Baker Hughes 2005 Annual Report Download

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A World of Opportunity
2005 Annual Report and Proxy Statement

Table of contents

  • Page 1
    2005 Annual Report and Proxy Statement A World of Opportunity

  • Page 2
    ... Baker Hughes is a technology leader in drilling, formation evaluation, completion and production. We continue to increase our investment in new technology development and have successfully introduced new technology to differentiate ourselves in a competitive market. Our world-class manufacturing...

  • Page 3
    ... resonance logging, and in acquiring data in high pressure high temperature wells. Baker Hughes Drilling Fluids Baker Hughes Drilling Fluids provides fluids systems and services that help optimize the drilling and completion processes, maximize hydrocarbon production and manage drilling waste...

  • Page 4
    ... in the mature fields of the North Sea and increased business in West Africa by applying advanced technology. The company continued to invest for growth in Russia and the Caspian. Middle East and Asia Pacific In the Middle East, Baker Hughes achieved high growth rates in Saudi Arabia, Qatar and the...

  • Page 5
    ... business. Furthermore, management uses operating profit internally as a measure of the performance of the company's operations. 2005 Revenues by Region Canada, 6% USA, 36% Latin America, 10% Europe, 15% Africa, 8% Russia, Caspian, 5% Middle East, 10% Asia Pacific, 10% $1,000 $500 $0 $2,000 $1,500...

  • Page 6
    ... and Evaluation segment (comprised of Hughes Christensen, INTEQ, Baker Atlas and Baker Hughes Drilling Fluids) and the Completion and Production segment (comprised of Baker Oil Tools, Centrilift, Baker Petrolite and our new Production Optimization business unit). These two segments are organized...

  • Page 7
    ... regions - North America; Latin America; Europe, Africa, Russia and the Caspian; and Middle East and Asia Pacific. Each division now has a vice president located in each region, who reports to the division president and is a member of a regional management council. We made this change to facilitate...

  • Page 8
    ... Hughes provided drilling systems, formation evaluation services, fluids, and completion systems for the country's high-volume gas wells. In China, INTEQ, Hughes Christensen, Baker Oil Tools and Centrilift contributed to successful multi-well offshore development projects for two Western operators...

  • Page 9
    North America Baker Hughes leveraged its traditional strength in North America by supporting increased natural gas development. Baker Hughes technology enabled customers to perform horizontal drilling and completion in Texas' Barnett Shale play, drill vertically through the faulted zones of the ...

  • Page 10
    ...-well campaign. In Latin America, Baker Hughes Drilling Fluids delivered innovative mud systems from Colombia to Argentina. Baker Atlas provided advanced logging services for deepwater wells in Brazil. Baker Hughes divisions combined drilling, evaluation and completion technologies to achieve high...

  • Page 11
    ...fluid from gas wells in the Rocky Mountains. Baker Petrolite also expanded international oilfield markets in Brazil, West Africa and the Middle East. Baker Petrolite's downstream business also grew through sales of products and services to help refineries process "opportunity" crude oils and operate...

  • Page 12
    ...we approved plans to build a new Center for Innovative Technology in Houston, where research engineers from our Completion and Production segment can concentrate on new technologies. We expect this center to accelerate development of new, innovative products and services that bring high value to our...

  • Page 13
    Europe, Africa, Russia and the Caspian With high oil and gas prices, Baker Hughes gained opportunities by helping improve production from the North Sea's aging fields. The company also participated in major offshore projects along the West African coast, and pursued new business in the Caspian Sea ...

  • Page 14
    ...in Saudi Arabia, Baker Hughes' horizontal well technology is increasing oil production and reducing water cut, while improving operating efficiency. Baker Hughes employees delivered quality drilling, formation evaluation and completion services throughout the Middle East, Asia Pacific region. Baker...

  • Page 15
    2006, we acquired Nova Technology Corporation, a supplier of monitoring and chemical injection systems for subsea wells. All three of these technology units are part of our new Production Optimization business unit. Baker Hughes formed Production Optimization in 2005 to meet the industry's need for ...

  • Page 16
    ... and rebuild excess production capacity. With very little excess capacity, energy prices will remain high and volatile driving investment in new field development in the Middle East, Russia and West Africa. At the same time, oil and gas companies in North America and the North Sea are investing...

  • Page 17
    ... Notice of Annual Meeting of Stockholders April 27, 2006 TO THE STOCKHOLDERS OF BAKER HUGHES INCORPORATED: The Annual Meeting of the Stockholders of Baker Hughes Incorporated ("Company" or "Baker Hughes") will be held at the offices of the Company, 3900 Essex Lane, Suite 210, Houston, Texas on...

  • Page 18
    .../Ethics Committee ...Annex C, Guidelines for Membership on the Board of Directors ...Annex D, Selection Process for New Board of Directors Candidates ...Annex E, Stockholder Communications with the Board of Directors...Annex F, Baker Hughes Incorporated Annual Incentive Compensation Plan ...Annex...

  • Page 19
    ...Lane, Houston, Texas 77027-5177. For a period of at least ten days prior to the Annual Meeting of Stockholders, a complete list of stockholders entitled to vote at the Annual Meeting will be available for inspection during ordinary business hours at the Company's executive offices by stockholders of...

  • Page 20
    ... this Proxy Statement, beneficial ownership of securities is defined in accordance with the rules of the SEC to mean generally the power to vote or dispose of securities regardless of any economic interest therein. Name and Address Shares Percent 1. Capital Research and Management Company 333 South...

  • Page 21
    ... America/ West Africa Division from 1992 to 1994. In 1992, he was named Vice President, Texaco Inc. He is a director and Executive Committee member of both the U.S. Saudi Arabian Business Council and the American Petroleum Institute. Chairman of the Board and Chief Executive Officer of Baker Hughes...

  • Page 22
    ...(city government) since 2003 and Chairman of Manchester Principal LLC and its predecessor company (high technology venture capital firm) since 1982. Mr. Lash also served as Chairman and Chief Executive Officer of Reading Tube Corporation from 1982 to 1996. Mr. Lash is a director of Ivy Animal Health...

  • Page 23
    ... the principles of conduct of the Company's business affairs to benefit its stockholders, which guidelines conform to the NYSE corporate governance listing standards and SEC rules. The Governance Guidelines are posted under the "About Baker Hughes" section of the Company's website at www.bakerhughes...

  • Page 24
    ...employee thrift plan and the employee stock purchase plan; setting bonus goals; approving salary and bonus awards to key executives; recommending incentive compensation and stock award plans for approval by stockholders; and reviewing management succession plans. Governance Committee. The Governance...

  • Page 25
    ... under the "About Baker Hughes" section of the Company's website at www.bakerhughes.com and are also available upon request to: Chairman, Governance Committee of the Board of Directors, P.O. Box 4740, Houston, Texas 77210-4740, or to the Corporate Secretary c/o Baker Hughes Incorporated, 3900 Essex...

  • Page 26
    SECURITY OWNERSHIP OF MANAGEMENT Set forth below is certain information with respect to beneficial ownership of the Common Stock as of March 1, 2006 by each director nominee, the persons named in the Summary Compensation Table below and the directors and executive officers as a group. The table ...

  • Page 27
    ...Other Annual Compensation(1) Long-Term Compensation Awards Restricted Stock Awards Securities Underlying Options (# Shares)(2) Name and Principal Position Year Salary Bonus Chad C. Deaton, Chairman of the Board and Chief Executive Officer(3) James R. Clark, President and Chief Operating Officer...

  • Page 28
    ...Annual Compensation includes Company contributions to the Baker Hughes Thrift Plan, the Baker Hughes Supplemental Retirement Plan, the Baker Hughes Pension Plan, life insurance premiums, perquisites and other compensation for the named executive officers. Amounts for fiscal year 2005 for the persons...

  • Page 29
    ... are presented pursuant to SEC rules and are calculated using the Black-Scholes Model for pricing options. The theoretical values of options trading in the stock markets do not necessarily bear a relationship to the compensation cost to the Company or potential gain realized by an executive. The...

  • Page 30
    ...1,100,000 825,000 Under the 2002 Director & Officer Long-Term Incentive Plan, each Performance Unit provides the individual an opportunity to earn a cash payment based upon the cumulative Baker Value Added (as that term has been defined by the Performance Unit Agreement) achieved by the Company for...

  • Page 31
    ...2006 2006 2006 2006 Under the Company's 2002 Director & Officer Long-Term Incentive Plan, individuals may be awarded target shares that subject to the terms and conditions of the plan may entitle the individual to receive shares of Common Stock. If (a) the Company's total shareholder return for the...

  • Page 32
    ...a single lump sum, a single life annuity, or if an employee is married, a joint and 50% survivor annuity. Estimated annual benefits payable upon retirement at normal retirement age (i.e., age 65) under the Baker Hughes Pension Plan to each executive named in this Proxy Statement are reflected in the...

  • Page 33
    ... in Control during the term as described above, in addition to any benefits he is due under the Company's employee benefit plans and equity and incentive compensation plans, he will receive the following benefits: (a) a lump sum payment equal to three (3) times the Named Officer's annual base salary...

  • Page 34
    ...the Change in Control occurs); (c) a lump sum payment equal to Named Officer's expected value target percentage under his bonus for the year in which he terminates employment multiplied by his Highest Base Salary and multiplied by three (3); (d) continuation of accident and health insurance benefits...

  • Page 35
    ... business results; promoting the Company's core values and keys to success; continuing educational and management training; improving product quality; developing relationships with customers, suppliers and employees; and demonstrating leadership abilities among co-workers. In setting the base salary...

  • Page 36
    ... The 1995 Employee Annual Incentive Compensation Plan, as amended and restated (the "Restated Plan"), provides executives with the opportunity to earn cash bonuses based on the achievement of specific Company-wide, business unit and individual performance goals. Each year, the Compensation Committee...

  • Page 37
    ... In 2002, the Compensation Committee and the Company's Board of Directors approved, subject to stockholder approval, the Baker Hughes Incorporated 2002 Director & Officer Long-Term Incentive Plan (the "2002 D&O Plan") for performance-related awards for senior executives in order to maintain a strong...

  • Page 38
    ... Audit/Ethics Committee assists the Board of Directors in overseeing matters relating to the accounting and reporting practices of the Company, the adequacy of the Company's disclosure controls and internal controls, the quality and integrity of the quarterly and annual financial statements of the...

  • Page 39
    ... informed the Audit/Ethics Committee that the Company's audited financial statements are presented fairly in conformity with generally accepted accounting principles. The Audit/Ethics Committee also monitored and reviewed the Company's procedures and policies relating to the requirements of Section...

  • Page 40
    ... Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"). In 1995 the Board of Directors adopted, and the stockholders approved, the Restated Plan, which prior to the current amendment and restatement provided for cash bonuses for key employees of the Company and its affiliates...

  • Page 41
    ... an address of 2215 Nelson Ave., No. 205, Redondo Beach, CA 90278) who is the owner of 1,000 shares of the Company's Common Stock, and is included in this Proxy Statement in compliance with SEC rules and regulations. The proposed resolution and supporting statement, for which the Board of Directors...

  • Page 42
    ... relating to that meeting. Such proposals should be mailed to the Corporate Secretary, c/o Baker Hughes Incorporated 3900 Essex Lane, Suite 1200, Houston, Texas 77027-5177. Nominations of directors by stockholders must be received by the Chairman of the Governance Committee of the Company's Board...

  • Page 43
    ... the Company's present executives serve on that company's compensation committee is not "independent" until three years after the end of such service or the employment relationship. 5. A director who is an executive officer or an employee, or whose immediate family member is an executive officer, of...

  • Page 44
    ... financial officer, principal accounting officer, controller, public accountant, auditor or person performing similar functions; (c) Experience overseeing or assessing the performance of companies or public accountants with respect to the preparation, auditing or evaluation of financial statements...

  • Page 45
    ... the quality and integrity of the financial statements of the Company; and (ii) to oversee the Company's compliance programs. The independent auditor is ultimately accountable to the Board of Directors and the Committee, as representatives of the Company's stockholders, and shall report directly to...

  • Page 46
    ... of the internal audit function. Review guidelines and policies on risk assessment and risk management related to the Company's major financial risk exposures and the steps management has taken to monitor and control such exposures. (8) Annually prepare a report to stockholders included in...

  • Page 47
    ...; and any "management" or "internal control" letter issued, or proposed to be issued, by the audit firm to the Company. With regard to its compliance responsibilities, the Committee shall: (10) Review the management's monitoring of compliance with the Company's Business Code of Conduct and Foreign...

  • Page 48
    ...sound business judgment and support for the Core Values of the Company; vii) Understand basic financial statements; viii) Are independent as defined by the Securities and Exchange Commission ("SEC") and the New York Stock Exchange; ix) Support the ideals of the Company's Business Code of Conduct and...

  • Page 49
    ... Annual Meeting of Stockholders. ANNEX E BAKER HUGHES INCORPORATED STOCKHOLDER COMMUNICATIONS WITH THE BOARD OF DIRECTORS In order to provide the stockholders and other interested parties of Baker Hughes Incorporated ("Company") with a direct and open line of communication to the Company's Board...

  • Page 50
    ... is a trade or business (whether or not incorporated) which is under common control (within the meaning of section 414(c) of the Code), which is a member of an affiliated service group (within the meaning of section 414(m) of the Code) with Baker Hughes. "Applicable Interest Rate" means the 10-year...

  • Page 51
    ... Relations Order" has the meaning ascribed to that term in section 414(p) of the Code. "Employer" means Baker Hughes and any Affiliate that adopts the Plan pursuant to the provisions of Article XII. "Entity" means any corporation, partnership, association, joint-stock company, limited liability...

  • Page 52
    ... of his job or a reduction in force. "Key Employee" means a key employee of Baker Hughes or an Affiliate who, in the opinion of the Chief Executive Officer of Baker Hughes, is in a position to significantly contribute to the growth and profitability of Baker Hughes and the Affiliates. "Merger" means...

  • Page 53
    ... a corporation owned, directly or indirectly, by the stockholders of Baker Hughes in substantially the same proportions as their ownership of stock of Baker Hughes. "Plan" means the Baker Hughes Incorporated Annual Incentive Compensation Plan, as amended from time to time. "Plan Administrator" means...

  • Page 54
    ...be limited to those Key Employees who, by the nature and scope of their position, contribute to the overall results or success of the Employers. 2.02 Participation. Participation in the Plan shall be determined annually based upon the recommendation of the Chief Executive Officer of Baker Hughes and...

  • Page 55
    ... Award Opportunities, as determined by the Committee based upon the recommendation of the Chief Executive Officer of Baker Hughes. 4.04 Disposition of Business. If the Participant's Employer or division is disposed of during the Plan Year and such disposition does not qualify as a Change in Control...

  • Page 56
    ...shall be debited to such Participant's or former Participant's Accounts. 7.05 Unclaimed Benefits. In the case of a benefit payable on behalf of a Participant or former Participant, if the Plan Administrator is unable, after reasonable efforts, to locate the Participant, the former Participant or the...

  • Page 57
    ... permitted under the Plan. A Domestic Relations Order will be disregarded to the extent it awards an Alternate Payee benefits in excess of the applicable Participant's or former Participant's Account balance under the Plan. ARTICLE VIII FORFEITURE OF BENEFITS Except as specified in Section 4.04 or...

  • Page 58
    ...Accounts shall not be forfeited. ARTICLE XI ADMINISTRATION OF THE PLAN 11.01 Resignation and Removal. The members of a Committee serving as Plan Administrator shall serve at the pleasure of the Board; they may be officers, directors, or employees or any other individuals. At any time during his term...

  • Page 59
    ... is based. 11.08 Employer to Supply Information. The Employer shall supply full and timely information to the Plan Administrator, including, but not limited to, information relating to each Participant's base salary, age, Retirement, death, or other cause of Separation From Service and such other...

  • Page 60
    ... all the terms, conditions and limitations of the Plan except those, if any, specifically described in the adoption instrument, and providing all information required by the Plan Administrator. The Plan Administrator and the adopting Affiliate may agree to incorporate specific provisions relating to...

  • Page 61
    ..., the stockholders of Baker Hughes approve the material terms of the performance goals under which the compensation is to be paid (within the meaning of Section 162(m)). 13.09 Compliance With Section 409A. To the extent applicable, the Plan shall be operated in compliance with Section 409A and...

  • Page 62
    ..., planning and tax audit assistance; limited situation projects related to the Company or employee statutory filings, requirements or applications; assignments related to financial statement and internal control risk assessments. The annual request must include a representation from management and...

  • Page 63
    ...aggregate market value of the voting and non-voting common stock held by non-affiliates as of the last business day of the registrant's most recently completed second fiscal quarter (based on the closing price on July 1, 2005 reported by the New York Stock Exchange) was approximately $17,495,000,000...

  • Page 64
    .... 11. 12. 13. 14. Directors and Executive Officers of the Registrant ...Executive Compensation ...Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters...Certain Relationships and Related Transactions ...Principal Accounting Fees and Services ... 69 69 69 72...

  • Page 65
    ... technology services and systems to the worldwide oil and natural gas industry, including products and services for drilling, formation evaluation, completion and production of oil and natural gas wells. We conduct our operations through subsidiaries, affiliates, ventures and alliances. Baker Hughes...

  • Page 66
    ... Hughes Drilling Fluids' primary competitors include M-I SWACO, Halliburton Company ("Halliburton"), Newpark Resources, Inc. and various other competitors. Key business drivers for Baker Hughes Drilling Fluids include the number of drilling rigs operating (especially the number of drilling programs...

  • Page 67
    ... reservoir, and • the quality of the wellbore. INTEQ's primary competitors in drilling and evaluation services are Halliburton, Schlumberger, Weatherford International Ltd. ("Weatherford") and various other competitors. Key business drivers for INTEQ include the number of drilling rigs operating...

  • Page 68
    ... purchasing decisions in well completion and wellbore intervention are superior wellsite service execution and value-adding technologies that improve production rates, protect the reservoir from damage and reduce cost. Specific opportunities for competitive differentiation include: • engineering...

  • Page 69
    ...PMG's flow-modeling capabilities can identify high-risk segments of a pipeline to ensure proper mitigation programs are in place. The main driver of customer purchasing decisions in specialty chemicals is superior application of technology and service delivery. Specific opportunities for competitive...

  • Page 70
    ... production. The main drivers of customer purchasing decisions for both permanent monitoring and chemical automation include application engineering expertise, ability to integrate a complete system, product reliability, functionality and local field support. Specific opportunities for competitive...

  • Page 71
    ... cash and assumed debt. Nova is a leading supplier of permanent monitoring, chemical injection systems, and multi-line services for deepwater and subsea oil and gas well applications and will be included in the Production Optimization business unit of the Completion and Production segment. Employees...

  • Page 72
    ... and Chief Executive Officer of Western Rock Bit Company Limited, Hughes Christensen's former distributor in Canada, from 1991 to 1997. General Manager of Century Valve Company from 1989 to 1991 and Vice President, Contracts and Marketing, of Adeco Drilling & Engineering from 1980 to 1989. Employed...

  • Page 73
    ...of Baker Petrolite Corporation since May 2005. President of Baker Hughes Drilling Fluids from 2004 to 2005. Vice President, Business Process Development of the Company from 1998 to 2002; Vice President, Manufacturing, of Baker Oil Tools from 1990 to 1998 and Plant Manager of Hughes Tool Company from...

  • Page 74
    ... Superfund Site located in Hempstead, Texas. The Texas Commission on Environmental Quality ("TCEQ") is overseeing the remedial work at this site. The Sheridan Site Trust was formed to manage the site remediation and we participate as a member. Based on the use of new remedial technologies, the cost...

  • Page 75
    ... (PCBs) are present at the site as a result of the operations of the former San Angelo Electric Services Company (SESCO), which manufactured, repaired and serviced transformers. SESCO declared bankruptcy in mid 2003, after which the TCEQ conducted emergency removal actions in response to reports of...

  • Page 76
    ... the number and productivity of new wells drilled and completed, as well as the rate of production and resulting depletion of existing wells. Advanced technologies, such as horizontal drilling, improve total recovery but also result in a more rapid production decline. Access to prospects and capital...

  • Page 77
    ...People are a key resource to developing, manufacturing and delivering our products and services to our customers around the world. Our ability to recruit, train and retain the highly skilled workforce required by our plans will impact our business. A well-trained, motivated work force has a positive...

  • Page 78
    ...of operations. The condition of the capital markets and equity markets in general can affect the price of our common stock and our ability to obtain financing, if necessary. If the Company's credit rating is downgraded, this would increase our costs under our credit agreement, as well as the cost of...

  • Page 79
    ... facilities are well maintained and suitable for their intended purposes. The table below shows our principal manufacturing plants by segment and geographic area: Canada and South America Segment United States Europe Far East Total Completion and Production Drilling and Evaluation 16 12...

  • Page 80
    ... of this litigation would not have a material adverse financial effect on our consolidated financial statements. Further information is contained in the "Environmental Matters" section of Item 1 herein. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 18 Baker Hughes Incorporated

  • Page 81
    ... terminated. During that term, the agent will use its best efforts to repurchase a fixed dollar value of our common stock each trading day, subject to applicable trading rules, until the cumulative amount purchased under the November Plan equals $250.0 million and under the February Plan equals...

  • Page 82
    ... loss, net of tax Cumulative effect of accounting change, net of tax Net income Per share of common stock: Income from continuing operations: Basic Diluted Dividends Financial Position: Working capital Total assets Long-term debt Stockholders' equity $ 7,185.5 4,942.5 1,009.6 - - - 5,952.1 1,233...

  • Page 83
    ...the productive life of oil and natural gas wells. • The WesternGeco segment consists of our equity interest in WesternGeco. Also in 2005, we organized the business operations of our divisions around four primary geographic regions: North America, Latin America, Middle East/Asia Pacific, and Europe...

  • Page 84
    ... workforce in place to support our business plans. Our focus on Best-in-Class opportunities starts with our product line focused organization structure. We believe that through our product line focused divisions, we develop the technologies that deliver Best-in-Class value to our customers. As...

  • Page 85
    .... Our rig counts are summarized in the table below as averages for each of the periods indicated. 2005 2004 2003 U.S. - land and inland waters U.S. - offshore Canada North America Latin America North Sea Other Europe Africa Middle East Asia Pacific Outside North America Worldwide U.S. Workover Rigs...

  • Page 86
    ... not limited to: (1) terrorist attacks targeting oil production from Saudi Arabia or other key producers; (2) labor strikes in key oil producing areas such as Nigeria; (3) the potential for other military actions in the Middle East; or (4) adverse weather conditions, especially in the Gulf of Mexico...

  • Page 87
    ... the North Sea in the first and second quarters of 2006. The Middle East, Africa and Latin America regions are expected to grow modestly in 2006 compared with 2005. Our expectations for spending and revenue growth could decrease if there are disruptions in key oil and natural gas production markets...

  • Page 88
    ... Business Code of Conduct policy, our Foreign Corrupt Practices Act (the "FCPA") policy, our internal control processes and procedures and other compliance related policies. Notwithstanding the devotion of such resources, and in part as a consequence thereof, from time to time we discover or receive...

  • Page 89
    ... products and services, future market conditions and technological developments. Significant and unanticipated changes to these assumptions could require a provision for impairment in a future period. Given the nature of these evaluations and their application to specific assets and specific times...

  • Page 90
    ...the fourth quarter of 2005, our management initiated and our Board of Directors approved a plan to sell the Baker Supply Products Division ("SPD"), a product line group within the Completion and Production segment. SPD distributes basic supplies, products and small tools to the drilling industry. In...

  • Page 91
    ... North America, particularly in Latin America, the Middle East and Asia Pacific, coupled with price increases in certain markets and product lines. Revenues for 2004 increased 16.2% compared with 2003, reflecting a 10.1% increase in the worldwide rig count. Revenues in North America, which accounted...

  • Page 92
    ... of $0.5 million, recorded as the cumulative effect of accounting change in the consolidated statement of operations. In conjunction with the adoption, we recorded conditional asset retirement obligations of $1.6 million as the fair value of the costs associated with the special handling of asbestos...

  • Page 93
    ... event an unanticipated and significant demand on cash flows could not be funded by operations. Our capital planning process is focused on utilizing cash flows generated from operations in ways that enhance the value of our company. In 2005, we used cash for a variety of activities including working...

  • Page 94
    ... in West Africa and received the remaining $22.0 million in proceeds. We also completed all purchase price adjustments related to the sale of our EIMCO division and received $2.0 million from the release of the escrow balance. We routinely evaluate potential acquisitions of businesses of third...

  • Page 95
    ... will provide us with sufficient capital resources and liquidity to manage our working capital needs, meet contractual obligations, fund capital expenditures, pay dividends, repurchase common stock and support the development of our short-term and long-term operating strategies. We currently expect...

  • Page 96
    ... any unamortized discounts, deferred issuance costs or net deferred gains on terminated interest rate swap agreements. Amounts represent the expected cash payments for interest on our fixed rate long-term debt. We enter into operating leases in the normal course of business. Some lease agreements...

  • Page 97
    ... value of the costs associated with certain conditional asset retirement obligations. In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections. SFAS No. 154 replaces Accounting Principles Board Opinion No. 20 ("APB No. 20"), Accounting Changes, and SFAS No. 3, Reporting...

  • Page 98
    ... regarding our business outlook, including changes in revenue, pricing, capital spending, profitability, strategies for our operations, impact of our common stock repurchases, oil and natural gas market conditions, market share and contract terms, costs and availability of resources, economic and...

  • Page 99
    ... 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. Foreign Currency and Foreign Currency Forward Contracts We conduct operations around the world in a number of...

  • Page 100
    ... The credit ratings and concentration of risk of these financial institutions are monitored 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 rate differential. 38 Baker Hughes...

  • Page 101
    ... of financial statements for external purposes in accordance with generally accepted accounting principles. Our control environment is the foundation for our system of internal control and is embodied in our Business Code of Conduct, which sets the tone of our company and includes our Core Values of...

  • Page 102
    ...ACCOUNTING FIRM To the Board of Directors and Stockholders of Baker Hughes Incorporated Houston, Texas We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that Baker Hughes Incorporated and subsidiaries (the "Company...

  • Page 103
    ... ACCOUNTING FIRM To the Board of Directors and Stockholders of Baker Hughes Incorporated Houston, Texas We have audited the accompanying consolidated balance sheets of Baker Hughes Incorporated and subsidiaries (the "Company") as of December 31, 2005 and 2004, and the related consolidated statements...

  • Page 104
    ... STATEMENTS OF OPERATIONS Year Ended December 31, (In millions, except per share amounts) 2005 2004 2003 Revenues Costs and expenses: Cost of revenues Selling, general and administrative Impairment of investment in affiliate Reversal of restructuring charge Total costs and expenses Operating...

  • Page 105
    ...821.3 Liabilities and Stockholders' Equity Current Liabilities: Accounts payable Short-term borrowings and current portion of long-term debt Accrued employee compensation Income taxes Other accrued liabilities Liabilities of discontinued operations Total current liabilities Long-term debt Deferred...

  • Page 106
    ..., net of tax of $0.3 Change in minimum pension liability, net of tax of $5.3 Total comprehensive income Cash dividends ($0.46 per share) Stock issued pursuant to employee stock plans, net of tax of $1.5 2.5 Repurchase and retirement of common stock (6.3) Balance, December 31, 2003 Comprehensive...

  • Page 107
    ...of affiliates Changes in operating assets and liabilities: Accounts receivable Inventories Accounts payable Accrued employee compensation and other accrued liabilities Pensions and postretirement benefit obligations and other liabilities Other Net cash flows from continuing operations Net cash flows...

  • Page 108
    ...FINANCIAL STATEMENTS Note 1. Summary of Significant Accounting Policies Nature of Operations Baker Hughes Incorporated ("Baker Hughes") is engaged in the oilfield services industry. Baker Hughes is a major supplier of wellbore-related products and technology services and systems to the worldwide oil...

  • Page 109
    ...permits, technology and presently enacted laws and regulations. For sites where we are primarily responsible for the remediation, our cost estimates are developed based on internal evaluations and are not discounted. Such accruals are recorded when it is probable that we will be obligated to pay for...

  • Page 110
    ... stock option awards equal the market prices of the underlying stock when granted and because our employee stock purchase plan is non compensatory. Our reported net income does include compensation expense associated with restricted stock awards. In December 2004, the Financial Accounting Standards...

  • Page 111
    ... models. These models require a number of subjective assumptions and estimates which can significantly affect the calculated values. These include future stock price volatility, expected time to exercise, discount rates, forfeiture rates and employee turnover rates. In addition, the number of awards...

  • Page 112
    ...the fourth quarter of 2005, our management initiated and our Board of Directors approved a plan to sell the Baker Supply Products Division ("SPD"), a product line group within the Completion and Production segment. SPD distributes basic supplies, products and small tools to the drilling industry. In...

  • Page 113
    .... The fair values were determined using a discounted cash flow approach. Pro forma results of operations have not been presented because the effect of this acquisition was not material to our consolidated financial statements. QuantX is included in the Completion and Production segment. 2005 Form...

  • Page 114
    ...of Luna. The fair values were determined using a discounted cash flow approach. Pro forma results of operations have not been presented because the effect of this acquisition was not material to our consolidated financial statements. Luna is included in the Completion and Production segment. In 2003...

  • Page 115
    ... Inventory Property Employee benefits Other accrued expenses Operating loss carryforwards Tax credit carryforwards Capitalized research and development costs Other Subtotal Valuation allowances Total Deferred tax liabilities: Goodwill Undistributed earnings of foreign subsidiaries Other Total...

  • Page 116
    ... 2003 to write-down the investment to its fair value. The fair value was determined using a combination of a market capitalization and discounted cash flow approach. In February 2004, we completed the sale of our minority interest in Petreco International, a venture we entered into in 2001, for $35...

  • Page 117
    ... 10. Goodwill and Intangible Assets The changes in the carrying amount of goodwill are detailed below by segment: Drilling and Evaluation Completion and Production At December 31, 2005 and 2004, net accounts receivable (payable) from unconsolidated affiliates totaled $0.4 million and $(1.1) million...

  • Page 118
    ... the maintenance of a funded indebtedness to total capitalization ratio (a defined formula per the facility) of less than or equal to 0.60, restrict certain merger transactions or the sale of all or substantially all of the assets of the company or a significant 56 Baker Hughes Incorporated $ 339...

  • Page 119
    ... are monitored 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...

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    .... Segment and Related Information In 2005, we reorganized our operating divisions into two separate segments: the Drilling and Evaluation segment, which consists of the Baker Atlas, Baker Hughes Drilling Fluids, Hughes Christensen and INTEQ divisions, and the Completion and Production segment, which...

  • Page 121
    ... discontinued operations Cash and other assets Total Note 14. Employee Stock Plans We have stock option plans that provide for the issuance of incentive and non-qualified stock options to directors, officers and other key employees at an exercise price equal to the fair market value of the stock at...

  • Page 122
    ... and executive officers and beginning in 2005 to other key employees. The fair value of the restricted stock on the date of grant is amortized ratably over the vesting period. The following table summarizes the restricted stock awarded during the years ended December 31: 2005 2004 2003 Number of...

  • Page 123
    ...presented. The reconciliation of the beginning and ending balances of the projected benefit obligations ("PBO") and fair value of plan assets and the funded status of the plans are as follows for the years ended December 31: U.S. Pension Benefits 2005 2004 Non-U.S. Pension Benefits 2005 2004 Change...

  • Page 124
    ... ("ABO") is the actuarial present value of pension benefits attributed to employee service to date and present compensation levels. The ABO differs from the PBO in that the ABO does not include any assumptions about future compensation levels. The ABO for all U.S. plans was $232.9 million and...

  • Page 125
    ... postretirement health care and life insurance benefits ("postretirement welfare benefits") to substantially all U.S. employees who retire and have met certain age and service requirements. The plan is unfunded. The measurement of plan obligations is as of October 1 of each year presented. The...

  • Page 126
    ... retirement plan ("SRP") for certain officers and employees whose benefits under the Thrift Plan and/or the U.S. defined benefit pension plan are limited by federal tax law. The SRP also allows the eligible employees to defer a portion of their eligible compensation and provides for employer...

  • Page 127
    ...former manufacturing facilities, the majority of which relate to properties obtained in acquisitions or to sites no longer actively used in operations. On rare occasions, remediation activities are conducted as specified by a government agency-issued consent decree or agreed order. Remediation costs...

  • Page 128
    ... consolidated statement of operations information is as follows for the years ended December 31: 2005 2004 2003 Rental expense (generally transportation equipment and warehouse facilities) $ 138.7 Research and development 188.2 $ 123.5 176.7 $ 111.5 173.3 The changes in the aggregate product...

  • Page 129
    ...changes in the asset retirement obligation liability are as follows: Balance as of December 31, 2003 Liabilities incurred Liabilities settled Accretion expense Revisions to existing liabilities Translation adjustments Balance...Foreign currency translation adjustments Pension adjustment Other Total $ ...

  • Page 130
    ... is a leading supplier of permanent monitoring, chemical injection systems, and multi-line services for deepwater and subsea oil and gas well applications and will be included in the Production Optimization business unit within the Completion and Production segment. 68 Baker Hughes Incorporated

  • Page 131
    ... Plan Awards During 2005," "Pension Plan Table," "Employment, Change in Control, and Indemnification Agreements," "Compensation Committee Report," "Compensation Committee Interlocks and Insider Participation," and "Corporate Performance Graph" in our Proxy Statement, which sections are incorporated...

  • Page 132
    ...the Compensation Committee of our Board of Directors has the authority to grant nonqualified stock options to purchase shares of our common stock to a broad-based group of employees. The exercise price of the options will be equal to the fair market value per share of our common stock at the time of...

  • Page 133
    ... for grant as awards other than options (the number of shares is subject to adjustment for changes in our common stock). The 2002 Employee LTIP is the companion plan to the Baker Hughes Incorporated 2002 Director & Officer LongTerm Incentive Plan, which was approved by our stockholders in 2002. The...

  • Page 134
    ... the sections entitled "Executive Compensation - Employment, Change in Control and Indemnification Agreements" in our Proxy Statement, which sections are incorporated by reference herein. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES Information concerning principal accounting fees and services is...

  • Page 135
    ... on October 25, 2004 in the amount of 75,000 shares of Company Common Stock (filed as Exhibit 10.4 to Quarterly Report of Baker Hughes Incorporated on Form 10-Q for the quarter ended September 30, 2004). 10.5+ Agreement regarding restricted stock award issued to Chad C. Deaton on October 25, 2004 in...

  • Page 136
    ...10.13+ Baker Hughes Incorporated Director Retirement Policy for Certain Members of the Board of Directors (filed as Exhibit 10.10 to Annual Report of Baker Hughes Incorporated on Form 10-K for the year ended December 31, 2003). 10.14+ Baker Hughes Incorporated Director Compensation Deferral Plan, as...

  • Page 137
    ... Agreement, including Terms and Conditions. 10.43+* Performance Goals for the Performance Unit Award granted in 2006. 10.44+* Compensation Table for Named Executive Officers and Directors. 10.45 Form of Credit Agreement, dated as of July 7, 2005, among Baker Hughes Incorporated, JP Morgan Chase Bank...

  • Page 138
    ... caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. BAKER HUGHES INCORPORATED Date: February 28, 2006 /s/CHAD C. DEATON Chad C. Deaton Chairman of the Board and Chief Executive Officer KNOWN ALL PERSONS BY THESE PRESENTS, that each person whose signature...

  • Page 139
    ... at Beginning of Period Additions Charged to Cost and Expenses Reversal of Prior Deductions(1) Charged to Other Accounts(3) Balance at End of Period (In millions) Write-offs(2) Year ended December 31, 2005: Reserve for doubtful accounts receivable Reserve for inventories Year ended December 31...

  • Page 140
    ... and senior executive management. The Corporate Governance Guidelines can be accessed electronically at www.bakerhughes.com in the "About Baker Hughes" section. The Baker Hughes board consists of 11 directors, including 10 independent non-employee directors. The company's bylaws allow the board to...

  • Page 141
    ... and sets bonus goals; • approves salary and bonus awards to key executives; • recommends incentive compensation and stock award plans for approval by stockholders; • periodically reviews management succession plans; • annually reviews levels of stock ownership by officers in accordance...

  • Page 142
    ... Executive Officers ...www.bakerhughes.com/investor/about/management.htm Ownership Structure Investors Source Shares (millions) % of Total Capital Research Fidelity Management Dodge & Cox Barclays T. Rowe Price State Street Vanguard Group Lord Abbett Montag & Caldwell Goldman Sachs Top 10 investors...

  • Page 143
    ... Design: Savage Design Group, Inc., Houston, Texas www.bakerhughes.com Baker Hughes Information Systems (888) 408-4244 Jay G. Martin Vice President, Chief Compliance Officer and Senior Deputy General Counsel Greg Nakanishi Vice President, Human Resources As a Baker Hughes stockholder, you are...

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    Baker Hughes Incorporated 3900 Essex Lane Houston, TX 77027 P.O. Box 4740 Houston, TX 77210-4740 (713) 439-8600 www.bakerhughes.com