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Baker Hughes Inc. (NYSE:BHI)

Q4 2007 Earnings Call

January 30, 2008 8:30 am ET

Executives

Gary Flaharty - Director of IR

Chad Deaton - Chairman and CEO

Peter Ragauss - SVP and CFO

Martin Craighead - Group President, Drilling and Evaluation

Analysts

Geoff Kieburtz - Citigroup

Bill Herbert - Simmons & Company

Jim Crandell - Lehman Brothers

Michael Lamotte – JP Morgan

Ken Sill - Credit Suisse

Dan Pickering - Tudor, Pickering, Holt

Brad Handler - Wachovia Capital Markets

Robin Shoemaker - Bear Stearns

Operator

Good morning. My name is Regina, and I will be your conference facilitator. At this time I would like to welcome everyone to the Baker Hughes fourth quarter 2007 Earnings Call. (Operator Instructions).

I would now turn the conference over to Mr. Gary Flaharty, Director of Investor Relations. Sir, you may proceed.

Gary Flaharty

Alright, thank you, Regina. Good morning, everyone. Welcome to the Baker Hughes fourth quarter 2007 earnings conference call. Here with me this morning are Chad Deaton, Baker Hughes' Chief Executive Officer and Chairman; Peter Ragauss, Baker Hughes' Senior Vice President and our Chief Financial Officer; and Martin Craighead, Group President for Drilling and Evaluation. Following management's comments we will open the lines for your questions this morning.

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 and those referenced in the new release are contained in the new release itself.

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 these risk factors. So 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?

Peter Ragauss

Thanks, Gary. Good morning and welcome to the Baker Hughes fourth quarter earnings conference call. This morning we reported net income for the fourth quarter of 2007 of $400 million or $1.26 per share. This $1.26 per share is up $0.04 or 3% from the $1.22 we reported in the third quarter of 2007 and up $0.24 or 24% from the $1.02 per share we reported in the fourth quarter 2006.

Q4 revenue was $2.74 billion, up $288 million or 12% from the fourth quarter 2006 and up $62 million or 2% from the prior quarter. Revenue from North American operations was up 7% compared to the year ago quarter and essentially flat with Q3. Non-North American revenue was up 16% compared to a year ago and up 4% sequentially.

For the full year operating profit was $4.73 per share, up 15% from the $4.10 per share in 2006. Operating profit for 2006 excludes the gain on the sale of our minority interest in the WesternGeco joint venture. 2007 full year revenue was $10.4 billion, up 16% from 2006. North American revenue was up 9% compared to the prior year. Non-North American revenue was up 21%.

Our oilfield operating margin for the full year of 2007 was 24%, with an oilfield incremental margin of 25% excluding the Baker Atlas inventory adjustment. Full year CapEx for 2007 was $1.1 billion, up $205 million from last year.

Q4 was a challenging quarter. Part of this was due to market conditions that we did not anticipate, such as weaker than expected activity in the Gulf of Mexico and increasing competitive conditions and price pressures particularly in North America.

Our oilfield operating margin in Q4 was 24%, up slightly from Q3 and down 50 basis points year-on-year. Excluding the $21.2 million inventory adjustment at Baker Atlas in year ago quarter, margins would have been up about 30 basis points. The year-on-year incremental margin for our oilfield operations in Q4 was 20% as reported, or 27% excluding the Q4 ’06 Baker Atlas inventory adjustment.

Moving over to the segment performance. Drilling and Evaluation revenue was $1.37 billion in Q4, up 9% from the fourth quarter of 2006, and up 1% sequentially. The D&E segment’s Q4 operating margin was 25%. Inflation and production revenue was also $1.37 billion, up 14% from the year ago quarter and up 4% from the third quarter of 2007.

C&P's operating margins of 23% was a record. The year-over-year incremental margin for this segment in Q4 was 38%. Chad and Martin Craighead will review our segment results in more detail later in the conference call.

In an effort to assist you in evaluating our Q4 earnings per share, I’ll now highlight a few significant items to provide a bridge between Q4 and the year ago quarter. Sequentially, from Q3 to Q4, the $0.04 improvement from a $1.22 in the third quarter to a $1.26 in the fourth quarter is purely operational. Looking at it year-over-year, from the $1.02 we reported in Q4, 2006, add about $0.12 for the charge relating to the settlement of our investigation with the SEC and DOJ in Q4 ’06.

Subtract $0.04 to back out the $21.2 million impact for the change in accounting procedures for certain inventory at Baker Atlas. Add about $0.01 for the impact of share repurchases netted against reduced interest income. Add about $0.02 for the impact of a lower comparative effective tax rate in the current quarter and lower corporate spending.

Add about $0.13 as the contribution from operations, which include $0.04 of price net of raw material and cost of inflation. This gets us to the $1.26 per share we reported for Q4.

Turning to the balance sheet. At quarter end, we had cash and short-term investments of $1.05 billion. In comparison, our outstanding debt was just under $1.1 billion. Our long-term debt-to-cap ratio at the end of the fourth quarter was 15%. We continue to generate cash in excess of our needs to grow our business through investment in rental tools, manufacturing equipment and global infrastructure. Our ongoing intent is to return cash in excess of our needs to our shareholders.

During the fourth quarter we repurchased just under 3 million shares of common stock at an average price of $81.75 per share or total of $242 million. At quarter end, we had authorization remaining to purchase up to $824 million common stock. In the fourth quarter, we made two changes that better reflect our operating results. First we reclassified sales and field service costs that directly support operations to cost of sales and service. The net impact of this was to increase our cost of sales and cost of service and rentals by $490 million in 2007 and decrease by the same amount what we are now calling marketing, general and administrative.

Second, we reclassified certain corporate and other expenses totaling $15 million in 2007 to our two operating segments. We have allocated these costs to the operating segments so that they have better visibility for the costs and can therefore manage them more effectively. All information in the news release has been reclassified to conform to both of these changes. Information discounting the impact of these changes for 2005 through 2007 by quarter can be found on our website.

Details of our guidance are in the news release. I do want to highlight that our guidance for non North American revenue growth in 2008 compared to 2007 is in the low to mid-teens percentage range. To support the growth we see in 2008 and 2009, we are increasing our capital spending 15% to $1.3 billion. This budget supports our continued expansion of international infrastructure and addition of high technology tools in anticipation of higher offshore rig activity in late 2008 and 2009.

I should also highlight that in Q4 2007, we had approximately $100 million of export of manufacturing shipments in our completion and production segment that are not likely to recur in the first quarter of 2008.

As I mentioned earlier, our year-over-year oil field incremental margin for the full year 2007 compared to 2006 was 25%, excluding the inventory adjustment of Baker Atlas.

The combination of more needed price increases and higher costs, which we are managing tightly, lead us to expect year-over-year oil field incremental margins to be between 20% and 25% in 2008.

I will now turn the call over to Chad.

Chad Deaton

All right, thank you, Peter. Good morning, everyone. Over the past two quarters we have continuously worked to try to control our costs and to be able to obtain fair pricing for the value of the services that we are delivering to our clients. What we are seeing over these last couple of quarters, is that several companies in the industry have seen some margin deterioration, while at Baker Hughes we have been able to hold operating field margins fairly steady. However, this overall margin deterioration in the industry does causes some concern as we are beginning to see some price erosion that is starting to occur in some markets.

Before I discuss our segment operations, I would like just set the stage here for a minute with a quick review of our regional performance. Looking at first at the non-North American regions, Latin American revenue increased 10% year-over-year compared to a 9% increase in the rate count. The majority of the revenue increase was in the D&E segment and that was led by INTEQ in Brazil and by gains of Hughes Christensen in Brazil and Mexico. Latin America revenue decreased 2% sequentially and that was about in line with what rig decrease in the rig activity were.

Revenue for the Europe, Africa, Russia and Caspian region was up 19% year-on-year and 1% sequentially. European revenues were strong, were up 20% compared to Q4 2006. And sequentially European revenue was up 2% despite a 3% decrease in the rig count, which was attributable to weather related delays in the quarter.

INTEQ, Baker Atlas, Baker Oil Tools and Baker Petrolite all reported strong results from the North Sea operation.

In Russia and the Caspian revenue was up 63% year-on-year, with strong contributions from all the divisions and sequentially revenues increased 15% with the strongest contribution coming from Centrilift and INTEQ. Russia now ranks as our number six country in terms of revenue with '07 revenue in access of $425 million. Russia itself is up over 80% compared to last year.

Africa was a challenge for us in Q4. Africa revenue was down 8% year-on-year and down 10% sequentially. The year-on-year in sequential revenue decline was primarily due to lower activity in the completion and production segment.

Looking at the Middle East, AsiaPac, Asia Pacific area revenue was up 14% year-on-year. That compares to a rig count which was up 6%. The Middle East revenue were up 21% year-over-year on a 5% increase in the rig count. And the Middle East revenue was up 23% sequentially and that was led by INTEQ and Baker Oil Tools in Saudi Arabia. Saudi is now the fifth largest country in terms of revenue with '07 revenues of about $480 million or a 23% increase from last year, which was a significant increase from a year before end.

North American revenue was up 7% year-over-year and flat sequentially compared to a rate count that was unchanged. In Q4 growth in the land rig count continue to slow, as US land revenue was up 2% year-on-year compared to a 6% increase in the land rig count with growth strongest for D&E led by INTEQ and Hughes Christensen up several percent as well. C&P's land revenue was up with strong increases at Centrilift and Baker Petrolite.

Weakness in the offshore market was greater than planned as the rig count did not rebound to Q3 levels following the hurricane season and offshore revenue was up 2% compared to the year ago quarter despite of 33% decline in the rig count. On a sequential basis, offshore revenue was down 2% and again that is compared to a 20% decline in the rig count, and we saw solid revenue growth in our C&P segment, which nearly offset the decrease in Drilling and Evaluation revenues.

As expected market conditions in Canada continue to be poor, revenue was down 10% year-on-year compared to a rig count that was down 19%. As expected, lower rate activity primarily impacted our D&E segment. C&P revenues actually increased 10% year-on-year with Baker Petrolite posting revenue growth in Canada approaching 20%.

Turning now to the segment discussion, market conditions in North America had a differential impact on our segment performance. Our completion of production segment continued to perform well, our D&E segment which is tied mostly as you know to the rig activity was challenged by a competitive price environment.

I'm going to turn the call over to Martin Craighead; Martin is our Group President for Drilling and Evaluation. He is going to review the results for his segment and I'm going to come back and tell the highlights for the completion of our production segment.

Martin Craighead

Thanks, Chad. Good morning everyone. Q4 revenue for the D&E segment was up 9% year-on-year and up 1% sequentially. To put this in some context, the worldwide rig count was up 2% year-on-year and essentially flat on a sequential basis.

D&E's operating margin in Q4 was 25% that's down 300 basis points compared to the fourth quarter of 2006 were down a little more than 100 basis points, when you exclude the impact of the $21.2 million inventory adjustment at Baker Atlas. The year-on-year incremental margin was 11% calculated on a basis that excludes the Baker Atlas inventory adjustment.

Chad discussed the challenging operating environment in North America that we faced in the fourth quarter. This environment presents us specific challenges to our Drilling and Evaluation business due to their leverage to the rig count. Overall, we saw price deterioration that resulted from a combination of the weak Canadian market, slower growth in the US land market, and a smaller than anticipated recovery in the US offshore market.

In Q4, supply finally met demand in the D&E segment for North America. As such, we realized no price improvements and we don't expect the environment to improve anytime soon. Yet, while gains realized from the previous supply demand in balance are diminishing, customers are still willing to pay for good well side execution for Premium Technologies that solve their toughest drilling or evaluation problems. Furthermore, we will continue to pursue price for the value we deliver and at the same time maintain discipline over our operational cost base.

Now outside of North America D&E saw areas of tremendous growth. In Latin America this is being led by Brazil were D&E revenue has more than doubled and profitability continues to improve quarter-to-quarter. In the Eastern Hemisphere, we drill the longest extended rich well in the world breaking the record, we set last year of over 37,000 feet. Baker Hughes provide a directional drilling, logging-while-drilling, drill bits on the project and we're happy to report that Baker Oil Tools had a world record (inaudible). Baker Hughes has now drilled 13 of the 15 longest extended reach wells ever drilled.

Working for Gazprom on a per gas rig in Russia, we drilled a well in Astrocon using advanced technology from INTEQ, directional drilling group, Hughes Christensen bits and Baker Hughes Drilling Fluids. We completed this important well 30% faster than any other offset well in the area leading to a ward of additional wells in 2008.

VertiTrak and related technologies were critical for our breaking into the Chinese land market in 2007, working for Chinese operators on land is a great opportunity for Baker Hughes to expand from the offshore market where we hold a significant position.

And last, I’m happy to report that Baker Atlas is delivering solid results on the investments we made in the past with good international revenue growth and very strong incrementals.

With that I'll turn the call back over to Chad.

Chad Deaton

Alright, thanks Martin. I want to just make one clarification point Gary pointed out to me when you were talking about North American land growth year-on-year, quarter-to-quarter. Land revenue was actually up 12% on a year-on-year compared to 6% rate count decline, I think I said 2%.

Moving now to completion of production, completion of production we've been working on this area for quite some time. It delivered very solid results in the fourth quarter, as we said before this segment and more specifically Baker Petrolite and Centrilift should perform well in periods where rig count growth slows and this is exactly what occurred beginning in Q3 and was clearly evident in Q4. These businesses were less constrained by the North American rig activity flatten and therefore had stronger performance in our rig dependant product line.

CMP revenues was up 14% year-on-year and was up 4% compared to the third quarter. Operating profit increased 26% compared to the year ago quarter and CMP's operating margin increased over 200 basis points year-on-year and over 100 basis points on a sequential basis in an increase. The segment delivered a year-on-year incremental margin of 38%.

Going forward and looking at the outlook, long-term fundamentals of this industry we do not believe have changed. Global demand continues to be driven by expanding economies in Asia and Middle East. We believe that oil and gas companies around the world will increase their spending on exploration, development and production in order to meet this growing demand and this is particularly true in the eastern hemisphere. And today's high price of oil tells us that we've not yet satisfied this need.

However there are some near-term challenges that we in this industry must manage through. We continue to see a challenging market in Canada, at least through 2008. We are in the peak drilling season right now, but expect a sharp pullback in activity as the breakup emerges in late Q1. We continue to take steps to ensure our business is appropriately sized to the market opportunity and we expect, however, that the competitive pricing environment will be there for the balance of the year.

In the US, we see a market where in the short-term supply and demand are relatively balanced. Pricing is more challenging in today's market than it was a year ago, but I expect Baker Petrolite and Centrilift will continue to perform well in this market.

We see continued growth opportunities in the international arena in 2008. The price outlook for non-North American markets is good and there is room for margins to continue to expand. However, market conditions are clearly not as tight in 2006 and early 2007 and therefore margin growth will moderate.

Deepwater activity will be constrained in 2008 by rig availability thus limiting the growth of some high margin product lines, but we expect this will improve as new bills enter the market in 2009.

Our operations are impacted by the rigorously compliant matter, and we are conducting business under the deferred prosecution agreement that we entered into with the U.S. government last year. We continue to expand significant resources in support of our compliance activity.

Wrapping up in 2008, we'll be intently focused on earrings improvement; new operation efficiency cost control and price initiatives in order to ensure that we are capturing the value that we provide. And given our confidence in long-term outlook, we will continue to execute on our strategy for investing in infrastructure, technology and people. Some examples of that, with respect to infrastructure, 15% increase in our capital spending in 2008 reflects our ongoing commitment to update and expand our international infrastructure. We have new or updated basis plan throughout the Eastern Hemisphere.

With respect to technology, we opened Phase I of the Center for Technology and Innovation here in Houston in November and Phase II is scheduled to completion in mid-2008. This facility will focus on development of completion of production systems for harsh environments, particularly the deepwater and extreme high temperature high pressure applications. The technologies that we are developing will be critical to completing and producing hydrocarbons from the deepwater wells scheduled to be drilled later this decade.

As the only facility in the world capable of simulating the temperatures and pressures we'll encounter in these harsh environments, the CTS center will help Baker Hughes maintain its leadership in the most advanced completion system. We've also continued to invest in other technologies, as evidenced by our ongoing increases in research and engineering spending, and R&D spending will increase by about 17% this year to approximately $435 million.

We continue to recruit and hire and develop people for the international growth that we see. The new campus in Dubai which opens this month will play an instrumental role on training for the Eastern hemisphere. The significant investment we've made in this facility demonstrates that we are committed to developing and training our people.

One example of our investment in people is the engineering and development training program for our recent engineering hires. This program is a first step in preparing these engineers for future management roles in Baker Hughes. I spend a lot of time with these young engineers, and personally I've had a chance to meet most of the 624 engineers, that have come from 42 different countries and universities around the world and have now graduated from our lead engineering development program in '07. They are an outstanding group with young talent that compliments our proven professionals that we have in Baker Hughes for a well.

So in summary, I think 2008 I thinks its going to be a challenging year for the industry, but I believe is one of transition. There is no doubt that global hydrocarbon demand is real, not going away. Oil and gas reservoir declines are real and there are 160 new offshore rigs that are being built and will be delivered over the next years are real. And with that all of this points to a strong market in this industry for many years to come. Gary lets open it for questions.

Gary Flaharty

Alright, thank you Chad. With this point I'll ask Regina 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. Regina, could we have the first question please.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question will be from Geoff Kieburtz with Citigroup.

Geoff Kieburtz - Citigroup

Good morning.

Gary Flaharty

Good morning Geoff.

Geoff Kieburtz - Citigroup

Chad, I guess I would like to focus on the guidance for the international growth and sort of frame it in terms of - trying to understand how you are thinking about it as we look at Baker's international growth over the last couple of years. It has lagged most of the peers. Your guidance for '08 is also a little bit lower. Is that a concern of yours, is there some expectation that that will change as we go through '08 and get into 2009?

Chad Deaton

You know Geoff, first our growth was 21% international '06, '07. You are right. It's not keeping up with some of the peers. Some thing that we are consciously aware of. Couple of years ago, we sat down and what we said is that we think that the West to East needs to happen and we pointed out several key countries where we wanted to do several things. We wanted to expand the build our infrastructure. We wanted to make sure we are in recruiting and getting the people.

Very importantly to us, as we wanted to just not have a presence in these countries, in order to win a contract, but we wanted to be able to make sure that we were there, executing properly and that we solve the technical issues of our client. So, we identified we were on to the countries Brazil, Russia, India, Qatar, Saudi, and Malaysia. These were all countries where Baker Hughes in essence had a presence. They sold products there. But we really didn't have the infrastructure that was needed. So, we targeted these countries and in everyone of those today, we have a very strong market share position. We are drilling some of the most complicated wells. And we are solidly there, and it's not that we are just in and out.

Now you look at some areas, where we are not growing as rapidly. In those, areas places like Mexico, Africa and specifically Nigeria, Angola, Libya to some degree. You got Asia, and this is Phase II. Now this is part of the $1.3 billion capital program that we have going through next year. We will start doing the similar type thing in those areas, and establishing ourselves stronger and to be able to expand those.

I think the other thing that we also just need to keep in mind, as a company we are operating under DPA, a deferred prosecution agreement. And this does tend to make the Management team a little cautious. We tend to probably air on the conservative side when it comes to looking at some of these.

We have established some very, very strong compliance standards in the company. I think they are state-of-the-art. We look at these projects very carefully. Maybe we're a little bit slow in terms of moving on some of these projects in some areas. We do the monitor and his team in place and we are working with them and his team with the processes we have and I think as time moves forward, Geoff. We will refine some of these processes and get better at them.

We like our position. We are proud of the fact that we do have strong compliance standards and we do believe that in time this is going to pay benefits to us. So, yeah, I think this is our strategy as we move forward. We looking at these countries, we move into them. We establish our sites strongly and then we move on to the next wave. I don't know if that answers your question.

Geoff Kieburtz - Citigroup

No, it does not. Just specifically on the deferred prosecution agreement, what's the duration of that or maybe that's not the relevant question, maybe its, how long do you think it takes to effectively get to the point where it's not an impediment to Baker's ability to do business?

Chad Deaton

Well, the DPA was a two year DPA and we have a three year monitor agreement. The two year DPA will expire a year from April. So, it will be one year this April we have been in it, we entered it a year ago. But whether it expires or not this is something that we believe is the way we need to operate in terms of our policies and procedures. And the thing is that we are getting better and again I think the monitor will help us with this.

It allows us to give extras in our processes, in our procedures, our in place so that we can move on some of these projects. It applies the same thing with acquisitions. We are moving through on acquisitions. We need a process that we will make the acquisition. We know that we've done our due diligence and that we are able to purchase a company that we understand clearly. So I think that we got to move through this next year and we'll continuously improve I believe as we go through it.

Geoff Kieburtz - Citigroup

Pretty good. Thank you

Chad Deaton

All right.

Gary Flaharty

Thank you, Geoff.

Operator

Your next question will be from Bill Herbert of Simmons & Company.

Bill Herbert - Simmons & Company

Thanks. Good Morning

Chad Deaton

Good Morning, Bill.

Bill Herbert - Simmons & Company

Chad, trying to understand a little bit the margin guidance. I guess last year if I recall correctly, we established targeted incrementals at 25%, now it's 20% to 25%. On a normalized basis, if you back out the inventory adjustment, we're 27% in the fourth quarter. So 20% to 25% or degradation in incrementals going forward is a function of what primarily, is it price?

Chad Deaton

Yeah, I think its North America, really in North America, you got to throw in price.

Bill Herbert - Simmons & Company

Yeah.

Chad Deaton

Prices are still holding up internationally.

Bill Herbert - Simmons & Company

Right.

Chad Deaton

You do see some big projects that are coming out now. We could start sensing some aggressiveness out there. But to the most part, I think our incrementals non-North America improved '06 to '07. We have room to do that. But I think the pressure is going to come from the North America side.

Bill Herbert - Simmons & Company

With the assumption that the first quarter for North America isn't a disaster, I mean you're having a reasonable winter out in Canada, although it's still fairly depressed from an activity standpoint, but improving and U.S. continues to lumber along. Expectations for the first quarter operationally, are you flat with Q4, higher or lower?

Chad Deaton

Total or are you talking about North America?

Bill Herbert - Simmons & Company

Total.

Chad Deaton

Well, I think we are going to be down from Q4. We put in a release about the $100 million.

Bill Herbert - Simmons & Company

Tax for sales, got that.

Chad Deaton

Yeah, Q4 is usually great for us. We will have '08 Q4 will be a strong for us as well. I think we are going to have -- Russia has now become a fairly large area for us.

Bill Herbert - Simmons & Company

Okay.

Chad Deaton

And go back to last year, first quarter Russia was a disaster.

Bill Herbert - Simmons & Company

Yeah.

Chad Deaton

I think Russia is going to be tough this first quarter as well.

Bill Herbert - Simmons & Company

Okay.

Chad Deaton

So if you factor those in, I think you will see that Q1 will be down, but we see Q2, Q3, Q4 building back up.

Bill Herbert - Simmons & Company

That's helpful. Thanks. And then just one last one for you. Any update on two fronts with regard to Manifa one and also I guess there has been talk about a large tender from Angola, BP offshore, that is pretty significant. Any updates on those two projects?

Chad Deaton

Manifa, they are hot and heavy in the awarding of this thing and I really shouldn't make any comments on that one.

Bill Herbert - Simmons & Company

Okay. Hot and heavy meaning they are about to award it?

Chad Deaton

I think it is very close to being awarded, yes.

Bill Herbert - Simmons & Company

Okay, great. We will keep our fingers crossed.

Chad Deaton

And as far as Angola goes, it is still pending and we did win a nice contract which they do look a lot at Angola in content and et cetera.

Bill Herbert - Simmons & Company

Yeah.

Chad Deaton

We were directly awarded, that helps us because we think that we are in pretty good standing with the client there. We just got to make sure that we remain in good standing with the client there, we just got to make sure that we are in good standing with the government.

Bill Herbert - Simmons & Company

And that's your contention with respect to your incremental investment in that region to enhance your local content there?

Chad Deaton

Yeah. Again, it goes back to this West Africa thing and our build out there, we are just signing, we are starting a new base in Nigeria, we are looking at doing a similar thing in Angola, so this will show that our commitment is there.

Bill Herbert - Simmons & Company

Okay. Thanks very much.

Chad Deaton

Yeah.

Operator

Your next question will be from the line of Jim Crandell with Lehman Brothers.

Chad Deaton

Good morning, Jim.

Jim Crandell - Lehman Brothers

Good morning. Smith yesterday announced the 7% US drill bit increase and there seems to be several areas, Martin, including many of yours where you are competitors that have either just announced price increases or are preparing to. Have you increased list prices in any of your US businesses to offset costs and maybe get a bit above that and what's your opinion on whether these price increases can spec?

Martin Craighead

Jim, yes, the price increases come out as new products come out and Hughes is a master at innovation and so we expect price increases to be part of the plan. But I think the thing to keep in mind is that price is obviously a function of demand and as I said in my comments, the supply demand balance in North America is pretty much in equilibrium right now.

So, as far as pushing price as a result of leveraging the lack of supply, that's passed. Price is going to be tied directly to innovation and new technology and again I go back to Hughes record on that.

Jim Crandell - Lehman Brothers

You don't believe that you could increase prices without matured increase or introduction of new products?

Martin Craighead

That's correct.

Jim Crandell - Lehman Brothers

Okay. Getting back to the first question Chad, you think that one of the major reasons for the slower growth internationally relative to your competitors is that, they are getting a lot more IPM work and in certain regions that's beginning to become a greater and greater part of the total and does that make you want to become more aggressive or more active in that area?

Chad Deaton

No, I don't think it's an IPM issue at all, Jim. We've use this term before you call it to me or I call it tomorrow. We are doing bundling or integrated services in certain parts of the world. Algeria, we hear about integrated project management in Algeria, we have six rigs for (inaudible) that we are managing. We are working with, as many as if more than any of them in there. Mexico is truly an area that IPM or integrated project management does hold. One of the issues there is you are managing third party services, clients tend to want to push these type of things, because they get better pricing and bundling of services. I don't think this IPM; I don't think we have a problem. We are taking some on in; Russia is an area where we have taken on some projects like that. But I don't think that's our issue.

Jim Crandell - Lehman Brothers

Okay. And just one point of clarification, the $100 million decline quarter-to-quarter you are expecting in export shipments. Is that mostly Russia and what product lines is that in?

Chad Deaton

Its mostly in the C&P side, its mostly in BOT, and in Centrilift, it's the combination of Russia, the Middle East, West Africa, several different places.

Jim Crandell - Lehman Brothers

Okay. And final question Martin, Atlas has gone through some fairly major changes in the US operations under new management can you comment on how ….

Martin Craighead

Yes, sure Jim. As I mentioned, internationally the company is running full throttle and we are all really satisfied. North America, it's progressing well. We have some ground that we need to make up. I'd say we are happy, but we are never going to be satisfied, and again we are looking at a price environment that won't be as buoyant and I think the execution on the wireline side is going to be very much in the hands of those companies that can sell value and that have a nice technology portfolio. And again as you know Atlas is sitting pretty in that regard. So, it's going well and we think it will be much, much better in '08.

Chad Deaton

Yeah Jim, I just want to make a comment, maybe Martin didn't pat himself on the back hard enough or Atlas on the back hard enough. But you know we all remember in '06 when we were pouring quite a bit of money into Atlas and making a lot of changes there, but Atlas if you look at '06 to '07, '07 for Atlas was a very good year, and North America was exception. Martin talked about the changes there, but the other three regions around the world, it was a very strong year. So, I think we got Atlas moving ahead, the morale out there is fantastic. We just had a meeting out there and listening to those guys and they are pumped up. So I think '08 will be a good year for Atlas.

Jim Crandell - Lehman Brothers

Okay. And Chad one final question. Andrew on his call mentioned Russia as being one of the areas of strongest growth, do you still see yourself in a rapid ramp up there with Russia being one among your let's say top ten countries, one of your strongest rates of increases in '08?

Chad Deaton

Yeah. Definitely Jim. Every single product line we have is doing well in Russia and we've had some good successes. Martin talked about the gas a prime success. Yeah, you don’t call that project management, but it was a bunch of Baker Hughes services out there, working with gas problem to solve the problems. So it’s a bundle, but Russia is going to be very strong.

Jim Crandell - Lehman Brothers

Okay. Thank you very much.

Chad Deaton

You bet.

Operator

Your next question will be from Michael LaMotte of JP Morgan.

Michael Lamotte – JP Morgan

Good morning.

Martin Craighead

Good morning, Mike.

Michael Lamotte – JP Morgan

Chad, in a period which you described as challenging, utilization of the equipment and operating efficiency is critical. Can you talk about some of the initiatives that you’ve taken to maintain operating efficiency this year?

Chad Deaton

Yeah, one of the things that Martin and David have come out with, we call that a Martin score card or dash board, which is looking at inventory turns utilization of equipment, etcetera. The other things that we’ve done and Peter referred to this comes around overhead, G&A and direct and indirect people and some of this reclassification that we did in terms of moving some of those G&A over to the two group Presidents allows them to be able to manage their cost a lot more closely. So, we think that that will help us in the last couple of quarters. We’ve seen some decent margins, we still want them able to increase them, but they've held in what looks like a market that’s deteriorating in margin. So, we think we still have some room there to find more efficiencies.

Michael Lamotte – JP Morgan

Okay. And then Baker Petrolite specifically interesting to see the revenue growth accelerate through the year, you’re in 10% range or so, year-over-year in the first half, now you’re in high teens in the second half. Can you talk about the trends in that business in particular, whether high teens is something we can continue to expect out of Petrolite this year?

Chad Deaton

Well Petrolite, go back a couple of years ago in that pressure pumping and everything was going crazy and we kept talking about our CMP business and that's why I said in the call that we're starting to see CMP do what we believe that it would do in a slowing market and Petrolite is a perfect example. These guys are sold out right now, they've been beat up pretty hard on material costs over the last couple of years. But they're starting to see, now this is nearly where we believe that we'll be seeing some price improvement as we go forward, Centrilift, a little bit the same thing.

So, we're going to put some capital in to Petrolite, we’ve not put as much in over the last couple of years, because we were feeding the D&E side. But clearly this coming year, '08 would be a year that more investment goes into Petrolite. And again the other thing that I think is part of their success is, Petrolite was very strong in the North Sea and in the U.S. and we used this west to east build out from the facilities we have to get Petrolite people in these countries around the world and they are having lot of success, Saudi some of these other areas, we're seeing some nice international growth coming out of them. So, I think the CMP side will be good in '08 and going into '09.

Michael Lamotte – JP Morgan

Is it flow assurance or paraffin or corrosion resistance within Petrolite?

Chad Deaton

Exactly its friction in our pipeline, it's refining, we’ve got a fairly large refining group in Petrolite that's doing well, its desalinations, it’s a very broad product line. And again it's not that just upstream, the downstream side is tending to grow as well.

Michael Lamotte – JP Morgan

Okay, good. Thanks

Operator

Your next question will be from Ken Sill with Credit Suisse.

Ken Sill - Credit Suisse

Good morning.

Chad Deaton

Hi, Ken.

Ken Sill - Credit Suisse

I was little surprise, I wanted to dig down a little bit more into, capacity reaching or supply demand imbalance in North America, I can kind of see that in some of the business, but is that also true for the directional drilling side of things? That seems to be an area where pretty much everybody is exciting, there is still pretty solid growth.

Martin Craighead

Ken, this is Martin. I would say that yes it is, it's -- there are some pockets in North America. If you look at Canada, certainly supply is reaching, if not in some cases exceeding demand, same within the Gulf Coast. Some of the shell place, resource basins in the continental U.S. are still tight. And I don't want to paint a completely dark picture, we're still getting some price increases when it comes to personnel and there is still shortage of supply on some specific technologies across all the D&E product lines. But the thing you have to keep in mind in North America is that the price outside of new technology and improving mix, if we just talk about price that this industry has enjoyed, which is exploding that supply demand, that as you referenced, that's past, in large part that's just about gone.

And so, what you're seeing is creative tendering, some of our competitors call it integrated services, quite frankly its integrated discounting. It's one way to blend the discount of one product line into another one. And in your models, price is not really directly co-relatable to rig count. It's the function of the rig count change. And so, what you've seen over the last couple of years is the rig count has definitely outpaced our ability in the supply chain to keep up with demand. But the modest growth we see going forward on the rig count is not going to strain our D&E groups or our competitive groups. So, I think the ability to leverage shortage of supply is a thing of the past.

Ken Sill - Credit Suisse

Just out of curiosity, I mean it looks like the penetration of directional into the market has gone from 15% or so of the market, I guess five or six years ago you announced maybe 44%, 45%. Do you think we're kind of reaching a point of market saturation? Or do you think with pricing kind of flatting out here or getting a little bit more competitive that you'll continue to see growth in that business in terms of demand, but not in terms of price?

Martin Craighead

Well, you know it Ken. The reason that technology took off because of the innovation of ourselves and some of our competitors in the stability of directional drilling, the fluid systems, the bits and some other formation evaluation that's come from guys like Atlas. And that allow our customers to develop that and exploit this resource place. That's going to continue and more people are going to move into the market. So, to answer your question, that percentage of horizontal and highly deviated wells is going to continue to grow. We don't see any shortage in that at all.

Ken Sill - Credit Suisse

Okay. And how long do you think you'll hit 80%, 90% penetration over another three to four years, or will it be a little bit slower than that going forward?

Martin Craighead

I don't know if I'd say it's that high and it depends on the mix of exploration versus development. And as you know, there are not many exploration plays left in North America, so it could get that far. It certainly could, but I think that's a few years out to reach those numbers.

Ken Sill - Credit Suisse

Okay. Thank you very much.

Chad Deaton

I think technology is going to play in this as well. Smaller diameter tools, equipment, etcetera, will continue to get new breakthroughs and efficiencies.

Ken Sill - Credit Suisse

Yeah, okay. And I mean obviously I guess there are four of you now that are primary competitors driving the technology, or is it easy to differentiate or possible to differentiate a lot between what you and main competitors can do?

Martin Craighead

Ken, that's a great question. If you look at some of the big resource developers, EnCana, EOG, Chesapeake and particularly Devon, these guys really only go to one or two directional drilling companies. They pay a premium. They've got a lot stake. They run their operations like a factory in some of these cases and don't mess around. Now there is lot of second tier, third tier developers out there and there are a little bit more price sensitive. But as Chad referenced and Peter referenced in terms of our margins, we kind of stayed focused on the guys pay for value.

Ken Sill - Credit Suisse

Okay. All right. Thanks.

Operator

Your next question will be from Dan Pickering with Tudor, Pickering, Holt.

Dan Pickering - Tudor, Pickering, Holt

Good morning guys.

Chad Deaton

Good morning, Dan.

Dan Pickering - Tudor, Pickering, Holt

I would like to look at the drilling and evaluation business, specifically in North America, you report four segments there. And again just trying to make sure I understand the components of the price pressure, if we look at those four areas or four business segments as we look to 2008, you would expect price to be down in which of the four segments in '08 year-over-year?

Martin Craighead

I think the one that's probably I would say our drilling include the business on the conventional fluid side is probably the one that could suffer the most on price. Now in particular that division what you see as lot of innovation on the completion fluid side and the environmental services to try to negate that, nut on one of the mill drilling fluids that's an area that's probably going to be under the most pressure.

On the other end of this spectrum, you are going to see somewhat more advanced wireline technologies, particularly again back this resource plays where you are seeing mineralogy typing and so forth, getting premium, premium values that we have never seen before, and if that penetrates more and more in the absorption into the market, we will see I think may be some price increases. So it really gets back Dan, to commodity products being attacked first and the higher value ones being insulated.

Dan Pickering - Tudor Pickering

Right, I understand that but. I am going try and pin you down, because the price pressure comment, again I think as questionnaires have indicated it. Its clearly, you guys are more cautious than anybody we've heard so far. So I want to make sure, I understand where. So, Atlas aggregate as you look at it, down year-over-year in pricing, for the business not just the high end but all of it?

Martin Craighead

I would say Atlas in aggregate, Dan will be flat to slightly down on price.

Dan Pickering - Tudor Pickering

Okay and I understand you guys are growing capacity and taking some share et cetera and then INTEQ aggregate pricing?

Martin Craighead

Aggregate North America, with the way Canada is shaping up and our strong, strong position. Yes, I would say probably down on price.

Dan Pickering - Tudor Pickering

Okay, bits in aggregate. New product mix, as I understand it's going to get some pricing commodity probably isn't aggregate Hughes Christensen.

Martin Craighead

No.

Dan Pickering - Tudor Pickering

Pricing will be up there in 2008.

Martin Craighead

It won't be down.

Dan Pickering - Tudor Pickering

Okay great fantastic. Second question would be, for Gary or Chad. You guys do a great job tracking rig count. And I know you look at expectations for 2008. Can you share with us how you see US, Canada and international from a rig count perspective?

Gary Flaharty

Sure can Dan, this is Gary. We have got the US rig count basically up a couple percentage points. The Canadian rig count, kind of I think in the range of other people, we've got it down about 9% compared to 2007. On the international side we've got a rig count forecast there, that's up about 9.5%.

Dan Pickering - Tudor Pickering

Great. Thank you so much guys.

Operator

Your next question will be from Brad Handler with Wachovia Capital Markets.

Brad Handler - Wachovia Capital Markets

Thanks, good morning.

Chad Deaton

Good morning.

Brad Handler - Wachovia Capital Markets

Could you please speak to how much of your '08 outlook is sort of in the books already. What opportunities there are given what you have bid on internationally to I suppose raise what you deliver at the end of the day?

Chad Deaton

It's hard to say that in the book, Brad. But I would say what our outlook is pretty firm. I think where the upside will be or in some of these areas like we talked about Angola. Although, if block 31 starts it would be towards the end of '08 at the best. I think Manifa, it's not in there, wherever that goes and what swings come out of that. We don't have much from Mexico plugged in there and Mexico is going to be a target area for us.

We said last call there are like $10 billion or so some large contracts out there, some kind of integrated type multi-service contracts out there. These will be awarded throughout '08 and a lot of these will start up in '09.

So I would say that we feel pretty comfortable with the numbers that we have in there, and there's clearly some upside depending on who wins some of these big projects. StatoilHydro has got a big tender that's sitting out there. It hasn't been awarded yet. We won't plug those in unless we think we've got a great shot of winning them.

Brad Handler - Wachovia Capital Markets

Sure. No, that's why it makes sense. I guess as a quickie follow-up on Mexico target area. Have you already begun bidding on some of what PEMEX is, and have you already begun working actively with PEMEX on opportunities?

Chad Deaton

Yeah, we've been working very actively with [PEMEX], we’ve preferred not to go into the project management where we are building roads and doing other things, but at the same time, we continue to be invited back with PEMEX to – they've got a lot of completions, some multi-laterals that we are looking at. They clearly want Baker Hughes in there, and this is part of what we’re trying to negotiate with them to see how we can come in and through some kind of arrangement, be able to offer our services in there, without necessarily becoming road builders and facility builders and etcetera.

Brad Handler - Wachovia Capital Markets

Are you describing a scenario where you might to be, kind of a, sort of a, I don’t know, picked to be sub-contractor for certain types of well construction activity?

Chad Deaton

Yeah, that’s correct. I mean, BOT does well in Mexico, we’ve got a majority of liner hangers been awarded to us, we provide a lot of it [but] from the integrated packages down there, we’re starting to see several different companies come in and say that they'll be the new project manager. Several different groups they've contacted us wanting our services in there. So rather and that's being one project manager running our services, if this goes in Mexico, there may be four or five that you can be working for that are called project managers.

Brad Handler - Wachovia Capital Markets

Okay, if I may just an unrelated follow up. The margin improvement in CNP this quarter, I guess, I was a little surprised by just because the strength and revenue seemed to come from what I think of as lower margin products in Petrolite, Centrilift relative to Baker oil source. Am I on target there, and does that suggests that there has been actually some easing of the cost pressure you guys have cited in previous quarters? Was that just a price function of getting the price on what you did ship?

Chad Deaton

No, I think, we got the price on what we shipped. We clearly got our supply chain in better shape on BOT. Centrilift depending on the ESP’s and the level of complexity, could have some good margins on some good shipments. This depends on whether it's a shallow-hole country or problem areas. And Petrolite, same thing, you can have it's not just a commodity. So there are some high-end products in Petrolite that will deliver good margins. As I mentioned Petrolite is an area where we've been under a lot of cost pressure because of materials. It's still there, but I think that we are now being able to pass on some of the pricing to offset those and that's one of the reasons why we are seeing C&P do better.

Brad Handler - Wachovia Capital Markets

Okay. So the comfort level with sort of running in the higher margin, it sounds like comfort level running at the higher margins in C&P based on some favorable mix going forward and what you've done on the supply chain side.

Chad Deaton

Yeah, again we talk about Q1, I think Q1 is going to be a challenged force in that area, but for '08, we like the direction that we see C&P going both from an activity standpoint, as well as some pricing potential.

Brad Handler - Wachovia Capital Markets

I understand, got it. That helps. Thanks.

Chad Deaton

Thanks.

Gary Flaharty

Alright, thanks, Fred. Regina, at this point could we take one final question please?

Operator

Yes, sir. Your last question will be from the line of Robin Shoemaker with Bear Stearns.

Robin Shoemaker - Bear Stearns

Yes, thank you. Chad, I wanted to ask you what you are calling Phase II of the international expansion. I assume that as that gets on track, we can expect to hear about startup costs and other issues that we heard about in Phase I. And I just wonder given the nature of those countries and what you have to do to establish infrastructure there, whether it would be the same order of magnitude as the Phase I countries or perhaps less or more?

Chad Deaton

Well, startup costs I think. Again I go back to Brazil, where we went from two rigs to 10 rigs, we are there now for four years and we have the new facility. Of course the huge one was Saudi, where again three to four years ago we really didn’t have a presence in Saudi and today, we have a very strong presence in Saudi.

That’s allowing us to start bringing some of these people out of Saudi, out of Brazil and start, being able to roll them into some of these other areas. So, there will be these people cost that needs to have expats versus nationals. But the build out will be, we just finished a new base in Mexico, we have another one that’s started, and like I said, Nigeria has got a base been built. You could look at what we have done over the last couple of years and that’s now going to be repeated in some of these next areas over the next year or two.

And one other thing, that if you looked at our margins, you can see that very strong margins '05 as we ramped up, hired 5,500 net people in the end of '05 and '06, that some pressure on margins in '07, '06, early '07. Last couple of quarters margins have been in there fairly strong compared to the industry margins. And we want to maintain those and we think we can and still be able to go into this phase too. Depending again what happens in North America. There is going to be some pressure in North America, but internationally we think we can continue to hold the margins.

Robin Shoemaker - Bear Stearns

Okay. Just one quick follow-up on your, just pricing commentary about, on world markets, are there any other markets apart from North America that you consider to be in equilibrium as you call it and where you are potentially experiencing some pricing pressure, either in the commodity lines or in the higher end higher end product lines.

Chad Deaton

No, is everything else is still -- we still have some opportunity there. North America is the only place, where we really seen that right now.

Robin Shoemaker - Bear Stearns

Okay. Thank you, that’s all I have.

Chad Deaton

Okay.

Gary Flaharty

Thanks, Robin and thank you Chad, Peter and Martin. We thank everyone and all of our participants this morning for your time and your thoughtful questions. Following the conclusion of today's call, both Gene and I will be available to answer any additional questions you may have. So, once again thank you for your participation. Regina?

Operator

Thank you for participating in today's Baker Hughes corporate conference call. This call will be available for replay, beginning at 11:30 a.m. Eastern, 10:30 a.m. Central and will be available through 11:59 p.m. Eastern time on Wednesday, February 13th, 2008. The conference ID number for the replay is 25959373. Again, the conference ID number for the replay is 25959373. The number to dial for the replay is 800-642-1687 in the U.S. or 706-645-9291 for international. That's 800-642-1687 in the U.S. or 706-645-9291 international. You may now disconnect.

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