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Baker Hughes, Inc. (NYSE:BHI)

Q2 2009 Earnings Call

August 5, 2009 8:30 am ET

Executives

Gary Flaharty - Director of Investor Relations

Peter Ragauss - Senior Vice President and Chief Financial Officer

Martin Craighead - Senior Vice President and Chief Operating Officer

Chad Deaton - Chief Executive Officer and Chairman

Analysts

Jim Crandell – Barclays

Dan Pickering - Tudor, Pickering, Holt

Geoff Kieburtz – Weeden

Waqar Syed – Tristone Capital

Dan Boyd - Goldman Sachs

Marshall Adkins – Raymond James

Robin Shoemaker – Citigroup

Brad Handler – Credit Suisse

Rob MacKenzie – FBR Capital Markets

Operator

(Operator Instructions) Welcome everyone to the Baker Hughes Second Quarter Earnings Conference Call. I would now like to turn the call over to Gary Flaharty, Director of Investor Relations.

Gary Flaharty

Welcome to the Baker Hughes second quarter 2009 earnings conference call. With me here this morning are Peter Ragauss, Baker Hughes’ Senior Vice President and Chief Financial Officer, Martin Craighead, Senior Vice President and Chief Operating Officer, and Chad Deaton, Baker Hughes’ Chief Executive Officer and Chairman.

Following management’s comments we’ll 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’ll 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 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’ll conclude our discussion of the administrative details and turn the call over to Peter Ragauss.

Peter Ragauss

This morning we reported net income on a US GAAP basis of $87 million or $0.28 per share. This compares to $1.23 per share a year ago and $0.63 per share for the first quarter 2009. Q2 revenue was $2.34 billion down 22% or $662 million compared to the second quarter of 2008 and down 12% or $332 million from last quarter. North American revenue was $794 million in the second quarter down 38% year over year and down 27% sequentially. Revenue outside of North America was $1.5 billion in the second quarter down 10% year on year and down 3% sequentially.

Oil field operating margin for the second quarter was 10% down from 23% in the year ago quarter and down from 14% in Q1. Severance and reorganization costs in the second quarter were $16 million and we increased our allowance for doubtful account by $38 million in the quarter for a total of $54 million or $0.13 per share. Excluding the impact for these charges our second quarter oil field operating margin would have been around 13%.

Turning to the performance of our two segments, Drilling and Evaluation revenue was $1.1 billion in Q2 down 27% year over year and down 14% sequentially. The Drilling and Evaluation segment’s operating margin was 7% in Q2 down from 24% in the year ago quarter and down from 12% in Q1. Adjusting for severance and reorganization costs and the increase in allowance for doubtful accounts, the operating margin would have been around 9%.

Revenue for our Completion and Production segment was $1.2 billion down 17% from the year ago quarter and down 11% sequentially. C&P operating margin in Q2 was 14% down from 22% in the second quarter 2008 and down from 17% in Q1. Again, adjusting for severance and reorganization costs and the increase in allowance for doubtful accounts, the operating margin would have been 16%.

To help you evaluate our earnings per share in the second quarter I’ll review the significant items that bridge the sequential and year ago quarters to second quarter EPS of $0.28. Sequentially in Q1 2009 our US GAAP net income per share was $0.63. From the $0.63 add $0.03 for the impact of a lower tax rate compared to Q1, subtract $0.06 as a result of higher corporate expense, subtract $0.29 for decreased profits in North America, and subtract $0.03 for decreased profits outside of North America. This gets us to the $0.28 we were reporting for the second quarter.

Now bridging from the year ago quarter. From the US GAAP net income per share of $1.23 we reported in the second quarter 2008 add $0.13 for the settlement of litigation in Q2 ’08, add $0.06 for the impact of a more favorable tax rate this quarter relative to the year ago quarter, subtract $0.04 for higher interest expense, subtract $0.06 as the result of higher corporate expense, subtract $0.75 for decreased profits in North America, and subtract $0.29 for decreased profits outside of North America. This gets us to the $0.28 we are reporting for the second quarter.

Turning to the balance sheet, at quarter end our total debt was $1.8 billion and our long term debt to cap ratio was 20%. Our net debt was $466 million. We have no maturities of long term debt until November 2013. We currently have $1 billion in un-drawn committed credit facilities, comprised of a $500 million facility which is accessible through 2012 and a $500 million 364 day facility which is accessible through March 2010. At quarter end we had cash and short term investments of $1.4 billion. This totals $2.4 billion in available liquidity.

Sequentially we released $300 million in working capital driven by reductions in receivables and inventory. Moving on to guidance, 2009 capital expenditures are expected to be $1.1 billion and our CapEx budget reflects our ongoing investment in infrastructure, particularly in international markets as well as capital for new rental tools. Our tax rate for the second half of 2009 is still expected to be between 31% and 32%. Finally, we still anticipate being highly cash flow positive in 2009.

Now I’ll turn the call over to Martin, who will highlight our geographic results.

Martin Craighead

I’m going to begin with North America which continues to be the most challenging region. The US land rig count was down 30% sequentially, exceeding the 27% sequential drop from Q4 2008. The US offshore rig count weakened in the second quarter 2009 and was the lowest since the second quarter 1992. In this challenging market, US revenues were down 39% year on year compared to a rig count that was down 50% and down 26% sequentially compared to a rig count that was down 30%.

It was a similar story in Canada where revenue was down 24% year on year compared to a 46% decrease in the rig activity. The spring break up was especially difficult in Canada with the Q2 rig count also the lowest since the spring of 1992. Revenue decreased 34% sequentially compared to a 73% decline in rig count.

Operating profit was only slightly positive in the second quarter of 2009 for North America. In comparison, our operating profit margin was 26% in the second quarter of ’08 and 12% in the prior quarter. Adjusting for severance and reorganization costs and the increase in allowance for doubtful accounts the operating margin for North America was 2% in the second quarter.

With activity cut in half there is ample capacity in the market and customers have taken advantage of the situation to push prices lower. In response to the lower activity and incremental pricing pressure we took additional steps in the quarter to reduce our operating costs to improve the profitability of our North American operations going forward.

We made incremental reductions of our workforce and implemented other programs to reduce our labor costs. As we previously disclosed, the severance we took in the first quarter was expected to benefit us in the third and fourth quarters at an annual run rate of $175 million. The incremental severance of $7 million we took this quarter will reduce costs in the fourth quarter onward. We closed or consolidated 30 field facilities in the quarter, primarily in the convention gas bases.

Looking forward, we believe we are or near the bottom on the US land gas rig count. We could see some incremental weakness should we reach full storage before November 1st, however, I believe that excluding short term market disruption the largest declines are behind us. We are currently seeing and expect some incremental strength in the US land oil rig count, Canada will strengthen seasonally but our customers in Canada continue to be impacted by challenges similar to those facing US operators.

We expect the offshore count on the shelf to improve in the latter half of 2009 as we exit the hurricane season. Four additional deep water rigs are expected to enter service by years end and as such our outlook for the deep water Gulf of Mexico remains positive.

Turning to the Latin America region, the year over year revenue growth in the region was led by near doubling of revenue from our Mexico/Central America geomarkets, led by incremental revenues from the integrated operations we are performing for PEMEX on the Alma Marine project. We are now operating on four offshore rigs and we expect to add one additional rig per quarter until we reach the contracts targeted objective of seven.

Also contributing to the year over year revenue growth was directional drilling and completions for customers in the Andean geomarket which includes Columbia, Ecuador and Peru, and directional drilling in fluids in the Brazil geomarket where we continue to benefit from contracts awarded over the past year.

Revenue declined sequentially as increases in the Mexico/Central America geomarket were offset by lower activity in revenue in the Venezuela and Southern Cone geomarkets. The operating profit margin in Latin America for the second quarter was 12% down from 16% in Q2 2008 and up from 9% in the prior quarter. Adjusting for severance and reorganization costs and the increase in allowance for doubtful accounts the operating margin was 21% in the second quarter.

We were awarded a number of noteworthy contracts in the quarter. An IOC awarded Baker Hughes a five year contract for ESPs in Columbia. The contract is expected to be worth more than $100 million. In Mexico, we are pleased to be providing direction drilling, wireline drill bits and drilling fluids on 288 wells for two of the local Mexican project management companies involved in the ATG projects.

Additionally, we will be providing wireline and drill bits for another local contractor who was recently awarded 144 wells. These projects provide Baker Hughes with a solid position in the Mexico land market providing products and services in over 430 wells.

Looking forward, I’m excited about our prospects in Latin America. We continue to focus on leveraging our success with Petrobras into incremental work with IOCs operating in Brazil. We are increasing our scale and scope of services in Mexico, consistent with our original strategy of providing highly value adding project management and technical consulting services for the challenging marine projects. And being a supplier of choice for the multitude of efficient and highly competitive local project management firms.

Now turning to the Middle East/Asia/Pacific region, revenues decreased from year ago levels as higher activity in the Southeast Asia and Gulf geomarkets was offset by lower revenue in the Saudi Arabia/Bahrain, North Asia and Indonesia geomarkets. Sequentially reduced activity in the Indonesia, Egypt and India geomarkets was offset by increases in wireline and completions revenue in the Southeast Asia geomarket, directional drilling in the gulf geomarket and increased completions revenue in the Austral/Asia market.

The activity decrease in the Indonesia geomarket in quarter two 2009 reflected the successful completion of our work on the first phase of PTEs giant tangu project. The operating profit margin was 14% in the second quarter compared to 20% in the year ago quarter and 14% in Q1 2009. Adjusting for severance and reorganization costs and the increase in allowance for doubtful accounts the operating margin was 15% in quarter two.

We are continuing to invest throughout the region with major facilities scheduled to open in the second half of ’09 and early ’10. We were awarded over $400 million in new or extended contracts in the quarter and we expect to win additional work in the second half of ’09 that will drive revenue increases in 2010.

Turning to Europe, Africa, Russia, and the Caspian, revenue declined 18% year over year in the region. The largest decline was in the Russia and Caspian geomarkets and reflects the overall decline in spending in the region where the recession and lower energy prices resulted in customer drilling budget cuts of approximately 30%.

Revenue declined in the Norway geomarket as activity on three platforms was suspended during the quarter. The revenue decline in the sub-Saharan, Nigeria and North Africa geomarkets reflects completion of major customer projects and the delayed start of new projects leading to a reduction and total customer spending in the quarter. Sequentially, revenue was down 4% as revenue increases in the UK, North Africa and Russia geomarkets were offset by reduced spending in the Norway, Nigeria, Libya and Caspian geomarkets.

Our operating profit for the Europe/Africa/Russia and Caspian region was 17% in the second quarter, down from 24% in the year ago quarter and down from 19% in the prior quarter. Adjusting for severance and reorganization costs and the increase in allowance for doubtful accounts, the operating margin was 19% in Q2.

Similar to our Middle East/Asia/Pacific region, in the next nine months we will open new or expanded facilities throughout the entire region. These include a new base, expanded facilities and a blend plant in Angola as well as expanded facilities in Algeria, Libya, Ghana and Nigeria. We were awarded over $1 billion in new work or renewals of existing contracts in quarter two ’09 including key contracts in Norway, Central Europe, deep water projects off West Africa and projects throughout Russia and in Azerbaijan.

Now I’ll turn the call over to Chad.

Chad Deaton

On our last call we forecast that the North America rig count would average about 950 rigs during Q2 and the actual number was 934. Our current view of the future remains much like we called it in the April conference call. First, we feel that the ongoing success in the Hainesville and Marcellus shale highlights how the recent technology advancements in horizontal drilling and completions are leading to a future with fewer rigs which are able to access the formation more efficiently.

Second, the economic activity and industrial demand remained weak. There’s still ample gas supply to keep North America drilling activity contained for the near term. While the LNG overhand is still there, the impact to date has been less then we actually anticipated it would be back in April. The slower pace of capacity additions and new re-gasification capacity is helping the North America market avoid a more serious disruption.

At the time we predicted that the rig count would bottom at the end of Q2 or early Q3 for US land we saw it bottom, or at least we hope it bottomed in early June. It has slowly improved since. Canada obviously reached bottom during the Q2 breakup and will improve in Q3 and Q4 that at levels much less then what we’ve seen in previous years.

Forecasting future rig activity is clearly difficult in today’s environment but our latest projection show an average 2009 rig count of 1,026 compared to an average of 1,879 rigs in 2008, that’s a 45% drop in average rig count from ’08 to full year ’09. Stepping out on a limb a little bit looking out, still a ways away but our early forecast for 2010 is for an increase of about 9% to 1,120 plus or minus. We’re believing that things are improving albeit very slowly.

Turning internationally the decline in activity has been less severe and isolated some specific geographical areas. I think by now you’ve probably heard from others just what areas are up or down but I’ll highlight a couple of areas that are material for Baker Hughes. We clearly are extremely pleased with our progress in Brazil. Petrobras has significantly increased activity and our future there looks very encouraging.

We’re very happy with our market position in the country with our directional drilling LWD and fluids project line and as a result of our long term commitment in Brazil we are building a technology center that represent a joint investment for both Baker Hughes and Petrobras. The technology center is also going to include the involvement of two top universities that are in the area.

In Mexico the recent party awards that Martin referred to along with the ongoing Alma project now provides us with a significant presence in the country. Our ongoing investments in Africa infrastructure and people are beginning to pay some significant dividends. Although not fully completed, the new facilities in Angola, Nigeria, Libya and Algeria have assured our customers of our commitment and resulted in our increased participation in current and future tender awards.

One last comment I’d like to make on the international market. While international activity appears to be stabilizing in many areas and increasing modestly in some, the price concessions negotiated in the first half of ’09 will have an impact on our profitability in the second half of the year.

In last April’s call I also made reference to some organizational change we were making in the company and I specifically talked to the areas of supply chain, information technology, and reliability. At that time I also mentioned that we’re moving forward with our geographical organization which will enhance our ability to quickly and efficiently respond to our customers, thus delivering technology solutions in value for multiple product lines.

On May 4th we officially announced our new geographical organization. The new organization is significantly shifts the way we manage our business. Prior to May 4th 100% of our senior line management that were responsible for the P&L and the day to day decision making resided in the United States. Post May 4th, 75% now reside in the key geographical regions around the world therefore closer to our customers.

This change is the result of months of planning, will greatly enhance our ability to be closer to our clients. The actual timing of this reorganization was dependent on several key events. One of the most important is that over the last three to four years we’ve made some real progress in the recruiting and the development of a multi-cultural workforce at all levels of the company. As I’ve said, we’ve greatly enhanced our functional as well as our operational employee base.

As mentioned earlier we’ve not strengthened the support functions such as the supply chain, IT functional heads, and clearly improved in the area of the executive management team, we did this in preparation for this change. Last, the reorganization of this magnitude in early stages of the deferred prosecution agreement was just not practical.

The benefits of a reorganization of this magnitude are clearly numerous; however, the challenges are not insignificant. There will be a period of a couple quarters where we have some overlapping areas of responsibility and assignment. There are costs associated with relocation of several hundred people and we estimate that the reorganization costs in 2009 to be approximately $30 million or somewhere around $0.07 per share with the bulk of that cost hitting us in Q3.

We are three months into the new organization and during this last quarter I spent the time and I visited six of the nine geographic regions. I spent time with our people on the ground in the Middle East, Europe, our Africa office, Russia, Latin America, and obviously here in the US. I also took the time and visited and discussed this new organization with the senior executive management of our key clients in all of these regional areas. I have to say that the response both internally and externally has been extremely positive.

Our people are clearly excited about this new organization. I have to say, we’re excited about they way they’re already moving forward to engage our customers in providing new and innovative solutions to their problems. Obviously we have to execute on this and I’m very encouraged by our progress to date over these last three months to get this new organization in place.

In summary, the new organization structure positions us closer to the customer and allows us to respond more promptly to their needs. It increases the speed of decision making and improves our ability to allocate resources effectively and it supports the multiple methods of delivering our products to customers from individual, discrete products or services all the way through to integrated operations.

In countries where we have previously implemented this organizational structure, such as in Nigeria, Saudi Arabia, Brazil, and Russia, we’ve had success in building market share and improving profitability. Now that we’ve implemented this organization for all geographies I’m confident that this new organization will deliver on its promise to grow share and to grow it profitably.

Gary I’ll turn it back to you for questions.

Gary Flaharty

At this point I’ll ask the operator to open the lines for your questions. To give everyone a fair chance to ask a question we do ask that you limit yourself to a single question and a related follow up question. Could we have the first question please?

Question-and-Answer Session

Operator

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

Jim Crandell – Barclays

Overall do you believe you’ve seen the bottom on a quarterly basis in international revenue? Secondly, what is the general magnitude of weakness you might expect in international profit margins in coming quarters?

Chad Deaton

We don’t think we’ve seen the bottom yet on international revenue. We’re hoping that occurs in Q3 maybe into Q4. We’re expecting that international margins backing out anything for doubtful accounts etc. we’re probably looking at somewhere in the 350 basis points ongoing deterioration.

Jim Crandell – Barclays

That would be true in probably all geomarkets or all major regions?

Chad Deaton

Yes, I think we’ve got a little bit more opportunity in the Latin America market due to obviously Brazil and Mexico now we’re pretty well established on these Alma projects. We do have some startup costs that are taking place as we move on to these land projects that Martin referred to on these 450 wells. For the most part I think the other two regions will take the brunt of some of the margin deterioration.

Jim Crandell – Barclays

You’ve had some nice product line wins that you talked about on your call. To what extent over the last three months have you also won contracts on bundled services or IPM basis and is there any sort of change in your willingness or aggressiveness in trying to beat that part of your business?

Chad Deaton

I think we had as many wins this quarter as we talked about last quarter. We’ve had this discussion before whether where do you switch over from bundled services to IPM. Again IPM to me is where you manage the entire project from picking locations to cleaning locations to managing the rig, the whole works. Again, we find that in certain places of the world, clearly Mexico, a little bit in a couple other countries in Latin America, to some degree Russia, Algeria. What we’re seeing is a lot more bundling of our services where we’re winning three, four, five product lines not necessarily managed locations.

This latest three wins that Martin talked about in Latin America clearly we’re acting as a sub-contractor to three independent so-called IPM Mexican companies. We don’t take the risk but we get to do what we do very well and that’s provide our services and technology to them. If we could do more of that, that’s a preferred model for us.

Jim Crandell – Barclays

Could you comment on what happened in Mexico on the first Burgos contract, I understand at least your partner was low bidder and that you were bypassed there. Also, I’m sure you are happy being a big component supplier to the independent companies that contempact but weren’t you low bidder on ATG5 and why do you think that you were bypassed there.

Chad Deaton

Are you talking about Burgos or ATG because you started off…

Jim Crandell – Barclays

I started with Burgos and my impression was your partner there who would do the rig and civil engineering work was low bidder on that but was bypassed. The second question was ATG5 my recollection was you were also low bidder on that one as well.

Chad Deaton

Burgos we didn’t go after Burgos. When we looked at Burgos it’s about a $550 million project. Our services for that project would have been about $55 million so the other $400 million and whatever else would have been third party services from bulldozers to who knows what. We just didn’t think that looked that attractive.

We did go after ATG5, we were low bidder. Through the process we ended up getting disqualified from that for technical reasons. Then after it was re-awarded they went ahead and awarded four projects of about 180 plus or minus wells a piece to these four Mexican contractors. Those are the three of the four that they contacted us and said would you provide services on those. You’re right; we’re pretty pleased with that. It allows us to continue to build out on land and again not necessarily take all the risk on drilling rigs etc.

Jim Crandell – Barclays

Is there an easy explanation on why you could be disqualified for technical reasons and then they give it to local competitors?

Chad Deaton

No, I don’t know the answer to that.

Operator

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

Dan Pickering - Tudor, Pickering, Holt

As we look at the North American business, revenues there stronger then we thought, profits weaker. Help us with from this 2% margin level what’s the Canada bounce back, what’s the reasonable expectation for those margins in Q3, Q4?

Chad Deaton

If you look first at Q2 D&E suffered terribly like everybody’s D&E. C&P held up better although on the completion side that’s kind of a mix between the drilling side as well as completion. If you look going forward on Q2, we said in the press release, that we felt that Q2 would be the bottom for us in North America profitability. We’re not saying that Q3 is going to turn around and be tremendously bright by any means.

We see that with Canada coming back a little bit, I think it got down as low as an average of 80 rigs in the quarter and we’re seeing somewhere around 200 plus or minus in Q3. That’s obviously going to help. We have our cost structure in Canada in pretty decent shape because Canada has been down a while so we’ve been able to take costs out this and there.

We should see the benefit in North America beginning in US Q3 from the severance that we took in Q1 and Q2 so that should benefit on land and offshore during the quarter so that’s why we’re saying we think we’ll see a little bounce back possible and we also feel now that for the most part the pricing has been worked through we’re not seeing pricing pressure, a lot of pricing pressure right now its terrible but its there and we can now adjust to it.

Dan Pickering - Tudor, Pickering, Holt

Q3 won’t be bright but we’re coming off of a pretty rough Q2. I’m groping for some magnitude here just because Q2 was a surprise. Does better mean 200 or 300 basis points better or 500 or 600 basis points better or you just don’t want to say because there are too many moving parts.

Chad Deaton

I’d prefer not to say. There’s still a lot of moving parts. We’re drawing a line in the sand and saying Q2 is the bottom that’s what we’re telling our people, so we’ll improve on it.

Dan Pickering - Tudor, Pickering, Holt

Corporate expenses could you talk about that increase was this geomarket expense or what should we expect from those corporate expenses as we move through the back part of the year?

Peter Ragauss

We did have some one time benefits in Q1 that aren’t going to repeat so that’s part of the delta. One of the things that Chad mentioned last conference call was that next year we expect shared services savings, the number quoted was $50 million and a lot of that’s the finance group, some of its other corporate functions. That is taking some investment and that’s actually ramping up. It ramped up in Q2 and its ramping up in Q3 and Q4.

We’re installing our enterprise wide accounting system in places in basically every country and that’s taking some time but once we’re done with that, that’s actually going to take, its not going to be finished in 2009 but it will continue. That’s a big part of the charges going on. We expect to see some savings coming through in 2010.

The other is some of these reorg costs Chad mentioned they’re going to be increasing in Q3. The bulk of them are going to be in Q3 and a chunk of those will probably come through the corporate line.

Dan Pickering - Tudor, Pickering, Holt

So the $86 million number is going to hold and maybe go up a little bit in Q3 and Q4?

Peter Ragauss

I hope it’s a little bit less but I would say closer to the Q2 run rate then the Q1 for sure.

Operator

Your next question comes from Geoff Kieburtz – Weeden

Geoff Kieburtz – Weeden

On the international margins, over what kind of time period do you think that this 350 basis point margin erosion is likely to play out?

Chad Deaton

I think the next two to three quarters.

Geoff Kieburtz – Weeden

You see the bottom some time in the first half of 2010?

Chad Deaton

Yes.

Geoff Kieburtz – Weeden

Is that dependent on oil prices being strong enough to stimulate increased international spending next year?

Chad Deaton

Yes, I think if we exit this year, oil prices hold in there this $70 range, I think the customers are getting comfortable with that, there will be some increase in activity going forward. There might be some projects that are dropped. If we see oil price fall back in the $50’s or low $60’s then I think we’re just going to have a longer ride through 2010. If we can be in the $70 range there seems to be a little more optimism out there with our clients to move forward with their projects.

Geoff Kieburtz – Weeden

I don’t want to be belligerent but when we hear you talking about the reorganization it does appear on the surface that Baker Hughes is doing some things that many of your competitors have already put in place in some cases a number of years ago. If there are such substantial benefits to this change and reorganization are you not in a position of having to catch up and if you are, how do you that? How do you catch up having for various reasons not been able to implement this reorganization earlier?

Chad Deaton

We have been building towards this for quite some time. We didn’t have an epiphany on April 1st and said let’s reorganize. We moved towards it about three years ago, two and a half years ago when we first created the super regions. We’ve been staffing those, we moved towards it in Russia, Saudi and Brazil. We’ve pretty much been running along that line for the last couple of years.

It was clearly not possible to do a couple years ago, two and a half years ago when we first entered in the DPA to go ahead and move several hundred people all around the world. About the time we just entered into that would have been chaos, probably suicide. Then I think the other one is we’ve been aggressively bringing people and developing people with all cultures of the company.

When you look at it today whereas three years ago out of the top 20 executives in the company they were all American or British. Today nine out of our top 20 are multi-cultural so therefore we’ve got Latinos running Latin America, Middle Easterners running Middle East, Russian running Russia. We wanted to pull the trigger on this when we thought we were ready to pull it. I don’t think we have a long catch up period to go because most of its in place.

We’ve been building out facilities in key areas which we didn’t have so now it’s just a matter of shifting these people with the shock collars out of here and putting them in these. I’ll tell you the response that I receive from our clients at high levels for big NOCs as well as the IOCs they’re ready for it and they’re excited about it. I think we could see some good things happen over the next year.

Operator

Your next question comes from Waqar Syed – Tristone Capital

Waqar Syed – Tristone Capital

As you look at your prior portfolio any missing pieces there and do you think this is time now for consolidation and do you see any opportunities in the marketplace?

Chad Deaton

We get that question every call. Yes, we’re constantly looking for any gaps in our portfolio. We continue to fill a gap that we had that we started on last year and we wanted to build out the reservoir capability. Last year we bought GMI and GCA this year we just bought Helix and Epic just this quarter. That builds us up to about 350 reservoir consultants and professionals, geophysicists, etc. We’ll continue to look for companies like that that could fit into our portfolio.

Then we look at just the white spaces and gaps we have. As Peter said, we have a very strong balance sheet; we’re in great shape from that standpoint. We think there’s going to be opportunities come up over the next few quarters, especially if this thing just kind of stays flat for a while. Yes, we will be looking and seeing what’s out there and if we see something we like we’ll move on it.

Waqar Syed – Tristone Capital

One of the ideas that has been talked about has been pressure pumping, do you still feel more about getting exposure on the international side or you feel that even gaining exposure in North America may not be a bad idea at this point?

Chad Deaton

I haven’t changed in my thinking for the last three years or since I’ve come in here four years ago. Pressure pumping could fit into a Baker Hughes product line situation very nicely, domestically as well as internationally. We said that same thing regarding certain other gaps that we think the price are right other type of portfolio fills we would take a look at different things. Yes, I still believe it’s a potential.

Operator

Your next question comes from Dan Boyd - Goldman Sachs

Dan Boyd - Goldman Sachs

You mentioned in the press release that you’re positioning the company to grow market share. If you could just comment on what regions or product lines you’re most excited about from a relative perspective and is it an area where you have the most opportunity where you’re catching up your competitors or is it where you think you’re going to gain share where you’re already strong?

Chad Deaton

It’s clearly the catch up. I think we just have to look at a couple areas again that we didn’t have much market share. Brazil we were almost non-existent four years ago now we’re a major player. Russia, other than selling a few products, central lift products, ESPs into Russia. Now today we’re offering full services. Saudi Arabia again other then completions we didn’t do much in Saudi four years ago and now we’re one of the largest players there.

Mexico is a perfect example again where we didn’t do much. These recent wins now put us in pretty good position. We’re targeting these key countries; West Africa is one where we made some nice investments. I just referred to that. We’re starting to see some wins for some clients that we haven’t worked for in the past. I don’t think it’s any one product line I think it’s a matter of getting the Baker Hughes brand and name which is very good, getting the people and the infrastructure and the position to be able to deliver to the clients.

In my comments I mentioned about West Africa and clearly three years ago some of the major IOCs in West Africa when the audited our base and talked about projects there they were very concerned could we handle a $400 or $500 million project, kind of bundled services. With what we’re building there and what we’ve shown them that’s not an issue today. I think that those are the type of low hanging fruit that we’ve been after that we’ll continue to go for.

Dan Boyd - Goldman Sachs

That’s all geobased, it should be handled by the restructuring, is there anything on the product line specifically where you need to play catch up a little where you think you can gain some share?

Chad Deaton

I don’t want to target our competition where we think we may want to go I’ll probably dodge that question.

Dan Boyd - Goldman Sachs

On North America, it sounds like in the US your rig count forecast for next year it isn’t that different from ours. When we look at the fourth quarter number it does sound like the fourth quarter rig count for 2010 with that type of trajectory would be similar to what we just experienced in the first quarter of 2009. When your North American margins adjust it would have been 16%.

How should we think about what margins might be with the same level of rig count in the fourth quarter of 2010 relative to where they were in the first quarter of this year, recognizing that obviously pricing is lower but at the same time you have been able to take a lot of cost out of your cost structure.

Chad Deaton

It’s the way we modeled it, we kind of see a ‘U’ coming from January two years back to the end of December seeing it build back up to about where it is. You’re exactly right, if we see that build towards the end of 2010 we could probably go back and look at things that took place in ’05, ’06 when everything was ramping up steeper then we’re projecting now. Then the cost starts falling, the benefit falls straight to the bottom line because you’ve got the cost out of the system, you’re back in a growth mode again.

Dan Boyd - Goldman Sachs

The 1,300 rig count in the US is a15% margins in North America out of the question or you think that’s something on a stretch goal could be achievable?

Chad Deaton

I don’t think they’re out of the question. I’ve often said that at a 1,200, 1,300, 1,400 rig count in the US the service sector can make money. There has to be some thing that take place, you can’t have as much capacity in this business as we have today. We can’t go from 2,200, 2,300 rigs go way down and be back at 1,300 and have the same capacity out there then margins won’t get there.

I think there’s going to be the next couple three quarters are probably going to be pretty tough in North America and in the end there’ll be some consolidation and we’ll be back to that point which we’ve seen in so many different cycles. We can make money with 1,300 rigs in the service sector.

Operator

Your next question comes from Marshall Adkins – Raymond James

Marshall Adkins – Raymond James

You gave a pretty good overview of the reconciliation by region on the severance costs and stuff. Could you give us a little more specifics on the numbers? It appeared that I guess Latin America bore the brunt of those write downs but I was just wondering if we could get a little specifics on the exact magnitude by region of the write downs.

Peter Ragauss

Why don’t I just give you the numbers so you don’t have to use your Ouija board to figure it out. The sum of the total is $54 million so North America give it $12 million, Latin America give it $25 million, EARC give it $12 million and Middle East/Asia/Pacific give it $6 million.

Marshall Adkins – Raymond James

Going forward you mentioned that we’re going to have some reorg costs, is that going to be more in corporate and are we going to see or do you expect to see more of the severance going forward or are we pretty much done with all that?

Peter Ragauss

I’ll answer the reorg allocation. Right now our best guess is probably half in corporate and half out in the business because we still have a lot of people moving around, etc. but we also have additional systems adjustments to make. We’ll tell you what it is next quarter.

Marshall Adkins – Raymond James

More international obviously for the part that will be embedded in the margins, right?

Peter Ragauss

That’s right.

Martin Craighead

On the severance, the first quarter was the big hit that we took, significantly down this quarter. I would say Q3 may be similar to Q2 and we definitely want to have it all behind us at the end of next quarter, depending on how the market evolves but it looks like its pretty much behind us.

Marshall Adkins – Raymond James

Maybe a little bit more in Q3 but not of the magnitude we saw the last couple quarters?

Martin Craighead

Not even close, no.

Operator

Your next question comes from Robin Shoemaker – Citigroup

Robin Shoemaker – Citigroup

I wanted to return to your 9% growth forecast for the US rig count and in that context if we grow by that amount and as you indicated most of the growth is coming in the oil rig count. What scope is there fore pricing improvement from the levels we’ve reached currently across your product lines basically?

Chad Deaton

If you looked across, split it between segments I think the C&P side has a better chance of getting some price improvement then D&E. I don’t think at that 9% rig count there’s the tremendous opportunity for much overall price increase on either of them. I think the other side of it is if again we grow 9% we still have the same capacity that we have today out there then there’s not going to be any price improvement.

Two functions there, one if we some consolidation and some other things in different product lines then that will help get us back perhaps to some reasonable margins and that’s got to come from price and a culmination of costs. Two I would think that the production side has a little better chance of getting some price increase going forward then D&E right now for the next several quarters.

Robin Shoemaker – Citigroup

Is it the case then that increase you’re anticipating most of that to come from oil related rig count improvement as has been the case thus far and if that’s the case what does that mean in terms of revenue per rig versus a recovery in gas drilling?

Chad Deaton

I think the recovery will come in the oil side. What it means revenue per rig I don’t know. I don’t think we have numbers on that exactly to look at. The gas side, which you’re going to see on the gas side on the recovery is these are going to be horizontal wells not vertical wells so our type of services are going to be much better because these are more technically challenging wells.

If we get into some like on the oil if you look up in the Balkan areas where we’re now starting to see multi-lateral wells and that’s very good for the completion side of the business because these well bores requires a lot more jewelry and it’s a lot more complicated. As we get into longer extended reach wells or perhaps some lateral, multi-lateral type wells that will benefit Baker Hughes.

Operator

Your next question comes from Brad Handler – Credit Suisse

Brad Handler – Credit Suisse

On the allowances for doubtful accounts it seems as thought that was a pretty big number larger then what I think we’ve seen out of peers although we may not get a clear read out of your peers. Maybe you could speak to that a little more, how concentrated is that, it sounds like maybe in Latin America but are we talking about just a small handful or are we talking about a number of clients, a more pretty broad based conservatism here, can you just give us more on that please.

Chad Deaton

About half of it is with one client, the other half is spread throughout the globe. To answer your question, you’re seeing different people take different approaches. We’ve seen a lot of the drillers actually taking write downs and pretty aggressive allowances for doubtful accounts. I think some of our peers haven’t shown anything yet, we’re probably in the middle of the road between what’s happening in the oil service and we’re basically following our internal rules, if you will, for taking these and we’re reserving to where we think we have an adequate reserve.

Brad Handler – Credit Suisse

Your comments in the press release as it related to regions in the quarter sort of revenue declines, are we supposed to infer that there’s already pricing. If you’re saying revenue versus activity is the inference that there’s already some pricing degradation and if you maybe you can give us some flavor on the international side in Q2 already.

Chad Deaton

The pricing degradation will come more in Q3, Q4 simply because for Q1 and Q2 we were in the midst of renegotiating, especially the IOCs a lot of projects around the globe. Some of those were not finally negotiated and finished until end Q2 so you had a partial effect of that in Q2. Now you’ll see it in Q3 and Q4 and on Q1 next year.

There will be other contracts that roll over and depending on what the activity level and what’s happening in the competition side as those roll over then those will be up for negotiation as well. We have not, I guess kind of a reference point, and we think that the actually pricing negotiations pretty much come to a stop, we’re not seeing the pressure that we saw Q1, Q2, most of those are done and so we know the numbers to move forward with. I don’t know if that helps your question or not.

Brad Handler – Credit Suisse

If I could just come back to it, if we think maybe about the Eastern Hemisphere is it possible to generalize and say the pricing is down 1%, 2%, 5% or more for that matter just again with references to revenue I’m assuming that there is some pricing degradation I’m just trying to get a flavor for how much has happened so far.

Chad Deaton

I don’t have a number to try to say the whole hemisphere. We look at these things country by country and contract by contract. Martin do you have a total number for hemisphere?

Martin Craighead

I don’t. To follow up on what Chad said it’s also product line by product line. Some of these have been probably more severe then we would have anticipated but that’s mixed into some that are still benefiting from negotiations a year ago or 18 months ago. It really just depends on how they all play out timing wise and the product line in particular.

Brad Handler – Credit Suisse

I understand we’re dealing with so many different countries and such, as you say by product line can you make some generalizations about some products in the Eastern Hemisphere seeing pricing degradation already versus others is there some consistency there by product?

Martin Craighead

What we’ve seen is that perhaps a couple of the product lines that are most hardly hit in North America and the assets are fungible are the ones that are the first to become exposed in the Eastern Hemisphere, again its by project. If I had to give you an example I would have to say that there’s a lot of wireline capacity leaving North America and moving east. I think that’s probably the one that is going to be maybe the last to come out.

Chad Deaton

I think it’s safe to say the D&E, drilling and evaluation side will feel it more then the C&P side.

Brad Handler – Credit Suisse

As you say it’s in part because North American capacity is fungible and so it’s becoming available in other markets?

Chad Deaton

Correct.

Operator

Your next question comes from Rob MacKenzie – FBR Capital Markets

Rob MacKenzie – FBR Capital Markets

Obviously it’s too soon to see results from this now but when should we start to expect seeing positive results from the reorganization? Where is that most likely to take place first and what kind of magnitude of share gains do you think you can achieve and in what kind of timeframe?

Chad Deaton

I think you’ll expect to see benefits clearly in Q1 2010 both from a revenue standpoint as well as a cost standpoint. Perhaps even some in Q4 but Q2 and Q3 will have a lot of costs. We do have some overlapping responsibilities obviously as we hand off one to the other and some inefficiencies that we’ll be taking care of. Peter talked about on the financial side getting that in place which is costing us clearly this year which will be much better position come January 1 to handle.

I think where you’ll see some of the real benefits to come through this is in Far East, I think Asia. We’re very happy with the team we’ve got out there, they’re in place. I think we’ve got some real opportunity to grow in Asia. I think Middle East not necessarily Saudi but perhaps Egypt and some of the Oman, some of these areas as they come back I think will benefit us with this new organization. West Africa I think is the next big one with the new facilities and the organization and just being closer to the client you’ll see it there.

In terms of actual percentage of market share gains that we’re going to have I’m not going to try and go out on a limb and predict that but I feel very comfortable that this will just put us in a much better position to make decisions faster then what we’ve had to go through with most of the management team sitting back in Houston. Now the management team is much closer and will move forward with it, be held accountable for it. I think that will help in the area of profitability.

Rob MacKenzie – FBR Capital Markets

How long do you expect to be able to, if there is say low hanging fruit, how long from say later this year, early next year, do you think you get to harvest most of that incremental benefit?

Chad Deaton

I don’t know an answer for that one. I can’t tell you.

Operator

Your last question comes from Jim Crandell – Barclays

Jim Crandell – Barclays

You’ve seen a lot of international cycles do you think that the price degradation you’re seeing in the international, particularly the Eastern Hemisphere business from the IOCs this cycle is worse then prior cycles particularly give the effect that this is a relatively shallow downturn in the Eastern Hemisphere?

Chad Deaton

Yes, I’d probably have to say in terms of them, some of them leveraging or putting the pressure on from a global basis. This is probably one of the more challenging, more pressure then what I’ve seen. Part of it I actually think the service sector tends to be more bundled or IO, integrated operations, we talked earlier so they tend to use that leverage to bring in all product lines.

In the past it was pretty much individual services they negotiated each one now they’re negotiating with companies on large packages. There’s no doubt that the pricing I think this time is more severe internationally then, more pressure then in the past. They didn’t necessarily get all the pricing that’s talked about in Q1 and early Q2 those were negotiated. Still they got their house of blood.

Jim Crandell – Barclays

I believe you established the base in Iraq; could you give me your perspective on how you expect business to evolve there both from the IOCs and the NOCs and how you think Baker Hughes is positioned?

Chad Deaton

We like our position. We are and have been selling product and material into Iraq. We’ve not taken on service contracts yet. We are, as you said, establishing a base; we will be up and operational by the year end, as kind of on speculation because we see a lot of potential activity there. We are in discussion with every IOC including national companies in Iraq to provide services. These are anywhere from individual type call out bundling usually because logistics issues there all the way through to some managing some projects.

I think Iraq has a lot of potential I just think its going to take a while to see it happen. I wouldn’t expect next year we’re talking that Iraq being one of our biggest customers or areas. Although I think it will grow as time goes on.

Gary Flaharty

One final reminder before we close, hopefully by now all of you have received an invitation to our 2009 analyst conference which will be held in Celle, Germany on September 16, 17. The conference will include presentations from our senior management team as well as a tour of our newly expanded technology center in Celle. We think it will be an enjoyable and an informative event. If you wish to attend and have not received details on the conference please call Haley VanMannen in our office at 713-439-8742.

At this point I’ll thank Chad, Peter and everyone, all of our participants this morning for your time and your thoughtful questions. Following the conclusion of today’s call both Jean and I will be available to answer any additional questions that you have. Once again, thank you for your participation.

Operator

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

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Source: Baker Hughes, Inc. Q2 2009 Earnings Call Transcript
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