BAKER HUGHES INC - 10-K Annual Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

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Commission File Number 1-9397

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BAKER HUGHES INCORPORATED
(Exact Name of Registrant as Specified in its Charter)

DELAWARE 76-0207995
(State or Other Jurisdiction (IRS Employer Identification No.)
of Incorporation or Organization)

3900 ESSEX LANE, SUITE 1200, HOUSTON, TEXAS 77027-5177
(Address of Principal Executive Offices) (Zip Code)

Registrant's Telephone Number, Including Area Code: (713) 439-8600

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Securities Registered Pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

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At March 1, 2002, the registrant has outstanding 336,743,642 shares of
Common Stock, $1 par value. The aggregate market value of the Common Stock on
such date (based on the closing price on February 28, 2002 reported by the New
York Stock Exchange) held by nonaffiliates was approximately $11,869,371,200.

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DOCUMENTS INCORPORATED BY REFERENCE

Portions of Registrant's 2001 Proxy Statement for the Annual Meeting of
Stockholders to be held April 24, 2002 are incorporated by reference into Part
III.

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PART I

ITEM 1. BUSINESS

Baker Hughes Incorporated (the "Company") is a Delaware corporation engaged
in the oilfield and process industries. In addition, the Company manufactures
and sells other products and provides services to industries that are not
related to the oilfield or continuous process industries. The Company conducts
certain of its operations through subsidiaries, affiliates, ventures,
partnerships or alliances. The Company was formed in April 1987 in connection
with the combination of Baker International Corporation and Hughes Tool Company.
The Company acquired Western Atlas Inc. ("Western Atlas") in a merger completed
on August 10, 1998.

As used herein, the "Company" may refer to Baker Hughes Incorporated or its
subsidiaries. The use of the terms Company and Baker Hughes are not intended to
connote particular corporate status or relationships.

For additional industry segment information for the three years ended
December 31, 2001, see Note 10 of the Notes to Consolidated Financial Statements
in Item 8 herein.

OILFIELD

The Oilfield segment of the Company consists of six operating divisions:
Baker Atlas, Baker Hughes INTEQ, Baker Oil Tools, Baker Petrolite, Centrilift
and Hughes Christensen. The Company, through its Oilfield segment, is a major
supplier of wellbore-related products, technology services and systems to the
oil and gas industry on a worldwide basis and provides equipment, products and
services for drilling, formation evaluation, completion and production of oil
and gas wells. These divisions have been aggregated because the long-term
financial performance of these divisions is affected by similar economic
conditions and the consolidated results are evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in assessing
performance. The principal markets for this segment include all major oil and
gas producing regions of the world, including North America, Latin America,
Europe, Africa, the Middle East and the Far East.

Baker Atlas. The Company, through its Baker Atlas division, is a premier
provider of a complete range of downhole well logging technology and services,
including advanced formation evaluation, production and reservoir engineering
and petrophysical and geophysical data acquisition services. In addition, the
Company provides perforating and completion technologies, pipe recovery and data
management, processing and analysis. This diverse range of services is
applicable through the life cycle of a reservoir - initially, in support of the
drilling process, continuing through the prospect evaluation and appraisal phase
and finally, to production and reservoir management. In performing well logging
services, the Company transmits electronic instrumentation and sensor packages
into the borehole by means of an electrical wireline, drill pipe, coiled tubing
or well tractor. The surface-controlled instrumentation gathers measurements,
collects samples and performs experiments downhole. The measurements are
recorded digitally and can be displayed on a continuous graph, or well log,
against depth or time. These well logs are processed, analyzed and interpreted
to determine physical attributes of the well, which can indicate the volume of
hydrocarbon present, the extent of the reservoir and its producibility.
Perforating services are offered by both Baker Atlas and the Company's Baker Oil
Tools division and provide a pathway through the casing and cement sheath in
wells so that the hydrocarbon can enter the wellbore from the formation. These
services and information that these divisions provide allow oil and gas
companies to define, reduce and manage their risk. The Company's largest
competitors in the downhole logging and perforating markets include Schlumberger
Limited ("Schlumberger") and Halliburton Company ("Halliburton").

Baker Hughes INTEQ. The Company, through its Baker Hughes INTEQ division, is
a major supplier of real-time drilling and evaluation services to the oil and
gas industry. These services include directional and horizontal drilling
technologies, drilling fluid systems, logging-while-drilling,
measurement-while-drilling, mud logging, coring and subsurface surveying. The
Company provides high-end technology solutions that oil and gas companies
require to drill complex wells in challenging reservoir environments. Baker
Hughes INTEQ is an industry leader in the design and planning of wells that
incorporate complex trajectories set to intercept multiple reservoir targets. As
exploration and development is increasingly conducted in the costlier offshore
deepwater areas, there is an increased demand for the Company's drilling
technology to reduce cost through optimized performance. In the upper hole
sections of an oil and gas well, the Company's survey services and high
performance drilling motors can help to provide safe and efficient drilling of
the formations. In the directional portion of the well, the Company's

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rotary steering technology is combined with logging-while-drilling technology to
allow clients to drill three-dimensional well trajectories while taking
measurements to evaluate the formations drilled. The measurements are
transmitted to the surface through the use of pulse telemetry, a system where
differential pressure patterns are transmitted through a fluid column to the
surface for decoding. The Company's visualization technology at the surface
allows this real-time data to be overlaid on images of the reservoir, permitting
engineers to steer the well while watching graphical representation of the
drilling assembly moving through the reservoir. These technologies allow access
to, and the efficient drilling of, reservoirs that could not have been developed
effectively five years ago. The Company competes principally with Halliburton
and Schlumberger in these products and services.

The Company, through its Baker Hughes INTEQ division, also produces and
markets drilling fluids (muds) and specialty chemicals and provides technical
services for the use of the muds and chemicals in oil and gas well drilling.
Drilling fluids typically contain barite or bentonite and may use a water or oil
base. The main purpose of the drilling fluid is to provide stability within the
wellbore by cleaning the bottom of a hole as it removes cuttings and transports
them to the surface, by cooling the bit and drill string, by controlling
formation pressures and by sealing porous well formations. To provide optimized
stability and future oil production, a fluid is often customized for a wellbore
as the well-site engineer monitors the interaction between the drilling fluid
and the formation. The Company also furnishes on-site, around-the-clock
laboratory analysis and examination of circulated and recovered drilling fluids
and recovered drill cuttings to detect the presence of hydrocarbons and identify
the formations penetrated by the drill bit. The Company's principal competitors
for these products and services are Smith International, Inc. ("Smith") and
Halliburton.

Baker Oil Tools. The Company, through its Baker Oil Tools division, is a
premier provider of downhole completion, workover and fishing equipment and
services. Downhole completion product lines include packers, flow control
equipment, subsurface safety valves, liner hangers and sand control systems.
Packers are used in the wellbore to seal the space between the production tubing
and the casing, to protect the casing from reservoir pressures and corrosive
formation fluids and to maintain the separation of production zones. Casing is
steel pipe used to line the well bore to keep the wall of the drilled hole from
caving in, to prevent fluids from moving from one formation to another and to
improve the efficiency of extracting oil and gas from producing wells.
Production tubing is the pipe through which the oil and gas flows from the
producing zone under the ground to the surface of the well. Flow control
equipment provides additional means to control and adjust the flow of downhole
fluids from producing zones, while subsurface safety valves shut off all flow of
fluids to the surface in the event of an emergency. New technology developments
in this area include intelligent completion systems, which can provide lower
customer operating costs through remote actuation and the opportunity for
enhanced production by controlling selective zone production based on real time
reservoir data. The Company is a major worldwide manufacturer and provider of
packers, flow control and safety valve equipment. Its principal competitors in
this area are Halliburton, Schlumberger and Weatherford International Inc.
("Weatherford").

The Company also manufactures and sells liner hanger systems which the
Company's customers use to suspend and set strings of casing pipe in wells. The
Company's new technology developments in this area include multi-lateral
completions systems, which provide multiple downhole casing pipes to be tied to
one main wellbore casing pipe with pressure seal integrity. The Company is a
leading worldwide producer of liner hangers and multi-lateral systems. Its
primary competitors in this area are Halliburton and Weatherford.

The Company offers sand control equipment (gravel pack tools, screens,
fluids and pumping) and services that prevent sand from entering the wellbore
and reducing productivity. The Company has expanded its marine vessel, high
pressure, "frac-pack" service capabilities. The frac-pack service involves
injecting fluids and propants into the formation to expand the formation and
increase the rate of production. Propants are spherical-shaped particles
(generally made of a silicant) that, when forced into fissures in the formation,
expand the fissures and maintain the expansion. The Company's new technology
developments in this area include expanding solid and sand screen pipe
technologies. By expanding pipe and screen downhole, the internal flow areas are
increased, which, in turn, allows for enhanced production. The Company is a
leading provider of sand control equipment and services. Its primary competitors
are Halliburton, Schlumberger and BJ Services Company.

For the workover segment of the market, the Company provides mechanical
services tools and inflatable packers. The inflatable products enable
thru-tubing remedial operations that utilize coiled tubing rigs. The inflatable
packers are also used in the open hole environment for testing the potential of
a well during the drilling phase prior to the installation of casing. The
inflatable packers also become an integral part of the casing (external

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casing packer) to provide zone separation. The Company's primary competitors for
these product lines are Halliburton, Schlumberger and Weatherford.

The Company also provides fishing equipment and services using specialized
tools to locate, dislodge and retrieve twisted off, dropped or damaged pipe,
tools or other objects from inside the wellbore, potentially hundreds or
thousands of feet below the surface. In addition, milling, cutting and whipstock
services are offered to clean out wellbores or mill windows in the casing to
drill a sidetrack, or multi-lateral well. The Company's fishing services are
also offered in a thru-tubing product line, making it compatible with coiled
tubing workover operations. The Company is a leading provider of fishing
services. Its major competitors are Weatherford and Smith.

The Company also provides other completion, remedial and production products
and services, including control systems for surface and subsurface safety valves
and surface flow lines and flow regulators and packers used in secondary
recovery waterflood projects. The Company's primary competitors are Halliburton
and Schlumberger.

Baker Petrolite. The Company, through its Baker Petrolite division, is a
premier provider of oilfield specialty chemicals and integrated chemical
technology solutions for petroleum production, transportation and refining.
Chemicals that the Company provides include specialty chemicals that production
segments of the petroleum industry use, as well as industrial chemicals that
customers use in refining, wastewater treatment and cooling and boiler water
processes. The Company also provides chemical technology solutions to other
industrial markets throughout the world including petrochemicals, fuel
additives, plastics, imaging, adhesives, steel and crop protection. The Company
believes that its primary competitors are Ondeo Nalco Energy Services, LP and
the Betz Dearborn division of Hercules, Inc.

Centrilift. The Company, through its Centrilift division, is a market leader
for oilfield electric submersible pumping systems, which help raise oil to the
surface. These pumping systems consist of an electric submersible pump placed
inside the oil well near the productive formation, power and control cables
between the pump and the surface and a surface control system. The Company
manufactures the critical components of the systems, including variable speed
motor controllers and specialty armored power cables designed for oilfield use.
Its major competitor is Schlumberger.

Hughes Christensen. The Company, through its Hughes Christensen division, is
a leading manufacturer and marketer of Tricone(R) roller cone drill bits and
polycrystalline diamond compact fixed cutter bits for the worldwide oil, gas,
mining and geothermal industries. The Company believes that its principal
competitors in this area are Smith, Halliburton and Schlumberger for oil and gas
applications, and Sandvik Smith and Varel International, Inc. for other
applications.

PROCESS

The Process segment of the Company consists of two operating divisions:
EIMCO Process Equipment and BIRD Machine. Through its Process segment, the
Company manufactures, markets and services a broad range of separation and
treatment solutions and continuous and batch centrifuges and specialty filters
to a wide range of markets.

EIMCO Process Equipment. The Company, through its EIMCO Process Equipment
division ("EIMCO"), provides a broad range of separation and treatment solutions
to a wide range of process industries including minerals processing, power
generation, pulp and paper production, municipal water and wastewater,
industrial water and wastewater, chemical processing, steel production and
refining. EIMCO designs, manufactures and installs customer-specific solutions
that can improve process performance and productivity. The Company's product
lines include vacuum filters (drum, disc and horizontal belt filters), pressure
filters (filter presses and belt presses), sedimentation products (thickeners,
hi-rate thickeners, Deep Cone(TM) paste thickeners, E-Cat(TM) clarifier
thickeners and EIMCO(R) clarifiers), Wemco(R) flotation cells, Pyramid(TM)
column cells, biological treatment equipment (Carrousel(R) system, aerators,
digestors and Advent integral systems), KnowledgeScape(R) process control
systems and specialty equipment (solvent-oil dewaxer and ClariDisc(R) filters).
EIMCO has one of the largest bases of installed equipment in the industry. The
Company's principal competitors include Krauss Maffei, Outokumpu, Metso Minerals
(formerly Svedala), U.S. Filter, Westec and Ahlstrom.

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BIRD Machine. The Company, through its BIRD Machine division, manufactures a
broad range of continuous and batch centrifuges and specialty filters, which are
each widely used in the municipal, industrial, chemical, minerals and
pharmaceutical markets to separate, dewater or classify process and waste
streams. The Company's principal competitors in its continuous centrifuge
product line are Alfa-Laval/Sharples Tomoe, Westfalia and Flottweg. There are
numerous small and large companies that compete in the batch centrifuge and
filter product lines.

The Company provides parts, repairs and services for all of its process
equipment product lines through a global network of personnel and facilities
strategically located to serve the customer community. The Company also offers
equipment and operation services for processes that utilize many of the
Company's process equipment product and service lines.

Petreco. The Company has a 49% interest in the voting power of Petreco, an
entity created by the Company and Sequel Holdings, Inc. ("Sequel"). Petreco was
formed in October 2001, and the Company contributed $16.6 million of net assets
of the refining and production product line of its Process segment for the
Petreco formation. Petreco sells process equipment to oil and gas production
(including electrostatic de-salters and hydrocyclones) and refining
applications.

WESTERN GECO

The Company owns a 30% interest in a venture, Western GECO, formed in late
2000, with Schlumberger owning the remaining 70%. Western GECO is a leading
provider of seismic data acquisition and processing services to assist oil and
gas companies in evaluating the producing potential of sedimentary basins and in
locating productive hydrocarbon zones. Seismic data is acquired by producing
sound waves which move through the ground and are recorded by audio instruments.
The recordings are then analyzed to determine the characteristics of the
geologic formations through which the sound waves moved and the extent that oil
and gas may be trapped in or moving through those formations. This analysis is
known as a seismic survey. Western GECO conducts seismic surveys on land, in
deep waters and across shallow-water transition zones worldwide. These seismic
surveys encompass high-resolution, two-dimensional and three-dimensional surveys
for delineating exploration targets. Western GECO also conducts time-lapse,
four-dimensional seismic surveys for monitoring reservoir fluid movement over
time. Seismic information can reduce field development and production costs by
reducing turnaround time, lowering drilling risks and minimizing the number of
wells necessary to explore and develop reservoirs. Western GECO's major
competitors in providing these services are Compagnie Generale de Geophysique,
Veritas DGC, Inc. and Petroleum Geo-Services ASA.

EXPLORATION AND PRODUCTION ACTIVITIES

The Company owns a 40% interest in the OML-114 project (formerly OPL-230), a
Nigerian oil and gas exploration and production operation. The Company's intent
to hold or divest of this project could change in the future depending on the
relative value of the project and the viability of an offer from a third party
with respect to a proposed transaction regarding the project. The Company
divested all of its other exploration and production properties in 2000 and 2001
and does not expect to actively pursue additional interests in exploration and
production properties.

MARKETING, COMPETITION AND ECONOMIC CONDITIONS

The Company markets the products of each of its principal industry segments
primarily through the Company's own sales organizations on a product line basis,
although certain of its products and services are marketed through supply
stores, independent distributors or sales representatives. The Company
ordinarily provides technical and advisory services to assist in its customers'
use of the Company's products and services. Stockpoints and service centers for
oilfield products and services are located in areas of drilling and production
activity throughout the world. The Company markets its oilfield products and
services in nearly all of the oil-producing countries. For process products and
services, stockpoints and service centers are located near the operations of the
Company's customers, and the Company markets process products and services
throughout the world. In certain areas outside the United States, the Company
utilizes licensees, sales representatives and distributors.

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The Company's products and services are sold in highly competitive markets,
and its revenues and earnings can be affected by changes in competitive prices,
fluctuations in the level of activity in major markets, general economic
conditions and governmental regulation. The Company competes with the oil and
gas industry's largest integrated oilfield service providers. The Company
believes that the principal competitive factors in the industries that it serves
are product and service quality, availability and reliability; health, safety
and environmental standards; technical proficiency and price.

Further information concerning marketing, competition and economic
conditions is contained under the caption "Business Environment" in "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations".

INTERNATIONAL OPERATIONS

The Company operates in over 70 countries worldwide, and its operations are
subject to the risks inherent in doing business in multiple countries with
various laws and differing political structures and situations. These risks
include, but are not limited to, war, boycotts, political changes, terrorism,
expropriation, foreign exchange or currency restrictions, taxes and changes in
currency exchange rates. Although it is impossible to predict the likelihood of
such occurrences or their effect on the Company, management believes these risks
to be acceptable. However, there can be no assurance that an occurrence of any
one or more of these events would not have a material adverse effect on the
Company's operations.

RESEARCH AND DEVELOPMENT; PATENTS

The Company is engaged in research and development activities directed
primarily toward the improvement of existing products and services, the design
of specialized products to meet specific customer needs and the development of
new products and processes. For information regarding the amounts of research
and development expense in each of the three years ended December 31, 2001, see
Note 14 of the Notes to Consolidated Financial Statements in Item 8 herein.

The Company has followed a policy of seeking patent and trademark protection
both inside and outside the United States for products and methods that appear
to have commercial significance. The Company believes its patents and trademarks
to be adequate for the conduct of its business, and while it regards patent and
trademark protection important to its business and future prospects, it
considers its established reputation, the reliability and quality of its
products and the technical skills of its personnel to be more important. The
Company aggressively pursues protection of its patents against patent
infringement worldwide.

BUSINESS DEVELOPMENTS

OILFIELD

In February 2002, the Company acquired Apollo Services, Inc. ("Apollo") for
its Baker Hughes INTEQ division drilling fluids product line. Apollo is
primarily engaged in the drying, injection and transfer of drill cuttings from
oil and gas wells.

In February 2002, the Company and Luna Innovations Incorporated ("Luna
Innovations") formed a venture named Luna Energy, L.L.C. ("Luna Energy") to
develop, manufacture, commercialize, sell, market and distribute downhole fiber
optic and other sensors for oil and gas exploration, production, transportation
and refining applications. The Company and Luna Innovations own 40% and 60%
interests, respectively, in Luna Energy.

PROCESS

In the year 2000, the Company had announced plans to sell Baker Process as
an entire business unit, but has since determined that it would consider selling
the Baker Process operations as individual units. The Company has separated the
product lines comprising Baker Process into three separate operational business
units to provide focus and to allow these business units to better meet the
needs of their individual client bases. These operations were reconstituted into
the three original business units that were put together in 1999 to form Baker
Process: EIMCO Process Equipment, BIRD Machine and a production and refining
product line.

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On October 30, 2001, the Company and Sequel created an entity to operate
under the name of Petreco International ("Petreco"). The Company contributed
$16.6 million of net assets of the refining and production product line of its
Baker Process segment to Petreco, consisting primarily of intangible assets,
accounts receivable and inventories. Petreco profits are shared by the Company
and Sequel in 49% and 51% interests, respectively. Sequel is entitled to a
liquidation preference upon the liquidation or sale of Petreco.

EMPLOYEES

At December 31, 2001, the Company had approximately 26,800 employees, as
compared to approximately 24,500 employees at December 31, 2000. Approximately
2,370 employees at December 31, 2001, were represented under collective
bargaining agreements that terminate at various times through September 30,
2006. The Company believes that its relations with its employees are
satisfactory.

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EXECUTIVE OFFICERS

The following table shows as of March 6, 2002, the name of each executive
officer of the Company, together with his age and all offices presently held
with the Company.

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David H. Barr 52 Vice President of the Company and President of Baker Atlas since 2000.
Employed as Vice President, Supply Chain Management, of Cooper Cameron from
1999 to 2000. Mr. Barr also held the following position with the Company:
Vice President, Business Process Development, from 1997 to 1998 and the
following positions with Hughes Tool Company/Hughes Christensen: Vice
President, Production and Technology, from 1994 to 1997; Vice President,
Diamond Products, from 1993 to 1994; Vice President, Eastern Hemisphere
Operations, from 1990 to 1993 and Vice President, North American Operations,
from 1988 to 1990. Employed by the Company in 1972.

James R. Clark 51 Vice President of the Company and President of Baker Petrolite Corporation
since 2001. President and Chief Executive Officer of Consolidated Equipment
Companies, Inc. from 2000 to 2001 and President of Sperry-Sun from 1996 to
1999. Employed by the Company in 2001.

William P. Faubel 46 Vice President of the Company and President of Centrilift since 2001. Vice
President, Marketing, of Hughes Christensen from 1994 to 2001 and served as
Region Manager for various Hughes Christensen areas (both domestic and
international) from 1986 to 1994. Employed by a predecessor of the Company,
Hughes Tool Company, in 1977.

Edwin C. Howell 54 Vice President of the Company since 1995 and President of Baker Oil Tools
since 1992. Employed as President of Baker Service Tools from 1989 to 1992 and
Vice President - General Manager of Baker Performance Chemicals (the
predecessor of Baker Petrolite) from 1984 to 1989. Employed by the Company in
1975.

Douglas J. Wall 49 Vice President of the Company and President of Hughes Christensen since 1997.
Served as President and Chief Executive Officer of Western Rock Bit Company
Limited, Hughes Christensen's former distributor in Canada, from 1991 to 1997.
Previously employed as 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 by the Company in 1997.

There are no family relationships among the executive officers of the
Company.

ENVIRONMENTAL MATTERS

The Company's operations are subject to U.S. federal, state and local
regulations with regard to air and water quality and other environmental
matters. The Company believes that it is in substantial compliance with these
regulations. Regulation in this area continues to evolve and changes in
standards of enforcement of existing regulations, as well as the enactment and
enforcement of new legislation, may require the Company and its customers to
modify, supplement or replace equipment or facilities or to change or
discontinue present methods of operation.

During the year ended December 31, 2001, the Company spent approximately
$15.8 million to comply with U.S. federal, state and local provisions regulating
the discharge of materials into the environment or otherwise relating to the
protection of the environment (collectively, "Environmental Regulations"). In
the upcoming year ending December 31, 2002, the Company expects to spend a total
of approximately $17 million to comply with the Environmental Regulations. Based
upon current information, the Company believes that its compliance with
Environmental Regulations will not have a material adverse effect upon the
capital expenditures, earnings and competitive position of the Company because
the Company has either made adequate reserves for such compliance expenditures
or the cost to the Company for such compliance is expected to be small in
comparison with the Company's overall net worth.

The Company estimates that it will incur approximately $4 million in capital
expenditures for environmental control equipment during the year ending December
31, 2002 and approximately $3 million in capital expenditures in 2003. The
Company believes that capital expenditures for environmental control equipment
for the years 2002 and 2003 will not have a material adverse effect upon the
financial condition of the Company because the

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aggregate amount of these expenditures is expected to be small in comparison
with the Company's overall net worth.

The Comprehensive Environmental Response, Compensation and Liability Act
(known as "Superfund") imposes liability for the release of a "hazardous
substance" into the environment. Superfund liability is imposed without regard
to fault and even if the waste disposal was in compliance with the then current
laws and regulations. With the joint and several liability imposed under
Superfund, a potentially responsible party ("PRP") may be required to pay more
than its proportional share of such costs. The Company and several of its
subsidiaries and divisions have been identified as PRPs at various sites
discussed below. The United States Environmental Protection Agency (the "EPA")
and appropriate state agencies are supervising investigative and cleanup
activities at these sites.

(a) Baker Petrolite Corporation ("Petrolite"), Hughes Christensen Company, a
Baker Hughes INTEQ predecessor entity, Baker Oil Tools and a former
subsidiary were named in April 1984 as PRPs at the Sheridan Superfund
Site located in Hempstead, Texas. The Texas Natural Resource
Conservation Commission ("TNRCC") is overseeing the remedial work at
this site. The Sheridan Site Trust was formed to manage the site
remediation, and the Company participates as a member of the Sheridan
Site Trust. Sheridan Site Trust officials estimate the total remedial
and administrative costs to be approximately $30 million, of which the
Company's estimated contribution is approximately 2%.

(b) In May 1987, Baker Performance Chemicals Incorporated (subsequently
merged into Petrolite) entered into an Agreed Administrative Order with
the Texas Water Commission (currently, the TNRCC) with respect to soil
and groundwater contamination at the Odessa - Hillmont site located in
Odessa, Texas. Baker Performance Chemicals used the site as a chemical
blending plant. The contaminated soil has been removed and the site
continues in the groundwater recovery and treatment phase at an annual
cost to the Company of approximately $25,000.

(c) In December 1987, a former subsidiary of the Company was named a
respondent in an EPA Administrative Order for Remedial Design and
Remedial Action associated with the Middlefield-Ellis-Whisman (known as
"MEW") Study Area, an eight-square mile soil and groundwater
contamination site located in Mountain View, California. Several PRPs
for the site have estimated the total cost of remediation to be
approximately $80 million. The conclusion of extensive investigations
conducted by the Company's third-party environmental consultants is that
the activities of the former subsidiary's operating facility in the MEW
Study Area could not have been the source of any contamination in the
soil or groundwater within the MEW Study Area. As a result of the
Company's environmental investigations and a resulting report delivered
to the EPA in September 1991, the EPA has informed the Company that no
further work needs to be performed on the former subsidiary's site, and
further, the EPA has indicated that it does not believe there is a
contaminant source on the property. Although the Company's former
subsidiary continues to be named in the EPA's Administrative Order, the
Company believes the Administrative Order is not valid with respect to
the Company's former subsidiary and is seeking the withdrawal of the
Administrative Order with respect to that subsidiary.

(d) In January 1996, the TNRCC named Petrolite as a PRP at the McBay Oil and
Gas State Superfund Site in Grapevine, Texas. According to Petrolite's
records, it sold product to McBay Oil and Gas Company, but did not
transport waste to the site. Documentation of the product sales has been
sent to the TNRCC. Based on available information, the Company does not
believe that Petrolite has any liability for contamination at this site.

(e) In July 1997, Petrolite was named by the EPA as a PRP at the Shore
Refinery Site, Kilgore, Texas. According to Petrolite's records, it did
not arrange for the disposal, treatment or transportation of hazardous
substances or used oil in relation to the site, and to date, the EPA has
not produced any documentation linking the Company or any of its
subsidiaries or divisions to the environmental conditions at the site.
The Company does not believe that it has any liability for contamination
at this site.

(f) In June 1999, the EPA named Hughes Tool Company (now known as Hughes
Christensen) as a PRP at the Li Tungsten Site in Glen Cove, New York.
The Company believes that it has contributed a de minimis amount of
hazardous substance to the site and has responded to the EPA's inquiry.
A third-party consultant is

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conducting investigative studies at the site to determine a suitable
remedial action plan, as well as the total estimated cost for
remediation.

(g) In January 1999, Baker Oil Tools, Petrolite and predecessor entities of
Petrolite were named as PRPs by the State of California's Department of
Toxic Substances Control for the Gibson site in Bakersfield, California.
The combined volume that Baker Hughes companies contributed to the site
is estimated to be less than 0.5%. The preliminary cost estimate for
remediation of the site is approximately $14 million.

(h) In December 2000, the EPA named Petrolite as a PRP at the Casmalia
Disposal Site, Santa Barbara County, California. The EPA estimated that
the volumetric portion of waste the Teir Group of PRPs (of which
Petrolite is a member) transported and placed at the site is less than
0.1% of the total material. The EPA has estimated the total cost of
remediation to range from $225 million to $290 million. Petrolite is
considered a de minimis contributor and is negotiating a settlement.

(i) In 2001, Hughes Christensen (formerly Hughes Tool Company), Baker Oil
Tools, Baker Hughes INTEQ and a former subsidiary of the Company were
named as PRPs in the Force State Superfund Site located in Brazoria
County, Texas. The TNRCC is overseeing the investigation and remediation
at the Force State Site. Although the investigation of the site is
incomplete, preliminary cost estimates for the closure of the site are
approximately $3 million, with the total contribution from the Company's
divisions estimated to be 25% of that cost.

While PRPs in Superfund actions have joint and several liability for all
costs of remediation, it is not possible at this time to quantify the Company's
ultimate exposure because the projects are either in the investigative or early
remediation stage. Based upon current information, the Company does not believe
that probable or reasonably possible expenditures in connection with the sites
described above are likely to have a material adverse effect on the Company's
financial condition because:

(1) the Company has established adequate reserves to cover the estimate the
Company presently believes will be its ultimate liability with respect
to the matter,

(2) the Company and its subsidiaries have only limited involvement in the
sites based upon a volumetric calculation, as described above,

(3) other PRPs involved in the sites have substantial assets and may
reasonably be expected to pay their share of the cost of remediation,

(4) the Company has adequate resources, insurance coverage or contractual
indemnities from third parties to cover the ultimate liability, and

(5) the Company believes that its ultimate liability is small compared with
the Company's overall net worth.

The Company is subject to various other governmental proceedings and
regulations, including foreign regulations, relating to environmental matters,
but the Company does not believe that any of these matters is likely to have a
material adverse effect on its financial condition or results of operation.

"Environmental Matters" contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. The words "will,"
"believe," "to be," "expects" and similar expressions are intended to identify
forward-looking statements. The Company's expectations regarding its compliance
with Environmental Regulations and its expenditures to comply with Environmental
Regulations, including (without limitation) its capital expenditures on
environmental control equipment, are only its forecasts regarding these matters.
These forecasts may be substantially different from actual results, which may be
affected by the following factors: changes in Environmental Regulations;
unexpected, adverse outcomes with respect to sites where the Company has been
named as a PRP, including (without limitation) the sites described above; the
discovery of new sites of which the Company is not aware and where additional
expenditures may be required to comply with Environmental Regulations; an
unexpected discharge of hazardous materials in the course of the Company's
business or operations; an acquisition of one or more new businesses; a
catastrophic event causing discharges into the

10

environment of hydrocarbons; and a material change in the allocation to the
Company of the volume of discharge and a resulting change in the Company's
liability as a PRP with respect to a site.

ITEM 2. PROPERTIES

The Company operates 69 manufacturing plants, ranging in size from
approximately 1,500 to 0.3 million square feet of manufacturing space. The total
area of the plants is more than 3.8 million square feet, of which approximately
2.3 million square feet (62%) are located in the United States, 0.4 million
square feet (10%) are located in the Western Hemisphere exclusive of the United
States, 0.9 million square feet (23%) are located in Europe, and 0.2 million
square feet (5%) are located in the Eastern Hemisphere exclusive of Europe.
These manufacturing plants by industry segment and geographic area appear in the
table below. The Company also owns or leases and operates various customer
service centers and shops and sales and administrative offices throughout the
geographic areas in which it operates.

The Company believes that its manufacturing facilities are well maintained.
The Company also has a significant investment in service vehicles, rental tools,
manufacturing and other equipment.

ITEM 3. LEGAL PROCEEDINGS

The Company and its subsidiaries are involved in litigation or proceedings
that have arisen in the Company's ordinary business activities. The Company
insures against these risks to the extent deemed prudent by its management, but
no assurance can be given that the nature and amount of such insurance will be
sufficient to fully indemnify the Company against liabilities arising out of
pending and future legal proceedings. Many of these insurance policies contain
self-insured retentions in amounts the Company deems prudent.

The Company has been named as a defendant in a number of shareholder class
action suits filed by purported shareholders shortly after the Company's
December 8, 1999 announcement regarding the accounting issues it discovered at
its Baker Hughes INTEQ division. These suits, which seek unspecified monetary
damages, have been consolidated in the federal district court for the Southern
District of Texas pursuant to the Private Securities Litigation Reform Act of
1995. The Company filed Motions to Dismiss in both the shareholder derivative
suit and the class action. The federal district court granted the Company's
Motions on both actions. No appeal was filed in the shareholder derivative suit,
but the class action case is currently on appeal at the U.S. Fifth Circuit Court
of Appeals. The Company believes the allegations in these suits are without
merit, and the Company intends to vigorously defend these lawsuits. Even so, an
adverse outcome in this class action litigation could have an adverse effect on
the Company's financial condition or results of operations.

See also "Item 1. Business - Environmental Matters".

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

11

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Common Stock, $1.00 par value per share (the "Common Stock"), of the
Company is principally traded on The New York Stock Exchange. The Common Stock
is also traded on the Pacific Exchange and the Swiss Exchange. At March 1, 2002,
there were approximately 75,581 stockholders and approximately 23,314
stockholders of record.

For information regarding quarterly high and low sales prices on the New
York Stock Exchange for the Common Stock during the two years ended December 31,
2001 and information regarding dividends declared on the Common Stock during the
two years ended December 31, 2001, see Note 15 of the Notes to Consolidated
Financial Statements in Item 8 herein.

12

ITEM 6. SELECTED FINANCIAL DATA

The Selected Financial Data should be read in conjunction with "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and with "Item 8. Financial Statements and Supplementary Data"
herein.

NOTES TO SELECTED FINANCIAL DATA

(1) In August 1998, the Board of Directors of the Company approved a change in
the fiscal year-end of the Company from September 30 to December 31,
effective with the calendar year beginning January 1, 1998. A three-month
transition period from October 1, 1997 through December 31, 1997 precedes
the start of the 1998 fiscal year.

13

(2) See Note 6 of the Notes to Consolidated Financial Statements in Item 8
herein for a description of the Western GECO venture formed by the Company
in November 2000.

(3) During 1998, the Company acquired WEDGE DIA-LOG, Inc. and 3-D Geophysical,
Inc. for $218.5 million in cash and $117.5 million in cash, respectively.
The Company also made several smaller acquisitions with an aggregate
purchase price of $121.6 million. The purchase method of accounting was
used to record these acquisitions. During the year ended September 30,
1997, the Company acquired Petrolite Corporation ("Petrolite") for 19.3
million shares of the Company's common stock and the assumption of
Petrolite's outstanding vested and unvested employee stock options,
resulting in total consideration of $751.2 million, and acquired Drilex
International Inc. ("Drilex") for 2.7 million shares of the Company's
common stock. The Petrolite acquisition was accounted for as a purchase,
and the Drilex acquisition was accounted for using the pooling of interests
method. In connection with the Petrolite acquisition, the Company wrote off
$118.0 million of in-process research and development because the
technological feasibility of the projects in-process had not been
established, and there was no alternative future use at that date.

(4) In August 1998, the Company completed a merger with Western Atlas, Inc.
("Western Atlas") accounted for using the pooling of interests method. In
connection with the merger, the Company recorded merger related costs of
$219.1 million for transaction costs, employee related costs, integration
costs, the write-off of the carrying value of a product line and the
triggering of change in control rights contained in certain stock options
plans of Western Atlas and the Company.

(5) See Note 2 of the Notes to Consolidated Financial Statements in Item 8
herein for a description of the unusual charges in 2001, 2000 and 1999. The
unusual charge in 1998 consisted of cash charges for severance benefits,
charges to combine operations and consolidate facilities, and
environmental and litigation reserves. The noncash portion of the charge
consisted of charges for impairment of inventory and rental tools, the
write-down of a former consolidated joint venture, the write-off and
write-down of certain assets, a ceiling test charge for the Company's oil
and gas properties and a write-down of real estate held for sale. In 1998,
the charges reflected in cost of revenues, selling, general and
administrative expense and unusual charge were $305.0 million, $68.7
million and $215.8 million, respectively. The unusual charge in the year
ended September 30, 1997 consisted of charges in connection with certain
1997 acquisitions to combine the acquired operations with those of the
Company, the write-down of a low margin product line and the write-down of
the Company's investment in a subsidiary held for sale to its net
realizable value.

(6) See Note 1 of the Notes to Consolidated Financial Statements in Item 8
herein for a description of the cumulative effect of accounting change in
2001 related to the adoption of Statement of Financial Accounting Standards
No. 133, Accounting for Derivative Instruments and Hedging Activities. In
the year ended September 30, 1997, the Company changed its method of
accounting for the impairment of long-lived assets and for long-lived
assets held for disposal.

14

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") should be read in conjunction with the consolidated
financial statements of the Company for the years ended December 31, 2001, 2000
and 1999 and the related Notes to Consolidated Financial Statements contained in
Item 8 herein.

FORWARD-LOOKING STATEMENTS

MD&A and certain statements in the Notes to Consolidated Financial
Statements include forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, (each a "Forward-Looking Statement"). The
words "anticipate," "believe," "expect," "plan," "intend," "estimate,"
"project," "forecasts," "will," "could," "may" and similar expressions, and the
negative thereof, are intended to identify forward-looking statements. Baker
Hughes' expectations about its business outlook, customer spending, oil and gas
prices and the business environment for the Company and the industry in general
are only its forecasts regarding these matters. These forecasts may be
substantially different from actual results, which are affected by the following
factors: the effect of competition; the level of petroleum industry exploration
and production expenditures; drilling rig and oil and gas industry manpower and
equipment availability; the Company's ability to implement and effect price
increases for its products and services; the Company's ability to control its
costs; the availability of sufficient manufacturing capacity and subcontracting
capacity at forecasted costs to meet the Company's revenue goals; the ability of
the Company to introduce new technology on its forecasted schedule and at its
forecasted cost; the ability of the Company's competitors to capture market
share; world economic conditions; price of, and the demand for, crude oil and
natural gas; drilling activity; weather; the legislative environment in the
United States and other countries; Organization of Petroleum Exporting Countries
("OPEC") policy; war or extended period of conflict involving the United States,
the Middle East and other major petroleum-producing or consuming regions; acts
of war or terrorism, the development of technology that lowers overall finding
and development costs; the condition of the capital and equity markets and the
timing of any of the foregoing. See "Business Environment" for a more detailed
discussion of certain of these factors.

Baker Hughes' expectations regarding its level of capital expenditures
described in "Liquidity and Capital Resources" below are only its forecasts
regarding these matters. In addition to the factors described in the previous
paragraph and in "Business Environment," these forecasts may be substantially
different from actual results, which are affected by the following factors: the
accuracy of the Company's estimates regarding its spending requirements;
regulatory, legal and contractual impediments to spending reduction measures;
the occurrence of any unanticipated acquisition or research and development
opportunities; changes in the Company's strategic direction; the need to replace
any unanticipated losses in capital assets and the factors listed in "Item 1.
Business-Environmental Matters".

BUSINESS ENVIRONMENT

The Company has eight operating divisions each with separate management
teams and infrastructure that offer different products and services. The
divisions have been aggregated into two reportable segments - "Oilfield" and
"Process".

The Oilfield segment consists of six operating divisions - Baker Atlas,
Baker Hughes INTEQ, Baker Oil Tools, Baker Petrolite, Centrilift and Hughes
Christensen - that manufacture and sell equipment and provide related services
used in exploring for, developing and producing hydrocarbon reserves. The
Oilfield segment also includes the Company's interest in an oil and gas property
in Nigeria and its investment in Western GECO. In 2001, revenues from the
Oilfield segment accounted for 94.1% of total revenues.

The Process segment consists of two operating divisions - EIMCO Process
Equipment and BIRD Machine - that manufacture and sell process equipment for
separating solids from liquids and liquids from liquids through filtration,
sedimentation, centrifugation and flotation processes.

The business environment for the Company's Oilfield segment and its
corresponding operating results can be significantly affected by the level of
energy industry capital expenditures for the exploration and production of oil

15

and gas reserves. These expenditures are influenced strongly by oil company
expectations about the supply and demand for crude oil and natural gas products
and by the energy price environment that results from supply and demand
imbalances.

Key factors currently influencing the worldwide crude oil and gas markets
are:

o Production control - the degree to which OPEC nations and other large
producing countries, such as Mexico, Norway, and Russia, are willing and
able to control production and exports of crude oil to reduce supply and
support their targeted oil price while meeting their market share
objectives.

o Global economic growth - particularly the impact of the U.S. and Western
European economies and economic activity in Japan, China, South Korea and
the developing areas of Asia where the correlation between energy demand
and economic growth is strong. The International Energy Agency forecasted
in February 2001 worldwide oil demand growth of approximately 0.5%,
compared with the 2.0% averaged for the 10 years ending December 2000.
During 2001, the U.S. economy went into a recession that is expected to
continue into 2002. An important factor in the global economic growth in
2002 is the timing and strength of the U.S. economic recovery.

o Oil and gas storage inventories - relative to historic levels. Inventory
levels offer a measure of the balance between supply and demand. North
American natural gas inventories at the beginning of November 2001 (the
start of the 2001/2002 winter withdrawal season) were at record high
levels. Continued high inventories, without an increase in demand, indicate
a market that is amply supplied.

o Technological progress - in the design and application of new products that
allow oil and gas companies to drill fewer wells and to drill, complete and
produce wells faster and at lower cost.

o Maturity of the resource base - of known hydrocarbon reserves in the North
Sea, U.S., Canada and Latin America.

o Pace of new investment - access to capital and the reinvestment of
available cash flow into existing and emerging markets.

o Price volatility - the impact of widely fluctuating commodity prices on the
stability of the market and subsequent impact on customer spending.

o Possible supply disruptions - from key oil exporting countries, including,
but not limited to, Iraq, Saudi Arabia and other Middle Eastern countries,
due to political instability or military activity.

o Weather - the impact of variations in temperatures as compared with normal
weather patterns and the related effect on demand for oil and natural gas.

OIL AND GAS PRICES

Generally, customers' expectations about their prospects from oil and gas
sales and customers' expenditures to explore for or produce oil and gas rise or
fall with corresponding changes in the prices of oil or gas. Accordingly,
changes in these expenditures will normally result in increased or decreased
demand for the Company's products and services in its Oilfield segment. Crude
oil and natural gas prices are summarized in the table below as averages of the
daily closing prices during each of the periods indicated.

Oil prices averaged $25.96/bbl in 2001, ranging from a low of $17.45/bbl to
a high of $32.19/bbl. Slower economic growth and higher OPEC production levels
contributed to an increase in inventories and a moderation in oil prices. Oil
prices over the course of the year fell from levels above OPEC's self-declared
targeted price zone in

16

the first half of 2001 to levels below OPEC's targeted price zone in the second
half of the year. In November 2001, OPEC abandoned defense of its targeted price
zone as it sought cooperation with certain non-OPEC countries, particularly
Russia, Norway and Mexico, to jointly reduce production in an effort to reduce
inventories and support prices.

During 2001, natural gas prices averaged $3.96/MMBtu, down from the
$4.30/MMBtu average price for 2000. Prices ranged from a high of $10.20/MMBtu in
January to a low of $1.74/MMBtu in November. The decline in natural gas prices
was driven by a decrease in demand for natural gas due to slowing U.S. economic
growth, offset only partially by increased demand from fuel switching back to
natural gas. A modest increase in production also contributed to the decline in
prices. At the beginning of the 2001/2002 withdrawal season, inventories were at
record high levels following record storage injections during the summer of
2001. Mild weather and the U.S. recession continued to moderate demand and
allowed year-over-year storage surpluses to grow through the remainder of 2001,
resulting in softer prices.

RIG COUNTS

The Company is engaged in the oilfield service industry providing products
and services that are used in exploring for, developing and producing oil and
gas reservoirs. When drilling or workover rigs are active, they consume the
products and services produced by the oilfield service industry. The rig counts
act as a leading indicator of consumption of products and services used in
drilling, completing, producing and processing hydrocarbons.

Rig count trends are governed by the exploration and development spending by
oil and gas companies, which in turn is influenced by current and future price
expectations for oil and natural gas. Rig counts therefore reflect the relative
strength and stability of energy prices. The Company's rig counts are summarized
in the table below as averages for each of the periods indicated and are based
on weekly rig counts for the U.S. and Canada and monthly rig counts for all
other areas.

INDUSTRY OUTLOOK

Caution is advised that the factors described above in "Forward Looking
Statements" and "Business Environment" could negatively impact the Company's
expectations for oil demand, oil and gas prices and drilling activity.

Oil - Oil prices are expected to average between $18/bbl and $22/bbl in
2002. Sustained oil prices in this range and an outlook that prices are likely
to remain in this range are expected to support the Company's forecast of
customer spending. Oil prices are particularly susceptible to changes in oil
supply as oil demand growth in 2002 compared with 2001 is expected to be the
lowest year-to-year growth in a decade. Prices could fall to $13/bbl to $15/bbl
by mid-year, resulting in lower than forecasted spending, if one or more of the
following occurs: OPEC is unwilling or unable to control its production; Russia
or other major non-OPEC producers are unwilling or unable to restrain their
production; or the U.S. economic recovery is delayed into late 2002 or 2003.
Prices could rise to $23/bbl to $25/bbl, or more, if one or more of the
following occur: the U.S. and worldwide economic recovery

17

occurs sooner or is stronger than forecasted; OPEC or key non-OPEC oil-exporting
countries, particularly Russia, constrain oil production; or a supply disruption
occurs, resulting from political or military action in a key oil exporting
region.

North America Natural Gas - U.S. natural gas prices are expected to average
between $2.25/MMBtu and $2.75/MMBtu in 2002. Prices are expected to average
between $1.90/MMBtu and $2.20/MMBtu in the first half of 2002 as year-over-year
inventory surpluses and weak demand continue to influence prices. As a result of
lower natural gas prices during this period, spending by the Company's customers
directed at developing natural gas supplies (and therefore, drilling activity)
is expected to remain soft. In the second half of the year, the impact of a
growing U.S. economy and production declines resulting from lower spending in
the second half of 2001 and the first half of 2002 are expected to result in a
tighter supply/demand balance in the market. As a result, prices could exceed
$3.00/MMBtu by year end. Prices could trade lower if weather is milder than
normal, if the economic recovery is delayed, or if production levels are
maintained despite lower drilling activity. Prices could trade higher if weather
is more extreme than normal, if the economic recovery occurs sooner or is
stronger than expected, or if production levels fall more than expected as a
result of lower drilling activity.

Customer Spending - Based upon the Company's discussions with its major
customers and its review of published industry surveys and reports and the
Company's outlook for oil and gas prices described above, the anticipated
customer spending trends are as follows:

o North America - Spending in North America, primarily towards developing
natural gas supplies, is expected to be down 15% to 20% in 2002 compared
with 2001.

o Outside North America - Customer spending, primarily directed at
developing oil supplies, is expected to be flat to up 5% in 2002
compared with 2001.

o Total spending is expected to be down 5% to 7% in 2002 compared with
2001.

Drilling Activity - Based upon the Company's outlooks for oil and natural
gas prices and customer spending described above, the Company's outlook for
drilling activity, as measured by the Baker Hughes rig count, is as follows:

o The North American rig count is expected to decline between 15% to 20%
in 2002 compared with 2001.

o Drilling activity outside of North America is expected to increase 3% to
5% in 2002 compared with 2001.

COMPANY OUTLOOK

The trends as described above relating to declining rig counts, decreased
customer spending and low oil and gas prices began in late 2001 and have
continued to develop in 2002. As a result, the Company expects that 2002 will
not be as strong as 2001, with revenues expected to decline by approximately 5%
to 7% as compared with 2001, with related declines in operating results.

Recent changes in currency laws and other economic events in Argentina are
expected to negatively impact the Company. Changes mandated by law may prevent
the Company from being able to fully recover outstanding receivables from its
customers and losses are expected as a result of the devaluation of the
Argentine Peso. In addition, the uncertain economic environment in Argentina
will likely negatively impact the exploration and production spending plans of
the Company's customers in Argentina in 2002 and beyond, thus reducing the
demand for the Company's products. The Company is responding to this situation
in a number of ways, including negotiating with its customers for acceptable
payment terms on outstanding receivables, increasing the use of U.S. Dollar
based invoicing (or U.S. Dollar equivalent pricing and invoicing), adjusting
pricing and contracts to reflect the changes in Argentina's currency, and
shipping products to Argentina directly from outside the country with payment
made offshore in U.S. Dollar or equivalent currency. Although the Company has
provided for its best estimate of uncollectible receivables at December 31,
2001, it is uncertain at this time as to the ultimate resolution of these
matters and the impact on the Company; however, the Company estimates potential
losses related to the devaluation and uncollectible receivables could be between
$5 million and $10 million. In 2001, revenues from

18

Argentina were less than 3% of the Company's total revenue; accordingly, the
impact on the Company's total revenues in 2002 is not expected to be
significant.

Historically, the Venezuelan economy has experienced high inflation and a
weakening currency. Recently, Venezuela has experienced additional political and
economic uncertainties, including large fluctuations in exchange rates with the
U.S. Dollar. This creates additional uncertainties for the business environment
and market for the Company's products and services. The Company continues to
closely monitor the economic situation in Venezuela and is taking appropriate
actions to minimize its exposure to these risks.

CRITICAL ACCOUNTING POLICIES

The Company has defined a critical accounting policy as one that is both
important to the portrayal of the Company's financial condition and results of
operations and requires the management of the Company to make difficult,
subjective or complex judgments. Estimates and assumptions about future events
and their effects cannot be perceived with certainty. The Company bases its
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments. These estimates may change as new events occur, as
more experience is acquired, as additional information is obtained and as the
Company's operating environment changes.

The Company believes the following are the most critical accounting polices
used in the preparation of the Company's consolidated financial statements as
well as the significant judgments and uncertainties affecting the application of
these policies.

REVENUE RECOGNITION

Inherent in the Company's revenue recognition policy is the determination of
collectibility, which requires the Company to use estimates and exercise
judgment. The Company routinely monitors its customers' payment history and
current credit worthiness to determine that collectibility is reasonably
assured. This requires the Company to make frequent judgments and estimates in
order to determine the appropriate amount of allowances needed for doubtful
accounts. The Company records provisions for doubtful accounts when it becomes
evident that the customer will not be able to make the required payments either
at contractual due dates or in the future. Adverse changes in the financial
condition of the Company's customers could require additional allowances for
doubtful accounts.

INVENTORY

The Company records inventory at the lower of cost or market. The Company
regularly reviews inventory quantities on hand and records provisions for excess
or obsolete inventory based primarily on its estimated forecast of product
demand, market conditions, production requirements and technological
developments. Significant or unanticipated changes to the Company's forecasts
could require additional provisions for excess or obsolete inventory.

IMPAIRMENT OF LONG-LIVED ASSETS

Long-lived assets, which include property, plant and equipment, goodwill and
other intangibles, and other assets comprise a significant amount of the
Company's total assets. The Company makes judgments and estimates in conjunction
with the carrying value of these assets, including amounts to be capitalized,
depreciation and amortization methods and useful lives. Additionally, the
carrying values of these assets are periodically reviewed for impairment or
whenever events or changes in circumstances indicate that the carrying amounts
may not be recoverable. An impairment loss is recorded in the period in which it
is determined that the carrying amount is not recoverable. This requires the
Company to make long-term forecasts of its future revenues and costs related to
the assets subject to review. These forecasts require assumptions about demand
for the Company's 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.

19

INCOME TAXES

The Company uses the liability method for reporting income taxes, under
which current and deferred tax liabilities and assets are recorded in accordance
with enacted tax laws and rates. Under this method, the amounts of deferred tax
liabilities and assets at the end of each period are determined using the tax
rate expected to be in effect when taxes are actually paid or recovered. A
valuation allowance to reduce deferred tax assets is established when it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. While the Company has considered future taxable income and ongoing
prudent and feasible tax planning strategies in assessing the need for the
valuation allowance, there can be no guarantee that the Company will be able to
realize its deferred tax assets.

The Company operates under many legal forms and in more than 70 countries.
As a result, the Company is subject to many domestic and foreign tax
jurisdictions and to many tax agreements and treaties among the various taxing
authorities. Determination of taxable income in any jurisdiction requires the
interpretation of the related tax laws and regulations and the use of estimates
and assumptions regarding significant future events. Changes in tax laws,
regulations, agreements and treaties, foreign currency exchange restrictions or
the Company's level of operations or profitability in each taxing jurisdiction
could have an impact upon the amount of income taxes that the Company provides
during any given year.

WESTERN GECO

On November 30, 2000, the Company and Schlumberger and certain wholly owned
subsidiaries of Schlumberger created a venture by transferring the seismic
fleets, data processing assets, exclusive and nonexclusive multiclient surveys
and other assets of the Company's Western Geophysical division and
Schlumberger's Geco-Prakla business unit. The venture operates under the name of
Western GECO. In conjunction with the transaction, the Company received $493.4
million in cash from Schlumberger in exchange for the transfer of a portion of
the Company's ownership in Western GECO. The Company also contributed $15.0
million in working capital to Western GECO. The Company did not recognize any
gain or loss resulting from the initial formation of the venture due to the
Company's material continued involvement in the operations of Western GECO. In
addition, as soon as practicable after November 30, 2004, the Company or
Schlumberger will make a cash true-up payment to the other party based on a
formula comparing the ratio of the net present value of sales revenue from each
party's contributed multiclient seismic libraries during the four-year period
ending November 30, 2004 and the ratio of the net book value of those libraries
as of November 30, 2000. The maximum payment that either party will be required
to make as a result of this adjustment is $100.0 million.

Summarized financial information for Western Geophysical included in the
Company's consolidated financial statements are as follows for the years ended
December 31 (in millions):

(1) Financial information for the eleven months ended November 30, 2000, the
effective close date of the transaction.

(2) Includes unusual items and corporate allocations excluding interest.

RESULTS OF OPERATIONS

REVENUES

Revenues for 2001 were $5,382.2 million, an increase of 2.8% compared with
2000. Excluding revenues from Western Geophysical, revenues increased 19.3%
compared with 2000. Oilfield revenues, excluding Western Geophysical, were
$5,063.4 million, an increase of 20.9% compared with 2000. Oilfield revenues in
North America, which account for 44.6% of total Oilfield revenues, increased
28.2% compared with 2000. This increase reflects the increased drilling activity
in this area, as evidenced by a 18.5% increase in the North American rig count,
and improved pricing for the Company's products and services. Outside North
America, Oilfield revenues increased 15.7% compared with 2000. This increase
reflects the improvement in international drilling activity, particularly in

20

the North Sea, Latin America, and the Middle East. Revenues from crude oil
production from the Company's interest in the Nigerian property decreased to
$58.9 million in 2001 from $132.1 million in 2000 primarily due to the decrease
in the price of oil and as a result of the Company reaching the cost recovery
threshold in its operating agreement.

Revenues for 2000 were $5,233.8 million, an increase of 6.0% compared with
1999. This increase reflects increased drilling activity, as evidenced by the
31.3% increase in the average worldwide rig count, increased oil and natural gas
prices and improved pricing for the Company's products and services offset by
the ongoing weakness in the seismic market. Approximately 55.6% of the Company's
2000 revenues were derived from sources outside North America. Revenues from
production of crude oil from the Nigerian property increased to $132.1 million
in 2000 from $68.2 million in 1999 due to higher crude oil prices and increased
productions.

GROSS MARGIN

Gross margin was 28.8%, 23.4% and 18.8% for 2001, 2000 and 1999,
respectively. As discussed in "Unusual Charges", during 1999 the Company
recorded unusual charges in cost of revenues of $72.1 million. Excluding these
charges and Western Geophysical, gross margin in 2000 and 1999 was 25.3% and
21.0%, respectively. The increases in gross margin in 2001 and 2000 are
primarily the result of pricing improvements for the Company's products and
services, primarily in North America, continued cost management measures
throughout the Company and higher utilization of the Company's assets.

SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative ("SG&A") expenses for 2001 were $818.6
million, an increase of 7.8% compared with 2000. SG&A expenses as a percentage
of revenues increased to 15.2% for 2001 from 14.5% in 2000. These increases were
primarily due to increased costs to support the higher revenue level, increased
employee incentive costs and decreased foreign exchange gains.

SG&A expenses for 2000 were $759.6 million, an increase of 2.4% compared
with 1999. As discussed in "Unusual Charges", during 1999 the Company recorded
an unusual credit of $20.3 million in SG&A expenses. Excluding this unusual
credit, SG&A expenses decreased 0.4% in 2000 compared with 1999. SG&A expenses
as a percentage of revenues decreased from 15.4% in 1999 to 14.5% in 2000. The
decreases primarily related to increased foreign exchange gains, partially
offset by increases in employee incentive costs.

UNUSUAL CHARGES

2001

During 2001, the Company recorded unusual charges of $9.2 million. The
Company accrued cash charges of $6.0 million that consisted of severance for
approximately 100 employees due to the restructuring of the German operations of
BIRD Machine, a division of the Process segment. The Company paid $1.1 million
of this accrued severance in 2001. Based on current estimates, the Company
expects that the remainder of the accrued severance will be paid in 2002 or when
the employees leave the Company. The noncash portion of the charge was $3.2
million, of which $2.2 million related to the ceiling test write-down for the
Company's oil and gas property in Nigeria.

The Company recorded unusual credits of $7.6 million, which included $4.2
million related to a reduction of an unusual charge accrual originally recorded
in 2000 and a gain of $3.4 million on the disposition of its interest in a joint
venture.

2000

In October 2000, the Company's Board of Directors approved the Company's
plan to substantially exit the oil and gas exploration business. The Company
sold its interests in its China, Gulf of Mexico and Gabon oil and gas properties
and recorded a loss of $75.5 million on the sale of these properties. The
Company also wrote off its remaining undeveloped oil and gas exploration
properties resulting in a loss of $16.2 million. The Company accrued cash
charges of $13.3 million for severance costs for approximately 50 employees and
other contractual

21

obligations. The Company has paid $2.6 million of this accrued severance through
2001. Based on current estimates, the Company expects that the remainder of the
accrued severance will be paid during 2002 or as the employees leave the
Company. In 2001, the Company paid $2.4 million of accrued contractual
obligations and reduced the accrual by $4.2 million to reflect the current
estimates of remaining expenditures. The remaining contractual obligations will
be paid as the Company settles with the various counterparties.

The Company has retained its interest in an oil and gas property in Nigeria.
The Company's intent to hold or divest this project could change in the future
depending on the relative value of the project and the value and viability of an
offer from a third party with respect to a proposed transaction regarding the
project.

The Company also recorded a noncash unusual charge of $6.0 million for
employee related obligations resulting from the Western GECO formation.

The Company recorded unusual credits of $41.4 million related to net
reductions to unusual charge accruals from prior years of $28.5 million and
gains of $12.9 million on the sale of various product lines within the Oilfield
and Process segments.

1999

As a result of continuing low activity levels, predominantly for the
Company's seismic products and services, the Company recorded charges during the
fourth quarter of 1999 of $122.8 million. The cash portion of the charges was
$50.7 million and consisted of severance benefits, expected costs to settle
contractual obligations and terminate leases on certain marine vessels and other
cash charges. As of December 31, 2000, all activities were completed and the
related accruals fully utilized through cash payments or adjustments. The
noncash portion of the charges was $72.1 million and related to the write-off
and write-down of certain assets utilized in the Company's seismic business.

During 1999, the Company realized unusual gains totaling $54.8 million. The
Company sold two large excess real estate properties for $68.1 million and
realized net gains totaling $39.5 million. In addition, the Company sold certain
assets related to its previous divestiture of a joint venture and realized a net
gain of $15.3 million.

During 1999, the Company reviewed the remaining balances of the accruals for
cash charges recorded in 1998 and prior years and made net reductions of $11.4
million to reflect the current estimates of remaining expenditures. These net
reductions included reversals of previously recorded accruals that will not be
utilized and related primarily to severance accruals and lease obligations. In
addition, for accruals related to certain terminated lease obligations,
revisions were made to increase previously recorded amounts based on current
information and estimates of expected cash flows related to these leases.

The unusual items described above were reflected in the following captions
of the consolidated statement of operations for the year ended December 31, 1999
(in millions):

EQUITY IN INCOME (LOSS) OF AFFILIATES

Equity in income (loss) of affiliates relates to the Company's share of the
income (loss) of affiliates accounted for using the equity method of accounting.
The increase in 2001 compared with 2000 is primarily due to the inclusion of a
full year of the Company's 30% share of the net income of Western GECO, a
venture formed in November 2000.

Included in equity in income (loss) of affiliates for 2001 and 2000 was
$10.3 million related to the write-off of certain assets associated with Western
GECO and $9.5 million for restructuring and integration charges associated with
Western GECO, respectively.

22

INTEREST EXPENSE

Interest expense for 2001 decreased $46.9 million compared with 2000. The
decrease was primarily due to lower debt levels coupled with lower average
interest rates on short-term debt and commercial paper. Average short-term debt
and commercial paper for 2001 was $259.7 million compared with $929.0 million
for 2000. The approximate average interest rate on short-term debt and
commercial paper was 4.0% for 2001 compared with 6.3% for 2000.

Interest expense for 2000 increased $6.3 million compared with 1999. The
increase was primarily due to higher average interest rates on the Company's
short-term debt and commercial paper. Average short-term debt and commercial
paper for 2000 was $929.0 million compared with $962.0 million for 1999. The
approximate average interest rate on short-term debt and commercial paper was
6.3% for 2000 compared with 5.2% for 1999.

INTEREST INCOME

Interest income primarily relates to income earned on cash and cash
equivalents. Interest income for 2001 increased $7.4 million compared with 2000
primarily due to $5.4 million of interest income recognized from a settlement
with the Internal Revenue Service ("IRS") related to an examination of certain
1994 through 1997 pre-acquisition tax returns and related refund claims of
Western Atlas.

GAIN ON TRADING SECURITIES

In the fourth quarter of 1999, the Company announced its intention to sell
its holdings in Tuboscope, Inc., now known as Varco International, Inc.
("Varco"), and reclassified these holdings from available-for-sale securities to
trading securities. As a result of this decision, the Company recognized a
pre-tax gain of $31.5 million in the fourth quarter of 1999. During 2000, the
Company disposed of these holdings and recorded additional pre-tax gains of
$14.1 million.

INCOME TAXES

The Company's effective tax rates differ from the statutory income tax rate
of 35% due to different tax rates on international operations, the
non-deductibility of certain goodwill amortization, incremental taxes due to
Western GECO and IRS settlements.

During 2001, additional taxes of $14.8 million from the Western GECO venture
arose due to unbenefitted foreign losses and due to taxes assessed in
jurisdictions on a deemed profit basis. In addition, a $23.5 million benefit was
recognized as a result of the settlement of the IRS examination of certain 1994
through 1997 pre-acquisition tax returns and related refund claims of Western
Atlas.

During 2000, the Company provided $9.4 million of foreign and additional
U.S. taxes as a result of the repatriation of the proceeds from the formation of
the Western GECO venture. The formation of the venture also reduced the expected
amount of foreign source income against which to use the Company's foreign tax
credit carryover; therefore, the Company provided $35.6 million for additional
U.S. taxes with respect to future repatriation of earnings necessary to utilize
the foreign tax credit carryover.

During 1999, the Company recognized a tax benefit of $18.1 million through
the reversal of previously deferred taxes after settling the IRS examination of
its 1994 and 1995 tax years.

LIQUIDITY AND CAPITAL RESOURCES

The Company's capital requirements have principally related to working
capital needs, payment of dividends, and capital expenditures. These
requirements have been met through a combination of bank debt and internally
generated funds.

In 2001, net cash inflows from operating activities totaled $720.8 million,
an increase of $157.3 million compared with 2000. This increase was primarily
due to increased profitability and improved balance sheet

23

management. Net cash inflows in 2000 increased $20.3 million compared with 1999.
This slight increase related to higher net income, partially offset by increases
in working capital.

Expenditures for capital assets and multiclient seismic data totaled $319.0
million, $599.2 million and $640.4 million for 2001, 2000 and 1999,
respectively. Excluding Western Geophysical, expenditures for capital assets
were $319.0 million, $289.6 million and $320.9 million for 2001, 2000 and 1999,
respectively. The majority of these expenditures was for rental tools and costs
associated with the implementation of SAP R/3.

The Company generates proceeds from the disposal or sale of assets in either
the normal course of its business or from non-recurring asset sales. During
2001, the Company generated total proceeds of $77.7 million, which included
non-recurring asset sales of $7.4 million related to the sale of a product line
and the disposition of the Company's interest in a joint venture. During 2000,
the Company generated total proceeds of $213.0 million. Non-recurring asset
sales totaled $124.5 million and included sales of product lines, the sale of
the Company's interests in its China, Gulf of Mexico and Gabon oil and gas
properties, and the sale of real estate held for sale. During 1999, the Company
generated total proceeds of $154.2 million, which included non-recurring asset
sales of $68.1 million related to the sale of two large excess real estate
properties.

In 2001, the Company redeemed its outstanding Liquid Yield Options Notes at
a redemption price of $786.13 per $1,000 principal amount, for a total of $301.8
million. The redemption was funded through the issuance of commercial paper. In
connection with the early extinguishment of debt, the Company recorded an
extraordinary loss of $2.3 million ($1.5 million after tax). The Company expects
that the redemption will not have a significant impact on interest expense in
future periods. In 2001, commercial paper and short-term borrowings were reduced
by $73.0 million primarily due to cash flow from operations. In 2000, commercial
paper and short-term borrowings were reduced by $669.4 million primarily due to
cash flow from operations, $117.7 million in proceeds from a sale/leaseback
transaction and $493.4 million in proceeds from the formation of Western GECO.
In 1999, the Company borrowed $1,010.7 million from the public debt market. The
proceeds were used to repay commercial paper and short-term borrowings of $816.0
million as well as $150.0 million in long-term debt.

Total debt outstanding at December 31, 2001 was $1,694.6 million, a decrease
of $368.3 million compared with December 31, 2000. Debt was repaid using cash
flow from operations, proceeds from the disposal or sale of assets and proceeds
from the issuance of common stock. The debt to equity ratio was 0.51 at December
31, 2001 compared with 0.68 at December 31, 2000. The Company's long-term
objective is to maintain a debt to equity ratio between 0.40 and 0.60.

At December 31, 2001, the Company had $1,289.9 million of credit facilities
with commercial banks, of which $800.5 million was committed. There were no
direct borrowings under these facilities during the years ended December 31,
2001 and 2000; however, to the extent the Company has outstanding commercial
paper, available borrowings under the committed credit facilities are reduced.
At December 31, 2001 and 2000, the Company had $95.0 million and $215.0 million,
respectively, in commercial paper outstanding under this program, with a
weighted average interest rate of 2.0% and 6.5%, respectively. The committed
facilities mature in September 2003. If the credit facilities are not renewed,
the Company would pursue other borrowing alternatives.

Cash flow from operations is expected to be the principal source of
liquidity in 2002. The Company believes that cash flow from operations, combined
with existing credit facilities, will provide the Company with sufficient
capital resources and liquidity to manage its operations, meet debt obligations
and fund projected capital expenditures. The Company currently expects 2002
capital expenditures to be between $300.0 million and $340.0 million, excluding
acquisitions. The expenditures are expected to be used primarily for normal,
recurring items necessary to support the growth of the Company.

There are no provisions in the Company's debt or lease agreements that would
accelerate their repayment or require collateral or material changes in terms
due to a reduction in the Company's debt ratings or stock price. Other than
normal operating leases, the Company does not have any off-balance sheet
financing arrangements such as securitization agreements, liquidity trust
vehicles or special purpose entities. As such, the Company is not materially
exposed to any financing, liquidity, market or credit risk that could arise if
the Company had engaged in such financing arrangements.

24

The words "expected" and "expects" are intended to identify Forward-Looking
Statements in "Liquidity and Capital Resources". See "Forward-Looking
Statements" and "Business Environment" above for a description of risk factors
related to these Forward-Looking Statements.

The following tables summarize the Company's contractual cash obligations
and commercial commitments as of December 31, 2001 (in millions):

RELATED PARTY TRANSACTIONS

The Company has investments in affiliates that are accounted for using the
equity method of accounting. The most significant of these affiliates is Western
GECO. In conjunction with the formation of Western GECO, the Company transferred
to the venture a lease on a seismic vessel. The Company is the sole guarantor of
this lease obligation; however, Schlumberger has indemnified the Company for 70%
of the total lease obligation. At December 31, 2001, the remaining commitment
under this lease is $96.4 million. The lease expires in 2002. As soon as
practicable after November 30, 2004, the Company or Schlumberger will make a
cash true-up payment to the other party based on a formula comparing the ratio
of the net present value of sales revenue from each party's contributed
multiclient seismic libraries during the four-year period ending November 30,
2004 and the ratio of the net book value of those libraries as of November 30,
2000. The maximum payment that either party will be required to make as a result
of this adjustment is $100.0 million.

In November 2000, the Company entered into an agreement with Western GECO
whereby Western GECO subleased a facility from the Company for a period of ten
years at current market rates. During 2001, the Company received $5.9 million of
rental income from Western GECO related to this lease.

At December 31, 2001 and 2000, net accounts receivable from affiliates
totaled $33.5 million and $11.4 million, respectively. There were no other
significant related party transactions.

ACCOUNTING STANDARDS

On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging
Activities, as amended by SFAS Nos. 137 and 138. SFAS No. 133 establishes
accounting and reporting standards for derivative instruments and hedging
activities that require an entity to recognize all derivatives as an asset or
liability measured at fair value. Depending on the intended use of the
derivative and its effectiveness, changes in its fair value will be reported in
the period of change as either a component of earnings or a component of
accumulated other comprehensive loss. The adoption of SFAS No. 133 on January 1,
2001 resulted in a gain of $0.8 million, net of tax, recorded as the cumulative
effect of an accounting change in the consolidated statement of operations and a
gain of $1.2 million, net of tax, recorded in accumulated other comprehensive
loss. During 2001, all of the $1.2 million gain was reclassified into earnings
upon maturity of the contracts.

25

In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, Business Combinations. SFAS No. 141 requires that all business
combinations initiated after June 30, 2001 be accounted for under the purchase
method and addresses the initial recognition and measurement of goodwill and
other intangible assets acquired in a business combination. Business
combinations accounted for under the pooling of interests method prior to June
30, 2001 were not changed. The adoption of SFAS No. 141 by the Company did not
have an impact on the consolidated financial statements of the Company.

In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 142 addresses the initial recognition and measurement of
intangible assets acquired in a business combination and the accounting for
goodwill and other intangible assets subsequent to their acquisition. SFAS No.
142 provides that intangible assets with finite useful lives be amortized and
that goodwill and intangible assets with indefinite lives not be amortized, but
rather be tested at least annually for impairment. SFAS No. 142 requires that a
transitional impairment test be performed within six months of adoption and any
transitional impairment loss will be recognized as the cumulative effect of a
change in accounting principle. The Company will adopt SFAS No. 142 effective
January 1, 2002. The cessation of amortization expense related to goodwill and
goodwill associated with equity method investments under the guidelines of SFAS
No. 142 will result in a reduction of approximately $52.5 million in annual
amortization expense in 2002. The Company has not completed its analysis of the
impact of the adoption of SFAS No. 142 as it relates to the possible impairment
of goodwill.

In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of long-lived assets and the
associated asset retirement costs. SFAS No. 143 requires that the fair value of
a liability associated with an asset retirement be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated retirement costs are capitalized as part of the carrying amount of
the long-lived asset and subsequently depreciated over the life of the asset.
The Company has not completed its analysis of the impact, if any, of the
adoption of SFAS No. 143 on its consolidated financial statements. The Company
will adopt SFAS No. 143 for its fiscal year beginning January 1, 2003.

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. SFAS No. 144 addresses the financial
accounting and reporting for the impairment or disposal of long-lived assets.
SFAS No. 144 replaces SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of. SFAS No. 144 provides
updated guidance concerning the recognition and measurement of an impairment
loss for certain types of long-lived assets and modifies the accounting and
reporting of discontinued operations. SFAS No. 144 is not expected to materially
change the methods used by the Company to measure impairment losses on
long-lived assets, but may result in future dispositions being reported as
discontinued operations to a greater extent than is currently permitted. The
Company will adopt SFAS No. 144 for its fiscal year beginning January 1, 2002.

EURO CONVERSION

A single European currency (the "Euro") was introduced on January 1, 1999,
at which time the conversion rates between the old, or legacy, currencies and
the Euro were set for participating member countries. The legacy currencies in
those countries were used as legal tender through December 31, 2001 and will be
used for a short transition period subsequent to December 31, 2001. Thereafter,
the legacy currencies will be canceled, and Euro bills and coins will be used in
the participating countries.

Prior to December 31, 2001, the Company converted its legacy currency based
financial records to the Euro. In addition, the Company reviewed existing
contracts and agreements with customers and vendors to assess the potential
impact of converting to the Euro. The Company did not experience any problems or
issues in converting its financial records and systems to the Euro that, in the
opinion of management, materially or adversely affected the consolidated
financial condition of the Company. In addition, due to the nature of the
Company's business as it relates to customers and vendors, it does not expect
any significant problems related to the Euro to arise subsequent to December 31,
2001 that could materially or adversely affect the financial condition of the
Company.

The word "expect" is intended to identify a Forward-Looking Statement in
"Euro Conversion." The Company's anticipation regarding the lack of significance
of the Euro introduction on the Company's operations is only its forecast
regarding this matter. This forecast may be substantially different from actual
results, which are affected

26

by factors such as the following: the failure of the Company to implement SAP
R/3 or another Euro compliant computer system or unforeseen difficulties in
updating computer systems to accommodate the Euro in any new geographic location
that prices in Euros or in any newly acquired entity; the inability of third
parties to adequately address their own Euro systems issues, including vendors,
contractors, financial institutions, U.S. and foreign governments and customers;
and the lack of alternatives available to the Company.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to certain market risks that are inherent in the
Company's financial instruments that arise in the normal course of business. The
Company may enter into derivative financial instrument transactions to manage or
reduce market risk. The Company does not enter into derivative financial
instrument transactions for speculative purposes. A discussion of the Company's
primary market risk exposure in financial instruments is presented below.

LONG-TERM DEBT

The Company is subject to interest rate risk on its long-term fixed interest
rate debt. Commercial paper borrowings, other short-term borrowings and variable
rate long-term debt do not give rise to significant interest rate risk because
these borrowings either have maturities of less than three months or have
variable interest rates. All other things being equal, the fair market value of
the Company's debt with a fixed interest rate will increase as interest rates
fall and the fair market value will decrease as interest rates rise. This
exposure to interest rate risk is managed by borrowing money that has a variable
interest rate or using interest rate swaps to change fixed interest rate
borrowings to variable interest rate borrowings.

At December 31, 2001, the Company had fixed rate debt aggregating $1,524.9
million and variable rate debt aggregating $169.7 million. The following table
sets forth, as of December 31, 2001 and 2000, the Company's principal cash flows
for its long-term debt obligations, which bear a fixed rate of interest and are
denominated in U.S. Dollars, and the related weighted average effective interest
rates by expected maturity dates. Additionally, the table sets forth the
notional amounts and weighted average interest rates of the Company's interest
rate swaps by expected maturity (dollar amounts in millions).

(1) Fair market value of long-term debt is $1,576.9 million and $1,874.3
million at December 31, 2001 and 2000, respectively.

(2) Fair market value of the interest rate swaps is a $1.3 million asset and a
$9.6 million liability at December 31, 2001 and 2000, respectively.

(3) Includes the Liquid Yield Options Notes ("LYONS") with an accreted value of
$296.2 million at December 31, 2000. The LYONS were redeemed for cash in
May 2001.

(4) Average six-month LIBOR for the Japanese Yen, the Euro and the Swiss Franc
plus 3.16%.

(5) Three-month LIBOR plus 2.7625%.

27

INVESTMENTS

During 2000, the Company sold its investment in common stock and common
stock warrants of Varco at an average price of $18.70 per share. Total proceeds
from the sale of the Company's investment in the common stock and the warrants
were $72.7 million.

CRUDE OIL CONTRACTS

During the year ended December 31, 2001, the Company entered into two crude
oil contracts to mitigate price risk associated with production from the
Company's interest in an oil producing property in Nigeria. Based on the
Company's outlook for crude oil prices, the Company elected to terminate these
contracts prior to their maturity dates. Accordingly, the contracts were
terminated on October 3, 2001, and the Company received a cash payment of $4.4
million. In accordance with SFAS No. 133, the net gain recognized in earnings in
2001 from all crude oil contracts was $3.1 million and is reported in revenue in
the consolidated statements of operations.

During the year ended December 31, 2000, the Company had entered into two
contracts to mitigate price risk associated with the Company's interest in an
oil producing property in Nigeria. The fair value of these contracts at December
31, 2000 was a $3.1 million unrecorded asset.

FOREIGN CURRENCY AND FOREIGN CURRENCY FORWARD CONTRACTS

The Company's operations are conducted around the world in a number of
different currencies. The majority of the Company's foreign subsidiaries have
designated the local currency as their functional currency. As such, future
earnings are subject to change due to changes in foreign currency exchange rates
when transactions are denominated in currencies other than the Company's
functional currencies. To minimize the need for foreign currency contracts, the
Company is generally able to manage its foreign currency exposure by maintaining
a minimal consolidated net asset or net liability position in a currency other
than the functional currency.

At December 31, 2001, the Company had entered into foreign currency forward
contracts with notional amounts of $8.5 million, $1.0 million and $0.7 million
to hedge exposure to currency fluctuations in the Canadian Dollar, the
Indonesian Rupiah and the Euro, respectively. These contracts are cash flow
hedges. Based on year-end quoted market prices for contracts with similar terms
and maturity dates, no asset or liability was recorded as the forward price is
substantially the same as the contract price.

At December 31, 2000, the Company had entered into foreign currency forward
contracts with notional amounts of $50.0 million, $0.3 million and $0.2 million
to hedge against exposure to fluctuations in the British Pound, the South
African Rand and the Euro, respectively. The fair market value of these forward
contracts was a $1.5 million unrecorded asset.

The counterparties to the Company's forward contracts are major financial
institutions. 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, the
Company's exposure is limited to the foreign currency rate differential.

Certain borrowings of the Company are denominated in currencies other than
its functional currency. At December 31, 2001, these nonfunctional currency
borrowings totaled $14.8 million with exposures between the U.S. Dollar and the
Euro, the Saudi Riyal, the Brazilian Real, the Thai Baht and the Malaysian
Ringgit. A 10% depreciation of the U.S. Dollar against these currencies would
not have a material adverse effect on the future earnings of the Company.

28

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

MANAGEMENT REPORT OF FINANCIAL RESPONSIBILITIES

The management of Baker Hughes Incorporated is responsible for the
preparation and integrity of the accompanying consolidated financial statements
and all other information contained in this Annual Report. The consolidated
financial statements have been prepared in conformity with generally accepted
accounting principles and include amounts that are based on management's
informed judgments and estimates.

In fulfilling its responsibilities for the integrity of financial
information, management maintains and relies on the Company's system of internal
control. This system includes written policies, an organizational structure
providing division of responsibilities, the selection and training of qualified
personnel and a program of financial and operational reviews by a professional
staff of corporate auditors. The system is designed to provide reasonable
assurance that assets are safeguarded, transactions are executed in accordance
with management's authorization and accounting records are reliable as a basis
for the preparation of the consolidated financial statements. Management
believes that, as of December 31, 2001, the Company's internal control system
provides reasonable assurance that material errors or irregularities will be
prevented or detected within a timely period and is cost effective.

Management recognizes its responsibility for fostering a strong ethical
climate so that the Company's affairs are conducted according to the highest
standards of personal and corporate conduct. This responsibility is
characterized and reflected in the Company's Standards of Conduct which are
distributed throughout the Company. Management maintains a systematic program to
assess compliance with the policies included in the standards.

The Board of Directors, through its Audit/Ethics Committee composed solely
of nonemployee directors, reviews the Company's financial reporting, accounting
and ethical practices. The Audit/Ethics Committee recommends to the Board of
Directors the selection of independent public accountants and reviews their fee
arrangements. It meets periodically with the independent public accountants,
management and the corporate auditors to review the work of each and the
propriety of the discharge of their responsibilities. The independent public
accountants and the corporate auditors have full and free access to the
Audit/Ethics Committee, without management present, to discuss auditing and
financial reporting matters.

/s/ MICHAEL E. WILEY /s/ G. STEPHEN FINLEY /s/ ALAN J. KEIFER
Michael E. Wiley G. Stephen Finley Alan J. Keifer
Chairman, President and Senior Vice President - Vice President and
Chief Executive Officer Finance and Administration, Controller
and Chief Financial Officer

29

INDEPENDENT AUDITORS' REPORT

Stockholders of Baker Hughes Incorporated:

We have audited the accompanying consolidated balance sheets of Baker Hughes
Incorporated and its subsidiaries as of December 31, 2001 and 2000, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2001. Our
audits also included the financial statement schedule II, valuation and
qualifying accounts. These financial statements and financial statement schedule
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements and financial statement
schedule based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Baker Hughes Incorporated and
its subsidiaries at December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States of America. Also, in our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.

As described in Note 1 to the consolidated financial statements, effective
as of January 1, 2001, the Company adopted Statement of Financial Accounting
Standards Nos. 133, 137 and 138, which established new accounting and reporting
standards for derivative instruments and hedging activities.

/s/ DELOITTE & TOUCHE LLP

Houston, Texas
February 13, 2002

30

BAKER HUGHES INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)

See Notes to Consolidated Financial Statements

31

BAKER HUGHES INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT PAR VALUE)

See Notes to Consolidated Financial Statements

32

BAKER HUGHES INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)

See Notes to Consolidated Financial Statements

33

BAKER HUGHES INCORPORATED
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN MILLIONS)

See Notes to Consolidated Financial Statements

34

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The consolidated financial statements include the accounts of Baker Hughes
Incorporated and all majority owned subsidiaries (the "Company"). Investments in
which the Company owns 20% to 50% and exercises significant influence over
operating and financial policies are accounted for using the equity method of
accounting. All significant intercompany accounts and transactions have been
eliminated in consolidation. In the Notes to Consolidated Financial Statements,
all dollar and share amounts in tabulations are in millions of dollars and
shares, respectively, unless otherwise indicated.

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Future events and their effects cannot be
perceived with certainty. Accordingly, the Company's accounting estimates
require the exercise of judgment. While management believes that the estimates
and assumptions used in the preparation of the consolidated financial statements
are appropriate, actual results could differ from those estimates. Estimates are
used for, but are not limited to, determining the following: allowance for
doubtful accounts and inventory valuation reserves, recoverability of long-lived
assets, useful lives used in depreciation and amortization, income taxes and
related valuation allowances, and insurance, environmental, legal and
restructuring accruals. The accounting estimates used in the preparation of the
consolidated financial statements may change as new events occur, as more
experience is acquired, as additional information is obtained and as the
Company's operating environment changes.

REVENUE RECOGNITION

The Company's products and services are generally sold based upon purchase
orders or contracts with the customer that include fixed or determinable prices
and that do not include right of return or other similar provisions or other
significant post delivery obligations. Revenue is recognized for products upon
delivery and when title passes or when services are rendered and only when
collectibility is reasonably assured. Certain revenues from the Company's
Process segment are reported on the percentage of completion method of
accounting using measurements of progress towards completion appropriate for the
products and services being provided. Provisions for estimated warranty returns
or similar types of items are made at the time the related revenue is
recognized.

CASH EQUIVALENTS

The Company considers all highly liquid investments with an original
maturity of three months or less at the time of purchase to be cash equivalents.

INVENTORIES

Inventories are stated at the lower of cost or market. Cost is primarily
determined on the average cost method and includes the cost of materials, labor
and manufacturing overhead.

PROPERTY AND DEPRECIATION

Property is stated at cost less accumulated depreciation, which is generally
provided by using the straight-line method over the estimated useful lives of
the individual assets. The Company manufactures a substantial portion of its
rental tools and equipment, and the cost of these items, which includes direct
and indirect manufacturing costs, are capitalized and carried in inventory until
the tool is completed and transferred into the rental tool fleet.

35

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Significant improvements and betterments are capitalized if they extend the
useful life of the asset. Routine repairs and maintenance are expensed when
incurred.

The Company has substantially completed its development and implementation
of SAP R/3 as an enterprise-wide software system. External direct costs of
consulting services and payroll-related cost of employees who worked full-time
on the implementation of the system were capitalized and classified in machinery
and equipment. Costs associated with business process reengineering were
expensed as incurred. Amortization of a pro-rata amount of the capitalized costs
began as the system was implemented at each of the Company's operations.

The Company uses the full-cost method of accounting for its investment in
oil and gas properties. Under this method, the Company capitalizes all
acquisition, exploration, and development costs incurred for the purpose of
finding oil and gas reserves. Depreciation, depletion, and amortization of oil
and gas properties are computed using the unit-of-production method based upon
production and estimates of proved reserves.

GOODWILL AND OTHER INTANGIBLES AND AMORTIZATION

Goodwill arising from acquisitions is amortized using the straight-line
method over the lesser of its expected useful life or 40 years. Other
intangibles are stated at cost and are amortized on a straight-line basis over
the asset's estimated useful life.

IMPAIRMENT OF LONG-LIVED ASSETS

Long-lived assets, which includes property, plant and equipment, goodwill
and other intangibles, and certain other assets are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount
may not be recoverable. An impairment loss is recorded in the period in which it
is determined that the carrying amount is not recoverable. The determination of
recoverability is made based upon the estimated undiscounted future net cash
flows, excluding interest expense. The impairment loss is determined by
comparing the fair value, as determined by a discounted cash flow analysis, with
the carrying value of the related assets.

INCOME TAXES

The Company uses the liability method for reporting income taxes, under
which current and deferred tax liabilities and assets are recorded in accordance
with enacted tax laws and rates. Under this method, the amounts of deferred tax
liabilities and assets at the end of each period are determined using the tax
rate expected to be in effect when taxes are actually paid or recovered. Future
tax benefits are recognized to the extent that realization of such benefits is
more likely than not.

Deferred income taxes are provided for the estimated income tax effect of
temporary differences between financial and tax bases in assets and liabilities.
Deferred tax assets are also provided for certain tax credit carryforwards. A
valuation allowance to reduce deferred tax assets is established when it is more
likely than not that some portion or all of the deferred tax assets will not be
realized.

The Company intends to indefinitely reinvest earnings of certain non-U.S.
subsidiaries in operations outside the United States; accordingly, the Company
does not provide U.S. income taxes for such earnings.

The Company operates under many legal forms and in more than 70 countries.
As a result, the Company is subject to many domestic and foreign tax
jurisdictions and to many tax agreements and treaties among the various taxing
authorities. Determination of taxable income in any jurisdiction requires the
interpretation of the related tax laws and regulations and the use of estimates
and assumptions regarding significant future events. Changes in tax laws,
regulations, agreements and treaties, foreign currency exchange restrictions or
the Company's level of operations or profitability in each taxing jurisdiction
could have an impact upon the amount of income taxes that the Company provides
during any given year.

36

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

ENVIRONMENTAL MATTERS

Remediation costs are accrued based on estimates of known environmental
remediation exposure using currently available facts, existing environmental
permits and technology and presently enacted laws and regulations. The Company's
estimates of costs are developed based on internal evaluations and, when
necessary, recommendations from external environmental consultants. Such
accruals are recorded when it is probable that the Company will be obligated to
pay amounts for environmental site evaluation, remediation or related costs, and
such amounts can be reasonably estimated. If the obligation can only be
estimated within a range, the Company accrues the minimum amount in the range.
Such accruals are recorded even if significant uncertainties exist over the
ultimate cost of the remediation. Ongoing environmental compliance costs,
including maintenance and monitoring costs, are expensed as incurred. Where the
Company has been identified as a potentially responsible party in a United
States federal "Superfund" site, the Company accrues its share of the estimated
remediation costs of the site based on the ratio of the estimated volume of
waste contributed to the site by the Company to the total volume of waste at the
site.

STOCK BASED COMPENSATION

The Company accounts for its stock based compensation using the intrinsic
value method of accounting in accordance with Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25"). Under
this method, no compensation expense is recognized when the number of shares
granted are known and the exercise price of the employee stock option is equal
to or greater than the market price of the Company's common stock on the grant
date.

FOREIGN CURRENCY TRANSLATION

The majority of the Company's foreign subsidiaries have designated the local
currency as their functional currency and, as such, gains and losses resulting
from balance sheet translation of foreign operations are included as a separate
component of accumulated other comprehensive loss within stockholders' equity.
For those foreign subsidiaries that have designated the U.S. Dollar as the
functional currency, gains and losses resulting from balance sheet translation
of foreign operations are included in the consolidated statements of operations
as incurred.

DERIVATIVE FINANCIAL INSTRUMENTS

The Company monitors its exposure to various business risks including
commodity price, foreign exchange rate and interest rate risks and occasionally
uses derivative financial instruments to manage the impact of certain of these
risks. The Company's policies do not permit the use of derivative financial
instruments for speculative purposes. The Company uses forward exchange
contracts and currency swaps to hedge certain firm commitments and transactions
denominated in foreign currencies. The Company uses interest rate swaps to
manage interest rate risk. The Company also uses crude oil swaps and collars to
hedge price risk associated with the Company's crude oil production.

On January 1, 2001, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging
Activities, as amended by SFAS Nos. 137 and 138. SFAS No. 133 establishes
accounting and reporting standards for derivative instruments and hedging
activities that require an entity to recognize all derivatives as an asset or
liability measured at fair value. Depending on the intended use of the
derivative and its effectiveness, changes in its fair value will be reported in
the period of change as either a component of earnings or a component of
accumulated other comprehensive loss. The adoption of SFAS No. 133 on January 1,
2001 resulted in a gain of $0.8 million, net of tax, recorded as the cumulative
effect of an accounting change in the consolidated statement of operations and a
gain of $1.2 million, net of tax, recorded in accumulated other comprehensive
loss. During 2001, all of the $1.2 million gain was reclassified into earnings
upon maturity of the contracts.

To qualify for hedge accounting, the derivative must qualify either as a
fair value hedge, cash flow hedge or a hedge of the net investment in foreign
operations. A fair value hedge is a hedge of a recognized asset or liability or
an unrecognized firm commitment. Both the effective and ineffective portions of
the changes in the fair value

37

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

of the derivative, along with the gain or loss on the hedged item, are recorded
in earnings and reported in the consolidated statements of operations on the
same line as the hedged item. A cash flow hedge is a hedge of a forecasted
transaction or the variability of cash flows to be received or paid in the
future related to a recognized asset or liability. The effective portion of the
changes in the fair value of the derivative is recorded in accumulated other
comprehensive loss. When the hedged item is realized, the gain or loss included
in accumulated other comprehensive loss is reported on the same line in the
consolidated statements of operations as the hedged item. In addition, both the
fair value changes excluded from the Company's effectiveness assessments and the
ineffective portion of the changes in the fair value of derivatives used as cash
flow hedges are immediately recognized in earnings. The Company is not currently
hedging any of its net investments in foreign operations.

At the inception of any new derivative, the Company designates the
derivative as a cash flow hedge or fair value hedge. The Company documents all
relationships between hedging instruments and the hedged items, as well as its
risk management objectives and strategy for undertaking various hedge
transactions. The Company assesses whether the derivatives that are used in
hedging transactions are highly effective in offsetting changes in cash flows of
the hedged item at both the inception of the hedge and on an ongoing basis.

NEW ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, Business Combinations. SFAS No. 141 requires that all business
combinations initiated after June 30, 2001 be accounted for under the purchase
method of accounting and addresses the initial recognition and measurement of
goodwill and other intangible assets acquired in a business combination.
Business combinations accounted for under the pooling of interests method prior
to June 30, 2001 were not changed. The adoption of SFAS No. 141 by the Company
did not have an impact on the consolidated financial statements of the Company.

In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets. SFAS No. 142 addresses the initial recognition and measurement of
intangible assets acquired in a business combination and the accounting for
goodwill and other intangible assets subsequent to their acquisition. SFAS No.
142 provides that intangible assets with finite useful lives be amortized and
that goodwill and intangible assets with indefinite lives not be amortized, but
rather be tested at least annually for impairment. SFAS No. 142 requires that a
transitional impairment test be performed within six months of adoption and any
transitional impairment loss will be recognized as the cumulative effect of a
change in accounting principle. The Company will adopt SFAS No. 142 effective
January 1, 2002. The cessation of amortization expense related to goodwill and
goodwill associated with equity method investments under the guidelines of SFAS
No. 142 will result in a reduction of approximately $52.5 million in annual
amortization expense in 2002. The Company has not completed its analysis of the
impact of the adoption of SFAS No. 142 as it relates to the possible impairment
of goodwill.

In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 addresses financial accounting and reporting for
obligations associated with the retirement of long-lived assets and the
associated asset retirement costs. SFAS No. 143 requires that the fair value of
a liability associated with an asset retirement be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated retirement costs are capitalized as part of the carrying amount of
the long-lived asset and subsequently depreciated over the life of the asset.
The Company has not completed its analysis of the impact, if any, of the
adoption of SFAS No. 143 on its consolidated financial statements. The Company
will adopt SFAS No. 143 for its fiscal year beginning January 1, 2003.

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. SFAS No. 144 addresses the financial
accounting and reporting for the impairment or disposal of long-lived assets.
SFAS No. 144 replaces SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of. SFAS No. 144 provides
updated guidance concerning the recognition and measurement of an impairment
loss for certain types of long-lived assets and modifies the accounting and
reporting of discontinued operations. SFAS No. 144 is not expected to materially
change the methods used by the Company to measure impairment losses on
long-lived assets, but may result in future dispositions being reported as
discontinued operations to a greater extent than is currently permitted. The
Company will adopt SFAS No. 144 for its fiscal year beginning January 1, 2002.

38

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

RECLASSIFICATIONS

Certain reclassifications have been made to the prior years' consolidated
financial statements to conform with the current year presentation.

NOTE 2. UNUSUAL ITEMS

2001

During 2001, the Company incurred items resulting in a net unusual charge of
$1.6 million. Unusual items included charges of $9.2 million offset by credits
of $7.6 million. The table set forth below summarizes these transactions:

The severance relates to the restructuring of the German operations of BIRD
Machine, a division of the Process segment. The employee groups to be terminated
will be engineering, field service and support personnel. The amount accrued for
severance is based upon the positions eliminated and the Company's specific or
statutory severance plans in place for these operations and does not include any
portion of the employees' salary through their severance dates. Based on current
estimates, the Company expects that the remainder of the accrued severance will
be paid during 2002 or when the employees leave the Company.

During 2001, the Company recorded an unusual credit of $4.2 million as a
reduction to an unusual charge accrual recorded in 2000 to reflect the current
estimate of remaining expenditures. The reduction related to adjustments to its
estimated costs to settle contractual obligations based on new events and
information. The Company recognized a gain of $3.4 million on the disposition of
its interest in a joint venture within the Oilfield segment and received net
proceeds of $6.0 million from this transaction. These items are reflected as
unusual credits in the consolidated statement of operations.

39

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

2000

During 2000, the Company incurred items resulting in a net unusual charge of
$69.6 million. Unusual items included charges of $111.0 million offset by
credits of $41.4 million. The table set forth below summarizes these
transactions:

In October 2000, the Company's Board of Directors approved the Company's
plan to substantially exit the oil and gas exploration business. The Company
sold its interests in its China, Gulf of Mexico and Gabon oil and gas properties
and recorded a loss of $75.5 million on the sale of these properties. Net
proceeds from these sales were $53.4 million and were used to repay outstanding
indebtedness. The Company also wrote off its remaining undeveloped exploration
properties in other foreign jurisdictions resulting in a loss of $16.2 million.
The Company accrued cash charges of $13.3 million for costs resulting from
exiting the business, including severance and other employee-related costs and
costs to settle contractual obligations. The employee groups to be terminated
will be executive, engineering, field service and support personnel. The amount
accrued for severance is based upon the positions eliminated and the Company's
specific or statutory plans in place for these operations and does not include
any portion of the employees' salary through their severance dates. Based on
current estimates, the Company expects that the remainder of the accrued
severance will be paid during 2002 or as the employees leave the Company. The
contractual obligations will be paid as the Company settles with the various
counterparties.

The Company incurred fees of $6.0 million in connection with the formation
of Western GECO, a venture formed by the Company in 2000.

During 2000, the Company recorded an unusual credit of $28.5 million as net
reductions to unusual charge accruals recorded in 1999 and prior years to
reflect current estimates of remaining expenditures. The net reductions
primarily related to severance accruals, legal accruals and accruals for lease
obligations. In addition, the Company recognized gains of $12.9 million on the
sale of various product lines within the Oilfield and Process segments. The
Company received net proceeds from these sales of $41.7 million. These items are
reflected as unusual credits in the consolidated statement of operations.

40

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

1999

As a result of continuing low activity levels, predominantly for the
Company's seismic products and services, the Company recorded charges during the
fourth quarter of 1999 totaling $122.8 million as summarized below:

The employee groups to be terminated were executive, marketing, field
service and support personnel of which substantially all were either terminated
by the Company or transferred as of December 31, 2000 to Western GECO. The
amount accrued for severance was based upon the positions eliminated and the
Company's specific or statutory severance plans in place for these operations
and did not include any portion of the employees' salary through their severance
dates.

The Company accrued $36.0 million related to expected costs to settle
contractual obligations based upon management's decision to reduce or abandon
certain operations and based on the terms of the applicable agreements. These
costs consisted primarily of the cost of terminating leases on certain marine
vessels that were taken out of service and removed from the fleet.

The impairment of property included the write-off or write-down of certain
assets utilized in the Company's seismic business. These assets were scrapped or
otherwise disposed of and consisted of $51.1 million of land and marine
recording equipment, $1.4 million of data processing equipment and $19.6 million
of marine vessels that were sold or otherwise abandoned. Write-down amounts were
generally determined by use of internal appraisal techniques to assess the
estimated fair value to be realized upon disposal.

During 1999, the Company realized unusual gains totaling $54.8 million. The
Company sold two large excess real estate properties and realized net gains
totaling $39.5 million. The Company received net proceeds of $68.1 million. In
addition, the Company sold certain assets related to its previous divestiture of
a joint venture and realized a net gain of $15.3 million.

During 1999, the Company reviewed the remaining balances of the accruals for
merger and unusual cash charges recorded in 1998 and prior years and made net
reductions of $13.0 million to reflect the current estimates of remaining
expenditures. These net reductions included reversals of previously recorded
accruals that will not be utilized and that relate primarily to severance
accruals and lease obligations. In addition, for accruals related to certain
terminated lease obligations, revisions were made to increase previously
recorded amounts based on current information and estimates of expected cash
flows related to these leases.

The unusual items described above were reflected in the following captions
of the consolidated statement of operations for the year ended December 31,
1999:

41

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 3. INCOME TAXES

The provision for income taxes is comprised of the following for the years
ended December 31:

The geographic sources of income before income taxes, extraordinary loss and
cumulative effect of accounting changes are as follows for the years ended
December 31:

Tax benefits of $5.5 million, $5.8 million and $4.2 million associated with
the exercise of employee stock options were allocated to equity and recorded in
capital in excess of par value in the years ended December 31, 2001, 2000 and
1999, respectively.

The provision for income taxes differs from the amount computed by applying
the U.S. statutory income tax rate to income before income taxes, extraordinary
loss and cumulative effect of accounting changes for the reasons set forth below
for the years ended December 31:

During 2001, incremental taxes of $14.8 million from the Western GECO
venture arose due to unbenefitted foreign losses and due to taxes assessed in
jurisdictions on a deemed profit basis. In addition, a current year benefit of
$23.5 million was recognized as a result of the settlement of the Internal
Revenue Service ("IRS") examination of certain 1994 through 1997 pre-acquisition
tax returns and related refund claims of Western Atlas, Inc. The Company
recognized interest income of $5.4 million associated with this settlement.

During 2000, as a result of the repatriation of the proceeds from the
formation of the Western GECO venture, the Company incurred $3.4 million of
foreign withholdings and other taxes and provided $6.0 million of additional
U.S. taxes. In addition, the formation of the venture reduced the expected
amount of foreign source income available in the future to utilize the Company's
foreign tax credit carryover; accordingly, the Company provided $35.6 million
for additional U.S. taxes with respect to future repatriation of earnings
necessary to utilize the foreign tax credit carryover. Such amounts, aggregating
$45.0 million, are presented in the above income tax rate reconciliation table
under the caption "Formation-related taxes for Western GECO."

42

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

During 1999, the Company recognized a tax benefit of $18.1 million through
the reversal of previously provided deferred taxes after settling the IRS
examination of its 1994 and 1995 U.S. tax years.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes, as well as operating loss
and tax credit carryforwards. The tax effects of the Company's temporary
differences and carryforwards are as follows at December 31:

A valuation allowance is recorded when it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The ultimate
realization of the deferred tax assets depends on the ability to generate
sufficient taxable income of the appropriate character in the future and in the
appropriate taxing jurisdictions. The Company has provided a valuation allowance
for operating loss carryforwards in certain non-U.S. jurisdictions where its
operations have decreased, currently ceased or the Company has withdrawn
entirely.

Provision has been made for U.S. and additional foreign taxes for the
anticipated repatriation of certain earnings of foreign subsidiaries of the
Company. The Company considers the undistributed earnings of its foreign
subsidiaries above the amount already provided to be indefinitely reinvested.
These additional foreign earnings could become subject to additional tax if
remitted, or deemed remitted, as a dividend; however, the additional amount of
taxes payable is not practicable to estimate.

At December 31, 2001, the Company had approximately $104.1 million of
foreign tax credits and $61.3 million of general business credits available to
offset future payments of federal income taxes, expiring in varying amounts
between 2004 and 2022. The Company's $21.5 million alternative minimum tax
credits carryforward may be carried forward indefinitely under current U.S. law.
The operating loss carryforwards without a valuation allowance will expire in
varying amounts over the next twenty years.

43

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

NOTE 4. EARNINGS PER SHARE

A reconciliation of the number of shares used for the basic and diluted
earnings per share ("EPS") computations is as follows for the years ended
December 31:

NOTE 5. INVENTORIES

Inventories are comprised of the following at December 31:

NOTE 6. INVESTMENTS IN AFFILIATES

The Company has investments in affiliates that are accounted for using the
equity method of accounting. The most significant of these affiliates is Western
GECO, which was formed on November 30, 2000 between the Company and Schlumberger
Limited ("Schlumberger"), and certain wholly owned subsidiaries of Schlumberger,
with the Company and Schlumberger owning 30% and 70% of the venture,
respectively. The Company contributed certain assets of its Western Geophysical
division with a net book value of $1.1 billion, consisting primarily of
multiclient seismic data and property and $15.0 million in working capital to
Western GECO. The Company did not recognize any gain or loss resulting from the
initial formation of the venture due to the Company's material continued
involvement in the operations of Western GECO. The Company incurred fees and
expenses of approximately $16.6 million in connection with the transaction. Of
this total, $10.6 million of direct costs were capitalized to the Company's
investment and $6.0 million were recorded as an unusual charge in the Company's
consolidated statement of operations for the year ended December 31, 2000.

In conjunction with the transaction, the Company received $493.4 million in
cash from Schlumberger in exchange for the transfer of a portion of the
Company's ownership in Western GECO. Additionally, as soon as practicable after
November 30, 2004, the Company or Schlumberger will make a cash true-up payment
to the other party based on a formula comparing the ratio of the net present
value of sales revenue from each party's contributed multiclient seismic data
libraries during the four-year period ending November 30, 2004 and the ratio of
the net book value of those libraries as of November 30, 2000. The maximum
payment that either party will be required to make as a result of this
adjustment is $100.0 million. In conjunction with the formation of Western GECO,
the Company transferred to the venture a lease on a seismic vessel. The Company
is the sole guarantor of this lease obligation; however, Schlumberger has
indemnified the Company for 70% of the total lease obligation. At December 31,
2001, the remaining commitment under this lease is $96.4 million. The Company
also entered into an agreement with Western GECO whereby Western GECO subleased
a facility from the Company for a period of ten years at current market rates.
During 2001, the Company received $5.9 million of rental income from Western
GECO.

Included in the caption "Equity in income (loss) of affiliates" in the
Company's consolidated statement of operations for 2001 and 2000 was $10.3
million for asset impairment charges associated with Western GECO and $9.5
million for restructuring and integration charges associated with Western GECO,
respectively.

44

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

On October 30, 2001, the Company and Sequel Holdings, Inc. ("Sequel")
created an entity to operate under the name of Petreco International
("Petreco"). The Company contributed $16.6 million of net assets of the refining
and production product line of its Process segment to Petreco consisting
primarily of intangible assets, accounts receivable and inventories. In
conjunction with the transaction, the Company received $9.0 million in cash and
two promissory notes totaling $10.0 million. Petreco profits are shared by the
Company and Sequel in 49% and 51% interests, respectively. Sequel is entitled to
a liquidation preference upon the liquidation or sale of Petreco. The Company
accounts for its ownership in Petreco using the equity method of accounting and
did not recognize any gain or loss from the initial formation of the entity due
to the Company's material continued involvement in the operations of Petreco.

Summarized unaudited combined financial information for all equity method
affiliates is as follows as of December 31:

At December 31, 2001 and 2000, net accounts receivable from affiliates
totaled $33.5 million and $11.4 million, respectively. As of December 31, 2001
and 2000, the excess of the Company's investment over the Company's equity in
affiliates is $303.4 million and $291.5 million, respectively. This amount is
being amortized over 40 years and the amortization is included in the Company's
equity in income (loss) of affiliates.

NOTE 7. PROPERTY, GOODWILL AND OTHER INTANGIBLES

Property, plant and equipment is comprised of the following at December 31:

45

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Goodwill and other intangibles are as follows at December 31:

NOTE 8. INDEBTEDNESS

Total debt consisted of the following at December 31:

At December 31, 2001, the Company had $1,289.9 million of credit facilities
with commercial banks, of which $800.5 million were committed. The committed
facilities mature in September 2003. The Company's policy is to classify
commercial paper and short-term borrowings as long-term debt to the extent of
its committed facilities because the Company has the ability under these credit
agreements and the intent to maintain these obligations

46

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

for longer than one year. There were no borrowings under these credit facilities
during the years ended December 31, 2001 and 2000.

On May 25, 2001, the Company redeemed its outstanding LYONS at a redemption
price of $786.13 per $1,000 principal amount, for a total of $301.8 million. The
redemption was funded through the issuance of commercial paper. In connection
with the early extinguishment of debt, the Company recorded an extraordinary
loss of $2.3 million ($1.5 million after tax) which represents the write-off of
the remaining debt issuance costs.

Maturities of debt at December 31, 2001 are as follows: 2002 - $12.2
million; 2003 - $272.6 million; 2004 - $347.8 million; 2005 - $0.1 million; 2006
- - $0.0 million and $1,061.9 million thereafter.

NOTE 9. FINANCIAL INSTRUMENTS

FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company's financial instruments include cash and short-term
investments, receivables, payables, debt, interest rate swaps, crude oil
contracts and foreign currency contracts. Except as described below, the
estimated fair value of such financial instruments at December 31, 2001 and 2000
approximate their carrying value as reflected in the consolidated balance
sheets. The fair value of the Company's debt, interest rate swaps, crude oil
contracts and foreign currency contracts has been estimated based on year-end
quoted market prices.

The estimated fair value of the Company's debt at December 31, 2001 and
2000 was $1,761.7 million and $2,131.5 million, respectively, which differs from
the carrying amounts of $1,694.6 million and $2,062.9 million, respectively,
included in the consolidated balance sheets.

INTEREST RATE SWAPS

The Company entered into an interest rate swap agreement in February 1999
for a notional amount of $325.0 million. The Company receives interest at a rate
of 6.25% and pays interest at a rate equal to the average of 6-month LIBOR for
the Yen, Euro and Swiss Franc plus a 3.16% spread. The interest rate swap
settles semi-annually and terminates in January 2009.

The Company entered into a second interest rate swap agreement in June 2001
for a notional amount of $100.0 million on which the Company receives interest
at a rate of 7.875% and pays interest at a rate of three-month LIBOR plus a
spread of 2.7625%. The interest rate swap settles semi-annually and terminates
in June 2004.

In accordance with SFAS No. 133, these two interest rate swap agreements
have been designated and have qualified as fair value hedging instruments. They
were fully effective, resulting in no net gain or loss recorded in the
consolidated statement of operations in 2001. In the unlikely event that the
counterparty fails to meet the terms of the interest rate swap agreements, the
Company's exposure is limited to the interest rate differentials.

The fair value of these contracts at December 31, 2001 and 2000 was a $1.3
million recognized asset, under SFAS No. 133, and a $9.6 million unrecorded
liability, respectively.

CRUDE OIL CONTRACTS

During the year ended December 31, 2001, the Company entered into two crude
oil contracts to mitigate price risk associated with production from the
Company's interest in an oil producing property in Nigeria. Based on the
Company's outlook on crude oil prices, the Company elected to terminate these
contracts prior to their maturity date. Accordingly, the contracts were
terminated on October 3, 2001 and the Company received a cash payment of $4.4
million. In accordance with SFAS No. 133, the net gain recognized in earnings in
2001 from all crude oil contracts was $3.1 million and is reported in revenue in
the consolidated statement of operations.

47

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

During the year ended December 31, 2000, the Company had entered into two
crude oil contracts to mitigate price risk associated with the Company's
interest in an oil producing property in Nigeria. The fair value of these
contracts at December 31, 2000 was a $3.1 million unrecorded asset.

FOREIGN CURRENCY FORWARD CONTRACTS

At December 31, 2001, the Company had entered into foreign currency forward
contracts with notional amounts of $8.5 million, $1.0 million and $0.7 million
to hedge exposure to currency fluctuations in the Canadian Dollar, the
Indonesian Rupiah and the Euro, respectively. These contracts are cash flow
hedges. Based on year-end quoted market prices for contracts with similar terms
and maturity dates, no asset or liability was recorded as the forward price is
substantially the same as the contract price.

At December 31, 2000, the Company had entered into foreign currency forward
contracts with notional amounts of $50.0 million, $0.3 million and $0.2 million
to hedge against exposure to fluctuations in the British Pound, the South
African Rand and the Euro, respectively. The fair value of these forward
contracts at December 31, 2000, was a $1.5 million unrecorded asset.

The counterparties to the Company's forward contracts are major financial
institutions. 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, the
Company's exposure is limited to the foreign currency rate differential.

During 2001, the Company entered into several foreign currency contracts to
hedge exposure to currency fluctuations for specific transactions or balances.
The impact on the consolidated statement of operations was not significant for
these contracts either individually or in the aggregate.

CONCENTRATION OF CREDIT RISK

The Company sells its products and services to numerous companies in the
oil and gas industry. Although this concentration could affect the Company's
overall exposure to credit risk, management believes that the Company is exposed
to minimal risk since the majority of its business is conducted with major
companies within the industry. The Company performs periodic credit evaluations
of its customers' financial condition and generally does not require collateral
for its accounts receivable. In some cases, the Company will require payment in
advance or security in the form of a letter of credit or bank guarantee.

The Company maintains cash deposits with major banks that from time to time
may exceed federally insured limits. The Company periodically assesses the
financial condition of the institutions and believes that the risk of any loss
is minimal.

NOTE 10. SEGMENT AND RELATED INFORMATION

The Company currently has eight operating divisions that have separate
management teams and infrastructures that offer different products and services.
The divisions have been aggregated into two reportable segments, "Oilfield" and
"Process".

The Oilfield segment consists of six operating divisions - Baker Atlas,
Baker Hughes INTEQ, Baker Oil Tools, Baker Petrolite, Centrilift, and Hughes
Christensen - that manufacture and sell equipment and provide services used in
the drilling, completion, production and maintenance of oil and gas wells and in
reservoir measurement and evaluation. They have been aggregated because the
long-term financial performance of these divisions is affected by similar
economic conditions and the consolidated results are evaluated regularly by the
chief operating decision maker in deciding how to allocate resources and in
assessing performance. The principal markets for this segment include all major
oil and gas producing regions of the world, including North America, Latin
America, Europe, Africa, the Middle East and the Far East. Customers include
major multi-national, independent and national or state-owned oil companies. The
Oilfield segment also includes the Company's interest in an oil and gas property
in Nigeria and its investment in Western GECO and other less significant equity
method investments.

48

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The Process segment consists of two operating divisions - EIMCO Process
Equipment and BIRD Machine- that manufacture and sell process equipment for
separating solids from liquids and liquids from liquids through filtration,
sedimentation, centrifugation and flotation processes. The principal markets for
this segment include all regions of the world where there are significant
industrial and municipal wastewater applications and base metals activity.
Customers include municipalities, contractors, engineering companies and pulp
and paper, minerals, industrial and oil and gas producers. The Process segment
also includes the Company's investment in Petreco.

The accounting policies of each segment are the same as those described in
Note 1 of Notes to Consolidated Financial Statements. The Company evaluates the
performance of its segments based on income before income taxes, accounting
changes, unusual items and interest income and expense. Intersegment sales and
transfers are not significant.

Summarized financial information is shown in the following table. The
"Other" column includes corporate related items, results of insignificant
operations and, as it relates to segment profit (loss), income and expense not
allocated to reportable segments.

For the years ended December 31, 2001, 2000 and 1999, there were no
revenues attributable to one customer that accounted for more than 10% of total
revenues for any segment.

The following table presents the details of "Other" segment loss for the
years ended December 31:

49

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The following table presents the details of "Other" total assets at
December 31:

The following table presents consolidated revenues by country based on the
location of the use of the product or service for the years ended December 31:

The following table presents net property by country based on the location
of the asset at December 31:

* These assets represent marine seismic vessels, land crews and related
equipment that are mobile and move frequently between countries. Data
processing centers, land and buildings have been included in the countries
where these assets were located.

NOTE 11. EMPLOYEE STOCK PLANS

The Company has 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 or greater than the fair market value of
the stock at the date of grant. These stock options generally vest over three
years. Vested options are exercisable in part or in full at any time prior to
the expiration date of ten years from the date of grant. As of December 31,
2001, 7.6 million shares were available for future option grants.

50

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The following table summarizes the activity for the Company's stock option
plans (shares in thousands):

The following table summarizes information for stock options outstanding at
December 31, 2001 (shares in thousands):

The Company also has an employee stock purchase plan whereby eligible
employees may purchase shares of the Company's common stock at a price equal to
85% of the lower of the closing price of the Company's common stock on the first
or last trading day of the Company's fiscal year. A total of 1.5 million shares
are remaining for issuance under the plan. Employees purchased 0.6 million
shares in 2001, 1.1 million shares in 2000 and 1.5 million shares in 1999.

As allowed by SFAS No. 123, the Company has elected to continue to follow
APB No. 25 in accounting for its employee stock plans. Under APB No. 25, the
Company does not recognize compensation expense upon the issuance of its stock
options because the option terms are fixed and the exercise price is equal to or
greater than the market price of the underlying stock on the grant date.

51

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

SFAS No. 123 requires the disclosure of pro forma net income and EPS as if
the Company had adopted the fair value method as of January 1, 1995. Under SFAS
No. 123, the fair value of stock based awards to employees is calculated through
the use of option pricing models. These models also require subjective
assumptions, including future stock price volatility and expected time to
exercise, which greatly affect the calculated values. The Company's calculations
were made using the Black-Scholes option pricing model with the following
weighted average assumptions:

The weighted average fair values of options granted in 2001, 2000 and 1999
were $15.04, $11.15 and $11.77 per share, respectively. If the Company had
recognized compensation expense based on these values, the Company's net income
and EPS would have been reduced to the pro forma amounts indicated below:

These pro forma calculations may not be indicative of future amounts since
the pro forma disclosure does not apply to options granted prior to 1996 and
additional awards in future years are anticipated.

NOTE 12. EMPLOYEE BENEFIT PLANS

DEFINED BENEFIT PENSION PLANS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS

The Company has various noncontributory defined benefit pension plans
covering various domestic and foreign employees. Generally, the Company makes
annual contributions to the plans in amounts necessary to meet or exceed minimum
governmental funding requirements. The Company also provides certain
postretirement health care and life insurance benefits other than pensions
("Postretirement Benefits") to substantially all U.S. employees who retire and
have met certain age and service requirements. During 2001, the Company approved
amendments to the Postretirement Benefits plan for certain employees to enhance
their health care benefits, which will be effective January 1, 2002.

52

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The reconciliation of the beginning and ending balances of benefit
obligations and fair value of plan assets, and the funded status of the plans
are as follows for the years ended December 31:

Amounts recognized in the consolidated balance sheet are as follows at
December 31:

Actuarial assumptions used to determine costs and benefit obligation for
these plans are as follows for the years ended December 31:

53

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The components of net pension and postretirement costs are as follows for
the years ended December 31:

The projected benefit obligation, accumulated benefit obligation, and fair
value of plan assets for the pension plans with accumulated benefit obligations
in excess of plan assets were $116.7 million, $112.4 million and $72.3 million,
respectively, as of December 31, 2001, and $109.3 million, $99.9 million and
$66.8 million, respectively, as of December 31, 2000. The Company's
postretirement benefit plan is not funded.

Assumed health care cost trend rates have a significant effect on the
amounts reported for the Postretirement Benefits plan. As of December 31, 2001,
the health care cost trend rate was 7.3% for employees under age 65 and 8.3% for
participants over age 65 with each declining gradually each successive year
until it reaches 5.0% for both employees under age 65 and over age 65 in 2007.
The assumed health care cost trend rate used in measuring the accumulated
benefit obligation for Postretirement Benefits was adjusted in 2000. A
one-percentage-point change in assumed health care cost trend rates would have
the following effects:

DEFINED CONTRIBUTION PLANS

During the periods reported, generally all of the Company's U.S. employees
were eligible to participate in the Company sponsored Thrift Plan, which is a
401(k) plan under the Internal Revenue Code of 1986, as amended. The Company
sponsored Thrift Plan allows eligible employees to elect to contribute from 1%
to 15% of their salaries to an investment trust. Employee contributions are
matched in cash by the Company at the rate of $1.00 per $1.00 employee
contribution for the first 3% and $0.50 per $1.00 employee contribution for the
next 2% of the employee's salary. Such contributions vest immediately. In
addition, the Company makes a cash contribution for all eligible employees
between 2% and 5% of their salary depending on the employee's age. Such
contributions become fully vested to the employee after five years of
employment. The Thrift Plan provides for nine different investment options, for
which the employee has sole discretion in determining how both the employer and
employee contributions are invested. The Company's contribution to the Thrift
Plan and other defined contribution plans amounted to $63.7 million, $57.5
million and $55.5 million in 2001, 2000 and 1999, respectively.

For certain non-U.S. employees who are not eligible to participate in the
Thrift Plan, the Company provides a non-qualified defined contribution plan that
provides basically the same benefits as the Thrift Plan. In addition, the
Company provides a non-qualified supplemental retirement plan ("SRP") for
certain officers and employees whose benefits under the Thrift 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 matching and
base contributions pursuant to limitations. Both non-qualified plans are fully
funded and invested through trusts, the assets of which are included in the
Company's consolidated balance sheet. The Company's contributions to these
non-qualified plans were $4.2 million, $2.4 million and $2.0 million for 2001,
2000 and 1999, respectively.

54

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

POST EMPLOYMENT BENEFITS

During the periods reported, the Company provided certain postemployment
disability and medical benefits to substantially all qualifying former or
inactive U.S. employees. Disability income benefits ("Disability Benefits"),
available at the date of hire, are provided through a qualified plan which has
been funded by contributions from the Company and employees. The primary asset
of the plan is a guaranteed insurance contract with an insurance company. The
asset currently earns interest at 5.7%. The actuarially determined obligation is
calculated at a discount rate of 7.25%. Disability Benefits (income) expense was
$(1.9) million, $0.4 million and $1.3 million in 2001, 2000 and 1999,
respectively. The continuation of medical, life insurance and Thrift Plan
benefits while on disability and the service related salary continuance benefits
("Continuation Benefits") are also provided through a qualified plan. Expense
for Continuation Benefits, which is primarily interest cost on the projected
benefit obligation, was $2.7 million, $2.6 million and $5.9 million, for 2001,
2000 and 1999, respectively. During 2000, the Company changed its salary
continuance benefits to a non-service related plan.

The following table sets forth the funded status and amounts recognized in
the Company's consolidated balance sheets for Disability Benefits and
Continuation Benefits at December 31:

Health care cost assumptions used to measure the Continuation Benefits
obligation are similar to the assumptions used in determining the obligation for
postretirement health care benefits. A discount rate of 6.50% in 2001 and 7.25%
in 2000 was used in the accounting for Continuation Benefits.

NOTE 13. COMMITMENTS AND CONTINGENCIES

LEASES

At December 31, 2001, the Company had long-term non-cancelable operating
leases covering certain facilities and equipment. The minimum annual rental
commitments, net of amounts due under subleases, for each of the five years in
the period ending December 31, 2006 are $54.5 million, $47.8 million, $34.2
million, $23.1 million and $16.5 million, respectively, and $109.9 million in
the aggregate thereafter. The Company has not entered into any significant
capital leases.

In September 2000, the Company sold four facilities for approximately
$117.7 million. The proceeds were used to repay outstanding indebtedness. The
facilities were leased back from the purchaser over a period of 15 years at
current market rates. One of these facilities was subsequently subleased to
Western GECO at current market rates for a period of 10 years, in conjunction
with the formation of the venture.

LITIGATION

The Company and its subsidiaries are involved in litigation or proceedings
that have arisen in the Company's ordinary business activities. The Company
insures against these risks to the extent deemed prudent by its management, but
no assurance can be given that the nature and amount of such insurance will be
sufficient to fully indemnify the Company against liabilities arising out of
pending and future legal proceedings. Many of these insurance policies contain
self-insured retentions in amounts the Company deems prudent.

The Company has been named as a defendant in a number of shareholder class
action suits filed by purported shareholders shortly after the Company's
December 8, 1999 announcement regarding the accounting issues it discovered at
its INTEQ division. These suits, which seek unspecified monetary damages, have
been consolidated in

55

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

the federal district court for the Southern District of Texas pursuant to the
Private Securities Litigation Reform Act of 1995. The Company filed Motions to
Dismiss in both the shareholder derivative suit and the class action. The
federal district court granted the Company's Motions on both actions. No appeal
was filed in the shareholder derivative suit, but the class action case is
currently on appeal at the U. S. Fifth Circuit Court of Appeals. The Company
believes the allegations in these suits are without merit, and the Company
intends to vigorously defend these lawsuits. Even so, an adverse outcome in this
class action litigation could have an adverse effect on the Company's results of
operations or financial condition.

ENVIRONMENTAL MATTERS

The Company's past and present operations include activities which are
subject to extensive federal and state environmental regulations.

The Company has been identified as a potentially responsible party ("PRP")
in remedial activities related to various "Superfund" sites. Applicable United
States federal law imposes joint and several liability on each PRP for the
cleanup of these sites leaving the Company with the uncertainty that it may be
responsible for the remediation cost attributable to other PRPs who are unable
to pay their share of the remediation costs. Generally, the Company has
estimated its share of such total cost based on the ratio that the estimated
volume of waste contributed to the site by the Company bears to the total
estimated volume of waste disposed at the site. The Company has accrued what it
believes to have been its pro rata share of the total estimated cost of
remediation of these Superfund sites based upon such a volumetric calculation.
No accrual has been made under the joint and several liability concept since the
Company believes that the probability that it will have to pay material costs
above its volumetric share is remote. The Company believes there are other PRPs
who have greater involvement on a volumetric calculation basis, who have
substantial assets and who may be reasonably expected to pay their share of the
cost of remediation. In some cases, the Company has insurance coverage or
contractual indemnities from third parties to cover the ultimate liability.

At December 31, 2001 and 2000, the Company had accrued $17.6 million and
$14.1 million, respectively, for remediation costs, including the Superfund
sites referred to above. The measurement of the accruals for remediation costs
is subject to uncertainty, including the evolving nature of environmental
regulations and the difficulty in estimating the extent and type of remediation
activity that will be utilized. The Company believes that the likelihood of
material losses in excess of those amounts recorded is remote.

OTHER

In the normal course of business with customers, vendors and others, the
Company is contingently liable for performance under letters of credit and other
bank issued guarantees totaling approximately $187.8 million at December 31,
2001. The Company also had commitments outstanding for purchase obligations
related to capital expenditures and inventory under purchase orders and
contracts of approximately $138.2 million at December 31, 2001. In addition, at
December 31, 2001, the Company has guaranteed debt of third parties totaling
$36.9 million. It is not practicable to estimate the fair value of these
financial instruments and management does not expect any material losses from
these financial instruments. In conjunction with the formation of Western GECO,
the Company transferred to the venture a lease on a seismic vessel. The Company
is the sole guarantor of this lease obligation; however, Schlumberger has
indemnified the Company for 70% of the total lease obligation. At December 31,
2001, the remaining commitment under this lease is $96.4 million.

NOTE 14. OTHER SUPPLEMENTAL INFORMATION

Supplemental consolidated statement of operations information is as follows
for the years ended December 31:

56

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Supplemental consolidated statement of cash flows information is as follows
for the years ended December 31:

The formation of Petreco in 2001 and Western GECO in 2000 included the
following cash and noncash amounts for the year ended December 31:

NOTE 15. QUARTERLY DATA (UNAUDITED)

* See Note 2 for unusual charges.

** Represents revenues less cost of revenues.

57

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information concerning the directors of the Company is set forth in the
section entitled "Election of Directors" in the Proxy Statement of the Company
for the Annual Meeting of Stockholders to be held April 24, 2002, which section
is incorporated herein by reference. For information regarding executive
officers of the Company, see "Item 1. Business - Executive Officers." Additional
information regarding compliance by directors and executive officers with
Section 16(a) of the Securities Exchange Act of 1934, as amended, is set forth
under the section entitled "Compliance with Section 16(a) of the Securities
Exchange Act of 1934" in the Proxy Statement for the Annual Meeting of
Stockholders to be held on April 24, 2002, which section is incorporated herein
by reference.

ITEM 11. EXECUTIVE COMPENSATION

Information for this item is set forth in the section entitled "Executive
Compensation" in the Proxy Statement of the Company for the Annual Meeting of
Stockholders to be held April 24, 2002, which section is incorporated herein by
reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information concerning security ownership of certain beneficial owners and
management is set forth in the sections entitled "Voting Securities" and
"Security Ownership of Management" in the Proxy Statement of the Company for the
Annual Meeting of Stockholders to be held April 24, 2002, which sections are
incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information concerning certain relationships and related transactions with
management is set forth in the section entitled "Certain Relationships and
Related Transactions" in the Proxy Statement of the Company for the Annual
Meeting of Stockholders to be held April 24, 2002, which section is incorporated
herein by reference.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) List of Documents filed as part of this Report

(1) Financial Statements

All financial statements of the Registrant as set forth under
Item 8 of this Annual Report on Form 10-K.

(2) Financial Statement Schedules

Schedule II Valuation and Qualifying Accounts

58

(3) Exhibits

Each exhibit identified below is filed as a part of this report.
Exhibits designated with an "*" are filed as an exhibit to this
Annual Report on Form 10-K. Exhibits previously filed as
indicated below are incorporated by reference.

3.1 Restated Certificate of Incorporation (filed as Exhibit 3.1 to
Annual Report of Baker Hughes Incorporated on Form 10-K for
the year ended December 31, 1998).

3.2* Bylaws of Baker Hughes Incorporated restated as of
January 30, 2002.

3.3 Certificate of Amendment to Restated Certificate of
Incorporation (filed as Exhibit 4.2 to Baker Hughes
Incorporated Registration Statement on Form S-3 dated
September 27, 1999).

4.1 Rights of Holders of the Company's Long-Term Debt. The Company
has no long-term debt instrument with regard to which the
securities authorized thereunder equal or exceed 10% of the
total assets of the Company and its subsidiaries on a
consolidated basis. The Company agrees to furnish a copy of
its long-term debt instruments to the SEC upon request.

4.2 Restated Certificate of Incorporation (filed as Exhibit 3.1 to
Annual Report of Baker Hughes Incorporated on Form 10-K for
the year ended December 31, 1998).

4.3* Bylaws of Baker Hughes Incorporated restated as of January 30,
2002 (filed as Exhibit 3.2 of this Form 10-K).

4.4 Certificate of Amendment to Restated Certificate of
Incorporation (filed as Exhibit 4.2 to Baker Hughes
Incorporated Registration Statement on Form S-3 dated
September 27, 1999).

4.5 Indenture dated as of May 15, 1994 between Western Atlas Inc.
and The Bank of New York, Trustee, providing for the issuance
of securities in series (filed as Exhibit 4.6 to Annual Report
of Baker Hughes Incorporated on Form 10-K for the year ended
December 31, 1999).

10.1 Employment Agreement by and between Baker Hughes Incorporated
and Michael E. Wiley dated as of July 17, 2000 (filed as
Exhibit 10.1 to Quarterly Report of Baker Hughes Incorporated
on Form 10-Q for the quarter ended June 30, 2000).

10.2 Severance Agreement between Baker Hughes Incorporated and
Michael E. Wiley dated as of July 17, 2000 (filed as Exhibit
10.2 to Quarterly Report of Baker Hughes Incorporated on Form
10-Q for the quarter ended June 30, 2000).

10.3 Severance Agreement between Baker Hughes Incorporated and G.
Stephen Finley dated as of July 23, 1997 (filed as Exhibit
10.6 to Annual Report of Baker Hughes Incorporated on Form
10-K for the year ended September 30, 1997).

10.4 Severance Agreement between Baker Hughes Incorporated and
Andrew J. Szescila dated as of July 23, 1997 (filed as Exhibit
10.13 to Annual Report of Baker Hughes Incorporated on Form
10-K for the year ended September 30, 1997).

10.5 Form of Amendment 1 to Severance Agreement between Baker
Hughes Incorporated and each of G. Stephen Finley and Andrew
J. Szescila effective November 11, 1998 (filed as Exhibit 10.7
to Annual Report of Baker Hughes Incorporated on Form 10-K for
the year ended December 31, 1998).

10.6 Severance Agreement between Baker Hughes Incorporated and Alan
R. Crain, Jr. dated as of October 25, 2000 (filed as Exhibit
10.6 to Annual Report of Baker Hughes Incorporated on Form
10-K for the year ended December 31, 2000).

59

10.7 Severance Agreement between Baker Hughes Incorporated and Greg
Nakanishi dated as of November 1, 2000 (filed as Exhibit 10.7
to Annual Report of Baker Hughes Incorporated on Form 10-K for
the year ended December 31, 2000).

10.8 Agreement regarding restricted stock award issued to Michael
E. Wiley on August 15, 2000 in the amount of 150,000 shares of
Company Common Stock (filed as Exhibit 10.8 to Annual Report
of Baker Hughes Incorporated on Form 10-K for the year ended
December 31, 2000).

10.9 Agreement regarding supplemental restricted stock award issued
to Michael E. Wiley on August 15, 2000 in the amount of 83,000
shares of Company Common Stock (filed as Exhibit 10.9 to
Annual Report of Baker Hughes Incorporated on Form 10-K for
the year ended December 31, 2000).

10.10 Amended and Restated 1991 Employee Stock Bonus Plan of Baker
Hughes Incorporated (filed as Exhibit 10.15 to Annual Report
of Baker Hughes Incorporated on Form 10-K for the year ended
September 30, 1997), as amended by Amendment No. 1997-1 to the
Amended and Restated 1991 Employee Stock Bonus Plan (filed as
Exhibit 10.16 to Annual Report of Baker Hughes Incorporated on
Form 10-K for the year ended September 30, 1997) and as
amended by Amendment No. 1999-1 to the Amended and Restated
1991 Employee Stock Bonus Plan (filed as Exhibit 10.11 to
Annual Report of Baker Hughes Incorporated on Form 10-K for
the year ended December 31, 1998).

10.11 Restated 1987 Stock Option Plan of Baker Hughes Incorporated
(amended as of October 24, 1990) (filed as Exhibit 10.17 to
Annual Report of Baker Hughes Incorporated on Form 10-K for
the year ended September 30, 1997).

10.12 Baker Hughes Incorporated Supplemental Retirement Plan (filed
as Exhibit 10.14 to Annual Report of Baker Hughes Incorporated
on Form 10-K for the year ended September 30, 1997), as
amended by Amendment No. 1997-1 to the Baker Hughes
Incorporated Supplemental Retirement Plan (filed as Exhibit
10.20 to Annual Report of Baker Hughes Incorporated on Form
10-K for the year ended September 30, 1997) and as amended by
Amendment No. 1999-1 to the Baker Hughes Incorporated
Supplemental Retirement Plan (filed as Exhibit 10.16 to Annual
Report of Baker Hughes Incorporated on Form 10-K for the year
ended December 31, 1998).

10.13 Executive Severance Policy (filed as Exhibit 10.12 to Annual
Report of Baker Hughes Incorporated on Form 10-K for the year
ended December 31, 1999).

10.14 1993 Stock Option Plan (filed as Exhibit 10.18 to Annual
Report of Baker Hughes Incorporated on Form 10-K for the year
ended December 31, 1998), as amended by Amendment No. 1997-1
to the 1993 Stock Option Plan (filed as Exhibit 10.23 to
Annual Report of Baker Hughes Incorporated on Form 10-K for
the year ended September 30, 1997) and as amended by Amendment
No. 1999-1 to the 1993 Stock Option Plan (filed as Exhibit
10.20 to Annual Report of Baker Hughes Incorporated on Form
10-K for the year ended December 31, 1998).

10.15 1993 Employee Stock Bonus Plan (filed as Exhibit 10.21 to
Annual Report of Baker Hughes Incorporated on Form 10-K for
the year ended December 31, 1998), as amended by Amendment No.
1997-1 to the 1993 Employee Stock Bonus Plan (filed as Exhibit
10.25 to Annual Report of Baker Hughes Incorporated on Form
10-K for the year ended September 30, 1997) and as amended by
Amendment No. 1999-1 to the 1993 Employee Stock Bonus Plan
(filed as Exhibit 10.23 to Annual Report of Baker Hughes
Incorporated on Form 10-K for the year ended December 31,
1998).

10.16 Amended and Restated Director Compensation Deferral Plan
(filed as Exhibit 10.24 to Annual Report of Baker Hughes
Incorporated on Form 10-K for the year ended December 31,
1998).

10.17 1995 Employee Annual Incentive Compensation Plan (filed as
Exhibit 10.20 to Annual Report of Baker Hughes Incorporated on
Form 10-K for the year ended December 31, 1999), as amended by
Amendment No. 1997-1 to the 1995 Employee Annual Incentive
Compensation Plan (filed as Exhibit 10.25 to Annual Report of
Baker Hughes Incorporated on Form 10-K for the year ended
September 30, 1997), and as amended by Amendment No. 1999-1 to
the 1995 Employee Annual Incentive

60

Compensation Plan (filed as Exhibit 10.27 to Annual Report of
Baker Hughes Incorporated on Form 10-K for the year ended
December 31, 1998).

10.18 Long Term Incentive Plan (filed as Exhibit 10.31 to Annual
Report of Baker Hughes Incorporated on Form 10-K for the year
ended September 30, 1997), as amended by Amendment No. 1999-1
to Long Term Incentive Plan (filed as Exhibit 10.32 to Annual
Report of Baker Hughes Incorporated on Form 10-K for the year
ended December 31, 1998).

10.19 1998 Employee Stock Option Plan (filed as Exhibit 10.33 to
Annual Report of Baker Hughes Incorporated on Form 10-K for
the year ended December 31, 1998), as amended by Amendment No.
1999-1 to 1998 Employee Stock Option Plan (filed as Exhibit
10.34 to Annual Report of Baker Hughes Incorporated on Form
10-K for the year ended December 31, 1998).

10.20 Form of Credit Agreement, dated as of October 1, 1998, among
Baker Hughes Incorporated and fourteen banks for $750,000,000,
in the aggregate for all banks (filed as Exhibit 10.35 to
Annual Report of Baker Hughes Incorporated on Form 10-K for
the year ended December 31, 1998).

10.21 Form of Credit Agreement dated as of October 1, 1998 among
Baker Hughes Incorporated and fourteen banks for $250,000,000,
in the aggregate for all banks (filed as Exhibit 10.36 to
Annual Report of Baker Hughes Incorporated on Form 10-K for
the year ended December 31, 1998), as amended by Form of First
Amendment of Credit Agreement dated as of September 29, 1999
among Baker Hughes Incorporated and fourteen banks for
$250,000,000, in the aggregate for all banks (filed as Exhibit
10.29 to Annual Report of Baker Hughes Incorporated on Form
10-K for the year ended December 31, 1999) and as amended by
Form of Second Amendment of Credit Agreement dated as of
September 25, 2000 among Baker Hughes Incorporated and
fourteen banks for $250,000,000, in the aggregate for all
banks (filed as Exhibit 10.35 to Annual Report of Baker Hughes
Incorporated on Form 10-K for the year ended December 31,
2000).

10.22 Form of Stock Option Agreement for executives effective
January 26, 2000 (filed as Exhibit 10.36 to Annual Report of
Baker Hughes Incorporated on Form 10-K for the year ended
December 31, 2000).

10.23 Form of Stock Option Agreement for executive officers
effective October 1, 1998 (filed as Exhibit 10.37 to Annual
Report of Baker Hughes Incorporated on Form 10-K for the year
ended December 31, 2000).

10.24 Form of Nonqualified Stock Option Agreement for employees
effective October 1, 1998 (filed as Exhibit 10.39 to Annual
Report of Baker Hughes Incorporated on Form 10-K for the year
ended December 31, 1998).

10.25 Form of Nonqualified Stock Option Agreement for directors
effective October 25, 1998 (filed as Exhibit 10.39 to Annual
Report of Baker Hughes Incorporated on Form 10-K for the year
ended December 31, 2000).

10.26* Form of Nonqualified Stock Option Agreement for directors
effective October 25, 1995.

10.27* Form of Nonqualified Stock Option Agreement for employees
effective October 25, 1995.

10.28* Form of Incentive Stock Option Agreement for employees
effective October 25, 1995.

10.29 Agreement regarding restricted stock award issued to Alan R.
Crain, Jr. on October 25, 2000 in the amount of 7,500 shares
of Company Common Stock (filed as Exhibit 10.43 to Annual
Report of Baker Hughes Incorporated on Form 10-K for the year
ended December 31, 2000).

10.30 Agreement regarding restricted stock award issued to Greg
Nakanishi on November 1, 2000 in the amount of 5,000 shares of
Company Common Stock (filed as Exhibit 10.44 to Annual Report
of Baker Hughes Incorporated on Form 10-K for the year ended
December 31, 2000).

61

10.31 Agreement regarding restricted stock award issued to Andrew J.
Szescila on January 24, 2001 in the amount of 25,000 shares of
Company Common Stock (filed as Exhibit 10.45 to Annual Report
of Baker Hughes Incorporated on Form 10-K for the year ended
December 31, 2000).

10.32 Agreement and Plan of Merger among Baker Hughes Incorporated,
Baker Hughes Delaware I, Inc. and Western Atlas Inc. dated as
of May 10, 1998 (filed as Exhibit 2.1 to Form 8-K dated May
20, 1998).

10.33 Tax Sharing Agreement dated October 31, 1997, between Western
Atlas Inc. and UNOVA, Inc. (filed as Exhibit 10.19 to Western
Atlas Inc.'s Form 10-Q for the quarter ended September 30,
1997).

10.34 Employee Benefits Agreement dated October 31, 1997, between
Western Atlas Inc. and UNOVA, Inc. (filed as Exhibit 10.21 to
Western Atlas Inc.'s Form 10-Q for the quarter ended September
30, 1997).

10.35 Master Formation Agreement by and among the Company,
Schlumberger Limited and certain wholly owned subsidiaries of
Schlumberger Limited dated as of September 6, 2000 (filed as
Exhibit 2.1 to Form 8-K dated September 7, 2000).

10.36 Shareholders' Agreement by and among Schlumberger Limited,
Baker Hughes Incorporated and other parties listed on the
signature pages thereto dated November 30, 2000 (filed as
Exhibit 10.1 to form 8-K dated November 30, 2000).

10.37 Corporate Executive Loan Program (filed as Exhibit 10.50 to
Annual Report of Baker Hughes Incorporated on Form 10-K for
the year ended December 31, 1998).

10.38* Amendment 1 to Employment Agreement, effective April 25, 2001,
by and between Baker Hughes Incorporated and Michael E. Wiley;
Amendment 2 to Employment Agreement, effective December 5,
2001, by and between Baker Hughes Incorporated and Michael E.
Wiley and Amendment 3 to Employment Agreement, effective
December 5, 2001, by and between Baker Hughes Incorporated and
Michael E. Wiley.

10.39* Severance Agreement, dated as of July 23, 1997, by and between
Baker Hughes Incorporated and Edwin C. Howell, as amended by
Amendment 1 to Severance Agreement, effective November 11,
1998.

10.40* Severance Agreement, dated as of December 3, 1997, by and
between Baker Hughes Incorporated and Douglas J. Wall, as
amended by Amendment 1 to Severance Agreement, effective
November 11, 1998.

10.41* Form of Baker Hughes Incorporated Nonqualified Stock Option
Agreement for executive officers, dated January 24, 2001.

10.42* Form of Severance Agreement, dated as of March 1, 2001, by and
between Baker Hughes Incorporated and certain executives,
executed by James R. Clark (dated March 1, 2001) and William
P. Faubel (dated May 29, 2001).

10.43* Form of Baker Hughes Incorporated Nonqualified Stock Option
Agreement for employees, dated January 30, 2002.

10.44* Form of Baker Hughes Incorporated Incentive Stock Option
Agreement for employees, dated January 30, 2002.

10.45* Form of Stock Matching Agreement, executed on March 1, 2001,
by and between Baker Hughes Incorporated and James Roderick
Clark, as amended by Amendment 1 to Stock Matching Agreement,
with the Amendment effective March 6, 2002.

21.1 Subsidiaries of Registrant.

62

23.1 Consent of Deloitte & Touche LLP.

(b) Reports on Form 8-K

None.

63

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized on the 6th
day of March, 2002.

BAKER HUGHES INCORPORATED

By /s/ MICHAEL E. WILEY
-----------------------------------------
(Michael E. Wiley, Chairman of the Board,
President and Chief Executive Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.

64

/s/ H. JOHN RILEY, JR. Director March 6, 2002
- ---------------------------------------
(H. John Riley, Jr.)

/s/ CHARLES L. WATSON Director March 6, 2002
- ---------------------------------------
(Charles L. Watson)

65

BAKER HUGHES INCORPORATED

SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS

66

INDEX TO EXHIBITS