based on internally
developed valuations using a variety of methods.
The write-off of intangible assets of $21.5 million includes $2.7 million
for capitalized software costs for product lines abandoned as a result of recent
acquisitions; $5.3 million for capitalized development costs for software
systems that are being replaced by the Company's implementation of SAP R/3; and
$13.5 million for goodwill associated with a discontinued business and a
subsidiary held for sale.
The write-down of real estate held for sale of $17.0 million is for a
specific property and the charge reduces the carrying value to the property's
appraised value.
The $10.7 million charge is to write-off investments in joint ventures in
both Russia and Indonesia and also includes a loss on the sale of Tracor Europa,
a discontinued subsidiary.
1997
During the year ended September 30, 1997, the Company recognized a $52.1 million
unusual charge consisting of the following:
Baker Petrolite:
Severance for 140 employees $ 2.2
Relocation of people and equipment 3.4
Environmental 5.0
Abandoned leases 1.5
Integration costs 2.8
Inventory write-down 11.3
Write-down of other assets 9.3
Drilex:
Write-down of property and other assets 4.1
Banking and legal fees 3.0
Discontinued product lines:
Severance for 50 employees 1.5
Write-down of inventory, property and other assets 8.0
------------
Total $ 52.1
============
In connection with the acquisitions of Petrolite, accounted for as a
purchase, and Drilex, accounted for as a pooling of interests, the Company
recorded unusual charges of $35.5 million and $7.1 million, respectively, to
combine the acquired operations with those of the Company. The charges include
the cost of closing redundant facilities, eliminating or relocating personnel
and equipment and rationalizing inventories which required disposal at amounts
less than cost. A $9.5 million charge was recorded as a result of the decisions
to: 1) discontinue a low margin, oilfield product line in Latin America; and, 2)
sell the Tracor Europa subsidiary, a computer peripherals distributor, which was
written down to net realizable value. Cash provisions of the unusual charge
totaled $19.4 million. The Company spent $12.3 million in 1998, $1.6 million
during the Transition Period, and $5.5 million during 1997.
1996
During the year ended September 30, 1996, the Company recognized a $39.6 million
unusual charge consisting of the following:
Patent write-off $ 8.5
Impairment of joint venture 5.0
Restructurings:
Severance for 360 employees 7.1
Relocation of people and equipment 2.3
Abandoned leases 2.8
Inventory write-down 1.5
Write-down of assets 10.4
Other 2.0
------------
Total $ 39.6
============
The Company recorded a $24.1 million restructuring charge, which includes
costs associated with the downsizing of Baker Hughes INTEQ's Singapore and Paris
operations, a reorganization of EIMCO Process Equipment's Italian operations,
and the consolidation of certain Baker Oil Tools manufacturing operations. The
Company had certain oilfield operations patents which no longer protected
commercially significant technology resulting
28
30
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
in a write-off of $8.5 million. A $5.0 million impairment of a Latin America
joint venture was recorded due to changing market conditions in the region in
which it operates. Cash provisions of the charge totaled $14.3 million. The
Company spent $3.8 million during the Transition Period, $6.3 million during
1997 and $4.2 million during 1996.
NOTE 9.
INDEBTEDNESS
Total debt consisted of the following:
December 31, 1998 December 31, 1997
----------------- -----------------
Short-term debt with an
average interest rate of 5.72%
at December 31, 1998 $ 943.3 $ 355.8
Commercial Paper with an
average interest rate of 5.28%
at December 31, 1998 759.1 370.3
Liquid Yield Option Notes
("LYONS") due May 2008 with a
yield to maturity of 3.5% per
annum, net of unamortized
discount of $109.6 at December
31, 1998 ($119.5 at December 31,
1997) 275.5 265.7
7.625% Notes due February
1999 with an effective
interest rate of 7.73%, net of
unamortized discount of $.3 at
December 31, 1997 150.0 149.7
8% Notes due May 2004 with
an effective interest rate of 8.08%,
net of unamortized discount of $.8
at December 31, 1998 ($.9 at
December 31, 1997) 99.2 99.1
7.875% Notes due June 2004 with
an effective interest rate of 8.13%,
net of unamortized discount of $2.2
at December 31, 1998 ($2.6 at
December 31, 1997) 247.8 247.4
8.55% Debentures due June 2024
with an effective interest rate of
8.80%, net of unamortized discount
of $2.8 at December 31, 1998
($2.9 at December 31, 1997) 147.2 147.1
8.59% Debentures due January 2000
with an effective interest
rate of 6.75% 93.0 93.0
5.65% Notes due 1998 48.5
Other debt with an effective
interest rate of 6.08%
at December 31, 1998 55.6 6.0
-------- --------
Total debt 2,770.7 1,782.6
Less short-term debt
and current maturities 44.4 177.3
-------- --------
Long-term debt $2,726.3 $1,605.3
======== ========
At December 31, 1998, the Company had $2,237.4 million of credit facilities
with commercial banks, of which $1,000.0 million was committed. The committed
facilities mature as follows: $250.0 million in 2000 and $750.0 million in 2003.
The Company's policy is to classify commercial paper and short-term borrowings
as long-term debt, to the extent of its committed facilities and to the extent
of its intent to refinance the short-term obligations, since the Company has the
ability under certain credit agreements, and the intent, to maintain these
obligations for longer than one year.
The Liquid Yield Option Notes ("LYONS") are convertible into the Company's
common stock at a conversion price of $38.88 per share, as of December 31, 1998,
which increases at an annual rate of 3.5 percent. At the option of the Company,
the LYONS may be redeemed for cash at a redemption price equal to the issue
price plus accrued original issue discount through the date of redemption. At
the option of the holder, the LYONS may be redeemed for cash on May 5, 2003, for
a redemption price equal to the issue price plus accrued original issue discount
through the date of redemption.
Subsequent to December 31, 1998, the Company issued $400 million of 6.875
percent Notes due January 2029, $325 million of 6.25 percent Notes due January
2009, $200 million 6.0 percent Notes due February 2009 and $100 million of 5.8
percent Notes due 2003 with effective interest rates of 7.07 percent, 6.36
percent, 6.09 percent and 6.01 percent, respectively. The proceeds were used to
repay $150.0 million of the 7.625 percent Notes due February 1999, commercial
paper and other short-term borrowings. Accordingly, such amounts are presented
as long-term debt in the accompanying consolidated statement of financial
position.
29
31
Maturities of debt at December 31, 1998 after consideration of the
refinancing subsequent to year end as discussed above are as follows: 1999-$44.4
million; 2000-$185.1 million; 2001-$1.5 million, 2002-$9.2 million, 2003-$849.3
million and $1,681.2 million thereafter.
NOTE 10.
FINANCIAL INSTRUMENTS
INTEREST RATE SWAPS
At December 31, 1998, the Company was party to an interest rate swap agreement
for a notional amount of $93.0 million on which the Company pays interest at a
rate of LIBOR plus 2 percent and receives interest at a rate of 8.59 percent.
The interest rate swap settles semi-annually and terminates on January 27,
2000. 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 December 31, 1998, the Company entered into an interest rate
swap with a notional amount of $325.0 million. The Company will receive interest
at a rate of 6.25 percent and pay interest at a rate equal to the average of 6
month LIBOR for Yen, Euro and Swiss Franc plus a 3.16 percent spread. The
interest rate swap will settle semi-annually and terminate in January 2009. 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.
FOREIGN CURRENCY CONTRACTS
At December 31, 1998, the Company had entered into foreign currency forward
contracts with notional amounts of $88.9 million to hedge the commitment to
purchase two seismic vessels and $29.1 million to hedge equipment purchases
under a long-term purchase agreement. The fair value of these contracts, based
on year-end quoted market prices for contracts with similar terms and maturity
dates, was $80.8 million and $30.2 million, respectively. Foreign currency
gains and losses for such purchases are deferred and will become part of the
cost of the assets. 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 and, in
management's opinion, present no significant credit risk to the Company.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments include cash and short-term investments,
receivables, long-term investments, payables, debt and interest rate, and
foreign currency contracts. Except as described below, the estimated fair
values of such financial instruments at December 31, 1998 and 1997 approximate
their carrying value as reflected in the consolidated statements of financial
position. The fair value of the Company's debt and interest rate and foreign
currency contracts has been estimated based on quoted market prices and the
Black-Scholes option-pricing model.
The estimated fair value of the Company's debt at December 31, 1998 and
1997 was $2,818.7 million and $1,913.8 million, respectively, which differs from
the carrying amounts of $2,770.7 million and $1,782.6 million, respectively,
included in the consolidated statements of financial position. The fair value of
the Company's interest rate swap contracts at December 31, 1998 and 1997 was
$1.6 million and $2.8 million, respectively.
CONCENTRATION OF CREDIT RISK
The Company sells its products and services to various companies in the oil and
gas industry. Although this concentration could affect the Company's overall
exposure to credit risk, management believes that the Company is exposed to
limited risk since the majority of its business is conducted with major
companies within the industry. The Company performs periodic credit evaluations
of its customers' financial condition and generally does not require collateral
for its accounts receivables. In some cases, the Company will require payment
in advance or security in the form of a letter of credit or bank guarantee.
The Company maintains cash deposits with major banks which from time to
time may exceed federally insured limits. The Company periodically assesses the
financial condition of the institutions and believes that any possible loss is
minimal.
30
32
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11.
EMPLOYEE STOCK PLANS
The Company has stock option plans that provide for granting of options for the
purchase of common stock to officers and other key employees. These stock
options may be granted subject to terms ranging from one to 10 years at a price
equal to or greater than the fair market value of the stock at the date of
grant.
Stock option activity for the Company was as follows:
Weighted Average
Number Exercise Price
(Shares in thousands) of Shares Per Share
--------- ---------
Outstanding at September 30, 1995 12,758 $ 15.30
------- --------
Granted 2,803 20.75
Exercised (2,965) 15.89
Forfeited (403) 18.45
------- --------
Outstanding at September 30, 1996 12,193 16.30
------- --------
Granted 3,237 30.15
Options assumed in acquisitions 2,324 16.04
Spin-off adjustment 2,387
Exercised (3,590) 16.04
Forfeited (204) 21.32
------- --------
Outstanding at September 30, 1997 16,347 16.54
------- --------
Granted 3,173 47.81
Exercised (818) 12.26
Forfeited (4) 30.83
Adjustment for change in year end 528
------- --------
Outstanding at December 31, 1997 19,226 21.66
------- --------
Granted 6,233 21.29
Exercised (1,661) 10.90
Forfeited (655) 28.30
Change in control rights converted (9,811)
------- --------
Outstanding at December 31, 1998 13,332 $ 27.24
------- --------
The Merger with Western Atlas triggered change in control rights contained in
certain Western Atlas employee stock option plans. Conversion of 9.8 million
options with these change in control rights resulted in the issuance of 7.5
million shares of the Company's common stock.
In connection with the Spin-off, all employee and director options of
Western Atlas outstanding immediately prior to the Spin-off were adjusted by
increasing the number of shares subject to the option and decreasing the
exercise price per share so as to preserve the difference between the aggregate
exercise price of the option and the aggregate market value of the shares
subject to the option.
Under the terms of the Baker Hughes and Western Atlas stock option plans,
all outstanding options at August 10, 1998 vested as a result of the Merger. At
December 31, 1998, 4.6 million shares were available for future option grants.
The fair market value of the options granted in 1998, the Transition
Period, 1997 and 1996 was $7.79, $14.47, $11.18 and $6.49, respectively, using
the following assumptions for those respective years in the Black-Scholes
option-pricing model: dividend yield of 2.2 percent, 0.96 percent, 1.5 percent
and 2.2 percent; expected volatility of 49.4 percent, 36.4 percent, 33.5 percent
and 26.7 percent; risk-free interest rate of 4.2 percent, 5.6 percent, 6.2
percent and 6.2 percent; and expected life of each option of 4.3 years, 3.2
years, 4.6 years and 4.6 years.
The following table summarizes information for stock options outstanding at
December 31, 1998 (shares in thousands):
Outstanding Exercisable
---------------------------------------------------------------------------
Weighted
Average Remaining Weighted Weighted
Range of Contractual Average Average
Exercise Prices Shares Life (Years) Exercise Price Shares Exercise Price
- --------------- ------ ----------------- -------------- ------ --------------
$ 0.61 - 14.86 872 6.45 $ 10.49 578 $ 10.94
16.74 - 20.50 1,720 6.51 19.07 1,650 19.15
21.00 - 27.85 6,733 9.18 21.19 725 22.77
28.50 - 38.69 1,020 7.25 35.13 952 35.08
39.88 - 47.81 2,987 8.73 47.75 2,975 47.78
------ ---- ------- ----- -------
Total 13,332 8.41 $ 27.24 6,880 $ 33.43
====== ==== ======= ===== =======
31
33
The following table summarizes pro forma disclosures assuming the Company
had used the fair market value method of accounting for its stock based
compensation plans:
Year Ended Three Months Year Ended
December 31, Ended December 31, September 30,
1998 1997 1997 1996
------------ ------------------ ------- ------
Pro forma
net income (loss) $ (318.0) $ 99.2 $ 16.2 $ 294.0
Pro forma EPS - basic (0.99) 0.31 0.05 1.02
Pro forma EPS - diluted (0.99) 0.31 0.05 1.01
The effects of applying the fair market value method of accounting in the
above pro forma disclosure may not be indicative of future amounts since the pro
forma disclosure does not apply to options granted prior to 1996 and additional
awards in future years are anticipated.
NOTE 12.
INCOME TAXES
The geographic sources of income (loss) from continuing operations before income
taxes and cumulative effect of accounting changes are as follows:
Year Ended Three Months Year Ended
December 31, Ended December 31, September 30,
1998 1997 1997 1996
-------- ------- ------- -------
United States $ (293.1) $ 40.9 $ 52.9 $ 149.6
Foreign 12.0 138.3 311.4 265.9
-------- ------- ------- -------
Total $ (281.1) $ 179.2 $ 364.3 $ 415.5
======== ======= ======= =======
The provision for income taxes is comprised of:
Year Ended Three Months Year Ended
December 31, Ended December 31, September 30,
1998 1997 1997 1996
------------ ------------------ ----------------
Current:
United States $ 35.9 $ 32.2 $ 54.6 $ 42.7
Foreign 87.4 40.0 112.7 97.8
-------- ------- ------- -------
Total current 123.3 72.2 167.3 140.5
-------- ------- ------- -------
Deferred:
United States (74.7) (14.1) 2.7 19.1
Foreign (32.3) 9.9 (6.6) 9.5
-------- ------- ------- -------
Total deferred (107.0) (4.2) (3.9) 28.6
-------- ------- ------- -------
Provision for
income taxes $ 16.3 $ 68.0 $ 163.4 $ 169.1
======== ======= ======= =======
Tax benefits of $16.1 million, $1.4 million, $11.0 million, and $5.1
million associated with the exercise of employee stock options were allocated to
equity in the periods ended December 31, 1998, December 31, 1997, September 30,
1997 and September 30, 1996, respectively.
The provision for income taxes differs from the amount computed by applying
the U.S. statutory income tax rate to income before income taxes and cumulative
effect of accounting changes for the reasons set forth below:
Year Ended Three Months Year Ended
December 31, Ended December 31, September 30,
1998 1997 1997 1996
------------ ------------------ ---------------
Statutory income
tax at 35% $ (98.4) $ 62.7 $ 127.5 $ 145.4
Merger and acquisition
related costs 55.8 41.3
IRS audit agreement
and refund claims (18.4) (11.4)
Nondeductible
goodwill amortization 13.7 2.0 6.1 7.0
State income taxes -
net of U.S. tax benefit 4.0 2.1 4.6 1.6
Incremental effect of
foreign operations 25.4 6.5 (6.7) 8.9
Foreign losses with no
tax benefit 36.0 1.7 4.9
Utilization of operating
loss carryforwards (0.6) (4.2) (3.3)
Other-net (1.8) (4.7) 4.5 4.6
------- ------- ------- -------
Provision for
income taxes $ 16.3 $ 68.0 $ 163.4 $ 169.1
======= ======= ======= =======
The effective tax rates before Merger and acquisition related costs, Spin-off
related costs, unusual and other nonrecurring items were 35.5 percent, 37.9
percent, 35.2 percent and 40.0 percent for the periods ended December 31, 1998,
December 31, 1997, September 30, 1997 and September 30, 1996, respectively.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
for income tax purposes, and of operating loss and tax credit carryforwards. The
tax effects of the Company's temporary differences and carryforwards are as
follows:
32
34
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, December 31,
1998 1997
------------ ------------
Deferred tax liabilities:
Property $ 90.4 $ 95.6
Other assets 55.6 153.8
Excess costs arising
from acquisitions 72.5 68.1
Undistributed earnings
of foreign subsidiaries 39.3 41.3
Other 41.1 43.4
------- -------
Total 298.9 402.2
Deferred tax assets:
Receivables 12.4 3.0
Inventory 126.7 99.1
Employee benefits 26.1 24.2
Other accrued expenses 75.6 52.6
Operating loss carryforwards 19.1 10.8
Tax credit carryforwards 55.3 15.5
Other 8.6 40.5
------- -------
Subtotal 323.8 245.7
Valuation allowances (32.3) (12.6)
------- -------
Total 291.5 233.1
------- -------
Net deferred tax liability $ 7.4 $ 169.1
======= =======
A valuation allowance is recorded when it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The ultimate
realization of the deferred tax assets depends on the ability to generate
sufficient taxable income of the appropriate character in the future. The
Company has reserved the operating loss carryforwards in certain non-U.S.
jurisdictions where its operations have decreased, currently ceased or the
Company has withdrawn entirely.
Provision has been made for U.S. and additional foreign taxes for the
anticipated repatriation of certain earnings of foreign subsidiaries of the
Company. The Company considers the undistributed earnings of its foreign
subsidiaries above the amount already provided to be permanently reinvested.
These additional foreign earnings could become subject to additional tax if
remitted, or deemed remitted, as a dividend; however, the additional amount of
taxes payable is not practicable to estimate.
At December 31, 1998, the Company had approximately $47.5 million of
foreign tax credits, $6.5 million of general business credits, and $1.3 million
of alternative minimum tax credits available to offset future payments of
federal income taxes, expiring in varying amounts between 2003 and 2009. The
alternative minimum tax credits may be carried forward indefinitely under
current U.S. law.
NOTE 13.
SEGMENT AND RELATED INFORMATION
The Company's nine business units have separate management teams and
infrastructures that offer different products and services. The business units
have been aggregated into two reportable segments--oilfield and process--since
the long-term financial performance of these reportable segments is affected by
similar economic conditions.
Oilfield: This segment consists of eight business units - Baker Atlas, Baker
Hughes INTEQ, Baker Oil Tools, Baker Petrolite, Centrilift, E&P Solutions,
Hughes Christensen and Western Geophysical - that manufacture and sell
equipment and provide services used in the drilling, completion, production and
maintenance of oil and gas wells and in reservoir measurement and evaluation.
The principal markets for this segment include all major oil and gas producing
regions of the world including North America, Latin America, Europe, Africa,
the Middle East and the Far East. Customers include major multinational,
independent and national or state-owned oil companies.
Process: This segment consists of one business unit--Baker Process --that
manufactures and sells process equipment for separating solids from liquids and
liquids from liquids through filtration, sedimentation, centrifugation and
floatation processes. The principal markets for this segment include all regions
of the world where there are significant industrial and municipal wastewater
applications and base metals activity. Customers include municipalities,
contractors, engineering companies and pulp and paper, minerals, industrial, and
oil and gas producers.
The accounting policies of the reportable segments are the same as those
described in Note 2 of Notes to Consolidated Financial Statements. The Company
evaluates the performance of its operating segments based on income before
income taxes, accounting changes, nonrecurring items, and interest income and
expense. Intersegment sales and transfers are not significant.
33
35
Summarized financial information concerning the Company's reportable
segments is shown in the following table. The "Other" column includes
corporate-related items, results of insignificant operations and, as it relates
to segment profit (loss), income and expense not allocated to reportable
segments.
Oilfield Process Other Total
-------- ------- ----- -----
1998
Revenues $5,801.8 $ 490.2 $ 19.9 $6,311.9
Segment profit (loss) 737.7 24.1 (1,042.9) (281.1)
Total assets 6,969.2 425.4 416.2 7,810.8
Capital expenditures 1,258.5 17.2 42.5 1,318.2
Depreciation, depletion
and amortization 729.7 12.9 15.7 758.3
Transition period
Revenues $1,441.6 $ 124.1 $ 7.2 $1,572.9
Segment profit (loss) 215.2 9.0 (45.0) 179.2
Total assets 6,314.8 375.3 540.5 7,230.6
Capital expenditures 279.0 1.6 16.0 296.6
Depreciation, depletion
and amortization 135.7 2.7 3.3 141.7
1997
Revenues $4,942.3 $ 386.1 $ 15.2 $5,343.6
Segment profit (loss) 676.8 36.3 (348.8) 364.3
Total assets 6,222.2 363.7 501.1 7,087.0
Capital expenditures 1,013.0 6.4 28.3 1,047.7
Depreciation, depletion
and amortization 529.9 8.4 16.6 554.9
1996
Revenues $4,065.4 $ 352.8 $ 27.6 $4,445.8
Segment profit (loss) 518.9 31.2 (134.6) 415.5
Total assets 4,429.7 258.9 1,108.0 5,796.6
Capital expenditures 646.4 6.6 4.7 657.7
Depreciation, depletion
and amortization 436.5 6.7 21.8 465.0
The following table presents the details of "Other" segment profit (loss).
Three Months
Year Ended Ended Year Ended
December 31, December 31, September 30,
1998 1997 1997 1996
------------ ------------ --------- --------
Corporate expenses $ (88.9) $ (21.6) $ (61.8) $ (59.2)
Interest expense-net (145.4) (23.4) (87.8) (83.0)
Unusual charge (215.8) (52.1) (39.6)
Acquired in-process research
and development (118.0)
Nonrecurring charges to costs
of revenues and SG&A (373.7) (21.9)
Gain on sale of Varco stock 44.3
Merger related costs (219.1)
Spin-off related costs (8.4)
Other 1.2 2.9
--------- ------- -------- -------
Total $(1,042.9) $ (45.0) $ (348.8) $(134.6)
========= ======= ======== =======
The following table presents consolidated revenues by country based on the
location of the use of the product or service.
Year Ended Three Months Year Ended
December 31, Ended December 31, September 30,
1998 1997 1997 1996
------------ ------------------ --------- ---------
United States $2,196.4 $ 545.6 $ 1,849.0 $ 1,479.3
United Kingdom 572.2 117.8 426.6 383.1
Venezuela 350.4 107.5 383.0 246.8
Norway 269.7 64.2 222.8 185.4
Canada 257.8 87.6 266.3 203.9
Other countries
(approximately
65 countries) 2,665.4 650.2 2,195.9 1,947.3
-------- -------- --------- ---------
Total $6,311.9 $1,572.9 $ 5,343.6 $ 4,445.8
======== ======== ========= =========
The following table presents long-lived assets by country based on the location
of the asset.
Year Ended Three Months Ended Year Ended
December 31, December 31, September 30,
1998 1997 1997 1996
------------ ------------------ --------- ---------
United States $ 929.0 $ 879.2 $ 823.7 $ 547.4
United Kingdom 242.0 204.2 192.7 118.9
Venezuela 70.1 70.8 54.8 45.6
Nigeria 86.9 41.4 38.9 30.4
Norway 50.0 37.2 32.0 45.5
Other countries 367.9 319.6 340.6 178.8
Western Geophysical
mobile assets (*) 546.4 426.6 426.6 324.6
--------- --------- --------- ---------
Total $ 2,292.3 $ 1,979.0 $ 1,909.3 $ 1,291.2
========= ========= ========= =========
(*) These assets represent marine seismic vessels, land crews and related
equipment that are mobile and move frequently between countries. Data processing
centers, land and buildings have been included in the countries where these
assets are located.
NOTE 14.
EMPLOYEE BENEFIT PLANS
DEFINED BENEFIT PENSION PLANS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company adopted SFAS No. 132, Employers' Disclosures about Pensions and
Other Postretirement Benefits, which is effective for the Company for the year
ended December 31, 1998. The statement revises the required disclosures about
pensions and postretirement benefit plans. The Company has
several noncontributory
34
36
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
defined benefit pension plans covering various domestic and foreign employees.
Generally, the Company makes annual contributions to the plans in amounts
necessary to meet minimum governmental funding requirements.
The Company has a defined benefit postretirement plan that provides certain
health care and life insurance benefits for substantially all U.S. employees who
retire having met certain age and service requirements.
Postretirement Benefits
Pension Benefits Other Than Pensions
-------------------------------------- ----------------------------------------
Year Ended Three Months Ended Year Ended Three Months Ended
December 31, 1998 December 31, 1997 December 31, 1998 December 31, 1997
----------------- ------------------ ----------------- ------------------
Change in benefit obligation:
Benefit obligation at beginning of year $ 184.6 $ 178.3 $ 115.7 $ 116.0
Service cost 5.0 1.2 1.6 0.3
Interest cost 13.3 3.3 8.4 2.0
Plan participants' contributions 1.1
Acquisition 2.8
Amendments (2.1) 0.2
Actuarial (gain)/loss 24.5 1.8 7.0
Curtailment loss 2.5 2.1
Settlement gain (6.7)
Benefits paid (9.0) (1.9) (9.0) (2.8)
Exchange rate adjustment 2.5 (0.9)
-------- -------- -------- --------
Benefits obligation at end of year 217.8 184.6 123.7 115.7
-------- -------- -------- --------
Change in plan assets:
Fair value of plan assets at beginning of year 269.3 260.3
Actual return on plan assets 2.0 7.3
Employer contribution 2.0 0.3
Settlement (6.7)
Plan participants' contributions 1.1
Acquisition 3.4
Benefits paid (7.4) (1.7)
Exchange rate adjustment 1.9 (0.3)
-------- -------- -------- --------
Fair value of plan assets at end of year 262.2 269.3 -- --
-------- -------- -------- --------
Funded status 44.4 84.7 (123.7) (115.7)
Unrecognized actuarial (gain)/loss 23.0 (17.0) (4.2) (10.3)
Unrecognized prior service cost 0.7 0.4 (2.2) (0.1)
-------- -------- -------- --------
Net amount recognized 68.1 68.1 (130.1) (126.1)
Benefits paid - October to December 1998 0.5 2.8
-------- -------- -------- --------
Net amount recognized $ 68.6 $ 68.1 $ (127.3) $ (126.1)
======== ======== ======== ========
Postretirement Benefits
Pension Benefits Other Than Pensions
-------------------------------------- --------------------------------------
Year Ended Three Months Ended Year Ended Three Months Ended
December 31, 1998 December 31, 1997 December 31, 1998 December 31, 1997
----------------- ------------------ ----------------- ------------------
Amounts recognized in the statement of
financial position consist of:
Prepaid benefit cost $ 96.2 $ 87.2
Accrued benefit liability (34.9) (24.7) $ (127.3) $ (126.1)
Intangible asset 0.5 0.2
Accumulated other comprehensive income 6.8 5.4
-------- -------- -------- --------
Net amount recognized $ 68.6 $ 68.1 $ (127.3) $ (126.1)
======== ======== ======== ========
35
37
Year Ended Three Months Ended Year Ended September 30,
Pension Benefits December 31, 1998 December 31, 1997 1997 1996
----------------- ------------------ --------- ---------
Weighted-average assumptions:
Discount rate 6.54% 7.51% 7.56% 7.90%
Expected return on plan assets 8.68% 8.92% 8.92% 8.81%
Rate of compensation increase 3.95% 3.89% 3.73% 4.73%
Components of net periodic benefit cost:
Service cost $ 5.0 $ 1.2 $ 3.9 $ 3.0
Interest cost 13.3 3.3 7.7 5.2
Expected return on plan assets (22.5) (5.4) (9.9) (6.1)
Amortization of transition (asset)/obligation (0.1) (0.4)
Recognized actuarial (gain)/loss (0.1) (0.2) 0.3 0.1
-------- -------- -------- --------
Net periodic benefit cost (4.3) (1.1) 1.9 1.8
Curtailment effect recognized 2.5
-------- -------- -------- --------
Total net periodic benefit cost $ (1.8) $ (1.1) $ 1.9 $ 1.8
======== ======== ======== ========
Postretirement Benefits Year Ended Three Months Ended Year Ended September 30,
Other Than Pensions December 31, 1998 December 31, 1997 1997 1996
----------------- ------------------ -------- --------
Weighted-average assumptions:
Discount rate 6.75% 7.50% 7.48% 7.50%
Components of net periodic benefit cost:
Service cost $ 1.6 $ 0.3 $ 1.3 $ 1.3
Interest cost 8.4 2.0 7.6 7.4
Recognized actuarial (gain)/loss .3 .1
-------- -------- -------- --------
Net periodic benefit cost $ 10.3 $ 2.3 $ 9.0 $ 8.7
======== ======== ======== ========
36
38
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The projected benefit obligation, accumulated benefit obligation, and fair
value of plan assets for the pension plans with accumulated benefit obligations
in excess of plan assets were $43.8 million, $39.0 million and $11.0 million as
of December 31, 1998, and $30.7 million, $26.3 million and $4.5 million as of
December 31, 1997.
The assumed health care cost trend rate used in measuring the accumulated
benefit obligation for postretirement benefits other than pensions as of
December 31, 1998 was 6.50% for 1999 declining gradually each successive year
until it reaches 5% in 2002. Assumed health care cost trend rates have a
significant effect on the amounts reported for the health care plan. A
one-percentage-point change in assumed health care cost trend rates would have
the following effects:
1-Percentage 1-Percentage
Point Increase Point Decrease
-------------- --------------
Effect on total service
and interest cost components $ 426.0 $ (411.0)
Effect on postretirement
benefit obligation 5,237.0 (5,103.0)
DEFINED CONTRIBUTION PLANS
During the periods reported, generally all Baker Hughes U.S. employees (other
than those employed at the time by Western Atlas) not covered under one of the
Baker Hughes pension plans were eligible to participate in the Baker Hughes
sponsored Thrift Plan. The Thrift Plan allows eligible employees to elect to
contribute from 2 percent to 15 percent of their salaries to an investment
trust. Employee contributions are matched by the Company at the rate of $1.00
per $1.00 employee contribution for the first 2 percent and $.50 per $1.00
employee contribution for the next 4 percent of the employee's salary. In
addition, the Company contributes for all eligible employees between 2 percent
and 5 percent of their salary depending on the employee's age as of January 1
each year. Such contributions become fully vested to the employee after five
years of employment. Baker Hughes' contribution to the Thrift Plan and other
defined contribution plans amounted to $51.0 million, $10.6 million, $35.9
million and $30.0 million in 1998, the Transition Period, 1997 and 1996,
respectively.
During the periods reported, most of Western Atlas' U.S. employees were
covered by a defined contribution plan. Western Atlas contributed an amount
based on its consolidated pretax earnings in accordance with the provisions of
such plan. This plan includes a voluntary savings feature that is intended to
qualify under Section 401(k) of the Internal Revenue Code and is designed to
enhance the retirement programs of participating employees. Under this feature,
Western Atlas matches up to 67 percent of a certain portion of participants'
contributions. Western Atlas' contributions to this plan were $31.4 million,
$10.5 million, $39.0 million, and $32.8 million in 1998, the Transition Period,
1997 and 1996, respectively.
POSTEMPLOYMENT BENEFITS
During the periods reported, the Company provided certain postemployment
disability and medical benefits to substantially all qualifying former or
inactive Baker Hughes U.S. employees (other than those employed at the time by
Western Atlas) following employment but before retirement. Disability income
benefits ("Disability Benefits"), available at the date of hire, are provided
through a qualified plan which has been funded by contributions from the
Company and employees. The primary asset of the plan is a guaranteed insurance
contract with an insurance company which currently earns interest at 7.2
percent. The actuarially determined obligation is calculated at a discount rate
of 6.5 percent. Disability Benefits expense was $2.9 million, $.5 million and
$1.1 million in 1998, the Transition Period and 1997, respectively. Disability
Benefits income was $.1 million in 1996. The continuation of medical, life
insurance and Thrift Plan benefits while on disability, and the service related
salary continuance benefits ("Continuation Benefits") were provided through a
nonqualified, unfunded plan until April 1997. The continuation of the medical
benefit portion of the plan was merged into the disability income benefits plan
beginning in April 1997. Expense for Continuation Benefits,
37
39
which is primarily interest cost on the projected benefit obligation, was $3.8
million, $.7 million, $3.3 million and $2.9 million for 1998, the Transition
Period, 1997 and 1996, respectively.
The following table sets forth the funded status and amounts recognized in
the Company's consolidated statements of financial position for Disability
Benefits and Continuation Benefits:
December 31, 1998 December 31, 1997
----------------- ------------------
Actuarial present value
of accumulated benefit
obligation $ (46.3) $ (40.2)
Plan assets at fair value 15.1 15.0
----------- -----------
Accumulated benefit
obligation in excess of
plan assets (31.2) (25.2)
Unrecognized net loss 8.9 5.7
----------- -----------
Postemployment liability $ (22.3) $ (19.5)
=========== ===========
Health care cost assumptions used to measure the Continuation Benefits
obligation are similar to the assumptions used in determining the obligation for
postretirement health care benefits. Additional assumptions used in the
accounting for Continuation Benefits were a discount rate of 6.5 percent in
1998, 7.0 percent in the Transition Period and 1997, and increases in
compensation of 5.0 percent for all periods presented.
NOTE 15.
LITIGATION
The Company is sometimes named as a defendant in litigation relating to the
products and services it provides. The Company insures against these risks to
the extent deemed prudent by its management, but no assurance can be given that
the nature and amount of such insurance will in every case fully indemnify the
Company against liabilities arising out of pending and future legal proceedings
relating to its ordinary business activities. Many of these policies contain
self insured retentions in amounts the Company deems prudent.
NOTE 16.
ENVIRONMENTAL MATTERS
The Company's past and present operations include activities which are
subject to extensive federal and state environmental regulations. The Company
has been identified as a potentially responsible party ("PRP") in remedial
activities related to various "Superfund" sites. Applicable federal law imposes
joint and several liability on each PRP for the cleanup of these sites leaving
the Company with the uncertainty that it may be responsible for the remediation
cost attributable to other PRPs who are unable to pay their share of the
remediation costs. Generally, the Company has estimated its share of such total
cost based on the ratio that the number of gallons of waste estimated to have
been contributed to the site by the Company bears to the total number of gallons
of waste estimated to have been disposed at the site. The Company has accrued
what it believes to have been its pro rata share of the total cost of
remediation of these Superfund sites based upon such a volumetric calculation.
No accrual has been made under the joint and several liability concept since the
Company believes that the probability that it will have to pay material costs
above its volumetric share is remote. The Company believes there are other PRPs
who have greater involvement on a volumetric calculation basis, who have
substantial assets and who may be reasonably expected to pay their share of the
cost of remediation. In some cases, the Company has insurance coverage or
contractual indemnities from third parties to cover the ultimate liability.
At December 31, 1998 and 1997, the Company had accrued $26.4 million, and
$23.7 million, respectively, for remediation costs, including the Superfund
sites referred to above. The measurement of the accruals for remediation costs
is subject to uncertainty, including the evolving nature of environmental
regulations and the difficulty in estimating the extent and type of remediation
activity that will be utilized. The Company believes that the likelihood of
material losses in excess of those amounts recorded is remote.
38
40
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17.
OTHER MATTERS
Supplemental consolidated statement of operations information is as follows:
Year Ended Three Months Ended Year Ended
December 31, December 31, September 30,
1998 1997 1997 1996
------------ ------------------- -------------
Rental expense (generally
transportation equipment
and warehouse facilities) $ 190.4 $40.5 $ 154.2 $ 114.6
Research and development 128.4 31.8 118.7 98.8
Income taxes paid 134.5 64.7 148.7 84.2
Interest paid 150.3 33.1 92.4 90.0
NOTE 18.
COMMITMENTS AND CONTINGENCIES
At December 31, 1998, the Company had commitments outstanding for capital
expenditures under purchase orders and contracts of approximately $214.2
million. Of this amount, $145.1 million related primarily to construction of
two seismic vessels. The cost of the vessels and related equipment is currently
estimated to be $204.0 million, excluding capitalized interest. Completion of
the vessels, including all related seismic equipment, is now expected for the
year 2000.
At December 31, 1998, the Company had long-term operating leases covering
certain facilities and equipment on which minimum annual rental commitments for
each of the five years in the period ending December 31, 2003 are $61.5 million,
$45.2 million, $26.4 million, $16.6 million and $7.4 million, respectively, and
$40.9 million in the aggregate thereafter. The Company has not entered into any
significant capital leases.
For the purpose of governing certain relationships between UNOVA and the
Company after the Spin-off, UNOVA and the Company entered into various
agreements including a Distribution and Indemnity Agreement, a Tax-Sharing
Agreement, a Benefits Agreement and an Intellectual Property Agreement.
39
41
BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19.
QUARTERLY DATA (UNAUDITED)
Fiscal Year 1998 (*)
--------------------------------------------------------------------------------
First Second Third Fourth Total
(Per share amounts in dollars) Quarter Quarter Quarter Quarter Fiscal Year
--------- --------- --------- --------- -----------
Revenues $ 1,648.1 $ 1,659.7 $ 1,584.9 $ 1,419.2 $ 6,311.9
Gross profit (**) 531.0 513.9 160.1 396.0 1,601.0
Income (loss) from continuing
operations before cumulative
effect of accounting change 112.9 118.1 (534.5) 6.1 (297.4)
Net income (loss) 112.9 118.1 (534.5) 6.1 (297.4)
Per share of
common stock:
Income (loss) from continuing
operations before cumulative
effect of accounting change
Basic 0.36 0.37 (1.65) 0.02 (0.92)
Diluted 0.35 0.36 (1.65) 0.02 (0.92)
Net income (loss)
Basic 0.36 0.37 (1.65) 0.02 (0.92)
Diluted 0.35 0.36 (1.65) 0.02 (0.92)
Common stock market prices:
High $ 44.13 $ 44.00 $ 34.94 $ 23.88
Low $ 34.88 $ 33.13 $ 17.75 $ 15.00
QUARTERLY DATA (UNAUDITED) Three Months
Ended
December 31,
1997(*) Fiscal Year 1997(*)
---------- ----------------------------------------------------------------------------
Transition First Second Third Fourth Total
(Per share amounts in dollars) Period Quarter Quarter Quarter Quarter Fiscal Year
--------- --------- --------- --------- --------- -----------
Revenues $ 1,572.9 $ 1,206.7 $ 1,268.7 $ 1,337.5 $ 1,530.7 $ 5,343.6
Gross profit (**) 527.2 365.9 386.2 428.4 486.2 1,666.7
Income (loss) from continuing
operations before cumulative
effect of accounting change 111.2 67.6 74.6 109.8 (51.1) 200.9
Net income (loss) 114.0 70.2 (111.9) 123.9 (48.3) 33.9
Per share of
common stock:
Income (loss) from continuing
operations before cumulative
effect of accounting change
Basic 0.35 0.23 0.25 0.37 (0.16) 0.67
Diluted 0.34 0.23 0.25 0.36 (0.16) 0.66
Net income (loss)
Basic 0.36 0.24 (0.38) 0.42 (0.15) 0.11
Diluted 0.35 0.24 (0.36) 0.41 (0.15) 0.11
Common stock market prices:
High $ 49.63 $ 38.88 $ 41.25 $ 40.13 $ 47.25
Low $ 39.00 $ 29.50 $ 34.13 $ 32.63 $ 38.38
(*) See Note 2 for accounting changes; see Note 3 for discontinued operations;
see Note 7 for acquisitions and dispositions; see Note 8 for unusual
charges.
(**) Represents revenues less costs of revenues.
40
42
BAKER HUGHES INCORPORATED
CORPORATE INFORMATION
CORPORATE OFFICERS: BOARD OF DIRECTORS:
MAX L. LUKENS LINDA J. SMITH LESTER M. ALBERTHAL, JR. JOHN F. MAHER*
Chairman, President, and Corporate Secretary Retired Chairman of the Board Retired President and Chief
Chief Executive Officer of EDS Executive Officer of Great
M. GLEN BASSETT Western Financial Corporation
THOMAS R. BATES, JR. Vice President and President, VICTOR G. BEGHINI
Senior Vice President Baker Petrolite Corporation Vice Chairman - Marathon Group JAMES F. MCCALL
USX Corporation and President, Lt. General, U.S. Army (Retired),
ERIC L. MATTSON JOSEPH F. BRADY Marathon Oil Company Executive Director of the American
Senior Vice President and Vice President and President, Society of Military Comptrollers
Chief Financial Officer Centrilift ALTON J. BRANN
Chairman and Chief Executive H. JOHN RILEY, JR.
G. STEPHEN FINLEY MATTHEW G. DICK Officer of UNOVA, Inc. Chairman, President, and
Senior Vice President and Vice President and President, Chief Executive Officer of
Chief Administrative Officer Baker Process JOSEPH T. CASEY Cooper Industries, Inc.
Retired Vice Chairman
ANDREW J. SZESCILA GERALD M. GILBERT and Chief Financial Officer JOHN R. RUSSELL
Senior Vice President Vice President and President, of Western Atlas Inc. Retired President of Baker
E&P Solutions Hughes Incorporated and Former
RAY A. BALLANTYNE EUNICE M. FILTER President and Chief Executive
Vice President Marketing, EDWIN C. HOWELL Vice President, Secretary, Officer of Western Atlas Inc.
Technology, and Business Vice President and President, and Treasurer of Xerox
Development Baker Oil Tools Corporation CHARLES L. WATSON
Chairman and Chief Executive
DOUGLAS C. DOTY GARY E. JONES JOE B. FOSTER Officer of Dynegy, Inc.
Vice President and Treasurer Vice President and President, Chairman and Chief Executive
Baker Atlas Officer of Newfield MAX P. WATSON, JR.
ARTHUR T. DOWNEY Exploration Company Chairman, President, and Chief
Vice President, TIMOTHY J. PROBERT Executive Officer of BMC Software,
Government Affairs Vice President and President, CLAIRE W. GARGALLI Inc.
Baker Hughes INTEQ Former Vice Chairman,
JAMES W. HARRIS Diversified Search and * Will retire at the Annual
Vice President, Tax DOUGLAS J. WALL Diversified Health Search Meeting of Stockholders to
and Controller Vice President and President, Companies be held on April 28, 1999.
Hughes Christensen Company
JOHN A. O'DONNELL RICHARD D. KINDER
Vice President, Business RICHARD C. WHITE Chairman and Chief Executive
Process Development Vice President and President, Officer of Kinder Morgan
Western Geophysical Energy Partners, L.P.
LAWRENCE O'DONNELL, III
Vice President and MAX L. LUKENS
General Counsel Chairman, President, and
Chief Executive Officer of
Baker Hughes Incorporated
SHAREHOLDER INFORMATION: INVESTOR RELATIONS OFFICE CORPORATE OFFICE LOCATION
Gary R. Flaharty AND MAILING ADDRESS
TRANSFER AGENT AND REGISTRAR Director Investor Relations 3900 Essex Lane
ChaseMellon Shareholder Services, L.L.C. Baker Hughes Incorporated Houston, Texas 77027
85 Challenger Road P.O. Box 4740 Telephone (713)439-8600
Ridgefield Park NJ 07660 Houston, Texas 77210-4740 P.O. Box 4740
1(888)216-8057 gary.flaharty@bakerhughes.com Houston, Texas 77210-4740
INDEPENDENT ACCOUNTANTS FORM 10-K WEBSITE
Deloitte & Touche LLP A copy of the Company's Annual Report to the http://www.bakerhughes.com
Houston, Texas Securities and Exchange Commission (Form 10-K) is
available by writing to Baker Hughes Investor BAKER HUGHES INFORMATION SYSTEM
STOCK EXCHANGE LISTINGS Relations. 1(800)969-7447
Ticker Symbol "BHI"
New York Stock Exchange, ANNUAL MEETING
Pacific Exchange, Inc., The Company's Annual Meeting of Stockholders will
The Swiss Stock Exchange be held at 11:00 AM on April 28, 1999 at the offices
of the company: 3900 Essex Lane, Suite 210,
Houston, Texas.
41