BAKER HUGHES INC - 10-Q Quarterly Report

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

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003

OR

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

Commission File Number 1-9397

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
(Address of Principal Executive Offices)

77027
(Zip Code)

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

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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES [X] NO [ ]

----------

As of August 1, 2003, the registrant has outstanding 334,695,802 shares of
Common Stock, $1 par value.

INDEX

1

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In millions, except per share amounts)
(Unaudited)

See accompanying notes to consolidated condensed financial statements.

2

BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED BALANCE SHEETS
(In millions)

See accompanying notes to consolidated condensed financial statements.

3

BAKER HUGHES INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)

See accompanying notes to consolidated condensed financial statements.

4

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

NOTE 1. GENERAL

NATURE OF OPERATIONS

Baker Hughes Incorporated ("Baker Hughes") is engaged primarily in the
oilfield services industry. Baker Hughes is a major supplier of wellbore related
products, technology services and systems to the oil and gas industry on a
worldwide basis and provides products and services for drilling, formation
evaluation, completion and production of oil and gas wells. Baker Hughes also
participates in the continuous process industry where it manufactures and
markets a broad range of continuous and batch centrifuges and specialty filters.

BASIS OF PRESENTATION

The unaudited consolidated condensed financial statements of Baker Hughes
and its subsidiaries (the "Company") included herein have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission.
Accordingly, certain information and disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. The Company believes that the presentations and
disclosures herein are adequate to make the information not misleading. The
unaudited consolidated condensed financial statements reflect all adjustments
(consisting of normal recurring adjustments) necessary for a fair presentation
of the interim periods. These unaudited consolidated condensed financial
statements should be read in conjunction with the Company's audited consolidated
financial statements included in its Annual Report on Form 10-K for the year
ended December 31, 2002. The results of operations for the interim periods are
not necessarily indicative of the results of operations to be expected for the
full year.

In the notes to the unaudited consolidated condensed financial statements,
all dollar and share amounts in tabulations are in millions of dollars and
shares, respectively, unless otherwise indicated.

NOTE 2. DISCONTINUED OPERATIONS

In November 2002, the Company sold EIMCO Process Equipment ("EIMCO"), a
division of the Process segment, and received total proceeds of $48.9 million,
of which $4.9 million was held in escrow pending completion of final adjustments
of the purchase price. In April 2003, all purchase price adjustments were
completed, resulting in the release of the escrow balance, of which $2.9 million
was returned to the buyer and $2.0 million was received by the Company. In the
first quarter of 2003, the Company also recorded an additional loss on sale due
to purchase price adjustments of $2.5 million, net of tax of $1.3 million.

In December 2002, the Company entered into exclusive negotiations for the
sale of the Company's interest in its oil producing operations in West Africa
and received $10.0 million as a deposit. The transaction was effective as of
January 1, 2003, and resulted in a gain on sale of $4.1 million, net of a tax
benefit of $0.2 million, recorded in the first quarter of 2003. The sales price
was $32.0 million and the Company received the remaining $22.0 million upon
closing, which occurred in April 2003.

5

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)

The Company has reclassified the consolidated financial statements for all
prior periods to present both of these operations as discontinued. Summarized
financial information from discontinued operations is as follows:

NOTE 3. ACQUISITIONS AND INVESTMENT IN AFFILIATES

In the second quarter of 2003, the Company made an acquisition within its
Oilfield segment for an aggregate purchase price of $12.6 million, of which $9.4
million was paid in cash. As a result of this acquisition, the Company recorded
approximately $2.0 million of goodwill. The purchase price is allocated based on
fair value of the acquisition. Pro forma results of operations have not been
presented because the effect of this acquisition was not material to the
Company's consolidated financial statements.

During the six months ended June 30, 2003, the Company invested cash of
$34.1 million in affiliates, of which $30.1 million related to the Company's 50%
interest in the QuantX Wellbore Instrumentation venture ("QuantX") with Expro
International ("Expro"), which occurred in the second quarter of 2003. The
venture is engaged in the permanent in-well monitoring market and was formed by
combining Expro's existing permanent monitoring business with one of the
Company's product lines. The Company accounts for its ownership in QuantX using
the equity method of accounting.

In the first quarter of 2002, the Company made three acquisitions within its
Oilfield segment for an adjusted aggregate purchase price of $51.7 million. As a
result of these acquisitions, the Company paid $38.8 million in cash and
recorded approximately $30.5 million of goodwill through June 30, 2002. The
purchase prices are allocated based on fair values of the acquisitions. The
purchase price of one of the acquisitions may be subject to change pending the
final outcome of arbitration proceedings. Pro forma results of operations have
not been presented because the effects of these acquisitions were not material
to the Company's consolidated financial statements on either an individual or
aggregate basis.

6

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)

NOTE 4. COMPREHENSIVE INCOME (LOSS)

Comprehensive income includes all changes in equity during a period except
those resulting from investments by and distributions to owners. The components
of the Company's comprehensive income, net of related tax, are as follows:

Total accumulated other comprehensive loss consisted of the following:

NOTE 5. STOCK-BASED COMPENSATION

As allowed for under Statement of Financial Accounting Standards ("SFAS")
No. 123, Accounting for Stock-Based Compensation, the Company has elected to
account 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. Under this method, no compensation
expense is recognized when the number of shares granted is known and the
exercise price of the stock option is equal to or greater than the market price
of the Company's common stock on the grant date. The Company has no compensation
expense associated with stock options included in net income but does have
compensation expense associated with restricted stock awards included in net
income.

If the Company had recognized compensation expense as if the fair value
based method had been applied to all awards as provided for under SFAS No. 123,
the Company's pro forma net income, earnings per share ("EPS") and stock-based
compensation cost would have been as follows:

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.

7

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)

NOTE 6. FINANCIAL INSTRUMENTS

In April 2003, the Company entered into an interest rate swap agreement for
a notional amount of $325.0 million associated with the Company's 6.25% Notes
due January 2009 that had been designated and had qualified as a fair value
hedging instrument. In June 2003, the Company terminated the interest rate swap
agreement and received proceeds of $15.5 million upon cancellation. This
deferred gain is being amortized as a reduction of interest expense over the
remaining life of the underlying debt security, which matures in January 2009.

At June 30, 2003, the Company had entered into several foreign currency
forward contracts with notional amounts aggregating $85.5 million to hedge
exposure to currency fluctuations in various foreign currencies, including the
British Pound Sterling , the Euro, the Norwegian Krone, the Brazilian Real and
the Indonesian Rupiah. These contracts are designated as fair value hedges.
Based on quoted market prices as of June 30, 2003 for contracts with similar
terms and maturity dates, the Company recorded a gain of $2.4 million to adjust
these foreign currency forward contracts to their fair market value. This gain
is included in selling, general and administrative expense in the consolidated
condensed statement of operations.

NOTE 7. RESTRUCTURING CHARGE REVERSAL

In 2001, the Company initiated a restructuring of its German operations of
BIRD Machine, a division of the Process segment. The restructuring consisted of
downsizing its German operations from a full manufacturing facility to an
assembly and repair facility. As a result, the Company recorded a charge of $6.0
million relating to expected severance for approximately 100 employees. The
employee groups that were terminated were comprised of engineering, field
service and support personnel. 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 terminated 67 employees and
paid $4.1 million of accrued severance in 2001 and 2002. The remaining accrual
of $1.9 million was reversed during the second quarter of 2002 due to
unanticipated voluntary terminations and more favorable separation payments than
had been originally estimated.

NOTE 8. EARNINGS PER SHARE

A reconciliation of the number of shares used for the basic and diluted EPS
calculation is as follows:

NOTE 9. INVENTORIES

Inventories are comprised of the following:

8

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)

NOTE 10. GOODWILL AND INTANGIBLE ASSETS

On January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other
Intangible Assets. The adoption of SFAS No. 142 required the Company to cease
amortizing goodwill and to perform a transitional impairment test of goodwill in
each of its reporting units as of January 1, 2002. The Company's reporting units
were based on its organizational and reporting structure. Corporate and other
assets and liabilities were allocated to the reporting units to the extent that
they related to the operations of those reporting units. Valuations of the
reporting units were performed by an independent third party. The goodwill in
both the EIMCO and BIRD Machine operating divisions of the Company's Process
segment was determined to be impaired using a combination of a market value and
discounted cash flows approach to estimate fair value. Accordingly, the Company
recognized transitional impairment losses of $42.5 million, net of tax of $20.4
million. The transitional impairment losses were recorded in the first quarter
of 2002 as the cumulative effect of accounting change in the consolidated
condensed statement of operations.

The changes in the carrying amount of goodwill (net of accumulated
amortization) for the six months ended June 30, 2003 relate to the Oilfield
segment and are as follows:

Balance as of December 31, 2002 $ 1,226.6
Goodwill acquired during the period 2.0
Translation adjustments and other 5.4
----------
Balance as of June 30, 2003 $ 1,234.0
==========

The Company has intangible assets which continue to be amortized and are
comprised of the following:

Amortization expense for intangible assets for the three months and six
months ended June 30, 2003 was $4.2 million and $7.5 million, respectively, and
is estimated to be $14.1 million for 2003. Estimated amortization expense for
each of the subsequent five fiscal years is expected to be within the range of
$11.0 million to $12.3 million.

NOTE 11. SEGMENT AND RELATED INFORMATION

The Company currently has seven operating divisions that have separate
management teams and are engaged in the oilfield services and continuous process
industries. The divisions have been aggregated into two reportable segments,
"Oilfield" and "Process". The consolidated results for these segments are
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance.

The Oilfield segment consists of six operating divisions - Baker Atlas,
Baker Oil Tools, Baker Petrolite, Centrilift, Hughes Christensen and INTEQ. They
have been aggregated into one reportable segment because they have similar
economic characteristics and because the long-term financial performance of
these divisions is affected by similar economic conditions. These six operating
divisions manufacture and sell products and provide services used in the oil and
gas exploration industry, including drilling, completion, production and
maintenance of oil and gas wells and in reservoir measurement and evaluation.
They also operate in the same markets and have substantially the same customers.
The principal markets for this segment include all major oil and gas producing
regions of the world, including North America, South 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 30% interest in WesternGeco, a seismic venture between
the Company and Schlumberger Limited ("Schlumberger"), and other similar
businesses.

9

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)

The Process segment consists of one operating division, BIRD Machine, and
the Company's investment in the Petreco venture, a venture between the Company
and Sequel Holdings, Inc. BIRD Machine manufactures and sells a broad range of
continuous and batch centrifuges and specialty filters for separating,
dewatering or classifying process and waste streams. The principal markets for
this segment include all regions of the world where there are significant
industrial, municipal and chemical wastewater applications. Customers include
municipalities, contractors, pharmaceuticals and industrial companies.

The Company evaluates the performance of its Oilfield and Process segments
based on income from continuing operations before income taxes, accounting
changes, restructuring charges or reversals 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. The "Other" column at December 31, 2002 also
includes assets of discontinued operations.

The following table presents the details of "Other" segment loss:

NOTE 12. GUARANTEES

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 which totaled approximately $219.1 million at June 30,
2003. In addition, at June 30, 2003, the Company has guaranteed debt and other
obligations of third parties totaling $123.3 million, which includes $90.6
million for a lease on a seismic vessel. This lease was transferred to
WesternGeco at the time of the formation of the venture and Schlumberger has
indemnified the Company for 70% of the total lease obligation.

The Company sells certain of its products to customers with a product
warranty that provides that customers can return a defective product during a
specified warranty period following the purchase in exchange for a replacement
product, repair at no cost to the customer or the issuance of a credit to the
customer. The Company accrues amounts for estimated warranty claims based upon
both current and historical product sales data and warranty costs incurred.

10

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)

The changes in the aggregate product warranty liabilities for the six months
ended June 30, 2003 are as follows:

Balance as of December 31, 2002 $ 12.2
Claims paid (2.1)
Additional warranties issued 2.5
Revisions in estimates for previously issued warranties (0.6)
Other 1.2
----------
Balance as of June 30, 2003 $ 13.2
==========

NOTE 13. NEW ACCOUNTING STANDARDS

Effective January 1, 2003, the Company adopted 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.
SFAS No. 143 requires that the fair value of a liability associated with an
asset retirement obligation ("ARO") be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The liability for
the ARO is revised each subsequent period due to the passage of time and changes
in estimates. The associated retirement costs are capitalized as part of the
carrying amount of the long-lived asset and subsequently depreciated over the
estimated useful life of the asset.

The adoption of SFAS No. 143 in the first quarter of 2003 resulted in a
charge of $5.6 million, net of tax of $2.8 million, recorded as the cumulative
effect of accounting change in the consolidated condensed statement of
operations. In conjunction with the adoption, the Company recorded ARO
liabilities of $11.4 million primarily for anticipated costs of obligations
associated with the future disposal of power source units at certain of its
Oilfield divisions and refurbishment costs associated with certain leased
facilities in Europe and with a fleet of leased railcars and tanks.

In November 2002, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 45 ("FIN 45"), Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others. FIN 45 elaborates on required disclosures by a guarantor in its
financial statements about obligations under certain guarantees that it has
issued and requires a guarantor to recognize, at the inception of certain
guarantees, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The adoption of the provisions of FIN 45 relating to the
initial recognition and measurement of guarantor liabilities, which were
effective for qualifying guarantees entered into or modified after December 31,
2002, did not have an impact on the consolidated condensed financial statements
of the Company. The Company adopted the new disclosure requirements in 2002.

In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
Consolidation of Variable Interest Entities. An entity is subject to the
consolidation rules of FIN 46 and is referred to as a variable interest entity
if the entity's equity investors lack the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its operations without additional financial support. FIN 46 applies
immediately to variable interest entities created or acquired after January 31,
2003. The Company has no such newly created or acquired entities. FIN 46 applies
after July 1, 2003, for variable interest entities created or acquired prior to
February 1, 2003. The Company is reviewing the provisions of FIN 46 but does not
expect the adoption to have a material impact, if any, on the consolidated
condensed financial statements.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, which amends and clarifies the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS
No. 149 is effective for contracts entered into or modified after June 30, 2003,
with some exceptions for hedging relationships designated after June 30, 2003.
The Company adopted SFAS No. 149 on July 1, 2003.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, which modifies
the accounting for certain financial instruments. SFAS No. 150 requires that
these financial instruments be classified as liabilities and applies immediately
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. The Company adopted SFAS No. 150 on July 1, 2003.

11

BAKER HUGHES INCORPORATED
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (CONTINUED)

NOTE 14. SUBSEQUENT EVENTS

In July 2003, the Company entered into a $500.0 million three-year committed
revolving credit facility (the "facility") to be used for commercial paper
backup and general corporate purposes. The facility replaces an aggregate of
$594.0 million in committed facilities which were to mature in September 2003
($56 million) and October 2003 ($538 million). The facility contains certain
covenants which, among other things, require the maintenance of a funded
indebtedness to total capitalization ratio, limit the amount of subsidiary
indebtedness and restrict the sale of significant assets, defined as 10% or more
of total consolidated assets. As of June 30, 2003, the Company has classified
commercial paper and $349.4 million of debt due within one year as long-term
debt to the extent of the facility because the Company has the ability under the
facility and the intent to maintain these obligations for longer than one year.

Also in July 2003, the Company entered into an interest rate swap agreement
for a notional amount of $325.0 million associated with the Company's 6.25%
Notes due January 2009. Under this agreement, the Company receives interest at a
fixed rate of 6.25% and pays interest at a floating rate of six-month LIBOR plus
a spread of 2.4425%. This interest rate swap will settle semi-annually and
terminates in January 2009. The interest rate swap agreement has been designated
and qualified as a fair value hedging instrument. The interest rate swap
agreement will be fully effective, resulting in no gain or loss recorded in the
consolidated condensed statement of operations. In the unlikely event that the
counterparty fails to meet the terms of the interest rate swap agreement, the
Company's exposure is limited to the interest rate differential.

12

ITEM 2. 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 Company's
consolidated condensed financial statements and the related notes thereto.

FORWARD-LOOKING STATEMENTS

MD&A and certain statements in the Notes to Consolidated Condensed 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," "if," "intend," "estimate," "project,"
"forecasts," "outlook," "will," "could," "would," "may," "likely" 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 risk factors: 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; the Company's ability to retain or increase its market share; world
economic conditions; the price of, and the demand for, crude oil and natural
gas; drilling activity; weather conditions that affect the demand for energy and
severe weather conditions, such as hurricanes, that affect exploration and
production activities; the legislative and regulatory environment in the U.S.
and other countries in which the Company operates; outcome of government and
internal investigations; Organization of Petroleum Exporting Countries ("OPEC")
policy and the adherence by OPEC nations to their OPEC productions quotas; war,
military action or extended period of international conflict, particularly
involving the U.S., Middle East or other major petroleum-producing or consuming
regions; any future acts of war, armed conflicts or terrorist activities; civil
unrest or in-country security concerns where the Company operates; the
development of technology by Baker Hughes or its competitors that lowers overall
finding and development costs; new laws and regulations that could have a
significant impact on the future operations and conduct of all businesses;
labor-related actions, including strikes, slowdowns and facility occupations;
the condition of the capital and equity markets in general; adverse foreign
exchange fluctuations and adverse changes in the capital markets in
international locations where the Company operates; and the timing of any of the
foregoing. See "Business Environment" for a more detailed discussion of certain
of these risk 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; and the need to
replace any unanticipated losses in capital assets.

BUSINESS ENVIRONMENT

The Company currently has seven operating divisions that have separate
management teams that are engaged in the oilfield services and continuous
process industries. The divisions have been aggregated into two reportable
segments - "Oilfield" and "Process".

The Oilfield segment consists of six operating divisions - Baker Atlas,
Baker Oil Tools, Baker Petrolite, Centrilift, Hughes Christensen and INTEQ -
that manufacture and sell products and provide services used in the oil and gas
exploration industry, including drilling, formation evaluation, completion and
production of oil and gas wells. The Oilfield segment also includes the
Company's 30% interest in WesternGeco, a seismic venture between the Company
and Schlumberger Limited ("Schlumberger"), and other similar businesses.

The Process segment consists of one operating division, BIRD Machine, and
the Company's investment in the Petreco venture, a venture between the Company
and Sequel Holdings, Inc. BIRD Machine manufactures and sells a broad range of
continuous and batch centrifuges and specialty filters for separating,
dewatering or classifying process and waste streams.

13

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 ("E&P")
of oil and gas reserves. These expenditures are influenced strongly by
expectations about the supply and demand for crude oil and natural gas products
and by the energy price environment.

The Company does business in approximately 70 countries. According to
Transparency International's annual Corruption Perceptions Index ("CPI") survey,
a high degree of corruption is perceived to exist in many of these countries.
For example, the Company does business in approximately one-half of the 30
countries having the worst scores in Transparency International's CPI survey for
2002. The Company devotes significant resources to the development, maintenance
and enforcement of its Business Code of Conduct policy, its Foreign Corrupt
Practices Act (the "FCPA") policy, its internal control processes and
procedures, as well as other compliance related policies. Notwithstanding the
devotion of such resources, and in part as a consequence thereof, the Company,
from time to time, discovers or receives information alleging potential
violations of the FCPA and the Company's policies, processes and procedures. The
Company conducts internal investigations of these potential violations. The
Company anticipates that the devotion of significant resources to compliance
related issues, including the necessity for such internal investigations, will
continue to be an aspect of doing business in a number of the countries in which
oil and gas exploration, development and production take place and the Company
is requested to conduct operations.

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

o Production control - the degree to which individual OPEC nations and other
large oil and gas producing countries, including, but not limited to,
Mexico, Norway and Russia, are willing and able to control production and
exports of crude oil, to decrease or increase supply and to support their
targeted oil price while meeting their market share objectives. Key measures
of production control include actual production levels compared with target
or quota production levels, oil price compared with targeted oil price and
changes in each country's market share.

o Global economic growth - particularly the impact of the U.S. and Western
European economies and the economic activity in Japan, China, South Korea
and the developing areas of Asia where the correlation between energy demand
and economic growth is strong. An important factor in the global economic
growth in 2003 will be the strength and timing of a U.S. economic recovery.
Key measures include U.S. and global economic activity, global energy demand
and forecasts of future demand by governments and private organizations.

o Oil and gas storage inventory levels - a measure of the balance between
supply and demand. A key measure of U.S. natural gas inventories is the
storage level reported weekly by the U.S. Department of Energy compared with
historic levels. Key measures for oil inventories include U.S. inventory
levels reported by the U.S. Department of Energy and American Petroleum
Institute and worldwide estimates reported by the International Energy
Agency, again compared with historic levels.

o Ability to produce natural gas - the amount of natural gas that can be
produced is a function of the number of new wells drilled, completed and
connected to pipelines as well as the rate of reservoir depletion and
production from existing wells. Advanced technologies, such as horizontal
drilling, result in improved total recovery, but also result in a more rapid
production decline.

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, recover more hydrocarbons and to do so at lower cost.
Also key are the overall levels of research and engineering spending and the
pace at which new technology is introduced commercially and accepted by
customers.

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. Key measures of access to
capital include cash flow, interest rates, analysis of oil and gas company
leverage and equity offering activity. Access to capital is particularly
important for smaller independent oil and gas companies.

o Energy prices and price volatility - the impact of widely fluctuating
commodity prices on the stability of the market and subsequent impact on
customer spending. Sustained higher energy prices can be an impediment to
economic growth. While current energy prices are important contributors to
positive cash flow at E&P companies, expectations for future prices are more
important for determining future E&P spending.

o Impact of energy prices and price volatility on demand for hydrocarbons -
short-term price changes can result in companies switching to the most
economic sources of fuel or temporary curtailment of demand while long-term
price changes can lead to

14

permanent changes in demand. Key indicators include hydrocarbon prices on a
Btu equivalent basis and indicators of hydrocarbon demand, such as
electricity generation or industrial production.

o Access to prospects - which are economically attractive to individual oil
and gas companies based on their expectations of required returns,
forecasted energy prices and required investment. Access to prospects may be
limited because host governments do not allow access to the reserves or
because another oil and gas company owns the rights to develop the prospect.

o Possible supply disruptions - from key oil exporting countries, including,
but not limited to, Iraq, Saudi Arabia or other Middle Eastern countries,
Nigeria and Venezuela, due to political instability, civil unrest or
military activity. In addition, adverse weather such as hurricanes could
impact production facilities, causing supply disruptions.

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. A
key measure of the impact of weather on energy demand is population-weighted
heating and cooling degree days as reported by the U.S. Department of Energy
and forecasts of warmer than normal or cooler than normal temperatures.

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. West
Texas Intermediate ("WTI") crude oil and U.S. Spot natural gas prices are
summarized in the table below as averages of the daily closing prices during
each of the periods indicated.

WTI crude oil prices averaged $29.02/bbl in the second quarter of 2003.
After falling into the high $20/bbl range in late March and early April due to
the beginning of conflict in Iraq and a growing belief that related supply
disruptions would be avoided, prices briefly crossed $30/bbl in mid-April before
falling to a quarter low of $25.24/bbl on April 29, 2003. Prices then rose
steadily, peaking at $32.36/bbl in mid-June before leveling off at around
$30/bbl for the remainder of the month. Modest increases in Iraqi oil production
have not negatively impacted the oil markets.

During the second quarter of 2003, natural gas prices averaged $5.64/MMBtu.
Natural gas prices rose from $4.90/MMBtu at the beginning of the quarter to a
high of $6.41/MMBtu in early June. Prices declined somewhat thereafter and ended
the quarter at $5.35/MMBtu. Following the end of the second quarter, prices fell
to approximately $5.00/MMBtu. During May and June, unseasonably cool weather and
higher gas prices resulted in reduced gas consumption and allowed storage
operators to make record injections narrowing the year-over-year deficit in
storage levels.

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 many of
the products and services provided 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, generally reflect the relative
strength and stability of energy prices.

The Company has been providing rig counts to the public since 1944. The
Company gathers all relevant data through its field service personnel worldwide
who obtain this information from routine visits to the various rigs, customers,
contractors, or other outside sources. This data is then compiled and
distributed to various wire services and trade associations and is published on
the Company's website. Rig counts are compiled weekly for the U.S. and Canada
and monthly for all international and workover rigs. North American rigs are
counted as active if the well being drilled has been started and drilling has
not been completed on the day the count is taken. For an international rig to be
counted as active on a monthly basis, drilling operations must comprise at least
15 days during the month. Published international rig counts do not include rigs
drilling in certain countries, such as Russia and onshore

15

China, because this information is extremely difficult to obtain. The Company's
rig counts are summarized in the table below as averages for each of the periods
indicated.

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 and gas demand, oil and gas prices and drilling activity.

Oil - The balance between oil supply and oil demand remained tight as the
third quarter of 2003 began. The supply disruptions caused by military action in
Iraq and the general strike in Venezuela in the first quarter tested, but did
not exceed, OPEC's ability to increase supply to stabilize the market. In the
second quarter, Venezuelan production increased but a significant Iraqi oil
production capability has yet to be restored. WTI crude oil prices are expected
to remain volatile and trade between $25/bbl and $34/bbl for the balance of
2003. Oil prices could move above this trading range if supply is disrupted
again in the Middle East, Africa or Venezuela. Oil prices could move below this
trading range if OPEC proves unwilling or unable to restrain production to match
market demand or if the U.S. and/or world economy slows.

North America Natural Gas - Prices are expected to trade between $4.00/MMBtu
and $6.00/MMBtu, as these prices must be sustained to discourage some industrial
demand and increase the amount of gas that can be injected into storage before
the start of the 2003/2004 heating season. Storage levels are expected to be at
normal levels at the start of the winter withdrawal season, traditionally in
early November. Gas prices could move to the top of this trading range and spike
above it if warmer than normal weather drives demand higher or if supply is
disrupted - e.g., by a Gulf of Mexico hurricane. Gas prices could move to the
bottom of this range if storage levels are high and demand does not increase as
prices fall.

Customer Spending - Based upon the Company's discussions with its major
customers, its review of published industry 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 increase approximately 10% to 15% in
2003 compared with 2002.

o Outside North America - Customer spending, primarily directed at
developing oil supplies, is expected to be flat to up by 5% in 2003
compared with 2002.

o Total spending is expected to be up 4% to 6% in 2003 compared with 2002.

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:

16

o The North American rig count is expected to increase approximately 8% to
10% in 2003 compared with 2002. The U.S. rig count is expected to remain
stable or increase slightly over the remainder of the year and end the
year at approximately 1,100 to 1,200 rigs.

o Drilling activity outside of North America, excluding Venezuela, is
expected to remain steady in 2003 and is expected to increase as much as
3% to 5% compared with 2002.

COMPANY OUTLOOK

The Company expects that 2003 will be stronger than 2002, with revenues
expected to increase by approximately 6% to 8% as compared with 2002, with
related improvements in operating results, primarily in the second half of the
year. Activity is expected to improve in the second half of 2003 as a result of
anticipated increased drilling activity in the U.S., primarily due to relatively
higher commodity prices. Activity outside of the U.S. is also expected to
increase as a result of the relatively high crude oil prices. The Company
expects the third quarter of 2003 activity to be up 1% to 3% compared with the
second quarter of 2003 due to improving international activity and seasonal
increases in Canadian activity.

In the first quarter of 2003, civil unrest related to electoral issues in
Nigeria resulted in a number of operators curtailing operations in Nigeria in
March 2003 and the delay of several export-direct customer orders for Nigerian
customers. Nigeria held national elections in April 2003 and activity stabilized
in the second quarter.

The military action in Iraq impacted the Company's operations in the Middle
East in the first quarter and resulted in delays affecting several export-direct
customer orders. The military action in Iraq entered a new phase in the second
quarter and the shipment of orders delayed in the first quarter was completed.

Activity in the North Sea, particularly in the U.K. sector, is expected to
be depressed for the next 12 to 18 months. As a result, the Company took steps
in the second quarter to reduce its cost structure in the North Sea. Although
activity is expected to increase seasonally, a meaningful increase in activity
levels is dependent upon a large number of assets being sold by the major oil
and gas companies to the independents.

NEW ACCOUNTING STANDARDS

Effective January 1, 2003, the Company adopted 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.
SFAS No. 143 requires that the fair value of a liability associated with an
asset retirement obligation ("ARO") be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The liability for
the ARO is revised each subsequent period due to the passage of time and changes
in estimates. The associated retirement costs are capitalized as part of the
carrying amount of the long-lived asset and subsequently depreciated over the
estimated useful life of the asset.

The adoption of SFAS No. 143 in the first quarter of 2003 resulted in a
charge of $5.6 million, net of tax of $2.8 million, recorded as the cumulative
effect of accounting change in the consolidated condensed statement of
operations. In conjunction with the adoption, the Company recorded ARO
liabilities of $11.4 million primarily for anticipated costs of obligations
associated with the future disposal of power source units at certain of its
Oilfield divisions and refurbishment costs associated with certain leased
facilities in Europe and with a fleet of leased railcars and tanks.

In November 2002, the Financial Accounting Standards Board ("FASB") issued
FASB Interpretation No. 45 ("FIN 45"), Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others. FIN 45 elaborates on required disclosures by a guarantor in its
financial statements about obligations under certain guarantees that it has
issued and requires a guarantor to recognize, at the inception of certain
guarantees, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The adoption of the provisions of FIN 45 relating to the
initial recognition and measurement of guarantor liabilities, which were
effective for qualifying guarantees entered into or modified after December 31,
2002, did not have an impact on the consolidated condensed financial statements
of the Company. The Company adopted the new disclosure requirements in 2002.

In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
Consolidation of Variable Interest Entities. An entity is subject to the
consolidation rules of FIN 46 and is referred to as a variable interest entity
if the entity's equity investors lack the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its operations without additional financial support. FIN 46 applies
immediately to variable interest entities created or

17

acquired after January 31, 2003. The Company has no such newly created or
acquired entities. FIN 46 applies after July 1, 2003, for variable interest
entities created or acquired prior to February 1, 2003. The Company is reviewing
the provisions of FIN 46 but does not expect the adoption to have a material
impact, if any, on the consolidated condensed financial statements.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, which amends and clarifies the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS
No. 149 is effective for contracts entered into or modified after June 30, 2003,
with some exceptions for hedging relationships designated after June 30, 2003.
The Company adopted SFAS No. 149 on July 1, 2003.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, which modifies
the accounting for certain financial instruments. SFAS No. 150 requires that
these financial instruments be classified as liabilities and applies immediately
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. The Company adopted SFAS No. 150 on July 1, 2003.

DISCONTINUED OPERATIONS

In November 2002, the Company sold EIMCO Process Equipment ("EIMCO"), a
division of the Process segment, and received total proceeds of $48.9 million,
of which $4.9 million was held in escrow pending completion of final adjustments
of the purchase price. In April 2003, all purchase price adjustments were
completed, resulting in the release of the escrow balance, of which $2.9 million
was returned to the buyer and $2.0 million was received by the Company. In the
first quarter of 2003, the Company also recorded an additional loss on sale due
to purchase price adjustments of $2.5 million, net of tax of $1.3 million.

In December 2002, the Company entered into exclusive negotiations for the
sale of the Company's interest in its oil producing operations in West Africa
and received $10.0 million as a deposit. The transaction was effective as of
January 1, 2003, and resulted in a gain on sale of $4.1 million, net of a tax
benefit of $0.2 million, recorded in the first quarter of 2003. The sales price
was $32.0 million and the Company received the remaining $22.0 million upon
closing, which occurred in April 2003.

The Company has reclassified the consolidated financial statements for all
prior periods to present both of these operations as discontinued. Summarized
financial information from discontinued operations is as follows:

18

RESULTS OF OPERATIONS

REVENUES

Revenues for the three months ended June 30, 2003 were $1,341.4 million, an
increase of 7.7% compared with the three months ended June 30, 2002. The Company
is primarily engaged in the oilfield service industry, which accounted for 98.0%
and 97.3% of total revenues for the three months ended June 30, 2003 and 2002,
respectively. Oilfield revenues were $1,314.8 million, an increase of 8.5%
compared with the three months ended June 30, 2002. Oilfield revenues in North
America, which account for 41.8% of total Oilfield revenues, increased 15.8% for
the three months ended June 30, 2003 compared with the three months ended June
30, 2002. This increase reflects increased activity in U.S. land operations and
Canada, as evidenced by a 29.0% increase in the North American rig count.
Outside North America, Oilfield revenues increased 3.8% for the three months
ended June 30, 2003 compared with the three months ended June 30, 2002. This
increase reflects the improvement in international drilling activity,
particularly in Latin America, the Middle East and Asia Pacific, partially
offset by weakening North Sea markets and price erosion in certain markets and
product lines.

Revenues for the six months ended June 30, 2003 were $2,567.9 million, an
increase of 4.9% compared with the six months ended June 30, 2002. Revenues were
positively impacted by the increased activity in North America, Latin America
and the Middle East, partially offset by the continued weakness in the North Sea
markets.

COST OF REVENUES

Cost of revenues for the three months ended June 30, 2003 was $970.7
million, an increase of 7.7% compared with the three months ended June 30, 2002.
Cost of revenues as a percentage of consolidated revenues was 72.4% for both the
three months ended June 30, 2003 and 2002. Cost of revenues for the six months
ended June 30, 2003 was $1,894.0 million, an increase of 6.6% compared with the
six months ended June 30, 2002. Cost of revenues as a percentage of consolidated
revenues was 73.8% and 72.6% for the six months ended June 30, 2003 and 2002,
respectively. The increase is primarily the result of pricing pressures and
changes in the geographic and product mix from the sale of the Company's
products and services.

SELLING, GENERAL AND ADMINISTRATIVE

Selling, general and administrative ("SG&A") expenses for the three months
ended June 30, 2003 were $213.4 million, a decrease of 2.9% compared with the
three months ended June 30, 2002. SG&A expenses as a percentage of consolidated
revenues for the three months ended June 30, 2003 and 2002 were 15.9% and 17.7%,
respectively. SG&A expenses for the six months ended June 30, 2003 were $415.2
million, a decrease of 2.3% compared with the six months ended June 30, 2002.
SG&A expenses as a percentage of consolidated revenues for the six months ended
June 30, 2003 and 2002 were 16.2% and 17.4%, respectively. These decreases were
primarily due to improvement in foreign exchange gains and losses partially
offset by higher marketing expenses.

RESTRUCTURING CHARGE

In 2001, the Company initiated a restructuring of its German operations of
BIRD Machine, a division of the Process segment. The restructuring consisted of
downsizing its German operations from a full manufacturing facility to an
assembly and repair facility. As a result, the Company recorded a charge of $6.0
million relating to expected severance for approximately 100 employees. The
Company terminated 67 employees and paid $4.1 million of accrued severance in
2001 and 2002. The remaining accrual of $1.9 million was reversed during the
second quarter of 2002 due to unanticipated voluntary terminations and more
favorable separation payments than had been originally estimated.

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 Company's most significant equity method investment is its 30% interest in
WesternGeco. The operating results of WesternGeco continue to be adversely
affected by the continuing weakness in the seismic industry. Accordingly, equity
in income (loss) of affiliates decreased $9.5 million for the three months ended
June 30, 2003 compared with the three months ended June 30, 2002, and decreased
$23.0 million for the six months ended June 30, 2003 compared with the six
months ended June 30, 2002.

19

INTEREST EXPENSE

Interest expense for the three months ended June 30, 2003 decreased $2.8
million compared with the three months ended June 30, 2002. The decrease was
primarily due to lower total debt levels resulting from the repayment of $100.0
million of long-term debt in February 2003 coupled with lower average interest
rates on interest rate swaps and amortization of deferred gains related to
terminated interest rate swaps.

Interest expense for the six months ended June 30, 2003 decreased $2.8
million compared with the six months ended June 30, 2002. The decrease was
primarily due to lower total debt levels coupled with lower average interest
rates on the Company's commercial paper and money market borrowings partially
offset by additional interest expense incurred related to the final settlement
of outstanding obligations with a venture partner. Total debt levels decreased
due to cash flow from operations and the repayment of $100.0 million of
long-term debt in February 2003. The approximate average interest rate on the
Company's commercial paper and money market borrowings was 1.3% for the six
months ended June 30, 2003 compared with 1.8% for the six months ended June 30,
2002.

INCOME TAXES

The Company's effective tax rate for the three and six months ended June 30,
2003 of 37% differs from the statutory income tax rate of 35% due to state
income taxes, differing rates of tax on international operations and higher
taxes within the WesternGeco venture that arose due to: (i) the venture being
taxed in certain foreign jurisdictions based on a deemed profit basis, which is
a percentage of revenues rather than profits, and (ii) unbenefitted foreign
losses of the venture, which are operating losses in certain foreign
jurisdictions where there was no current tax benefit and where a deferred tax
asset was not recorded due to the uncertainty of its realization.

CUMULATIVE EFFECT OF ACCOUNTING CHANGE

On January 1, 2003, the Company adopted 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.
SFAS No. 143 requires that the fair value of a liability associated with an
asset retirement obligation ("ARO") be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The liability for
the ARO is revised each subsequent period due to the passage of time and changes
in estimates. The associated retirement costs are capitalized as part of the
carrying amount of the long-lived asset and subsequently depreciated over the
estimated useful life of the asset.

The adoption of SFAS No. 143 in the first quarter of 2003 resulted in a
charge of $5.6 million, net of tax of $2.8 million, recorded as the cumulative
effect of accounting change in the consolidated condensed statement of
operations. In conjunction with the adoption, the Company recorded ARO
liabilities of $11.4 million primarily for anticipated costs of obligations
associated with the future disposal of power source units at certain of the
Oilfield divisions and refurbishment costs associated with certain leased
facilities in Europe and with a fleet of leased railcars and tanks.

On January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other
Intangible Assets. The adoption of SFAS No. 142 required the Company to cease
amortizing goodwill and to perform a transitional impairment test of goodwill in
each of its reporting units as of January 1, 2002. The Company's reporting units
were based on its organizational and reporting structure. Corporate and other
assets and liabilities were allocated to the reporting units to the extent that
they related to the operations of those reporting units. Valuations of the
reporting units were performed by an independent third party. The goodwill in
both the EIMCO and BIRD Machine operating divisions of the Company's Process
segment was determined to be impaired using a combination of a market value and
discounted cash flows approach to estimate fair value. Accordingly, the Company
recognized transitional impairment losses of $42.5 million, net of tax of $20.4
million. The transitional impairment losses were recorded in the first quarter
of 2002 as the cumulative effect of accounting change in the consolidated
condensed statement of operations.

LIQUIDITY AND CAPITAL RESOURCES

The Company's capital requirements have been principally related to working
capital needs, payment of dividends and long-term debt, repurchase of its common
stock and capital expenditures. These requirements have been met through a
combination of commercial paper borrowings, cash on hand and internally
generated funds.

In the six months ended June 30, 2003, net cash inflows from operating
activities of continuing operations totaled $121.3 million, a decrease of $61.1
million compared with the six months ended June 30, 2002. This decrease was
primarily due to lower income from continuing operations and an increase in
working capital due to increased activity.

20

Expenditures for capital assets totaled $151.0 million and $136.0 million
for the six months ended June 30, 2003 and 2002, respectively. The majority of
these expenditures were for machinery and equipment and rental tools. During the
six months ended June 30, 2003 and 2002, the Company received proceeds of $36.4
million and $37.1 million, respectively, from the disposal of assets.

During the six months ended June 30, 2003, the Company made an acquisition
within its Oilfield segment having an aggregate purchase price of $12.6 million,
of which $9.4 million was paid in cash. As a result of this acquisition, the
Company recorded approximately $2.0 million of goodwill. The purchase price is
allocated based on fair value of the acquisition. In addition, during the six
months ended June 30, 2003, the Company invested $34.1 million in affiliates, of
which $30.1 million related to the Company's 50% interest in the QuantX Wellbore
Instrumentation venture, which is engaged in the permanent in-well monitoring
market

In the second quarter of 2003, the Company received the remaining $22.0
million in proceeds from the sale of its interest in its oil producing
operations in West Africa.

During 2002, the Company's Board of Directors authorized the Company to
repurchase up to $275.0 million of its common stock. During the six months ended
June 30, 2003, the Company repurchased 2.5 million shares at an average cost of
$28.69 per share, for a total of $72.9 million. Upon repurchase, the shares were
retired. The Company has authorization remaining to repurchase up to $153.0
million in common stock.

In April 2003, the Company entered into an interest rate swap agreement for
a notional amount of $325.0 million associated with the Company's 6.25% Notes
due January 2009 that had been designated and had qualified as a fair value
hedging instrument. In June 2003, the Company terminated the interest rate swap
agreement and received proceeds of $15.5 million upon cancellation. This
deferred gain is being amortized as a reduction of interest expense over the
remaining life of the underlying debt security, which matures in January 2009.

Total debt outstanding at June 30, 2003 was $1,606.3 million, an increase of
$58.5 million compared with December 31, 2002. The Company repaid the $100.0
million 5.8% Notes due February 2003. The repayment was funded with cash on
hand, cash flow from operations and the issuance of commercial paper. The debt
to equity ratio was 0.46 at June 30, 2003 and December 31, 2002. The Company's
long-term objective is to maintain a debt to equity ratio between 0.40 and 0.60.

At June 30, 2003, the Company had $986.1 million of credit facilities with
commercial banks, of which $594.0 million was committed. The committed
facilities were to expire in September 2003 ($56 million) and October 2003 ($538
million). There were no direct borrowings under these facilities during the six
months ended June 30, 2003; however, to the extent the Company has outstanding
commercial paper, available borrowings under the committed credit facilities are
reduced. At June 30, 2003, the Company had $120.0 million in commercial paper
outstanding with a weighted average interest rate of 1.3%. At December 31, 2002,
the Company had no outstanding commercial paper.

In July 2003, the Company replaced its $594.0 million committed credit
facilities with a $500.0 million three-year committed revolving credit facility
(the "facility") to be used for commercial paper backup and general corporate
purposes. The facility contains certain covenants which, among other things,
require the maintenance of a funded indebtedness to total capitalization ratio,
limit the amount of subsidiary indebtedness and restrict the sale of significant
assets, defined as 10% or more of total consolidated assets. As of June 30,
2003, the Company has classified commercial paper and $349.4 million of debt due
within one year as long-term debt to the extent of the facility because the
Company has the ability under the facility and the intent to maintain these
obligations for longer than one year. Available borrowings under the facility
will be reduced to the extent the Company has outstanding commercial paper.

Cash flows from continuing operations and borrowings from short-term debt
and commercial paper are expected to be the principal sources of liquidity in
2003. The Company believes that cash flow from continuing operations, combined
with its new and 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 2003 capital expenditures to be between $310.0 million and $330.0
million, excluding acquisitions. The expenditures are expected to be used
primarily for normal, recurring items necessary to support the growth and
operations of the Company.

If the Company incurred a reduction in its debt ratings or stock price,
there are no provisions in the Company's debt or lease agreements that would
accelerate their repayment, require collateral or require material changes in
terms. 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.

21

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 which totaled approximately $219.1 million at June 30,
2003. In addition, at June 30, 2003, the Company has guaranteed debt and other
obligations of third parties totaling $123.3 million, which includes $90.6
million for a lease on a seismic vessel. This lease was transferred to
WesternGeco at the time of the formation of the venture and Schlumberger has
indemnified the Company for 70% of the total lease obligation.

The words "believes," "will," "would," "if," "to be," "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.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's operations are conducted around the world in a number of
different currencies. The majority of the Company's significant 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's objective is 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 June 30, 2003, the Company had entered into several foreign currency
forward contracts with notional amounts aggregating $85.5 million to hedge
exposure to currency fluctuations in various foreign currencies, including the
British Pound Sterling , the Euro, the Norwegian Krone, the Brazilian Real and
the Indonesian Rupiah. These contracts are designated as fair value hedges.
Based on quoted market prices as of June 30, 2003 for contracts with similar
terms and maturity dates, the Company recorded a gain of $2.4 million to adjust
these foreign currency forward contracts to their fair market value. This gain
is included in selling, general and administrative expense in the consolidated
condensed statement of operations.

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.

In April 2003, the Company entered into an interest rate swap agreement for
a notional amount of $325.0 million associated with the Company's 6.25% Notes
due January 2009 that had been designated and had qualified as a fair value
hedging instrument. In June 2003, the Company terminated the interest rate swap
agreement and received proceeds of $15.5 million upon cancellation. This
deferred gain is being amortized as a reduction of interest expense over the
remaining life of the underlying debt security, which matures in January 2009.

In July 2003, the Company entered into an interest rate swap agreement for a
notional amount of $325.0 million associated with the Company's 6.25% Notes due
January 2009. Under this agreement, the Company receives interest at a fixed
rate of 6.25% and pays interest at a floating rate of six-month LIBOR plus a
spread of 2.4425%. This interest rate swap will settle semi-annually and
terminates in January 2009. The interest rate swap agreement has been designated
and qualified as a fair value hedging instrument. The interest rate swap
agreement will be fully effective, resulting in no gain or loss recorded in the
consolidated condensed statement of operations. In the unlikely event that the
counterparty fails to meet the terms of the interest rate swap agreement, the
Company's exposure is limited to the interest rate differential.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this quarterly report, the Company
has evaluated the effectiveness of the design and operation of its disclosure
controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act
of 1934, as amended (the "Exchange Act"). This evaluation was carried out under
the supervision and with the participation of the Company's management,
including its principal executive officer and principal financial officer. Based
on this evaluation, these officers have concluded that the design and operation
of the Company's disclosure controls and procedures are effective. There were no
significant changes to the Company's internal controls or in other factors that
could significantly affect internal controls subsequent to the date of their
evaluation. No significant deficiencies or material weaknesses in the internal
controls were identified during the evaluation and, as a consequence, no
corrective action is required to be taken.

Disclosure controls and procedures are the Company's controls and other
procedures that are designed to ensure that information required to be disclosed
by the Company in the reports that the Company files or submits under the
Exchange Act, such as this Quarterly Report, is recorded, processed, summarized
and reported, within the time periods specified in the SEC's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required

22

to be disclosed by the Company in the reports that the Company files under the
Exchange Act is accumulated and communicated to the Company's management,
including its principal executive officer and principal financial officer, as
appropriate, to allow timely decisions regarding required disclosure.

23

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On March 25, 2002, a former employee alleging improper activities relating
to Nigeria filed a civil complaint against the Company in the 281st District
Court in Harris County, Texas, seeking back pay and damages, including future
lost wages. On August 2, 2002, the same former employee filed substantially the
same complaint against the Company in the federal district court for the
Southern District of Texas. The state court case has been stayed pending the
outcome of the federal suit. Discovery in the federal suit is in the preliminary
stages.

On March 29, 2002, the Company announced that it had been advised that the
Securities and Exchange Commission ("SEC") and the Department of Justice ("DOJ")
are conducting investigations into allegations of violations of law relating to
Nigeria and other related matters. The SEC has issued a formal order of
investigation into possible violations of provisions under the Foreign Corrupt
Practices Act ("FCPA") regarding anti-bribery, books and records and internal
controls, and the DOJ has asked to interview current and former employees. Prior
to the filing of the former employee's complaint, the Company had independently
initiated an investigation regarding its operations in Nigeria, which is
ongoing. The Company is providing documents to and cooperating fully with the
SEC and the DOJ.

The Company's ongoing internal investigation has identified apparent
deficiencies with respect to certain operations in Nigeria in its books and
records and internal controls, and potential liabilities to governmental
authorities in Nigeria. The investigation was substantially completed during the
first quarter of 2003. Based upon current information, the Company does not
expect that any such potential liabilities will have a material adverse effect
on the Company's results of operations or financial condition.

On August 6, 2003, the SEC issued a subpoena seeking information about the
Company's operations in Angola and Kazakhstan as part of its ongoing
investigation. The Company intends to provide documents and to cooperate with
the SEC. In addition, the Company is conducting an internal investigation into
these matters.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

The information concerning the matters submitted to a vote of the
stockholders and the voting results from the Company's Annual Meeting of
Stockholders held on April 23, 2003 was previously reported in response to Item
4 of Part II of the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 2003.

ITEM 5. OTHER INFORMATION

On July 29, 2003, the Company issued a press release announcing certain
management changes, a copy of which is filed with this Quarterly Report on Form
10-Q as Exhibit 99.1 and incorporated herein by reference.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits:

10.1 Form of Baker Hughes Incorporated Stock Option Award Agreement,
dated July 22, 2003 for employees and for directors and
officers.

10.2 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.

24

10.3 Baker Hughes Incorporated 1998 Employee Stock Option Plan, as
amended by Amendment No. 1999-1 to 1998 Employee Stock Option
Plan.

10.4 Form of Nonqualified Stock Option Agreement for employees
effective October 1, 1998.

10.5 Form of Credit Agreement dated July 7, 2003, among Baker Hughes
Incorporated and a syndicate of thirteen banks for $500,000,000
in the aggregate for all banks.

10.6 Interest Rate Swap Confirmation, dated July 30, 2003, and
Schedule to the Master Agreement (Multicurrency-Cross Border),
dated July 30, 2003.

31.1 Certification of Michael E. Wiley, Chief Executive Officer,
dated August 8, 2003, pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934, as amended.

31.2 Certification of G. Stephen Finley, Chief Financial Officer,
dated August 8, 2003, pursuant to Rule 13a-14(a) of the
Securities Exchange Act of 1934, as amended.

32 Statement of Michael E. Wiley, Chief Executive Officer, and G.
Stephen Finley, Chief Financial Officer, dated August 8, 2003,
furnished pursuant to Rule 13a-14(b) of the Securities Exchange
Act of 1934, as amended.

99.1 Press release of the Company dated July 29, 2003 regarding
certain management changes.

(b) Reports on Form 8-K:

A Current Report on Form 8-K was filed with the SEC on April 15, 2003,
to furnish under "Item 9. Regulation FD Disclosure" pursuant to "Item
12. Results of Operations and Financial Condition" (in accordance with
SEC Release No. 33-8216) the Company's updated outlook for the three
months ended March 31, 2003.

A Current Report on Form 8-K was filed with the SEC on April 25, 2003,
(a) to report under "Item 5. Other Events and Required FD Disclosure"
the preliminary results of the Company's Annual Meeting of Stockholders
and the election of certain members of the Board of Directors and
stockholder proposals and (b) to furnish under "Item 9. Regulation FD
Disclosure" pursuant to "Item 12. Results of Operations and Financial
Condition" (in accordance with SEC Release No. 33-8216) the Company's
announcement of financial results for the first quarter of 2003.

A Current Report on Form 8-K was filed with the SEC on July 8, 2003, to
report under "Item 5. Other Events and Required FD Disclosure" the
issuance of a press release whereby the Company announced that it had
entered into a $500 million three-year revolving credit facility to be
used for commercial paper backup and general corporate purposes.

A Current Report on Form 8-K was filed with the SEC on July 24, 2003,
to furnish under "Item 9. Regulation FD Disclosure" pursuant to "Item
12. Results of Operations and Financial Condition" (in accordance with
SEC Release No. 33-8216) the Company's announcement of financial
results for the second quarter of 2003.

25

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

BAKER HUGHES INCORPORATED
(REGISTRANT)

Date: August 8, 2003 By: /s/ G. STEPHEN FINLEY
-------------------------------------------
G. Stephen Finley
Sr. Vice President - Finance and
Administration and Chief Financial Officer

Date: August 8, 2003 By: /s/ ALAN J. KEIFER
-------------------------------------------
Alan J. Keifer
Vice President and Controller

26

EXHIBIT INDEX

10.1 Form of Baker Hughes Incorporated Stock Option Award Agreement, dated
July 22, 2003 for employees and for directors and officers.

10.2 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.

10.3 Baker Hughes Incorporated 1998 Employee Stock Option Plan, as amended
by Amendment No. 1999-1 to 1998 Employee Stock Option Plan.

10.4 Form of Nonqualified Stock Option Agreement for employees effective
October 1, 1998.

10.5 Form of Credit Agreement dated July 7, 2003, among Baker Hughes
Incorporated and a syndicate of thirteen banks for $500,000,000 in the
aggregate for all banks.

10.6 Interest Rate Swap Confirmation, dated July 30, 2003, and Schedule to
the Master Agreement (Multicurrency-Cross Border), dated July 30, 2003.

31.1 Certification of Michael E. Wiley, Chief Executive Officer, dated
August 8, 2003, pursuant to Rule 13a-14(a) of the Securities Exchange
Act of 1934, as amended.

31.2 Certification of G. Stephen Finley, Chief Financial Officer, dated
August 8, 2003, pursuant to Rule 13a-14(a) of the Securities Exchange
Act of 1934, as amended.

32 Statement of Michael E. Wiley, Chief Executive Officer, and G. Stephen
Finley, Chief Financial Officer, dated August 8, 2003, furnished
pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934, as
amended.

99.1 Press release of Baker Hughes Incorporated dated July 29, 2003
regarding certain management changes.