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Executives

Chad Deaton - President, Chief Executive Officer and Chairman

Peter Ragauss - Senior Vice President and Chief Financial Office

Gary Flaharty - Director of Investor Relations

Analysts

Bill Herbert - Simmons and Company.

Dan Pickering - Tudor, Pickering, Holt

Doug Becker - Banc of America

Chuck Minervino - Goldman Sachs

Brad Handler – Credit Suisse

James Crandell – Barclays

Kurt Hallead - Royal Bank

Robin Shoemaker - Citigroup

Mike Urban – Deutsche Bank

Geoff Kieburtz – Weeden & Co.

Baker Hughes, Inc. (BHI) Q3 2008 Earnings Call October 22, 2008 8:30 AM ET

Operator

Welcome everyone to the Baker Hughes third quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. (Operator Instructions)

I will now turn the conference over to Mr. Gary Flaharty, Director of Investor Relations.

Sir, you may proceed.

Gary Flaharty

Alright, thank you and good morning, everyone. Welcome to the Baker Hughes third quarter 2008 earnings conference call. Here with me this morning are Chad Deaton, Baker Hughes’ Chief Executive Officer and Chairman, President, and Peter Ragauss, Baker Hughes’ Senior Vice President and Chief Financial Officer.

Following management’s comments, we will open the lines for your questions.

Reconciliation of operating profits and non-GAAP measures to GAAP results for historic periods can be found on our website at www.bakerhughes.com in the investor relations section under financial information. Finally, I caution you that any company outlooks discussed this morning are subject to various risk factors. We will try to highlight these risk factors as we make these forward-looking statements.

However, the format of the call does prevent a more thorough discussion of the risk factors. For a full discussion of these risk factors, please refer to our annual report 10K, 10Q, and in particular the forward-looking disclosure in this morning’s news release. With that, I will conclude our discussion to the administrative details and turn the call over to Peter Ragauss.

Peter?

Peter Ragauss

Good morning. This morning we reported net income on a U.S. GAAP basis of $429 million or $1.39 per share. This includes a one-time tax benefit of $0.10 per share. It also includes a negative impact from the third quarter Delta Mexico hurricane. The total hurricanes impact was approximately $78 million in revenue, $50 million in profit before tax or about $0.11 per share. The Q3 EPS of $1.39 compares to $1.22 per share a year ago and compares to $1.23 per share for the second quarter 2008.

Net income for the second quarter of 2008 included a charge of $0.13 per share for litigation settlement. Q3 revenue was $3 billion, up $332 million or 12% from the second quarter of 2007 and up $12 million from last quarter.

North American revenue was $1.3 billion, up 15% compared to the year-ago quarter and up 3% compared to the prior quarter. U.S. land revenue was up 25% year-over-year compared to a rig count up 11% versus a year ago. U.S. offshore activity was impacted by hurricanes Gustav and Ike. Offshore revenue was down 14% year-over-year and down 19% sequentially.

The impact of the hurricanes on offshore operations of the direct impact was approximately $55 million in revenues. Adjusting for the impact of the hurricanes, offshore revenue would have been up 10% year-over-year and would have been up 3% sequentially.

Total non-North American revenue was up 11% year-over-year and down 1% sequentially. Both comparisons exclude the hurricane impact of about $23 million of revenue that was delayed from the third quarter.

Latin American revenue increased 19% year-over-year followed by Europe, Africa, Russia and Caspian Region with a 9% and the Middle East/Asia Pacific region where revenue was 8% higher than the year-ago quarter.

Sequentially, the Latin American region led again with a 7% revenue increase while revenue for the Europe, Africa, Russia and Caspian Region was down 3% and revenue for the Middle East/Asia Pacific region was down 2%.

Our oil field operating margin in Q3 was 22%. This compares to 24% in the year-ago quarter and 23% in the prior quarter. Excluding the impact from the hurricanes, margins would have been flat quarter-to-quarter which is in line with what we said in the last conference call.

Turning to the performance of our two segments, drilling and evaluation revenue was $1.56 billion in the third quarter, up 15% compared to the year-ago quarter and up 2% sequentially. Year-over-year revenue growth was strongest in Latin America, followed by Europe, Africa, Russia Caspian region and the Middle East/Asia Pacific region.

As was the case in the second quarter our directional drilling, drilling fluids and drill bit product lines saw the largest increase in revenue compared to the year-ago quarter. The drilling and evaluation segments operating margin was 22% down from 26% in the third quarter 2007 and down from 24% in the second quarter.

Revenue for our completion production segment was $1.45 billion, up 10% from the year-ago quarter and down 1% sequentially. Year-over-year revenue growth was strongest in North America and Latin America. Completions in oil field chemicals had the largest revenue increases compared to the year-ago quarter. CMP's operating margin was essentially flat in comparison to the third quarter 2007 and the second quarter of 2008.

To help you evaluate our earnings per share in the third quarter I will walk you through the significant items that bridged the sequential and year-ago quarters to third quarter EPS. In the second quarter of 2008 our U.S. GAAP net income per share was $1.23 per share. From this $1.23 add $0.13 to adjust for the Q2 litigation settlement, that gets us to $1.36 on an operational basis for last quarter. Subtract $0.01 for the impact of higher corporate costs in Q3 compared to Q2. Add $0.08 to adjust for a more favorable effective tax rate, subtract $0.11 for the impact from hurricanes and add $0.07 from operations. This gets us to the $1.39 we are reporting for the third quarter.

Looking at it year-over-year from the $1.32 we reported in the third quarter 2007, subtract $0.02 for the impact of higher corporate costs in Q3 2008 compared to the year-ago quarter. Subtract $0.01 for the impact of higher interest expense. Add $0.05 for the impact of lower share count. Add $0.10 to account for the benefit of a more favorable effective tax rate. Subtract $0.11 for the impact from hurricanes and add $0.16 from operations. This gets us to $1.39 we are recording for the third quarter.

Turning to the balance sheet, total debt increase just slightly to $1.63 billion. At quarter end our total debt to cap ratio was 19%. We currently have $1 billion in undrawn credit facilities. This is comprised of $500 million under a revolver accessible through July 2012 and $500 million under a 360 day facility we plan to extend in March. At the end of the third quarter we also had cash and short-term investments of $1.1 billion. This totals $2.1 billion in liquidity. We have $505 million in A1 T-1 rated commercial paper outstanding backed up by our credit facilities. We have had no problems selling commercial paper to meet our needs on a daily basis through the credit crisis. We have $525 million in debt maturities coming due in the first quarter of 2009. We are prepared to fund this debt obligation prior to its maturity.

During the third quarter we repurchased about 139,000 shares of common stock at an average price of $71 per share for a total of $38 million. At quarter end we had authorization remaining to purchase up to $1.2 billion in common stock.

Given the uncertain nature of the current credit markets, we will remain prudent with the use of our cash in the near-term.

Last, I will review the updated guidance for the fourth quarter of 2008. Our guidance for revenue growth outside North America is in the range of 14-15% for the fourth quarter 2008 compared to fourth quarter 2007. Our guidance for capital spending in 2008 remains unchanged at $1.3 billion. Our guidance for corporate spending and other for the year excluding the Q2 litigation settlement is unchanged at $270 million. Our tax rate for the fourth quarter is now expected to be between 31-32% and our tax rate for the full year is now expected to be between 30-30.5%.

I will now turn the call over to Chad who will highlight our geographic results.

Chad Deaton

Good morning ladies and gentlemen. During Q3 we continued to strengthen our position in some of the key markets around the world. We’ll walk around the world and look at these different regions starting with North America. Revenue was up 15% compared to the year-ago quarter and it was up 3% compared to the prior quarter.

U.S. land revenue was strong. It was up 25% year-over-year and an 11% increase on rig count and was up 6% sequentially which is in line with the 6% increase in rig activity. U.S. land activity continues to be driven by unconventional gas plays. We have provided strong demand for the directional drilling of LWD services such as Auto Track Express and Completion Solutions such as our frac point completion system.

U.S. offshore revenue was down 14% year-over-year and down 19% sequentially and excluding the impact of the hurricanes offshore revenue would have been up 10% year-over-year and up 3% sequentially.

The industry lost about 21-28 working days due to Gustav and Ike. Deep water operations had more disruption due to the time associated with moving on and off location. The non-moored deep water vessels did not return to normal operations until mid-September. The shallow water fleet sustained greater damage as most of the deep water rigs were able to move out of the path of the hurricanes.

Canadian activity recovered from second quarter lows and revenue was up 12% year-over-year and up 28% sequentially. As expected, a sharp rebound in rig count provided a strong sequential revenue increase for our D&E segment but also our C&P segment saw strong sequential revenue increase which was led by completions product sales.

Our operating profit margin for North America was 24% in the third quarter compared with 27% in the year-ago quarter and 25% in the prior quarter. The outlook in North America, last quarter we commented on our expectations for the arrival of newly constructed rigs in the Gulf of Mexico. We now see 21 new rigs entering the Gulf over the next three years and we experienced a very solid success in securing contract awards for these rigs. To date we won in excess of 40% of the awards that have been made for our products and services. These rigs typically generate in excess of $40 million a year in our drilling and evaluation types of services.

Looking at Latin America, revenue for the region was up 19% year-over-year and this compares to an 8% increase in the rig count for the region. Contributing to the year-over-year revenue increase was a strong quarter for our directional drilling LWD group in Brazil and increased activity for our completions product line in Mexico. In addition, our directional drilling and drilling fluids and drill bit product lines had another strong quarter in Columbia where revenues for the D&E segment were up 82% year-over-year.

Latin American revenue was up 7% sequentially compared to a 1% increase in the rig count and sequential revenue increases were driven by the same factors that impacted our year-over-year growth.

Looking at sequential and revenue trends, activity in Brazil supported strong increases for our DDL, WD and completions division and the trend in strong demand in Columbia for our drilling and evaluation segment continues.

The operating profit margin in Latin America for the second quarter was 18%. That is down about 200 basis points from the year-ago quarter but was up 17% in the prior quarter. As we said in the last call in conjunction with recent contract wins in Brazil and Mexico we are now mobilizing and incurring start-up costs related to these start ups which in the short-term will impact profitability.

In Q3 we incurred about $5 million in start-up costs on these projects. In addition, labor costs in Argentina have increased where the industry is facing some significant labor inflation. In Mexico we continue to mobilize under the recent marine contract award. Our mobilization is on schedule and initial well is now expected to spud in January, a delay from the original plan as the result of rig availability issues.

For the revenue for the Europe, Africa, Russia and Caspian region, it increased 9% year-over-year and decreased 3% compared to the very strong result in the second quarter of 2008. For Europe revenues were up 13% year-over-year compared to a 6% decrease in the North Sea rig count and revenue is unchanged sequentially.

In Norway, every product line posted some strong results year-over-year and revenue in our D&E segment increased 23% sequentially. Our drilling fluids and artificial lift product lines also had significant improvement in the region compared to a year ago.

In Russia revenue is unchanged compared to the third quarter of 2007 and down 8% compared to the second quarter. Revenue for Russia, however, excluding [inaudible] was up 18% year-over-year. Drilling fluids and artificial lift posted strong quarters in Russia compared to the year-ago period and sales in completion systems doubled in Kazakhstan compared to the year-ago quarter.

Sequentially, completions revenue declined for Russia and Kazakhstan following some strong second quarter sales for both countries. Africa revenue was up 11% year-over-year compared to a 4% decrease in rig count and was down 6% sequentially compared to a 5% decrease in rig count. Year-over-year improvement was strong by every product line in Libya and sequential revenue comparisons were impacted by the completion of the initial phase of what was a major contract in Equatorial Guinea that ended last quarter.

Our operating profit margin for Europe, Africa, Russia and Caspian was 23% in the third quarter compared to 21% in the third quarter of 2007 and 24% in the second quarter of 2008. In the region we have been awarded more than $800 million in new contracts during the quarter and that includes a $450 million award from BP Norway which included several product lines.

Middle East/Asia Pacific revenue was up 8% compared to the year-ago quarter and was down 2% sequentially. Looking at just the Middle East, revenues were up 15% year-over-year compared to a 5% increase in rig activity and Middle East revenue is unchanged sequentially.

The year-over-year improvement was led by drilling fluids, wire line, drill bits, chemicals and artificial lift in Egypt and record revenues for our directional drilling and LWD services in Saudi Arabia. Asia Pacific revenue was up 3% year-over-year but down 3% sequentially. Historically the Asia Pacific area received the least amount of focus and investment from Baker Hughes. For this reason it also offers up one of the most promising areas for the future.

As we focus and build out key countries we have realized success. For example in India revenues increased 17% compared to the year-ago quarter and that was led by completions, directional drilling and LWD, drilling fluids as well as wire lines. In Malaysia revenue was up 13% compared to the year-ago led by the same directional drilling, LWD and this time chemicals and sequentially revenue increased 21% led by the wire line and chemicals.

In Brunei revenue increased 24% year-over-year and doubled sequentially.

Operating profit margin for the Middle East/Asia Pacific is 19% in the second quarter compared to 23% in the third quarter of 2007 and 20% in the second quarter of 2008. Outlook for the Middle East/Asia Pac during the quarter we were awarded several contracts. We were awarded the artificial lift ESP system and the completion systems from Manifah in Saudi Arabia. Also in Manifah we have been called out numerous times to drill and evaluate the reservoir supply. Key tools included our 4.75 inch NMR nuclear magnetic resonance tool which was jointly built with Saudi Aramco as well as our test track pressure testing tools and in all cases we were able to provide the client with some much needed reservoir information.

Other recent key awards in the Middle East/Asia Pacific region included significant drilling contract in Australia, awards for drilling fluids and completions for [cairn] in India and a significant wire line contract covering eight expiration rigs for ONGC in India.

In closing, the near-term outlook for activity has changed over the last quarter. There are three issues that will impact the outlook for incremental spending. The credit crisis and its impact on regional and global economic growth and also oil and gas supply and demand fundamentals.

In North America several operators have already announced their intentions to lower their capital spending levels in 2009 and some have indicated they will cut 2008 planned activity. In the U.S. the rig count peaked at the end of August at 2,031 rigs. Since then rig count has declined 55 rigs. Gas directed drilling has fallen 69 rigs or about 4.3% and oil directed drilling is increased 12 rigs or about 3%.

We do expect to exit the fourth quarter with between 1,800 and 1,840 rigs down 190-230 from the peak.

Internationally we expect spending to maintain its momentum, although we could see a slowing of spending growth in some markets. Unlike U.S. natural gas, we believe the supply demand fundamentals for oil remain relative. The price of oil has been cut in half from its summer highs but it is still high enough to provide attractive returns to many of our customers.

Our strategy at Baker Hughes really remains mostly unchanged. We are well positioned to navigate through these issues. We have a strong portfolio, lean technologies and we have a high exposure to rig independent production related spending. We have a strong balance sheet, strong credit rating and a highly skilled, motivated work force.

We will manage our ongoing investment in people and the infrastructure and technology continue to position Baker Hughes for long-term growth and in doing so we also balance the need to invest for long-term growth with the need to safeguard the near-term performance. We will monitor the markets, watch discretionary spending and redeploy people and tools as necessary.

This market will, in time, begin to produce acquisition opportunities and we will continue to monitor areas where we can fill portfolio gaps or complement existing product lines or technology needs. There is no doubt we are in a position to emerge from this market as an even stronger competitor.

On a final note, as we previously described hurricanes Gustav and Ike hit Baker Hughes pretty hard in the quarter. We had a significant operation and manufacturing base in southeast Texas and Louisiana and I want to take just a minute and thank our 7,500 people that were affected by these storms. Fortunately we had no serious injuries to our employees or their families. But there were many employees that experienced some personal damage. Like so many companies in the area our people had to cope with restoring a sense of normality in both the personal as well as professional lives and we’d like to take a moment and appreciate and recognize all your efforts.

Let’s open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from Bill Herbert - Simmons and Company.

Bill Herbert - Simmons and Company

With regard to your processes of the U.S. rig count being down about 200 rigs from the recent peak by the end of Q4, we think that is on track and likely you will see more unrest unfold in the first half of 2009. Difficult question to answer, but at this stage could you give us some sort of parameters and even hazard a guess or hypothesis with regard to impact on margins? I realize lower. How much lower?

Chad Deaton

I think the way to look at it, at the beginning of the year we were down 200 rigs from the peak. We saw this activity come on at the end of the first quarter with 200 rigs coming on. We started to get tight on services. Really, I think at the end of Q2 and Q3 we are at an inflection point where we were starting to see price move from many of our product lines and move positively. So if we drop 200 rigs in a quarter I think we kind of have to look at we are back to where we were in the first quarter.

Now pricing wasn’t bad in the first quarter. Margins were good in the first quarter. So I think if it goes down 200 rigs we are going to have to tighten up. It will be a question of how much additional capacity everybody has added during the year which will take pressure out. But I think we will be fairly decent on a 200 rig drop. The next 200 rigs are the ones that are going to hurt a little bit more.

Peter Ragauss

The paradox of this is we are currently to date very, very busy. We are still turning down business in North America. I think it is a question of the pace of the drop and if it is slower than that then you won’t see any effect.

Bill Herbert - Simmons and Company

You have this dislocation between current prosperity and expected woe and you sort of indicated as to conceptually what you might do. But as you look forward into this sort of chasm or down draft what specifically do you plan on doing? Largely retaining your cost structure in anticipation of a relatively quick recovery? Do we pare back fairly significantly? Freeze headcount? Chop heads? Capital spending plans, etc.? If you could kind of walk us through some of the components of the game plan in the event of a 200-400 rig count drop.

Chad Deaton

I think there is a series of events that take place as you adjust to the market. I don’t think any one thing happens. Obviously the first thing, and we are already doing that, is you look at your hiring. You never want to completely stop hiring recruits or college graduates but you want to temper that to what you think is going to happen so you start to back off on the hiring in North America. You start to obviously, which we have already done in North America, look at your day to day costs and start controlling the things you can. You start working and focusing on working capital. I think the whole industry over the last couple of three years has probably been less focused on inventory and receivables because everybody is growing. It is not the focus. You start tightening up there. You start following inventories. You start collecting your money better and get your cash flowing better and begin reallocating resources. As Peter said, right now we wouldn’t want to ship any tools or people to other parts of the world because again we have been turning down work in Q3 and so we will absorb that but as time goes on we will start shipping some of these things to other areas.

We also as we see pricing pressure come to us we will also increase pricing pressure on our suppliers. So we start the supply chain squeezing down. Then as the rigs continue to drop you start adjusting your workforce as necessary. That is one of the things the service industry has done for many years and knows how to do. I guess the end game if it gets really bad and it is a duration for a couple of years or whatever then you start getting into that position where you consolidate areas. You close some offices. You bring facilities together, etc. So I think it has got to be that whole chain of events that takes place as you watch this thing unwind. Of course watch the economic factors and see if you see a light at the end of the tunnel. It also goes back, you have heard it from every call and you guys know it, we can’t keep these rigs down forever in the U.S. or the decline is going to eat us up so you don’t let it come to that.

Bill Herbert - Simmons and Company

Remind us what percentage of your North American revenues come from Petro Light and lift.

Chad Deaton

We’re not disclosing the exact number but we said meaningful. So I mean it is a pretty good chunk. It is a nice business portfolio to have right now.

Operator

The next question comes from Dan Pickering - Tudor, Pickering, Holt.

Dan Pickering - Tudor, Pickering, Holt

Could you give us a conceptual first look at 2009 CapEx? You talked about being kind of prudent with your balance sheet but given the outlook as it is today where are you in the capital budgeting process and what is it telling you?

Chad Deaton

The one we can say, there is two sides to our CapEx program, one is the infrastructure facility type build out and the other one obviously is the tools we use to do our business and the technologies. The infrastructure side is pretty easy because we are going to continue with our program. We are going to spend roughly $300 million in build up facilities this year and next year we are probably looking at $400 million or somewhere in there. Again, we still believe our best growth opportunities come in many of these locations around the world where we need to upgrade or add facilities. So that is going to happen for the long-term.

What we will do on the other $800-900 million what we spent this year on tools, part of that is locked in for the next 3-5 months because we are building those tools and then we will look at it. If we need to pull down on that we will. We are going to have to adjust that as time goes on. You can look out six months and decide what you need to do. We are going through the budgeting process starting next month and that will tell us a little bit as we hear what our customers say.

Peter Ragauss

We are still very cash flow positive so it is not like we are facing a CapEx cut in order to meet cash flow. We can maintain our current CapEx or even raise it next year and still be cash flow positive depending on what the year looks like. We don’t feel that pressure necessarily to have to cut CapEx next year.

Chad Deaton

We have been pretty successful the last two quarters winning some pretty big contracts. So we have a commitment to go ahead and from a facility standpoint put those in place and be able to staff them with tools which again can be moved. Facilities can’t.

Dan Pickering - Tudor, Pickering, Holt

Given the outlook for offshore rig deliveries, oil is now $70 and change. Any signals or indications from your international customers that $70 oil is going to change their plan and are you a double-digit grower in 2009 with $70 oil internationally?

Chad Deaton

We have not heard anything from any of our clients on offshore rigs and deep water that says they are going to cut back. We are still in the discussions of meeting the obligations we have committed to for those. We continue to see these 21 rigs come into the Gulf. We still see Brazil’s rigs coming in. We still see Europe and Africa’s rigs coming in and the clients are still awarding contracts there and we are doing quite well on all those. I’m not seeing the deep water having an effect. It is hard to say on the international side what our revenue growth will be rest of the world just because you have to look at land Russia, etc. So I’m not really ready to say what the percentage number will be yet. Again, we just have a heck of a lot better vision here in the next month or month and a half as we go through talking to our clients and looking at their budget.

Operator

The next question comes from Doug Becker - Banc of America.

Doug Becker - Banc of America

You mentioned in Latin America start up costs were still impacting Brazil and Mexico. It sounds like the spud date for the project in Mexico has been pushed again. What is the expected impact in the fourth quarter here because of start up costs?

Chad Deaton

Probably about $0.02 a share. We are looking at about $10 million for Brazil and Mexico start up costs.

Doug Becker - Banc of America

As we think about the hurricane impact into the fourth quarter you mentioned about $0.02 of deliveries were delayed. How does that play out in the fourth quarter beyond that?

Chad Deaton

A lot of the delays will get into the fourth quarter. There is a couple of shipments that had to be out of the ship channel which were marginal because they are going to very remote places. I think one of them was in Russia. So they have got a window there to get in before the ice comes. I’m not sure where we stand on if that made it or not.

Peter Ragauss

That has another week. In other words we have to get it done in the week.

Chad Deaton

Right, and of course the ship channel was just backed up. A lot of the other should go ahead and be shipped and we will see some of that in the fourth quarter.

Peter Ragauss

There is still a little bit of activity as well. We aren’t up to 100% in the Gulf on October 1. Not all the rigs were up and drilling on October 1 so there is a little bit of spill over there from operations as well.

Chad Deaton

Some of the rigs that were four jack ups were lost so there is another rig that the derrick went in and a couple of those were very good for us. We had a lot of services on it so of course that is gone. That is not going to repeat itself.

Doug Becker - Banc of America

On the U.S. you have been highlighting the [most durable] tools, have been highlighting the frac point technology. Is it your perception you are taking market share in those markets and are you able to do that? How does market share play out in a declining rig count environment?

Chad Deaton

I think we are taking market share in both of those. Clearly on the DD side we have turned down business there and we go to a lot of clients and say we have got the tools and they want us to work. We have been taking market share there. The frac point technology a couple of years ago we really weren’t in that business. We went from basically zero to a pretty healthy chunk of it now. Again, this is the horizontal frac point technology where we can isolate and they can frac that into ten zones and isolate each zone. It has been a real growth opportunity for us.

Doug Becker - Banc of America

North American growth appears slower than the peers. Certainly some of that can be explained by higher leverage to offshore. Is there any other moving part that might explain that?

Chad Deaton

I don’t think our North America has been slower. U.S. land was up 25% year-over-year. I’m not sure anybody else was up 25% on U.S. land. Last quarter we clearly were up 20%. That was the highest last quarter if I remember right for U.S. growth. Our U.S. growth is strong.

Doug Becker - Banc of America

I was referring to the third quarter. Certainly second quarter looked very good.

Operator

The next question comes from Chuck Minervino - Goldman Sachs.

Chuck Minervino - Goldman Sachs

I just wanted to touch on the international outlook a little bit more. I’m just wondering if you guys could give us a little bit of a sense of some of the regions or countries that are a little bit higher on your watch list in terms of potential slow down next year and if you are taking steps right now to prepare to scale back in those regions or if you have a plan in place to prepare to scale back in those regions if there was a cut back in activity?

Chad Deaton

I really can’t think of an international country right now where…we would do the same thing there each country by country that I just described we would do in North America if we saw a slow down. Obviously the U.K. we would have to watch. Again, I think it is more client related than it is really geography or geology related which is kind of like the U.S. Depending on the cash flow of the client and what their costs are will they stay busy or not. The U.K. could be one that we’d have to watch. Fortunately right now we are extremely busy in Norway and with the big win in Norway we are going to need additional services in Norway which is pretty handy to support that out of the U.K.

Brazil again looks…nothing has changed down there as of yet and I’m not sure it will. Mexico continues to go forward. Saudi has probably hit its rig count and will hold on to that but we are staffed properly there. In fact we had to add a little resources in Saudi for some business we won. I can’t go around the world and think right now if there is a country we are taking any action to begin to reduce.

Now we will have to watch the customers. There are some countries where clearly there have been some clients that have come in that have been private equity or small investors that have raised some funds to go in and they used the project management type approach to get companies to come in and drill those wells for them. Those are going to have an effect. I think those are going to be possibly hit just due to cash flow constraints. We are not big with those guys. I think that answers your question.

Chuck Minervino - Goldman Sachs

I believe in your press release you said you increased Europe revenues about 13% in the quarter despite about a 6% decrease in the rig count. I’m just wondering if you can give us a little color on what took place there that would cause that big deviation. Not the deviation but that revenues were up so much despite rig count going down so much. Was there a start up there or is it just natural operational performance?

Chad Deaton

I think first you have to be a little careful. We have seen over the years that we have to be careful how we tie revenue to rigs because any more like in Alaska and Norway and so many other places you are providing so much more service an drilling so much more hole on the same rig with that rig sitting there but it may be sitting there for eight months now instead of moving every three months. I think that is just a trend in the industry. You are generating a lot more revenue per rig. The big driver was Norway an a sequential basis.

Operator

The next question comes from Brad Handler – Credit Suisse.

Brad Handler – Credit Suisse

I guess I will stick with the fourth quarter outlook questions for a minute. If we rewind to last quarter when you were looking at your budget were you also forecasting something like 14-15% growth for the fourth quarter or has that outlook changed at all?

Chad Deaton

No, I think we are still probably looking in that ballpark. For the rest of the world you are talking about, right?

Brad Handler – Credit Suisse

Yes, exactly. Trying to get back to what you mentioned in your release.

Chad Deaton

That is what we said we would be running in the fourth quarter. Actually I think we said last quarter we thought it was going to be a little higher in the fourth quarter so we have toned that down just a bit for the fourth quarter. Some of that is we anticipated we would have some Mexico revenue in Q4. That is not going to happen until Q1. There was some Angola slow down we didn’t participate in and didn’t get kicked off. So I think we are down a little bit from what we said in the last call we’d be in the fourth quarter.

Peter Ragauss

A little bit of slow down, a couple more in the U.K. and cutter we are slowing down a little bit in the fourth quarter compared to what we thought.

Chad Deaton

Cutter has declined a considerable rigs. We did get extension. We were re-awarded the RAS gas work but it will just be less rigs than the ten rigs we were running. It was cut in half now. That has had an effect.

Brad Handler – Credit Suisse

Your margins in CMP whether I add that to hurricane impact or not were really good it seemed. I was just hoping you could add a little bit of color there. Was the surcharge impact in Petro Light for example? Was this simply a function of mix? Something to help fill that out would be great.

Chad Deaton

The margins in CMP have held up very nicely. Again, they are not rig dependent for the most part. We have been very aggressive on bidding price in Petrolight. I think the guys have done an outstanding job there but they had to because they saw their commodity costs going out of sight. I think that has helped. They have been able to hold their own there. I think the other one is artificial lift has been very good and very strong. I think that has been able to help that side and we have seen some improvement in the completion side of the business. D&E has been a little bit more rig focused and clearly there is quite a bit of competition in the U.S. and others that have come in on the D&E side and I think that is why D&E for everybody is down a little bit. CMP for us as you recognize has been holding in there nicely.

Peter Ragauss

I would say in the artificial lift side and in chemicals we have been playing catch up on the cost increases particularly in chemicals. Obviously what has happened is a lot of the raw materials stopped going up? So we are kind of catching up to that and that is improving the margins in the short-term.

Brad Handler – Credit Suisse

Has that catch up, I mentioned surcharges, but perhaps I shouldn’t assume that. Is it surcharging? Is it price increases? Do you think you have the ability to hold on to some of the gains and have a leveling out of raw materials costs?

Peter Ragauss

I would say we are catching up on the lag.

Chad Deaton

To me surcharge is something that is temporary. We are not calling it a surcharge. We are saying getting our pricing back. We don’t have any surcharges.

Operator

The next question comes from James Crandell – Barclays.

James Crandell – Barclays

It was a little bit of surprise to me the looking versus the last quarter the revenues were down in Russia, Asia Pacific and Africa and flat in the Middle East and Europe. In what areas was this a surprise to you or did you anticipate this all along?

Chad Deaton

Russia was mainly Sakhalin Island if you look at the role of Sakhalin Island it is part of Russia but we adjusted for that. Sakhalin Island was very busy a year ago. A couple of clients have stopped there and there has been some slower activity there. Russia was actually up year-over-year so Russia itself I think is okay. I don’t think it was a great quarter in Russia but I think looking forward we are in pretty good shape in Russia.

Africa doesn’t bother me so much. We had a great quarter last quarter so sequentially you have to look at that. Africa we have had some good wins for some completion contracts there. I think Africa we just need to continue to push and invest in. We don’t have there the infrastructure we really need yet so Africa we will continue to invest in.

The U.K. was down quite a bit. It was down for everybody. That was partially offset for us by very, very strong Norway as we said.

So I think those areas are okay. The one that clearly we have work to do is in the Middle East/Asia Pac and that is where our focus has got to be. Again, we have had some wins. We had last year selling a lot of equalizer completion pack equipment in Saudi. They bought up most of the stock and put it in their inventory. There has hardly been any of that type of sales. Very low sales through most of this year. But they have just announced this $800 million or $750 million completions award. That will start up in Q1. We should do quite well with that by all indications. I think that is going to be fine.

But we have some work to do in Asia Pac and a couple of other parts of the Middle East. There is an area that we are concerned about or disappointed in it would be MEAP.

James Crandell – Barclays

I thought it was pretty exciting and interesting the fact you are now putting the sensors actually on the bits or are starting to at least in the test market in some of your rotary steerable jobs. Could you talk to that a little bit and talk about what may be the significance of this and how important that could be to your order track?

Chad Deaton

That was supposed to be top secret when you brought your people through. We gave you a confidentiality agreement. We are pretty excited about that. We have done quite a few tests on that. We are getting good results. It is proven to be very robust. That is not the problem. It is now getting us tied back in through the bits and the DHA and getting the data to surface. You hit it right on the head. We are pretty excited about it. We probably wouldn’t have talked about it quite yet until we get a few more jobs in the ground but we think that is going to be a good break through for us.

Operator

The next question comes from Kurt Hallead - Royal Bank.

Kurt Hallead - Royal Bank

Your reference point on the international growth rates for next year I think everybody was expecting mid teens. You guys were referencing kind of a mid teens growth rate. Maybe a little bit higher. You talk about a slow down. Since you are growing less than your peer group anyway does that kind of slow down definitively impact you or on a relative scale will you wind up closing the gap relative to the peers? What is your best guess on that?

Chad Deaton

I think it is too early for us to tell what is really going to happen internationally. What encourages me is that we have been very successful these last two quarters on some big, major international wins. Those will eventually start pulling through. I think without a doubt the end of 2006 and early 2007 when we were finalizing all of our things with the government and EPA monitor I don’t think there is any doubt our focus was there trying to get all that done and we probably missed out on some pretty good opportunities and contracts and other things I think we are paying the price for this year and a little bit right now.

What is encouraging to me is the number of big contracts we have won and the number of contracts or number of awards is coming off of these deep water rigs that are being placed in Europe, Africa, Gulf of Mexico and Brazil. So yes we had all those things through and I think we should start closing some of that gap. We still have certain countries where it is going to be tough for us to participate and it depends on what happens in activity in those countries and response and how they operate. That will determine what some of the other growth rates are like. Again, I am encouraged by the wins we have had these last few quarters. They have been pretty impressive in our line and we should see some of that coming through in 2009 and definitely in 2010.

Kurt Hallead - Royal Bank

There has been some recent articles about Petrobras getting a little bit more cautious in their development plans and reining some things in potentially. You are big in Brazil. What are you hearing?

Chad Deaton

We have not been told yet by them to rein anything in. So we stay in pretty good touch with them and the team down there every week. So far it is still full blast ahead.

Kurt Hallead - Royal Bank

Your hurricane impact was twice that of your peers. I was just kind of curious was that just a function of your manufacturing facilities being so consolidated in Houston or I’m just trying to figure that out.

Chad Deaton

I actually think it is the absolute dollar numbers and the share count that changes what it is cents per share. I saw the text from Halliburton and it was almost as shocking. I think their D&E segment was hit for $40 million revenue and $27 million of CBT and ours was $44 million in revenue and $27 million CBT and their CMP was almost identical to ours as well. I think [Somerjay’s] was pretty close to the same in the $70-80 million range. For the three of us dollar wise it was close. We just have different share counts.

Operator

The next question comes from Robin Shoemaker – Citigroup.

Robin Shoemaker - Citigroup

I wanted to ask you have taken us through the end of the year on U.S. rig count of 1,800 or so and I wonder if you could postulate beyond that. Especially if you could comment on the fact we kind of had a plateau in the U.S. rig count in 2006 and 2007 at around 1,750 and obviously I think we are expecting it to go below that. Assuming it does where within the North American land and offshore rig count, gas and oil, do you think you will see the most cut backs and will we see the same level of cut backs in the big unconventional resource plays as in some of the other plays that are in the market?

Chad Deaton

I think the thing you have to look at is again rather than geographically or by base you look at it by client. Clearly we think the oil side is going to stay busy. I think that is pretty reflected in this last rig count drop. Gas rigs down 70 and oil rigs actually up. So $70 oil these guys continue to find oil at economic value that they can go ahead and drill. But if you go around whichever basin it is customers have a different cost base. They pay differently for their acreage. So I think we have some customers we talked about that we have talked to that have said at $6 gas they are still in great shape whether it is the Barnett or the Mercel or some of the others. There are other clients that already are facing some cash flow issues. So I think you have to go through customer by customer. We went through our top 50 customers and try to determine cash flow, etc. and that kind of gives us a feel for what percentage of those will continue to go and which ones may slow down for awhile. I think that is the way you have to look at it.

Robin Shoemaker - Citigroup

I wonder if you could comment on the share repurchase plan going forward? As you know Halliburton indicated they were going to put their repurchase on hold and only do share repurchases to the extent of offsetting share creep. You have got authorization. Your stock is way down from where you bought it in the second quarter. I just wonder what your stance is currently with regard to your authorization.

Peter Ragauss

We agree the stock price looks attractive at these levels but our first priority is refinancing our upcoming debt obligation so we need to do that before we start thinking about any other uses for cash. We need to clear that up which I think we will do promptly. Our second priority after that obviously is reinvesting in the business. We still believe it is more important to grow the top line than shrink the share count and there is a lot more opportunity today than there was three months ago with respect to attractive acquisitions in terms of technology, geography and in terms of portfolio gaps. It is more attractive than it has been in years. If I had my druthers I would pick up something that would contribute to the portfolio rather than shrink the share count. We are going to be probably more opportunistic on that side than we have been in the past. We have been patient and maybe our day is coming on that front.

Operator

The next question comes from Mike Urban – Deutsche Bank.

Mike Urban – Deutsche Bank

You have talked a little bit in your prepared comments and a little in the last question about M&A but at the same time in the past you have also spoken about restrictions or at least maybe some limitation on what you may be able to do or not do because of the DPA and the monitor. Could you go through a little bit what that process might be? Is there anything you would have to rule out? Is it a country issue? In other words would you be more inclined to do something in the U.S. as opportunities come out and maybe be a little more restricted internationally? If you could just walk us through that thought process on how you are going to approach that.

Chad Deaton

We have made a couple three small acquisitions which sets the stage so that we are working with the monitor and working with the DPA we know the process now. Obviously it gets more complicated if you are making big acquisitions with operations in multiple countries around the world. It depends on whether that potential target is operating in areas where they use a lot of agents and other things. That does complicate obviously our due diligence process. Buying a U.S. company that mainly operates in the U.S. is not a problem. It can be done. It would just have to…I can’t give you a general answer because it does truly depend on which client, competitor and which areas they are operating in and how complex it may be. But we have proven we have got a process in place now where we can buy these and we have a due diligence process that we can work our way through and as Peter said we think there is going to be some opportunities and we will take advantage of them if we can.

Mike Urban – Deutsche Bank

More specifically, in the past you have talked and spoken to the interest in adding pressure pumping competence and you have done some things there on a smaller scale. As some of the U.S. spec capacity maybe gets squeezed or suffers a little bit is that something you would look at or does that not give you necessarily the critical mass you might need for the scale of your business?

Chad Deaton

I think there is definitely the critical mass out there. There are 2-3 million horsepower that is spread among these people so yes that is a possibility.

Operator

The next question comes from Geoff Kieburtz – Weeden & Co.

Geoff Kieburtz – Weeden & Co.

Coming back to the international topic you mentioned earlier you see no signs of erosion in the deep water market outlook. Could you give us a little bit of a sense of how important that market is in terms of your overall international revenue?

Chad Deaton

I think we get about 65% roughly or 60% of our international revenue from offshore. I don’t want to say some of these rigs being built may not get cancelled. When I say we haven’t seen any slowdown I am mainly talking about the clients that have the rigs and are already coming and delivered. What we are talking to now there actually will be work and that is the side I’m saying we have not had any pull back on any of that award.

Geoff Kieburtz – Weeden & Co.

In terms of rig construction being cancelled that would presumably impact 2011 and 2012, correct?

Chad Deaton

Probably not because most of these that are being built we see coming out over the next three years have pretty much been committed and clients have signed up for. 93 new rigs out there now under construction. That is up from 86 this last quarter. So I think that is where you could be starting to see those extra 8-10 rigs do they have contracts or are they spec and those may be under some…they are probably 4 years away from delivery anyway.

Geoff Kieburtz – Weeden & Co.

That’s not a 2009 or 2010 issue?

Chad Deaton

We see 22 rigs coming into the Gulf over these next three years. A lot of that is work that has bee awarded now. We see 21 rigs coming into Brazil. We see 14 rigs coming into Europe and Africa over the next three years and again that is what will be generating the revenue for the next three years is those rigs. That again is revenue that has been awarded and if you add all those up we are sitting on in excess of 40% of what has been awarded so far has come to us. We think unless the client decides all of a sudden to get drastic and cancel a contract which would surprise me. These are long-term programs with customers that have long-term plans. I think this activity will stay there.

Geoff Kieburtz – Weeden & Co.

The related question, outside of the offshore markets and I’m assuming a large part of that 60% that is offshore is deep water.

Chad Deaton

Yes a pretty good chunk of it is.

Geoff Kieburtz – Weeden & Co.

Outside of the offshore component, do you have a significant amount of contracted visibility on the land activity?

Chad Deaton

Yes, it depends. Russia is not putting out long-term contracts on land. You get into the Middle East, Saudi has some contracts they have put out there but they are always subject to performance. If you aren’t performing it doesn’t necessarily mean you are going to be on it. We don’t have much visibility there. Latin America what land is there you win some contracts in Venezuela and Mexico. These are two-year type packages.

Geoff Kieburtz – Weeden & Co.

So you kind of have a mix there?

Chad Deaton

Yes, a mix.

Geoff Kieburtz – Weeden & Co.

I don’t know if you are willing to give us any insight here but in talking about your infrastructure spend it sounded like you are sticking with the program. $300 million this year. $300-400 million next year. Is there any significant shift in the mix where you are spending that money in 2009 versus where you have been spending it in 2008?

Chad Deaton

Well it will be international. It will be increasingly becoming more actual operational base facilities. There are several in Russia. There are several in the Middle East itself. Several in Asia. Several in Latin America, Brazil and Mexico. I guess the difference in end of 2007 and 2008 a pretty good chunk of that $300 million was we did some R&D expansion on the CPI base. We did some expansion in our D&E technology base. We did a couple when it comes to the training facilities in the Middle East and others. I think what you would see is this increasingly becomes more beyond operational facilities. We are going to stick with that next year. We don’t want to fall in the trap the company has been guilty of in the past and not have the facilities. We still believe in the long-term the activity is going to be there. We need to continue to build out with our long-term plan. As Peter said we have the cash flow to do it. We are financially in good shape and this is a good investment for the long-term side of it.

Geoff Kieburtz – Weeden & Co.

You mention in your comments the Middle East/Asia margins were down but I didn’t pick up on any elaboration as to why.

Chad Deaton

Mainly it is Asia Pacific. A couple of product lines out there struggled in Q3. It was mainly in the Asia Pacific area.

Gary Flaherty

I want to be respectful of other people who have calls scheduled. With this we will thank Chad and Peter. We thank everyone for your time and participation and your very thoughtful questions. Following the conclusion of today’s call both Jean and I will be available to answer any additional calls you may have. Once again thank you for your participation.

Operator

Thank you for participating in today’s Baker Hughes Inc. conference call.

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Source: Baker Hughes, Inc. Q3 2008 (Qtr End 09/30/08) Earnings Call Transcript
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