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Baker Hughes Incorporated (BHI)

Q1 2008 Earnings Call

April 22, 2008 8:30 am ET

Executives

Gary Flaharty – Director IR

Chad Deaton – CEO, President, Chairman

Peter Ragauss – SVP, CFO

Analysts

Jim Crandell – Lehman Brothers

Robin Shoemaker – Bear Stearns

Bill Herbert – Simmons & Company

Dan Pickering – Tudor Pickering Holt

Geoff Kieburtz – Citigroup

Michael LaMotte – J.P. Morgan

Brad Handler – Wachovia Capital Markets

Charles Minervino – Goldman Sachs

Ken Sill – Credit Suisse

Ole Slorer – Morgan Stanley

Operator

Good morning, my name is Katina and I will be your conference facilitator. At this time I would like to welcome everyone to the Baker Hughes first quarter 2008 earnings conference call. (Operator instructions). Thank you, I will now turn the conference over to Mr. Gary Flaharty, Director of Investor Relations, sir you may proceed.

Gary Flaharty

Alright, thank you Katina. Good morning everyone. Welcome to the Baker Hughes first quarter 2008 earnings conference call. Here with me this morning are Chad Deaton, Baker Hughes' Chief Executive Officer, President and Chairman and Peter Ragauss, Baker Hughes' Senior Vice President and Chief Financial Officer. Following management's comments this morning we’ll open the lines for your questions. Reconciliation of operating profits and any non GAAP measures to GAAP results for historic periods can be found on our website at www.bakerhughes.com in the investor relations section under financial information.

Finally, I want to caution you this morning that any company outlooks discussed 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. For a full discussion of these risk factors please refer to our annual report, 10K, 10Q and in particular the forward looking disclosure in this morning's news release. With that I’ll conclude our discussion of the administrative details and turn the call over to Chad Deaton. Chad.

Chad Deaton

Thanks Gary, good morning and welcome everyone to the Baker Hughes first quarter 2008 earnings conference call. This morning we reported net income for the first quarter of 2008 of $395 million or $1.27 per share. The $1.27 per share is up $0.01 from the $1.26 we reported in the fourth quarter of 07 and is up $0.10 or 8% from the $1.17 that we reported in the first quarter of 07. Looking at our results for the first quarter I’ll say that there are areas where I’m pleased with our results but there are also some areas that will continue to need some attention.

We’ve made strides in expanding our infrastructure and in the hiring and training program. We’re going to continue to emphasize investments in these very important areas. We’ve made and have made numerous, we have numerous examples of a lot of the technological success and in many areas of the world we continue to be the go to company for many of the most difficult drilling and completion challenges that our clients are faced with. We have also established a world class compliance culture and all of these achievements have played a part in helping us to go ahead and continue to expand our business.

I do remain convinced that we’re in the process of implementing the correct strategies for Baker Hughes and that is continuing investment in technology, infrastructure and people. Last week we announced the acquisition of Gaffney, Cline and GeoMechanics International, two premier companies that will continue the process of integrating our leadership position in well bore related technologies with reservoir and midstream expertise. I’ve said to many of you in the past that expanding our reservoir competency would be an area of focus and these acquisitions are tangible evidence that we’re executing on our strategy.

In addition we are focused on expanding our capabilities in the area of integrated operations, but we’re going to be selective about the type of projects and the risks we assume. Expanded reservoir and integrated operation capabilities will be important as we focus on growth in key markets. I’m going to discuss our operational highlights a little bit later in the call but at this point I want to turn it over to Peter to discuss some of the financial highlights. Peter.

Peter Ragauss

Thanks Chad. As Chad said, net income for the first quarter 2008 was $395 million or $1.27 per share. Q1 revenue was $2.67 billion, up $198 million or 8% from the first quarter of 2007 and down $70 million or 3% from the prior quarter. North American revenue was up 8% compared to the year ago quarter and up 4% compared to the prior quarter. Non-North American revenue was up 8% compared to a year ago and down 7% sequentially. Our oil field operating margin in Q1 was 23%, this is compared to 24% in the prior quarter and 25% a year ago.

Drilling and evaluation revenue was $1.39 billion in the first quarter, up 8% compared to the year ago quarter and up 2% compared to the prior quarter. Year on year revenue growth was strong in Russia Caspian, Middle East, Latin America and the US. The drilling and evaluation segment’s operating margin was 25% in Q1, essentially flat on a sequential basis. Completion and production revenue was $1.28 billion, up 8% from the year ago quarter and down 7% from the fourth quarter 2007.

The sequential revenue decline was anticipated as we highlighted in our last conference call, that is approximately $100 million of export orders in Q4 that would not repeat in the first quarter. Baker Petrolite and Centrilift had strong year on year revenue growth which was driven by fundamentals other than improvement in drilling activity. C&P’s operating margin was 21%. In an effort to assist you in evaluating our Q1 earnings per share I want to highlight a few significant items to provide a bridge between Q1, the prior quarter and the year ago quarter. From the $1.26 we reported in the fourth quarter 2007, add about $0.06 for the gain on the product line sale, add about $0.03 to account for the benefit of a more favorable tax rate this quarter.

Add about $0.03 for the impact of the lower share count. Subtract about $0.01 for higher corporate interest and other costs. The anticipated decline in completion and production export sales cost us about $0.10 per share. This gets you to the $1.27 we are reporting for the first quarter. From the $1.17 we reported in the first quarter of last year, add about $0.06 for the gain on the product line sale, add about $0.03 to account for the benefit of a more favorable tax rate this quarter. Add about $0.04 to account for the impact of a lower share count. Subtract about $0.04 for higher corporate, interest and other costs, reflecting an increase in compliance costs. And add about $0.01 for the contribution from operations.

This gets you to the $1.27 we are reporting for the first quarter. During the first quarter we repurchased 8.2 million shares of common stock at an average price of about $69.00 per share for a total $568 million. At quarter end we had authorization remaining to repurchase up to $256 million of common stock. With respect to the balance sheet, at the end of the first quarter we had cash and short term investments of about $1 billion. A significant portion of this cash is in our international operations. Therefore, in order to continue our share repurchases, we incurred short term borrowings during the quarter in the US. Our outstanding debt increased $462 million as a result of these short term borrowings.

At quarter end, our outstanding debt was $1.55 billion and our total debt to cap ratio was 20%. Our guidance for non-North American revenue growth in 2008 compared to 2007 remains unchanged in the low to mid-teens percentage range relative to 2007. Our guidance for capital spending in 2008 continues to be $1.3 billion. We expect our capital spending rate to increase in the balance of the year. Finally, we expect our total oil field operating margin in the second quarter to be flat with Q1. I’ll now turn it back over to Chad.

Chad Deaton

Okay, thanks Peter. I want to walk through some of the operational highlights for our four regions and looking first outside of North America. In Latin America our revenue increased 9% year on year compared to a 6% increase in the rig count. The majority of the revenue increase was in the D&E segment where we had strong revenue growth for Intech and for Baker Atlas and also Hughes Christensen in Brazil. Our C&P segment, Centrilift saw strong revenue growth in Columbia and Venezuela and Baker Petrolite had increased activity in Brazil and Venezuela.

Latin American revenue decreased 1% sequentially as gains in the D&E segment were offset by lower C&P export product sales. Revenue for the Europe, Africa, Russia and Caspian region was up 8% year on year, was down 6% sequentially. In Europe, revenues were up 3% year on year, revenue was down 4% sequentially and this was primarily impacted by some North Sea weather delays. In Russia and the Caspian, revenue was up 55% year on year with strong revenue growth in both segments. The revenue decreased 17% sequentially in part due to a large manufacturing shipment to Centrilift in Q4 that did not recur in Q1 and also due to the typical weather related seasonality in Russia. Africa revenue was down 8% year on year and up 1% sequentially.

The year on year revenue decline in part reflects operational delays in Nigeria which impacted both the D&E and C&P segment and also year on year revenue comparisons for our C&P segment also reflect extraordinarily high Q1 2007 product shipments for Baker oil tools in Equatorial Guinea that did not repeat in Q1 2008. These shipments were under a very large contract in which the client made an advanced purchase of the completion equipment in order to satisfy a couple year’s need. We’re still providing work under this contract but there’s been a notable shift in revenue mix from product sales to the service and installation revenue as we move through that contract. Middle East, Asia Pacific revenue was up 7% compared to the year ago quarter, it was down 12% sequentially.

Middle East revenues were up 6%, Middle East itself was up 6% year on year and that’s in line with rig activity. Middle East revenue was down 16% sequentially. The sequential comparison was impacted by large export shipments in the fourth quarter that did not recur and which impacted sequential revenue comparisons. For some time BOT, Bake oil tools was the sole supplier of what’s call the inflow control systems in Saudi Arabia or the equalizer product line where we had 100% market share. However our market share has decreased and there’s also been a reduction in pricing for this product as a competitor has entered the market.

Asia Pacific revenue was up 9% year on year, down 7% sequentially. Looking at North America, Q1 revenue was 8% compared to the year ago quarter, it was up 4% on a sequential basis. The US land revenue was up 16% year on year compared to a 4% increase in the land rig count. In the D&E segment, InTech, Baker Hughes drilling fluids, Hughes Christensen, all had very strong growth and land revenue for the completion and production segment increased due to strong revenue growth at both Centrilift and Baker Petrolite.

US offshore revenue was down 10% on a year on year compared to a 30% decline in the rig count, it was down 8% sequentially. In Canada revenue was up 4% compared to the first quarter of last year on a rig count that was down 5% as lower activity for our drilling and evaluation segment was offset by solid growth in the completion and production group. Canadian revenue was up 24% compared to Q4 2007 with the strongest growth at Baker Atlas and InTech on the D&E side and with Baker oil tools in the C&P segment. Turning now to the two segments and looking at them in a little more detail. Overall as I look at the D&E performance, we had some good successes for the first quarter. Hughes Christensen delivered strong revenue growth and Baker Atlas delivered solid results with the highest year on year non-North American revenue growth of the D&E segment.

Our new operations base in Macae, Brazil was inaugurated during this quarter, it is delivering services for the deep water offshore operation at or above our contractually signed participation for D&E services. As Brazil continues to expand its deep water activity and advances in assessing the recently announced finds in what is a very challenging sub-salt play, our newly deployed capabilities will bring increasing value to our Brazilian clients and continue to lead our D&E growth in the region for 2008. We’re moving from a position of low representation in the country to a majority position and we are now able to service 13 rigs simultaneously.

This is up from two a little over a year and a half ago and this will expand to 17 by year end. We’re providing higher levels of geoscience and reservoir navigation services and with five additional offshore rigs arriving in Q2, two more in Q3 and two expected in Q4, Baker Hughes will capture 50% of the market by contract. In fact if you look at the last quarter, InTech actually had 55% of Petrogras’ offshore market share for the month of March. Also in Latin America, the Orinoco heavy oil belt in Venezuela has been identified as a primary strategic element in the vast hydrocarbon reserves for the country.

Baker Hughes technologies in the formation evaluation and the fluids sampling area are delivering results previously not seen in what is a very challenging environment that will help [Pedavas] better see and better have access reservoir potential an evaluate new production horizons. Looking at North America, InTech has recently secured a development project for up to ten rigs in the Horn River Source Rock play which is in northeast British Columbia. Utilizing on track and star track technologies to exploit these [imoit] reserves, producers are projecting that this shale play could be as much as ten times more productive than the Barnett shale.

We do like our position and the potential for growth as [that] heavy develops in this area. The position of Baker Atlas is also deploying XMAC, imaging and PCL services and technologies in order to assist the producers with their Horn River exploration programs. Looking at completion and production segment, also delivered many technological successes in the quarter. Baker oil tools increased activity in the [bachan] play in southeastern Saskatchewan utilizing frac point completions technology. Local exploration companies are demanding more sophisticated efficiency and execution for bringing in wells and was a very fast developing area which is adjacent to the same play which is across the US-Canadian border.

BOT’s frac point technology allows for multi-stage fracturing and horizontal wells. These eliminate cementing and perforating as used by numerous pressure pumping companies and just went into service about a year ago, installations have grown some eightfold over a one year period of time. Baker oil tools also completed the first installation of the equalizer reservoir management system for customers in both India and Russia. Looking at the outlook, the long term fundamentals of the industry have not changes and in fact if anything, probably improved form our last call, especially in North America. High oil prices will have some impact on US demand and in those economies most closely tied to the US dollar.

However the growth engine of the world’s economy, China, India, Middle East and other areas are expected to continue to grow placing incremental demand for oil and gas on a system that is already stretched. Production declines in key producing areas around the world have only heightened the concerns around production levels and the industry’s ability to keep up with demand. Many governments are calling for increased spending to help increase production rates. As holders of the vast majority of petroleum reserves, the national oil companies will increasingly have to step to the plat to find, to develop and to produce significant volumes of hydrocarbon in order to meet this world demand. Different NOCs are going to require different levels of support and assistance.

Although we at Baker Hughes can offer what is a rather large compliment of technologies and services, the missing component has been the area of reservoir capability. The acquisitions that I referred to earlier of Gaffney Cline and GeoMechanics International will allow us to significantly broaden our portfolio of technologies and services. I’d like to give you some examples. GeoMechanics International currently advises some 60 clients around the world on a whole variety of technical challenges in some of the following areas: optimizing drilling direction to intersect fractured zones, obviously that works very closely with InTech. Also, pore pressure prediction, utilizing wire line and LWD data, much of this data is already InTech’s and Baker Atlas’ data.

Prediction of sand production based on geomechanical models and clearly a very strong link to Baker oil tools’ product lines [overlay]. In this acquisition we also get a link to one of the top university geophysics departments in the world, that being Stanford. And of course we significantly strengthen our technical base by adding over 50 PhDs to our company’s ranks. Gaffney Cline, our other acquisition brings similar technical capabilities.

Through this acquisition we’ll add over 125 technical consultants with a wide range of expertise, including reservoir evaluation, fuel development, field operations, integrated technical and management advice and asset management. Gaffney Cline offers a multi-disciplined approach to both frontier exploration and evaluation all the way to reservoir characterization of more mature fields. These consultants advise on areas across the entire oil and gas landscape, from drilling and completion to well intervention to pipelines and everything in between. We believe that these two acquisitions are going to strengthen us in two key areas, one obviously is in the reservoir and geoscience side, the other is in the area of capabilities under project management. At this time, Gary why don’t we open it up for questions.

Gary Flaharty

Great, well thank you Chad. At this time I’ll ask Katina 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. Katina, could we have the first question please?

Question-and-Answer Session

Operator

(Operator instructions). Your first question comes from Jim Crandell with Lehman Brothers.

Jim Crandell – Lehman Brothers

Chad, you’ve reiterated your forecast of I think low to mid-teens international growth for 2008, most of your competitors think that their growth rate will maintain the same pace or accelerate as we go beyond 08. As you lose the quarter pointed monitor in the spring of the year do you see that impacting your growth rate and would you see international growth accelerating beyond 08?

Chad Deaton

Well, we have the monitor for two years, Jim, two years from this April. We lose the DPA, expires a year from this April, about a year from now in fact. You know now we’re looking at 2009 in terms of what growth will come out of that. You know it’s a hard thing to call right now, clearly as we talked about on the last call, we are operating under a fairly conservative environment you know in a couple areas I think that it’s affecting our international growth. One is clearly in the area of acquisitions, we’ve not been active in acquisitions.

It doesn’t mean we haven’t been out looking and in fact we’ve actually done some due diligence on several companies. I didn’t listen to the call but I understand one of our competitors said in the last quarter they bought 11 companies and you know that clearly does help with international growth. I think we’ve learned by the two acquisitions we just made with Gaffney Cline and GCA, the monitor was involved in that and the compliance teams and that gave us a roadmap or a process that hopefully we’re going to be able to apply to find some growth opportunities around the world going forward.

I think the other area which won’t change from a year from now when the DPA ends is in that we made a very significant reduction over the last few years in agents, several hundred agents down to less than 50 now. We won’t be going back to agents in the future. And clearly I think when you drop agents, move away from agents in some parts of the world, it does take some time to rebuild up the relationships back with the clients and you know we have to work through that and that’s what we’ve been doing this last year, what we’ll continue to do the next several months and that’s why we’re saying that our growth is going to be in this low to mid-teens range.

Jim Crandell – Lehman Brothers

Okay and as a follow up, Peter maybe you could comment on the decline in margins in the completion and production side, it seemed to me that given the fall off in revenue that the quarter to quarter decline in operating income in the completion and production side certainly was more than I would have expected.

Peter Ragauss

Yeah, sure Jim. We signaled there would be $100 million decline in revenues and those were export sales which are pretty high profit margin items and so the decrementals on those were on the order of 50% and that’s the simple math of it and that’s the $0.10 that I referred to. Just high decrementals on what were high margin products.

Jim Crandell – Lehman Brothers

Okay, I hadn’t realized the decrementals were that high, thank you.

Operator

Your next question comes from Robin Shoemaker with Bear Stearns.

Robin Shoemaker – Bear Stearns

Thank you Chad. There’s been a lot of discussion in these recent conference calls on integrated project management and I’m sure you were anticipating getting a question about that which you’ve I think referred to in the past as bundled services and have had, it seems to me, a little bit of a more cautious view on entering into that business and I just wonder if you could give us an update on your thinking in that regard?

Chad Deaton

Yeah, we did expect a question in there Robin. We expected a question in international growth and IPM and I think they do go hand in hand. You know we’ve been strengthening our project management team, part of the two acquisitions clearly help us on the reservoir but with that also we get some experience in drilling and completion and project management from these two companies. Today we’re operating on 11 rigs under what we call integrated operations.

We’ve put in a new president here about three months ago, he’s been doing some recruiting to get additional expertise in the area. Right now we’re actively tendering on some $850 million worth of IO type projects. I think it’s how you count it, whether it’s a true project management like in Mexico where you’re managing you know field locations and rigs and building roads versus like Algeria where it really is, you got a project manager on site, we’re on six rigs in Algeria and we have of our services out there. So you know we are taking a more aggressive look at what we can do in integrated project management.

You know there’s some concerns in terms of the pull through in your other services and yes you do get revenue but it can also affect your overall margins. And you know the industry I think over the last three, four quarters have clearly seen margins deteriorating as revenue goes up on a lot of project management and I think that’s one of the concerns you have to be careful of, not just to chase the revenue but also to make sure that you’re keeping up good earnings on it. So we are entering into project management in certain parts of the world, Russia, Mexico, Algeria we talked about, Columbia we’ve got a rig there and [unintelligible], Gabon, so we’re building that product line up.

Robin Shoemaker – Bear Stearns

Okay, just as a follow up on that then, is it safe to say that you would be less inclined to get involved in one of these projects that would entail a significant amount of third party services under your direction or supervision which would include I guess hiring rigs and other things. Or do you want to basically be able to take on these projects mostly with your in house capabilities? Is that fair to say?

Chad Deaton

I think that’s fair and I think what we would rather do is team up with drilling contractors which is what we’re doing now in these 11 rigs and providing a joint service in there without us necessarily taking on the risk of the rig and so on, that’s correct.

Robin Shoemaker – Bear Stearns

Okay, alright, thank you.

Operator

Your next question comes from Bill Herbert with Simmons & Company.

Bill Herbert – Simmons & Company

Good morning Chad. No mention of margins with regard to the outlook. I think last time we spoke on the call, targeted incrementals were in the range of 20-25%, do we still stick with that?

Chad Deaton

Well, I’ve not seen anybody’s incrementals looking real bright lately but Peter you want to, we’ve done a lot of work on this on the margin side.

Peter Ragauss

Bill we did mention margins in the outlook. We said that Q2 would be similar to Q1. And I think that we would expect that trend to continue through the year so that fits right into the [overlay].

Bill Herbert – Simmons & Company

The trend so meaning, so the flattish margins from this point forward for the year?

Peter Ragauss

We think we can hold margins at this level, there may be some upside with North America beefing up a little bit. But you know somewhere flat to up.

Bill Herbert – Simmons & Company

Right, which was going to be my next line of inquiry, North America, I mean clearly we’ve had a resurgence in activity and the outlook I think is demonstrably better, curious as to what you’re hearing and seeing, not what you saw but hearing and seeing with regard to leading edge indicators and setting up for the second half of the year and if you could have a brief commentary on pricing as well in North America as well, thanks.

Chad Deaton

Yeah, no I think second half of the year looks right now Bill looks good for North America. You know I think we’ve got the Canada issue in the second quarter which everybody’s faced with as that balances out. Clearly British Columbia right now is a very exciting area which is taking off that I think some very good discoveries up there and some exciting things which will drive that area. I think that Gulf of Mexico, second half of the year is going to improve as these rigs come in. We do all know clearly that there’s plenty of gas production that’s on there but we do quite a bit to refill and storage et cetera which is going to drive production.

So I think the second half looks good, we had a good first quarter, you know InTech was exceptionally strong in North America first quarter on the horizontal wells. Hughes had a good first quarter. So yeah I think and clearly growth is not a problem for us in North America or Europe, compared to our peers. You look at it, we’ve got as good a growth as anybody. So I think this is an area that we’re going to focus hard on is North America this year and I think 09 will be good.

Bill Herbert – Simmons & Company

Okay, I’m not sure if I heard you mention anything on pricing.

Chad Deaton

Pricing, we are not seeing a tremendous pressure on pricing. You know I think it’s nothing like what we’re hearing or seeing from the pressure pumping side. There are pockets of a little bit of pricing pressure but for the most part it’s holding up.

Bill Herbert – Simmons & Company

Are there any pockets of pricing prosperity?

Chad Deaton

Yes, you know our C&P side, two of them Centrilift and Petrolite are doing very well, had very strong quarters. And we’re finally seeing some improvement there especially on the Petrolite side, finally getting some pricing through you know on some of the material and hydrocarbon products that we buy. So I think the C&P side is doing quite well on that area right now.

Bill Herbert – Simmons & Company

Okay, thank you very much.

Operator

Your next question comes from Dan Pickering with Tudor Pickering Holt.

Dan Pickering – Tudor Pickering Holt

I’d like to follow up a little bit on the second half margin statements that you made Peter. It feels like revenue growth is improving flattish margins for the second half would imply that incrementals are only in the 20’s and I just want to make sure that it sounds like you’re guiding sort of flattish for the second half but maybe I’m just reading that too conservatively?

Peter Ragauss

I wouldn’t be adjusting my models up or down at this point but for the full year but you know we had a relatively soft 1Q. And you know 2Q’s affected by Canada so we’ve got some, but the C&P ought to be coming back in 2Q. And then 3 and 4, you know there’s some potential upside, but like I said, I wouldn’t be banking it yet.

Dan Pickering – Tudor Pickering Holt

Okay, alright and then I guess as we look at the outlook around the world, I asked this question last quarter, I’m going to come back and ask it again because it does feel like the answer may be different. You guys do a good job of tracking rig count, can you just review for us what your current expectations would be regionally for rig count for 08 and if you have an 09 look that would be great.

Chad Deaton

Yeah, North America, right now, we’re at about the 3.5-4% rig count growth. You know this could be better in the second half of the year, we’ll see how that first quarter goes. We’re about 9-10% for the rest of the world. Gary do you have the break down by region?

Gary Flaharty

I’d add to that Canada, we’re looking for probably down a percentage or two, that’s significantly different from the forecast we had last quarter, a good deal more optimistic and there may be a little bit more upside on that. Europe we’re looking for something on the order of up about 10%, Latin America a little bit stronger than that about 10.5%. And then if we go through the other areas, Middle East, a little bit more modest about 7% there, about 10% in Asia and about 10% in Africa. So somewhere in that 8-10% range.

Chad Deaton

And we show offshore year on year, full year on year down about 20%.

Dan Pickering – Tudor Pickering Holt

And I’m sorry, the US number, Canada’s up from your forecast, what is the US number changed at this point?

Chad Deaton

Canada’s actually down about 2% if you go the full year on year Dan.

Dan Pickering – Tudor Pickering Holt

Right but I think it was down 9% on your last [overlay].

Gary Flaharty

Yeah the original forecast was down 8-10, we’re now down about 2, I believe our original forecast on the US was up about 1%, we’re looking more like 4% and that’s probably a little bit conservative. Some upside there.

Dan Pickering – Tudor Pickering Holt

Great, thank you.

Operator

Your next question comes from Geoff Kieburtz with Citigroup.

Geoff Kieburtz – Citigroup

Could we talk a little bit more about the international growth outlook and in particular I was wondering if you could kind of characterize, you know how much of your international revenue growth is going to be dependent on building new infrastructure as opposed to exploiting what you’ve already completed?

Chad Deaton

Well clearly Brazil, we’re pretty good shape in Brazil from these ten rigs to the 17 rigs, we’ve got the facilities in place, nothing there. Russia, we’re going to need to continue to build our infrastructure but I don’t think that’s any different from anybody else Geoff in terms of what’s there. We’ve got some infrastructure in West Africa that we’re in the process of building out, Nigeria, Angola, a couple bases there.

We’re, India, we’re building out an additional base there, we have one that should be completed before long. We’re under project, we just finished the Middle East, Dubai Emirates facility and operational center, that was opened this year, that’s a very large center for repair and maintenance which we handle all the Middle East area, so that’s done. I think we’re like most people, we’re going to be continuing to build out, Australia needs to build out, so we’ll continue to build out in the areas as this thing continues to see activity in many parts of the Eastern Hemisphere.

You know if you look at some of the international growth Geoff, right now we’re tracking or we noted about $10 billion of big tenders that are sitting out there that are being bid or should be awarded before long. And I think you know that’s going to determine the participation in 2009 and 2010, how successful different companies are in many of those tenders. So.

Peter Ragauss

We’re spending about $300 million on international infrastructure this year, that compares to $130 last year. It’s going to take some time for that to actually get built, the concrete poured, you know the computers ordered and everything else and by the time that’s up and running you know that leads into 2009, probably will be spending, probably still heavily in 2009, so we’ve done a lot already but I think there’s still a long way to go and it is a bottleneck for us in certain particular geographies. So we’re trying to uncork that bottle if you will and that’s unfolding over years, not over quarters.

Chad Deaton

I mean Kazakhstan, new base going into Kazakhstan, Libya is under construction, that’ll be a new base. Like Peter said I think this is a, we’ll just continue over the next several years to build out.

Geoff Kieburtz – Citigroup

In doubling your infrastructure spending this year, should we imply that you have an anticipation of acceleration in your international revenue growth, I mean this is kind of a different version of the same question that was asked earlier.

Chad Deaton

Well I think it comes back to the $10 billion of the tenders that are sitting out there and how many we win, I mean we’re building the new base in Qatar, you know putting all the company’s in Qatar, will be a first class operation but that, we’re already operating in Qatar but it’s a little bit like the way it was in Dubai, we had several different locations scattered around and now we’ve got everybody under one roof in Dubai, we’ll do the same thing in Qatar.

So we continue to operate in some of these countries but we’ve got to get better facilities, repair facilities et cetera in place to be able to be successful on some of these other tenders. So I think it’s a, yes I think like in West Africa, the build out in Nigeria and Angola will help us be more competitive on winning some of those contracts. Places like Qatar we’ve already got the contract, it’s a matter of making sure we have the facility to handle it, service it properly.

Geoff Kieburtz – Citigroup

Can you give us an idea of approximately how many different contracts are including in that $10 billion and kind of over what time period you expect them to be awarded?

Chad Deaton

I would say there’s probably 70 or 80 projects that our guys are tendering, some will be awards in Q2, some in Q3, some in Q4, probably some going into Q1, Q2 of next year. Some are delayed. BPA Angola for example is a big one but it keeps sliding, keep waiting to hear from that one. So you know there’s quite a few out there but they just, some of them slip a little bit Geoff.

Geoff Kieburtz – Citigroup

And last question, with the acquisitions that you’ve made this quarter, do you feel as if there is a clear hole in your portfolio in regards to competing for these international project opportunities?

Chad Deaton

No I think it’s going to get us in earlier on some of these, for instance, GCA does a lot on feed studies, working with the client early on, they work, GeoMechanics, GMI works in terms of some of the drilling challenges and problems early on. So this will get us in to better understand what some of the challenges are in the reservoir which should allow us to help I think probably do a better job of tendering on some of these. One of the things that both GCI and GCA and GMI we’re clearly excited about and one of the reasons why we wanted to get these two companies is we think a real opportunity comes back in terms of driving the completion into the reservoir.

And there’s been a lot of work done obviously on the D&E side and R&D and technology development, we think that there’s a lot more that can happen on the completion side. And part of that is you have to have a very good understanding of the reservoir in order to design a completion for a multi-lateral or a formation that could water out in 15 years. So we think is going to help us be much more competitive in that area.

Geoff Kieburtz – Citigroup

Great, thank you.

Operator

Your next question comes from Michal LaMotte with J.P. Morgan.

Michael LaMotte – J.P. Morgan

Good morning. Peter I want to make sure I heard you correctly, did you say the compliance was $0.04 in the quarter?

Peter Ragauss

I said the whole corporate G&A year over year was around $0.04 and much of that has to do with compliance cost.

Michael LaMotte – J.P. Morgan

Okay, when do you think that sort of begins to work its way out, where are we on the schedule and program there?

Peter Ragauss

I think we’ve built a world class clients program that will continue.

Chad Deaton

These aren’t one time charges.

Michael LaMotte – J.P. Morgan

They’re not, okay, so it’s not like its sort of beefing up to get a [plane] in place and then it will work its way out?

Peter Ragauss

No and we don’t do our accounting that way either, we don’t call them one time charges.

Chad Deaton

We’ve been eating these costs for the last couple years, every quarter as they come and you know that’s the way we’ve been reporting them.

Michael LaMotte – J.P. Morgan

Understood, just looking for a little relief where we can. On the acquisitions following up on Geoff’s line of questioning, what’s, is the revenue model going to change? I think one of the concerns that’s been raised is that reservoir engineering and consulting services is sometimes viewed as a cost of business as opposed to a real value sale to the customer. So I’m wondering if you really see an opportunity here to not just sort of maintain the revenues of these companies but actually grow them as they pull through the business. I suppose you’re considering them a cost of sale or service in another product or service line?

Chad Deaton

I clearly think we’ll have the opportunity to grow these two businesses Michael and I think there’s going to be I think from BOT to Atlas to InTech to the new completion center we just built, I think there’s going to be a lot of pull through back the other way in terms of them helping enhance some of the capabilities of our tools and the technologies. So you know these are both profitable companies, we expect them to remain profitable, revenue will roll up under the D&E side of the business.

But we will let them sit out there on their own and generate and they need to be profitable, but at the same time we’ll be adding resources to them in order to grow the business. They’re in several places of the world but they’re not in all the countries where we are. So I think one of the things that excites them is they do get an opportunity to be in Angola and other places where we have operations. So I think we’ll see some growth coming out of there.

Michael LaMotte – J.P. Morgan

That’s great, that’s just what I wanted to hear, thanks Chad.

Operator

Your next question comes from Brad Handler with Wachovia.

Brad Handler – Wachovia Capital Markets

Good morning guys. Can you please speak to your cap ex budget which is unchanged and I guess what I’m trying to, what I’m hoping you’ll speak to is what flexibility do you have to respond to revenue opportunities in North America in light of a fixed cap ex budget, right and how much wiggle room you have if you will to respond, that sort of thing.

Chad Deaton

You know our cap ex is $1.3 billion, we spent about $235 million this quarter which on a run rate is less than that, but what you’ll see is we’re going to be spending almost $400 million in Q2, so we’re not worried about being on pace to spend our $1.3 billion. And we’re not, if we see growth take off, if we have opportunities, we win some of these contracts whether it’s North America or elsewhere, we’re not shy to go ahead and say we’re going to increase our capital spending for tools especially. So you know if we see the activity and it’s there and we can get it, we’re going to, we’ll increase the capital expenditure plan.

Brad Handler – Wachovia Capital Markets

Okay, that’s certainly good to hear, can you give us a sense maybe for a couple of your product divisions about how quickly you can get your hands on tools now, what are lead times like? So how quickly do you need to anticipate opportunities to be able to deliver something for 08?

Chad Deaton

Anywhere from 6-12 months. One of the things that we are hearing from some of our suppliers is that some of our competition have turned back some time and space. Which allows us to be able to pick that. Two years ago you know you couldn’t find space for any of the suppliers that build for all of us but today we’ve got a little bit more room in our supply chain. So I think as we see it we can go ahead and build out.

Brad Handler – Wachovia Capital Markets

Okay, that makes sense, although it still sounds like you’re responding more to the 09 and beyond opportunities as you win them as opposed to picking up something in North America in the second half? Based on the six months?

Chad Deaton

Again, you know we can move tools around the world really easily, this is big pressure pumping equipment or rigs or whatever else. So if we see North America take off an we’ve got some capacity sitting somewhere in the Middle East or North Sea if it’s a little slower we’ll ship it back here.

Brad Handler – Wachovia Capital Markets

Okay, alright, that’s helpful, thanks.

Operator

Your next question comes from Charles Minervino with Goldman Sachs.

Charles Minervino – Goldman Sachs

Just wanted to get a little color on the international growth for the remainder of the year, first quarter was about 8% and you’re guiding I guess low to mid-teens, can you talk to us, it looks like you’d have to be a little bit above that for the remainder of the year to kind of balance out there. Can you talk about maybe second quarter and then the second half of the year, is it going to be you know second quarter going to be similar to 1Q and then higher in the second half of the year or is it kind of above that for I guess the next three quarters, can you just give us a little color there?

Chad Deaton

Its stair steps up.

Charles Minervino – Goldman Sachs

Stair steps up, okay.

Chad Deaton

And next quarter’s going to be better, it’s going to be pushing that number for internationally in Q3, Q4 improvement from there.

Charles Minervino – Goldman Sachs

And could you just give us color on where that incremental growth is taking place?

Chad Deaton

Yeah, obviously Latin America is going to be a key area. You know Brazil as we talked about going from the ten rigs to 15 or so by yearend, those will ramp up. Russia is an area, we’ve got West Africa, we’ve got some areas growing in West Africa. Far East, Australia is a strong area for us. India, China, Malaysia looks good. Kazakhstan, Caspian area. And it’s by different product lines, Latin America we’re going to see InTech out with BOT come through, Europe, right now Hughes Christensen and Centrilift is very strong in Europe you know with some of the watering problems in the North Sea and those issues.

Same thing in Africa, Centrilift showing some good growth in Africa. Russia it’s mainly in BOT, BOTs very strong in Russia for 2008, so there’s going to be contributing. Atlas really in all three international markets are doing quite well, the exploration work, we’ve picked up several deep water rigs. So I think that’s going to help us in terms of Atlas.

Charles Minervino – Goldman Sachs

Okay and could you just quickly a little color on how much of this is going to be pricing driven versus activity driven? It sounds like you’re talking a lot about activity growth here, what is the level of pricing strength internationally?

Chad Deaton

Pricing is okay internationally but it’s not what’s going to drive this revenue growth, it’s going to come from activity. Some of it’s going to come from you know the IPM project management integrated operations side as we pick up and look at Russia and Algeria as two areas. But the rest of its going to be mainly just activity and again some of these contracts with we think that we’re sitting pretty good to win.

Charles Minervino – Goldman Sachs

Thank you very much.

Operator

Your next question comes from Ken Sill with Credit Suisse.

Ken Sill – Credit Suisse

Guys, wanted to get back to the international growth question and kind of stretch out to 09. Clearly you’ve had a lot of cap ex a lot of [floaties] open in Brazil, Dubai, India, you’re building in Qatar, West Africa. And those revenues I guess, the benefits of those facilities should start flowing through as you move into next year I guess significantly but is there a significant level of startup costs or expenses that are going in there that might decline as we move into 09 that would affect margins or is this going to be kind of a steady state thing?

Chad Deaton

Well I think obviously Brazil is a perfect example Ken and now that we have that built out, margins are improving and part of it’s a volume game when you’re two rigs going to five and you’re building new facilities and hiring 300 engineers in Brazil et cetera, margins aren’t great, so we’ve been through that for the last year. But now that we’re at ten, 11 rigs and climbing, the bases in place, the engineers are in place, we’re starting to rotate out some ex pats as we used more locals.

You know and that takes a couple three years. That one, now we’re moving on with, same thing in Dubai, same thing in Saudi Arabia where we’ve got the new facility that is being built and plus we have a big infrastructure there. So I think those margins will improve in those areas but as we build out West Africa and Russia and continue to do that, we’re going to go through the same build out costs and startup costs. So I think it’s something to just continue to kind of rotate through as business grows.

Ken Sill – Credit Suisse

Because you’ve got, you said you did $130 million in cap ex in infrastructure in 07, $300 million this year and that’s been one of my things I tell people is look this will turn into growth at you know in the future it just takes time. But you know so how many years of kind of heavy infrastructure spend do you think it takes to catch up? Is it 08 09 and it’ll start tilling off in 010 or is? You know because I guess the issue is the differential cap ex and the kind of catch up that’s happening on your international construction.

Chad Deaton

You know, let’s also face the facts, from 1998 to 2004 the company averaged $15 million a year on infrastructure. You know we’ve quoted that number before, so now we’re spending $300 million this year on infrastructure. So is there some catch up in order to get the existing facilities like Qatar and these where we are operating up to speed, yes. Does that mean that revenue will flow higher in Qatar? No I don’t think so. We’re already on 40% of the activity there.

But where we haven’t had some infrastructure and other things like Australia and Argentina and Peru and some of these others, as we move back into those areas or move in there and build things then yes we expect to see revenue increases coming out of that. A perfect example is Brazil, two rigs, hardly any revenue, same thing with Saudi Arabia four years ago, just very little revenue in Saudi. Those are two examples where we’ve made quite a bit of not only just infrastructure but people in the hiring and the Brazilians and the Saudis et cetera. Today they’re very strong organizations and we need to repeat that process.

Ken Sill – Credit Suisse

I guess just to kind of close it out here, you know low to mid-teens international growth for 08, do you think that can be higher in 09 or similar in 09?

Chad Deaton

I’m hoping that it’s higher in 09. It’s for a couple things, one we rotate these things through, we’re able get all these facilities opened up and get the revenue. Two we can make some acquisitions which you know clearly there’s people making acquisitions, that’s revenue growth. Third is you know hopefully be able to manage these integrated projects so that yes they’re generating revenue but you’re not seeing a significant deterioration in margins which you know I think that’s a challenge for the industry today on some of these projects.

You know the client is going to tend to want you to bundle and to integrate these because then you’re out there as a group and you’ll have a better tendency to do some pricing negotiation and power. So I think that’s the danger we’ve and an issue we’ve got to watch but at the same time this is the direction and we’re going to participate in it.

Ken Sill – Credit Suisse

Okay, thank you Chad.

Operator

Your next question comes from Ole Slorer with Morgan Stanley.

Ole Slorer – Morgan Stanley

Thank you very much. I wondered whether you could just summarize for us what part of your international revenue base is offshore versus onshore, I think we had another company yesterday highlighted they had 50% offshore versus onshore, I would imagine that your split would be a little bit more biased towards offshore.

Chad Deaton

That seems awfully high to have, Ole to have 50% just in offshore revenue.

Ole Slorer – Morgan Stanley

50% of the international revenues.

Chad Deaton

Well obviously it’s higher than that in Europe. But it’s you know you look at Russia, that’s almost all land. India, it’s higher offshore. You look at the Middle East, Saudi it’s probably 70% land or higher. Brazil, all offshore. I don’t know, we’d have to go through and add that, I think that’s a good point, we can take a look at it and get back to you on that but we can, we’ve got the numbers. Gary you want to follow up with Ole on that?

Ole Slorer – Morgan Stanley

Thanks and it strikes me that you would be higher anyway but if you look at your offshore position and globally, broad based in say four lines, auto track, completion, fluids and Atlas, as we shift to more of an offshore momentum, are there geographic regions where you are afraid of maintaining your market share because of your use of agents or are there areas where you’re getting more of a super major end user type of customer base that typically don’t use agents in the same way? Could you just highlight a little bit broad brush talking international as we shift to an offshore environment, where do you feel that you are perfectly happy about being able to maintain or grow market share and where do you see some threats after those product lines?

Chad Deaton

I think you’re exactly right Ole, when it comes to offshore, you know whether the agent does and the technical level of the product that you’re putting out there, you know agents don’t come into play. Brazil, we don’t deal with any agents, we deal straight with the client and we have a very strong position in almost all of the products that you just walked through. Same thing obviously Gulf of Mexico, same thing Europe, Norway, UK, not a problem, we’ve got good market share in both of those particular areas. So yes we obviously do a lot better where we can deal straight with the client.

Ole Slorer – Morgan Stanley

What about Algeria, Angola, other parts of West Africa, India, other areas where there were heavy use of agents, will you find yourself at a disadvantage?

Chad Deaton

Well, you end up having commercial agents and you have processing agents and part of what you have to do is get your tools and equipment through customs and ports and you know the logistics side of things and that’s the challenge in some countries to be able to get that done. And you know then it depend on where you are in the world and the national oil company and some of their involvement in terms of awarding other work which sometimes comes into play. So yes there are certain parts that are more challenging than other parts of the world, let’s leave it at that.

Ole Slorer – Morgan Stanley

But looking forward for the type of growth industry wide, North American land, international offshore much more over the next two years, more than you’ve had over the past two years. I mean shouldn’t you be in a heck of a better position in terms of capturing that on a level playing field basis?

Chad Deaton

Well, yes. We’re excited about the 170 rigs that are coming in over the next two, three, four years, offshore rigs, deep water rigs. You know we’ve got them broken down exactly when they’re coming out and we track our market share very carefully or closely on each one of those rigs. The ones that are operating now plus the ones that are coming out over the next three years, so we think that we’re going to be able to sit in a pretty good position for those product lines you talked about. Obviously Hughes, probably got 50% market share in deep water rigs, InTech’s very high, Atlas is making good grounds penetration, so yeah I think we’ll be able to improve our share in those rigs as they come out over the next three years.

Ole Slorer – Morgan Stanley

Anything going on on completion which makes you nervous about maintaining your offshore market share there?

Chad Deaton

No, I think we’ve got a couple areas in completion that we’ve got to [emphasize] and we’ve got a couple areas on our completion business that we’re very strong on the offshore.

Gary Flaharty

Plus we just opened the center for technology and innovation that should be a real asset for us there.

Chad Deaton

Yeah, we just opened that and already we’ve had two super majors book days to come in to work with our guys regarding some of the challenges to complete these extreme high temperature high pressure wells. You know they may be two, three, four years away but already they’re talking to us about some joint R&D projects and some challenges. So we think that’s going to put us in pretty good shape.

Gary Flaharty

Great, well thank you very much Ole, we’re approaching the bottom of the hour and I do want to be respectful of others that have calls scheduled today and we know that you have a very busy schedule lined up for the rest of the morning. So with this I want to thank Chad, Peter, I want to thank all of our participants this morning for your time and your very thoughtful questions. Following the conclusion of our call, Gene and I will both be available to answer any additional calls you may have. So once again thank you for your participations.

Operator

Thank you for participating in today’s Baker Hughes Incorporated conference call. This call will be available for replay beginning at 10:30 am Eastern Time, 9:30 am Central and will be available through 10:00 pm Eastern Time on Tuesday, May 6th, 2008. The conference ID number for the replay is 39514631. (Repeating number). The number to dial for the replay is 800-642-1687 in the US or 706-645-9291 international. (Repeating numbers). You may now disconnect.

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Source: Baker Hughes Incorporated Q1 2008 Earnings Call Transcript
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