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. 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, economic growth, hydrocarbon demand and estimates of current and future oil and natural gas production.
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. 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. As of September 30, 2009, we had approximately 35,000 employees, with approximately 61% of these employees working outside the United States.
During the first three quarters of 2009, as the global economy continued to weaken, many of our customers reduced their 2009 exploration and development spending, and we have seen significant decreases from peak 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 $2.23 billion in the third quarter of 2009, which is down $778 million or 26% compared to the third quarter of 2008, and compared to a 39% decrease in the worldwide average rig count for the same time period. Our North American revenues for the third quarter of 2009 were $817 million, a decrease of 38% compared to a 51% decrease in the U.S. rig count and a 57% decrease in the Canadian rig count, which reflects the severe contraction in customer spending and activity. Revenues outside of North America were $1.41 billion, a decrease of 17% compared to the third quarter of 2008. As a result of the decline in activity and contractions in customer spending, we have taken actions to adjust our operating cost base, which consisted primarily of reductions in workforce. In connection with the reductions in workforce, we recorded expenses of $10 million and $75 million in the three months and nine months ended September 30, 2009, respectively, related to employee severance costs. Net income for the third quarter of 2009 was $55 million compared with $429 million in the third quarter of 2008.
PENDING MERGER WITH BJ SERVICES
On August 30, 2009, the Company and BJ Services entered into a merger agreement to which the Company will acquire 100% of the outstanding common stock of BJ Services. We have estimated the total consideration expected to be issued and paid in the merger to be approximately $6.0 billion, consisting of approximately $0.8 billion to be paid in cash and approximately $5.2 billion to be paid through the issuance of approximately 118 million shares of Baker Hughes common stock valued at the October 7, 2009, closing Baker Hughes share price of $43.67 per share. Subject to satisfaction of conditions to closing, it is anticipated that closing of the transaction will occur in the first quarter of 2010; however, we cannot guarantee when or if the merger will be completed or that, if completed, it will be exactly on the terms as set forth in the merger agreement.
BJ Services is a Delaware corporation formed in 1990. BJ Services is a leading provider of pressure pumping and oilfield services for the petroleum industry. BJ Services' pressure pumping services consist of cementing and stimulation services used in the completion of new oil and natural gas wells and in remedial work on existing wells, both onshore and offshore. BJ Services' oilfield services include casing and tubular services, precommissioning, maintenance and turnaround services in the pipeline and process

Table of Contents

business, including pipeline inspection, chemical services, completion tools and completion fluids.
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 global economic recession and lower oil and natural gas prices are all impacting our business environment. The economic slowdown is also negatively impacting the incremental demand for hydrocarbon products around the world. Our customers typically fund their activity through a combination of borrowed funds and internally-generated cash flow. The limited availability of commercial credit is having a negative effect on the general economy and the ability of our customers to continue to fund operations. The decline in oil prices and natural gas prices from 2008 mid-summer highs reduced our customers' operational cash flow, further reducing the near-term outlook for our products and services. 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         Nine Months Ended
                                           September 30,              September 30,
                                         2009          2008         2009         2008
       Oil prices ($/Bbl)              $  68.14     $ 118.23      $ 57.21     $ 113.54
       Natural gas prices ($/mmBtu)        3.17         9.06         3.80         9.71

Oil prices averaged $68.14/Bbl in the third quarter of 2009. Prices ranged from a low of $59.52/Bbl in mid-July to a quarter high of $73.82/Bbl in late August supported by expectations for an improvement in global economic activity and a decision by the Organization for Petroleum Exporting Countries ("OPEC") in early September to maintain existing output levels. In its October 2009 Oil Market Report, the International Energy Agency ("IEA") made an additional 0.2 million barrel per day increase in its 2009 oil demand forecast on growing evidence that the global economy may be stabilizing. In the October 2009 report, the IEA expected 2009 worldwide demand to reflect a 2% decline compared to 2008, and that 2009 worldwide demand would average 84.6 million barrels per day, down from an estimated 86.3 million barrels per day in 2008.
Natural gas prices averaged $3.17/mmBtu in the third quarter of 2009. Natural gas prices ranged from a high of $3.78/mmBtu in early August to a low of $1.83/mmBtu in early September, before strengthening through quarter-end as pipeline maintenance reduced available supply and natural gas powered generation capacity drove higher demand. The near-term outlook for natural gas prices remains subject to many factors including the level of industrial demand, drilling activity and production trends, high levels of natural gas in storage, and the impact of weather on natural gas demand and storage levels. 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

Table of Contents

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

                                 Three Months Ended                 %                  Nine Months Ended                 %
                                    September 30,                Increase                September 30,                Increase
                                2009             2008           (Decrease)           2009             2008           (Decrease)

U.S. - land and inland
waters                            936            1,910               (51 )%          1,036            1,806               (43 )%
U.S. - offshore                    34               69               (51 )%             47               65               (28 )%
Canada                            186              433               (57 )%            202              372               (46 )%

North America                   1,156            2,412               (52 )%          1,285            2,243               (43 )%

Latin America                     350              386                (9 )%            357              380                (6 )%
North Sea                          40               47               (15 )%             44               44                 - %
Other Europe                       38               54               (30 )%             39               52               (25 )%
Africa                             57               64               (11 )%             60               66                (9 )%
Middle East                       243              287               (15 )%            253              279                (9 )%
Asia Pacific                      241              257                (6 )%            239              254                (6 )%

Outside North America             969            1,095               (12 )%            992            1,075                (8 )%

Worldwide                       2,125            3,507               (39 )%          2,277            3,318               (31 )%

Third Quarter of 2009 Compared to the Third Quarter of 2008 The rig count in North America decreased 52% reflecting declines in natural gas drilling activity. Outside North America, the rig count decreased 12%. The rig count in Latin America declined as increases in Mexico and Brazil were offset by decreased rig activity in Argentina, Venezuela and Colombia. The North Sea rig count decreased primarily due to lower activity in the U.K. sector. The rig count in Africa decreased primarily due to lower activity in West Africa and North Africa. The rig count decreased in the Middle East due to lower activity in Egypt, Saudi Arabia, Oman and Yemen. In the Asia Pacific region, the rig count declined due to lower activity in Australia, Indonesia and Vietnam, partially offset by increases in 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 nine months ended September 30, 2009 and 2008, respectively.

                                                    Three Months Ended September 30,
                                                       2009                    2008

     Revenues                                 $  2,232          100 %   $ 3,010       100 %
     Cost of revenues                            1,761           79 %     2,028        67 %
     Research and engineering                       88            4 %       103         3 %
     Marketing, general and administrative         272           12 %       278         9 %



                                                    Nine Months Ended September 30,
                                                      2009                    2008

     Revenues                                 $  7,236         100 %   $ 8,678       100 %
     Cost of revenues                            5,518          76 %     5,794        66 %
     Research and engineering                      299           4 %       312         4 %
     Marketing, general and administrative         837          12 %       798         9 %

Table of Contents

Revenues

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

      Geographic Revenues:
      North America                   $    817      $ 1,312       $   (495 )       (38 )%
      Latin America                        265          285            (20 )        (7 )%
      Europe Africa Russia Caspian         666          874           (208 )       (24 )%
      Middle East Asia Pacific             484          539            (55 )       (10 )%

      Total revenues                  $  2,232      $ 3,010       $   (778 )       (26 )%




                                        Nine Months Ended
                                          September 30,          Increase
                                        2009         2008       (decrease)      % Change

      Geographic Revenues:
      North America                   $  2,694     $ 3,767      $   (1,073 )       (28 )%
      Latin America                        830         786              44           6 %
      Europe Africa Russia Caspian       2,185       2,542            (357 )       (14 )%
      Middle East Asia Pacific           1,527       1,583             (56 )        (4 )%

      Total revenues                  $  7,236     $ 8,678      $    1,442         (17 )%

Third Quarter of 2009 Compared to the Third Quarter of 2008 Revenues for the third quarter of 2009 decreased 26% compared with the third 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 39% during the third quarter of 2009 compared with the third quarter of 2008. Revenues in the third quarter of 2008 were adversely impacted by hurricanes in the Gulf of Mexico by approximately $55 million.
Revenues in North America, which accounted for 37% of total revenues, decreased 38% in the third quarter of 2009 compared to the third 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 third quarter of 2009. This was reflected in the North America rig count which averaged 1,156 in the third quarter of 2009, down 52% compared to the third quarter of 2008.
Revenues in the Latin America region decreased 7% in the third quarter of 2009 compared to the third quarter of 2008 and compared to a 9% decrease in the rig count. The decline in Latin America revenues was principally due to lower activity in the Venezuela and Argentina/Bolivia/Chile geomarkets, partially offset by increases in the Brazil and Mexico geomarkets. The Europe Africa Russia Caspian ("EARC") region revenues decreased 24% in the third quarter of 2009 compared to the third quarter of 2008. The revenue decline in the EARC region was broad-based with only the Angola geomarket demonstrating increased revenue. The Middle East Asia Pacific ("MEAP") region revenues decreased 10% for the third quarter of 2009 compared to the third quarter of 2008 in line with the decline in the MEAP rig count as revenue increases in the Australasia and India/Southwest Asia geomarkets were offset by lower revenues throughout the region.
First Nine Months of 2009 Compared to the First Nine Months of 2008 Revenues for the nine months ended September 30, 2009 decreased 17% compared with the nine months ended September 30, 2008, primarily due to declines in North America as a result of contractions in customer spending primarily from a weakening global economic environment that resulted in sharp reductions in activity and lower pricing for our products and services. Revenues in North America decreased 28% primarily due to a decrease in drilling activity and outside North America revenues decreased 7%. Latin America revenues increased 6% which was primarily led by directional drilling in Mexico; EARC revenues decreased 14% due to a decrease in sales in the U.K., Russia and Caspian geomarkets; and MEAP revenues decreased 4% principally due to lower activity in the Saudi Arabia/Bahrain and North Asia geomarkets.

Table of Contents

Cost of Revenues
Cost of revenues as a percentage of consolidated revenues was 79% and 67% for the three months ended September 30, 2009 and 2008, respectively. Cost of revenues as a percentage of consolidated revenues was 76% and 66% for the nine months ended September 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 $61 million for the three and nine months ended September 30, 2009, respectively; costs associated with increasing our allowance for doubtful accounts of $5 million and $71 million for the three months and nine months ended September 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 15% in the three months ended September 30, 2009 compared with the three months ended September 30, 2008 and decreased 4% in the nine months ended September 30, 2009 compared with the nine months ended September 30, 2008. The decrease is in line with the decrease in activity; however, 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 decreased 2% in the three months ended September 30, 2009 compared with the three months ended September 30, 2008 and increased 5% in the nine months ended September 30, 2009 compared with the nine months ended September 30, 2008. The decrease in the three months ended September 30, 2009 resulted primarily from lower marketing and compliance related expenses. The increase in the nine months ended September 30, 2009 resulted primarily from an increase in costs associated with enterprise-wide accounting system implementations, reorganization and acquisition activities, and employee severance partially offset by lower marketing and compliance related expenses. 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 $8 million for the three months ended September 30, 2009 compared with the three months ended September 30, 2008 and increased $45 million in the nine months ended September 30, 2009 compared with the nine months ended September 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 $9 million in the three months ended September 30, 2009 compared with the three months ended September 30, 2008 and decreased $17 million in the nine months ended September 30, 2009 compared with the nine months ended September 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 third quarter of 2009 is 34.2%, which is lower than the U.S. statutory income tax rate of 35% due to lower rates of tax on certain international operations offset by state income taxes.
Our 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.

Table of Contents

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 Accounting Standards Codification ("ASC") 740, Income Taxes.
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 global economic recession, lower oil and natural gas prices, and the uncertainty regarding governmental policies are all impacting our business environment. The economic slowdown is also negatively impacting the incremental demand for hydrocarbon products. 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.
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 IEA and the Monthly Oil Market Report published by 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"), the Organization for Economic Cooperation and Development ("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. . . .