Summary of BAKER HUGHES INC

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 our consolidated condensed financial statements and the related notes thereto, as well as our Annual Report on Form 10-K for the year ended December 31, 2008 ("2008 Annual Report").
EXECUTIVE SUMMARY
We are a major supplier of wellbore-related products and technology services and systems and provide products and services for drilling, formation evaluation, completion and production, and reservoir technology and consulting to the worldwide oil and natural gas industry. We report our results under two segments: the Drilling and Evaluation segment and the Completion and Production segment, which are aligned by product line based upon the types of products and services provided to our customers and upon the business characteristics of the product lines during business cycles. Collectively, we refer to the results of these two segments as Oilfield Operations.
Prior to May 4, 2009, the business operations were organized around four primary geographic regions: North America; Latin America; Europe, Africa, Russia, Caspian; and Middle East, Asia Pacific. As of June 30, 2009, we had approximately 36,100 employees, with approximately 60% of these employees working outside the United States.
On May 4, 2009, we reorganized the Company by geography and product lines. Global operations are now organized into a number of geomarket organizations, which report to nine Region Presidents who in turn report to two Hemisphere Presidents (Eastern and Western). The product-line marketing and technology organizations report to a Products and Technology President. The Products and Technology President and the two Hemisphere Presidents report to our Chief Operating Officer. The reorganization of the Company by geography and product lines is intended to strengthen our client-focused operations by moving management into the countries where we conduct our business. The product-line organizations will continue to be responsible for product development and manufacturing, technology, marketing and delivery of solutions for our customers to advance their reservoir performance. The new organization structure will also improve cross-product-line technology development, sales processes and integrated operations capabilities.
The primary driver of our business is our customers' capital and operating expenditures dedicated to oil and natural gas exploration, field development and production. Our business is cyclical and is dependent upon our customers' expectations for future oil and natural gas prices, future economic growth, hydrocarbon demand and estimates of future oil and natural gas production.
During the first half of 2009, as the global economy continued to weaken, many of our customers announced reductions in their planned 2009 spending, and we have seen significant decreases in drilling activity, particularly in the U.S. land market and Canada, and a decline in prices for our products and services. In this challenging environment, we generated revenues of $2.34 billion in the second quarter of 2009, which is down $662 million or 22% compared to the second quarter of 2008, and compared to a 36% decrease in the worldwide average rig count for the same time period. Our North American revenues for the second quarter of 2009 were $794 million, a decrease of 38% compared to a 50% decrease in the U.S. rig count and a 46% decrease in the Canadian rig count, which reflects the severe contraction in customer spending and activity. Revenues outside of North America were $1.54 billion, a decrease of 10% compared to the second quarter of 2008. As a result of the decline in activity and contractions in customer spending, we took actions to adjust our operating cost base, which consisted primarily of a reduction in workforce. In connection with this reduction in workforce, we recorded expenses of $10 million and $64 million in the three months and six months ended June 30, 2009, respectively, related to employee severance costs. Net income for the second quarter of 2009 was $87 million compared with $379 million in the second quarter of 2008.
BUSINESS ENVIRONMENT
Our business environment and its corresponding operating results are affected significantly by the level of energy industry spending for the exploration, development and production of oil and natural gas reserves. Spending by oil and natural gas exploration and production companies is dependent upon their forecasts regarding the expected future supply and future demand for oil and natural gas products and their estimates of costs to find, develop, and produce reserves. Changes in oil and natural gas exploration and production spending will normally result in increased or decreased demand for our products and services, which will be reflected in the rig count and other measures.
The credit crisis, lower oil and natural gas prices, and the global economic recession are all impacting our business environment. Our customers typically fund their activity through a combination of borrowed funds and internally-generated cash flow. The limited

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availability of commercial credit is having a negative effect on the general economy and the ability of our customers to continue to operate at pre-crisis levels. The decline in oil prices and natural gas prices from 2008 mid-summer highs reduced our customers' operational cash flow, further challenging their ability to continue to operate at past levels and reducing the near-term outlook for our products and services. The economic slowdown is also negatively impacting the incremental demand for hydrocarbon products around the world. Oil and Natural Gas Prices
Oil (West Texas Intermediate (WTI)/Cushing Crude Oil Spot Price) and natural gas (Henry Hub Natural Gas Spot Price) prices are summarized in the table below as averages of the daily closing prices during each of the periods indicated.

                                         Three Months Ended          Six Months Ended
                                              June 30,                   June 30,
                                         2009         2008          2009         2008

       Oil prices ($/Bbl)             $  59.69     $  123.80     $  51.57     $  111.14
       Natural gas prices ($/mmBtu)       3.71         11.36         4.12         10.03

Oil prices averaged $59.69/Bbl in the second quarter of 2009. Prices ranged from a low of $45.88/Bbl in mid-April to a quarter high of $72.68/Bbl in mid-June supported by expectations for an improvement in global economic activity and a late-May decision by OPEC to maintain existing output levels. Prices peaked in mid-June and declined into July as a result of persistently high inventories, weak near-term demand and lowered expectations for a global economic recovery. The International Energy Agency ("IEA") estimated in its July 2009 Oil Market Report that worldwide demand would decrease 2.9% to 83.8 million barrels per day in 2009, down from an estimated 86.2 million barrels per day in 2008.
Natural gas prices averaged $3.71/mmBtu in the second quarter of 2009. Natural gas prices ranged from a high of $4.42/mmBtu to a low of $3.19/mmBtu in the quarter. During the quarter, the discount relative to oil prices increased on a Btu equivalent basis. This was due to a number of factors including weak natural gas demand, continued increases in natural gas production despite reductions in drilling activity, high storage levels, moderate temperatures and increased receipts of LNG.
Rig Counts
Baker Hughes has been providing rig counts to the public since 1944. We gather all relevant data through our field service personnel, who obtain the necessary data from routine visits to the various rigs, customers, contractors and/or other outside sources. This data is then compiled and distributed to various wire services and trade associations and is published on our website. Rig counts are compiled weekly for the U.S. and Canada and monthly for all international and U.S. workover rigs. Published international rig counts do not include rigs drilling in certain locations, such as Russia, the Caspian and onshore China, because this information is not readily available.
Rigs in the U.S. are counted as active if, on the day the count is taken, the well being drilled has been started but drilling has not been completed and the well is anticipated to be of sufficient depth to be a potential consumer of our drill bits. Rigs in Canada are counted as active if data obtained by the Canadian Association of Oilwell Drillers and Contractors indicates that drilling operations have occurred during the week and we are able to verify this information. In most international areas, rigs are counted as active if drilling operations have taken place for at least 15 days during the month. In some active international areas where better data is available, we compute a weekly or daily average of active rigs. In international areas where there is poor availability of data, the rig counts are estimated from third-party data. The rig count does not include rigs that are in transit from one location to another, rigging up, being used in non-drilling activities, including production testing, completion and workover, and is not expected to be significant consumers of drill bits.

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Our rig counts are summarized in the table below as averages for each of the periods indicated.

                                 Three Months Ended                 %                  Six Months Ended                 %
                                      June 30,                   Increase                  June 30,                  Increase
                                2009             2008           (Decrease)          2009             2008           (Decrease)

U.S. - land and inland
waters                            885            1,797               (51 %)         1,086            1,755               (38 %)
U.S. - offshore                    50               67               (25 %)            53               62               (15 %)
Canada                             89              166               (46 %)           211              341               (38 %)

North America                   1,024            2,030               (50 %)         1,350            2,158               (37 %)

Latin America                     350              382                (8 %)           360              377                (5 %)
North Sea                          42               46                (9 %)            46               43                 7 %
Other Europe                       40               51               (22 %)            40               51               (22 %)
Africa                             63               68                (7 %)            61               67                (9 %)
Middle East                       251              278               (10 %)           259              275                (6 %)
Asia Pacific                      237              259                (8 %)           238              252                (6 %)

Outside North America             983            1,084                (9 %)         1,004            1,065                (6 %)

Worldwide                       2,007            3,114               (36 %)         2,354            3,223               (27 %)

Second Quarter of 2009 Compared to the Second Quarter of 2008 The rig count in North America decreased 50% reflecting declines in natural gas drilling activity. Outside North America, the rig count decreased 9%. The rig count in Latin America decreased due to lower activity in Argentina, Venezuela and Colombia, partially offset by increases in Brazil and Mexico. The North Sea rig count decreased primarily due to decreases in the Norwegian and U.K. sectors. The rig count in Africa decreased primarily due to lower activity in West Africa. The rig count decreased in the Middle East due to lower activity in Egypt, Saudi Arabia, Yemen and Qatar and in the Asia Pacific region due to lower activity in Australia and India.
RESULTS OF OPERATIONS
The discussions below relating to significant line items from our consolidated condensed statements of operations are based on available information and represent our analysis of significant changes or events that impact the comparability of reported amounts. Where appropriate, we have identified specific events and changes that affect comparability or trends and, where possible and practical, have quantified the impact of such items. In addition, the discussions below for revenues and cost of revenues are on a combined basis as the business drivers for the individual components of product sales and services and rentals are similar.
The table below details certain consolidated condensed statement of operations data and their percentage of revenues for the three months and six months ended June 30, 2009 and 2008, respectively.

                                                      Three Months Ended June 30,
                                                      2009                   2008

      Revenues                                $  2,336       100 %   $  2,998       100 %
      Cost of revenues                           1,797        77 %      1,997        67 %
      Research and engineering                     102         4 %        106         4 %
      Marketing, general and administrative        284        12 %        270         9 %



                                                       Six Months Ended June 30,
                                                      2009                   2008

      Revenues                                $  5,004       100 %   $  5,668       100 %
      Cost of revenues                           3,757        75 %      3,766        66 %
      Research and engineering                     211         4 %        209         4 %
      Marketing, general and administrative        565        11 %        520         9 %

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Revenues

                                   Three Months Ended June 30,         Increase
                                     2009               2008          (decrease)      % Change

Geographic Revenues:
North America                   $        794        $      1,278       $    (484 )       (38 )%
Latin America                            276                 266              10           4 %
Europe Africa Russia Caspian             743                 906            (163 )       (18 )%
Middle East Asia Pacific                 523                 548             (25 )        (5 )%

Total revenues                  $      2,336        $      2,998       $     662         (22 )%


                                    Six Months Ended June 30,          Increase
                                     2009               2008          (decrease)      % Change

Geographic Revenues:
North America                   $      1,876        $      2,455       $    (579 )       (24 )%
Latin America                            565                 501              64          13 %
Europe Africa Russia Caspian           1,519               1,668            (149 )        (9 )%
Middle East Asia Pacific               1,044               1,044               -           - %

Total revenues                  $      5,004        $      5,668       $    (664 )       (12 )%

Second Quarter of 2009 Compared to the Second Quarter of 2008 Revenues for the second quarter of 2009 decreased compared with the second quarter of 2008, primarily due to declines in North America as a result of contractions in customer spending resulting in sharp reductions in activity, lower pricing for our products and services and the weak global economic environment. The worldwide rig count decreased 36% during the second quarter of 2009 compared with the second quarter of 2008.
Revenues in North America, which accounted for 34% of total revenues, decreased 38% in the second quarter of 2009 compared to the second quarter of 2008. In North America, our customers continued to adapt to a market characterized by low natural gas prices, strong production, decreased demand and ample natural gas in storage by trimming their spending in the second quarter of 2009. This was reflected in the North America rig count which averaged 1,024 in the second quarter of 2009, down 50% compared to the second quarter of 2008.
The Latin America region revenues increased 4% in the second quarter of 2009 compared to the second quarter of 2008 and compared to an 8% decrease in the rig count. The growth in Latin America revenue was led by our Mexico / Central America geomarket, where operations on the Alma Marine Integrated Operations project for Petroleos Mexicanos ("PEMEX") increased from two to four offshore rigs. The Andean (Colombia/Ecuador/Peru) geomarket led by increased revenues for directional drilling and completions and the Brazil geomarket also contributed to year-over-year growth.
The Europe Africa Russia Caspian ("EARC") region revenues decreased 18% in the second quarter of 2009 compared to the second quarter of 2008. The revenue decline in the EARC region was led by the overall decline in spending in the Russia and Caspian geomarkets, where customer activity decreased by approximately 30%. Also contributing to the year-over-year decline were project delays and completions of existing projects in the Norway, Sub Sahara Africa, Nigeria and North Africa geomarkets.
The Middle East Asia Pacific ("MEAP") region revenues decreased 5% for the second quarter of 2009 compared to the second quarter of 2008 as revenue increases in the Southeast Asia and Gulf geomarkets were offset by lower revenues throughout the region.
First Six Months of 2009 Compared to the First Six Months of 2008 Revenues for the six months ended June 30, 2009 decreased 12% compared with the six months ended June 30, 2008, primarily due to declines in North America as a result of contractions in customer spending resulting in sharp reductions in activity, lower pricing for our products and services and the weakening global economic environment. Revenues in North America decreased 24% primarily due to a decrease in drilling activity and outside North America revenues decreased 3%. Latin America revenues increased 13% which was primarily led by directional drilling in Mexico; EARC revenues decreased 9% due to a decrease in sales in the U.K., Russia and Caspian; and MEAP revenues were flat compared to the six months ended June 30, 2008.

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Cost of Revenues
Cost of revenues for the three months ended June 30, 2009 decreased 10% compared with the three months ended June 30, 2008. Cost of revenues as a percentage of consolidated revenues was 77% and 67% for the three months ended June 30, 2009 and 2008, respectively. Cost of revenues for the six months ended June 30, 2009 was flat compared with the six months ended June 30, 2008. Cost of revenues as a percentage of consolidated revenues was 75% and 66% for the six months ended June 30, 2009 and 2008, respectively. The increase in both periods in cost of revenues as a percentage of revenues is primarily due to significant declines in activity worldwide resulting in excess manufacturing capacity, lower utilization of our rental tools and price deterioration, primarily in North America. Additional contributing factors to this increase include costs associated with employee severance of $8 million and $53 million for the three and six months ended June 30, 2009, respectively; costs associated with increasing our allowance for doubtful accounts of $38 million and $67 million for the three months and six months ended June 30, 2009, respectively; and a change in the geographic and product mix from the sale of our products and services as we continue to emphasize productivity and cost improvements. Research and Engineering
Research and engineering expenses decreased 4% in the three months ended June 30, 2009 compared with the three months ended June 30, 2008 and increased 1% in the six months ended June 30, 2009 compared with the six months ended June 30, 2008. We continue to be committed to developing and commercializing new technologies as well as investing in our core product offerings. Marketing, General and Administrative
Marketing, general and administrative expenses increased 5% in the three months ended June 30, 2009 compared with the three months ended June 30, 2008 and increased 9% in the six months ended June 30, 2009 compared with the six months ended June 30, 2008. The increase in both periods resulted primarily from costs associated with enterprise-wide accounting system implementations, reorganization, employee severance and foreign exchange losses. Litigation Settlement
In connection with the settlement of litigation with ReedHycalog, in June 2008, the Company paid ReedHycalog $70 million in royalties for prior use of certain patented technologies, and ReedHycalog paid the Company $8 million in royalties for the license of certain Company patented technologies. The net charge of $62 million for the settlement of this litigation is reflected in the consolidated condensed statement of operations. Interest Expense
Interest expense increased $17 million for the three months ended June 30, 2009 compared with the three months ended June 30, 2008 and increased $37 million in the six months ended June 30, 2009 compared with the six months ended June 30, 2008. The increase in both periods is primarily due to higher average debt levels as a result of the long-term debt issuances of $1.25 billion in October 2008.
Interest and Dividend Income
Interest and dividend income decreased $1 million in the three months ended June 30, 2009 compared with the three months ended June 30, 2008 and decreased $8 million in the six months ended June 30, 2009 compared with the six months ended June 30, 2008. The decrease in both periods was primarily due to a reduction of the average interest rate earned partially offset by an increase in the average investment balance.
Income Taxes
Our effective tax rate in the second quarter of 2009 is 28.2%, which is lower than the U.S. statutory income tax rate of 35% due to lower rates of tax on certain international operations, a decrease in tax reserves as a result of favorable audit settlements, offset by state income taxes and a net increase in the valuation allowance associated with certain foreign deferred tax assets.
Our tax filings for various periods are subject to audit by the tax authorities in most jurisdictions where we conduct business. These audits may result in assessment of additional taxes that are resolved with the authorities or through the courts. We believe these assessments may occasionally be based on erroneous and even arbitrary interpretations of local tax law. We have received tax assessments from various taxing authorities and are currently at varying stages of appeals and/or litigation regarding these matters.

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We believe we have substantial defenses to the questions being raised and will pursue all legal remedies should an unfavorable outcome result. However, resolution of these matters involves uncertainties and there are no assurances that the outcomes will be favorable. We provide for uncertain tax positions pursuant to Financial Interpretation ("FIN") 48, Accounting for Uncertainty in Income Taxes: an Interpretation of FASB Statement No. 109.
OUTLOOK
Worldwide Oil and Natural Gas Industry Outlook This section should be read in conjunction with the factors described in "Part II, Item 1A. Risk Factors" and in the "Forward-Looking Statements" section in this Part I, Item 2, both contained herein. These factors could impact, either positively or negatively, our expectation for: oil and natural gas demand; oil and natural gas prices; exploration and development spending and drilling activity; and production spending.
The credit crisis, lower oil and natural gas prices, the global economic recession and the uncertainty regarding governmental policies are all impacting our business environment. Our customers typically fund their activity through a combination of borrowed funds and internally-generated cash flow. The continued limited availability of commercial credit is having a negative effect on both the general economy and the ability of our customers to continue to operate at pre-crisis levels. The decline in oil prices and natural gas prices from 2008 mid-summer highs has also reduced our customers' operational cash flow, further challenging their ability to continue to operate at past levels as well as their future spending for our products and services. The economic slowdown is also negatively impacting the incremental demand for hydrocarbon products.
Our outlook for exploration and development spending is based upon our expectations for customer spending in the markets in which we operate, and is driven primarily by our perception of industry expectations for oil and natural gas prices and their likely impact on customer capital and operating budgets as well as other factors that could impact the economic return oil and gas companies expect for developing oil and gas reserves. Our forecasts are based on our analysis of information provided by our customers as well as market research and analyst reports including the Short Term Energy Outlook ("STEO") published by the Energy Information Administration of the U.S. Department of Energy ("DOE"), the Oil Market Report published by the International Energy Agency ("IEA") and the Monthly Oil Market Report published by the Organization for Petroleum Exporting Countries ("OPEC"). Our outlook for economic growth is based on our analysis of information published by a number of sources including the International Monetary Fund ("IMF"), OECD and the World Bank.
As an oil service company, our revenue is dependent on spending by our customers for oil and natural gas exploration, field development and production. This spending is dependent on a number of factors, including their forecasts of future energy demand, their expectations for future energy prices, their access to resources to develop and produce oil and gas and their ability to fund their capital programs.
Our industry is cyclical, and past cycles have been driven primarily by alternating periods of ample supply or shortage of oil and natural gas relative to demand. The current down cycle is different in that the primary driver is the rapid deterioration of the global economy, which has led to declining demand and forecasts for further reductions in future demand. The drop in commodity prices, in conjunction with reduced access to the debt markets, has forced many oil and gas companies to reduce their spending to levels supportable by their expected free cash flow.
In North America, the outlook for spending in 2009 is also dependent on the outlook for the natural gas industry. The drop in demand coupled with increased drilling activity through September 2008 and the application of horizontal drilling and advanced fracturing and completion technologies in the unconventional gas fields has resulted in gas production exceeding demand. Natural gas prices have fallen from mid-2008 highs and are not expected to increase until drilling is reduced to a level below the rate necessary to offset depletion, and supply and demand come back into balance. The commodity cycle in North American natural gas is being aggravated by the recession, mid-summer storage levels that are approximately 25% greater than last year, low natural . . .