Baker Hughes 2007 Annual Report Download - page 107

24 Baker Hughes Incorporated
between seven and nine percent and increases in market share
in selected product lines and geographic areas. Revenues in
North America, which accounted for 44.3% of total revenues,
increased 31.2% for 2006 compared with 2005. This increase
reflects a continued broad based increase in drilling activity in
the U.S., as evidenced by the 15.3% increase in the North
American rig count, with activity dominated by land-based
gas-directed drilling. Revenues outside North America, which
accounted for 55.7% of total revenues, increased 21.5% for
2006 compared with 2005. This increase reflects the improve-
ment in international drilling activity in 2006, as evidenced by
the 8.7% increase in the rig count outside North America, par-
ticularly in the Middle East, Africa and the North Sea, coupled
with price increases in certain markets and product lines.
Cost of Revenues
Cost of revenues for 2007 increased 16.5% compared
with 2006. Cost of revenues as a percentage of revenues
was 65.6% and 65.1% for 2007 and 2006, respectively. The
increase in cost of revenues as a percentage of consolidated
revenues was primarily due to a change in the geographic
and product mix from the sale of our products and services
and increasing competitive conditions and pricing pressures,
particularly in North America. In addition, higher raw material
costs and employee compensation costs contributed to the
increase. Effective January 1, 2007, we increased the deprecia-
ble lives of certain assets of our Baker Atlas division result-
ing in a reduction to cost of services and rentals for 2007
of approximately $23 million.
Cost of revenues for 2006 increased 17.0% compared
with 2005. Cost of revenues as a percentage of revenues
was 65.1% and 69.9% for 2006 and 2005, respectively. The
decrease in cost of revenues as a percentage of consolidated
revenues was primarily the result of overall average price
increases between seven and nine percent and continued high
utilization of our rental tool fleet and personnel. A change in
the geographic and product mix from the sale of our products
and services also contributed to the decrease in the cost of
revenues as a percentage of revenues. This increase was par-
tially offset by higher raw material costs and employee com-
pensation costs. In addition to these factors, during the fourth
quarter of 2006, we revised the accounting procedures related
to certain inventory for our Baker Atlas division resulting in a
one time reduction in cost of services and rentals in 2006 of
$21.2 million.
Research and Engineering
Research and engineering expenses increased 9.8% in 2007
compared with 2006 and 13.1% in 2006 compared with 2005.
The increase in both years reflects our commitment in develop-
ing and commercializing new technologies as well as invest-
ing in our core product offerings. During 2007, we opened
the first phase of the Center for Technology and Innovation in
Houston, Texas. This facility focuses on research and develop-
ment of completion and production systems in harsh environ-
ments. The second phase is scheduled for completion in 2008.
Marketing, General and Administrative
Marketing, general and administrative expenses increased
6.3% in 2007 compared with 2006. The 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.
Marketing, general and administrative expenses increased
39.6% in 2006 compared with 2005. The increase corresponds
with increased activity and resulted primarily from higher mar-
keting and employee compensation costs, including stock-based
compensation which increased due to the adoption of State-
ment of Financial Accounting Standard No. 123(R) – Shared
Based Payment, using the modified prospective application
method. The increase also results from the financial charge of
$46.1 million recorded in the fourth quarter of 2006 in connec-
tion with the settlement negotiations with the SEC and DOJ.
Equity in Income of Affiliates
Equity in income of affiliates decreased $59.2 million in
2007 compared with 2006 and $39.7 million in 2006 com-
pared with 2005. These decreases in equity in income of affili-
ates are due to the sale of our 30% interest in WesternGeco
on April 28, 2006.
Gain on Sale of Interest in Affiliate
On April 28, 2006, we sold our 30% interest in
WesternGeco to Schlumberger for $2.4 billion in cash and
recorded a pre-tax gain of $1,743.5 million ($1,035.2 million,
after-tax).
Interest Expense and Interest and Dividend Income
Interest expense decreased $2.8 million in 2007 compared
with 2006 and $3.4 million in 2006 compared with 2005. These
decreases were primarily due to slightly lower average total
debt levels. Interest and dividend income in 2007 decreased
$23.7 million over 2006, primarily due to lower average cash
and short-term investment balances in 2007 as a result of our
share repurchase programs. Interest and dividend income in
2006 increased $49.5 million over 2005, primarily due to the
interest and dividends earned on the invested cash received
from the sale of our interest in WesternGeco.
Income Taxes
Our effective tax rate in 2007 is 32.9%, which is 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 effective tax rate in 2006 was 35.8%,
which was higher than the U.S. statutory income tax rate of
35% due to taxes related to the sale of our interest in the
WesternGeco venture and state income taxes, offset by lower
rates of tax on our international operations. During 2006, we
provided $708.3 million for taxes related to the sale of our
interest in WesternGeco, which included an estimate of taxes
related to the future repatriation of the non-U.S. proceeds.
In 2005 our effective tax rate was 31.6%, which reflected