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Note฀12.฀Financial฀Instruments
Fair฀Value฀of฀Financial฀Instruments
Our฀financial฀instruments฀include฀cash฀and฀short-term฀
investments,฀receivables,฀payables,฀debt฀and฀foreign฀currency฀
forward฀contracts.฀Except฀as฀described฀below,฀the฀estimated฀
fair฀value฀of฀such฀financial฀instruments฀at฀December฀31,฀2004฀
and฀2003฀approximate฀their฀carrying฀value฀as฀reflected฀in฀our฀
consolidated฀balance฀sheets.฀The฀fair฀value฀of฀our฀debt฀and฀
foreign฀currency฀forward฀contracts฀has฀been฀estimated฀based฀
on฀year-end฀quoted฀market฀prices.
The฀estimated฀fair฀value฀of฀our฀debt฀at฀December฀31,฀
2004฀and฀2003฀was฀$1,315.0฀million฀and฀$1,609.8฀million,฀
respectively,฀which฀differs฀from฀the฀carrying฀amounts฀of฀
$1,162.3฀million฀and฀$1,484.4฀million,฀respectively,฀included฀
in฀our฀consolidated฀balance฀sheets.
Interest฀Rate฀Swap฀Agreements
In฀April฀2004,฀we฀entered฀into฀an฀interest฀rate฀swap฀agree-
ment฀for฀a฀notional฀amount฀of฀$325.0฀million฀associated฀with฀
our฀6.25%฀Notes฀due฀January฀2009.฀Under฀this฀agreement,฀
we฀receive฀interest฀at฀a฀fixed฀rate฀of฀6.25%฀and฀pay฀interest฀
at฀a฀floating฀rate฀of฀six-month฀LIBOR฀plus฀a฀spread฀of฀2.741%.฀
The฀interest฀rate฀swap฀agreement฀has฀been฀designated฀and฀
qualifies฀as฀a฀fair฀value฀hedging฀instrument.฀The฀interest฀rate฀
swap฀agreement฀is฀fully฀effective,฀resulting฀in฀no฀gain฀or฀loss฀
recorded฀in฀the฀consolidated฀statement฀of฀operations.฀We฀
recorded฀the฀fair฀value฀of฀the฀interest฀rate฀swap฀agreement,฀
which฀was฀a฀$2.3฀million฀liability฀at฀December฀31,฀2004,฀based฀
on฀quoted฀market฀prices฀for฀contracts฀with฀similar฀terms฀and฀
maturity฀dates.
At฀different฀times฀during฀2003,฀we฀entered฀into฀three฀฀
separate฀interest฀rate฀swap฀agreements,฀each฀for฀a฀notional฀
amount฀of฀$325.0฀million,฀associated฀with฀our฀6.25%฀Notes฀
due฀January฀2009.฀These฀agreements฀had฀been฀designated฀
and฀had฀qualified฀as฀fair฀value฀hedging฀instruments.฀Due฀to฀
our฀outlook฀for฀interest฀rates,฀we฀terminated฀the฀three฀agree-
ments฀and฀received฀payments฀totaling฀$26.9฀million.฀Each฀of฀
the฀three฀agreements฀was฀terminated฀prior฀to฀entering฀into฀a฀
new฀agreement.฀The฀deferred฀gains฀are฀being฀amortized฀as฀a฀
reduction฀of฀interest฀expense฀over฀the฀remaining฀life฀of฀the฀
underlying฀debt฀security,฀which฀matures฀in฀January฀2009.
During฀2002,฀we฀terminated฀two฀interest฀rate฀swap฀฀
agreements฀that฀had฀been฀entered฀into฀in฀prior฀years.฀These฀
agreements฀had฀been฀designated฀and฀had฀qualified฀as฀fair฀
value฀hedging฀instruments.฀Upon฀termination,฀we฀received฀
proceeds฀of฀$4.8฀million฀and฀$11.0฀million.฀The฀deferred฀
gain฀of฀$4.8฀million฀was฀amortized฀as฀a฀reduction฀of฀interest฀
expense฀over฀the฀remaining฀life฀of฀the฀underlying฀debt฀secu-
rity,฀which฀matured฀in฀June฀2004.฀The฀deferred฀gain฀of฀
$11.0฀million฀is฀being฀amortized฀as฀a฀reduction฀of฀interest฀
expense฀over฀the฀remaining฀life฀of฀the฀underlying฀debt฀secu-
rity,฀which฀matures฀in฀January฀2009.
Foreign฀Currency฀Forward฀Contracts
At฀December฀31,฀2004,฀we฀had฀entered฀into฀several฀฀
foreign฀currency฀forward฀contracts฀with฀notional฀amounts฀
aggregating฀$78.0฀million฀to฀hedge฀exposure฀to฀currency฀฀
fluctuations฀in฀various฀foreign฀currencies,฀including฀the฀British฀
Pound฀Sterling,฀the฀Norwegian฀Krone,฀the฀Euro฀and฀the฀Brazil-
ian฀Real.฀These฀contracts฀are฀designated฀and฀qualify฀as฀fair฀
value฀hedging฀instruments.฀Based฀on฀quoted฀market฀prices฀as฀
of฀December฀31,฀2004฀for฀contracts฀with฀similar฀terms฀and฀
maturity฀dates,฀we฀recorded฀a฀loss฀of฀$0.4฀million฀to฀adjust฀
these฀foreign฀currency฀forward฀contracts฀to฀their฀fair฀market฀
value.฀This฀loss฀offsets฀designated฀foreign฀exchange฀gains฀
resulting฀from฀the฀underlying฀exposures฀and฀is฀included฀in฀
selling,฀general฀and฀administrative฀expense฀in฀our฀consoli-
dated฀statement฀of฀operations.
At฀December฀31,฀2004,฀we฀had฀also฀entered฀into฀several฀
foreign฀currency฀forward฀contracts฀with฀notional฀amounts฀
aggregating฀$122.4฀million฀to฀hedge฀exposure฀to฀currency฀
fluctuations฀in฀various฀foreign฀currencies,฀including฀the฀British฀
Pound฀Sterling฀and฀the฀Canadian฀Dollar.฀These฀exposures฀arise฀
when฀local฀currency฀operating฀expenses฀are฀not฀in฀balance฀
with฀local฀currency฀revenue฀collections.฀The฀funding฀of฀such฀
imbalances฀is฀supported฀by฀short-term฀intercompany฀borrow-
ing฀commitments฀that฀have฀definitive฀amounts฀and฀funding฀
dates.฀All฀commitments฀are฀scheduled฀to฀take฀place฀on฀or฀
before฀December฀31,฀2005.฀These฀foreign฀currency฀forward฀
contracts฀are฀designated฀as฀cash฀flow฀hedging฀instruments฀
and฀are฀fully฀effective.฀Based฀on฀quoted฀market฀prices฀as฀of฀
December฀31,฀2004฀for฀contracts฀with฀similar฀terms฀and฀matu-
rity฀dates,฀we฀recorded฀a฀loss฀of฀$0.1฀million฀to฀adjust฀these฀
foreign฀currency฀forward฀contracts฀to฀their฀fair฀market฀value.฀
This฀loss฀is฀included฀in฀other฀comprehensive฀income฀in฀the฀
consolidated฀balance฀sheet.
Additionally,฀during฀2004฀and฀2003,฀we฀entered฀into฀and฀
settled฀foreign฀currency฀forward฀contracts฀to฀hedge฀exposure฀
to฀currency฀fluctuations฀for฀specific฀transactions฀or฀balances.฀
The฀impact฀on฀our฀consolidated฀statements฀of฀operations฀
was฀not฀significant฀for฀these฀contracts฀either฀individually฀or฀
in฀the฀aggregate.
The฀counterparties฀to฀our฀foreign฀currency฀forward฀con-
tracts฀are฀major฀financial฀institutions.฀The฀credit฀ratings฀and฀
concentration฀of฀risk฀of฀these฀financial฀institutions฀are฀moni-
tored฀on฀a฀continuing฀basis.฀In฀the฀unlikely฀event฀that฀the฀
counterparties฀fail฀to฀meet฀the฀terms฀of฀a฀foreign฀currency฀
contract,฀our฀exposure฀is฀limited฀to฀the฀foreign฀currency฀
exchange฀rate฀differential.
Concentration฀of฀Credit฀Risk
We฀sell฀our฀products฀and฀services฀to฀numerous฀companies฀
in฀the฀oil฀and฀natural฀gas฀industry.฀Although฀this฀concentration฀
could฀affect฀our฀overall฀exposure฀to฀credit฀risk,฀we฀believe฀that฀
we฀are฀exposed฀to฀minimal฀risk฀since฀the฀majority฀of฀our฀busi-
ness฀is฀conducted฀with฀major฀companies฀within฀the฀industry.฀
We฀perform฀periodic฀credit฀evaluations฀of฀our฀customers’฀
financial฀condition฀and฀generally฀do฀not฀require฀collateral฀for฀
our฀accounts฀receivable.฀In฀some฀cases,฀we฀will฀require฀pay-
ment฀in฀advance฀or฀security฀in฀the฀form฀of฀a฀letter฀of฀credit฀
or฀bank฀guarantee.
We฀maintain฀cash฀deposits฀with฀major฀banks฀that฀may฀
exceed฀federally฀insured฀limits.฀We฀periodically฀assess฀the฀
financial฀condition฀of฀the฀institutions฀and฀believe฀that฀the฀risk฀
of฀any฀loss฀is฀minimal.
54฀฀฀฀฀Baker฀Hughes฀Incorporated