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Baker Hughes Incorporated (NYSE:BHI)

Q4 2008 Earnings Call

January 28, 2009 8:30 am ET

Executives

Gary Flaharty - Director of Investor Relations

Chad Deaton - Chief Executive Officer, Chairman, and President

Peter Ragauss - Senior Vice President and Chief Financial Officer

Analysts

Jim Crandell – Barclays Capital

Bill Herbert - Simmons & Company

Kurt Hallead – RBC Capital Markets

Ole Slorer – Morgan Stanley

Dan Pickering - Tudor, Pickering, Holt

Charles Minervino - Goldman Sachs

Brad Handler – Credit Suisse

David Anderson – UBS

Robin Shoemaker – Citigroup

Mike Urban – Deutsche Bank

Geoff Kieburtz – Weeden

Operator

(Operator Instructions) Welcome everyone to the Baker Hughes Fourth Quarter 2008 Earnings Conference Call. I will now turn the conference over to Mr. Gary Flaharty, Director of Investor Relations.

Gary Flaharty

I want to welcome you to the Baker Hughes fourth quarter 2008 earnings conference call. Here with me this morning are Chad Deaton, Baker Hughes’ Chief Executive Officer, Chairman, and President, and Peter Ragauss, Baker Hughes’ Senior Vice President and Chief Financial Officer.

Following management’s comments this morning we will open the lines for your questions. Reconciliation of operating profits and any 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.

I also want to caution you that any company outlooks 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 10-K, 10-Q, and in particular the forward looking disclosure in this morning’s news release.

With that, I will conclude our discussion of the administrative details and turn the call over to Peter Ragauss.

Peter Ragauss

Today we reported net income on a US GAAP basis of $432 million or $1.41 per share. This compares to $1.26 per share a year ago and $1.39 per share for Q3 2008. Q4 revenue was $3.2 billion up $446 million or 16% from Q4 2007 and up $176 million or 6% from last quarter. Our oil field operating margin in Q4 was 22% this compares to 24% from year ago quarter and 22% again in Q3. For the full year operating profit was $5.30 per share up 12% from the $4.73 per share in 2007.

Two thousand eight full year revenue was $11.9 billion up 14% from $10.4 billion in 2007. North American revenue was up 17% compared to 2007 and non-North American revenue was up 12%. Our oil field operating margin for the full year 2008 was 23%. Full year CapEx ended up at $1.3 billion.

Moving to the regions, the North American revenue was $1.4 billion in the fourth quarter up 25% compared to the year ago quarter and up 8% sequentially. Total non-North American revenue was up 10% year on year and up 5% sequentially. Latin American revenue increased 42% year on year. Revenue from the Europe/Africa/Russia/Caspian increased 5% compared to the year ago quarter. Revenue from the Middle East/Asia/Pacific region was also up 5% compared to the fourth quarter 2007.

Sequentially revenue from the Latin American region was up 20%, revenue for the Middle East/Asia/Pacific region was up 10% and revenue for the Europe/Africa/Russia/Caspian region was down 3%.

Turning to the performance of our two segments; drilling and evaluation revenue was $1.57 billion in Q4 up 15% compared to the year ago quarter up 1% sequentially. Year on year revenue growth was strongest in Latin America and North America. Our drilling fluids and directional drilling product lines saw the largest increase in revenues compared to the year ago quarter. The drilling and evaluation segments operating margin was 21% down from 25% in the fourth quarter 2007 and down from 22% in the third quarter.

Revenue for completion and production segment was $1.6 billion up 18% from the year ago quarter and up 11% sequentially. Year on year revenue growth was again strongest in Latin America and North America. Oil field chemicals and artificial lift had the largest revenue increase compared to the year ago quarter. C&P’s operating margin in the fourth quarter was 23% basically flat to the fourth quarter of 2007 and actually up from 22% in Q3 2008.

To help you evaluate our earnings per share in the fourth quarter I’ll walk you through the significant items that bridged the sequential and year ago quarters to the fourth quarter EPS and I’ll walk through a full year bridge.

In Q3 2008 our US GAAP net income per share was $1.39. From this $1.39 add about $0.01 for the impact of lower share count, subtract $0.08 for the impairment of auction rate securities we took in this quarter, subtract $0.05 as the result of higher interest expense compared to Q3, subtract $0.01 to adjust for a higher tax rate, then add about $0.06 to reflect lower corporate costs in Q4 compared to Q3 due to one time gains in the quarter which are not expected to recur. Finally, add $0.09 from operations. This gets us to the $1.41 we are reporting for the fourth quarter.

Looking at year over year from the $1.26 reported in the fourth quarter 2007 subtract $0.08 for the impairment of auction rate securities again, subtract $0.06 to account for the impact of higher interest expense, add $0.10 to account for the benefit of the more favorable tax rate this quarter, add $0.05 for the impact of lower share count and add about $0.05 for the impact of lower corporate costs in Q4 compared to the year ago quarter, again attributed to the one time gains in the quarter which are not expected to recur. Finally, add $0.09 from operations. This gets us to the $1.41 we are reporting for the fourth quarter.

Looking at the full year from the $4.73 we reported for the full year 2007 subtract $0.13 for the litigation settlement, subtract $0.09 to account for the impact of higher interest expense, subtract $0.08 for the impairment of auction rate securities, subtract about $0.03 for the impact of higher corporate costs, add $0.28 to account for the benefit of a more favorable tax rate, add $0.20 for the impact of the lower share count, add $0.06 for the gain on the sales of a product line, and add $0.36 from operations. This gets us to the $5.30 we are reporting in 2008.

Turning to the balance sheet. Total debt increased $703 million to $2.3 billion. During the quarter we issued $1.25 billion in long term debt to repay $500 million of short term Commercial Paper and to pre-fund debt maturities of $525 million in the first quarter. We will now have no maturities of long term debt until November 2013. At quarter end our total debt GAAP ratio was 26% and our net debt was $378 million.

We currently have $1 billion in un-drawn committed facilities comprised of $500 million under a revolver which is accessible through 2012 and $500 million under a 364 day facility we plan to extend in March. At the end of the fourth quarter we also had cash and short term investments of $2 billion so this totals $3 billion in liquidity.

With respect to working capital in the quarter we actually released $65 million in working capital against a revenue increase of $176 million. Our credit and collections teams are working hard to preserve our cash position.

Moving on to guidance, our guidance for capital spending in 2009 is $1.1 to $1.2 billion. The budget includes: a) continued investment in infrastructure with an emphasis on the international market; b) incremental capacity for completions and production segment product lines; c) capital for new rental tools. We will manage our incremental capital spending for rental tools to match market demand while we build additional tools to service some of the key contract awards we won last year. Last, our tax rate for 2009 is expected to be between 31% and 32%.

I would like to comment more specifically to the first quarter 2009. Typically we experience a seasonal decline in Q1 with a heavier equipment direct sales in our completions and ESP businesses. For example, you will recall last year this amount was about $100 million sequential revenue decline. The seasonal impact will probably be greater this year.

In addition, weather will play its normal factor in the North Sea and Russia. Unique to this year are the dramatic drops in the US rig count that have occurred every single week for the past couple of months. Pricing is also dropping while we typically experience about a 90 day accounting lag for product costs to catch up thereby squeezing reported margin. Q1 is difficult to pin down at the moment with so many downward indicators but it should be significantly lower in all regions.

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

Chad Deaton

The fourth quarter results were particularly strong in the Western Hemisphere despite the global economic slowdown and of course the eroding commodity prices. North America US revenue was up 26% compared to the year ago quarter and up 7% sequentially. Canadian revenue was up 18% year on year and was up 7% sequentially and a 5% decrease in rig activity. Year on year revenue growth was strongest for our directional growing completions and specialty chemical product lines and sequential revenue growth was highest for the directional growing and again specialty chemical.

Our operating profit margin for North America was 23% in the fourth quarter that was down from 26% in Q4 ’07 and 24% in the prior quarter. In the fourth quarter we continued to support the horizontal drilling trend and the unconventional gas place with technology such as our G3 AutoTrack rotary steerable system and our FracPoint completion system. We are seeing some very strong growth in the demand for the FracPoint completion technology and we’ve now completed 520 installations for over 70 customers in a variety of formations.

We continue to deliver value to our customers with new technologies like our Quatech PDC bits which are delivering longer run life through application and markets that were previously drillable only with Triclone or diamond impregnated bits. Q4 was a strong quarter for our sand control product line in the Gulf of Mexico as well as Alaska. Our artificial lift division also has strong sales in the Gulf of Mexico where activity recovered from the Q3 2008 hurricanes.

Turning to the south to Latin America, year on year revenue growth in the region was led by Brazil where we had strong increases in sales for our artificial lift and directional drilling businesses. Revenue in Colombia more than doubled year on year due to the increased demand for artificial lift and drilling fluids and our completions had a strong quarter in Mexico and Venezuela.

Sequentially Latin America revenue was up 20% compared to a 3% increase in the rig count. Sequential revenue growth was led by Colombia with increased sales of artificial lift systems and by Mexico with growth across our completion new production product lines. The operating profit margin in Latin America for the fourth quarter was 21% and that’s down from 22% in Q4 last year but its up from the 18% in the third quarter.

In the fourth quarter we continued to deliver a broad base of products and services in Brazil through our strong contract and market share position held by or directional drilling LWD MWD and drilling fluids businesses. In Mexico in conjunction with installing our equalizer ICD completion technology in the Cantarell field we successfully ran the first RE packer with is our oil based rubber swell technology delivering initial flow rates that were more than 25% greater than planned production estimates. We’ll continue to build out our infrastructure and integrated operations capability in order to support future opportunities in Mexico.

Turning now to Europe/Africa/Russia/Caspian or EARC. A variety of factors led to lower activity across the region in the fourth quarter. Many operators are struggling to manage a cost base that has effectively doubled since the last oil prices were in the $40 range. For Europe, revenue declined year on year and sequentially due to weather and project related delays. Revenue for Russia and Caspian was down year on year but improved sequentially. Operators in Russia scaled back activity in response to lower oil prices, the valuation of the Rubel, a difficult tax structure and liquidity concerns.

For Africa, activity in Nigeria was affected by rig delays. This was partially offset by increased activity in Angola, Algeria, and Libya. Africa revenue was up year over year and sequentially. We experienced strong demand for wireline and directional drilling MWD LWD and completion product lines in North Africa. Our operating profit margin for Europe/Africa/Russia/Caspian was 20% in the fourth quarter that’s compared to 22% in Q4 ’07 and 23% in Q3.

Middle East revenues were up both year on year and sequentially. Fourth quarter revenue improvement was let by our D&E segment in Saudi Arabia where our Mag Track NMR tool has been used to drill and more importantly evaluate wells in the challenging Manifa field. Our completions and oil field chemical product lines also experienced very solid quarter in the kingdom. Sequential revenue growth in Egypt was led by our directional drilling and LWD MWD business.

Asia/Pacific revenue improved year on year and sequentially. The year on year revenue growth reflects increased directional drilling activity in Indonesia and sequential revenue growth was led by increased wireline activity in Australia. Our operating profit margin for the Middle East/Asia/Pacific was 23% in the fourth quarter that compares to 25% in Q3 ’07 and 19% in the last quarter.

Now looking forward its difficult to give specific guidance in the current market. However, I’d like to comment on some of the activities and trends that we are seeing and that are changing almost day to day. In North America the use of advanced technologies and the unconventional gas place has led to production increases that exceeded demand growth in 2008. Looking forward, the recession, its impact on demand and reduced access to capital has resulted in activity and spending cuts by our customers.

Operators are now cutting their budgets in order to live within their free cash flow. Drilling is already down 25% from peak levels with the Rockies, Southern and Central areas of the US being hit hardest. Vertical drilling is down 33% from peak. In comparison to historic turn downs today we are experiencing a steeper decline in the rig count than we saw in the four prior cycles. The unconventional gas place have faired the best so far with horizontal drilling activity falling only 10% from peak. Horizontal drilling in the oil sectors has fallen further.

We expect drilling in Canada to hold until the spring break up in a few weeks then be soft for the balance of the year. The unconventional gas place in British Columbia the Horn River and the Motney could be areas of relative strength.

Offshore activity is holding up well, although lower gas prices do pose a threat to shelf drilling and deep water activity increases for 2009 remain in tact. In this environment we expect our production oriented product lines such as artificial lift and chemicals to hold up the best. The rig count should bottom in the second or possibly the third quarter and of course recovery will depend on the supply/demand balance for natural gas.

Regarding Latin America we remain confident about our opportunities there. Petrobras announced an increase in their budget Monday confirming their plans to develop the pre-sell plays. We continue to ramp up our capability for activity and share gains in Brazil and in Mexico and after a few delays we expect rig availability issues to be resolved with Pemex and begin work on our marine projects sometime in the first quarter.

To further augment our presence in Brazil we are investing in a new technology and training center in Rio. The new facility will become operational in 2010 and will include laboratory space devoted to drilling completion, artificial lift and geo-science projects that are oriented toward pre-sell reservoirs.

In the Europe/Africa/Russia/Caspian region customers are under pressure to lower costs, improve efficiency and maintain activity. As in other areas, operators are displaying a preference for quality and reliability which are Baker Hughes strength. In the North Sea, Norway is expected to remain stable while the UK and independents will struggle with low commodity prices and reduced credit in a relatively high cost market.

While near term prospects in Russia are limited we all know that this region has huge reserves and has an important role to play in the future of the industry. The same holds true for the Caspian area. It is politically complex and lacks export infrastructure but remains strategically important to the West. In Russia and the Caspian we will need to balance the near term activity slowdown with our long term investments in people and infrastructure.

Activity in the North Africa area should remain stable being driven primarily by demands for gas in Europe. The Middle East is not going to be an end to the challenges. Saudi Arabia has announced plans to cut back oil directed activity but will offset part of the decline by increasing gas drilling activity in the kingdom. Cutter activity will slow as they conduct a reservoir analysis before continuing development of the North field. China is expecting to reduce activity offshore but is also planning more deep horizontal wells on land.

Trying wrap all this up and in summary, North America has clearly been the first to feel the affects of the global recession and lower commodity prices. The North American rig count averaged 1,879 rigs for 2008 and peaked at 2,031. The average rig count in 2009 could be down 25% to 30% compared to the 2008 average or an average of about 1,300 to 1,400 rigs compared to the 1,879 we saw in 2008.

Because the projects are larger and longer lasting the international markets will be slower to react. We’ve seen weakness today in markets such as Russia the Caspian and UK. We expect the international rig count to fall as much as 10% in 2009 compared to 2008. In this environment we will manage our business to protect market share, cash flow, and near term profitability.

Despite near term cost pressures we also will not cut costs in a way that will jeopardize the future of the company so we will continue to invest in research and engineering, employee development and in the infrastructure we’ll need to exit this cycle as a much stronger competitor in all markets. Given this outlook current consensus earning estimates for Q1 and full 2009 are too high.

In closing, as the year develops we’ll monitor our activity levels across the company in order to determine what further adjustments are necessary. In the long history of this company Baker Hughes has successfully managed numerous business cycles because our employees share a common commitment; to be an industry leader, a step up to the plate, met market challenges with ingenuity, hard work and dedication and I expect this downturn will be no different.

Gary Flaharty

I’ll ask the operator to open the lines for your questions. To give everyone a fair chance to ask a question we ask that you limit yourself to a single question and a related follow up question.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jim Crandell – Barclays Capital

Jim Crandell – Barclays Capital

In 2008 you took a relatively cautious approach, you weren’t willing to bid on some of the big IPM contracts to the extent your competitors have. With a lot of business forthcoming with Pemex in Mexico and given what’s happening in the business would you expect that to have a more aggressive stance in this business in 2009?

Chad Deaton

We would look in each market and determine whether we wanted to participate in that area. Obviously the two other Chicontepec tenders are coming up soon or the ATG tenders. We will participate in that. We don’t want them for what they went last time. If we can get them and make money on them then yes we’ll tender them. We’re also looking at Algeria, other parts of Latin America where we have won several of these projects. We’ll take a look at each one of them, if they make some sense and we think we can make money then yes we’ll take them on.

Jim Crandell – Barclays Capital

If we look at the business from a product perspective and look at the drilling and evaluation, $200 million of pick up year to year in revenues with I believe operating income being slightly lower is that mostly a North American phenomenon?

Peter Ragauss

It is mainly a North American phenomenon. If we look year over year, full year over full year, that’s right.

Jim Crandell – Barclays Capital

How about quarter to quarter?

Peter Ragauss

Q4 over Q4 its both North America and rest of world, probably rest of world has a little bit less, North America probably had a little less decline. If you get in the detail, the rest of world it was all in Europe/Africa/Russia/Caspian.

Operator

Your next question comes from Bill Herbert - Simmons & Company

Bill Herbert - Simmons & Company

Given your prophecy here of North America being down 25% to 30% on average year over year and international down 10%, difficult question to answer but do you hazard a guess as to the evolution from current to trough margins in 2009, lower for sure but I guess by how much?

Chad Deaton

On rig count?

Bill Herbert - Simmons & Company

Based upon what you’re prophesying for rig count the margin evolution for your business. In other words, current margins compressed by how much do you think order of magnitude as we progress lower 25% to 30% on average year over year in North America and 10% internationally?

Chad Deaton

I don’t know that answer. What we’re going to have to do is obviously costs have got to come out of the business as rigs go down. You can look back in previously cycles in this industry and you can see that margins were cut considerably until people react then we’re able to build them back up again. I wouldn’t want to try to give you a number. I just don’t know it depends on how far this keeps pace and how long it lasts.

Bill Herbert - Simmons & Company

With regard to your current discussions with customers I think we understand what’s happening with your work the more asset intensive business and pricing and where it’s going and that is considerably lower. I’m curious as to whether with regard to your respective product lines what you’re seeing on pricing; freefall, gradually lower, how would you characterize it right now?

Chad Deaton

You’ve got to break it out by product line and you have to break it out by geographic area. C&P is holding up much better. Clients are moving towards more development and production. We have tighter supply in those product lines. We’ve not seen the pricing pressure on the C&P side especially artificial lifting chemicals as much.

D&E it’s a different story. In the end there you probably go a little more geographical. If you look at North America, Central, Southern area pricing is much more severe there or pricing pressure than if you look at the horizontal or where the technology is the more challenging drilling less pricing pressure we’ve seen.

Internationally again same thing, there’s pricing pressure in Russia simply because of the activity decrease. UK similar thing. In certain parts of other areas of the world contracts are locked in and a lot of clients are saying when we roll them we’ll take a look at pricing. There’s no single answer to the globe.

Bill Herbert - Simmons & Company

No mention of Block 31 I’m curious as to where you guys stand there on that completion package.

Chad Deaton

We were not successful.

Operator

Your next question comes from Kurt Hallead – RBC Capital Markets

Kurt Hallead – RBC Capital Markets

Everybody’s been chatting about protecting market share. You’re referencing your prior answer to Bill’s question about pricing pressures in different locales that being pretty obvious in terms of where the activity hits are coming. If everybody’s talking about protecting market share does that concern you that we are going to see much more rapid and severe pricing declines in all areas, technology notwithstanding?

Chad Deaton

Yes, it concerns you but I think its also just fact. You go back to any of the last four or five cycles that’s just what happens. People will then turn around and they don’t want to lose market share. It will affect pricing and those with a strong balance sheet and good cash flow and what they can do to control their costs will be the ones that will survive it. Yes, I think pricing could be under a lot of pressure.

Kurt Hallead – RBC Capital Markets

You referenced the fact that a lot of these international projects have long term contracts. We talked to some of the other competitors about their business in the US; they could reference for example Frac business is 60% to 70% contract for the year. Can you give us some general sense when you look at your international business approximately what percent is potentially exposed to contract rollover? You don’t have to get too specific I’m just trying to get a general sense.

Chad Deaton

For the domestic first, what we’ve seen is some of the majors come through which the majors are going to stay fairly active. We’re not seeing near as much cut from the majors when they talk about their activity for 2009. Some are dropping 15% some say they’re going to be even busier. Some of the work for the majors on the D&E side is fairly locked up under new pricing regime for the year.

Internationally probably about two thirds of our business is under contract so you’ve got about a third rolling off which will be up for discussion.

Kurt Hallead – RBC Capital Markets

I heard some comments in some of the other conference calls about customers internationally going into this horse trading process price for term or price for volume. How does that typically work on the international front, can they come in midstream and say, let’s spend it now but you’ve got to give of some price concession. Can you give us some color on that?

Chad Deaton

Depends on the client, depend on the area, and depends on the amount of excess capacity or service companies in that particular area. If there is excess capacity obviously the client is in a position to do that. In some areas the customers have tried it and there just isn’t that much excess capacity and they haven’t been successful. It depends on the customer and again the capacity that’s sitting there.

Operator

Your next question comes from Ole Slorer – Morgan Stanley

Ole Slorer – Morgan Stanley

I wondered if we could have a little bit more color on what is said in seasonality. ESP you said is seasonally strong in the fourth quarter a little bit down more than $100 million in the first quarter but still strong for 2009. What about other seasonally sensitive aspects such as completion or in the unit sales except for the wireline division.

Chad Deaton

Completions usually what we see in completions are weaker in the first quarter, large completion sales are weaker in the first quarter than the fourth quarter. That’s what Peter was referring to in his comments. In terms of equipment sales we’ve backed off selling a lot of our wireline equipment. We’ve chosen not to do that and need it for our own internal uses. We’re not really affected by that where as two or three years ago we were.

Ole Slorer – Morgan Stanley

You highlighted emerging as a strong company that’s something we’ve heard out of every company that’s reported so far. Who do you think will lose out; do you think it will be a consolidation towards the major players again in this down cycle? We’ve seen a lot of fragmentation in a lot of product lines segments particularly in North America. Do you see any consolidation or are you looking for other ways of emerging stronger?

Chad Deaton

You look at history and this is what’s happened in all these previous cycles. Today we don’t know how long or how deep this one will be. Clearly there’s consolidation factor that comes out of these. If we see pricing deterioration and things that we’ve seen in the last two, two and a half years where it’s really looking and recognizing revenue growth as a most important metric everybody looked at. Over 2009 and 2010 other metrics such as cash flow, return on capital, balance sheet strength, debt coming due etc. will be what a lot of people are looking to.

Those companies with the stronger balance sheet, the good cash flow, solid products, I think those will be the ones that will come out the winner as this cleansing process, as we work our way through it the next year or two.

Ole Slorer – Morgan Stanley

No clear consolidation necessarily but taking market share.

Chad Deaton

Yes, and we look back at past cycles usually things will start coming online with much better value in terms of potential acquisition than what we’ve seen in the last two or three years. Eventually reach that and it looks like we’re marrying the bottom of something that’s usually when I think people start taking advantage of it.

Operator

Your next question comes from Dan Pickering - Tudor, Pickering, Holt

Dan Pickering - Tudor, Pickering, Holt

Baker Hughes obviously went through a period of swapping from vendors to more Baker Hughes both from the international side as the result of all this FCPA situation. Can you tell us where you are in that transition and does that make it easier or harder to manage the cost side as step through the next 18 months?

Chad Deaton

We’ve talked about it in the past. We’ve gone from 300 or 400 agents three or four years ago to around 40 today, of the so called vendors you talk about that’s been a significant reduction. We’re mostly done with that. We continue with our DPA until April and our monitor this team until a year after that. We’ve got a pretty good feel now for what our costs are associated with that.

You will see in 2009 that we will have some significant costs as we implement some of the procedures and processes that he and his team want us to see in terms of SAP globally etc. Peter and our HR group do have some costs that we will be seeing in 2009 as we implement that. We will come out of that in 2010 with those costs behind us and we’ll have a team around the world that we won’t have to worry about things like FCPA and investigations and agents again. It’s been a long road, a long process but the light is at the end of the tunnel and when we get through 2009 we’ll be in pretty good shape.

Dan Pickering - Tudor, Pickering, Holt

You talked a little bit about this in addressing one of the prior questions; you’ve talked in the past about the pumping business. You’re not in it; it’s helpful in some of these global IPM projects it would appear that values for that business have fallen a lot in the last year. How are you thinking about it now? Is 2009 a year where you make some steps in that direction?

Chad Deaton

I’d hate to signal anything we’re trying to do. You’re right; I think there is five million horsepower in the US last time I looked and that is way too much to go into the next 2009, 2010 downturn. I do think the valuation of these type businesses is going to improve as we go through the year. It goes back to the point, we’ve got a good balance sheet, Peter and his team did an excellent job of getting out with the bond offering. We’re in a pretty good position to watch this thing and again that’s part of the comment we’ll come out of this strong when it does turn. We’ll look at that and we’ll look at other potential product lines.

Dan Pickering - Tudor, Pickering, Holt

Would you say the urgency level is higher than it has been given how things are playing out or do capital markets and the market outlook keep you on the same keel or maybe even more conservative?

Chad Deaton

No, I don’t think the urgency is stepped up. Jim asked a question earlier about project management and IPM. Yes, you do need pumping to win some of those. We’ve teamed up successfully with a company in many of these projects where we worked together with them. Some of these IPM type projects a lot of those were being done for venture capital groups or people that were looking for somebody to co-manage the project. A lot of that is disappearing in today’s market.

I don’t think there’s a real urgency that we have to go out and fill that void right away. We’re going to have an opportunity based on what we see over the next year or two. We’ll continue to watch the space.

Operator

Your next question comes from Charles Minervino - Goldman Sachs

Charles Minervino - Goldman Sachs

I wanted to talk a little bit about Latin America. You guys have a very strong presence in Brazil that came through a little bit this quarter. Can you give us a little update of where you stand there and how you plan to participate in the growth in that market given Petrobras’ aggressive CapEx plan?

Chad Deaton

We’ve got a very strong position there. We’ve got 50% of the long term contract for their offshore drilling and LWD type work and we also have 50% from the drilling fluid side. One of the successes we’ve had down there is by having that strong presence we’ve been able to bring in the sister product lines on artificial lifts, completions, etc. Its one of the reasons why we’re opening up the new Rio technology center down there to specialize on sub-sell.

We’re also opening up the Geo-science center down there with our acquisition of GMI and GSA. They’ve already been working closely with Petrobras we’re expanding that. We’re very encouraged by what we’ve seen in Brazil and we’re very excited about what we see going forward. Their comment over the weekend that they were going to continue to fund these projects we’re watching that closely. We like our position there.

Charles Minervino - Goldman Sachs

Mexico is another one of those areas that could generally be better than other markets in 2009. Can you give us an update how you’re thinking about Mexico in 2009?

Chad Deaton

Our number one priority, we don’t necessarily control it, we were successful on winning the offshore contract was issued the end of last year, third quarter last year. We were due to start that end of fourth quarter we have not started it yet but we are geared up ready to go on that. That’s going to give us a good foothold. It was about a $450 million project.

That positions us to be able to do the similar thing like we did in Brazil. Once you get in you’ve got to execute. If you execute then the client tends to give you more. That’s what it’s all about.

Operator

Your next question comes from Brad Handler – Credit Suisse

Brad Handler – Credit Suisse

Maybe I could just bounce backwards to a couple of the questions and follow up. First on Latin America, given the optimism about Brazil and Mexico do you think it’s possible that you might end the year with higher revenues is that a reasonable take away? Higher in ’09 versus ’08?

Chad Deaton

Yes. I would say that that is based on what we know for Latin America today that is the best of the four regions to be able to see that happen.

Brad Handler – Credit Suisse

In the US horizontal market given the strength in FracPoint and it sounds like you’ve penetrated as well in with your AutoTrack product. Can you give us a sense perhaps at how much share you think you’ve taken in US horizontal land? I know that maybe parsing it out may be difficult to do it that way but can you quantify that for us?

Chad Deaton

No, I don’t really have that in front of me. I don’t know the answer to that. I know that on FracPoint we’ve taken considerable share but I can’t tell you from the horizontal drilling side what we’ve done from DD LWD side. I don’t know that. We gained share, I know that much but I can’t quantify it.

Brad Handler – Credit Suisse

On Saudi, come back to your comments about there is some offset or partial offset thanks to gas projects. Maybe I could just ask you to do the same thing there. What does your best crystal ball tell you about your revenue outlook in Saudi for ’09 versus ’08?

Chad Deaton

We know that Saudi is dropping from about 130 rigs to 107 or 108. There’s going to be less emphasis on oil thus dropping back several rigs most of that came out of the Manifa project. Clearly they have an emphasis towards gas. Gas is often times more challenging drilling. We do quite well there on the bit side as well as the DD LWD side. We could have a very good year in Saudi. I wouldn’t say necessarily that we’ve going to have a better year than we had in 2008 but I think we could hold our own and be relatively flat in that area.

Two thousand eight in Saudi if you compare that to 2007 which was a very strong year as well we had a lot of equalizer sales in 2007. They had a huge inventory in ’08 that they were using up and by ’09 this year they’ll be back in need for some more equalizers. We could see completions do a little bit better and we could see D&E relatively hold its own in Saudi.

Brad Handler – Credit Suisse

If I remember picking up on that, I think you mentioned in the last call that they were warming up or maybe even had already placed an order for equalizers am I not remembering that right?

Chad Deaton

We’ve sold some in there but they’re still burning through some of their inventory as well.

Brad Handler – Credit Suisse

So it’s maybe a little bit more of a staggered process then it has been.

Chad Deaton

I think it will stagger all year long. They’ve got some inventory still there and they’re trying to use it up.

Brad Handler – Credit Suisse

Your comments about lift and chemicals resiliency I’m wondering if you could do the same thing for us is it plausible that in those product lines again you could even have a flat ’09 versus ’08 based on what you see today and your sense of how activity will skew?

Chad Deaton

Yes, I think we can. We’ve been very successful in the last three or four quarters on winning several large artificial lift contracts around the world. One of the things that we are seeing in many parts of the world is fields are aging, they’re starting to increase on water production and so the ESP side of the business has mainly been North America, North Sea, some Latin America type stuff. Increasingly in the Middle East, West Africa we start to see that happening.

ESP side could have an improved year. Chemicals as long as gas is flowing and oil is flowing they need to treat those wells. Yes, I think both of those could be okay in 2009.

Peter Ragauss

Chemicals was our fastest revenue growth business in 2008. Part of that we also had some capacity constraints in it. We’re still sold out on chemicals. That bodes well for the chemical side. If anything performs well in 2009 it will be the chemicals.

Chad Deaton

Peter mentioned in his comments that when we talk about our capital spending for ’09 one of the areas was in the area of completions and productions so that’s adding some capacity reactors, etc. for the chemical group. The other thing that we could get a benefit in ’09 is in ’08 we were just chasing our cost inflation for chemicals etc. Some of that’s come down now. We should be able to hopefully get a little bit of improvement in the margin side in chemicals.

Peter Ragauss

Not necessarily in the first.

Operator

Your next question comes from David Anderson – UBS

David Anderson – UBS

Some of your competitors you mentioned operators are shipping more towards development or at least planning. Is this a trend that we’re already starting to see coming through in your C&P results? Based on your product lines which regions in particular do you think will benefit from this trend?

Chad Deaton

Yes, I think we are seeing it. In fact, one statistic I saw the other day I found interesting. If you go back for Gulf of Mexico Q1 ’08 there were 127 rigs drilling and 14 rigs on work order. By Q4 this last quarter it was 108 rigs drilling and 34 on work order. They’ll shift quarter to quarter but I think we’re going to see rigs coming out and more development work or more work order work which that helps Baker Hughes a lot not only on the chemical side but also just in an oil tools completions and things. I think we’ll see that in 2009.

David Anderson – UBS

Right now you’re seeing P&D are neck and neck we should expect see the C&P pull ahead?

Chad Deaton

Yes, I think that’s a fair assumption.

David Anderson – UBS

On Latin America, my understanding is that the service and equipment companies have been filling up the rooms at the recent Petrobras CapEx presentations and that Petrobras has repeatedly been talking about cost reductions. Can I get a little bit more on your take on the announcements, has anything changed in your outlook in the region in the near to medium term? The CapEx numbers they’re putting out there they seem to be putting pretty big asterisk next to them. I wonder if you could give us a little bit more color on that.

Chad Deaton

We’ve not had any discussions with them. The most recent discussions we’ve have has continued to build out our infrastructure down there so we can handle these nine rigs that are, part of these nine rigs, our share of these nine rigs that are coming on the second half of the year. That’s been mainly the discussions we’ve had with them.

David Anderson – UBS

These pre-sell contracts that you signed I assume that’s contributed to the strong Latin American 4Q results?

Chad Deaton

That’s correct.

David Anderson – UBS

You mentioned offshore Mexico contributing to first quarter results. Can you give us a sense as to how much incremental revenue we’re talking about and how that could progress throughout the year?

Chad Deaton

First we’ve got to start the contract. Once that’s started I’ll feel better about predicting that. We don’t know when. We thought we were going to get started in Q4 and with rig moves etc. it just didn’t happen. We’re now trying to find out when the rig will be assigned. Unless that starts then we’ll be able to give you some better numbers in terms of what we see coming throughout the year.

David Anderson – UBS

We should be thinking at least a couple hundred million in that range right?

Chad Deaton

A couple hundred million in the year?

David Anderson – UBS

Yes.

Chad Deaton

No. We’re probably two year project of which there’s a $450 million project we had two thirds of it there’s a third that we’re not part of. As soon as we get started we’ll give you a lot more detail.

Operator

Your next question comes from Robin Shoemaker – Citigroup

Robin Shoemaker – Citigroup

In terms of your comments about wanting to exit the cycle as a stronger competitor. It seems that part of that strategy is maybe to be a little more restrained on the cost reduction side with an eye toward that goal. Is that a fair statement? When you talk about a possible average of 1,300 to 1,400 rig count in North America this year do you think you’re sized appropriately for that now or that there’s more to come?

Chad Deaton

I’m glad you asked that. I want to make sure and clarify that. I said that we wanted to be cautious on our costs when it comes to certain areas. That was as we highlighted on our capital expenditure program we want to continue with our infrastructure build out and we’ve got projects for Algeria, Nigeria, the Caspian, several international projects. We’ve won contracts there that will be coming on in 2010 and so on. We’re not going cut there; we’ll continue to build that infrastructure.

We also talked about, I said in care on employee development and that is we still want to be recruiting in some of these areas and developing Angolans and Nigerians etc. The third area was in the area of technology we didn’t want to be cutting in our R&D expenditure. We’re going to manage it better but we don’t want to cut there so that we’re strong in that area coming out.

Other costs we’ll have to adjust those as those rigs come down. We announced yesterday that we’re having our first 1,500 layoff. We all hope that’s the end of it but we don’t know. If the activity continues to go down then we’re going to have to take a look at that and adjust accordingly. I don’t want you to get the impression that we’re not going to be watching our day to day costs closely. It’s our long term costs that we’ve got to manage properly.

Robin Shoemaker – Citigroup

In terms of the international strategy in the new markets you’re entering the phase two as you once called it, is there any part of that, that’s a little less attractive now or not where you might have envisioned a greater effort but you’re going to hold off for now.

Chad Deaton

No, I don’t think so. There’s a combination of geographical exposure that we want, that we targeted as our top projects. I don’t think those have changed. Its North West Africa, it’s the Middle East, it’s the Caspian, those areas that 85% of the world’s oil and gas sit in and we know we’ll be there for the next four years. The other one was clearly deep water and these rigs that are coming out over the next four years.

Some of them may get cancelled and that may affect us a little bit but for the most part this is an area where we’ve targeted. We do very well on deep water rigs; we have a significant market share. We continue to emphasize that area. We won’t back off many of these long term plans or phase two as we put it.

Operator

Your next question comes from Mike Urban – Deutsche Bank

Mike Urban – Deutsche Bank

A follow up to the previous question. Let’s say the downturn does end up being much longer and deeper than you might think or hope. What would the priority be in terms of some of the infrastructure investments that you’ve talked about and want to push forward on in preserving the balance sheet in that kind of environment? Despite definition they’re kind of mutually exclusive so I would be interested on how firm you are in pushing ahead with those investments.

Chad Deaton

The infrastructure outside North America many of those facilities that we’re in the process of building off the ground and are building we’ll continue. We’ll obviously take a look at 2011, 2012 looks bad then we’ll have to make some adjustments. We’ll continue to invest in those through 2009. We do have about $700 or $800 million of this $1.1 to $1.2 billion that Peter talked about that is tied to tools, replacement tools, new technologies etc. Obviously that gives us a lot of room to bring those down if the market continues to go down we’ll cut that area because we won’t need tools or the bits etc. That flexibility we have.

The rest of it, it comes back to managing cash flow and keeping cash flow positive and working within cash flow.

Operator

Your last question comes from Geoff Kieburtz – Weeden

Geoff Kieburtz – Weeden

Could we go back to your big picture in terms of rig count and can you elaborate a little bit on the underlying assumptions you’re using to come up with that rig count forecast both domestically and internationally?

Chad Deaton

Domestically it’s a little bit of talking to the client, trying to get your hands on what they’re saying. It is changing daily. We put original plans together in the last quarter we thought that the rigs were going to drop to about 1,500 or so and obviously we now are predicting it could be a little further than that. It’s a combination of talking to the clients, looking at how much excess gas is out there, and looking at some of the Haynesville and Marcellus horizontal wells coming in at 20 to 23 million cubit feet a day trying to factor that in, in terms of what it’s going to do.

It’s also looking back at four previous cycles and seeing where they bottomed out. If you look at it they’ve all bottomed out about off a peak about the same area. Recovery was all different and that’s more the challenge of what we’ve got to face with the day. We will probably see down to 1,200 rigs or whatever. How long will they last there? That’s the tough question that we’re trying to answer now.

Internationally we haven’t seen the international rig count fall off much but again you go back to look at previous cycles it could go more than 10%. We’ve got 10% plugged in right now to watch it. The one thing that’s different about this cycle versus the previous four I lived through is we really are dealing with a global recession. The moods probably about as bad as I’ve ever seen it anywhere in the world in previous four cycles.

Its just demand instruction right now and how long that will last. The one good thing we still see out there is from an oil side still a lot of decline. There’s significant decline. We’ve got to balance all those things and these are just what we’re playing with right now and trying to come up with our numbers for 2009.

Geoff Kieburtz – Weeden

In that context of uncertainty there’s a little bit of contrast here in what Baker has decided to do in regards to headcount reductions, but essentially maintaining capital spending plans. Can you elaborate a little bit on the thinking behind that?

Peter Ragauss

It comes back to the $350 million roughly that we have in infrastructure spend. That’s about $100 million up over what we ended up 2008. You’ve got to subtract that from tools and tools are down a reasonable amount.

Chad Deaton

We’ll adjust the two thirds of our capital spending be adjusted based on what happens with activity. The other third we’re going to go ahead and finish building out this because five years ago we weren’t building anything out and the company hasn’t invested in some of the infrastructure internationally we should have. We’re finally getting there. We’re getting caught up in that area. Another year of it will put us in very good shape.

The good news is we’ve got a good strong balance sheet. We’ve got the cash and we think this is a wise use of $350 or $400 million. This explains that third of our capital plan. The other two thirds we’ll adjust depending on activity.

Geoff Kieburtz – Weeden

What’s your lead time on that two thirds that’s related to tools? If you said today I’m going to cut that by 10% when do you actually implement that?

Peter Ragauss

Bits you can do it in five days. Some of the high end logging equipment everything else anywhere from three to six months probably.

Gary Flaharty

We’ve reach the bottom of the hour. I do want to thank Chad and Peter for their time this morning as well as all of our participants this morning for your time and your very thoughtful questions. Following the conclusion of today’s call both Jean and I will be available to answer any additional questions that you may have. Once again we thank you for your participation.

Operator

(Operator Instructions) Thank you for participating in today’s Baker Hughes Incorporated Conference Call. You may now disconnect.

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Source: Baker Hughes Incorporated Q4 2008 Earnings Call Transcript

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