Baker Hughes 2009 Annual Report Download - page 96

22 Baker Hughes Incorporated
MG&A expenses increased 12% in 2008 compared with
2007. This increase corresponds with increased activity and
resulted primarily from higher employee related costs including
compensation, training and benefits, higher marketing
expenses as a result of increased activity and an increase
in legal, tax and other compliance related expenses. These
increases were partially offset by foreign exchange gains.
Litigation Settlement
In connection with the settlement of litigation with
ReedHycalog, in June 2008, the Company paid ReedHycalog
$70 million in royalties for prior use of certain patented tech-
nologies, and ReedHycalog paid the Company $8 million in
royalties for the license of certain Company patented technol-
ogies. The net pre-tax charge of $62 million for the settlement
of this litigation is reflected in the 2008 consolidated statement
of operations. See Note 15. “Commitment and Contingencies –
Litigation” in the Notes to Consolidated Financial Statements in
Item 8 herein.
Gain on Sale of Product Line
In February 2008, we sold the assets associated with
the Completion and Production segment’s Surface Safety
Systems (“SSS”) product line and received cash proceeds of
$31 million. The SSS assets sold included hydraulic and pneu-
matic actuators, bonnet assemblies and control systems. We
recorded a pre-tax gain of $28 million ($18 million after-tax).
Gain (Loss) on Investments
The Company had investments in auction rate securities
(“ARS”) that represent interests in three variable rate debt
securities. These are credit linked notes and generally combine
low risk assets and credit default swaps (“CDS”) to create a
security that pays interest from the assets’ coupon payments
and the periodic sale proceeds of the CDS. Since September
2007, we had been unable to sell our ARS investments
because of unsuccessful auctions. We estimated the fair value
of our ARS investments based on the underlying structure of
each security and their collateral values, including assessments
of counterparty credit quality, default risk underlying the secu-
rity, expected cash flows, discount rates and overall capital
market liquidity. In December 2008, we recorded an impair-
ment loss of $25 million, to record the ARS to fair value. In
December 2009, we sold the ARS for $15 million and recorded
a gain of $4 million.
Interest Expense and Interest and Dividend Income
Interest expense increased $42 million in 2009 compared
with 2008 and increased $23 million in 2008 compared with
2007. These increases are primarily due to the new long-term
debt issuances of $1.25 billion in October 2008, resulting in
higher average debt levels throughout 2009 and 2008.
Interest and dividend income decreased $21 million in
2009 compared with 2008 and decreased $17 million in 2008
compared with 2007. The decrease in both years was primarily
due to a reduction of the average interest rate earned, par-
tially offset by an increase in the average investment balance.
Income Taxes
Our effective tax rates in 2009, 2008 and 2007 are 31.1%,
29.5%, and 32.9% respectively, which are lower than the U.S.
statutory income tax rate of 35% due to lower rates of tax on
certain international operations offset by state income taxes.
Our tax filings for various periods are subject to audit by
the tax authorities in most jurisdictions where we conduct
business. These audits may result in assessment of additional
taxes that are resolved with the authorities or through the
courts. We believe these assessments may occasionally be
based on erroneous and even arbitrary interpretations of
local tax law. We have received tax assessments from various
taxing authorities and are currently at varying stages of appeals
and/or litigation regarding these matters. We believe we have
substantial defenses to the questions being raised and will
pursue all legal remedies should an unfavorable outcome result.
However, resolution of these matters involves uncertainties and
there are no assurances that the outcomes will be favorable.
We provide for uncertain tax positions pursuant to Accounting
Standards Codification (“ASC”) 740, Income Taxes.
OUTLOOK
This section should be read in conjunction with the factors
described in “Part I, Item 1A. Risk Factors” and in the “For-
ward-Looking Statements” section in this Part I, Item 7, both
contained herein. These factors could impact, either positively
or negatively, our expectation for: oil and natural gas demand;
oil and natural gas prices; exploration and development spend-
ing and drilling activity; and production spending.
Our industry is cyclical, and past cycles have been driven
primarily by alternating periods of ample supply or shortage of
oil and natural gas relative to demand. As an oilfield services
company, our revenue is dependent on spending by our cus-
tomers for oil and natural gas exploration, field development
and production. This spending is dependent on a number of
factors, including our customers’ forecasts of future energy
demand, their expectations for future energy prices, their
access to resources to develop and produce oil and gas and
their ability to fund their capital programs.
The recovery from the global economic recession is
expected to be the primary driver impacting the 2010 business
environment. As the worldwide economy recovers, demand for
hydrocarbons will increase. The largest incremental demands
for oil are expected to be generated by China, India and the
Middle East. Increasing oil demand along with the weakness in
the U.S. Dollar relative to other currencies is expected to sup-
port oil prices between $60/Bbl and $85/Bbl. In North America,
the 12-month futures price for natural gas, as quoted in Febru-
ary 2010, has been trading above $6/mmBtu, offering opera-
tors an opportunity to hedge future gas production and lock-in
an attractive return regardless of near-term spot prices. As a
result of improved cash flow and outlook for stronger eco-
nomic growth, our customers are expected to increase their
spending to explore for and develop oil and natural gas in
2010 compared to 2009. Capital discipline on the part of our
competitors, attrition of existing rental fleets and rising demand
are expected to result in an environment that we believe will
support increasing prices for our products and services in some
markets by the second half of 2010.