BAKER HUGHES INC - 10-K Annual Report

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

FORM 10-K

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

OR

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

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Commission File Number 1-9397

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

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

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

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

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

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

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

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

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DOCUMENTS INCORPORATED BY REFERENCE

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

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PART I

ITEM 1. BUSINESS

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

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

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

OILFIELD

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

PROCESS

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

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

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

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

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

WESTERN GECO

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

EXPLORATION AND PRODUCTION ACTIVITIES

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

MARKETING, COMPETITION AND ECONOMIC CONDITIONS

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

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

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

INTERNATIONAL OPERATIONS

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

RESEARCH AND DEVELOPMENT; PATENTS

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

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

BUSINESS DEVELOPMENTS

OILFIELD

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

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

PROCESS

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

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

EMPLOYEES

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

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EXECUTIVE OFFICERS

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

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

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

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

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

Douglas J. Wall 49 Vice President of the Company and President of Hughes Christensen since 1997.
Served as President and Chief Executive Officer of Western Rock Bit Company
Limited, Hughes Christensen's former distributor in Canada, from 1991 to 1997.
Previously employed as General Manager of Century Valve Company from 1989 to
1991 and Vice President, Contracts and Marketing, of Adeco Drilling &
Engineering from 1980 to 1989. Employed by the Company in 1997.

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

ENVIRONMENTAL MATTERS

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

10

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

ITEM 2. PROPERTIES

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

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

ITEM 3. LEGAL PROCEEDINGS

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

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

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

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

None.

11

PART II

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

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

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

12

ITEM 6. SELECTED FINANCIAL DATA

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

NOTES TO SELECTED FINANCIAL DATA

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

13

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

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

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

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

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

14

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

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

FORWARD-LOOKING STATEMENTS

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

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

BUSINESS ENVIRONMENT

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

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

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

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

15

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

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

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

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

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

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

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

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

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

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

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

OIL AND GAS PRICES

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

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

16

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

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

RIG COUNTS

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

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

INDUSTRY OUTLOOK

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

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

17

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

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

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

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

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

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

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

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

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

COMPANY OUTLOOK

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

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

18

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

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

CRITICAL ACCOUNTING POLICIES

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

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

REVENUE RECOGNITION

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

INVENTORY

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

IMPAIRMENT OF LONG-LIVED ASSETS

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

19

INCOME TAXES

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

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

WESTERN GECO

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

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

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

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

RESULTS OF OPERATIONS

REVENUES

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

20

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

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

GROSS MARGIN

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

SELLING, GENERAL AND ADMINISTRATIVE

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

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

UNUSUAL CHARGES

2001

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

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

2000

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

21

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

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

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

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

1999

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

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

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

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

EQUITY IN INCOME (LOSS) OF AFFILIATES

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

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

22

INTEREST EXPENSE

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

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

INTEREST INCOME

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

GAIN ON TRADING SECURITIES

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

INCOME TAXES

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

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

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

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

LIQUIDITY AND CAPITAL RESOURCES

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

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

23

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

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

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

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

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

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

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

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

24

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

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

RELATED PARTY TRANSACTIONS

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

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

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

ACCOUNTING STANDARDS

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

25

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

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

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

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

EURO CONVERSION

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

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

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

26

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

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is exposed to certain market risks that are